Securities Regulation and Corporate Governance


SEC Chairman Jay Clayton Delivers First Public Remarks Since Confirmation

In his first public speech since being confirmed as Chairman of the U.S. Securities and Exchange Commission (“SEC” or “the Commission”), Jay Clayton addressed the Economic Club of New York on July 12, 2017.  In his remarks, available here, Chairman Clayton discussed his vision of the principles that should guide the Commission and opportunities to apply those principles in practice.

Guiding Principles

Chairman Clayton laid out eight principles to guide his tenure as SEC Chairman, including:

(1)   Analysis of Long-Term and Cumulative Effects of Small Regulatory Changes.  Incremental regulatory changes can have long lasting, dramatic impacts on markets and should be analyzed cumulatively, in addition to incrementally.  The increased attractiveness of private sources of funding and markets for certain companies may be linked to these requirements.

(2)   Evolution of the SEC Alongside Changing Markets.  The Commission must evolve with the market, including utilizing technology to find new ways of analyzing regulatory filings and detecting suspicious activity.  However, such advances should be balanced against the costs companies incur to comply with new regulatory changes.

(3)   Retrospective Review of Adopted Rules.  The SEC should regularly review its rules retrospectively to determine where rules are, or are not, functioning as intended.

(4)   Consideration of Costs of Compliance.  The Commission must write rules in a clear manner, with a vision in mind for how those rules will be implemented, recognizing implementation costs that are likely to arise. 

Principles in Practice

Chairman Clayton additionally explained how he expects to put these principles into practice, including:

(a)   Enforcement and Examinations; Cyber Risks.  In addition to emphasizing that the SEC “intend[s] to continue deploying significant resources to root out fraud and shady practices in the markets,” Chairman Clayton also noted that public companies have an obligation to disclose material information ...Read More

SEC Significantly Expands Confidential Review of Registration Statements

Will Allow Confidential Submission of All Registration Statements for IPOs, Spin-Offs and Most Offerings Within 12 Months of an IPO or Spin-Off

The Securities and Exchange Commission (“SEC”) announced[1] on Thursday that its the Staff of the Division of Corporation Finance (the “Staff”) will soon allow all companies to submit initial public offering (“IPO”) draft registration statements for confidential review. This change expands a benefit previously reserved for Emerging Growth Companies (“EGCs”), and is specifically aimed at encouraging more companies to enter the public market.  The SEC also announced that it will review draft registration statements submitted by non EGCs that omit financial statements that the issuer reasonably believes will not be required when the registration statement is filed publicly, and indicated a willingness to discuss expedited reviews with issuers and their advisors. 

Confidential Review. 

Under the new process, which will go into effect on July 10, 2017, all companies, regardless of their prior year revenue, will be allowed to submit a draft IPO registration statement and related revisions to the SEC for confidential Staff review.

This process is also being made available to initial registrations of a class of securities under Section 12(b) of the Securities Exchange Act of 1934. This will allow companies conducting spin-off transactions to submit draft registration statements for confidential review. 

The Staff will also confidentially review draft registration statements for most other offerings made during the first twelve months following a company’s IPO. The confidential review is limited to the initial submission, however, and responses to Staff comments must be made with a public filing and not a revised draft registration statement. Any further review by the Staff will be done following normal procedures, which require public filings of amendments to a registration statement.

Since the Jumpstart Our Business Startups Act (“JOBS Act”)[2] was signed into law in 2012, only EGCs, companies with less than $1.07 billion in gross revenues in their most recently completed fiscal year, have been permitted to submit registration statements for confidential review. Since the JOBS Act was enacted, approximately 88 percent of the EGCs that have filed IPO registration statements have taken advant...Read More

SEC Economist Comments on New Technologies Used by the Commission to Identify Risk, Detect Fraud and Enforce the Securities Laws

Last week Scott Bauguess, Acting Director and Acting Chief Economist of the Securities and Exchange Commission’s (SEC) Division of Economic Risk and Analysis, shared insights about how the SEC is leveraging artificial intelligence and machine learning to track, and perhaps predict, emerging risks in the marketplace.[1]  In the latest in a series of speeches,[2] Bauguess also described how the SEC is using big data, harnessed with the appropriate processing power and partnered with human intuition, to focus investigative and enforcement resources.  While Bauguess and others at the SEC see a bright future for data analytics at the SEC, particularly in identifying emerging trends, Bauguess stressed the human element is ever important in assessing risk, combatting fraud and bringing or recommending enforcement actions.

The SEC’s initial foray into machine learning was sparked by the financial crisis.  Using hindsight, coupled with simple word counts and regular expressions, the SEC searched issuer filings to test whether increased use of “credit default swap” in filing documents could have alerted SEC staff to the growing market risk.  While the frequency analysis was not particularly impressive, the study highlighted the power of applying text analytics and natural language processing to SEC filings, and the SEC has built on this simple text modelling approach.

The SEC has since moved to more sophisticated topic modelling approaches, like latent dirichlet allocation (LDA), to identify emerging trends in disclosure documents and identify potential risks.  Rather than analyzing documents based on user-supplied terms like “credit default swaps”, LDA synthesizes large sets of documents and compares the text to language probability distributions in order to organically determine which new topics or terms to track.  Thus, LDA not only reports on the frequency and use of new terms in filing documents, but it also determines which new terms warrant future monitoring. 

LDA can function without specialized expertise or programming, making it applicable across departments within the SEC (and of course, the private sector).  Generally referred to as unsupervised machine learning, this form of analytics al...Read More

Changes Coming to Governance Provisions of New York Nonprofit Law
Amendments to New York’s Not-For-Profit Corporation Law are set to take effect on May 27.  The amendments impact several provisions of The New York Nonprofit Revitalization Act (“NRA”), which imposed substantial governance requirements on nonprofits when it took effect in 2014.  The amendments build greater flexibility into aspects of the NRA that were viewed as overly broad or prescriptive.  Key elements of the amendments are summarized below.  A redline showing the changes to the statutory language is available here.

Nonprofits incorporated in New York, and other nonprofits that may be subject to the Not-For-Profit Corporation Law due to their activities, should take note of the amendments and consider whether changes to their governance practices and documents are appropriate.

1.      Related party transactions.  The NRA provides for enhanced board oversight of related party transactions.  The amendments explicitly permit an authorized committee of the board to review and approve related party transactions, as an alternative to full board approval.  They also codify exceptions to the definition of “related party transaction” that are based on guidance previously issued by the Charities Bureau of the New York Attorney General’s office (available here).  These exceptions mean that immaterial or ordinary course transactions are no longer subject to the board/committee approval procedures under the NRA.  Specifically, the exceptions cover: (a) transactions that are themselves “de minimis” or where the related party’s financial interest is de minimis, with the judgment of what is de minimis to be left to individual nonprofits based on factors such as size and budget; (b) transactions that “would not customarily be reviewed” by the board at “similar organizations in the ordinary course of business” and that are available to others on the same or similar terms; and (c) transactions where a related party receives a benefit as a result of being a member of a class that benefits from the nonprofit’s work, where the benefit is available to all similarly situated members of the class on the same terms.  The amendments also create a defense to actions brought by the New York Attorney General challenging related party transactions.  The defense allows nonprofits to take steps to ratify transactions that were not approved in accordance with the procedures ...Read More
Top Five Reminders for Reporting Annual Meeting Results
With annual meeting season in high swing, over the coming weeks, many public companies will be preparing Form 8-Ks to report their voting results. Specifically, Item 5.07 of the Form 8-K requires a public company to report the voting results for all matters submitted to a vote of security holders. Here are our top five reminders when preparing this year’s voting results 8-Ks:

Number 1 -- If your public company is holding a “say on frequency” vote on executive compensation, remember to disclose the company’s decision as to how often the company plans to conduct future “say on pay” votes. This decision may be included in the same Form 8-K reporting the voting results -- or it can be included in an amendment to the Form 8-K reporting the voting results (but not in a new Form 8-K; see
Question 121A.04 of the SEC’s C&DIs) that is filed no later than 150 calendar days after the end of the annual meeting (but no later than 60 calendar days prior to the deadline for submission of shareholder proposals for the 2018 annual meeting under Rule 14a-8). As noted in Question 121A.04, the company’s decision alternatively may be disclosed in a Form 10-Q (under Part II, Item 5 (“Other Information”)) filed in time to meet the deadline for the disclosure. Failure to provide this disclosure on a timely basis can result in the loss of Form S-3 eligibility, so it is important to report the company’s decision within the filing deadline. The SEC rules are designed to allow boards sufficient time following the annual meeting to evaluate and determine the company’s frequency (including, if needed, to engage with stockholders). However, in practice, some companies may determine that it is not necessary for their board of directors to undertake an extended discussion or take formal action to approve the future frequency decision if the shareholder vote heavily supported the frequency recommended by the board. As a result, many companies may include their frequency disclosure in the Form 8-K reporting the voting results, rather than in a later filing.

Number 2 -- Remember to update your cover page of the Form 8-K to include the information regarding emerging growth company status. The SEC recently adopted technical changes to its forms to provide a way for emerging growth companies to reflect information about their status on the cover page of their SEC filings, as discussed in our prior
blog. Even if your company is not an emerging growth company, the c...Read More
SEC Revises Cover Page of Exchange Act and Other Forms and Revises Other Rules Under JOBS Act

Today, new rules became effective that change the cover page of many forms filed with the Securities and Exchange Commission (the “SEC”).  The SEC has adopted technical amendments to conform certain rules and forms to self-executing provisions of the Jumpstart Our Business Startups Act (the “JOBS Act”).  The SEC’s adopting release is available here.  Although the rule changes were driven by the need to accommodate Emerging Growth Companies (“EGCs”) in the SEC’s reporting regime, the amendments affect the Securities Act registration forms and Exchange Act reporting forms used by all companies, even those that are not EGCs.  The technical amendments apply to Forms S-1, S-3, S-4, S-8, S-11, F-1, F-3, F-4, 10, 8-K, 10-Q, 10-K, 20-F, 40-F and C.

The SEC’s technical amendments are intended to provide a uniform method for an EGC to notify the SEC and the public that it is an EGC and whether it has opted out of the extended transition period for complying with new accounting standards.  The amendments modify the cover pages of each of the forms to include two additional checkboxes.  The first checkbox allows the company to indicate whether it is an EGC.  The second checkbox allows the company to make an irrevocable election not to use the extended transition period for complying with new or revised accounting standards.

The amendments are made necessary by the JOBS Act, which, in relevant part, exempts EGCs from a number of disclosure and regulatory requirements.  An EGC is permitted to provide two years, rather than three years, of audited financial statements in its registration statement for an initial public offering of common equity securities (“IPO Registration Statement”).  In subsequent registration statements or periodic reports, an EGC need not present selected financial data under Item 301 or management discussion and analysis under Item 303 of Regulation S-K for any period prior to the earliest audited period presented in the IPO Registration Statement.  An EGC is exempt from the required advisory shareholder votes on compensation of named executive officers (“say-on-pay”), the frequency of say-on-pay votes, and golden parachutes, and is not required to provide an auditor attestation on management’s assessment of its internal control over financial reporting.  An EGC may comply with the requirements of Item 402 of Regulation S-K by providing only the information required of a smaller reporting company.  Furthermore, an EGC may defer compliance with any new or revised accounting standards until such standards are applicable to companies that are not subject to SEC reporting. 

The Division o...Read More

SEC’s Division of Corporation Finance Suspends Enforcement of Certain Conflicts Minerals Requirements

It has been an eventful week for those following the conflict minerals rules in the news.  The United States District Court for the District of Columbia issued final judgment in the long-running conflicts minerals litigation (detailed here) and, following a statement by Acting Chairman Piwowar, the Division of Corporation Finance has issued a blanket statement that it will not recommend enforcement of some of the most burdensome requirements of the rules (available here).

Final Court Decision

On April 3, 2017, the D.C. District Court entered final judgment in National Association of Manufacturer’s et al. v. SEC et al.  Consistent with prior rulings, the District Court held that Section 1502 of the Dodd-Frank Act, which mandated the adoption of the conflict mineral rules, and Exchange Act Rule 13p-1 and Form SD adopted thereunder, violate the First Amendment to the extent that they compel companies to disclose on their websites that any of their products “have not been found to be ‘DRC-conflict free.’”  The decision, however, left the other requirements of the conflicts minerals rules in place.  The District Court remanded to the Commission to take action in accordance with its decision.

Statements by the Acting Chairman and Corporation Finance No-Action Position

On April 7, 2017, in response to the District Court’s final judgment, the Commission’s Acting Chairman, Michael Piwowar, issued a public statement on the issue (available here).  Piwowar noted that the Court of Appeals left it to the Commission to determine how to address the Court’s decision – specifically, whether Congress’s intent in the portion of Section 13(p)(1) that the Court deemed unconstitutional can be achieved through a means that does not infringe on companies’ First Amendment rights, and how the Court’s determination affects the conflicts minerals rules overall.

Piwowar noted that he has instructed the Commission’s Staff to begin working on a recommendation for future Commission action.  In the meantime, Piwowar explained that the requirements listed in Item 1.01(c) of Form SD (including requir...Read More

SEC Adopts Amendment Shortening Trade Settlement Cycle From T+3 to T+2 (potential implications)

The SEC has adopted an amendment to Rule 15c6-1(a) of the Exchange Act (the Settlement Cycle Rule) shortening the standard settlement cycle for most broker-dealer transactions from three business days after the trade date (“T+3”) to two business days after the trade date (“T+2”).  The compliance date for the amendment is September 5, 2017.  The new requirement will prohibit broker-dealers from effecting or entering into a contract for the purchase or sale of a security (other than exempted securities, government securities, municipal securities, commercial paper, bankers’ acceptances, and commercial bills) that provides for payment of funds and delivery of securities later than the second business day after the date of the contract, unless otherwise expressly agreed to by the parties at the time of the transaction.

Since 1993, T+3 has been the standard settlement cycle for broker-dealer transactions.  Advancements in technology, the desire to reduce market and credit risk from unsettled trades and the transition of certain international markets to a two day settlement cycle led the SEC to make the move from T+3 to T+2.  The parties to a trade will retain the ability to utilize a longer settlement cycle by expressly agreeing to do so at the time of the trade.  

While the new T+2 settlement cycle is likely achievable for routine capital markets transactions like the issuance of common stock or investment grade debt by repeat issuers, more complex offerings may be difficult to close on this timetable.  As has been the case under the T+3 cycle, issuers will be able to opt into a longer, alternative settlement cycle by clearly disclosing that they intend to settle on a longer cycle.  In such instances, initial purchasers who wish to trade such securities prior to two business days before the closing of the initial trade will be required to specify an alternative settlement cycle at the time of any such secondary trade to prevent a failed settlement.

One area where this change may have an unexpected impact is the settlement time for payment in tender offers.  Rule 14e-1(c) of the Exchange Act requires a bidder to promptly pay the consideration offered upon termination (i.e., expiration)  of the tender offer.  While “promptly” is undefined in the rule, the SEC has stated that “this standard may be determined by the practices of the financial community, including current settlement practices.”  In most cases, the payment of funds and delivery of securities occurs by the third business day after the transaction date.  In light of the new T+2 settlement cycle, it is quite possible the SEC Staff will begin to take the position that the “prompt payment” obligation requires a bidder to pay the co...Read More

Non-Voting Shares Make Their Public Debut and Generate Some Governance Concerns, but How Will Courts View the Structure When First Presented?

On March 1, 2017, Snap Inc. (“Snap” or the “Company”) – owner of the popular social media platform Snapchat – priced its highly anticipated initial public offering (“IPO”). With 200 million shares sold at $17 per share, the IPO raised approximately $3.4 billion for the Company. On their first trading day, Snap shares opened at $22.41 per share and peaked as high as $28.84 the following day. As of March 10, shares closed at $22.07, above its initial offering price, but below its opening trading price. As the largest IPO of any U.S.-based company since Facebook’s public offering in 2012, many investors’ primary focus here has been on the complete lack of voting privileges associated with the shares sold in the IPO. 

As described in Snap’s IPO prospectus, the Company has three classes of shares: Class A common stock, the publicly traded shares; Class B common stock, reserved for early investors and executives; and Class C common stock, owned solely by the company’s co-founders Evan Spiegel and Bobby Murphy. Class A shares are not entitled to vote, while Class B and Class C shares are each entitled to one and ten votes, respectively, and vote together as a single class. Given this structure, even before shares were sold in the IPO, 88.5 percent of the voting power of the Company remained concentrated in its two founders. Furthermore, Class B shares lose voting privileges when sold or transferred, and Spiegel’s and Murphy’s control of the Company through their Class C shares will not diminish even if either or both leave Snap.

Attempting to preserve control through non-traditional voting structures is not a new concept for companies, especially technology companies. Many technology companies have dual class structures, in which founders and other early-round investors hold higher vote shares (typically ten votes per share) and others hold low vote shares (typically one vote per share).  In the last several years, a number of companies including Alphabet, Google’s parent company, Facebook, Zillow and Under Armour have introduced non-voting shares into their capital structures in order to delay the loss of voting control of their founder(s). Snap, however, is the first to issue only non-voting shares to the public in an IPO.

There has been a fair amount of criticism of Snap’s move to publicly offer shares that do not include voting rights. Kurt Schacht, the Chair o...Read More

SEC Adopts Requirements for Active Hyperlinks In Exhibit Indexes

The SEC has adopted final rules requiring an active hyperlink to each filed exhibit identified in the exhibit index of most Securities Act and Exchange Act registration statements and reports that are required to include exhibits under Item 601 of Regulation S-K.  The rules become effective on September 1, 2017 (though the adopting release encourages early compliance), provided that smaller reporting companies and non-accelerated filers that submit filings in ASCII format need not comply with the rules until September 1, 2018.  The new requirements will apply to Forms S-1, S-3, S-4, S-8, S-11, F-1, F-3, F-4, SF-1, SF-3, 10, 10-K, 10-Q, 8-K, F-10, 20-F and 10-D (though the compliance date for Form 10-D will be announced at a later date).  The requirement will not apply to other forms under the multi-jurisdictional disclosure system used by certain Canadian issuers or to Form 6-K, as exhibits and exhibit indexes are not required by those forms. 

Hyperlinks are required for each exhibit other than exhibits filed with Form ABS-EE, XBRL exhibits, and exhibits filed in paper pursuant to a temporary or continuing hardship exemption.  Registration statements will require hyperlinks in the exhibit index of the initial filing and each subsequent pre-effective amendment. 

Historically, the EDGAR system has supported filings in either HTML format or ASCII format, but registrants will now have to file registration statements and reports subject to the hyperlinking requirements in HTML format, because the ASCII format does not support hyperlinking.  The adopting release noted that in 2015, less than one percent of the forms affected by the rule were submitted in the ASCII format.  The SEC provided the one-year phase-in period for smaller reporting companies and non-accelerated filers that file in ASCII format to mitigate some of the cost burdens for those companies related to switching to the HTML format.

In the event that a hyperlink is malfunctioning or incorrect, the hyperlink must be corrected (i) by pre-effective amendment, in the case of a registration statement that is not yet effective, or (ii) in the next Exchange Act report that contains an exhibit index, in the case of an effective registration statement or Exchange Act report. An inaccurate hyperlink in an effective registration statement may also be corrected in a post-effective amendment.   The adopting release provides that an inaccurate hyperlink alone will not render a filing materially deficient, nor affect a registrant’s eligibility to use short-form registration statements. 

The SEC will be issuing an updated EDGAR Filer Manual that will describe the procedures necessary to create hy...Read More

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