Securities Regulation and Corporate Governance

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NASDAQ Proposes Disclosure of Third-Party Compensation for Directors and Nominees
NASDAQ has proposed changes to its listing standards to require disclosure of third-party compensation arrangements for directors and nominees.  After withdrawing an initial proposal on this subject, NASDAQ has revised the proposal, and it has been published in the Federal Register for public comment.  Comments are due on or before April 26, 2016.  The proposal is available here, and a redline showing proposed changes to the rule text begins on page 21 of the document.  

Under amendments NASDAQ is proposing to Rule 5250(b), NASDAQ companies would have to disclose all agreements and arrangements between any director, or director nominee, and any third party that provide for compensation or other payments in connection with the individual’s candidacy or service as a director.  The proposed rule would be construed broadly to apply to both compensation and other forms of payment, such as health insurance.  The disclosure requirement would not apply to reimbursement of expenses incurred in connection with serving as a nominee.  The proposal also addresses the following aspects of the proposed disclosure requirement:
  • Timing of disclosure.  The proposed rule would require disclosure of third-party compensation “either” on a company’s website or in the proxy statement for the next annual meeting.  Accordingly, where companies appoint directors during the year, it does not appear that waiting until the next proxy statement to disclose the compensation would comply with the rule.  Instead, companies could comply by including the material terms of a third-party compensation arrangement in the Form 8-K disclosure announcing the appointment.  Form 8-K requires disclosure of “any arrangement or understanding between [a] new director and any other persons, naming such persons, pursuant to which such director was selected as a director.”  If a company opts to make the initial disclosure on its website, the proposed rule is silent on the time frame for doing so.  After the initial disclosure, a third-party compensation arrangement “is subject to the continuous disclosure requirements of the proposed rule on an annual basis.”  The disclosure requirement ceases to apply upon the earlier of the director’s departure from the board or one year after termination of the ...Read More
When the Tail Wags the Unicorn: SEC Chair Voices Concerns About Pre-IPO Investments

On March 31, SEC Chair Mary Jo White gave a keynote address at Stanford University in which she discussed some of the SEC’s emerging priorities with respect to pre-IPO stage companies, private capital markets and fintech.  According to Chair White, the SEC is paying particular attention to the risks of fraud and investor confusion that can arise when companies choose to stay private longer. 

The federal securities laws historically have subjected private securities markets to reduced levels of regulation, so long as these markets are largely restricted to sophisticated investors—i.e., angel investors, venture capital firms and private equity firms—who are deemed to understand the risk that many of their investments may lose money, and quickly, along the way to a successful moonshot.  Chair White is concerned that this risk can be compounded by market pressures to show high valuations (particularly “unicorn” valuations of $1 billion), akin to the pressures faced by public companies to meet market expectations and projections.  In her view, the risk of loss from an overinflated valuation is ultimately borne not just by the sophisticated venture capital or sophisticated institutional investors, but also employees, retail investors and other deserving startups.  To mitigate the risk, Chair White suggested that large private companies consider, as appropriate, implementing enhanced governance structures and controls and adding to their boards outsiders with public company experience and regulatory, financial and industry expertise. 

As pre-IPO companies have stayed private longer, both primary and secondary markets for equity securities of pre-IPO companies have expanded significantly.  Chair White noted that the SEC is monitoring these markets for, among other things, disclosure and transparency issues, liquidity issues, unregistered broker-dealer activity, undisclosed compensation, conflict of interest issues, and fraudulent offers of pooled investment vehicles purporting to hold pre-IPO stock.  Chair White also voiced concerns regarding the use of derivative structures, which can be used to transfer the economic interest in a pre-IPO company without transacting in its stock.  Among other things, the SEC is concerned that use of these derivative structures may amplify any valuation errors.  Chair White stated that the SEC is relying on financial advisers to serve as gatekeepers with respect to the private securities markets. 

Chair White also reported that the SEC is monitoring the new methods of capital-raising created under the JOBS Act including:  Rule 506(c) (permitting general solicitation in Regulation D private placements), Regulation A+ (permitting offerings of up to $50 million in 12 ...Read More

FASB Modifies Accounting Rules for Stock-Based Compensation

On March 30, 2016, the Financial Accounting Standards Board (FASB) released Accounting Standards Update (ASU) 2016-09, which amends ASC Topic 718, Compensation-Stock Compensation, to require changes to several areas of employee share-based payment accounting.  

In an effort to simplify share-based reporting, among other things, the update revises requirements in the following areas: 

  • Minimum Statutory Withholding: The new standard permits share-based withholding up to the maximum statutory tax rates, whereas currently an employer may only withhold up to the minimum statutory tax rate without causing the award to be classified as a liability.
  • Accounting for Income Taxes – The revised standard will require recording the tax effects of share-based payments at settlement or expiration on the income statement, whereas ASC 718 previously provided for tax benefits in excess of compensation cost and tax deficiencies to be reported in equity to the extent of any previous excess benefits, and then to the income statement.  Under the new rule excess tax benefits are also to be classified with other operating income tax cash flows as an operating activity.
  • Forfeitures – Whereas accruals of compensation cost are currently based on the number of awards that are expected to vest, the revised standard allows an entity to make an entity-wide accounting policy election to either estimate the number of awards that are expected to vest or account for forfeitures when they occur.
  • Intrinsic Value Accounting for Private Entities:  Under the update, nonpublic entities will be permitted to make a one-time accounting policy election to switch from measuring all liability-classified awards at fair value to intrinsic value.

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SEC Files Fraud Charges Against Public Biotechnology Company and its Officers for Alleged Materially Misleading FDA-Related Disclosures

On March 29, 2016, the SEC announced that it had filed fraud charges in U.S. federal court against AVEO Pharmaceuticals, Inc. (“AVEO”), a Massachusetts-based biotechnology company, and three of its former executives. The complaint alleges that AVEO and its former Chief Executive Officer, Chief Financial Officer and Chief Medical Officer violated the antifraud provisions of the federal securities laws by misleading investors about the company’s communications with the FDA during the approval process for tivozanib, AVEO’s leading product candidate being developed as a treatment for kidney cancer.

According to the complaint, the FDA raised concerns to AVEO in a May 2012 pre-NDA, or New Drug Application, meeting related to the survival rates of patients receiving tivozanib during AVEO’s first clinical trial of tivozanib relative to patients receiving the other compound, sorafenib, being used as a comparator in the trial. An NDA is the formal process by which a company seeks FDA approval of a new pharmaceutical for commercialization. In the pre-NDA meeting, FDA staff recommended that AVEO conduct a second clinical trial. The SEC alleged in its complaint that, for more than eleven months following the FDA’s recommendation of a second clinical trial, AVEO and the officers named in the complaint concealed from investors the extent of the FDA’s concerns about tivozanib and its recommendation that the company conduct a second clinical trial. Among other charges, the SEC alleged that: 

  • AVEO raised approximately $53 million in a public stock offering following the filing of the NDA, but failed to disclose in its offering materials the extent of the FDA’s concerns about tivozanib and its recommendation that the company conduct a second clinical trial.  
  • AVEO’s CEO and CFO knowingly approved and certified a press release and public filings that omitted information regarding the FDA’s recommendation of a second clinical trial, and suggested that data from “additional analyses” would satisfy the FDA’s concerns about survival rates among patients receiving tivozanib in the first clinical trial.  
  • AVEO’s CFO made statements at investor conferences suggesting that the FDA had only requested an explanation of the patient survival results from the first clinical trial, and omitted information about the FDA’s recommendation of a second clinical trial.  
  • AVEO filed a number of Exchange Act filings with the SEC which noted the FDA’s concerns about patient survival rates,...Read More
New SEC Staff Guidance on Describing Shareholder Proposals on Proxy Cards

On March 22, 2016, the Division of Corporation Finance of the Securities and Exchange Commission (the “Staff”) issued a new Compliance and Disclosure Interpretation (C&DI) regarding how Rule 14a-8 shareholder proposals should be described on issuer proxy cards in compliance with Rule 14a-4(a)(3) of the Securities Exchange Act of 1934.  This C&DI was issued in response to complaints the Staff received from shareholder proponents about the lack of specificity on some companies’ proxy cards.

Rule 14a-4(a)(3) requires that the form of proxy “identify clearly and impartially each separate matter intended to be acted upon.”  The new C&DI states that, as a result, proxy cards “should clearly identify and describe the specific action on which shareholders will be asked to vote,” regardless of whether it is a company or shareholder proposal.

The C&DI then provides practical examples of the types of generic descriptions that the Staff will view as not satisfying the requirements of Rule 14a-4(a)(3).  Under the C&DI, the Staff would not view it as appropriate to describe:

  • a company proposal to amend a company’s certificate of incorporation to increase the authorized number of shares as “a proposal to amend our certificate of incorporation;” 

  • a shareholder proposal asking that the bylaws be amended to allow holders of 10% of a company’s common stock to call special meetings as “a shareholder proposal on special meetings;” or

  • a shareholder proposal in the following generic manners:  “a shareholder proposal on executive compensation,” “a shareholder proposal on the environment,” “a shareholder proposal, if properly presented” or “Shareholder proposal #3.”

The CD&I does not indicate that a shareholder proponent’s title or description of its own proposal is necessarily determinative of how that proposal should be identified on the company’s proxy card.  For example, if a shareholder captions her proposal as “Proposal on Special Meetings,” that description presumably still may not satisfy Rule 14a-4(a)(3).  Thus, a company remains ultimately responsible for determining how a shareholder proposal is described on the company’s proxy card. 

Because the Staff’s interpretation was based on Rule 14a-4, it applies only to how proposals are addressed on a company’s proxy card.  Nevertheless, we would expect the Staff to hold similar views in interpreting the requirement under Rule 14a-16(d)(6) ...Read More

One More Time! SEC Seeks to Re-Adopt Resource Extraction Disclosure Rules

On December 11, 2015, the Securities and Exchange Commission voted to propose a new rule implementing Section 1504 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.  That provision directs the SEC to promulgate rules requiring “resource extraction issuer[s]” (i.e., issuers that extract natural resources) to disclose payments they make to the U.S. government or foreign governments for the commercial development of oil, natural gas, or minerals.  The SEC’s latest action follows a ruling by a federal district court in Massachusetts directing the SEC to expedite its promulgation of a new rule implementing Section 1504. 


This is the SEC’s second attempt to adopt a rule implementing that Section.  The SEC’s prior rule, which was adopted in August 2012, was later vacated in 2013 by the U.S. District Court for the District of Columbia on the ground that it was arbitrary and capricious in two respects.  First, the court determined that the SEC had incorrectly construed Dodd-Frank as requiring that the agency make each issuer’s reports available to the public; and, second, the SEC had failed to provide a reasonable explanation for its refusal to provide an exemption for companies operating in countries that prohibit the disclosures.  Gibson Dunn represented the plaintiffs in that case. 


Today’s proposed rule again seeks to require resource extraction issuers to publicly file an annual report that would disclose the issuer’s payments to the U.S. and foreign governments.  And, like the first rule, the new proposed rule contains no exemptions for countries that prohibit the disclosures.  The SEC made clear, however, that it would consider exemptions on a case-by-case basis under its existing authority under the Securities Exchange Act of 1934. 

Based on the SEC’s statements today, we note the following additional points:

  • The proposed rule requires project-level reporting, where the term project is defined as the operational activities governed by a single contract, license, lease, concession or similar legal agreement and that form the basis for payment liabilities.
  • Under the proposed rule, resource extraction issuers would have to file an annual report that includes information regarding, among other things, the total amounts of payments to a government for each project, the total amount of payments to each government in the aggregate; the...Read More
“FAST” Act Legislation Enacted -- Potentially Significant Impact on Capital Markets

On December 4, 2015, President Obama signed into law the Fixing America’s Surface Transportation Act, known as the “FAST Act.”  This five-year transportation bill also includes a number of provisions related to securities laws and capital-raising measures. The key securities law provisions of the FAST Act are summarized as follows:

Reforming Access for Investments in Startup Enterprises:

  • Codifies as new Section 4(a)(7) of the Securities Act the so-called “Section 4(a)(1½) exemption.”
  • Effective immediately, Section 4(a)(7) exempts from registration any resale transaction that meets certain conditions, including, among others, no general solicitation, participation only by accredited investors, no offering by the issuer, provision of certain basic financial and other information (for issuers that are neither subject to nor exempt from Exchange Act reporting requirements) and the securities must be of a class of securities that have been outstanding for more than 90 days. 
  • Facilitates the creation of a secondary market in securities of private companies, by clarifying the rules of the road for market participants.
  • Securities sold under Section 4(a)(7) will be “covered securities” under the Securities Act and thus will be exempt from certain aspects of state “blue sky” regulation.
  • Securities acquired in transactions exempt from Registration under the new Section 4(a)(7) will be deemed “restricted securities” within the meaning of Rule 144.
  • Use of 4(a)(7) is subject to “bad actor” disqualifications, similar to those under the current Regulation D regime.

Improving Access to Capital for Emerging Growth Companies:

  • Effective immediately, emerging growth companies under the JOBS Act (“EGCs”) may publicly file confidential submissions with the SEC only 15 days before a roadshow (reduced from 21).
  • An issuer that was an EGC when it confidentially submitted a draft registration statement to the SEC or publicly filed for its IPO, but subsequently falls out of EGC status, will continue to be treated as an EGC for one year or until consummation of its IPO, whichever is earlier.  This grace period, applicable to former EGCs, is effective immediately.
  • EGC Form S-1 or Form F-1 registration statements may omit Regulation S-X financial information for historical periods otherwise required as of the time of filing or confidential submission if all required information is provided to investors at the time a preliminary prospectus is distributed and the registrant reasonably believes that the omitted historical information will not be required at...Read More
Mark Your Calendars – Pending Deadlines for Submitting Updated Company Peer Group Information to ISS and Equilar/Glass Lewis

Institutional Shareholder Services (“ISS”) has announced that companies can provide it with updated information as to the company-selected compensation benchmarking peer group, beginning at 9 am EST on Tuesday, November 24, 2015.  In addition, Equilar Inc.’s (“Equilar”) company-selected peer group update portal opened earlier this week.  Since July 2012, Glass Lewis & Co., LLC (“Glass Lewis”) has been using peer groups generated by Equilar in its pay-for-performance analysis.  

ISS and Equilar/Glass Lewis provide companies the opportunity to submit updated self-selected peer groups in advance of each proxy season.  While ISS and Equilar develop their own peer groups for purposes of benchmarking a company’s executive compensation programs, they both take into account a company’s self-selected peer group and may incorporate updated peers for companies that modified their peer groups since their last disclosure.  According to Glass Lewis’ website, Glass Lewis does not alter the peer group selection it receives from Equilar.  Thus, companies that have revised the composition of their compensation peer group from that which was disclosed in their most recent proxy statement may use this process to provide that updated information to the proxy advisory firms.    

Detailed information regarding ISS’ peer group selection methodology can be found in its FAQs on this subject, which were published on November 18, 2015 and are available here.  Information regarding Equilar’s peer group updates can be found in its FAQs, which are available here.

A summary of this information appears in the table below:

 

ISS

Equilar/Glass Lewis

Submission windows

9 am EST on November 24 through 8 pm EST on December 11, 2015.

Now through December 31, 2015.

 

Companies invited to participate

...Read More
FASB Votes to Approve New Lease Accounting Standard and Plans to Issue the New Standard in Early 2016

At a November 11, 2015 meeting, the Financial Accounting Standards Board (“FASB”) voted to proceed with final revised standards for lease accounting.  The new standards would require lessees to record certain assets and liabilities for all leases with a term in excess of 12 months.  This is a departure from existing accounting standards, which require balance sheet presentation only for leases classified as capital leases.  This change is anticipated to have a significant impact on balance sheets for a broad swath of companies, potentially resulting in recognition of material amounts of lease-related assets and liabilities for many companies.  Companies and their advisors should consider now whether the new standards will affect compliance with financial covenants in existing or future debt arrangements.

FASB’s vote is the result of an extensive review and comment process initiated after the staff of the Securities and Exchange Commission issued a report in 2005 indicating that FASB should reconsider the accounting treatment for leases.  FASB subsequently issued exposure drafts of revised lease accounting standards in 2010 and 2013.

The FASB indicated that it expects to publish the new standards in early 2016.  The standards will be applicable to public companies for fiscal years beginning after December 15, 2018 and to private companies for fiscal years beginning after December 15, 2019.  Companies may elect to adopt the final standard sooner.

Although public companies will not be required to comply with the new lease standards until fiscal 2019, companies and their advisors should consider whether existing or future debt arrangements will be affected by the new standards and, if so, what steps should be taken to condition creditors, investors and analysts about the impact of the changes.  In particular, companies with significant off-balance sheet leases under current standards may find that application of the new standard significantly increases their reported assets, liabilities, amortization expense and interest expense.  These reporting changes could affect a company’s ability to comply with financial covenants, including leverage ratios and income ratios, in their outstanding credit agreements and bond indentures.  In addition, both borrowers and lenders should carefully consider the effects of implementing the new standards when negotiating and entering into new debt arrangements.

Corp Fin Issues New Guidance on Unbundling of Proposals

On October 27, 2015, the Division of Corporation Finance of the Securities and Exchange Commission (the “SEC”) issued two new Compliance and Disclosure Interpretations (“CDIs”) regarding the “unbundling” of certain proposals under Rule 14a-4(a)(3) of the Exchange Act in the context of mergers, acquisitions, and similar transactions.  Federal proxy rules generally prohibit the grouping of separate matters into a single proposal submitted for shareholder approval.  The rules provide that companies must separately submit — or “unbundle” — proposals to allow shareholders to vote on each matter.  In connection with business combination transactions, acquiring companies have at times attempted to bundle several amendments to their organizational documents with the business combination when seeking shareholder approval of the transaction.  The new CDIs clarify the Staff’s position with respect to this circumstance, requiring separate votes for the transaction and for any material amendment to the acquiror’s organizational documents.  The new CDIs are available here.

The SEC interpretation explains that if one or more material amendments to the acquiror’s organizational documents is included as part of a transaction requiring the approval of its shareholders, the acquiror’s proxy statement must present such amendment(s) separately from any other material items proposed for a vote, including approval of the transaction itself.  Changes to organizational documents will be considered material if they substantively affect shareholder rights.  Examples of changes that may be proposed in connection with a transaction that would clearly be material include governance- and control-related provisions.  In addition, a target company that is subject to the SEC proxy rules must also present any such amendments to the acquiror’s organizational documents for a vote in its own proxy statement, if one is required.  The SEC explains that target shareholders should have the opportunity to vote on matters that will establish their substantive rights as continuing shareholders in the combined entity.  The CDIs further clarify that these interpretations apply equally to transactions where the parties form a new entity to act as an acquisition vehicle that will issue equity securities in the transaction.

The new CDIs acknowledge that parties to a transaction are free to cross-condition the vote on the transaction with any other proposals, although such conditions must be clearly disclosed.  While this provides companies engaged in a business combination with an out if certain corporate governance and/or control-related amendments are not approved by their respective shareholders, the new CDIs may prompt companies to give more careful consideration to the specific amendments to organizational documents be...Read More

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