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The SEC Adopts Strategic Plan for 2018-2022

​On June 19, 2018, the Securities and Exchange Commission (the “SEC") published a draft strategic plan outlining the SEC's priorities through 2022 (the “Plan Draft"). As previously reported, the Plan Draft comprised three broad goals: focusing on retail investors, increasing innovation, and strengthening performance.

After seeking public comment on the Plan Draft until July 25, 2018, the SEC ultimately published the final strategic plan (the “Final Plan") on October 11, 2018. The Final Plan is an exact replica of the Plan Draft, save for the redaction of four names from Chairman Jay Clayton's “Message from the Chairman" in lieu of a general thank you to his fellow Commissioners. The change was likely precipitated by the departure of Commissioner Michael Piwowar in July and the subsequent appointment of Commissioner Elad Roisman to the SEC in September. While the Plan Draft also included a statement that the Commissioners hoped to “gain the benefit of additional outside perspectives" through the public review and comment process, the SEC ultimately stuck to its guns and adopted the Plan Draft in its entirety.

The Final Plan's first broad goal is to focus on the long-term interests of “Main Street" investors through five initiatives. First, the SEC intends to educate itself on the breadth of investment participation so as to better tailor its resources to the reality of modern capital markets. Armed with this knowledge, the SEC's subsequent mission is to enhance outreach and education in a way that reflects the diversity of modern investors and businesses. Additionally, the SEC plans to expand efforts in enforcement and deterrence of securities manipulation, fraud, and abuse, while also modernizing EDGAR and information delivery to make it easier for investors to acquire, and filers to disseminate, key information. Lastly, the SEC hopes to increase investment opportunities by expanding the amount of SEC-registered and exchange-listed companies in play.

The second goal for the SEC in the coming years is to stay abreast of technological innovation, particularly with an eye toward globalization. By continually learning and adapting, the SEC aims to make sure it remains an effective regulator. Moreover, the SEC intends to be self-reflective and self-critical when it comes to its current rules and procedures with the help of public feedback. While addressing the increase in cybersecurity risks for market participants, the SEC aspires to ...

Nasdaq Amends 20% Private Placement Shareholder Approval Rule

On September 26, 2018, the SEC approved a significant change to the price tests used in Nasdaq's 20% private placement shareholder approval rule, Nasdaq Rule 5635(d) (the “Private Placement Shareholder Approval Rule"), effective immediately. Rule 5635(d) is the Nasdaq shareholder approval rule that is often implicated in PIPE transactions (private investments in public equity) and other private offerings, including many private offerings involving convertible securities or warrants.  

Prior to the recent rule change, the Private Placement Shareholder Approval Rule exempted from shareholder approval offerings priced at or above the greater of book or market value per share.  The book value concept now has been eliminated from the rule, and the market value concept has been revised to incorporate a five-day average concept and to use the last closing price, instead of the consolidating closing bid price.  

Generally speaking, under the amended rule, a private offering involving a 20% or greater issuance will not require shareholder approval if the offering price is greater than or equal to the lesser of: (i) the last closing price immediately preceding the signing of a binding agreement and (ii) the average closing price of the common stock on Nasdaq for the five trading days immediately preceding the signing of the binding agreement. The amended rule also reflects certain other clean up and conforming changes.  

As was the case previously, in addition to applying to private offerings, the Private Placement Shareholder Approval Rule applies to certain SEC-registered offerings that Nasdaq does not consider to be “public offerings" under its interpretive material (e.g., many registered direct offerings). Note that the Rule 5635(d) amendments do not affect the other requirements to obtain shareholder approval under Rule 5635 in connection with certain acquisitions, in connection with a change of control or in connection with equity compensation. 

As amended, Rule 5635(d) now reads in its entirety as follows: 

 (d) Transactions other than Public Offerings

(1) For purposes of this Rule 5635(d):

(A) "Minimum Price" means a price that is the lower of: (i) the closing price (as reflected on Nasdaq.com) immediately preceding the signing of the binding agreement; or (ii) the average closing price of the common stock (as reflected on Nasdaq.com) for the five trading days immediately preceding the signing of the binding agreement.

(B) "20% Issuance" means a transaction, other than a public offering as defined in IM-5635-3, involving the sale, issuance or potential issuance by the Company of common stock (or securities convertible into or exercisable for common stock), which alone or together with sales by officers, directors or Substantial ...

California Requires Public Companies Headquartered in California to Have Minimum Number of Women Directors on Board

​On September 30, 2018, Governor Jerry Brown signed SB 826 into law (effective January 1, 2019), requiring a minimum number of female directors on the boards of publicly traded corporations with principal executive offices in California. Under this new Section 301.3 to the California Corporation Code, the location of a corporation's principal executive office will be determined by the corporations' Annual Report on Form 10-K, and publicly traded corporation means any “corporation with outstanding shares listed on a major United States stock exchange."

A corporation covered by the law must have at least one female member on its board of directors by December 31, 2019, and additional female members by 2021 depending on the size of the board.  If the corporation has a board of directors with:

  • four members or less, no additional female directors are required
  • five members, the board must have at least two female directors by December 31, 2021, and
  • six or more members, at least three female directors are required to be in place by December 31, 2021. 

The California Secretary of State can impose fines of $100,000 for a first violation and $300,000 for subsequent violations.  Each board seat not filled by a female director for at least a portion of each year will count as a violation.  The Secretary of State can also impose fines of $100,000 for failure to comply with annual reporting requirements regarding board composition.  Specific provisions regarding the form and timing of these reporting requirements will be established by regulation.

As California Governor Brown acknowledged in his signing statement, this new law has “potential flaws that indeed may provide fatal to its ultimate implementation" and will likely be subject to challenge.  Potential challengers argue that the law violates the commerce clause and the equal protection clause of the US Constitution.  Internal affairs of a corporation, including the governance of a corporation, are generally governed by the law of the state in which it is incorporated, not where it is physically located.  California would bear the burden in showing a compelling interest in regulating the internal affairs of foreign corporations as it relates to its local interests if forced to defend the law against a commerce clause challenge.  More broadly, commentators have noted that a mandate based on gender classification at private organizations such as corporations could run afoul of the equal protection clause o...

Proposed Legislation Would Require Public Companies to Significantly Expand Their Climate-Related Disclosures

Proposed Legislation Would Require Public Companies to Significantly Expand Their  Climate-Related Disclosures

On September 24, 2018, U.S. Senator Elizabeth Warren (D-MA), along with seven co-sponsors, introduced bill S.3481, the Climate Risk Disclosure Act of 2018 (the “Bill").

If enacted, the Bill would require public companies to disclose a substantial amount of new information about their exposure to climate-related risks. The disclosure would be intended to provide more qualitative and quantitative information about the financial risks that result from both exposure to climate change and climate change mitigation and adaptation. The text of the Bill contends “many sectors of the economy of the United States are exposed to multiple channels of climate-related risk," “companies have a duty to disclose financial risks that climate change presents," and the Securities and Exchange Commission (the “SEC") “has a duty to promote a risk-informed securities market." The Bill is available here and its status in Congress can be tracked here.

The Bill would amend the Securities Exchange Act of 1934 (the “Exchange Act") to include a subsection entitled “Disclosures Relating to Climate Change." The new subsection would direct the SEC to issue final rules requiring any issuer required to file an annual report pursuant to Section 13(a) or 15(d) of the Exchange Act to disclose in its annual reports information regarding:

(A) the identification of, the evaluation of potential financial impacts of, and any risk-management strategies relating to…physical risks posed to the covered issuer by climate change and transition risks posed to the covered issuer by climate change; and

(B) a description of any established corporate governance process and structures to identify, assess, and manage climate-related risks.

The Bill defines "physical risks" as financial risks to long-lived fixed assets, locations, operations, or value chains that result from exposure to physical climate-related effects, including: (i) increased average global temperatures; (ii) increased severity and frequency of extreme weather events; (iii) increased flooding; (iv) sea level rise; (v) ocean acidification; (vi) increased frequency of wildfires; (vii)  decreased arability of farmland; and (viii) decreased availability of fresh water. And the Bill defines "transition risks" as financial risks that are attributable to climate change mitigation and adaptation, including e...

SEC Division of Corporation Finance Provides Interpretive Relief on New Disclosure Requirement

On September 25, 2018, the Division of Corporation Finance of the Securities and Exchange Commission (the "Staff") issued a new Compliance and Disclosure Interpretation ("C&DI") providing transition guidance and relief on reporting requirements under the disclosure update and simplification rules adopted on August 17, 2018 (the "Final Rules"). As discussed in our recent post (available here), the Final Rules become effective 30 days from publication in the Federal Register, but do not indicate whether the amendments should be applied to periodic reports covering periods ending on or after the effective date or to all periodic reports filed after the effective date.  (As of the date of this posting, the Final Rules have still not been published in the Federal Register.)  The timing is significant because the Final Rules require companies' quarterly reports on Form 10-Q to include a new statement of changes in stockholders' equity and to disclose the amount of dividends per share for each class of shares with respect to the interim period. 

The Staff's new interpretation set forth in Question 105.09 of the Exchange Act Forms C&DIs (available here) explains that the amendments are effective for all filings made after the effective date, but advises that, with respect to the new requirement to present changes in stockholders' equity and dividends per share in quarterly reports on Form 10-Q, the Staff would not object to issuers waiting to apply this requirement to interim periods beginning after the effectiveness of the Final Rules. As such, December 31 fiscal year companies may omit the new disclosure about changes in shareholders' equity from the third quarter 2018 10-Q. 

In its entirety, CD&I 105.09 and stated the following:

Question: On August 17, 2018, the SEC adopted amendments to certain disclosure requirements in Securities Act Release No. 33-10532, Disclosure Update and Simplification. The amendments will become effective 30 days after publication in the Federal Register. Among the amendments is the requirement to present the changes in shareholders' equity in the interim financial statements (either i...

SEC Division of Corporation Finance Provides Interpretive Relief on New Disclosure Requirement

 

On September 25, 2018, the Division of Corporation Finance of the Securities and Exchange Commission (the “Staff") issued a new Compliance and Disclosure Interpretation (“C&DI") providing transition guidance and relief on reporting requirements under the disclosure update and simplification rules adopted on August 17th, 2018 (the “Final Rules"). As discussed in our recent post (available here), the Final Rules become effective 30 days from publication in the Federal Register, but do not indicate whether the amendments should be applied to periodic reports covering periods ending on or after the effective date or to all periodic reports filed after the effective date. ( As of the date of this posting, the Final Rules have still not been published in the Federal Register.)  The timing is significant because the Final Rules require companies' quarterly reports on Form 10-Q to include a new statement of changes in stockholders' equity and to disclose the amount of dividends per share for each class of shares with respect to the interim period. 

The Staff's new interpretation set forth in Question 105.09 of the Exchange Act Forms C&DIs (available here) explains that the amendments are effective for all filings made after the effective date, but advises that, with respect to the new requirement to present changes in stockholders' equity and dividends per share in quarterly reports on Form 10-Q, the Staff would not object to issuers waiting to apply this requirement to reporting periods beginning after the effectiveness of the Final Rules. As such, December 31 fiscal year companies may omit the new disclosure about changes in shareholders' equity from the third quarter 2018 10-Q. 

In its entirety, CD&I 105.09 and stated the following:

Question: On August 17, 2018, the SEC adopted amendments to certain disclosure requirements in Securities Act Release No. 33-10532, Disclosure Update and Simplification. The amendments will become effective 30 days after publication in the Federal Register. Among the amendments is the requirement to present the changes in shareholders' equity in the interim financial statements (either in a separate statement o...

Important Reminders for Upcoming 10-Q Filings

​As calendar year filers begin preparing their Forms 10-Q for the third quarter, there are a few items they should keep in mind.

Potential Impact of SEC's New Disclosure Update and Simplification Release

As discussed in greater detail in our client alert (available here), on August 17, 2018, the Securities and Exchange Commission (the “SEC") adopted several dozen amendments (available here) to “simplify compliance without significantly altering the total mix of information" (the “Final Rules").  Ironically, the first effect of the Final Rules that companies may encounter is one that requires additional disclosure.  The Final Rules require Form 10-Q to contain a statement of changes in stockholders' equity and to disclose the amount of dividends per share for each class of shares with respect to the interim period, pursuant to revised Rule 3-04 of Regulation S-X.  Previously, this information was only required in Form 10-K.  The adopting release for the Final Rules notes that “[t]he extension of the disclosure requirement in Rule 3-04 of Regulation S-X may create some additional burden for issuers . . . because it will require disclosure of dividends per share for each class of shares, rather than only for common stock, and disclosure of changes in stockholders' equity in interim periods," but the SEC staff “expect[s] this burden will be minimal, as the required information is already available from the preparation of other aspects of the interim financial information such as the balance sheet and earnings per share."  The required analysis of changes in stockholders' equity for the “current and comparative year-to-date periods, with subtotals for each interim period," can be presented in a note to the financial statements or in a separate financial statement.

The Final Rules become effective 30 days from publication in the Federal Register.  As of the date of this blog post, the Final Rules have not been published in the Federal Register.  Moreover, the adopting release does not indicate (1) whether the amendments should be applied only to periodic reports covering periods ending on or after the effective date, or (2) whether the amendments should be applied to all periodic reports filed after the effective date.  Accordingly, assuming the Final Rules are published in the Federal Register sometime this month, it is unclear whether companies with a Septe...

EDNY Rejects Motion to Dismiss in First ICO Criminal Securities Fraud Trial

​On September 11, 2018, Judge Raymond Dearie of the Eastern District of New York rejected a motion to dismiss in U.S. v. Zaslavskiy, the first criminal securities fraud prosecution relating to an initial coin offering. The motion to dismiss challenged the prosecution's characterization of two virtual currencies promoted by Maxim Zaslavskiy as “securities" under the federal securities law.

In rejecting the motion, Judge Dearie determined only that a reasonable jury could conclude that the alleged coins satisfy the Howey test and that, as such, the question of whether these ICOs constituted offerings of securities is a question of fact to be determined by the jury. In scholarly and practitioner discussions of the potential applicability of the securities laws to ICOs, the most difficult question is typically whether the profit "through the efforts of others" component of Howey is satisfied insofar as many virtual currencies do not involve a clear link between managerial efforts and expected profits. In Zaslavskiy, however, Judge Dearie held that the alleged facts make “clear that the investors could have reasonably expected their profits to be derived primarily from the managerial efforts of Zaslavskiy and his team." Zaslavskiy is alleged to have marketed one coin as “real estate-backed currency" whose value was derived  from real estate investment decisions managed by “an experienced team of brokers, lawyers, and developers." The other coin was similarly marketed as a currency whose value was derived from expert investments in diamonds. In both cases, the court noted that there was no indication that investors were to be given any opportunity to manage the real estate and diamond investments “backing" the virtual currencies and that the expected profit from these currencies was to be derived from the investment strategies of Zaslavskiy's “expert" team.

As the first instance of a federal court opining on these questions in a criminal context Judge Dearie's findings are notable; however, as with the SEC's 2017 DAO ICO investigative report, the court's analysis has limited generalizable implications. The alleged facts of the coins forming the subject of the criminal complaint allowed for a straightforward application of Howey and accordingly the ruling provides relatively little guidance as to how federal courts will apply the securities laws to the often more ambiguous character of many ICOs.  Practitioners will undoubtedly watch the resulting criminal trial with interest. 

This post was prepared by Alan Bannister, Nicolas Dumont, and Michael Mencher. 


SEC Streamlines Disclosure Requirements as Part of its Overall Disclosure Effectiveness Review

On August 17, 2018, the Securities and Exchange Commission (the “Commission") adopted several dozen amendments (available here) to “simplify compliance without significantly altering the total mix of information" (the “Final Rules").  In Release No. 33-10532, the Commission characterized the amended requirements as redundant, duplicative, overlapping, outdated or superseded, in light of subsequent changes to Commission disclosure requirements, U.S. GAAP, IFRS and technology developments.  

The Final Rules are largely consistent with the changes outlined in the Commission's July 13, 2016 proposing release, available here and discussed in a previous post. They form part of the Commission's ongoing efforts in connection with the Disclosure Effectiveness Initiative relating to Regulations S-K and S-X and the Commission's mandate under the Fixing America's Surface Transportation Act to eliminate provisions of Regulation S-K that are duplicative, overlapping, outdated, or unnecessary. The Final Rules will become effective 30 days from publication in the Federal Register.  

In the short term, issuers and registrants will need to revise their disclosure practices and compliance checklists in light of the amendments before filing a registration statement or periodic report following effectiveness of the Final Rules.

We discuss the Final Rules in greater detail in our client alert (available here).

Our thanks to Michael Mencher in New York and Maya Hoard in Orange County for their assistance in preparing the summary above and the client alert. ​


The PCAOB’s Draft Strategic Plan: Overview and Outlook

On August 10, 2018, the Public Company Accounting Oversight Board (PCAOB or Board) released a draft of its five-year strategic plan and sought public comment on the plan through September 10, 2018. This represents the first time that the Board has solicited public input to a draft strategic plan, and follows the Board's announcement in April of a public survey to permit stakeholder input on the strategic plan even in advance of the draft's release. In a speech on May 17, 2018, at the Deloitte/University of Kansas Auditing Symposium (Kansas Speech), PCAOB Chairman William D. Duhnke III announced that after the public comment period, the Board plans to finalize the strategic plan in November 2018.[1]

Coming on the heels of a complete turnover of the Board and the subsequent departure of numerous senior personnel, the process by which the Board is crafting its strategic plan provides further evidence—if any were necessary—that this Board intends to seek out new ways to operate and to fulfill the PCAOB's mission.

This post surveys the current state of the Board's three most important functions—standard setting, inspections, and enforcement—in light of the Kansas Speech and the draft strategic plan, and offers some thoughts concerning what stakeholders might expect as the PCAOB moves forward.

Standard Setting

In recent years, the PCAOB's standard-setting process has vacillated between a focus on structural changes to the audit process—such as disclosure of critical audit matters (CAMs) and exploring whether audit firm rotation could be viable—and so-called “blocking and tackling" issues—in the words of former U.S. Securities and Exchange Commission (SEC) Commissioner Daniel Gallagher—that beef up the procedures that auditors are required to perform. After the adoption last year of a new auditor's reporting model that includes CAMs, the pendulum now seems to be swinging back toward more mechanical standards. The Office of the Chief Auditor's current Standard-Setting Agenda includes items relating to auditing estimates, the use of specialists, the supervision of other audit firms, and going-concern provisions.

The just-released draft strategic plan is consistent with this apparent approach. The plan sets as an objective that the standard-setting process should better incorporate economic and risk analysis. It also reaffirms t...

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