CURRENT MONTH (February 2019)

Securities Regulation

SEC Proposes to Expand “Test the Waters” Accommodation

By Anna Pinedo, Mayer Brown

On February 19, 2019, the Securities Exchange Commission (SEC or Commission) proposed a new rule under the Securities Act that would extend the ability to “test-the-waters” to all issuers. Currently, this ability is available only to emerging growth companies (EGCs).  This has been highly anticipated. In prior sessions of Congress, legislation had been proposed to do exactly this. Although most of the issuers that have undertaken IPOs in recent years are EGCs and already benefit from the ability to communicate with institutional investors, the notion of extending this communications safe harbor to other issuers has been viewed as providing greater flexibility without raising any investor protection concerns. 

The new accommodation is reflected in proposed Rule 163B.  The rule would allow all issuers to engage in test the waters communications with potential investors that are reasonably believed to be institutional accredited investors or qualified institutional buyers either prior to or following the date of filing of a registration statement relating to the offering.  The proposed rule would provide an exemption from the registration requirements of Section 5 of the Securities Act.  The communications could be oral or written, would not be required to be filed with the Commission, and would not be required to bear any legends.  Since written communications will be permitted, the Commission also proposes to amend Rule 405 to exclude written test the waters communications from the definition of “free writing prospectus.”  Of course, information shared in any test the waters communication must not conflict with material information included in the registration statement for the offering.  The Commission notes that issuers subject to Regulation FD would need to consider whether such communications trigger any Regulation FD obligations.  

IOSCO Issues Statement on Disclosure of ESG Matters by Issuers

By Rani Doyle, EY

The SEC is a member of the International Organization of Securities Commissions (IOSCO), an association whose membership regulates more than 95% of the world’s securities markets. On January 18, 2019, IOSCO published a statement setting out the importance of corporate consideration of environmental, social, and governance (ESG) matters when disclosing information material to investors’ decisions. IOSCO noted that ESG disclosures are increasing, in particular in some industries, and include “environmental factors related to sustainability and climate change, social factors including labor practices and diversity, and general governance-related factors that have a material impact on [a company’s] business.”

In its publication, IOSCO “encourages [companies] to consider the materiality of ESG matters to their business and to assess risks and opportunities in light of their business strategy and risk assessment methodology. When ESG matters are considered to be material, [companies] should disclose the impact or potential impact on their financial performance and value creation.”

The SEC did not vote on the publication of IOSCO’s statement and therefore the statement should not be viewed as an expression of the SEC’s views or as an endorsement by the SEC. However, with its Disclosure Effectiveness Initiative, the SEC is considering and indeed must consider the demand and support for disclosures on intangible assets and ESG matters that impact company performance and value, both in the short and long term.

SEC Division of Corporation Finance Issues No-Action Letter Regarding Mandatory Arbitration Bylaw

By Cydney Posner, Cooley LLP

The issue of mandatory arbitration bylaws is a hot potato—and a partisan one at that (with Rs tending to favor and Ds tending to oppose).  And in this no-action letter issued yesterday to Johnson & Johnson—granting relief to the company if it relied on Rule 14a-8(i)(2) (violation of law) to exclude a shareholder proposal requesting adoption of  mandatory arbitration bylaws—Corp Fin successfully passed the potato off to the State of New Jersey.  Crisis averted.  However, the issue was so fraught that SEC Chair Jay Clayton felt the need to issue a statement supporting the staff’s hands-off position: “The issue of mandatory arbitration provisions in the bylaws of U.S. publicly-listed companies has garnered a great deal of attention.  As I have previously stated, the ability of domestic, publicly-listed companies to require shareholders to arbitrate claims against them arising under the federal securities laws is a complex matter that requires careful consideration,” consideration that would be more appropriate at the Commissioner level than at the staff level. However, as Clayton has previously indicated, mandatory arbitration is not an issue that he is anxious to have the SEC wade into at this time. To be sure, if the parties really want a binding answer on the merits, he suggested, they might be well advised to seek a judicial determination.

SEC Releases Guidance on Diversity Disclosures

By Lisa R. Stark, K&L Gates LLP

In February, the SEC’s Division of Corporation Finance released Compliance & Disclosure Interpretations (C&DIs) relating to diversity disclosure under Items 401 and 407 of Regulation S-K. The C&DIs state that, to the extent the board or nominating committee considered an individual’s self-identified diversity characteristics in assessing the person’s “experience, qualifications, attributes or skills,” the company’s Item 401 discussion should identify those characteristics and how they were considered. Similarly, the C&DIs state that the description of diversity policies under Item 407 should “include a discussion of how the company considers the self-identified diversity attributes of nominees, as well as any other qualifications its diversity policy takes into account, such as diverse work experiences, military service, or socio-economic or demographic characteristics.”

Nasdaq Permits Direct Listings

By Eric Johnson, Michael J. Blankenship, Robert Evans III, and Stanley Keller, Locke Lord LLP

On February 15, 2019, Nasdaq filed an immediately effective rule proposal to permit “direct listings” without an IPO and, in doing so, joins the NYSE, whose proposal to permit direct listings was approved by the SEC in February 2018.  For a private company that does not need to raise capital in the public markets, but would like to provide greater liquidity for its existing shareholders and employees or make its common equity a more valuable currency in acquisition transactions, a direct listing is an excellent alternative to a traditional underwritten initial public offering. Spotify executed a direct listing in April 2018, and Slack Technologies indicated earlier this month that it would take the same approach.

Nasdaq’s Listing Rule IM-5315-1 sets forth the direct listing requirements for common equity securities and describes how Nasdaq will determine compliance with the Nasdaq Global Select Market initial listing standards based on the price of a security, including the bid price, market capitalization and market value of publicly held shares requirements. Under the rule, a company that lists through a direct listing on the Nasdaq Global Select Market:

  • will be subject to all initial listing requirements applicable to equity securities and, subject to applicable exemptions, the corporate governance requirements set forth in Nasdaq’s Rule 5600 Series;
  • must have an effective registration statement allowing existing shareholders to sell their shares;‎ and
  • will be required to obtain an independent third-party valuation to ensure the company satisfies the initial listing requirements.

SEC Chair Jay Clayton Remarks on Human Capital and Proxy Plumbing

By Rani Doyle, EY

 In a call with SEC Investor Advisory Committee Members on February 6, 2019, SEC Chair Jay Clayton addressed current human capital disclosure requirements and proxy plumbing as follows:

Framework for Analyzing Disclosure Rules. As you know from my previous remarks to the Committee, I believe the Commission’s disclosure requirements must be rooted in the principles of: (1) materiality—as so well defined by Justice Marshall; (2) comparability—as demonstrated by our commitment to U.S. GAAP; (3) flexibility—as requirements that are too rigid can lead to superfluous and, in some cases, misleading disclosure; (4) efficiency—as the question generally is notrule or no rule, but rather what rule is most effective with the least cost; and (5) responsibility (or liability)—as rules have little long-term value if they cannot be effectively monitored and enforced. I also believe that our disclosure requirements and guidance must evolve over time to reflect changes in markets and industry while being true to the principles I articulated.

Current human capital disclosure requirements—I am thinking of Items 101 and 102 of Regulation S-K—date back to a time when companies relied significantly on plant, property, and equipment to drive value. Today, human capital and intellectual property often represent an essential resource and driver of performance for many companies. This is a shift from human capital being viewed, at least from an income statement perspective, as a cost.

I believe our disclosure rules and guidance, and our issuers, should focus on the material information that a reasonable investor needs to make informed investment and voting decisions. Applying this unassailable tenet to human capital is not a simple task. Each industry, and even each company within a specific industry, has its own human capital circumstances. For example, I would expect that the material human capital information for a manufacturing company will be different from that of a biotech startup, and different from that of a large healthcare provider. Further, the human capital considerations for a car manufacturer will be different from that of a home manufacturer. Because of those differences and the principles of materiality, comparability, and efficiency, I am wary of jumping in with rules or guidance that would mandate rigid standards or metrics for all public companies.

Instead, I think investors would be better served by understanding the lens through which each company looks at their human capital. Does management focus on the rate of turnover, the percentage of their workforce with advanced degrees or relevant experience, the ease or difficulty of filling open positions, or some other factors? I have heard this and similar questions on earnings conference calls and in other investor settings. I am interested in hearing from those on the Committee who manage investment capital—what is it that you are looking for as an investor, and what questions do you ask the issuers when it comes to human capital?

Here, a note on comparability. In some cases it is possible to identify metrics that provide for reasonable market-wide comparability (for example, U.S. GAAP). In other cases, this is not possible at a market-wide level, and comparability is reasonably possible at an industry level or only at a company level (this is demonstrated by the development of non-GAAP financial measures). For example, for human capital, I believe it is important that the metrics allow for period to period comparability for the company.

Proxy Plumbing. Turning to the proxy solicitation and voting process (or proxy plumbing), I think there is broad agreement that the current system needs a major overhaul. As I mentioned previously, I am interested in suggestions for what such an overhaul would entail. I am also interested in ideas for what the Commission can do in the interim (short of a total overhaul) to improve the current system, and I hope market participants will continue to submit those ideas to the comment file from the November proxy roundtable.

I am delighted to report that I have asked Commissioner Roisman to take the lead on efforts to consider improvements to the proxy process generally, including proxy plumbing, and I am even more delighted that Commissioner Roisman has agreed to take up this task. I am pleased that Commissioner Roisman is able to join me today on this call.


Rani Doyle

Rani Doyle

Managing Editor, Securities Law

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