CURRENT MONTH (January 2020)

Securities Regulation

Second Circuit Ups the Ante on Undisclosed Wrongdoing in 10b-5 Claims

By Keith R. Fisher, Domestic & International Court Initiatives – ‎National Center for State Courts

A recent Second Circuit decision raises the bar on 10b-5 claims predicated on undisclosed wrongdoing.  In Gamm v. Sanderson Farms, the court held that a plaintiff must plead with particularity not only the alleged misstatement or omission but also the facts of the underlying misconduct – i.e., that statements made by a defendant were rendered false and misleading because of nondisclosure of illegal activity.  This is necessary to comply with Fed. R. Civ. P. 9(b) (some of the pleading standards of which were discussed in a 2017 ABA Litigation Section article) and § 10(b) of the Private Securities Litigation Reform Act.

The case involved allegations of an antitrust conspiracy to manipulate prices in the chicken industry.  While plaintiffs acknowledged that allegations of misstatements and omissions must be pleaded with particularity, they argued that the facts of the underlying antitrust conspiracy need not similarly be pleaded with particularity but need merely to meet the “short and plain statement” requirement of Fed. R. Civ. P. 8.  The court disagreed, holding that in this case the alleged misstatements or omissions and the facts of the underlying antitrust conspiracy were inseparable.  “In order to properly provide ‘all facts’ upon which their securities fraud claim is  based, the[] allegations must also provide particularized facts about the underlying conspiracy.”

SEC Publishes Three New C&DIs on MD&A

By Alan J. Wilson, WilmerHale

On January 24, 2020, the Securities and Exchange Commission (SEC) published three new Compliance and Disclosure Interpretations (C&DIs) (Questions 110.02–.04) regarding Management’s Discussion and Analysis of Financial Condition and Results of Operations under Item 303 of Regulation S-K.  The new C&DIs offer guidance on last spring’s FAST Act Modernization and Simplification of Regulation S-K amendments to the instructions to Item 303(a), which enable registrants to omit from MD&A discussion about the earliest year in certain circumstances: (i) financial statements covering three years are included in the filing, (ii) MD&A discussion of such earliest year was included in prior filings, and (iii) the filing identifies the location of the omitted discussion in the prior filing. 

The C&DIs provide, consistent with last spring’s adopting release, that a registrant may not rely on Instruction 1 to Item 303(a) to omit discussion of the earliest of the three years if discussion of that year is “necessary to an understanding of its financial condition, changes in financial condition and results of operations.”

As a more technical matter, the C&DIs discuss incorporation by reference in a filing with omitted MD&A disclosure, noting that if a registrant wishes to incorporate prior disclosures by reference, it must “expressly state” that the information is incorporated by reference.  “[M]erely identifying the location in a prior filing where the omitted discussion can be found” in accordance with the instruction does not incorporate such disclosure by reference into the filing.  The C&DIs illustrate this point with an example of a Section 10(a)(3) update to an effective registration statement. 

SEC Proposes Amendments to Auditor Independence Rules

By Thomas W. White, Retired Partner, WilmerHale

Accounting firms that audit US publicly-traded companies are required to be independent of their audit client in fact and appearance.  The SEC, along with the Public Company Accounting Oversight Board (PCAOB), regulates auditor independence through prescriptive rules and vigorous enforcement.  In late December 2019, the SEC proposed to amend the auditor independence rules “to more effectively structure the independence rules and analysis so that relationships and services that would not pose threats to an auditor’s objectivity and impartiality do not trigger non-substantive rule breaches or potentially time consuming audit committee review of non-substantive matters.”

Most notably, the proposed amendments address situations in which relationships with sister companies “under common control” with the entity under audit, such as portfolio companies controlled by the same private equity firm, or companies affiliated with an investment company, can cause independence violations.  The proposal would narrow the definitions of “affiliate of the audit client” and “investment company complex” to only encompass sister entities that are material to the ultimate controlling entity.

Other proposed amendments to the SEC’s independence rules would liberalize the rules’ application to periods prior to an audit client’s initial public offering and following mergers and acquisitions involving an audit client, as well as expanding categories of personal loans to an accountant by an audit client that do not impair independence.

Comments on the rule are due on March 16, 2020. 

SEC Officials Issue Reminder on Key Audit Committee Oversight Responsibilities

By Rani Doyle, Ernst & Young*

On December 30, 2019, SEC Chairman Jay Clayton, SEC Chief Accountant Sagar Teotia and William Hinman, Director of the SEC Division of Corporation Finance, issued a public statement highlighting the important role that audit committees play in the financial reporting system and reaffirming their key oversight responsibilities.

The statement encouraged audit committees to continue to focus on:

  • Tone at the top, with the objective of creating and maintaining an environment that supports the integrity of the financial reporting process and the independence of the audit;
  • Compliance with auditor independence rules;
  • Implementation of new GAAP standards, including whether the implementation plan provides sufficient time and resources for management to develop well-reasoned judgments and accounting policies and to understand management’s processes to establish and monitor controls and procedures over adoption and transition;
  • Internal control over financial reporting issues, including understanding and monitoring any areas for improvement or in remediation; and
  • Communications to the audit committee from the independent auditor (PCAOB AS 1301).

The statement outlined the following issues that audit committees should focus on this year:

  • Non-GAAP financial measures, taking steps to be “actively engaged in the review and presentation of non-GAAP measures and metrics” and understanding how management uses the measures, period-to-period consistency and related disclosure controls and procedures;
  • Reference rate reform (LIBOR transition), taking steps to understand management’s plan to identify and address the risks of reform and the impact on accounting and financial reporting; and
  • Critical audit matters (CAMs), continuing efforts to understand the new PCAOB CAM standard and remaining engaged with the independent auditors in the implementation process.

BlackRock CEO: Climate Change and the Fundamental Reshaping of Finance

By Rani Doyle, Ernst & Young*

BlackRock CEO, Larry Fink, has taken a bold stance on climate change in his annual letter to chief executives on January 14, 2020.  The world’s largest asset manager, with nearly $7 trillion in assets under management, cited growing concerns over potential physical and financial risks associated with climate change.  BlackRock has integrated climate risk into its investment process to provide better risk-adjusted returns to investors.  Other related initiatives include: “making sustainability integral to portfolio construction and risk management; exiting investments that present a high sustainability-related risk, such as thermal coal producers; launching new investment products that screen fossil fuels; and strengthening our commitment to sustainability and transparency in our investment stewardship activities.” BlackRock acknowledged that government action is needed to address climate change but believes “companies and investors have a meaningful role to play.” The letter highlighted disclosure as a measure of corporate performance and steered companies toward the Sustainability Accounting Standards Board (SASB) framework to report on sustainability information, and the Task Force on Climate-related Financial Disclosures (TCFD) guidelines to disclose climate-related risks.  BlackRock will use engagement and any SASB- and TCFD-aligned reporting to evaluate how well companies are managing climate-related risks.  BlackRock believes boards should be held accountable for the push towards sustainability and will “vote against management and the board of directors when companies are not making sufficient progress on sustainability-related disclosures and the business practices and plans underlying them.”

House Passes 8-K Trading Gap Act of 2019

By Alan J. Wilson, WilmerHale

Taking aim at trading practices of corporate insiders, the 8-K Trading Gap Act of 2019, H.R. 4335, received overwhelming bipartisan support in the House of Representatives, which voted 384-7 in favor of the bill.  If passed into law, the SEC would be tasked with promulgating rules requiring issuers to establish “policies, controls, and procedures that are reasonably resigned to prohibit executive officers and directors” from buying, selling or otherwise transferring securities of an issuer between the occurrence of certain events and the filing or furnishing of Form 8-K disclosures about those events. 

The bill would divide triggering events into two categories: (i) those reported under the first six sections of Form 8-K and (ii) those reported under section 7 (Regulation FD disclosure) or section 8 (other events) of Form 8-K.  With regards to the former category, which includes, among several others, entry into material definitive agreements, M&A transactions and costs of exit activities, the proposed prohibition would apply from the occurrence of the event through the filing or submission of the Form 8-K.  The latter category would prohibit securities transfers from the date the issuer determines that it will disclose the event until the filing or furnishing of the Form 8-K.

The bill includes a number of exemptions, including for certain automatic transactions (e.g., transactions pursuant to properly adopted Rule 10b5–1(c) plans), certain investment companies, and events described under sections 1 through 6 of Form 8–K that the issuer has announced in a press release or otherwise publicly disseminated in compliance with Regulation FD.

*Material included in this Month-In-Brief publication is for general informational purposes only and does not represent the advice of Ernst & Young LLP or any of its professionals as to any client or particular set of facts; nor does it represent any undertaking to keep recipients advised of all legal developments. Prior results do not guarantee a similar outcome.


Rani Doyle

Rani Doyle

Managing Editor, Securities Law

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