Month-In-Brief: Securities Law

CURRENT MONTH (November 2020)

 Securities Regulation

SEC Refreshes Regulation S-K’s Financial Information Requirements

By Alan Wilson, WilmerHale

On November 19, the SEC approved amendments that “modernize, simplify and enhance” financial information disclosure requirements contained in the 300 series of Regulation S-K.  The S-K amendments become mandatory for a company’s first fiscal year ending on or after the date that is 210 days after publication in the Federal Register, although voluntary early compliance will be allowed starting 30 days after publication in the Federal Register.

Among other changes, the amendments:

• Eliminate the requirement to provide up to five years of selected financial data and the contractual obligations table
• Replace the requirement that certain filings include two years of selected quarterly financial information with a new principles-based requirement to disclose material quarterly changes resulting from retrospective changes to the statements of comprehensive income
• Renumber S-K 303 to add a statement of the objective of MD&A at the outset of the rule
• Replace the requirement to disclose off-balance sheet arrangements with a new instruction prompting companies to consider disclosing such arrangements in MD&A
• Permit the comparison of interim period results to either the prior year period (as is currently required) or the prior sequential period
• Make a number of clarifications, including codifying that companies must disclose critical accounting estimates in MD&A, as well as that “reasonably likely” is the disclosure threshold that applies to the requirements to describe known trends or uncertainties; MD&A should include a discussion of material changes in net sales or revenue, not just material increases; and the requirement to explain material changes from period-to-period also includes discussion of offsetting items

SEC Adopts Amendments Permitting Use of Electronic Signatures

By Bella Zaslavsky, K&L Gates LLP

On November 17, 2020, the SEC announced that it voted to adopt amendments to Rule 302(b) of Regulation S‑T in order to permit the use of electronic signatures in authentication documents filed with the SEC. In order to sign authentication documents through an electronic signature, signatories will need to follow the signing procedures set forth in the EDGAR Filer Manual, which include, among other things, that the signature be affixed or otherwise attached to the document being signed such that the signatory has notice of the substance of the document and that a timestamp be included to record the date and time of signature.  The SEC also adopted corresponding revisions to allow for electronic signatures for certain other filings as well. The new rules will be effective upon publication in the Federal Register.

On November 20, 2020, the SEC updated its statement on the use of electronic signatures in light of health and safety concerns related to COVID‑19 to allow for the early use of electronic signatures so long as signatories comply with all of the requirements of amended Rule 302(b).

ISS Announces 2021 Benchmark Policy Updates

By Madeline A. Moore, K&L Gates LLP

On November 12, 2020, Institutional Shareholder Services Inc. (ISS) announced updates to its benchmark proxy voting policies for 2021. These updates will become effective for stockholder meetings taking place on or after February 1, 2021. The updates focus on two main areas for the United States: (1) racial/ethnic board diversity in director elections and (2) exclusive forum proposals.

Racial/Ethnic Board Diversity

In response to desire from investors for increased ethnically or racially diverse board composition, ISS is implementing a new voting policy with respect to boards that appear to lack racial and ethnic diversity. For 2021, ISS will highlight boards that lack, or lack disclosure regarding, racial and ethnic diversity for companies in the Russell 3000 or S&P 1500 indexes. For 2022, ISS will recommend that stockholders vote against or withhold from the chair of the nominating committee (or other directors on a case-by-case basis) for companies in the Russell 3000 or S&P 1500 indexes with no apparent racially or ethnically diverse board members.

Exclusive Forum Proposals

ISS is implementing a new voting policy with respect to exclusive forum proposals on both the federal and state levels. Under this policy, ISS will generally recommend that stockholders vote for federal forum selection provisions in a company’s charter or bylaws that specify the exclusive forum for federal securities law matters as “the district courts of the United States.” Accordingly, ISS will generally recommend that stockholders vote against provisions that restrict the forum to a specific district court.

With respect to exclusive forum provisions for state law matters, in the absence of concerns about abuse of the provision or about poor governance more generally, ISS will generally recommend that stockholders vote in favor of charter or bylaw provisions designating courts in Delaware as the exclusive forum for state corporate law matters for companies incorporated in that state.

PCAOB Reports on Initial Critical Audit Matters Experience

By Thomas W. White, Retired Partner, WilmerHale

In 2017, the Public Company Accounting Oversight Board adopted a new requirement for public company auditors to discuss “critical audit matters” (CAMs) in their reports on financial statement audits.  In general, a CAM is a matter addressed in the audit that required especially challenging, subjective, or complex auditor judgment.  The requirement took effect for large accelerated filers for audits of fiscal years ending on or after June 30, 2019.

The PCAOB recently issued a report on the initial impact of the CAMs standard, based on research and analysis by the staff of its Office of Economic and Risk Analysis.  The staff analyzed 2420 audit reports.  It found that the average number of CAMs per report was 1.7, and the range of number of CAMs communicated was 0-7.  The most frequently communicated CAMs were revenue recognition, goodwill, other intangible assets and business combinations.  The staff’s other key findings were:

• Audit firms made significant investments to support initial implementation of the CAM requirements.
• Investor awareness of CAMs communicated in the auditor’s report is still developing, but some investors are reading CAMs and find the information beneficial.
• The staff has not found evidence of significant unintended consequences from auditors’ implementation of the CAM requirements for large accelerated filers in the first year of implementation.

For public companies other than large accelerated filers, the CAMs standard will be effective for audits of financial statements for periods ending on after December 15, 2020.  The PCAOB indicated that it will continue to monitor and evaluate the impact of the CAM requirements as auditors begin to implement the requirements for these companies.

SEC Adopts Changes to Exempt Offering Framework

By Anna Pinedo, Mayer Brown  

November 2, 2020, the SEC voted to adopt amendments proposed in March 2020 that harmonize and modernize the exempt offering framework.  Predictably, the SEC Commissioners were split in their vote, with two Commissioners voting against the amendments.  Despite the statements of the dissenting Commissioners, who cited investor protection issues, it is important to note that the SEC’s Division of Economic Risk and Analysis (DERA) has undertaken several studies, including a recent study published in August 2020, regarding the private markets, providing ample economic analysis and data.

The changes brought about by the amendments are incremental, not revolutionary, but nonetheless important to both private companies and to public companies that rely on private placements as capital-raising alternatives.  The amendments simply acknowledge the reality of our current capital markets.  The amount of capital raised in exempt offerings in the United States vastly exceeds the amount raised in SEC-registered offerings.  In its proposing release on these measures, the SEC noted that in 2019, registered offerings accounted for $1.2 trillion of new capital, compared to $2.7 trillion that was estimated to have been raised in exempt offerings.  Given that the statistics collected and analyzed by the SEC’s DERA rely on Form D filings, it is likely that the amounts attributable to exempt offerings are understated since many exempt offerings made to institutional accredited investors are made in reliance on the statutory private placement exemption in Section 4(a)(2) of the Securities Act of 1933, as amended (the Securities Act).  Emerging companies continue to rely on successive rounds of private placements to fund their growth and continue to defer their initial public offerings or other exits.  As a result, exempt offerings have become increasingly important to the capital markets.  The framework relating to offering exemptions has come together over many years through the adoption of various safe harbors, including those under Regulation D of the Securities Act, and those that have developed following the enactment in 2012 of the Jumpstart Our Business Startups (JOBS) Act.  Increased reliance on private capital markets and the choice to defer IPOs is not solely, or even largely, the result of regulatory change.  Today’s amendments, which rationalize a number of exempt offering alternatives, will not dramatically change the dynamics of public versus private.

Among other changes, the amendments:

• Modernize the framework for the securities integration analysis, by establishing general guiding principles, and establishing four clear integration safe harbors, which should result in greater clarity and certainty;
• Revise the requirements for verification of investor status in Rule 506(c) offerings;
• Increase the offering thresholds for Regulation A offerings, Regulation Crowdfunding Offerings and Rule 504 offerings;
• Provide additional certainty regarding certain communications that do not constitute general solicitation; and
• Align the disclosure requirements for exempt offerings that include non-accredited investors.

The amendments will be effective 60 days after publication in the Federal Register, except for the extension of the temporary Regulation Crowdfunding provisions, which will be effective upon publication in the Federal Register.  The SEC’s fact sheet on the final rules may be accessed here. The final rules may be accessed here.

SEC Proposes Amendments to Modernize Framework for Securities Offerings and Sales to Workers

By Rani Doyle, EY*

On November 24, the SEC proposed amendments to Securities Act Rule 701 and Form S-8. Rule 701 provides an exemption from registration for securities issued by non-reporting issuers pursuant to compensatory arrangements. Form S-8 is the Securities Act registration statement for compensatory offerings by reporting issuers. 

The proposed amendments to Rule 701 would:

• Revise the additional disclosure requirements for exempt transactions exceeding $10 million;
• Revise the time at which such disclosure is required to be delivered for derivative securities that do not involve a decision by the recipient to exercise or convert in specified circumstances where such derivative securities are granted to new hires;
• Raise two of the three alternative regulatory ceilings that cap the overall amount of securities that a non-reporting issuer may sell pursuant to the exemption during any consecutive 12-month period; and
• Make the exemption available for offers and sales of securities under a written compensatory benefit plan established by the issuer’s subsidiaries, whether or not majority-owned.

The proposed amendments to Form S-8 would:

• Implement improvements and clarifications to simplify registration on the form, including:
  • Clarifying the ability to add multiple plans to a single Form S-8;
  • Clarifying the ability to allocate securities among multiple incentive plans on a single Form S-8; and
  • Permitting the addition of securities or classes of securities by automatically effective post-effective amendment.

• Implement improvements to simplify share counting and fee payments on the form, including:
  • Requiring the registration of an aggregate offering amount of securities for defined contribution plans;
  • Implementing a new fee payment method for registration of offers and sales pursuant to defined contribution plans; and
  • Conforming Form S-8 instructions with current IRS plan review practices.

• Revise Item 1(f) of Form S-8 to eliminate the requirement to describe the tax effects of plan participation on the issuer.

Both Rule 701 and Form S-8 would be amended to:

• Extend consultant and advisor eligibility to entities meeting specified ownership criteria designed to link the securities to the performance of services; and
• Expand eligibility for former employees to specified post-termination grants and former employees of acquired entities.

The comment period for the proposal will remain open for 60 days following publication in the Federal Register. The proposed rule is linked here.

SEC Proposes Temporary Rules to Facilitate Participation by Gig Workers in Compensatory Offerings Under Rule 701 and Form S-8

By Rani Doyle, EY*

In a companion release to the proposed amendments to Rule 701 and Form S-8, the SEC separately proposed rules that, on a temporary basis and subject to percentage limits (no more than 15% of annual compensation), dollar limits (no more than $75,000 in three years) and other conditions, would permit an issuer provide equity compensation to certain “platform workers” or gig workers who provide services available through the issuer’s technology-based platform or system.

According to the SEC’s press release, the proposed rules reflect the significant evolution that has taken place in the composition and participation of the workforce since the SEC last substantively amended Rule 701 or Form S-8, particularly the development of the so-called “gig economy,” which has resulted in new work relationships. Issuers operating internet-based marketplace platforms may have the same compensatory and incentive motivation to offer equity compensation to individuals participating in their platform-based businesses as they do to their employees, but they currently are unable to provide that equity compensation under Rule 701 or on Form S-8.  The press release quotes Jay Clayton as saying:

Work relationships have evolved along with technology, and workers who participate in the gig economy have become increasingly important to the continued growth of the broader U.S. economy. The rules we are proposing today are intended to allow platform workers to participate at a measured level — up to 15% of their compensation — in the growth of the companies that their efforts support.

The full press release and fact sheet for the proposed rules is here, and a link to the proposed temporary rules is here.

Division of Corporation Finance Updates Financial Reporting Manual and Securities Act CDIs re: Equity Line Financing

By Rani Doyle, EY*

On November 18, 2020, the Division of Corporation Finance updated its Financial Reporting Manual. The revisions: 

• Reflect changes to smaller reporting company, accelerated filer and large accelerated filer definitions and amendments from Disclosure Update and Simplification;
• Clarified the application of Rule 3-13 to Form 8-K and the income test for Rule 3-09 financial statements when there is more than one equity method investee;
• Clarified audit requirements for a special-purpose acquisition company target in Form S-4/F-4;
• Described the substantial deficiency situation impact on certain rule and eligibility standards;
• Included another example of a “To Be Issued” accountant’s report; and
• Removed outdated references and updated for changes to GAAP, guidance issued by the PCAOB, Division of Corporation Finance, and SEC’s Office of Chief Accountant in the last few years.

On November 13, the Division updated Securities Act CDIs relating to equity line financing, withdrawing six questions (139.15-139.20) and updating Question 139.13, which addresses when companies can file a registration statement for the resale by investors of securities sold in a private equity line financing.