CURRENT MONTH (October 2019)

Securities Regulation

Pharmaceutical Company Settles SEC Charges of Failing to Properly Account for and Disclose Government Investigation

By Thomas W. White

On September 27, 2019, Mylan N.V. settled charges by the Securities and Exchange Commission that it had failed to properly account for and disclose a Department of Justice investigation into whether Mylan overcharged Medicaid for sales of its EpiPen treatment for severe allergic reactions.   Without admitting or denying the SEC’s allegations, Mylan agreed to pay $30 million to resolve the case.

In its Complaint filed in the United States District Court for the District of Columbia, the SEC alleged that Mylan misclassified EpiPen as a “generic” drug for purposes of the Medicaid Drug Rebate Program, which resulted in Mylan paying lower rebates to the government on Medicaid payments for purchases of EpiPen than if EpiPen had been classified as a “branded” drug.  In October 2014, the government asserted that Mylan had misclassified EpiPen and, in November 2014, the Department of Justice commenced a civil investigation into potential violations of the False Claims Act by virtue of the misclassification and the resulting overcharges.  During the nearly two-year investigation, Mylan responded to multiple subpoenas and investigative demands, signed tolling agreements, provided damages estimates to DOJ, was informed by DOJ that it was prepared to file suit, and made offers of settlement to DOJ.  Mylan did not disclose the investigation or its potential liability until October 2016, when it announced a $465 million agreement in principle with DOJ.

The SEC alleged that Mylan failed to disclose the investigation and accrue for possible liabilities to the government as required by Accounting Standards Codification (ASC) 450-20, which governs accounting for loss contingencies. The SEC summarized ASC 450-20’s requirements as follows: “A public company facing a material loss contingency, such as one arising from a lawsuit or government investigation, is required under accounting principles and the securities laws to (1) disclose the loss contingency if a loss is at least reasonably possible, and (2) record an accrual for the estimated loss if a loss is probable and reasonably estimable.”   Applying this standard, the SEC asserted that Mylan should have disclosed the investigation no later than the filing its Form 10-Q for the third quarter of 2015, and Mylan should have accrued for the loss no later than the filing of its second quarter 2016 Form 10-Q.

The SEC also alleged that Mylan made misleading statements in the risk factors disclosure in its 2014 and 2015 annual reports.  Mylan stated that the government “may” take the position that its Medicaid submissions were incorrect, when the government had in fact already taken that position.

The Mylan case represents another instance in which the SEC has taken enforcement action based on failure to disclose and accrue for government investigations at a stage prior to announcement of a settlement.  A case making similar charges, SEC v. RPM International, remains pending in the DC District Court.

SEC Division of Corporation Finance Announces a New Approach to Company No-Action Requests to Exclude Shareholder Proposals and Issues a New Staff Legal Bulletin Providing Further Guidance on Rule 14a-8(i)(7)

By Rani Doyle

No-Action Letter: On September 6, the Division of Corporation Finance announced that, starting with the 2019-2020 shareholder proposal season, it may respond orally instead of in writing to some company no-action requests submitted under Rule 14a-8 to exclude shareholder proposals. In making that announcement, the staff noted its intention to issue a written response letter where it believes doing so would provide value, such as more broadly applicable guidance about complying with Rule 14a-8. In its announcement, the staff reiterated its belief, as noted in Staff Legal Bulletin 14I and Staff Legal Bulletin 14J, that when a company seeks to exclude a shareholder proposal from its proxy materials under paragraphs (i)(5) or (i)(7) of Rule 14a-8, an analysis by its board of directors is often useful.

In addressing Rule 14a-8 no-action requests, the staff will inform the company – orally or in writing – of whether it concurs, disagrees or declines to state a view on the company’s arguments for exclusion. The announcement reminds companies that where it declines to state a view, neither the company nor the proponent should interpret that position as indicating that the proposal must be included or cannot be validly excluded.

Staff Legal Bulletin 14k:  On October 16, 2019, the Staff issued another staff legal bulletin to provide further guidance on Rule 14a8-(i)(7) – the “ordinary business” exception, allowing a company to exclude a shareholder proposal that “deals with a matter relating to the company’s ordinary business operations.” The new guidance addresses:

  • board analysis provided in no-action requests to demonstrate that the policy issue raised by the proposal is not significant to the company;
  • proof of beneficial ownership letters;
  • the scope and application of “micromanagement” as a basis to exclude a proposal; and, more generally,
  • the analytical framework of Rule 14a-8(i)(7).

Testing the Waters for All—New Rule 163B Expands TTW to All Issuers

By Anna Pinedo, Mayer Brown

On September 26, 2019, the SEC extended the ability to test the waters to all issuers by adopting the highly anticipated new Rule 163B under the Securities Act of 1933 (the Securities Act). The new rule allows any issuer, or any person acting on the issuer’s behalf, to engage in test the waters communications with potential investors that are reasonably believed to be institutional accredited investors (IAIs) and qualified institutional buyers (QIBs), either prior to or following the date of filing of a registration statement relating to the offering, without violating the Securities Act’s “gun jumping” rules. Prior to Rule 163B, testing the waters was limited to emerging growth companies (EGCs) only.

Rule 163B extends Securities Act Section 5(d)’s testing-the waters provisions to all issuers and permits any issuer, or any person authorized to act on its behalf, to engage in oral or written communications with potential investors that are, or are reasonably believed by the issuer to be, QIBs or IAIs, either prior to or following the filing of a registration statement, to determine whether such investors might have an interest in a contemplated registered securities offering. The rule provides an exemption from Section 5(b)(1) and Section 5(c) of the Securities Act for such communications. The adopting release also amends Rule 405 to exclude communications used in reliance on either Rule 163B or Section 5(d) from the definition of free writing prospectus. 

Rule 163B contains no legend or filing requirements, but does require that testing-the-waters communications not conflict with information in the registration statement for the related offering. Although the SEC acknowledged that “circumstances or messaging” may change between the time a pre-filing Rule 163B communication is made and the time a registration statement is filed, statements made in any Rule 163B communications must not contain material misstatements or omissions at the time such statements are made. Rule 163B is non-exclusive, meaning an issuer could also rely on other exclusions or exemptions to the gun-jumping rules when determining how to communicate about a potential securities offering. 

The adopting release makes clear that communications benefiting from Rule 163B are considered offers under the Securities Act and are subject to liability under Section 12(a)(2) under the Securities Act or anti-fraud provisions such as Rule 10b-5 under the Securities Exchange Act of 1934, as amended (the Securities Exchange Act). 

SEC Proposes Update of Statistical Disclosures for Bank and Savings and Loan Registrants, Replacing Industry Guide 3

By Anna Pinedo, Mayer Brown

On September 17, 2019, the SEC proposed rules to update the statistical disclosures that banks and loan registrants provide to investors, and eliminate disclosures that overlap with SEC rules, U.S. GAAP or IFRS.  The proposed rules would replace Industry Guide 3, Statistical Disclosure by Bank Holding Companies, with updated disclosure in a new subpart of Regulation S-K.  SEC Chairman Jay Clayton noted that Industry Guide 3 has not been substantively updated for more than 30 years.  The SEC’s proposed rules, which would apply to bank holding companies, banks, savings and loan holding companies, and savings and loan associations, would update disclosures that investors receive, codify certain Guide 3 disclosure and eliminate other Guide 3 disclosure.  The proposed rules would require disclosure about the following:

  • Distribution of assets, liabilities and stockholders’ equity, the related interest income and expense, and interest rates and interest differential;
  • Weighted average yield of investments in debt securities by maturity;
  • Maturity analysis of the loan portfolio including the amounts that have predetermined interest rates and floating or adjustable interest rates;
  • An allocation of the allowance for credit losses and certain credit ratios; and
  • Information about bank deposits including amounts that are uninsured.

The proposal will have a 60-day public comment period following its publication in the Federal Register.  The SEC’s Fact Sheet and the proposing release provide additional information.

Proposed Changes to Rule 15c2-11

By Anna Pinedo, Mayer Brown

One of the SEC’s priorities under Chair Clayton’s leadership has been protection of retail investors, including through rigorous enforcement of microcap fraud.  Consistent with that focus, yesterday, the Commission released proposed amendments to Securities Exchange Act Rule 15c2-11.  This rule requires that certain issuer information be made available to and be reviewed by broker-dealers before broker-dealers publish quotes for the issuer’s securities on the OTC market.  The proposed changes would update the rule and impose stricter requirements by removing certain exemptions that are currently available.  The proposed rule would require that broker-dealers receive and review issuer information that is current and that is publicly available.  A broker-dealer would not be able to continue to provide quotes on a security (such as under the current “piggyback exemption”) if the issuer information is not current and not publicly available.  Under the proposed rule, broker-dealers would not be permitted to continuously quote prices for the securities of shell companies.  New exceptions would be made available under the proposed rule to broker-dealers in instances where there is current public information available about an issuer and there is less risk of potential market manipulation.  The Commission also solicits comments on “information repositories.”  Chair Clayton’s public statements are available here and the fact sheet is available here.  The proposed rule and concept release is available here.

SEC Issues Proposing Release to Further Modernize Certain Regulation S-K Disclosures

By Rani Doyle

In its continuing Disclosure Effectiveness work to modernize its disclosure requirements, the SEC proposed on August 8, 2019 to amend Regulation S-K rules regarding the issuer’s disclosures about its business (S-K Item 101), legal proceedings (S-K Item 103), and risk factors (S-K Item 105). The goal of the amendments, the SEC states, is to improve the readability of disclosure documents, as well as discourage repetition and disclosure of information that is not material.

The proposed amendment of Item 101(a) would:

  • make it largely principles-based by providing a non-exclusive list of the types of information that a registrant may need to disclose, and by requiring disclosure of a topic only to the extent such information is material to an understanding of the general development of a registrant’s business;
  • include as a listed disclosure topic, to the extent material to an understanding of the registrant’s business, transactions and events that affect or may affect the company’s operations, including material changes to a registrant’s previously disclosed business strategy;
  • eliminate a prescribed timeframe for this disclosure; and
  • permit a registrant, in filings made after a registrant’s initial filing, to provide only an update of the general development of the business that focuses on material developments in the reporting period, and with an active hyperlink to the registrant’s most recent filing that, together with the update, would contain the full discussion of the general development of the registrant’s business.

The proposed amendment of Item 101(c) would:

  • clarify and expand its principles-based approach, by including disclosure topics drawn from a subset of the topics currently contained in Item 101(c);
  • include, as a disclosure topic, human capital resources, including any human capital measures or objectives that management focuses on in managing the business, to the extent such disclosures would be material to an understanding of the registrant’s business, such as, depending on the nature of the registrant’s business and workforce, measures or objectives that address the attraction, development, and retention of personnel; and
  • refocus the regulatory compliance requirement by including material government regulations, not just environmental provisions, as a topic.

The proposed amendment of Item 103 would:

  • expressly state that the required information about material legal proceedings may be provided by including hyperlinks or cross-references to legal proceedings disclosure located elsewhere in the document in an effort to encourage registrants to avoid duplicative disclosure; and
  • revise the $100,000 threshold for disclosure of environmental proceedings to which the government is a party to $300,000 to adjust for inflation.

The proposed amendment of Item 105 would:

  • require summary risk factor disclosure if the risk factor section exceeds 15 pages;
  • refine the principles-based approach of that rule by changing the disclosure standard from the “most significant” factors to the “material” factors required to be disclosed; and
  • require risk factors to be organized under relevant headings, with any risk factors that may generally apply to an investment in securities disclosed at the end of the risk factor section under a separate caption.

The comment period expires on October 22, 2019.

2019 ISS Global Policy Survey

By Bella Zaslavsky, K&L Gates LLP

Institutional Shareholder Services Inc. (ISS) released the results of its 2019 Global Policy Survey (2019 Survey) on September 11, 2019. The 2019 Survey solicits feedback from institutional investors, corporate executives, board members, among others, regarding areas of potential policy change for 2020 and beyond. Of the 396 respondents, 128 were investors (of which 88 represent asset managers, 23 represent asset owners, and 4 represent both) and 268 were non‑investors (of which 227 were public companies, 19 were advisors, and 6 were public company board members). The 2019 Survey focused on topics like gender diversity, overboarding, combined CEO and chair roles, sunsets on multi-class capital structures, quantitative pay-for-performance and climate change risk. Some highlights below:

  • Diversity (US): Most responders consider gender diversity to be an important for board composition, with only 3% of investor and non-investor responders indicating that is not a significant factor.
  • Overboarding (Global): Revisiting the 2015 topic of how many boards are too many boards for directors to sit on, a plurality of investors (42%) responded that 4 total board seats is the limit for non-executive directors, while a plurality of non-investors prefer no limit (39% with respect to non-executive directors and 36% for executive directors). The investor numbers change slightly when it comes to executive directors, with a 45% plurality of investors preferring a 2 seat maximum for executive directors.
  • Combined CEO/Chair (US): The U.S. continues to be ambiguous on the best method for achieving independent board leadership. The ISS survey, instead, focused on what factors responders indicated the need for an independent board chair. Among the highest factors ranked by investors and non-investors were: poor responsiveness to shareholder concerns, a weakly-defined lead director role, and a corporate crisis.
  • Climate Change Risk (Global): Investors and non-investors are split the on how important a role climate change should play in a companies’ risk assessments, although it is important to note that only 5% of investors and 11% of non-investors thought that the risks are too uncertain to be incorporated into risk-assessment models. A majority (60%) of investors feel that it should be assessing and disclosing climate-related risks, while a majority (68%) of non-investors believe it should be one among a number of company-specific factors to be considered.

NYC Comptroller Launches “Boardroom Accountability Project 3.0” Calling on Companies to Adopt the “Rooney Rule” in Searches for New Board Directors and CEOs

By Rani Doyle

The influential NYC Comptroller Scott M. Stringer issued a press release on October 11, 2019 and sent a letter on October 10, 2019 to 56 S&P 500 companies to adopt a “Rooney Rule” policy for director and CEO searches. The “Rooney Rule” derives from the NFL and, in that context, requires teams to interview minority candidates for head coaching, general manager jobs and equivalent front office positions. In looking to have companies adopt the “Rooney Rule” for director and CEO searches, the Comptroller is seeking “to make meaningful, long-lasting, and structural change in the market practice so that women and people of color are welcomed in the door and open for every open director seat as well as for the job of CEO.” Past initiatives of the NYC Comptroller have had broad influence on the S&P 500. 

Executive Compensation

Executive Compensation Decisions Benefiting a Controlling Stockholder Are Subject to Entire Fairness Review Even If Ratified by Stockholders

By Lisa R. Stark, K&L Gates LLP

In a recent decision, challenging Tesla’s performance-based compensation plan for its CEO, Elon Musk, the Delaware Court of Chancery held that executive compensation decisions which benefit a controlling stockholder are subject to entire fairness review even if the executive compensation has been ratified by the corporation’s stockholders.  Musk’s compensation package, which was valued at up to $55.8 billion, was approved by Tesla’s board and stockholders in 2018 and subsequently challenged by a Tesla stockholder as a breach of fiduciary duty.  Defendants moved to dismiss plaintiff’s complaint, arguing that stockholder ratification of the executive compensation plan invoked the deferential business judgment standard of review.  The Court disagreed, finding that executive compensation decisions like any other transaction between a corporation and a controller is subject to entire fairness review absent robust procedural protections.  Specifically, the Court held that under the Delaware Supreme Court’s holding in Kahn v. M&F Worldwide Corp, a board may invoke business judgement review of executive compensation decisions benefiting a controller only if the executive compensation is conditioned on approval by (1) an independent special committee, and (2) a fully informed, disinterested majority of the minority stockholders. 

Private Equity and Venture Capital

Court Finds Venture Capital Investors Are Not Control Group

By Melissa Sanders, Fox Rothschild LLP

The Delaware Court of Chancery recently rejected a claim that a group of venture capital investors were a controlling shareholder group who owed fiduciary duties to a company’s minority shareholders.  The venture capital investors in Sheldon v. Pinto Technologies Ventures collectively owned 60% of the stock of the company.  Plaintiffs claimed that because the investors collectively owned sufficient stock to control the company, the group of investors should be considered a control group.  The plaintiffs attempted to rely on prior precedent involving investors who had co-invested in a number of investments over a 20-year period and who had declared themselves as an investor group to the SEC.  However, in Sheldon there was no such history of concerted investments.  The court found that the investors in the Sheldon case were more like shareholders in cases where no control group was found.  In those cases, groups of shareholders may have shared an interest in voting in a certain manner but did not have any agreement to vote as a group on general matters.

Limitation on Board Observer Liability

By Melissa Sanders, Fox Rothschild LLP

In Obasi Inv., Ltd. v. Tibet Pharmaceuticals, Inc. et al, the U.S. Court of Appeals provided guidance on the liability that may be imposed on investor-appointed board observers and directors.  The plaintiffs argued that the board observers were akin to directors and therefore liable for omissions in the company’s registration statement.  The plaintiffs relied on language in Section 11 of the Securities Act that imposes liability on directors and those “performing similar functions.”   In holding that the observers were not liable under Section 11, the court distinguished the roles of observers and directors.   The three key differences the court focused on were: (1) the inability of observers to vote on board actions, (2) the observers’ loyalties were to placement agents rather than shareholders, and (3) unlike board members, observers cannot be removed by the shareholders.  The court noted that observers might be considered directors in other contexts, such as insider trading actions.






Rani Doyle

Rani Doyle

Managing Editor, Securities Law

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