CURRENT MONTH (October 2020)

 Securities Regulation

SEC Amends Auditor Independence Rules

By Thomas White, WilmerHale, Retired Partner

On October 16, the Securities and Exchange Commission adopted amendments to its rules governing independence of accounting firms that audit US publicly-traded companies.  The final amendments largely follow the SEC’s proposed amendments (see January 2020 Month-in-Brief), with modifications in certain areas.  According to SEC Chairman Jay Clayton, “These modernized auditor independence requirements will increase investor protection by focusing audit clients, audit committees, and auditors on areas that may threaten an auditor’s objectivity and impartiality.  They also will improve competition and audit quality by increasing the number of qualified audit firms from which an issuer can choose.”

Most notably, the 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 an audit client” and “investment company complex” to only encompass sister entities that are material to both the entity under audit and the controlling entity.

Other amendments to the SEC’s independence rules 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.  The amendments also modify the standard for determining when an accountant’s business relationship with stockholders of an audit client may impair independence.

SEC Commissioners Allison Lee and Caroline Crenshaw dissented, principally on the ground that the revised definitions of affiliate of the audit client gave too much discretion to auditors to decide what control relationships were “material.”

SEC Proposes Conditional Exemption from Broker Registration for Individual Finders

By Melissa Sanders, Fox Rothschild LLP

The SEC recently proposed an exemption that would allow individual finders to receive transaction-based compensation when assisting in private company capital raises without registering as brokers, as long as the conditions of the exemption are met.  The exemption would help facilitate capital raises for small issuers that may not have access to many capital raising resources, according to SEC Chairman Jay Clayton.  The exemption would create two categories of finders – Tier I Finders and Tier II Finders – and would apply only where all investors are accredited investors.  To qualify for the exemption, Finders would only be able to undertake certain enumerated limited actions.  Tier I Finders could only provide contact information of potential investors to issuers and would not be able to engage in communications with the potential investors or provide any other assistance related to the capital raise.  Tier II Finders would be allowed to take a more active role, such as sending offering materials prepared by the issuer to potential investors.  However, even Tier II finders would be prohibited from taking a number of actions, such as providing valuation advice or preparing sales materials.  Tier II Finders would also be subject to disclosure requirements, including disclosing his or her role and compensation to potential investors, and obtaining a written acknowledgment of the disclosure from each investor. 

California Requires Representation of Underrepresented Communities on Public Company Boards

By Bella Zaslavsky, K&L Gates LLP

On September 30, 2020, California Governor Gavin Newsom signed California Assembly Bill No. 979 into law, requiring that California-based publicly traded companies (regardless of their places of incorporation) have a minimum number of directors from underrepresented communities on their boards.  Much like California’s 2018 board gender diversity law, the new statute is the first state or federal law to mandate this type of board representation.

Underrepresented communities are defined broadly under the new law, including individuals that self‑identify as Black, African American, Hispanic, Latino, Asian, Pacific Islander, Native American, Native Hawaiian, or Alaska Native, gay, lesbian, bisexual, or transgender. The law does not specify whether a director can satisfy both the underrepresented community diversity requirement and the gender diversity requirement.

The law requires that there be at least one director from an underrepresented community on a California-based company board by no later than the end of 2021. By the end of the 2022, any such company must have:

  • at least one diverse director, if its number of directors is four or fewer;
  • at least two diverse directors, if its number of directors is more than four but fewer than nine; or
  • at least three diverse directors, if its number of directors is nine or more.

Beginning March 1, 2022, the California Secretary of State will be required to publish an annual report documenting the number of publicly held corporations that (1) were in compliance with the requirements of the new law during at least one point during the preceding calendar year; (2) moved their U.S. headquarters into or out of California in the preceding calendar year; and (3) were subject to the new law during the preceding calendar year but are no longer publicly traded.

Fines associated with violations will range from $100,000 for a first violation and $300,000 for a subsequent violation, and $100,000 for failure to timely file board member information.

Proposed Changes to NYSE Shareholder Approval Rules

By Brian Hirshberg, Mayer Brown

On October 6, 2020, the New York Stock Exchange (“NYSE”) filed a proposed rule amendment in order to seek approval to amend certain of the shareholder approval requirements set forth in Section 312 of the NYSE Listed Company Manual. Paragraphs (b) and (c) of Section 312 require NYSE-listed companies to obtain shareholder approval prior to certain equity issuances. The proposed changes would bring the NYSE’s shareholder approval rules into closer alignment with those of Nasdaq and the NYSE American.

Section 312.03(b) requires shareholder approval for certain issuances of common stock to specified related parties.  This approval is required if the shares to be issued exceed 1% of the shares outstanding before the issuance. However, a limited exception permits sales to related parties that are only substantial security holders of the issuer so long as no more than 5% of outstanding shares are issued and the shares are issued at no less than the minimum price. The NYSE proposes to amend this rule to limit the class of related parties that would require shareholder approval. Section 312.03(b) as amended would require prior shareholder approval only for sales to directors, officers and substantial security holders and would no longer require approval for sales to such related party’s subsidiaries, affiliates or other persons closely related or to entities in which a related party has a substantial interest.  Further, Section 312.03(b) as amended would no longer require shareholder approval of issuances of more than 5% of outstanding shares to a related party so long as they are issued at a minimum price. Instead, the NYSE proposes to require that any listed company obtain shareholder approval for a transaction in which a director, officer or substantial security holder has a 5% or greater interest (or such persons collectively have a 10% or greater interest) in the company or assets to be acquired or in the consideration to be paid in the transaction and the issuance of shares could result in an increase in outstanding shares of 5% or more.

Section 312.03(c) requires shareholder approval of any issuance of 20% or more of outstanding shares before such issuance, excluding (i) any public offering; or (ii) any bona fide private financing (defined as no one purchaser acquiring more than 5% of outstanding shares) that complies with a minimum price requirement. The NYSE proposes to replace the reference to “bona fide private financing” with “other financing in which the company is selling securities for cash.” This change would effectively eliminate the 5% limit for any single purchaser but retain the minimum price requirement.  The NYSE has provided COVID relief for listed companies with respect to this rule, as discussed in our prior posts.  

See the NYSE’s proposed rule set forth here.

SEC Enforces Effective Controls on 10b5-1 Share Repurchase Plans 

By Mark L. Johnson, Madeline A. Moore, Bella Zaslavsky, K&L Gates LLP 

Historically, companies engaging in stock buybacks have relied on Rule 10b5-1, coupled with Rule 10b-18, in order to avoid civil and criminal liability related to insider trading prohibitions. Specifically, Rule 10b51 offers an affirmative defense to insider trading. Through its novel enforcement order against San Antonio-based petroleum refining company, Andeavor LLC, the Securities and Exchange Commission (“SEC”) took the position that Rule 10b5-1 share repurchase plans are also subject to the internal accounting controls provisions of Section 13(b)(2)(B) of the Securities Exchange Act of 1934. 

On October 15, 2020, the SEC announced that it settled charges against Andeavor for controls violations related to a Rule 10b5-1 plan to implement a share repurchase plan, while at the same time undergoing discussions to be acquired by Marathon Petroleum Corp. Andeavor relied on existing board authorization to implement a Rule 10b5-1 share repurchase plan, pursuant to which it repurchased 2.6 million shares of stock from investors. Approximately six weeks after initiating, and two weeks after completing, the buyback at an average price of $97 per share, Andeavor and Marathon agreed to the acquisition of Andeavor by Marathon in a deal valuing Andeavor stock at over $150 per share.  

Rather than focusing on Andeavor implementing a 10b5-1 plan at a time when it possessed material nonpublic information  ̶ a clear violation of insider trading laws—the SEC instead charged Andeavor with failure to devise and maintain an effective system of internal accounting controls to sufficiently implement its Rule 10b5-1 share repurchase plan. Specifically, the SEC found that Andeavor lacked an effective process for obtaining an accurate and complete understanding of the facts and circumstances necessary to determine whether it was in compliance with its existing internal policy that prohibited the company from buying, or entering into a Rule 10b5-1 plan to buy, its securities while in possession of material non-public information at the time the share repurchase was initiated.  

Going forward, companies looking to implement share repurchase plans in reliance on Rule 10b5-1 will need to ensure compliance with both insider trading laws and the adequacy of their internal accounting controls in managing risk and diminishing the occurrence of fraud. To that end, the SEC emphasized that for internal accounting controls to be both sufficient and effective, they must be combined with documented procedures created by management that are consistently monitored and properly maintained for compliance. One of the key aspects of proper implementation of internal accounting controls is accurate communication of information among company management.  



Rani Doyle

Rani Doyle

Managing Editor, Securities Law

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