CURRENT MONTH (September 2021)

Securities Regulation

SEC Staff Scrutiny of Climate Change Disclosures Has Arrived: What to Expect and How to Respond

By Andrew Fabens, Brian Lane, Courtney Haseley, Elizabeth Ising, James Moloney, Lori Zyskowski, Michael Titera, Thomas Kim, and Ronald Mueller, Gibson, Dunn & Crutcher

Recently, the SEC’s Division of Corporation Finance has issued a number of comment letters relating exclusively to climate change disclosure issues. The letters we have seen to date comment on companies’ most recent Form 10-K filings, including those of calendar year companies who filed their Form 10-K more than 6 months ago, and have been issued by a variety of the Division’s industry review groups, including to companies that are not in particularly carbon-intensive industries. Many of the climate change comments appear to be drawn from the topics and considerations raised in the SEC’s 2010 guidance on climate change disclosure. We expect this is part of a larger Division initiative because the letters are similar (although not identical), contain relatively generic comments, and have been issued in close proximity to one another. Accordingly, it is reasonable to expect that additional comment letters will be issued in the coming weeks and months.

The issuance of these comments and their focus comes as no surprise given that the SEC’s Chair and several commissioners have indicated that climate change disclosures are a priority. As detailed in Gibson Dunn’s client alert of June 21, 2021, the SEC also recently announced its anticipated rulemaking agenda, which includes a near-term focus on rules that would prescribe climate change disclosures.

Shortly after the initial issuances of comment letters, the Division issued a notice with an “illustrative letter” containing sample comments that the Division may continue to issue. In that notice, the SEC stated, “The sample comments do not constitute an exhaustive list of the issues that companies should consider. Any comments issued would be appropriately tailored to the specific company and industry, and would take into consideration the disclosure that a company has provided in Commission filings.”

Ninth Circuit’s Slack Decision Forges New Ground for Securities Act Liability Related to Direct Listings

By: Andrew Clubok, Susan E. Engel, Gavin M. Masuda, Matt Rawlinson and Gregory Mortenson, Latham & Watkins

On September 20, 2021, the US Court of Appeals for the Ninth Circuit issued its highly anticipated decision in the Pirani v. Slack litigation concerning stockholders’ ability to bring claims under the Securities Act of 1933 related to direct listings.

In the direct listing as described by the Ninth Circuit, Slack’s outstanding shares—both those registered pursuant to the Company’s registration statement, and those unregistered in accordance with Rule 144—were listed on the New York Stock Exchange (NYSE) beginning on June 20, 2019. Because both registered and unregistered shares of Slack stock had been made available for purchase at that time, Slack moved to dismiss Pirani’s complaint on the grounds that he could not “trace” his shares to the registration statement he was challenging.

In a published 2–1 opinion on this issue of first impression, the panel held over sharp dissent that even “unregistered shares sold in a direct listing” are actionable under Sections 11 and 12 of the Securities Act “because their public sale cannot occur without the only operative registration in existence.”

In reaching its opinion, the Ninth Circuit pointed to certain characteristics of Slack’s direct listing—most notably, that in the “direct listing, the same registration statement makes it possible to sell both registered and unregistered shares to the public.” Significantly, in reaching this conclusion, the Ninth Circuit departed from earlier Ninth Circuit and other circuit court precedent limiting “such security” under Section 11 to mean “that the person must have purchased a security issued under that, rather than some other, registration statement.” At least for a direct listing, the court held, securities fall within the reach of Section 11 so long as they are purchased after the effectiveness date of a registration statement.

In a September 27, 2021, filing with the Ninth Circuit, Slack indicated its intent to petition the court for rehearing or rehearing en banc. Slack’s petition is due on November 3, 2021.

For further analysis, please review our full Client Alert, dated September 29, 2021.

Another Caremark Case Survives a Challenge

Cydney Posner, Cooley

In re The Boeing Company Derivative Litigation, Vice Chancellor Morgan Zurn of the Delaware Court of Chancery opened her opinion this way:

A 737 MAX airplane manufactured by The Boeing Company . . . crashed in October 2018, killing everyone onboard; a second one crashed in March 2019, to the same result. Those tragedies have led to numerous investigations and proceedings in multiple regulatory and judicial arenas to find out what went wrong and who is responsible. Those investigations have revealed that the 737 MAX tended to pitch up due to its engine placement; that a new software program designed to adjust the plane downward depended on a single faulty sensor and therefore activated too readily; and that the software program was insufficiently explained to pilots and regulators. In both crashes, the software directed the plane down. The primary victims of the crashes are, of course, the deceased, their families, and their loved ones. While it may seem callous in the face of their losses, corporate law recognizes another set of victims: Boeing as an enterprise, and its stockholders.

Do the directors bear any responsibility for these losses? The question before the Court in this derivative litigation was whether the plaintiff stockholders—New York and Colorado public pension funds—had adequately alleged, under In re Caremark International Inc. Derivative Litigation and Marchand v. Barnhill, that, as a result of the directors’ “complete failure to establish a reporting system for airplane safety,” or “their turning a blind eye to a red flag representing airplane safety problems,” the board faced a “substantial likelihood of liability for Boeing’s losses.” In a 102-page opinion, the Court concluded that the answer was yes—on both bases. (Other claims regarding the company’s officers and the board’s handling of the CEO’s retirement and compensation were dismissed.)

At a certain stage in the litigation, where the Court assumes the truth of the allegations, the plaintiff “must allege particularized facts that satisfy one of the necessary conditions for director oversight liability articulated in Caremark: either that (1) ‘the directors utterly failed to implement any reporting or information system or controls’; or (2) ‘having implemented such a system or controls, [the directors] consciously failed to monitor or oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention.’” According to the Court, “a showing of bad faith is a necessary condition to director oversight liability.” The allegations must “allow a reasonable inference the directors acted with scienter which in turn ‘requires [not only] proof that a director acted inconsistent[ly] with his fiduciary duties,’ but also ‘most importantly, that the director knew he was so acting.’”

The Court agreed that the plaintiffs had stated a claim under the first prong of Caremark, which requires that the board must “make a good faith effort—i.e., try—to put in place a reasonable board-level system of monitoring and reporting.” Comparing the specific “failings” of the Boeing board to those of the board in Marchand—also a case involving “‘essential and mission critical’ regulatory compliance risk”—the Court concluded that the burden had been met. The Board, the Court said citing Marchand, has a “rigorous oversight obligation where safety is mission critical.” The Court was careful to state that the deficiencies identified in Marchand (see this PubCo post) were not necessarily “prescriptive”—directors “have great discretion to design context- and industry-specific approaches tailored to their companies’ businesses and resources’’—but rather that Marchand was “dispositive in view of Plaintiffs’ remarkably similar factual allegations.” As such, the Court then marched through the specific failures in Marchand as applied to the Boeing board, finding for the plaintiffs on certain of their claims.

No doubt a Caremark claim is still a tough claim for a plaintiff to establish. But, as Boeing shows, a board can make that claim much easier to establish if it leaves risk oversight to the discretion of management and fails to raise questions in the face of red flags. As the Court made clear, boards need to oversee compliance and monitor risks. Moreover, what Boeing, Marchand and other similar cases have underscored is the imperative of board engagement on risks that relate to mission-critical operations of the business.

To effectively carry out its responsibilities, Boeing suggests, the board needs to periodically identify key risks and challenges facing the company, especially mission-critical risks, and make a good faith effort to proactively establish reporting systems or other communication protocols that require management to report to the board on a regular basis about risk and compliance issues, especially those that are “essential and mission critical” to the company’s business. Boeing showed that Board reporting systems and protocols should be sufficiently rigorous to put boards on notice promptly in the event any mission-critical risk begins to emerge so that directors can immediately assess and monitor the situation, including the need for further response. Whether responsibility is retained at the board level or delegated to a committee dedicated to oversight of mission-critical risk, appropriate time should be allocated to monitor, review and consider any risk-related information. Care should also be taken to document board and committee consideration of risk-related information.

For further analysis, please review our full publication, dated September 15, 2021.

SEC Issues a No-Action Letter to FINRA Granting Time Relief on the Application of SEC Rule 15c2-11 to Fixed Income Securities

By Nathan Spanheimer and Steven D. Lofchie, Cadwalader Wickersham & Taft LLP

On September 24, 2021, the SEC issued a no-action letter to FINRA stating that it will not take enforcement action against member firms that do not comply with Rule 15c2-11, as amended on September 16, 2020 (the “Amended Rule“), on fixed income securities until January 3, 2022.

Rule 15c2-11 provides that a broker-dealer may not submit quotations for a security in a “quotation medium” other than a national securities exchange unless the broker-dealer is able to satisfy specified information requirements as to the security and its issuer. Rule 15c2-11, which has been effect since 1971, has by its terms always applied to fixed income securities but was never applied to debt securities. The SEC has made clear that it intends to interpret the Amended Rule as applying to debt securities. The Amended Rule compliance date is September 28, 2021. Market participants are trying to figure out how they can comply and whether it is possible to make a market for fixed income securities in light of the obligations imposed by the Amended Rule. While the SEC granted a three-month delay in enforcement as to fixed income securities, the SEC’s letter did not address whether the Commission might reconsider its decision to apply Rule 15c2-11 as to fixed income securities, whether in whole or in part.

For further analysis, please review our full publication, dated September 24, 2021.

PCAOB Approves Rule Implementing Holding Foreign Companies Accountable Act

By: Thomas W. White, Retired Partner, WilmerHale

In May of this year, the Public Company Accounting Oversight Board proposed a rule to govern the determinations it is required to make under the Holding Foreign Companies Accountable Act (HFCAA). (See our prior note on the proposed rule.) The HFCAA requires the Securities and Exchange Commission to prohibit trading in companies that are audited by foreign public accounting firms that the PCAOB has determined it is unable to inspect or investigate completely due to a position taken by a foreign jurisdiction. The SEC is required to prohibit trading of the securities of a covered issuer’s securities after the PCAOB has been unable to inspect or investigate completely the issuer’s auditor for three consecutive years.

On September 22, the PCAOB adopted a final rule that largely follows the proposed rule, with some technical modifications. As adopted, the rule contains various technical and procedural provisions, but the key substantive provision is the enumeration of factors that will govern the PCAOB’s determinations regarding whether it is unable to inspect or investigate a foreign registered firm completely. The PCAOB will assess whether a foreign jurisdiction’s position impairs its ability to conduct inspections or investigations in one or more of the following respects:

  • The PCAOB’s ability to select engagements, audit areas, and potential violations to be reviewed or investigated;
  • The PCAOB’s access to, and ability to retain and use, documents or information possessed or controlled by a foreign firm or its associated persons that the PCAOB considers relevant to an inspection or investigation; and
  • The PCAOB’s ability to conduct inspections and investigations in a manner consistent with the Sarbanes-Oxley Act and the PCAOB’s rules, as it interprets and applies them.

Notably, the PCAOB expects that in most cases it will make the determination on a jurisdiction-wide basis, applicable to all foreign firms headquartered in the jurisdiction; however, the PCAOB may also make a determination as to a particular firm that has an office in a jurisdiction in which the PCAOB is unable to inspect or investigate the firm completely.

The final rule is subject to SEC approval.

SEC Chair Gensler Provides Testimony Before the U.S. Senate Committee on Banking, Housing, and Urban Affairs

By Rani Doyle, EY*

SEC Chair Gary Gensler provided testimony to the Committee on Banking, Housing, and Urban Affairs on September 14, 2021. His testimony opened with praise of the U.S. capital markets, which he noted “represent 38 percent of the globe’s capital markets . . . [exceeding] even our impact on the world’s gross domestic product, where we hold a 24 percent share.”

In his testimony, Chair Gensler noted, among other points, that he asked SEC staff to look at five market structure–based projects across the U.S. capital markets, including:

  • Treasury, with SEC staff asked to (i) work with colleagues at the Department of the Treasury and the Federal Reserve on enhancing resiliency and competition in the treasury market and (ii) reconsider some initiatives on Treasury trading platforms.
  • Equity, with SEC staff asked to (i) provide recommendations on facilitating competition and efficiency on an order-by-order basis and (ii) put together a draft proposal on shortening the standard settlement cycle.
  • Security-Based Swaps, with SEC staff asked to (i) finalize rules for the registration and regulation of security-based swap execution facilities and (ii) consider potential rules under the SEC’s authority to mandate disclosure for positions in security-based swaps and related securities.
  • Crypto Assets, with SEC staff asked to work with other financial regulators to bring investor protection to crypto finance, issuance, trading and lending, including on a broader set of policy frameworks in addition to the SEC’s current regulatory framework.

Chair Gensler remarked that SEC staff has also been asked to:

  • Develop proposals for issuer disclosure requirements on the topics of climate risk, human capital and cybersecurity.
  • Provide recommendations on how the SEC “might tighten” Rule 10b5-1 to “modernize [that] 20-year-old safe harbor and fill perceived gaps in our insider trading regime.”

Chair Gensler also noted developments in the funds and investment management space and in the SEC’s enforcement and examination programs.


Rani Doyle

Rani Doyle

Managing Editor, Securities Law

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