Disclosure Requirements

On Tuesday, July 25, 2017, SEC Chairman Jay Clayton spoke at the U.S. Chamber of Commerce Center for Capital Markets Competitiveness (CCMC). During the panel, Chairman Clayton discussed the Commission’s priorities on a variety of issues.

Bad Actors/Retail Fraud. Chair Clayton noted the substantial costs of the effects of a bad actor and the costs of restoring faith in our capital markets. He also made it clear that there would be no tolerance for retail fraud under his tenure.

Enforcement. Chair Clayton noted that the Commission has increased the use of data to determine more effective ways to target exams, taking into consideration to whom to issue an exam, how to conduct the exam and whether the Commission is being effective in these examinations.

Proxy Reports/Disclosure Effectiveness. Chairman Clayton noted that adding disclosure does not signal better disclosure. The Chairman stressed that disclosure should be written to protect the investor rather than be written in case of a court appearance.

Reduction in Number of Public Companies. The Chairman stressed that the Commission would not do anything to inhibit private capital formation. He cited a recent meeting with a number of small- and mid-cap companies where they discussed the timing of their respective IPOs. Chairman Clayton noted that having both a healthy public capital market and a private equity market provides companies with financing options, facilitates capital formation and provides healthy and necessary market competition.

Lifecycle of a Company. Chairman Clayton referenced that, in the past, the general public used to be able to participate in the growth of a company, but in our current environment, Main Street has a limited ability to participate. He noted that it is difficult to offer private investment opportunities to individual investors in a cost effective way.

Effectiveness of the U.S. Capital Markets. The Chairman noted that the U.S. capital markets are efficient for large-cap companies, but Chairman Clayton noted that there is room for improvement for mid- and small-cap companies. The Chairman outlined a number of factors affecting the effectiveness of the U.S. capital markets for smaller companies, including liquidity in the secondary trading markets and the costs of being a public company.

Costs of Compliance. Chairman Clayton acknowledged the Commission’s need to keep in mind the costs of compliance when writing rules, given that compliance can be very costly depending on how the rule is written.

Pay Ratio Rule. The Chairman noted that the Commission will be reviewing the rule but recognizes that the compliance date is coming.

Best Interest Standard. The Chairman directly stated that he would be disappointed if there were any reductions in choices for the individual investor relating to the best interest standard. The Chairman noted that, with the DOL’s Fiduciary Rule on the books, having differing standards for individual investors would not make sense. He then noted that the market would benefit from greater clarity on this issue. Chairman Clayton stressed that the Commission wants the best for the main street investor and is hopeful that common ground exists between the DOL and the Commission’s mandates.

Coordination Among Domestic Regulators. Chairman Clayton acknowledged the cooperative nature between the Commission and other domestic regulators such as FSOC and the CFTC. The Chairman stressed, however, that there should be no gaps between the various regulatory rules, no duplication and that regulators should not be asking for the same information in different ways. He noted that his colleagues at the other regulators share this view. Specifically, the Chairman confirmed that the Commission is engaged with the CFTC on this issue, given that these two entities oversight sometimes overlaps.

Cyber Security. The Chairman stressed that coordination among regulators is very important when it comes to cyber security and that regulators should be developing standards in order to effectively respond to these incidents. He acknowledged that fellow regulators are very open to cooperation and indeed see the need for this cooperation. The Chairman also addressed the issue of punishing victims of a cyber attack. He noted that if a company was acting responsibly in terms of protections and disclosures, regulators should not be punishing them for being victims.

International Harmonization. Chairman Clayton noted that it is part of the Commission’s mission to handle international coordination of regulation as more U.S.-based companies become global companies and participants. The Chairman specifically acknowledged the Commission’s preparation for the implementation of MiFIID II and for any issues that might arise from the rule.

Materiality. Chairman Clayton also touched on the issue of materiality during the Q&A portion. The Chairman noted that having a flexible materiality standard is useful given that, when a court is determining materiality, the determination is reflective of the substantial difference between certain projects.  In this instance, the Chairman was referencing the municipal bond space when discussing materiality.

In closing, the Chairman thanked former Chairman of the Commission Mary Joe White and Commissioner Michael Piwowar for their service.

Recently, the SEC’s Office of Investor Advocate released the report it is required to file with the Committee on Banking, Housing and Urban Affairs of the U.S. Senate and the Committee on Financial Services of the House of Representatives.  In the report, the Office outlines its objectives for the 2018 fiscal year.

The report notes that the Office anticipates that the SEC will continue to advance the Disclosure Effectiveness initiative and intends to contribute to the SEC’s work in this area in order to update disclosure rules.

The report also discusses what it refers to as “the phenomenon of fewer initial public offerings,” and notes that that evidences suggests that disclosure and other related burdens do not account for the downturn in IPOs.  The report notes various studies that attribute the downturn to other causes.  For example, the report discusses the lack of institutional demand for smaller companies and the increased dominance of institutional investor participation (over retail participation) in the markets.  The report cites another study that attributes the decline to evidence that the benefits of being public have declined as significant capital has become available through private markets.  The report notes that the Office intends to focus on understanding better the dynamics of the public and private markets, including the demand of institutional investors for smaller company shares.

The full report is accessible here.

Many groups have come forward in recent weeks with their lists of regulations that should be reviewed or amended, as well as their list of areas that merit close review in light of the potential burdens that may be imposed by current regulation.  As far as securities regulation is concerned, much of the focus, at least in the popular press, has been placed on measures that relate to IPOs; however, modest changes in other areas would have a positive impact on capital formation—here is our current list:

  • Adopting the proposed amendments relating to smaller reporting companies;
  • Continuing to advance the disclosure effectiveness initiative;
  • Continuing the review of the industry guides in order to modernize these requirements and eliminate outdated or repetitive requirements;
  • Revisiting the WKSI standard in order to see if similar accommodations and offering related flexibility should be made available to a broader universe of companies;
  • Reviewing existing communications safe harbors in order to modernize these and make communications safe harbors available to a broader array of companies, including business development companies;
  • Adopting the proposed amendment to Rule 163(c) that would allow underwriters or other financial intermediaries to engage in discussions on a WKSI’s behalf relating to a possible offering;
  • Assessing whether a policy rationale remains for including MLPs within the definition of “ineligible issuer” when MLPs undertake public offerings on a best efforts basis;
  • Assessing who suffers when ineligible issuers are prevented from using FWPs other than for term sheet purposes;
  • Removing the limitations that require certain issuers to conduct live only roadshows;
  • Eliminating the need for “market-maker” prospectuses;
  • Reviewing the one-third limit applicable to primary issuances off of a shelf registration statement for certain smaller companies;
  • Modernizing the filing requirements for BDCs, permitting access equals delivery for BDCs and modernizing the research safe harbors to include BDCs;
  • Adding knowledgeable employees to the definition of accredited investor;
  • Eliminating the IPO quiet period;
  • Working with the securities exchanges to review their “20% Rules” (requiring a shareholder vote for private placements completed at a discount that will result in an issuance or potential issuance of securities greater than 20% of the pre-transaction total shares outstanding);
  • Addressing the Rule 144 aggregation rules for private equity and venture capital fund related sales;
  • Shortening the Rule 144 holding period for reporting companies;
  • Including sovereign wealth funds and central banks within the definition of QIBs;
  • Shortening the 30-day period in Rule 155; and
  • Shortening the six-month integration safe harbor contained in Regulation D.

Below, a continuation of our bibliography of thought-provoking articles on issues related to right-sizing regulation, staying private versus going public, and related topics:

The JOBS Act:  Unintended Consequences of the “Facebook Bill,” Tyler Adam, 9 Hastings Bus L.J. 99.  This article discusses the effects of the changes to the Exchange Act Section 12(g) threshold, essentially making it easier for companies to remain private, defer IPOs, and limit their disclosure requirements.

The Law and Economics of Scaled Equity Market Regulation, Jeff Schwartz, 39 J. Corp. L. 347.  This article questions the case for reduced disclosure requirements for smaller or entrepreneurial companies and suggests a framework for evaluating regulatory relief and the costs of securities regulation.

Fool’s Gold, Abraham J.B. Cable.  This article considers whether employees in startup or entrepreneurial companies, for whom stock-based compensation may constitute a significant percentage of overall compensation, are well-equipped to evaluate the risks and rewards of their investment in such companies and the related regulatory implications.

Thursday, April 20, 2017
1:00 p.m. – 2:00 p.m. EDT

During this session, we will review the benefits and accommodations available to foreign private issuers, or non-U.S. domiciled companies, that choose to access the U.S. capital markets. We will discuss assessing status as a foreign private issuer, the initial and ongoing disclosure requirements for foreign private issuers, liability considerations, and related topics. The speakers also will address important recent developments significant to foreign private issuers, including:

  • Recent Staff guidance regarding the foreign private issuer definition;
  • Areas of focus for SEC comments, including the use of non-GAAP measures;
  • Corporate governance developments;
  • Exhibits, HTML and XBRL for foreign private issuers and IFRS filers; and
  • Areas of likely SEC focus, including potential rollback of certain specialized disclosure requirements, the disclosure effectiveness initiative and related matters.

Speakers:

For more information, or to register, please click here.

Please contact cmg-events@mofo.com for a promotional code for 25% off tuition.

Wednesday, April 26, 2017
11:00 a.m. – 12:30 p.m. EDT

After the 2016 decline in the number of U.S. initial public offerings (IPOs), commentators questioned whether the trend toward companies deferring initial public offerings and remaining private longer would be a new norm.  Already this year’s IPO market appears to be rebounding.  During the session, the presenters will discuss:

  • Whether cross-over (or late stage) private rounds still remain an important milestone on the road to the IPO;
  • U.S. IPO activity (sectors, VC- and PE-backed companies, foreign private issuer activity, syndicate structures);
  • Disclosure and governance trends among IPO issuers;
  • Dual track processes and the legal and business considerations;
  • Multiple share classes; and
  • Other developments.

Speakers:

CLE credit is pending for California and New York.

For more information, or to register, please click here.

At today’s Practising Law Institute SEC Speaks annual program, Acting Chair Piwowar made opening remarks.  During his wide-ranging discussion, Acting Chair Piwowar, inspired by William Graham Sumner’s the “forgotten man” referred throughout to the Securities and Exchange Commission’s investor protection mission and the objective of keeping in mind the interests of the “forgotten investor.”  Piwowar commented on the Commission’s focus on effective disclosure requirements and the need to be guided by the concept of materiality in formulating disclosure requirements.  He pointed to various specialized disclosure requirements introduced by the Dodd-Frank Act, including the resource extraction, conflict minerals and related matters.  Piwowar noted the importance of avoiding disclosure overload.  Piwowar also commented on Regulation D and questioned the utility of applying the “accredited investor” standard as a means of identifying individual investors that do not require the protection of the disclosures associated with registered offerings.

Providing a glimpse into upcoming actions, Piwowar noted that the Commission will consider whether to propose a request to comment on the requirements of Industry Guide 3 for offerings by financial services companies, consideration of a final rule requiring registrants that file registration statements and periodic and current reports that are subject to the exhibit requirements under Item 601 of Regulation S-K, or that file on Forms F-10 or 20-F, to include a hyperlink to each exhibit listed in the exhibit index of these filings and in order to enable the inclusion of such hyperlinks, to require that registrants submit all such filings in HTML format (see the proposed rule:  https://www.sec.gov/rules/proposed/2016/33-10201.pdf), a proposed rule relating to the use of inline XBRL data in filings, and amendments to Rule 15c2-12 relating to muni disclosures.

The use of non-GAAP financial measures by public companies continues to be an area of growing concern for the Securities and Exchange Commission (“SEC”). Since the staff of the SEC’s Division of Corporation Finance (the “Staff”) released its updated Compliance and Disclosure Interpretations on May 17, 2016, on the use of non-GAAP financial measures (the “Updated C&DIs”), the Staff has issued more than 200 comment letters related to non-GAAP financial measures that have become publicly available.

In this alert, we look at common themes or areas of concern identified by the Staff in these comment letters, as well as responses given by registrants. We also highlight pronouncements by senior members of the Staff on the important “critical gatekeeper” role audit committee members play in ensuring credible and reliable financial reporting, including compliance with the Updated C&DIs. Finally, we look at industry initiatives aimed at improving the dialogue among management, audit committee members, external auditors and other stakeholders with respect to the use and disclosure of non-GAAP financial measures.

Read our Practice Pointers: Anticipating and Addressing SEC Comments on Non-GAAP Financial Measures.

In a recent letter, the Chamber commented to the SEC’s Advisory Committee on Small and Emerging Companies about the Committee’s consideration of the factors affecting the trend of companies remaining private and deferring their IPOs.  The Chamber’s letter attributes some of the “hurdles” of becoming a public company to the SEC’s complex disclosure requirements, recent specialized disclosure requirements, and the influence of proxy advisory firms on governance in U.S. public companies.  The Chamber recently published a white paper, Essential Information:  Modernizing Our Corporate Disclosure System, which addresses materiality as a guiding principle for securities disclosures and cautions against “special interest disclosure” requirements.  Presumably, the SEC will continue to advance the disclosure effectiveness initiative, which had been undertaken under former Chair White’s leadership.

The Chamber’s letter is available here:  http://www.centerforcapitalmarkets.com/wp-content/uploads/2017/02/2017.2.15-US-Chamber-Letter-to-SEC-re-advisory-cmte-meeting-on-companies-staying-private.pdf?x48633

The Chamber’s white paper is available here:  http://www.centerforcapitalmarkets.com/wp-content/uploads/2013/08/U.S.-Chamber-Essential-Information_Materiality-Report-W_FINAL.pdf?x48633

Bloomberg BNA announced the recently updated SEC Reporting Issues for Foreign Private Issuers (Portfolio 5507) authored by Morrison & Foerster partners Anna T. Pinedo and James R. Tanenbaum.

This portfolio serves as a practical resource for both practitioners and foreign private issuers.  This new edition explains in detail various SEC proposed and finalized rules and regulations issued in 2016. It analyzes how those regulations would affect foreign private issuers–including the updated SEC staff guidance on how foreign private issuers should disclose the use of non-GAAP financial measures.