On June 1, 2017, the Public Accounting Oversight Board (PCAOB) adopted Auditing Standard No. 3101, The Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion, which the PCAOB believes will increase the relevance and utility of auditors’ reports by including additional information regarding the audit process, and other disclosures. Most significantly, the new standard requires inclusion in the audit report of a discussion of critical audit matters (CAMs) identified in the course of the audit. The new standard also contains an auditor tenure disclosure requirement and standardizes the format of the report, among other changes. The new standard retains the pass/fail opinion of the existing auditor’s report.

The new standard and other changes are subject to Securities and Exchange Commission (SEC) approval. Assuming that approval is obtained, the PCAOB expects the provisions, other than those related to CAMs, to take effect for audits for fiscal years ending on or after December 15, 2017. Provisions related to CAMs will take effect for (1) large accelerated filers, in connection with audits for fiscal years ending on or after June 30, 2019, and (2) all other filers, in connection with audits for fiscal years ending on or after December 15, 2020.

Read our client alert.

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 effects of removing barriers to equity issuance, Journal of Financial Economics, July 14, 2016.  This article examines whether the relaxation of the eligibility requirements for use of a shelf registration statement, permitting smaller issuers to use a shelf registration statement, contributed to a decline in reliance by such companies on PIPE transactions for their follow-on capital-raising efforts.

Principles for Publicness, Florida Law Review, Omnig H. Dombalagian.  This article considers the duties that “public” companies owe investors and considers a tiered regulatory framework for companies as companies mature.

The Law and Economics of Scaled Equity Market Regulation, The Journal of Corporation Law, Jeff Schwartz.  This article reviews the concept of tiered regulation based on the size and age of companies using a marginal analysis model and concludes that size-based regulatory scaling is beneficial.

The Monitoring Role of the Media: Evidence from Earnings Management, Yangyang Chen, C.S. Agnes Cheng, Shuo Li, and Jingran Zhao, May 2017.  This article looks at the effect of media coverage on earnings management.  Media scrutiny serves to limit management of earnings in ways that favor insiders.

On June 1, 2017, the Public Company Accounting Oversight Board (PCAOB) adopted a new standard for auditor’s reports that requires a description of “critical audit matters,” for purposes of providing investors with information regarding the most challenging, subjective or complex aspects of the audit. Under the new standard, critical audit matters are defined as any matter arising from the current period’s audit of the financial statements that was communicated or required to be communicated to the audit committee and that (1) relates to accounts or disclosures that are material to the financial statements and (2) involved especially challenging, subjective or complex auditor judgment. If no critical audit matters arose from the audit, the auditor’s report must state that there were no critical audit matters. The communication of each critical audit matter in the auditor’s report must include: (a) the identification of the critical audit matter; (b) a description of the principal considerations that led the auditor to determine that the matter was a critical audit matter; (c) a description of how the critical audit matter was addressed in the audit; and (d) a reference to the relevant financial statement accounts or disclosures. Additional changes to the auditor’s report under the new standard include items that are intended to clarify the auditor’s role and responsibilities, provide additional information about the auditor and make the auditor’s report easier to read for investors. Under the new standard, the auditor’s report will still retain the pass/fail opinion of the existing auditor’s report.

The new standard will apply to audits conducted under PCAOB standards, but communication of critical audit matters will not be required for audits of: (1) broker-dealers reporting under Exchange Act Rule 17a-5; (2) investment companies other than business development companies (BDCs); (3) employee stock purchase, savings and similar plans; and (4) emerging growth companies (EGCs) as defined under Exchange Act Section 3(a)(80). The new standard is still subject to approval by the SEC. If approved, all provisions other than those related to critical audit matters will take effect for audits for fiscal years ending on or after December 15, 2017. The provisions related to critical audit matters will take effect for audits for fiscal years ending on or after June 30, 2019 for large accelerated filers and for fiscal years ending on or after December 15, 2020 for all other companies subject to such provisions.

A copy of the PCAOB’s fact sheet on the new standard is available at: https://pcaobus.org/News/Releases/Pages/fact-sheet-auditors-report-standard-adoption-6-1-17.aspx.

A copy of the PCAOB’s release on the new standard is available at: https://pcaobus.org/Rulemaking/Docket034/2017-001-auditors-report-final-rule.pdf.

Ernst & Young LLP recently published a report, which contains useful data, regarding the U.S. IPO market and the factors contributing to a decline in the number of IPOs.  In particular, the study notes the contribution of increased M&A activity as a factor in the decline.  These charts show the very significant jump in acquisitions of private companies from the IPO peak in 1996 (about 1,950 acquisitions) to 2016 when more than 4,800 private companies were acquired.  We reprint below the three most relevant charts illustrating this trend.

 

CHART 1

CHART 2

CHART 3

The full report may be accessed here.

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 Economics of Primary Markets, Kathleen Weiss Hanley, March 15, 2017.  The paper discusses the public offering process, including the economics of IPOs, such as whether there is underpricing in IPOs, and considers, in this regard, the costs and benefits associated with the IPO bookbuilding process.  In assessing the factors associated with the decline in the number of IPOs, the paper discusses some trade-offs associated with going public versus relying on private offerings, which is very timely given the ongoing dialogue on this topic.

The JOBS Act and the Costs of Going Public, Susan Chaplinsky, Kathleen Weiss Hanley, and S. Katie Moon, January 2017.  The article concludes that there is little evidence that the JOBS Act has reduced the direct costs of going public.  However, there may be accommodations resulting from the JOBS Act, such as those related to reduced disclosure, deferral of certain corporate governance related requirements, the ability to make confidential submissions, and the ability to test the waters, which result in savings that are difficult to .

Patching a Hole in the JOBS Act:  How and Why to Rewrite the Rules that Require Firms to Make Periodic Disclosures, Michael D. Guttentag, 88 Ind. L. J. 151, 2013.  This article examines the circumstances under which, or the conditions that should trigger when, companies should be required to comply with periodic disclosure requirements.

Information Issues on Wall Street 2.0, Elizabeth Pollman, 161 U. Pa. Rev. 179 2012-2013.  The article examines concerns arising from secondary private transactions as a result of lack of information, asymmetric information, and conflicts of interest, as well as concerns regarding insider trading.

“Publicness” in Contemporary Securities Regulation After the JOBS Act, Donald C. Langevoort and Robert B. Thompson, 101 Geo. L.J. 337, 2012-2013.  This paper considers whether the number of record holders is the right measure to use in determining “publicness,” or whether a different measure ought to be used, and how we should think about distinguishing between private and public companies.

Mutual Fund Investments in Private Firms, Sungjoung Kwon, Michelle Lowry, and Yiming Qian, April 2017.  Institutional investors hold a significant percentage of public equity.  The underlying premise of the paper is that mutual funds tend to invest in private companies backed by high quality venture capitalists.

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.

In the May 10, 2017 dialogue held by the SEC’s Division of Economic and Risk Analysis and New York University’s Stern School of Business, academics and industry representatives provided recommended measures for rejuvenating the U.S.’s IPO market.  Such measures, aimed at increasing the incentive for companies of varying sizes, geographic backgrounds and industries to utilize and thrive in the public markets, included the following recommendations:

  • Exempt dividends from taxation at the corporate level for all public companies.
  • Increase regulations on private companies to align them with public companies. These regulations can include mandatory accounting standards and restrictions on ownership.
  • Exclude accredited investors from 500 shareholder thresholds for private companies under Section 12(g) of the Exchange Act to ensure that companies are able to enter the public market at the most advantageous time.
  • Require disclosure of short positions for small public companies to make smaller companies more attractive to institutional investors.
  • For public companies, base operational decisions on investment and growth of the company rather than meeting earnings guidance. Public companies should speak to investors about the long term and get independent directors involved in the company’s strategy.

On April 13, 2017, the NYSE issued a proposed rule change that would amend Sections 204.12, 204.21, and 202.06(B) of its NYSE Listed Company Manual to require listed companies to provide notice to the NYSE at least ten minutes before making any public announcement about a dividend or stock distribution, including outside of the hours during which the NYSE’s immediate release policy is in operation.  The principal effect of the change would be to require listed companies to provide ten minutes advance notice to the NYSE with respect to a dividend announcement made at any time, rather than just during the hours of operation of the immediate release policy as is currently the case.  The NYSE noted that the proposed rule change will help avoid confusion in the marketplace if there is contradictory information available from multiple sources or uncertainty as to whether news reports of dividends are accurate and also enable NYSE staff to answer questions from market participants about corporate actions.

A copy of the proposed rule change is available at: https://www.nyse.com/publicdocs/nyse/markets/nyse/rule-filings/filings/2017/NYSE-2017-17.pdf.

The Nasdaq recently published a report, titled “The Promise of Market Reform,” which sets out proposed structural changes that are intended to relieve some of the burdens associated with being a public company.  The report notes the decline in the number of U.S. public companies and notes the trend in U.S. IPOs and the increased reliance on private placements.  The report suggests reform of the proxy process, by, among other things, raising the minimum ownership amount and holding period to introduce a proxy proposal and addressing proxy advisory firms.  The report suggests various measures that would streamline corporate disclosures by eliminating quarterly reporting requirements, providing additional accommodations for smaller reporting companies, and reducing politically motivated disclosure obligations.  The report notes that litigation reform also is needed.  Various tax reform measures also are discussed as possible incentives to encourage investment.  Finally, the report discusses possible market structure changes.  Finally, the report addresses measures that are intended to promote long-termism.

The report can be accessed here:  https://globenewswire.com/news-release/2017/05/04/978502/0/en/U-S-Financial-Markets-Require-Comprehensive-Market-Reform-to-Reignite-Job-Growth-and-Create-a-Healthier-Economic-Ecosystem.html

In researching and updating our treatise, Exempt and Hybrid Securities Laws, we regularly review recent literature regarding capital markets developments.  The principal underlying thesis of the treatise has been that exempt and hybrid offerings were becoming significantly more important as capital-raising tools.  While that was true although not necessarily obvious when we first published the treatise, it seems to be a trend that has become even more pronounced in recent years, even affecting the number of IPOs.  Each week, we’ll be posting our “favorite” articles on these topics.  Herewith, the first installment:

Unicorns, Guardians, and the Concentration of the U.S. Equity Markets, Amy Deen Westbrook and David A. Westbrook.  This article discusses the more concentrated ownership of both private and public companies in recent years, including the closely held nature of most unicorns.  Given the concentration of ownership in successful privately held companies and in most public companies today, the article addresses the governance and stewardship issues that this ownership concentration poses.

The Twilight of Equity Liquidity, Jeff Schwartz, 34 Cardozo L. Rev. 531.  This article discusses a new approach to regulating companies, with the cornerstone being a new market for newly public companies (a “venture exchange”), which should be designed to encourage companies to pursue IPOs and revive the IPO market, as well as a more extensive “on-ramp” or phasing in of regulatory requirements as companies mature.

Regulating Unicorns:  Disclosure and the New Private Economy, Jennifer Fan, 57 B.C. L. Rev. 583.  This article discusses the unicorn phenomenon and the need to re-think regulation to address the growth of privately held companies with robust valuations and dispersed ownership.