Developments in Securities Regulation, Corporate Governance, Capital Markets, M&A and Other Topics of Interest. MORE

In Pascal v. Czerwinski et al, the Delaware Court of Chancery considered whether disclosures in Columbia Financial’s 2019 proxy statement related to the adoption of an equity incentive plan, or EIP, were adequate.  The directors of the company granted awards to themselves as compensation for past efforts to take the company public.

The plaintiffs claimed the director defendants:

  • planned to use the EIP to retroactively reward themselves for taking the Company public (the “go-public conversion”),
  • had been planning to do so even before issuing the 2019 Proxy, which solicited the stockholders’ vote for the EIP, but
  • did not include any disclosure of that plan in the 2019 Proxy, as demonstrated by the fact that the 2019 Proxy’s language regarding the EIP framed the EIP as contemplating forward-looking compensation only.

The complaint alleged that one of the reasons for the EIP was the directors’ intent to award themselves equity under the plan to compensate past efforts to take the company public  However it was claimed the defendants failed to disclose in the 2019 Proxy that they intended the EIP to reward past efforts, as the alleged proxy disclosures only addressed the intent to incentivize future actions.

The defendants argued the 2019 Proxy did disclose both intentions: the proxy provided that the EIP was meant to “attract, retain and reward the best available persons for positions of substantial responsibility and to recognize significant contributions made by such individuals to the Company’s success.”

The Court found that the 2019 Proxy did not explicitly mention the possibility of retrospective payment for the go-public conversion.  However, the 2019 Proxy did set out that the company might issue awards in part for past accomplishments. And, given that “awards for past accomplishments” encompasses “retrospective payment for the conversion,” the Court did not find it reasonably conceivable that stockholders would have found the difference between the two to be material.

It’s a good reminder at this time of year to think carefully about disclosures when asking for approval of equity compensation plans.

It’s worth noting the Court indicated  the awards would be subject to entire fairness review and the Court did not decide any claims regarding breach of fiduciary duty.

The SEC adopted final rules that will require resource extraction issuers that are required to file reports under Section 13 or 15(d) of the Securities Exchange Act of 1934 to disclose payments made to the U.S. federal government or foreign governments for the commercial development of oil, natural gas, or minerals.  The rules implement Section 13(q) of the Exchange Act, which was added by the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”).

The SEC adopted rules to implement Section 13(q) in 2016, but the 2016 Rules were disapproved pursuant to the Congressional Review Act, or CRA, by a joint resolution of Congress.  Although the 2016 Rules were disapproved under the CRA, the statutory mandate in Section 13(q) of the Exchange Act has remained in effect.  As a result, the Commission was statutorily obligated to issue a new rule, however, pursuant to the CRA the Commission may not reissue the disapproved rule in “substantially the same form” or issue a new rule that is “substantially the same” as the disapproved rule.

The final rules will, among other things:

  • require public disclosure of company-specific, project-level payment information;
  • define the term “project” to require disclosure at the national and major subnational political jurisdiction, as opposed to the contract, level, recognizing that more granular contract-level disclosure could be used to satisfy the rule;
  • add two new conditional exemptions for situations in which a foreign law or a pre-existing contract prohibits the required disclosure;
  • add a conditional exemption for smaller reporting companies and emerging growth companies;
  • define “control” to exclude entities or operations in which an issuer has a proportionate interest;
  • limit the liability for the required disclosure by deeming the payment information to be furnished to, but not filed with, the Commission;
  • add relief for issuers that have recently completed their U.S. initial public offerings; and
  • extend the deadline for furnishing the payment disclosures.

The SEC also issued an order finding that certain resource extraction payment disclosure regimes by the European Union and certain countries are alternative reporting regimes that satisfy the transparency objectives of Section 13(q) under the Exchange Act for purposes of alternative reporting under Rule 13q-1(c) and paragraph (c) of Item 2.01 of Form SD.

Rule 13(q)(1) will become effective 60 days after publication in the Federal Register.  Following a two-year transition period, an issuer will be required annually to submit Form SD no later than 270 days following the end of its most recently completed fiscal year.  For example, if the rules were to become effective on March 1, 2021, the compliance date for an issuer with a December 31 fiscal year-end would be Monday, September 30, 2024 (i.e., 270 days after its fiscal year end of December 31, 2023).

The pending National Defense Authorization Act (NDAA) for Fiscal Year 2021 (H.R. 6395) will require many private companies to confidentially report the beneficial ownership of their common stock in many circumstances.  The beneficial ownership provisions are included in what is named the “Corporate Transparency Act.”

The Corporate Transparency Act excludes the following types of companies from reporting beneficial ownership:

  • an issuer:
    • of a class of securities registered under section 12 of the Securities Exchange Act of 1934; or
    • that is required to file supplementary and periodic information under section 15(d) of the Securities Exchange Act of 1934;
  • an entity:
    • established under the laws of the United States, an Indian Tribe, a State, or a political subdivision of a State, or under an interstate compact between 2 or more States; and
    • that exercises governmental authority on behalf of the United States or any such Indian Tribe, State, or political subdivision;
  • a bank, as defined in:
    • section 3 of the Federal Deposit Insurance Act;
    • section 2(a) of the Investment Company Act of 1940; or
    • section 202(a) of the Investment Advisers Act of 1940;
    • a Federal credit union or a State credit union (as those terms are defined in section 101 of the Federal Credit Union Act);
  • a bank holding company (as defined in section 2 of the Bank Holding Company Act of 1956) or a savings and loan holding company (as defined in section 10(a) of the Home Owners’ Loan Ac)t;
  • a broker or dealer (as those terms are defined in section 3 of the Securities Exchange Act of 1934) that is registered under section 15 of that Act;
  • an exchange or clearing agency (as those terms are defined in section 3 of the Securities Exchange Act of 1934) that is registered under section 6 or 17A of that Act;
  • certain other entities not described above that are registered with the Securities and Exchange Commission under the Securities Exchange Act of 1934;
  • an entity that:
    • is an investment company (as defined in section 3 of the Investment Company Act of 1940) or an investment adviser (as defined in section 202 of the Investment Advisers Act of 1940); and
    • is registered with the Securities and Exchange Commission under the Investment Company Act or the Investment Advisers Act of 1940;
  • an investment adviser described in section 203(l) of the Investment Advisers Act of 1940 and that has filed Item 10, Schedule A, and Schedule B of Part 15 1A of Form ADV, or any successor, with the Securities and Exchange Commission;
  • an insurance company (as defined in section 2 of the Investment Company Act of 1940):
  • an entity that:
    • is an insurance producer that is authorized by a State and subject to supervision by the insurance commissioner or a similar official or agency of a State; and
    • has an operating presence at a physical office within the United States;
  • a registered entity (as defined in section 1a of the Commodity Exchange Act); or
  • an entity that is:
    • a futures commission merchant, introducing broker, swap dealer, major swap participant, commodity pool operator, or commodity trading advisor (as those terms are defined in section 1a of the Commodity Exchange Act); or
    • a retail foreign exchange dealer, as described in section 20 2(c)(2)(B) of that Act; and registered with the Commodity Futures Trading Commission under the Commodity Exchange Act;
  • a public accounting firm registered in accordance with section 102 of the Sarbanes-Oxley Act of 2002;
  • a financial market utility designated by the Financial Stability Oversight Council under section 804 of the Payment, Clearing, and Settlement Supervision Act of 2010;
  • certain pooled investment vehicles advised by other exempt entities;
  • any:
    • organization that is described in section 501(c) of the Internal Revenue Code of 1986 (determined without regard to section 508(a) of such Code) and exempt from tax under section 501(a) of the Code, except that in the case of any such organization that loses an exemption from tax, such organization shall be considered to be continued to be exempt for the 180-day period beginning on the date of the loss of such tax-exempt status;
    • political organization (a defined in section 527(e)(1) of the Code) that is exempt from tax under section 527(a) of the Code;
    • trust described in paragraph (1) or (2) of section 4947(a) of the Code;
  • any corporation, limited liability company, or other similar entity that:
    • operates exclusively to provide financial assistance to, or hold governance rights over, any entity described in the foregoing bullet point;
    • is a United States person;
    • is beneficially owned or controlled exclusively by 1 or more United States persons that are United States citizens or lawfully admitted for permanent residence; and
    • derives at least a majority of its funding or revenue from 1 or more United States persons that are United States citizens or lawfully admitted for permanent residence;
  • any entity that:
    • employs more than 20 employees on a full-time basis in the United States;
    • filed in the previous year Federal income tax returns in the United States demonstrating more than $5,000,000 in gross receipts or sales in the aggregate, including the receipts or sales of:
      • other entities owned by the entity; and
      • other entities through which the entity operates; and
    • has an operating presence at a physical office within the United States;
  • any corporation, limited liability company, or other similar entity:
    • in existence for over 1 year;
    • that is not engaged in active business;
    • that is not owned, directly or indirectly, by a foreign person;
    • that has not, in the preceding 12-month period, experienced a change in ownership or sent or received funds in an amount greater than $1,000 (including all funds sent to or received from any source through a financial account or accounts in which the entity, or an affiliate of the entity, maintains an interest); and
    • that does not otherwise hold any kind or type of assets, including an ownership interest in any corporation, limited liability company, or other similar entity; and
  • any entity or class of entities that the Secretary of the Treasury, with the written concurrence of the Attorney General and the Secretary of Homeland Security, has, by regulation, determined should be exempt from the requirements of beneficial ownership reporting because requiring beneficial ownership information from the entity or class of entities:
    • would not serve the public interest; and
    • would not be highly useful in national security, intelligence, and law enforcement agency efforts to detect, prevent, or prosecute money laundering, the financing of terrorism, proliferation finance, serious tax fraud, or other crimes.

The National Defense Authorization Act (NDAA) for Fiscal Year 2021 (H.R. 6395) conference report that passed the Senate will require private companies to report the beneficial ownership of their common stock in many circumstances.  The legislation generally excludes public companies from reporting.

The provisions are buried in Title LXIV of the over 4,500 pages of the NDAA and are titled the “Corporate Transparency Act.”  The Act’s requirements apply to perhaps the inaptly named “reporting companies” which is likely to cause confusion with reporting public companies.  In any event, “reporting companies” include a corporation, limited liability company, or other similar entity that is:

  • created by the filing of a document with a secretary of state or a similar office under the law of a State or Indian Tribe; or
  • formed under the law of a foreign country and registered to do business in the United States by the filing of a document with a secretary of state or a similar office under the laws of a State or Indian Tribe.

The bill includes a host of exclusions from the definition of “reporting company” including certain public companies reporting under Section 12 and 15(d) of the Exchange Act, banks, credit unions, bank holding companies, money transmitters, broker dealers, stock exchanges, registered investment companies and the like.

The bill requires reporting of “beneficial ownership” which is defined to include, subject to certain exceptions, with respect to an entity, an individual who, directly or indirectly, through any contract, arrangement, understanding, relationship, or otherwise:

  • exercises substantial control over the entity; or
  • owns or controls not less than 25 percent of the ownership interests of the entity.

Existing companies have two years after regulations are promulgated to report beneficial ownership.  Reporting companies formed or registered after the effective date of regulations must at the time of formation or registration, submit to FinCEN a report that contains information which includes with respect to the beneficial owner:

  • full legal name;
  • date of birth;
  • current, as of the date on which the report is delivered, residential or business street address; and
  • a unique identifying number from an acceptable identification document; or
  • FinCEN identifier in accordance with the legislation.

The legislation includes provisions limiting disclosure of collected information except where necessary.

The SEC has adopted final rules regarding electronic signatures with respect to Regulation S-T Rule 302.

New Rule 302(b)(2) of Regulation S-T provides that, before a signatory initially uses an electronic signature to sign something to filed with the SEC, the signatory must manually sign a document attesting that the signatory agrees that the use of an electronic signature for an SEC filing constitutes the legal equivalent of such individual’s manual signature.

What sort of document might satisfy such a requirement?  Maybe something like this:

The undersigned acknowledges and agrees with [name of issuer] that my electronic signature on filings with the United States Securities and Exchange Commission (“SEC”) is the legal equivalent of my manual signature, including for the purposes of Regulation S-T Rule 302(b)(2).  You are authorized to attach my electronic signature in the form of “/s/ [name of undersigned]” to such SEC filings upon receipt by you of a reply to an email which includes a draft of such SEC filing together with any changes to such draft approved by [title].  I understand that I may not repudiate any such electronic signature filed with the SEC.

                                                ________________________________

                                                            Name:

                                                            Title:

The SEC adopted amendments intended to modernize, simplify and enhance certain financial disclosure requirements in Regulation S-K, including rules related to MD&A.

The changes to Items 301, 302, and 303 of Regulation S-K include:

  • Eliminating Item 301 (Selected Financial Data); and
  • Modernizing, simplifying and streamlining Item 302(a) (Supplementary Financial Information) and Item 303 (MD&A). Specifically, these amendments:
    • Revise Item 302(a) to replace the current requirement for quarterly tabular disclosure with a principles-based requirement for material retrospective changes;
    • Add a new Item 303(a), Objective, to state the principal objectives of MD&A;
    • Amend current Item 303(a)(1) and (2) (amended Item 303(b)(1)) to modernize, enhance and clarify disclosure requirements for liquidity and capital resources;
    • Amend current Item 303(a)(3) (amended Item 303(b)(2)) to clarify, modernize and streamline disclosure requirements for results of operations;
    • Add a new Item 303(b)(3), Critical accounting estimates, to clarify and codify Commission guidance on critical accounting estimates;
    • Replace current Item 303(a)(4), Off-balance sheet arrangements, with an instruction to discuss such obligations in the broader context of MD&A;
    • Eliminate current Item 303(a)(5), Tabular disclosure of contractual obligations, in light of the amended disclosure requirements for liquidity and capital resources and certain overlap with information required in the financial statements; and
    • Amend current Item 303(b), Interim periods (amended Item 303(c)) to modernize, clarify and streamline the item and allow for flexibility in the comparison of interim periods to help registrants provide a more tailored and meaningful analysis relevant to their business cycles.

The amendments will become effective 30 days after they are published in the Federal Register. Registrants are required to comply with the rule beginning with the first fiscal year ending on or after the date that is 210 days after publication in the Federal Register (the “mandatory compliance date”).  Registrants will be required to apply the amended rules in a registration statement and prospectus that on its initial filing date is required to contain financial statements for a period on or after the mandatory compliance date. Although registrants will not be required to apply the amended rules until their mandatory compliance date, they may comply with the final amendments any time after the effective date, so long as they provide disclosure responsive to an amended item in its entirety.

We previously discussed an SEC enforcement action against Andeavor LLC for controls violations relating to a stock buyback plan it implemented while it was in discussion to be acquired by Marathon Petroleum Corp. in 2018. Andeavor agreed to pay a $20 million penalty to settle the charges.  According to the SEC order, the matter involved Andeavor’s failure to devise and maintain a system of internal accounting controls sufficient to provide reasonable assurance that stock buyback transactions were executed in accordance with management’s authorization.  Andeavor did not admit or deny the findings in the SEC order.

Many were mystified as to why the enforcement action rested on an internal control violation and not an insider trading charge.

In a public statement SEC Commissioner Hester M. Peirce and Commissioner Elad L. Roisman explain their views on the enforcement action.

The two Commissioners note that the Commission’s order does not charge or find a violation of insider trading law under Rule 10b-5.  That would have required finding that Andeavor acted with scienter. However, Andeavor took steps to confirm that it did not possess material nonpublic information.

Since insider trading charges could not be proved, the Commission’s order found that Andeavor used an “abbreviated and informal process” to evaluate the materiality of the acquisition discussions, resulting in a “deficient understanding” of the facts and circumstances by its legal department.  On that basis, the Commission found that Andeavor failed to maintain an adequate system of internal accounting controls, in violation of Section 13(b)(2)(B).

Pierce and Roisman note that since Section 13(b)(2)(B)’s enactment in 1977, the Commission has never before found that the “internal accounting controls” required by that provision include management’s assessment of a company’s potential insider trading liability.

The pair of Commissioners take issue with casting Section 13(b)(2)(B) as a generic “internal controls” provision.  This provision requires not “internal controls” but “internal accounting controls.” Read in its statutory context, the required internal accounting controls seem primarily to concern the accounting for a public company’s assets and transactions to ensure that its financial statements are prepared in accordance with generally accepted accounting principles.  The purpose is to ensure that financial statements are accurate and reliable when disclosed to investors. It is not meant to address insider trading.

The two Commissioners are concerned that the Commission’s resolution of the case—if pursued to its logical conclusion in future cases—risks uprooting the core concept of “internal accounting controls” from the language, statutory context, and history of Section 13(b)(2)(B).  There may be temptation to simply view this provision as a generic “internal controls” requirement.

As for this case, the two Commissioners saw no evidence that Andeavor’s internal controls were inadequate with respect to the accounting for its repurchase transactions.  Andeavor’s Board of Directors authorized the company to spend $2 billion for share repurchases, and its CEO directed the company’s CFO to initiate the repurchase of $250 million of its shares over a period of several weeks.

The two Commissioners agree that Andeavor’s decision processes in this case left substantial room for improvement, and inadequate processes may expose a company to potential Rule 10b-5 liability. However the Commissioners doubt it is the SEC’s role under Section 13(b)(2)(B) to second-guess management’s decision processes on matters that do not directly implicate the accuracy of a company’s accounting and financial statements.

The SEC adopted final rules which the SEC believes harmonizes, simplifies, and improves the complex exempt offering framework.

The amendments generally:

  • Establish more clearly, in one broadly applicable rule, the ability of issuers to move from one exemption to another;
  • increase the offering limits for Regulation A, Regulation Crowdfunding, and Rule 504 offerings, and revise certain individual investment limits;
  • set clear and consistent rules governing certain offering communications, including permitting certain “test-the-waters” and “demo day” activities; and
  • harmonize certain disclosure and eligibility requirements and bad actor disqualification provisions.

The amendments establish a new integration framework that provides a general principle that looks to the particular facts and circumstances of two or more offerings, and focuses the analysis on whether the issuer can establish that each offering either complies with the registration requirements of the Securities Act, or that an exemption from registration is available for the particular offering.

The amendments additionally provide four non-exclusive safe harbors from integration providing that:

  • any offering made more than 30 calendar days before the commencement of any other offering, or more than 30 calendar days after the termination or completion of any other offering, will not be integrated with such other offering(s). However, where an exempt offering for which general solicitation is prohibited follows by 30 calendar days or more an offering that allows general solicitation, the issuer must have a reasonable belief, based on the facts and circumstances, with respect to each purchaser in the exempt offering prohibiting general solicitation, that the issuer (or any person acting on the issuer’s behalf) either did not solicit such purchaser through the use of general solicitation or established a substantive relationship with such purchaser prior to the commencement of the exempt offering prohibiting general solicitation;
  • offers and sales made in compliance with Rule 701, pursuant to an employee benefit plan, or in compliance with Regulation S will not be integrated with other offerings;
  • an offering for which a Securities Act registration statement has been filed will not be integrated if it is made subsequent to:
    • a terminated or completed offering for which general solicitation is not permitted,
    • a terminated or completed offering for which general solicitation is permitted that was made only to qualified institutional buyers and institutional accredited investors, or
    • an offering for which general solicitation is permitted that terminated or was completed more than 30 calendar days prior to the commencement of the registered offering; and
  • offers and sales made in reliance on an exemption for which general solicitation is permitted will not be integrated if made subsequent to any terminated or completed offering.

The final rules are effective 60 days after publication in the Federal Register with the exception of certain temporary crowdfunding accommodations covered by the amendments which become effective on the earlier of the date of publication in the Federal Register or March 1, 2021 and remain in effect until March 1, 2023.

The PCAOB released an interim analysis report and two accompanying white papers providing the PCAOB’s perspective on the initial impact of critical audit matter (CAM) requirements and insights learned from stakeholders.

The PCAOB performed an interim analysis of the CAM requirements to gain an initial understanding of audit firms’ and engagement teams’ responses to the requirements, investors’ use of CAM communications, and audit committee and preparer experiences related to CAM implementation. The key findings include the following:

  • Audit firms made significant investments to support initial implementation of CAM requirements.
  • Investor awareness of CAMs communicated in the auditor’s report is still developing, but some investors are reading CAMs and find the information beneficial.
  • The staff has not found evidence of significant unintended consequences from auditors’ implementation of CAM requirements for audits of large accelerated filers in the initial year.

This interim analysis represents the PCAOB’s first step in analyzing the CAM requirements. The PCAOB intends to continue to review the CAM requirements.

The SEC announced settled charges against Andeavor LLC for controls violations relating to a stock buyback plan it implemented while it was in discussions to be acquired by Marathon Petroleum Corp. in 2018. Andeavor agreed to pay a $20 million penalty to settle the charges.  According to the SEC order, the matter involved Andeavor’s failure to devise and maintain a system of internal accounting controls sufficient to provide reasonable assurance that stock buyback transactions were executed in accordance with management’s authorization.

In 2015 and 2016, Andeavor’s Board of Directors authorized the company to spend $2 billion for share repurchases. This authorization required Andeavor to comply with a policy that prohibited the company from repurchasing stock while it was in possession of material nonpublic information.

The SEC maintained Andeavor did not, however, have internal accounting controls sufficient to provide reasonable assurance it was complying with this policy such that buyback transactions were executed in accordance with management’s authorization. Specifically, Andeavor lacked an effective process for obtaining an accurate and complete understanding of the facts and circumstances necessary to determine whether it was in possession of material non-public information and therefore prohibited from engaging in buyback transactions. As a consequence of this internal accounting controls failure, Andeavor engaged in buyback transactions that were not executed in accordance with management’s authorization.

On February 21, 2018, Andeavor’s then-Chairman and Chief Executive Officer (Andeavor’s CEO) directed the company’s Chief Financial Officer to initiate a share buyback to repurchase $250 million of shares over a period of several weeks. At the time of this direction, Andeavor’s CEO was scheduled to meet with his counterpart at Marathon two days later to resume the confidential discussions about Marathon’s potential acquisition of Andeavor at a significant premium that had taken place in 2017 (but were suspended in October of that year).

On February 22, 2018, Andeavor’s legal department approved a Rule 10b5-1 plan to repurchase $250 million of stock. It did so after concluding, based on a deficient understanding of all relevant facts and circumstances regarding the two companies’ discussions, that those discussions did not constitute material non-public information.

The SEC charges state this lack of understanding was the result of Andeavor’s insufficient internal accounting controls. Andeavor used an abbreviated and informal process to evaluate the materiality of the acquisition discussions that did not allow for a proper analysis of the probability that Andeavor would be acquired. Andeavor’s informal process did not require conferring with persons reasonably likely to have potentially material information regarding significant corporate developments prior to approval of share repurchases. As a result, for example, despite Andeavor’s CEO’s leadership role at the company and the fact that he was the primary negotiator with Marathon, no one involved in Andeavor’s process discussed with him the prospects that Andeavor and Marathon would agree to a deal. Because they did not do so, the company failed to appreciate that the probability of Marathon’s acquisition of Andeavor was sufficiently high at that time as to be material to investors. In short, Andeavor did not have internal accounting controls that provided reasonable assurance that its buyback would be executed in accordance with its Board’s authorization.

On February 23, 2018, Andeavor executed the Rule 10b5-1 plan that its legal department had approved. Pursuant to that plan, Andeavor repurchased 2.6 million shares of its stock from investors at an average of $97 per share in February and March 2018. About six weeks after initiating the buyback, and two weeks after completing the buyback, the two companies’ CEOs reached an agreement in principle for Marathon to acquire Andeavor. On April 30, 2018, Andeavor publicly announced that it would be acquired by Marathon in a deal valuing Andeavor at over $150 per share.

Andeavor did not admit or deny the findings in the SEC order.