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

ISS announced the launch of its annual benchmark voting policy comment period. ISS has made available for public comment a number of proposed changes to ISS’ benchmark voting policies for 2021. Key proposed changes for the U.S. are set forth below.

Director Elections: Racial/Ethnic Board Diversity

For companies in the Russell 3000 or S&P 1500 index, effective for meetings on or after Feb. 1, 2022, the proposal provides ISS will generally recommend a vote against or withhold from the chair of the nominating committee (or other directors on a case-by-case basis) where the board has no apparent racially or ethnically diverse members. Mitigating factors include the presence of a racial and/or ethnic minority on the board at the preceding annual meeting and a firm commitment to appoint at least one racial and/or ethnic diverse member.

Exclusive Forum Proposals

The proposal provides ISS will generally recommend a vote for federal forum selection provisions in the charter or bylaws that specify “the district courts of the United States” as the exclusive forum for federal securities law matters. ISS will generally recommend a vote against provisions that restrict the forum to a particular federal district court. Unilateral adoption (without a shareholder vote) of such a provision will generally be considered a one-time failure under the Unilateral Bylaw/Charter Amendments policy.

The proposal provides ISS will generally recommend a vote for charter or bylaw provisions that specify Delaware, or the Delaware Court of Chancery, as the exclusive forum for corporate law matters for Delaware corporations, in the absence of serious concerns about corporate governance or board responsiveness to shareholders. For states other than Delaware, the IRS proposes a vote case-by-case on exclusive forum provisions after taking into consideration a number of factors.

The proposal provides ISS will generally recommend a vote against provisions that specify a state other than the state of incorporation as the exclusive forum for corporate law matters, or that specify a particular local court within the state. Unilateral adoption of such a provision will generally be considered a one-time failure under the Unilateral Bylaw/Charter Amendments policy.

At an open meeting of the Securities and Exchange Commission on October 7th, the Commission approved issuance of a proposed conditional exemptive order that would allow “finders” to engage with accredited investors in connection with a private securities offering without registering as brokers under the Exchange Act.

The regulatory status of finders has been a recurring issue for businesses accessing the private capital markets. In particular, smaller businesses are often reliant on the services of finders to connect with in investors who are interested in supporting emerging enterprises. The Commission’s proposed order would provide frequently requested clarity on precisely what activities a finder may engage in without triggering registration requirements for brokers.

Specifically, the proposal would create two classes of finders, Tier I Finders and Tier II Finders, that would be subject to conditions tailored to the scope of their respective activities as follows:

Tier I Finder

  • May provide contact information of potential investors in connection with a single capital raising transaction by a single issuer in a 12 month period.
  • May not have any contact with a potential investor about the issuer.

Tier II Finder

  • May solicit investors on behalf of an issuer but limited to:
    • identifying, screening, and contacting potential investors;
    • distributing issuer offering materials
    • discussing issuer information included in any offering materials (without advising on valuation or advisability of the investment); and
    • arranging or participating in meetings with the issuer and investor.

A Tier II Finder would also be required to provide disclosures describing their role and compensation prior to or at the time of the solicitation and obtain a dated written acknowledgment of receipt of the required disclosures from the investor.

Both Tier I and Tier II Finders would also be subject to various conditions specified in the order including the following:

  • the issuer conducting the securities offering must not be required to file reports under Section 13 or Section 15(d) of the Exchange Act;
  • the issuer must be conducting the securities offering in reliance on an applicable exemption from registration under the Securities Act;
  • the Finder may not engage in general solicitation; and
  • the potential investor is an “accredited investor” as defined in Rule 501 of Regulation D or the Finder has a reasonable belief that the potential investor is an “accredited investor”
  • the Finder provides services pursuant to a written agreement with the issuer that includes a description of the services provided and associated compensation;
  • the Finder is not an associated person of a broker-dealer; and
  • the Finder is not subject to statutory disqualification, as that term is defined in Section 3(a)(39) of the Exchange Act, at the time of his or her participation.

The Commission also provided a helpful chart outlining the permissible activities under the exemption.

The proposed exemption will be subject to a 30-day comment period following publication in the Federal Register.

Our preliminary list of important planning considerations for the 2021 proxy season is set forth below.

Directors’ and Officers’ Questionnaires; Committee Charters

We have identified only a few possible changes to date for D&O questionnaires and committee charters for the 2020 proxy season.

As noted in previous years, the Tax Cuts and Jobs Act eliminated the exception to IRC §162(m) for performance-based compensation, subject to a transition rule. We continue to urge caution in eliminating questions in directors’ and officers’ questionnaires related to §162(m) for compensation committee members unless it is clear the compensation committee is not required to administer any compensation arrangements under the transition rule. The same can be said for eliminating references to §162(m) in compensation committee charters.

In February 2020, the SEC approved a Nasdaq proposal to amend the definition of “Family Member” used in its corporate governance rules, which is incorporated into the definition of “Independent Director.” The definition will no longer include step-children and will include a carve out for domestic employees who share a director’s home. The issuer’s board must still affirmatively determine that no relationship exists that would interfere with a director’s ability to exercise independent judgment.

Physical or Virtual Annual Meeting

Public companies will need to determine whether to hold a physical or virtual annual meeting in the upcoming year.  Many may wish to initially defer the issue until there is additional clarity from proxy advisors and key shareholders on preferences and formats.  The status of the pandemic may also influence the decision.  Public companies may wish to proceed on a dual path, analyzing the requirements for a physical and virtual meeting in tandem, to provide clarity on timing requirements and the like.

Determine Your Status as an Issuer

While not new this year, the SEC adopted final rules, effective September 10, 2018, to expand the availability of scaled disclosure requirements for a company qualifying as a smaller reporting company, or SRC, by allowing companies with a public float of less than $250 million to qualify as an SRC, as compared to the $75 million threshold under the prior definition. In addition, companies that either do not have a public float or have a public float of less than $700 million are now permitted to provide scaled disclosures if annual revenues are less than $100 million, as compared to the prior threshold of less than $50 million in annual revenues. A reporting company must determine whether it qualifies as a SRC annually as of the last business day of its second fiscal quarter. If it qualifies as a SRC on that date based on public float, it may elect to reflect that determination and use the SRC scaled disclosure accommodations in its subsequent filings, beginning with its second quarter Form 10-Q. Otherwise the new status is reflected on Form 10-Q for the first fiscal quarter of the next year.

On March 12, 2020, the Securities and Exchange Commission adopted long-awaited amendments to the accelerated filer and large accelerated filer definitions with the stated goal of “reduc[ing] unnecessary burdens for certain smaller issuers while maintaining investor protections.”

Among other things, the final rules:

  • Exclude from the accelerated and large accelerated filer definitions an issuer that is eligible to be a smaller reporting company (“SRC”) and that has annual revenue of less than $100 million in the most recent fiscal year for which audited financial statements are available (“SRC revenue test”);
  • Exempt issuers meeting the SRC revenue test from the requirements applicable to an accelerated or large accelerated filer including, most notably, the required auditor attestation of management’s assessment of internal controls over financial reporting (“ICFR”); and
  • Add a new check box to annual filings on Form 10-K, 20-F and 40-F to indicate the inclusion of an auditor attestation over ICFR. These amendments exclude from the definitions of accelerated filer and large accelerated an issuer that is eligible to be an SRC and has annual revenue of less than $100 million in the most recent fiscal year thereby meeting the SRC revenue test. The most notable effect of the amendments would be that an issuer that is eligible to be an SRC and that meets the SRC revenue test would not be subject to the requirements of SOX Section 404(b). The amendments also allow business development companies (“BDCs”) to qualify for this exclusion if they meet the requirements of the SRC revenue test using their annual investment income as the measure of annual revenue, although BDCs would continue to be ineligible for the other scaled disclosures available to SRCs.

The final amendments include a requirement for an issuer to prominently disclose in its filing whether an ICFR auditor attestation is included. As such, issuers must include a new check box will be added to the cover pages of Forms 10-K, 20-F, and 40-F to indicate whether an ICFR auditor attestation is included in an annual report filing. Once issuers are required to tag the cover page disclosure data using Inline XBRL, they are also be required to tag this cover page check box disclosure pursuant to Item 406 of Regulation S-T.

Many public companies experienced fluctuations in market capitalization as a result of the COVID-19 pandemic so it may be worthwhile to review qualifications for scaled disclosures. Issuers that rely on emerging growth company status, or EGCs, should also determine if they remain eligible as an EGC. Among other tests, an issuer is only allowed to retain EGC status for five years after its IPO, and the five-year window continues to close for some.

As in prior years, issuers should verify whether or not they are transitioning from status as a non-accelerated filer, accelerated filer, or large accelerated filer.

Say-on-Pay Frequency Vote

Rule 14a-21(b) requires a say-on-pay frequency vote every six years. Issuers should review their own particular facts and circumstances to determine if they are required to hold a say-on-pay frequency vote.  We note that issuers that formerly qualified as EGCs should also remain mindful of say-on-pay requirements as issuers that no longer qualify as EGCs lose their exemption from the requirements under Exchange Act Sections 14A(a) and (b).  Such former EGCs are required to begin providing say-on-pay votes within one year of losing EGC status (or no later than three years after selling securities under an effective registration statement if an issuer was an EGC for less than two years).  Typically, such companies will also hold say-on-pay frequency votes when they hold their first say-on-pay vote as a non-EGC.

If you include a frequency vote, consider the related Form 8-K filing obligations.

COVID-19 Disclosures

Public companies should review SEC guidance on matters related to COVID-19.  Principal guidance includes:

MD&A

Metrics

In January 2020, the SEC published guidance on the disclosure of financial metrics in MD&A. Given the timing of issuance, some issuers considered this guidance when preparing their last Form 10-K and perhaps others did not.

The SEC said it would generally expect, based on the facts and circumstances, the following disclosures to accompany any metric presented:

  • A clear definition of the metric and how it is calculated;
  • A statement indicating the reasons why the metric provides useful information to investors; and
  • A statement indicating how management uses the metric in managing or monitoring the performance of the business.

Other

In January 2020, the SEC also proposed to eliminate Item 301 of Regulation S-K, Selected Financial Data and Item 302 of Regulation S-K, Supplementary Financial Information because they are largely duplicative of other requirements and to amend Item 303 of Regulation S-K, Management’s Discussion & Analysis of Financial Condition and Results of Operations (“MD&A”) to modernize and enhance MD&A disclosures. These proposed rules have not been adopted.

Intellectual Property and Technology Risks Associated with International Business Operations

In January 2020, the SEC published Disclosure Topic No. 8 which provides guidance on intellectual property and technology risks associated with international business operations. Given the timing of issuance, some issuers considered this guidance when preparing their last Form 10-K and perhaps others did not.

Modernization of Business, Human Capital, Legal Proceedings, and Risk Factors Disclosures

The SEC adopted amendments to modernize the description of business, legal proceedings, and risk factor disclosures that registrants are required to make pursuant to Regulation S-K. These disclosure items have not undergone significant revisions in over 30 years.  The final amendments:

  • Revise the requirements to discuss the general development of the business to be largely principles-based, requiring disclosure of information material to an understanding of the general development of the business.
  • Adopt as a disclosure topic material changes to a registrant’s previously disclosed business strategy.
  • Include, as a disclosure topic, a description of the registrant’s human capital resources to the extent such disclosures would be material to an understanding of the registrant’s business.
  • Require summary risk factor disclosure of no more than two pages if the risk factor section exceeds 15 pages.

 SEC Adopts Final Rules Regarding Proxy Advisors

The SEC has adopted final rules regarding proxy voting advice businesses, or PVABs, like ISS and Glass Lewis.  The final principle-based rules adopted by the SEC require PVABs to take certain actions to maintain a statutory exemption from the information and filing requirements of the Federal proxy rules. Specifically, PVABs must comply with certain disclosure and procedural requirements, including disclosure of material conflicts of interest in their proxy advice, and adopt and publicly disclose certain written policies and procedures.

The final rules include a non-exclusive safe harbor provision that, if followed, will give assurance to a PVAB that it has met certain principles-based requirements of the new rules. In accordance with this safe harbor, a PVAB will be deemed to satisfy the final rules discussed above if it has written policies and procedures that are reasonably designed to provide registrants with a copy of its proxy voting advice, at no charge, no later than the time it is disseminated to the business’s clients. Such policies and procedures may include conditions requiring that such registrants have (i) filed their definitive proxy statement at least 40 calendar days before the shareholder meeting, and (ii) expressly acknowledged that they will only use the proxy voting advice for their internal purposes and/or in connection with the solicitation and it will not be published or otherwise shared except with the registrant’s employees or advisers.

The final rules include an additional safe harbor pursuant to which a proxy voting advice business must have written policies and procedures reasonably designed to inform clients who have received proxy voting advice about a particular registrant in the event that such registrant notifies the proxy voting advice business that the registrant either intends to file or has filed additional soliciting materials with the SEC setting forth its views regarding such advice.

PVABs are not required to comply with the final rules discussed above until December 1, 2021.  At this point it is unclear what effect these rules will have on the upcoming proxy season.

Hedging Disclosures

The SEC approved final rules on hedging that require companies to disclose practices or policies related to the ability of employees or directors to engage in hedging transactions with respect to a company’s equity securities. Companies that do not maintain a hedging policy are required to disclose this fact and note, if accurate, that hedging transactions are generally permitted.

All public companies are now required to include the hedging disclosures in proxy and information statements..

Modernization of Property Disclosures for Mining Registrants

The SEC adopted amendments to modernize the property disclosure requirements for mining registrants, and related guidance, previously set forth in Item 102 of Regulation S-K and in Industry Guide 7. The amendments are intended to provide investors with a more comprehensive understanding of a registrant’s mining properties, which should help them make more informed investment decisions. The SEC’s revised mining property disclosure requirements now appear in Subpart 1300 of Regulation S-K.

Registrants engaged in mining operations must comply with the final rule amendments for the first fiscal year beginning on or after January 1, 2021. Industry Guide 7 will remain effective until all registrants are required to comply with the final rules, at which time Industry Guide 7 will be rescinded.

Critical Audit Matters

The Public Company Accounting Oversight Board previously adopted a new auditor reporting standard that requires information about critical audit matters, or CAMs. The new standard was approved by the SEC and was required for large accelerated filers for audits for fiscal years ending on or after June 30, 2019.  Audit reports for all other issuers are required to address critical audit matters, if any, for fiscal years ending on or after December 15, 2020.

ISS Proxy Voting Policies

ISS is in the process of formulating changes to its voting recommendation policies.  ISS recently released the results of its global policy survey. The survey generally foreshadows changes to policies for the upcoming proxy season.  We recommend that issuers monitor ISS’s new and updated policies, including ISS’s official proxy voting guidelines, which are typically issued in December for the upcoming proxy season.

Inline XBRL

In 2018 year the SEC also adopted final rules to require the use of Inline XBRL. Previously, data in XBRL format was attached as an exhibit to SEC filings. Inline XBRL allows filers to embed XBRL data directly into the body of the SEC filing, eliminating most of the need to tag a copy of the information in a separate XBRL exhibit. Inline XBRL will still require exhibits to be used to provide contextual information about the XBRL tags embedded in the filing.

Large accelerated filers have already been required to fully transition Inline XBRL. Accelerated filers that prepare their financial statements in accordance with U.S. GAAP are required to use Inline XBRL with their first Form 10-Q filing for the fiscal period ending on or after June 15, 2020 and this requirement will apply to Form 10-Ks. Other filers are required to use Inline XBRL with their first Form 10-Q filing for the fiscal period ending on or after June 15, 2021.

Shareholder Proposals

The Commission recently adopted rules altering the shareholder proposals submission framework under Rule 14a-8 of the Exchange Act for the first time in over twenty years.

The share ownership thresholds for eligibility to submit an initial shareholder proposal have been revised to employ a sliding scale based on the amounts of securities owned as follows:

  • Holders of at least $2,000 worth of company securities must have held those securities for an extended period of three years (instead of one year, as under the current formulation of the rule).
  • Holders of at least $15,000 worth of company securities must have held those securities for at least two years, and
  • Holders of at least $25,000 worth of company securities must have held those securities for at least one year.

The Commission’s revised rules also modified the resubmission thresholds under Rule 14a-8 to increase the required support necessary to resubmit a proposal.  Under the amendments, a shareholder proposal would be excludable from a company’s proxy materials if it addressed substantially the same subject matter as a proposal, or proposals, previously included in the company’s proxy materials within the preceding five calendar years if the most recent vote occurred within the preceding three calendar years and the most recent vote in favor of the proposal was:

  • Less than 5 percent of the votes cast if previously voted on once;
  • Less than 15 percent of the votes cast if previously voted on twice; or
  • Less than 25 percent of the votes cast if previously voted on three or more times.

The amendments also adopted modifications to Rule 14a-8 consistent with the proposing release to:

  • Require certain documentation to be provided when a proposal is submitted on behalf of a shareholder proponent;
  • Require shareholder proponents to identify specific dates and times they can meet with the company in person or via teleconference to engage with the company with respect to the proposal; and
  • Provide that a person may submit no more than one proposal, directly or indirectly, for the same shareholders’ meeting.

The new thresholds become effective 60 days after being published in the Federal Register and will apply to any proposal submitted for an annual or special meeting to be held on or after January 1, 2022.  The amendments also include transitions rules permitting shareholders to submit proposals in reliance on the prior initial submission threshold for meetings held prior to January 1, 2023.

Our expanded analysis of the changes is available here.

Description of Registrant’s Securities Exhibit

In connection with the SEC’s modernization and simplification of rules pursuant to The Fixing America’s Surface Transportation Act, or FAST Act, registrants were required by new Item 601(b)(4)(vi) of Regulation S-K to file a new exhibit to last year’s Form 10-K to provide certain information about their registered capital stock, debt securities, warrants, rights, American Depositary Receipts, and other securities as specified under Item 202(a)-(d) and (f)).

For this year’s Form 10-K (and any subsequent annual filings), issuers may incorporate by reference to the previously filed “Description of Securities”, so long as there has not been any change to the information since the filing date of the linked filing. However, any modifications and amendments to the Item 202 disclosure during a fiscal year must also be reflected in an exhibit to the registrant’s annual report for such year.  Issuers should take note that there is no “materiality” threshold for changes to the rights and privileges of its securities.  In other words, if any changes are made to the items of information in Item 202, a registrant would be required to update the description of securities in the exhibit filed with its Form 10-K.

Confidential Treatment Requests

In March 2019, the Commission modified its confidential treatment rules with respect to the filing of exhibits to permit companies to omit immaterial, competitively harmful information without having to provide the omitted information to the SEC or request staff approval of the omission. Most companies appear to now rely on these provisions to avoid the technical requirements of the confidential treatment process.

However, for those companies that do not choose to rely on the new rules, the Division of Corporation Finance also issued CF Disclosure Guidance Topic No. 7, which outlines the procedures for submitting a “traditional” confidential treatment request.

In September 2020, Corporation Finance updated that guidance to provide the following options for expiring confidential treatment requests:

  • Refile an unredacted copy of the exhibit;
  • Extend the confidential period pursuant to Rules 406 or 24b-2; or
  • Transition to the new rules governing the filing of redacted exhibits under Regulation S-K Item 601.

Other Regulatory Initiatives

Proposed rules have also been issued on the following topics in prior years, but final rules have not been adopted:

On September 23rd, the Commission adopted rules altering the shareholder proposals submission (and re-submission) framework under Rule 14a-8 of the Exchange Act for the first time in over twenty years.

Following another split-vote of the commissioners, the SEC approved the staff’s recommended modifications to the current shareholder ownership threshold for initial submissions as well as the shareholder support levels required for resubmissions of proposals and adopted several other notable changes in-line with staff’s proposing release.

Initial Submission Thresholds

With respect to initial submission requirements, the adopting release noted the Commission’s view that the amount of stock owned by a shareholder is not the only way to demonstrate an interest in a company, particularly for smaller investors.  The final rules reflect the Commission’s conclusion that the length of time owning a company’s securities may be a more meaningful indicator that a shareholder has a sufficient interest that warrants use of the company’s proxy statement.

Accordingly, the share ownership thresholds for eligibility to submit an initial shareholder proposal have been revised to employ a sliding scale based on the amounts of securities owned as follows:

  • Holders of at least $2,000 worth of company securities must have held those securities for an extended period of three years (instead of one year, as under the current formulation of the rule),
  • Holders of at least $15,000 worth of company securities must have held those securities for at least two years, and
  • Holders of at least $25,000 worth of company securities must have held those securities for at least one year.

The new thresholds are intended to require a more appropriate demonstrated “economic stake or investment interest” in a company before a shareholder may draw on company and shareholder resources to require the inclusion of a proposal in the company’s proxy statement.

Consistent with the proposing release, aggregation of holdings for purposes of meeting the ownership requirements will no longer be permitted under the rules. Instead, each shareholder must satisfy one of the three ownership thresholds to be eligible to submit or co-file a proposal.

Resubmission Thresholds

The Commission’s rules also revised the resubmission thresholds under Rule 14a-8 to increase the required support necessary to resubmit a proposal.  Under the amendments, a shareholder proposal would be excludable from a company’s proxy materials if it addressed substantially the same subject matter as a proposal, or proposals, previously included in the company’s proxy materials within the preceding five calendar years if the most recent vote occurred within the preceding three calendar years and the most recent vote in favor of the proposal was:

  • Less than 5 percent of the votes cast if previously voted on once;
  • Less than 15 percent of the votes cast if previously voted on twice; or
  • Less than 25 percent of the votes cast if previously voted on three or more times.

In the Proposing Release, the Commission expressed a concern that the prior resubmission thresholds of 3, 6, and 10 percent did not adequately distinguish between proposals that are more likely to obtain broader or majority support upon resubmission and those that are not.  As such, the modifications are intended to avoid a result in which company and shareholder resources may end up being used to consider and vote on matters that are unlikely to be supported by shareholders.

Submissions by Representatives

The adopted rules require a shareholder who elects to use a representative for the purpose of submitting a shareholder proposal to provide documentation to make clear that the representative is authorized to act on the shareholder’s behalf and to provide a meaningful degree of assurance as to the shareholder’s identity, role and interest in a proposal that is submitted for inclusion in a company’s proxy statement.  In this regard, when a proposal is submitted on behalf of a shareholder proponent, such shareholder will be required to include certain documentation that:

  • Identifies the company to which the proposal is directed;
  • Identifies the annual or special meeting for which the proposal is submitted;
  • Identifies the shareholder submitting the proposal and the shareholder’s designated representative;
  • Includes the shareholder’s statement authorizing the designated representative to submit the proposal and otherwise act on the shareholder’s behalf;
  • Identifies the specific topic of the proposal to be submitted;
  • Includes the shareholder’s statement supporting the proposal; and
  • Is signed and dated by the shareholder.

Required Engagement with Company

Under the amendments, shareholder proponents will be required to engage in discussions with companies in connection with their submission of shareholder proposal.  Specifically, shareholder proponents will be required to provide the company with a written statement that they are able to meet with the company in person or via teleconference at specified dates and times that are no less than 10 calendar days, nor more than 30 calendar days, after submission of the proposal.  Here, the Commission’s stated goal is facilitating a “swifter resolution” to shareholder proposal issues, reducing “friction” between the respective parties and pre-empting the need to submit a no-action request to the SEC staff.

One proposal limit

The SEC’s newest amendments revise Rule 14a-8(c) to apply the one-proposal rule to “each person” rather than “each shareholder” who submits a proposal.  In particular, the new rule will state that each person may submit no more than one proposal, directly or indirectly, to a company for a particular shareholders’ meeting and specify that “[a] person may not rely on the securities holdings of another person for the purpose of meeting the eligibility requirements and submitting multiple proposals for a particular shareholders’ meeting.”

In application, the amendments will prohibit a shareholder-proponent from submitting one proposal in its own name and simultaneously serving as a representative to submit a different proposal on another shareholder’s behalf for consideration at the same meeting.

Effectiveness and Transition Guidance

The new thresholds become effective 60 days after publication in the Federal Register and will apply to any proposal submitted for an annual or special meeting to be held on or after January 1, 2022.  However, the final rules also provide transition accommodations for application of the new submission thresholds, such that a shareholder that has continuously held at least $2,000 of a company’s securities entitled to vote on the proposal for at least one year as of the effective date of the amendments, and who continuously maintains such ownership through the date he or she submits a proposal, will be eligible to submit a proposal to such company, and need not satisfy the amended share ownership thresholds for an annual or special meeting to be held prior to January 1, 2023.

The SEC’s final amendments can be viewed here.

 

The U.S. Department of Labor today made available a proposed rule that would address the application of the prudence and exclusive purpose duties under the Employee Retirement Income Security Act (ERISA) with respect to proxy voting and exercises of other shareholder rights. The proposed rule amends the Department’s longstanding “Investment duties” regulation at 29 CFR 2550.404a-1.

The DOL is concerned that some fiduciaries and proxy advisory firms may be acting in ways that unwittingly allow plan assets to be used to support or pursue proxy proposals for environmental, social, or public policy agendas that have no connection to increasing the value of investments used for the payment of benefits or plan administrative expenses, and in fact may have unnecessarily increased plan expenses

The Department has issued sub-regulatory guidance and individual letters over the years affirming that, in voting proxies and in exercising other shareholder rights, plan fiduciaries must consider factors that may affect the value of the plan’s investment and not subordinate the interest of participants and beneficiaries in their retirement income to unrelated objectives. The Department believes, however, that aspects of the guidance and letters may have led to some confusion or misunderstandings. The proposal is designed to address those issues through a notice and comment rulemaking process that will build a public record to help the Department develop an improved investment duties regulation with the goal of ensuring plan fiduciaries execute their ERISA duties in an appropriate and cost-efficient manner when exercising shareholder rights.

According to a DOL official, the proposal would clarify Employee Retirement Income Security Act fiduciary duties for proxy voting and monitoring proxy advisory firms.  In addition, the proposed rule would reduce plan expenses by giving fiduciaries clear directions to refrain from spending workers’ retirement savings to research and vote on matters that are not expected to have an economic impact on the plan.

The proposal includes provisions that would articulate general duties requiring fiduciaries to vote any proxy where the fiduciary prudently determines that the matter being voted upon would have an economic impact on the plan. It also prohibits fiduciaries from voting any proxy unless the fiduciary prudently determines that the matter has an economic impact on the plan. To assist fiduciaries to comply with these duties, the proposal also sets forth “permitted practices” under which the plan fiduciary can adopt certain proxy voting policies and parameters reasonably designed to serve the plan’s economic interest.

As we noted here, the SEC has expanded the definition of accredited investor. This means many forms of subscription agreements may need to be updated. No two agreements are exactly alike, but we have updated one form we use. You can find a word version here, and a PDF version showing changes to the prior version here.

The SEC adopted amendments to modernize the description of business, legal proceedings, and risk factor disclosures that registrants are required to make pursuant to Regulation S-K. These disclosure items have not undergone significant revisions in over 30 years.  The final amendments:

  • Revise the requirements to discuss the general development of the business to be largely principles-based, requiring disclosure of information material to an understanding of the general development of the business.
  • Adopt as a disclosure topic material changes to a registrant’s previously disclosed business strategy.
  • Include, as a disclosure topic, a description of the registrant’s human capital resources to the extent such disclosures would be material to an understanding of the registrant’s business.
  • Require summary risk factor disclosure of no more than two pages if the risk factor section exceeds 15 pages.

The final amendments are effective 30 days after publication in the Federal Register.

In General

Item 101(a)

Currently Item 101(a) requires a description of the general development of the business of the registrant during the past five years, or such shorter period as the registrant may have been engaged in business.

The final amendments revise Item 101(a) to be largely principles-based, requiring disclosure of information material to an understanding of the general development of the business, and eliminating the previously prescribed five-year timeframe. As discussed further below, this includes adopting as a disclosure topic material changes to a registrant’s previously disclosed business strategy.

The final amendments also revise Item 101(h) to eliminate the three-year timeframe for these disclosures with respect to smaller reporting companies.

In addition, the final amendments revise Items 101(a) and (h) to clarify that registrants, in filings made after a registrant’s initial filing, may provide an update of the general development of the business rather than a full discussion. The update must disclose all of the material developments that have occurred since the registrant’s most recent filing containing a full discussion of the general development of its business, and incorporate by reference that prior discussion.

Item 101(c)

Item 101(c) currently requires a narrative description of the business done and intended to be done by the registrant and its subsidiaries, focusing on the registrant’s dominant segment or each reportable segment about which financial information is presented in its financial statements. To the extent material to an understanding of the registrant’s business taken as a whole, the description of each such segment must include disclosure of several specific matters.

The final amendments revise Item 101(c) to:

  • Clarify and expand the principles-based approach of Item 101(c), with a nonexclusive list of disclosure topic examples (drawn in part from the topics currently contained in Item 101(c));
  • As discussed further below, include, as a disclosure topic, a description of the registrant’s human capital resources to the extent such disclosures would be material to an understanding of the registrant’s business; and
  • Refocus the regulatory compliance disclosure requirement by including as a topic compliance with all material government regulations, not just environmental laws.

Item 103

Item 103 currently requires disclosure of any material pending legal proceedings including the name of the court or agency in which the proceedings are pending, the date instituted, the principal parties thereto, a description of the factual basis alleged to underlie the proceeding and the relief sought. Similar information is to be included for any such proceedings known to be contemplated by governmental authorities. The Item contains a threshold for disclosure based on a specified dollar amount ($100,000) for proceedings related to Federal, State, or local environmental protection laws.

The final amendments revise Item 103 to:

  • Expressly state that the required information may be provided by hyperlink or cross-referenced to legal proceedings disclosure located elsewhere in the document to avoid duplicative disclosure; and
  • Implement a modified disclosure threshold that increases the existing quantitative threshold for disclosure of environmental proceedings to which the government is a party from $100,000 to $300,000, but that also affords a registrant the flexibility to select a different threshold that it determines is reasonably designed to result in disclosure of material environmental proceedings, provided that the threshold does not exceed the lesser of $1 million or one percent of the current assets of the registrant and its subsidiaries on a consolidated basis.

Item 105

Currently Item 105 requires disclosure of the most significant factors that make an investment in the registrant or offering speculative or risky and specifies that the discussion should be concise, organized logically, and furnished in plain English. The item also states that registrants should set forth each risk factor under a subcaption that adequately describes the risk. Additionally, Item 105 directs registrants to explain how each risk affects the registrant or the securities being offered and discourages disclosure of risks that could apply to any registrant.

As discussed further below, the final amendments revises Item 105 to:

  • Require summary risk factor disclosure of no more than two pages if the risk factor section exceeds 15 pages;
  • Refine the principles-based approach of Item 105 by requiring disclosure of “material” risk factors; and
  • Require risk factors to be organized under relevant headings in addition to the subcaptions currently required, with any risk factors that may generally apply to an investment in securities disclosed at the end of the risk factor section under a separate caption.

Business Strategy

The final amendments to Item 101(a) adopt as a disclosure topic material changes to a registrant’s previously disclosed business strategy.   The SEC believes that once a registrant has disclosed its business strategy, it is appropriate for it to discuss changes to that strategy, to the extent material to an understanding of the development of the registrant’s business.  The final amendments do not include a requirement to disclose a company’s business strategy annually.

Human Capital Management

Under the final amendments, Item 101(c) requires, to the extent such disclosure is material to an understanding of the registrant’s business taken as a whole, a description of a registrant’s human capital resources, including any human capital measures or objectives that the registrant focuses on in managing the business. The SEC believes that, in many cases, human capital disclosure is important information for investors. The final rules also note the Commission’s view that human capital is a material resource for many companies and often is a focus of management, in varying ways, and an important driver of performance.

The final amendments identify various human capital measures and objectives that address the attraction, development, and retention of personnel as non-exclusive examples of subjects that may be material, depending on the nature of the registrant’s business and workforce. The SEC emphasized that these are examples of potentially relevant subjects, not mandates. Each registrant’s disclosure must be tailored to its unique business, workforce, and facts and circumstances.

The SEC did not define “human capital” because it believes this term may evolve over time and may be defined by different companies in ways that are industry specific.

Risk Factors

Under the final amendments, if a registrant’s risk factor disclosure exceeds 15 pages, Item 105(b) requires in the forepart of the document a series of concise, bulleted or numbered statements summarizing the principal factors that make an investment in the registrant or offering speculative or risky. Because the risk summary is not required to contain all of the risk factors identified in the full risk factor discussion, registrants may prioritize certain risks and omit others.

Amended Item 105 requires registrants to organize their risk factor disclosure under relevant headings, in addition to the subcaptions that are currently required. The final amendments, except for the heading “General Risk Factors”, do not specify risk factor headings that registrants should use. The final amendments require registrants to present risks that could apply generally to any company or offering of securities at the end of the risk factor section under the caption “General Risk Factors.”

The final amendments do not require registrants to prioritize the order in which they discuss their risk factors. Accordingly, if a registrant believes it is useful or important to emphasize the relative importance of certain risks, it is free to write those risk factors and other disclosures in such a way that their relative importance is apparent.

On August 26, 2020, the Securities and Exchange Commission adopted amendments and issued a related order to expand the definition of “accredited investor” under Rule 501(a) of the Securities Act to include natural persons with certain professional certifications, designations; credentials issued by an accredited educational institution, including Series 7, Series 65, and Series 82 licenses; and other credentials which the Commission may designate from time to time by order.  In addition, the accredited investor definition was expanded with respect to investments in a private fund to include natural persons who are “knowledgeable employees” of the fund.  The Commission also added the term “spousal equivalent” to the accredited investor definition, so that spousal equivalents may pool their finances for the purpose of qualifying as accredited investors.

Aside from modifications to the natural persons that may qualify as accredited investors, the Commission also took action to expand the categories of entities that may now qualify as accredited investors by:

  • Clarifying that limited liability companies with $5 million in assets may be accredited investors;
  • Adding SEC- and state-registered investment advisers, exempt reporting advisers, and rural business investment companies (RBICs) to the list of entities that may qualify;
  • Adding a new category for any entity, including Indian tribes, governmental bodies, funds, and entities organized under the laws of foreign countries, that own “investments” in excess of $5 million and that was not formed for the specific purpose of investing in the securities offered; and
  • Adding “family offices” with at least $5 million in assets under management and their “family clients,” as each term is defined under the Investment Advisers Act.

The SEC’s amendments also expanded the definition of “qualified institutional buyer” in Rule 144A to include limited liability companies and RBICs if they meet the $100 million in securities owned and invested threshold in the definition.  The amendments also broadened the applicable definition for “qualified institutional buyer” to include any institutional investors included in the accredited investor definition that satisfies the $100 million threshold, even if such entity is not otherwise specifically listed within the definition of “qualified institutional buyer.”

The Commission noted that the amendments are part of its “ongoing effort to simplify, harmonize, and improve the exempt offering framework” and are intended to update and improve the definition to identify more effectively investors that have sufficient knowledge and expertise to participate in investment opportunities and thereby expanding investment opportunities while maintaining appropriate investor protections and promoting capital formation.

The amendments become effective 60 days after publication in the Federal Register.

In CHS/Community Health Systems, Inc. et al v. Steward Health Care System LLC, the Delaware Court of Chancery examined who was an intended third-party beneficiary of an indemnification provision in an Asset Purchase Agreement.

The dispute arose in a transaction where Steward agreed to purchase substantially all the assets of certain hospitals owned by CHS.

Specifically, the APA listed a series of “Seller Entities” that would “sell to [Steward] . . . substantially all of [their] assets . . . which are . . . used in connection with . . . [a] ‘Healthcare Business.’”

Steward agreed to “assume . . . the future payment and performance of . . . all obligations accruing . . . after the Effective Time with respect to the Assumed Contracts.”

In the indemnification provision, Steward also promised to “defend, indemnify and hold harmless [CHS] and its Affiliates . . . from and against any and all Losses” incurred in connection with any of the Assumed Contracts. In turn, the APA defined a party’s “Affiliates” to include “any other Person directly or indirectly controlling or controlled by, or under direct or indirect common control with, such specified person.”

Following the Closing, an Affiliate of [CHS], CHSPSC paid approximately $3,000,000 to satisfy contractual obligations that it believed met the definition of “Assumed Liabilities” under the APA—meaning they should have been paid by Steward. CHSPC was one of the plaintiffs in a law suit to recover these costs.

Specifically, CHSPSC sought to hold Steward to its promise to “indemnify . . . CHS and its Affiliates” (i.e., CHSPSC) for Losses incurred “in connection with” the Assumed Contracts.  CHSPSC brought this claim, not as a party to the APA, but as an “intended third-party beneficiary.”

Steward argued CHSPSC lacked standing to sue for indemnification under the APA. In support of the argument, Steward cited Section 12.22 of the APA, which stated (emphasis added):

“The terms and provisions of this Agreement are intended solely for the benefit of [CHS], [Steward], their Affiliates and their respective permitted successors or assigns, and it is not the intention of the parties to confer, and this Agreement shall not confer, third-party beneficiary rights upon any other person other than the Seller Entities and the Buyer Entities, which the parties agree are express third party beneficiaries of the rights of Seller and Buyer, respectively”

CHSPSC was not a defined Seller Entity in the APA.

CHSPSC emphasized that the indemnification section extended an indemnification right to CHS “and its Affiliates.”  Along similar lines, CHSPSC underscored language in Section 12.22 that “the terms . . . of this Agreement are intended solely for the benefit of [] [CHS and its] Affiliates.” Also, CHSPSC was alleged to be a CHS Affiliate.  The Court of Chancery was satisfied that CHSPSC’s reading was reasonable.

The Court also found Steward’s interpretation of the APA was also reasonable. Steward emphasized the second clause in Section 12.22, where the parties stated, “it is not the intention of the parties to confer, and this Agreement shall not confer, third-party beneficiary rights upon any other person other than the Seller Entities. . . .” Because, as Steward argued, the Seller Entities were all “Affiliates” of CHS as that term is used in the APA, the only way to ascribe independent meaning to the second clause in Section 12.22 was to read it as limiting the universe of CHS “Affiliates” entitled to third party beneficiary status (i.e., only the “Seller Entities”). If all CHS “Affiliates” had third-party beneficiary standing, then the second clause in Section 12.22 added nothing.

The Court denied Steward’s motion to dismiss the claim.  The Court was satisfied the APA was ambiguous as to whether CHSPSC has standing to sue for indemnity as a third party beneficiary. Because the APA was ambiguous, it could not be determined on the pleadings whether “an express, enforceable contract that controls” CHSPSC’s relationship with Steward actually existed.

At its August 19, 2020 Board meeting, FASB Board discussed what changes should be made to the disclosure requirements for interim reporting. The Board decided to:

  • Add a principle to Topic 270, Interim Reporting, that requires disclosures for significant events or transactions that have material effects on an entity. This addition is related to changes to U.S. Securities and Exchange Commission (SEC) Regulation S-X, Rule No. 10-01, Interim Financial Statements. The principle would result in disclosures that are transaction or event specific.
  • Clarify that the disclosure requirements in Topic 270 are subject to a materiality assessment that includes considering the financial statements of the previous annual period.
  • Add guidance to Topic 270 stating that the Topic contains a complete listing of interim disclosure requirements.
  • Add links to Topic 270 for interim disclosure requirements that are currently included in other Topics.
  • Revise phrasing such as for all periods presented to clarify that such phrasing requires comparative disclosure consistent with periods on the face of the financial statements and does not require interim disclosure.