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

The SEC recently settled an enforcement action against Mylan N.V., claiming Mylan failed to timely disclose to investors a possible loss relating to a nearly two-year Department of Justice  probe into whether Mylan overcharged Medicaid by hundreds of millions of dollars for sales of EpiPen Auto-Injector by misclassifying EpiPen as a “generic” or “non-innovator” drug.

The SEC’s complaint notes a public company facing a material loss contingency, such as one arising from a lawsuit or government investigation, is required under accounting principles and the securities laws to:

  • disclose the loss contingency if a loss is at least reasonably possible, and
  • record an accrual for the estimated loss if a loss is probable and reasonably estimable.

The SEC complaint includes a detailed timeline of the DOJ’s investigation. In August 2015, Mylan’s counsel made a presentation to DOJ, setting forth detailed arguments about why DOJ had no basis to bring any claims. DOJ, however, rejected Mylan’s request that it close the investigation, and requested that Mylan sign a tolling agreement that stopped the statute of limitations from running and thus would permit DOJ to charge Mylan for conduct spanning a longer time period. In October 2015, Mylan produced an analysis to DOJ, showing that for just one quarter in 2015, potential damages owed to the government from Mylan’s classifying EpiPen as a generic rather than a branded drug ranged from approximately $12 million to $42 million.

According to the SEC, by at least the filing of its Form 10-Q for the third quarter of 2015, Mylan knew or should have known that the likelihood of a material loss relating to Mylan’s EpiPen classification and DOJ investigation was reasonably possible. The SEC thus infers signing a tolling agreement and calculating damages for discussion purposes is enough to know a loss is reasonably possible.

In May 2016, DOJ requested a meeting to discuss the investigation, including potential resolution of the matter, and requested that Mylan provide additional information relevant to calculating damages in advance of the meeting. In response, in June 2016, Mylan provided additional data, including an estimate that non-trebled damages for the year 2015, alone, would range from about $114 to $260 million.

Mylan also consented to an extension of the tolling agreement in June 2016 and agreed to a meeting on July 12, 2016. Mylan executives, including those involved in the preparation and review of Mylan’s financial statements, were involved in preparations for the DOJ meeting.  During the July 12, 2016 meeting, DOJ made a detailed presentation to Mylan, setting forth the bases for its claims. DOJ also provided damages estimates and indicated that it was prepared to sue Mylan unless Mylan made a settlement offer. On July 29, 2016, Mylan offered $50 million to settle DOJ’s claims.  On August 3, DOJ rejected the $50 million offer and counter-offered at a significantly higher amount. The parties continued to negotiate until they reached a settlement in principle for $465 million in October 2016. On October 7, 2016, Mylan, for the first time, disclosed DOJ’s investigation and Mylan’s liability resulting from its misclassification of EpiPen.

According to the SEC, by at least the filing of the Form 10-Q for the second quarter of 2016, Mylan knew, or should have known, that a material loss resulting from the DOJ investigation and claims that Mylan incorrectly classified EpiPen was probable. Mylan also knew, or should have known, that a loss was reasonably estimable, as Mylan had sufficient information in its possession to estimate a range of losses. Therefore, the SEC stated, Mylan should have accrued its best estimate of the loss (or, if it did not have a best estimate, the minimum amount of the loss within the estimated range of losses).

The SEC also alleged Mylan’s 2014 and 2015 risk factor disclosures that a governmental authority may take a contrary position on Mylan’s Medicaid submissions, when Mylan had already been informed EpiPen was misclassified, were misleading.

Mylan agreed to the entry of a final judgment ordering a $30 million penalty and permanently enjoining it from violating certain securities laws.

The SEC issued new rules in a release captioned “Solicitations of Interest Prior to a Registered Public Offering.”   New Rule 163B enables all issuers to engage in test-the-waters communications with qualified institutional buyers, referred to as QIBs, and institutional accredited investors, referred to as IAIs, regarding a contemplated registered securities offering.

The communications permitted by the new rules will be exempt from restrictions imposed by Section 5 of the Securities Act on written and oral offers prior to or after filing a registration statement.  The expanded test-the-waters provision will provide all issuers with flexibility in determining whether to proceed with a registered public offering while maintaining appropriate investor protections.

New Rule 163B permits any issuer or person authorized to act on behalf of an issuer, including an underwriter, either prior to or following the filing of a registration statement, to engage in oral or written communications with potential investors that are, or that the issuer reasonably believes are, QIBs or IAIs, to determine whether such investors might have an interest in the contemplated offering.

Under current securities law:

  • Section 5(c) of the Securities Act prohibits any written or oral offers prior to the filing of a registration statement.
  • Once an issuer has filed a registration statement, Section 5(b)(1) limits written offers to a “statutory prospectus” that conforms to the information requirements of Securities Act Section 10 of the Securities Act.

As a result of the SEC’s action, Rule 163B communications are exempt from Section 5(b)(1) and Section 5(c). However, Rule 163B communications are subject to liability under Section 12(a)(2) of the Securities Act in addition to liability under other anti-fraud provisions of the federal securities laws.

Rule 163B communications do not need to be filed with the SEC.  In addition, such communications are not required to include any specific legends.

In the adopting release, the SEC expressed its view that whether a test-the-waters communication constitutes a general solicitation depends on the facts and circumstances regarding the manner in which the communication is conducted.  The SEC noted if an issuer chooses to engage in test-the-waters communications under Rule 163B concurrently with communications related to a private offering, it can conduct such communications in a manner that preserves the availability of both Rule 163B and any offering exemption upon which it might otherwise rely.

The SEC also cautioned that when an issuer wishes to pursue a private placement in lieu of a registered offering immediately after engaging in test-the-waters communications, the issuer should consider whether the test-the-waters communication was conducted in such a way as to constitute a general solicitation. If the communication constitutes a general solicitation, the issuer should consider whether the private offering exemption upon which the issuer is relying allows for general solicitation and, if it does not, whether the investors in the private placement were solicited by means of such a test-the-waters communication, or through some other means that would otherwise not foreclose the availability of the exemption.

The new rule does not modify the Commission’s existing framework for analyzing how an issuer can conduct simultaneous registered and private offerings. This 2007 guidance continues to be applicable to address circumstances that may arise with respect to pre-filing test-the-waters communications and concurrent or immediately subsequent private offerings.

All issuers—including non-reporting issuers, EGCs, non-EGCs, well-known seasoned issuers, or WKSIs, and investment companies (including registered investment companies and business development companies)—are eligible to rely on the rule.

Our preliminary list of important planning considerations for the 2020 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.

New rules adopted to implement the FAST Act clarify that registrants may, but are not required to, rely only on Section 16 reports that have been filed on EDGAR (as well as any written representations from the reporting persons) to assess whether there are any Section 16 delinquencies to disclose. Accordingly, on the directors’ and officers’ questionnaires, registrants may replace  questions regarding whether all Section 16 reports have been provided to the registrant with a question about whether all required Section 16 reports have been filed on EDGAR.

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

D&O questionnaires for Nasdaq issuers would perhaps have to be updated if the Nasdaq proposal is approved by the SEC. The SEC is considering the legal and policy implications of the Nasdaq proposal, and the proposal has not yet been approved.

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.

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.

Changes to Accelerated Filer and Large Accelerated Filers Definitions (Proposed)

In May, the SEC issued proposed rule amendments that would, if enacted:

  • exclude from the accelerated and large accelerated filer definitions an issuer that is eligible to be a SRC and had no revenue or annual revenues of less than $100 million in the most recent fiscal year for which audited financial statements are available and thereby eliminate the requirement to provide an ICFR auditor attestation for such companies; and
  • adjust the transition thresholds for issuers exiting accelerated and large accelerated filer status.

As a result of the amendments, certain low-revenue issuers would not be required to have their assessment of the effectiveness of internal control over financial reporting attested to, and reported on, by an independent auditor, although they would continue to be required to make such assessments and to establish and maintain the effectiveness of their internal control over financial reporting.

The SEC has not yet acted on the May proposal.

Fast Act Changes

The Fixing America’s Surface Transportation Act, or FAST Act, required the SEC to consider ways to streamline SEC regulations. Accordingly, the SEC adopted final amendments intended to modernize and simplify certain disclosure requirements in Regulation S-K, and related rules and forms, in a manner that reduces the costs and burdens on registrants while continuing to provide all material information to investors.

For Form 10-Ks:

  • Cover Page: Eliminate the following reference on the cover page to delinquent Section 16 filings:

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. □

  • Cover page; Delete the previously required disclosure for securities registered pursuant to 12(b) of the Act and add the “Trading Information Table“: Delete the current required tabular disclosure referring to the title of each class of securities and the name of each exchange where registered for securities registered pursuant to Section 12(b) of the Act and replace it with the following Trading Information Table, which is placed immediately following the required disclosure regarding the registrant’s telephone number:

Securities registered pursuant to Section 12(b) of the Act:

Title of each class Trading Symbol(s) Name of each exchange where registered
     

 

  • “Cover Page Tagging Requirements”: All cover page data must be tagged in Inline XBRL. For large accelerated filers, cover page tagging of Form 10-K will be required for calendar year issuers. Other issuers are subject to the following compliance schedule:
    • Accelerated filers that prepare their financial statements in accordance with U.S. GAAP — Reports for fiscal periods ending on or after June 15, 2020
    • All other filers — Reports for fiscal periods ending on or after June 15, 2021
  • MD&A
    • Instruction 1 of Item 303 has been revised under the new rules to eliminate the reference to year-to-year comparisons. As revised, Instruction 1 now states that registrants may use any presentation that in the registrant’s judgment enhances a reader’s understanding of the registrant’s financial condition, changes in financial condition, and results of operations, without suggesting that any one mode of presentation is preferable to another. Instruction 1 has also been revised to delete the reference to five-year selected financial data.
    • The SEC also revised Instruction 1 to Item 303(a) to allow registrants who are providing financial statements covering three years in a filing to omit discussion of the earliest of the three years if such discussion was already included in any other of the registrant’s prior filings on EDGAR that required disclosure in compliance with Item 303. Registrants electing not to include a discussion of the earliest year in reliance on this instruction must identify the location in the prior filing where the omitted discussion may be found.
  • Description of Property: The SEC revised Item 102 of Regulation S-K to make clear that, unless otherwise specified, disclosure need only be provided about a physical property to the extent it is material to the registrant.
  • Description of Registrant’s Securities. The revised rules require registrants to provide the information required by Item 202(a)-(d) and (f) as an exhibit to Form 10-K. Item 202 of Regulation S-K requires registrants to provide a brief description of their registered capital stock, debt securities, warrants, rights, American Depositary Receipts, and other securities. You can review sample disclosures here.
  • Directors, Executive Officers, Promoters, and Control Persons. New general instruction 1 to Item 401 (moved from Instruction 3 to Item 401(b)) allows registrants to include required information about their executive officers in Part I of Form 10-K as per previous practice. The revised rules also require the caption for the disclosure included in Part I of Form 10-K to reflect a “plain English” approach. The required caption is “Information about our Executive Officers” instead of “Executive officers of the registrant.”

For proxy statements:

  • Change the disclosure heading required by Item 405(a)(1) from “Section 16(a) Beneficial Ownership Reporting Compliance” to the more specific “Delinquent Section 16(a) Reports”. The SEC also encourages registrants to exclude this heading altogether when they have no Section 16(a) delinquencies to report. The revised rules eliminate the requirement in Rule 16a-3(e) that reporting persons furnish Section 16 reports to the registrant.
  • In the audit committee report, change the reference to whether the audit committee has discussed with the independent auditor the matters required by AU section 380, Communication with Audit Committees to “the applicable requirements of” the Public Company Accounting Oversight Board (“PCAOB”) and the Commission.

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.

Inline XBRL

Last 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 were required to use Inline XBRL beginning with their first Form 10-Q filing for a fiscal period ending on or after June 15, 2019, and the upcoming 10-K will be the first to require use of 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. 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.

Special care should be paid to the XBRL exhibits in the exhibit index. The SEC issued Compliance and Disclosure Interpretations, or C&DIs, which provide:

  • Registrants subject to Inline XBRL requirements should identify any Interactive Data File required under Rule 405 of Regulation S-T as Exhibit 101 in the exhibit index.
  • The Interactive Data File required because the cover page is tagged under Rule 406 of Regulation S-T should be identified as Exhibit 104 in the exhibit index.
  • When an interactive data file is submitted using Inline XBRL, Instruction 1 to paragraphs (b)(101)(i) and (ii) of Regulation S-K Item 601 requires that the exhibit index include the word “Inline” within the title description for any such exhibit.

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.

Large accelerated and accelerated filers will need to include the hedging disclosures in proxy and information statements for the election of directors for fiscal years beginning on or after July 1, 2019. SRCs and EGCs were given an additional year to phase-in the disclosures which will be required for SRCs and EGCs in proxy and information statements on or after July 1, 2020.

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.

Diversity Disclosures

In new C&DIs the SEC staff provided guidance on disclosure of self-identified specific diversity characteristics of board members and board nominees. The SEC staff noted Item 401(e) of Regulation S-K requires a brief discussion of the specific experience, qualifications, attributes, or skills that led to the conclusion that a person should serve as a director. Item 407(c)(2)(vi) of Regulation S-K requires a description of how a board implements any policies it follows with regard to the consideration of diversity in identifying director nominees. To the extent a board or nominating committee in determining the specific experience, qualifications, attributes, or skills of an individual for board membership has considered the self-identified diversity characteristics (e.g., race, gender, ethnicity, religion, nationality, disability, sexual orientation, or cultural background) of an individual who has consented to the company’s disclosure of those characteristics, the staff would expect that the company’s discussion required by Item 401 would include, but not necessarily be limited to, identifying those characteristics and how they were considered. Similarly, in these circumstances, the staff would expect any description of diversity policies followed by the company under Item 407 would include a discussion of how the company considers the self-identified diversity attributes of nominees as well as any other qualifications its diversity policy takes into account, such as diverse work experiences, military service, or socio-economic or demographic characteristics.

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 is applied for large accelerated filers for audits for fiscal years ending on or after June 30, 2019.  Audit reports identifying CAMs have begun to appear in public filings (as discussed here). 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.  This year’s survey solicited feedback on board gender diversity, overboarding, climate change, and a combined CEO chair position. 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.

Shareholder Proposals

The SEC staff will no longer respond in writing (and, in some cases, at all) to all issuer requests for no action letters to exclude shareholder proposals. The staff of the Division of Corporation Finance has indicated that a written response can be expected if Corp Fin “believes doing so would provide value, such as more broadly applicable guidance about complying with Rule 14a-8.” See these additional thoughts from the thecorporatecounsel.net for related implications.

Strike Suits

Thecorporatecounel.net reports a variety of strike suit patterns from last proxy season. The report indicates the plaintiffs’ bar has been sending demand letters to companies alleging inadequate or inaccurate disclosure about the vote required to approve proposals included on the company’s proxy materials, and threatening legal action in the event that corrective disclosure is not provided. Other strike suit demands include matters related to compensation plans on issuer’s ballots, alleging inadequate disclosure under Item 10(a) of Schedule 14A, which relates to general disclosures for compensation plans being submitted for shareholder approval. We recommend issuers carefully scrub these areas before filing a proxy statement.

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

In August 2019 the SEC issued proposed rule amendments to modernize the description of business, legal proceedings, and risk factor disclosures that registrants are required to make pursuant to Regulation S-K. Among other things, the proposal would require as a disclosure topic, human capital resources, including any human capital measures or objectives that management focuses on in managing the business, to the extent such disclosures would be material to an understanding of the registrant’s business, such as, depending on the nature of the registrant’s business and workforce, measures or objectives that address the attraction, development, and retention of personnel. The SEC has not yet taken further action on the proposal.

SEC Guidance on Investment Advisers’ Proxy Voting Responsibilities and Application of Proxy Rules to Voting Advice

The SEC provided guidance to assist investment advisers in fulfilling their proxy voting responsibilities. The guidance discusses, among other matters, the ability of investment advisers to establish a variety of different voting arrangements with their clients and matters they should consider when they use the services of a proxy advisory firm.  In addition, the Commission issued an interpretation that proxy voting advice provided by proxy advisory firms generally constitutes a “solicitation” under the federal proxy rules and provided related guidance about the application of the proxy antifraud rule to proxy voting advice.  Both of these actions explain the Commission’s view of various non-exclusive methods entities can use to comply with existing laws or regulations or how such laws and regulations apply.

At this point it is unclear as to how the SEC guidance might impact the upcoming proxy season.  Ed Hauder has some interesting thoughts on different paths this could go down.

Other Regulatory Initiatives

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

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

New rules adopted to implement the FAST Act clarify that registrants may, but are not required to, rely only on Section 16 reports that have been filed on EDGAR (as well as any written representations from the reporting persons) to assess whether there are any Section 16 delinquencies to disclose. Accordingly, in directors’ and officers’ questionnaires, registrants may replace  questions regarding whether all Section 16 reports have been provided to the registrant with a question about whether all required Section 16 reports have been filed on EDGAR.

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

D&O questionnaires for Nasdaq issuers would perhaps have to be updated if the Nasdaq proposal is approved by the SEC. The SEC is considering the legal and policy implications of the Nasdaq proposal, and the proposal has not yet been approved.

FASB has issued a proposed Accounting Standards Update, or ASU, intended to improve guidance used to determine whether debt should be classified as a current or noncurrent liability in a classified balance sheet.

The amendments in this proposed ASU would introduce a principle for determining whether debt or other instruments within the scope of the proposed amendments would be classified as a noncurrent liability as of the balance sheet date. According to that principle, an entity would classify an instrument as noncurrent if either of the following criteria is met as of the balance sheet date:

  • The liability is contractually due to be settled more than one year (or operating cycle, if longer) after the balance sheet date.
  • The entity has a contractual right to defer settlement of the liability for a period greater than one year (or operating cycle, if longer) after the balance sheet date.

The amendments in this proposed ASU would continue to require that an entity classify debt as a noncurrent liability when:

  • there has been a debt covenant violation, and
  • the entity receives a waiver of or a forbearance agreement for that violation that meets certain conditions before the financial statements are issued (or are available to be issued).

The amendments in this proposed ASU also would require more comprehensive disclosures about defaults resulting from violations of a loan covenant, grace periods within which a debtor may cure a violation, and triggers of a subjective acceleration clause.

According to the proposed ASU:

The amendments in the proposed ASU could shift classification of certain debt arrangements between noncurrent liabilities and current liabilities as compared with current guidance. The existing classification guidance would be superseded by a principle that may result in a classification that differs from the classification produced under existing rules.

An example of one of the most significant changes to the classification would be short-term debt that is refinanced on a long-term basis after the balance sheet date. Current guidance requires that short-term debt (at the balance sheet date) that is refinanced on a long-term basis (after the balance sheet date but before the financial statements are issued or are available to be issued) be classified as a noncurrent liability. Consistent with the accounting for other subsequent events, the amendments in this proposed ASU would prohibit an entity from considering a subsequent refinancing when determining the classification of debt as of the balance sheet date. A subsequent refinancing provides evidence about conditions that did not exist at the date of the balance sheet but arose after that date (that is, a nonrecognized subsequent event). Similarly, under the proposed amendments a subsequent refinancing of short-term debt with the issuance of equity securities no longer would affect the classification of debt as of the balance sheet date. Therefore, those debt arrangements would be classified as current liabilities.

Another example of a change in the classification would be short-term debt that has an associated long-term financing arrangement. Under current GAAP, short term debt is classified as a noncurrent liability if an entity enters into a financing arrangement and meets certain conditions. The amendments in this proposed ASU would preclude an entity from considering other financing arrangements (such as letters or lines of credit) in determining the classification of the debt.

An additional example of a change in the classification would result from debt that contains subjective acceleration clauses or material adverse change clauses. Current GAAP requires that an entity consider the likelihood of acceleration of the due date when determining noncurrent or current classification. The amendments in this proposed ASU would remove that probability assessment, and, instead, the subjective acceleration clause would affect the classification of debt when it is triggered. However, when there is debt subject to a covenant violation as of the balance sheet date, an entity would be required to assess whether it is probable that the subjective acceleration clause would be violated within 12 months from the balance sheet date.

There also could be a change in classification when a borrower violates a provision of a long-term debt arrangement and the debt arrangement provides a specified grace period. Current GAAP requires that an entity classify that debt as a current liability unless it is probable that the violation will be cured within the period, which would prevent the debt from becoming callable. The amendments in this proposed ASU would require that the principle be applied in that scenario, which would result in a noncurrent liability classification if either of the criteria in the principle is met as of the balance sheet date.

The SEC published this statement announcing a new position on requests for no action letters to exclude shareholder proposals:

After the recent proxy and shareholder proposal season, the Division considered whether additional guidance or changes to its process of administering Exchange Act Rule 14a-8 were warranted. As a result of that consideration, the staff focused on how it could most efficiently and effectively provide guidance where appropriate.

The staff will continue to actively monitor correspondence and provide informal guidance to companies and proponents as appropriate. In cases where a company seeks to exclude a proposal, the staff will inform the proponent and the company of its position, which may be that the staff concurs, disagrees or declines to state a view, with respect to the company’s asserted basis for exclusion. Starting with the 2019-2020 shareholder proposal season, however, the staff may respond orally instead of in writing to some no-action requests. The staff intends to issue a response letter where it believes doing so would provide value, such as more broadly applicable guidance about complying with Rule 14a-8.

The staff continues to believe, as noted in Staff Legal Bulletin 14I and Staff Legal Bulletin 14J, that when a company seeks to exclude a shareholder proposal from its proxy materials under paragraphs (i)(5) or (i)(7) of Rule 14a-8, an analysis by its board of directors is often useful.

If the staff declines to state a view on any particular request, the interested parties should not interpret that position as indicating that the proposal must be included. In such circumstances, the staff is not taking a position on the merits of the arguments made, and the company may have a valid legal basis to exclude the proposal under Rule 14a-8. And, as has always been the case, the parties may seek formal, binding adjudication on the merits of the issue in court.

FASB has issued a proposed Accounting Standards Update, or ASU, to provide temporary optional guidance to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform on financial reporting. In particular the proposed ASU is meant to address the expected discontinuance of LIBOR.

Without any relief by FASB any contract modifications resulting from contract modification to implement a new reference rate would be required to be evaluated in determining whether the modifications result in the establishment of new contracts or the continuation of existing contracts. The application of existing accounting standards on modifications could be costly and burdensome due to the significant volume of affected contracts and the compressed time frame for making contract modifications.

In addition, changes in a reference rate could disallow the application of certain hedge accounting guidance, and certain hedge relationships may not qualify as highly effective during the period of the market-wide transition to a replacement rate.  The inability to apply hedge accounting because of reference rate reform would result in financial reporting outcomes that would not reflect entities’ intended hedging strategies when those strategies continue to operate as effective hedges.

The proposed ASU would simplify accounting analyses under current GAAP for contract modifications if qualifying criteria are met:

  • Modifications of loans, debt, and other financial instruments would be accounted for by prospectively adjusting the effective interest rate.
  • Lease modifications would be accounted for as a continuation of the existing contract with no reassessments or remeasurements.
  • Modifications of contracts would not require a reassessment of whether an embedded derivative should be accounted for as a separate instrument.
  • Modifications of contracts for which explicit guidance is not proposed would also be accounted for as a continuation of those contracts with no reassessments of previous determinations.

The proposed ASU would allow hedging relationships to continue without dedesignation upon the following changes in the critical terms of an existing hedging relationship due to reference rate reform:

  • A change in the critical terms of a designated hedging instrument in a fair value, cash flow, or net investment hedge
  • A change to rebalance or adjust the hedging relationship
  • For a cash flow hedge, a change in the method used to assess hedge effectiveness when initially applying an optional expedient method and when reverting to the requirements under current GAAP.

Other matters addressed by the proposed ASU include:

  • Providing optional expedients for existing fair value hedging relationships for which the derivative designated as the hedging instrument is affected by reference rate reform
  • Providing temporary optional expedients for cash flow hedging relationships affected by reference rate reform.

Omega Protein Corporation manufactured and distributed omega-3 fish oils and fish meal products. Omega financed its operations through federal government programs under Title XI of the Merchant Marine Act of 1936.  The Title XI loans were administered by the National Marine Fisheries Service, or NMFS.  NMFS regularly required that Omega’s subsidiary, OPI, and Omega provide a “Certification and Indemnification Agreement Regarding Environmental Matters.”  The Certification required the Omega entities to make broad covenants such as the Omega entities at all times complied with and were currently in compliance with applicable federal laws and regulations relating to environmental matters and that the entities had not received any notices of violation of any federal laws and regulations relating to environmental matters.

Omega finance personnel engaged in a standardized process for testing the company’s compliance with its Title XI loan covenants.  As part of this process, Omega finance personnel used a two-page template document entitled “Title XI Compliance Check Off List.”  However, none of the items on the checklist addressed environmental compliance.

In addition, as part of the standardized process at the quarterly close for testing the company’s compliance with its Title XI loan covenants, Omega distributed a questionnaire to corporate officers and key management personnel designed to identify any material noncompliance with environmental requirements. Omega’s Vice President for Operations also completed a quarterly Environmental Certificate regarding the status of compliance with environmental obligations. This information was submitted to Omega’s Disclosure Committee for review in advance of quarterly filings. The Disclosure Committee and the finance personnel reviewed all of the referenced documents and spoke to other Omega employees in order to ensure that the company was in compliance with the line entries on the “Check Off Lists.”

In June 2013, OPI pleaded guilty in the U.S. District Court for the Eastern District of Virginia to two criminal felony counts of violating the Clean Water Act, or CWA.  As a result, the Environmental Protection Agency, or EPA, provided a notice to Omega in January 2014 that it was ineligible for receipt of governmental loans or benefits if any part of the work would be performed or if the loan collateral would be located at the facility where the offense occurred.  After becoming aware of the EPA’s notice to Omega, NMFS determined in September 2014 not to approve additional loans to Omega under existing commitments made prior to the events that gave rise to the 2013 plea.

Despite the first guilty plea and its associated requirement to implement an environmental compliance program, Omega made no changes to the standardized process at the quarterly close for testing the company’s compliance with its Title XI loan covenants – even the “Title XI Compliance Check Off List” remained the same. Furthermore, Omega made no changes to the standardized process as a result of either the EPA’s notice or NMFS’s decision not to approve additional loans to Omega.

In March 2015, Omega received a report, through its toll-free, 24-hour ethics hotline, of employee theft and illegal dumping at its Abbeville, Louisiana facility. The caller offered to give more information upon a return call. Not receiving one, the caller placed another call to the ethics hotline on the following day, requesting a return call.

Omega did not return these calls in a timely manner in March 2015 because the hotline system Omega put in place failed to notify the appropriate Omega executives.

By April 2015, however, Omega’s senior management had become aware of the calls to the internal hotline, but through a source other than the hotline, and as a result became aware of the allegation of illegal dumping potentially in violation of environmental laws. Shortly thereafter, Omega commenced an internal investigation into the allegations made through the hotline.

In January 2017, OPI pleaded guilty in the Western District of Louisiana to two criminal felony counts of violating the CWA.

In its 2014 annual report on Form 10-K Omega stated that it “was in compliance with all of the covenants contained” in the borrowings outstanding under Title XI. Omega repeated this representation in the three quarterly reports subsequently filed on Form 10-Q with the Commission on May 11, 2015, August 5, 2015, and November 4, 2015.

According to the SEC, these representations were false. OPI admitted in connection with its 2017 guilty plea that it knowingly discharged pollutants into U.S. waters surrounding its Abbeville facility on or about December 8, 2014. Also as already described, following the first guilty plea, Omega made no changes to the “Title XI Compliance Check Off List” and standardized process at the quarterly close for testing the company’s compliance with its Title XI loan covenants, despite the first guilty plea and its associated requirement to implement an environmental compliance program. Furthermore, by April 2015, Omega executives were on notice of an accusation that illegal dumping was taking place at the Abbeville plant. Those accusations were later substantiated by a criminal investigation that resulted in the company’s second guilty plea to criminal felony violations of the CWA.

The SEC charged Omega with violating Section 13(a) of the Exchange Act and Rules 13a-1 and 13a-13 thereunder which require issuers of securities registered pursuant to Section 12 to file with the Commission accurate annual reports. An issuer violates Section 13(a) and Rules 13a-1 and 13a-13 thereunder if it files a report that contains materially false or misleading information. The SEC noted by engaging in the described conduct, Omega violated Rule 12b-20 of the Exchange Act, which requires that reports contain such further material information necessary to make the required statements made in the reports not misleading.

Omega did not admit or deny the SEC’s findings.

Activist investor Third Point LLC and three funds that it controls have agreed to settle Federal Trade Commission charges that the funds violated the premerger notification and waiting period requirements of the Hart-Scott-Rodino Act, or HSR Act, after they acquired the voting securities of Dow DuPont Inc. (“Dow DuPont”).

Dow Chemical Company (“Dow”) and E.I du Pont de Nemours and Company (“DuPont”) entered into a Merger Agreement pursuant to which Dow and DuPont would consolidate into Dow DuPont.  On August 31, 2017, Dow and DuPont completed the consolidation pursuant to the Merger Agreement. As a result of the consolidation, all holders of Dow and DuPont voting securities received voting securities of Dow DuPont.

According to the complaint, on August 31, 2017, each defendant fund received voting securities of DowDuPont valued in excess of the size-of the-transaction test which was $80.8 million. Defendant Third Point Offshore acquired 6,446,300 voting securities of DowDuPont valued at approximately $429.6 million. Defendant Third Point Ultra acquired 4,376,813 voting securities of DowDuPont valued at approximately $291.7 million. Defendant Third Point Partners acquired 2,540,700 voting securities of DowDuPont valued at approximately $169.3 million.

The complaint alleges that each defendant fund was its own ultimate parent entity within the meaning of the HSR Rules and had its own obligation to comply with the notification and waiting period requirements of the HSR Act and the HSR Rules.

Previously, on April 7, 2014, each defendant fund had filed under the HSR Act to acquire voting securities of Dow and had observed the waiting period. According to the complaint, Section 802.21 of the HSR Rules did not exempt the defendant funds’ acquisitions of DowDuPont voting securities because DowDuPont was not the same issuer as Dow within the meaning of the HSR Rules. Among other things, for example, DowDuPont competes in additional lines of business from those in which Dow competed.

The complaint notes that the defendants are currently under a court decree resulting from allegations that they previously violated the HSR Act in connection with acquisitions of voting securities of Yahoo! Inc.. Specifically, on August 24, 2015, the United States filed a complaint for equitable relief alleging that defendants’ acquisitions of Yahoo voting securities in August and September of 2011 violated the HSR Act. The complaint does not allege that the defendants’ conduct alleged in the current complaint violated the 2015 court order.

Under the stipulated proposed order that the Department of Justice filed on behalf of the FTC in the U.S. District Court for the District of Columbia, the three Third Point funds will collectively pay $609,810 in civil penalties, and they, together with Third Point LLC, will be barred from committing future violations of the HSR Act in connection with corporate consolidations.

The proposed settlement is subject to notice and comment and final court approval.

The SEC provided guidance to assist investment advisers in fulfilling their proxy voting responsibilities. The guidance discusses, among other matters, the ability of investment advisers to establish a variety of different voting arrangements with their clients and matters they should consider when they use the services of a proxy advisory firm.  In addition, the Commission issued an interpretation that proxy voting advice provided by proxy advisory firms generally constitutes a “solicitation” under the federal proxy rules and provided related guidance about the application of the proxy antifraud rule to proxy voting advice.  Both of these actions explain the Commission’s view of various non-exclusive methods entities can use to comply with existing laws or regulations or how such laws and regulations apply.

Proxy Voting Responsibilities of Investment Advisers

Investment advisers owe each of their clients a duty of care and loyalty with respect to services undertaken on the clients’ behalf, including proxy voting.  Rule 206(4)-6 under the Advisers Act requires an investment adviser who exercises voting authority with respect to client securities to adopt and implement written policies and procedures that are reasonably designed to ensure that the investment adviser votes proxies in the best interest of its clients.

The guidance clarifies how an investment adviser’s fiduciary duty and Rule 206(4)-6 under the Advisers Act relate to an adviser’s proxy voting on behalf of clients, particularly if the investment adviser retains a proxy advisory firm.  The guidance follows a question and answer format and provides examples to help facilitate compliance.

In particular, the guidance discusses, among other things:

  • How an investment adviser and its client, in establishing their relationship, may agree upon the scope of the investment adviser’s authority and responsibilities to vote proxies on behalf of that client;
  • What steps an investment adviser, who has assumed voting authority on behalf of clients, could take to demonstrate it is making voting determinations in a client’s best interest and in accordance with the investment adviser’s proxy voting policies and procedures;
  • Considerations that an investment adviser should take into account if it retains a proxy advisory firm to assist it in discharging its proxy voting duties;
  • Steps for an investment adviser to consider if it becomes aware of potential factual errors, potential incompleteness, or potential methodological weaknesses in the proxy advisory firm’s analysis that may materially affect one or more of the investment adviser’s voting determinations;
  • How an investment adviser could evaluate the services of a proxy advisory firm that it retains, including evaluating any material changes in services or operations by the proxy advisory firm; and
  • Whether an investment adviser who has assumed voting authority on behalf of a client is required to exercise every opportunity to vote a proxy for that client.

Applicability of the Federal Proxy Rules to Proxy Voting Advice

The federal proxy rules apply to any solicitation for a proxy with respect to any security registered under Exchange Act Section 12.  Under Exchange Act Rule 14a-1(l), a solicitation includes, among other things, a “communication to security holders under circumstances reasonably calculated to result in the procurement, withholding or revocation of a proxy,” and includes communications by a person seeking to influence the voting of proxies by shareholders, regardless of whether the person itself is seeking authorization to act as a proxy.

Under the Commission interpretation, proxy voting advice provided by proxy advisory firms generally constitutes a solicitation subject to the federal proxy rules.  The Commission’s interpretation does not affect the ability of proxy advisory firms to continue to rely on the exemptions from the federal proxy rules’ filing requirements.  These exemptions, found in Rule 14a-2(b), among other things, provide relief from the obligation to file a proxy statement, as long as the advisory firm complies with the exemption’s conditions.

Solicitations that are exempt from the federal proxy rules’ filing requirements remain subject to Exchange Act Rule 14a-9, which prohibits any solicitation from containing any statement which, at the time and in the light of the circumstances under which it is made, is false or misleading with respect to any material fact.  The Commission guidance explains what a person providing proxy voting advice should consider when considering the information it may need to disclose in order to avoid a potential violation of Rule 14a-9 where the failure to disclose such information would render the advice materially false or misleading.

For example, the provider of the proxy voting advice should consider whether, depending on the particular statement, it may need to disclose the following types of information in order to avoid a potential violation of Rule 14a-9:

  • an explanation of the methodology used to formulate its voting advice on a particular matter (including any material deviations from the provider’s publicly-announced guidelines, policies, or standard methodologies for analyzing such matters) where the omission of such information would render the voting advice materially false or misleading;
  • to the extent that the proxy voting advice is based on information other than the registrant’s public disclosures, such as third-party information sources, disclosure about these information sources and the extent to which the information from these sources differs from the public disclosures provided by the registrant if such differences are material and the failure to disclose the differences would render the voting advice false or misleading; and
  • disclosure about material conflicts of interest that arise in connection with providing the proxy voting advice in reasonably sufficient detail so that the client can assess the relevance of those conflicts.