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

The SEC charged TherapeuticsMD Inc., a pharmaceutical company headquartered in Boca Raton, Florida, with violations of Regulation FD based on its sharing of material, nonpublic information with sell-side research analysts without also disclosing the same information to the public.  No individuals were charged.  The company did not admit or deny the SEC findings.

The enforcement case serves as a reminder that Regulation FD prohibits public companies from selectively disclosing material, nonpublic information to certain persons outside the company, including institutional investors, securities analysts, and other securities professionals.  Whenever a public company discloses material, nonpublic information to any such person, Regulation FD requires that the company also disclose the information to the public. Where a selective disclosure is “intentional,” the company must simultaneously make public disclosure with the selective disclosure. Under Regulation FD, intentional is defined as “when the person making the disclosure either knows, or is reckless in not knowing, that the information he or she is communicating is both material and nonpublic.”   When the disclosure is “non-intentional,” the public disclosure must be made “promptly,” which Regulation FD defines to mean “as soon as reasonably practicable (but in no event after the later of 24 hours or the commencement of the next day’s trading on the New York Stock Exchange).”

The SEC’s order found that on two separate occasions in 2017, TherapeuticsMD selectively shared material information with analysts about the company’s interactions with the U.S. Food and Drug Administration, or FDA.  The SEC’s allegations involved a drug TherapeuticsMD was developing known as TX-004HR, which was intended to be a hormone drug therapy. TX-004HR had not yet received FDA approval.

TherapeuticsMD had submitted an initial New Drug Application, or NDA, to the FDA for approval of TX-004HR. On May 5, 2017, TherapeuticsMD received a Complete Response Letter, or CRL from the FDA that cited a single deficiency in the NDA: the lack of long-term safety data for TX004HR. TherapeuticsMD disclosed the receipt and contents of the CRL in a press release and 8-K before the market opened on May 8, 2017, the next trading day, and the Company’s stock price declined 10.5% that day on heavy volume. TherapeuticsMD requested a meeting with the FDA to discuss the CRL, and it received a meeting date of June 14, 2017. On May 31, 2017, TherapeuticsMD publicly announced the June 14th FDA meeting date in an 8-K that also described the contents of the CRL. The Company explained it had two likely paths forward depending on how the June 14th meeting went: either the FDA would allow them to resubmit a revised NDA (putting TX-004HR back on the path to approval), or the Company would pursue formal dispute resolution against the FDA.

On June 14, 2017, TherapeuticsMD met with the FDA and discussed existing medical studies in support of the Company’s position that TX-004HR did not pose any concerns for endometrial safety. Additionally, TherapeuticsMD discussed preliminary data from a soon-to be published, long-term NIH study with favorable indicators for TX-004HR. The meeting lasted an hour and ended without the FDA providing a clear path forward for approval of TX-004HR.

Certain sell-side research analysts covering TherapeuticsMD were favorable about TX-004HR’s prospects for approval going into the June 14th meeting, and TherapeuticsMD executives assumed analysts and investors would seek news about the status of the NDA following the meeting. On June 15, 2017, TherapeuticsMD executives held an internal meeting to discuss next steps, including how the Company would respond to anticipated questions.

That afternoon, a TherapeuticsMD executive sent emails to each of the six sell-side research analysts covering TherapeuticsMD, writing that the June 14th meeting with the FDA was “very positive and productive,” and that they would be “waiting on meeting minutes to decide on the path forward.” The content of these messages was consistent with the plan that Company executives had developed that morning for responding to anticipated questions. Four of the emails concluded with an offer to discuss further, and at least three of the analysts arranged follow-up phone calls.

On June 16, 2017, TherapeuticsMD’s stock price increased significantly, closing up 19.4% on heavy volume. In the past, stock price and trading volume changes of similar magnitude had coincided with disclosures relating to the progress of TX-004HR through the FDA approval process. At 1:16 PM, a market watch official at NYSE contacted TherapeuticsMD executives, noting that the stock was trading up approximately 21% on heavy volume and asking whether the Company was aware of material information that could be affecting the stock. The Company executives who responded did not know of the emails sent to analysts the prior day and were anticipating market events that day that could cause possible volatility due to the expiration of futures contracts and options. They replied that they were not aware of any material information. The executives did not conduct any inquiry to determine the cause of the significant stock price movement, or to assess whether the magnitude of the price movement could be explained by the anticipated volume or possible market volatility that day.

TherapeuticsMD did not make any public disclosures about the June 14th FDA meeting until July 17, 2017.

On July 5, 2017, TherapeuticsMD received the meeting minutes for the June 14th meeting from the FDA.

In the early hours of July 17, 2017, TherapeuticsMD released an 8-K and press release updating the investing public on TX-004HR’s regulatory approval status following receipt of the formal minutes regarding the June 14th FDA meeting. The press release stated that the meeting had “enabled the Company to present new information” to the FDA that could “address concerns raised by the FDA in the C[omplete] R[esponse] L[etter] and positively affect the status of the NDA for TX-004HR.” The release also said that the meeting minutes did not put TX-004HR on a formal timeline for approval, and that TherapeuticsMD continued to reserve its options for moving forward. The press release did not identify or discuss details about the new information provided to the FDA.

After TherapeuticsMD published the press release at 6:56 AM on July 17th, its stock price began to decline sharply, falling approximately 16% in pre-market and early trading. Analysts immediately responded in emails to the Company with questions about what the press release meant.

At 7:30 AM, TherapeuticsMD executives held a pre-scheduled conference call with the sell-side analysts. During the call TherapeuticsMD executives discussed the meeting with the FDA, identified the new information submitted—which consisted of three previously published medical studies, as well as introducing the FDA to the authors of an ongoing long-term NIH study whose results had not yet been published (the “Newly Submitted Data”)—and discussed the significance and relevance of that data to TX-004HR’s safety. During the call, at 8:10 AM, a TherapeuticsMD employee sent an email to the analysts attaching the three medical studies that TherapeuticsMD had submitted to the FDA. The email also included a summary from TherapeuticsMD’s Chief Medical Officer describing why the Company believed the studies supported their position regarding TX-004HR’s safety, and concluding that based upon the findings in these studies, TX-004HR did not have a negative impact on the endometrium and therefore posed no safety risk.

Thereafter, in the following hours, each analyst published a research note that included specific information about the FDA meeting and the Newly Submitted Data.

By the end of the day on July 17th, the stock had rebounded from its 16% downward movement in the early hours of trading to finish down only 6.6% by market close.

TherapeuticsMD did not publicly disclose what Newly Submitted Data it had provided to the FDA, or the Newly Submitted Data’s application to TX-004HR in terms of safety, until its earnings call held on August 3, 2017.

The SEC noted that In June and July 2017, the time of the conduct described above, TherapeuticsMD did not have policies or procedures relating to compliance with Regulation FD. TherapeuticsMD subsequently implemented policies and procedures which, among other things:

  • required public disclosure of material, nonpublic information in connection with Regulation FD,
  • provided examples of types of material, nonpublic information that may arise in light of TherapeuticsMD’s business model, and
  • established specific review protocols for all external communications, including earnings calls, analyst meetings, and press releases.

TherapeuticsMD also now requires Regulation FD Training for employees.

The Financial Accounting Standards Board issued a proposed Accounting Standards Update, or ASU, that would grant private companies, not-for-profit organizations, and SEC registrants classified as smaller reporting companies additional time to implement FASB standards. For smaller reporting companies this would include the standard on current expected credit losses (CECL), and for private companies it would include CECL and standards on leases and hedging.

Smaller reporting companies would have to implement CECL by January 2023.

The proposed ASU describes a new FASB philosophy that extends and simplifies how effective dates for major standards are staggered between larger public companies and all other entities. Those other entities include private companies, smaller public companies, not-for-profit organizations, and employee benefit plans. Under this philosophy, a major standard would first be effective for larger public companies.  For all other entities, the Board would consider requiring an effective date staggered at least two years later.  Generally, it is expected that early application would continue to be permitted for all entities.

 

In Manti Holdings LLC et al v. Authentix Acquisition Company, Inc., the Delaware Court of Chancery held a stockholder could waive appraisal rights in a stockholders agreement. The Court noted:

  • The stockholders agreement was not a contract of adhesion. Sophisticated parties were involved and were represented by counsel, and counsel exchanged drafts of the proposed stockholders agreement before agreeing to a final contract.
  • There is no record evidence that the petitioners were not fully informed.
  • The Delaware General Corporation Law, or the DGCL, does not explicitly prohibit contractual modification or waiver of appraisal rights, nor does it require a party to exercise its statutory appraisal rights. Thus, such modification or waiver serves to supplement the DGCL, and is not inconsistent with, nor contrary to, the DGCL.
  • The stockholders agreement clearly and unambiguously waived appraisal rights.
  • The Court did not decide whether a waiver of appraisal would be upheld in other circumstances.

A question some ponder is whether all audit reports will include a discussion of critical audit matters, or CAMs. The answer is “yes” if you consider the 11 audit reports issued by the Big 4 on and after August 1 for large accelerated filers with June 30, 2019 year ends to be a representative sample.  All included one or more CAMs.

For those keeping track, today I came across two more audit reports with CAMs which you can find here and here. In this blog, I linked to nine audit reports with CAMs.

It doesn’t have to be that way though. There are a number of audit reports from smaller accounting firms on smaller issuers which indicate no CAMs were identified. Some may think this will change when the Big 4 start issuing reports on those beneath the large accelerated filer tier. That may be the case, but large accelerated filers by their nature seem to have complex accounting, which may not be true for smaller issuers and a finding of no CAMs may be appropriate.

We noted a couple of early CAMs here and here.  In addition, as of the end of the week on August 9, 1019, we identified the following CAMs (note that the easiest way to navigate the EDGAR documents to find the CAMs is to search for “critical audit” or if the table of contents is hyperlinked click on Item 8 for the financial statements which should place you close to the audit report):

Diageo PLC – CAMs for impairment assessment of indefinite-lived brand intangible assets and goodwill, taxation – provisions for tax uncertainties and legal contingent liabilities and proceedings.

The Procter & Gamble Company – CAMs for Goodwill and Intangible Assets – Shave Care Goodwill and Gillette Indefinite Lived Intangible Asset and acquisition of the over the counter healthcare business of Merck KGaA.

Broadridge Financial Solutions, Inc.  — CAM for evaluation of goodwill for impairment.

K12 Inc. – CAMs for managed public schools revenues and accounting for income taxes.

Automatic Data Processing, Inc. —  CAMs for goodwill – employer services reportable segment and client fund obligations.

 Paylocity Holding Corporation – CAMs for evaluation of implementation services and determination of capitalized internal-use software development costs.

Cimpress N.V. – CAMs for goodwill – quantitative impairment assessment and acquisition of BuildASign – intangible assets.

In this blog maintained by my colleagues Scott Hecht and Christina Arnone, Scott and Jessica Pixler of Stinson outline a recent case in the Delaware Superior Court where the Court ruled that a Delaware General Corporation Law § 262 appraisal action constituted a “Securities Claim” within the meaning of the insuring agreement of a directors and officers liability insurance policy.

If you’re interested in insurance issues, this is a blog worth following.

The SEC has 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.  The SEC stated the proposed amendments are intended to update the rules to improve disclosures for investors and to simplify compliance efforts for registrants.  The proposed rules will be subject to a 60-day comment period once published in the Federal Register.

The proposed amendments would revise Item 101(a), which requires a description of the general development of the registrant’s business, to:

  • make it largely principles-based by providing a non-exclusive list of the types of information that a registrant may need to disclose, and by requiring disclosure of a topic only to the extent such information is material to an understanding of the general development of a registrant’s business;
  • include as a listed disclosure topic, to the extent material to an understanding of the registrant’s business, transactions and events that affect or may affect the company’s operations, including material changes to a registrant’s previously disclosed business strategy;
  • eliminate a prescribed timeframe for this disclosure; and
  • permit a registrant, in filings made after a registrant’s initial filing, to provide only an update of the general development of the business that focuses on material developments in the reporting period, and with an active hyperlink to the registrant’s most recent filing that, together with the update, would contain the full discussion of the general development of the registrant’s business.

The proposed amendments would revise Item 101(c), which requires a narrative description of the registrant’s business, to:

  • clarify and expand its principles-based approach by including disclosure topics drawn from a subset of the topics currently contained in Item 101(c);
  • include, 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; and
  • refocus the regulatory compliance requirement by including material government regulations, not just environmental provisions, as a topic.

The proposed amendments would revise Item 103, which requires a description of the registrant’s  pending legal proceedings, to:

  • expressly state that the required information about material legal proceedings may be provided by including hyperlinks or cross-references to legal proceedings disclosure located elsewhere in the document in an effort to encourage registrants to avoid duplicative disclosure; and
  • revise the threshold for disclosure of environmental proceedings to which the government is a party from $100,000 to $300,000 to adjust for inflation.

Finally, the proposed amendments would revise Item 105, which requires a description of the registrant’s risk factors, to:

  • require summary risk factor disclosure if the risk factor section exceeds 15 pages;
  • refine the principles-based approach of that rule by changing the disclosure standard from the “most significant” factors to the “material” factors required to be disclosed; and
  • require risk factors to be organized under relevant headings, 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.

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 to its rules that are 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.

Historically, 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. Registrants provide Item 202 disclosure about registered securities in their registration statements, but are not required to provide this disclosure in their Form 10-K or Form 10-Q.

The revised rules require registrants to provide the information required by Item 202(a)-(d) and (f) as an exhibit to Form 10-K, rather than limiting this disclosure to registration statements.

You can find examples of the required exhibits describing the terms of capital stock etc. here, here (Exhibits 4.3. to 4.11) and here.

It’s more than a modicum of work in the interest of “disclosure simplification” and some registrants might want to get a head start on pulling the pieces together.

An audit report was filed with a 10-K that includes two CAMs.  One is related to revenue recognition and the other is related to uncertain tax positions.

More specifically on revenue recognition the audit report states the auditors identified the evaluation of the allocation of contract price to the identified performance obligations within the contracts as a critical audit matter because a higher degree of auditor judgment was required in evaluating the methodology and frequency used to establish stand alone selling price.  I doubt this is a surprise to anyone as the prior 10-K included extensive language in the MD&A regarding critical accounting polices although perhaps cast somewhat differently.

I think revenue recognition CAMs are going to become somewhat boiler plate and not likely to attract a lot of attention absent special circumstances.

The CA M on uncertain tax positions is a little more interesting.  The audit report provides “We identified the evaluation of uncertain tax positions as a critical audit matter because a higher degree of auditor judgment was required in evaluating the Company’s interpretation of, and compliance with tax law globally across its multiple subsidiaries. In addition, a higher degree of auditor judgment was required in evaluating the Company’s estimate of the ultimate resolution of its tax positions.”

I don’t know if this will raise eyebrows but maybe some will wonder why it is so hard to figure out the accrual and what games are being played.

Neither CAM reflects adversely on the issuer, its Board or audit committee.

To my knowledge this 10-K includes the first critical audit matter, or CAM, issued by a Big 4 firm.  The first of two CAMs is straightforward and does not reflect negatively on the company or its audit committee or cast doubt on its financial reporting.  If anything, it most likely reflects an attitude by the auditor that we have to find something to protect us in the case of a PCAOB inspection.

The audit report provides:

The critical audit matters communicated below are matters arising from the current-period audit of the financial statements that were communicated or required to be communicated to the Company’s Audit Committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.

Critical Audit Matter Description

The Company recognizes revenue upon transfer of control of promised products or services to customers in an amount that reflects the consideration the Company expects to receive in exchange for those products or services. The Company offers customers the ability to acquire multiple licenses of software products and services, including cloud-based services, in its customer agreements through its volume licensing programs.

Significant judgment is exercised by the Company in determining revenue recognition for these customer agreements, and includes the following:

      • Determination of whether products and services are considered distinct performance obligations that should be accounted for separately versus together, such as software licenses and related services that are sold with cloud-based services.
      • Determination of stand-alone selling prices for each distinct performance obligation and for products and services that are not sold separately.
      • The pattern of delivery (i.e., timing of when revenue is recognized) for each distinct performance obligation.
      • Estimation of variable consideration when determining the amount of revenue to recognize (e.g., customer credits, incentives, and in certain instances, estimation of customer usage of products and services).

Given these factors, the related audit effort in evaluating management’s judgments in determining revenue recognition for these customer agreements was extensive and required a high degree of auditor judgment.

How the Critical Audit Matter Was Addressed in the Audit

Our principal audit procedures related to the Company’s revenue recognition for these customer agreements included the following:

      • We tested the effectiveness of internal controls related to the identification of distinct performance obligations, the determination of the timing of revenue recognition, and the estimation of variable consideration.
      • We evaluated management’s significant accounting policies related to these customer agreements for reasonableness.
      • We selected a sample of customer agreements and performed the following procedures:
        • Obtained and read contract source documents for each selection, including master agreements, and other documents that were part of the agreement.
        • Tested management’s identification of significant terms for completeness, including the identification of distinct performance obligations and variable consideration.
        • Assessed the terms in the customer agreement and evaluated the appropriateness of management’s application of their accounting policies, along with their use of estimates, in the determination of revenue recognition conclusions.
      • We evaluated the reasonableness of management’s estimate of stand-alone selling prices for products and services that are not sold separately.
      • We tested the mathematical accuracy of management’s calculations of revenue and the associated timing of revenue recognized in the financial statements.

The audit report also contains a CAM related to uncertain tax positions.