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

In Batty v. UCAR International Inc. et al the Delaware Court of Chancery considered the terms of a severance agreement.  The agreement, which was entered into in 2000, set the compensation that plaintiff Batty, who was employed by certain of the defendants for 34 years, would receive from the defendants in the event he resigned for “good reason” following a “change in control.”  A change of control occurred in 2015, and Batty resigned in early 2017.  The parties did not dispute that the change of control occurred or that Batty’s resignation triggered his entitlement to compensation under the agreement, but the amounts payable were at issue.

Section 2(a)(ii) of the agreement entitled Batty to the amount of his “accrued Incentive Compensation” upon his resignation. Section 2(a)(ii) specifically requires a defendant to pay accrued amounts of Batty’s “target variable compensation payment.” Batty alleged that the term “target variable compensation” included equity awards, and that defendants breached the agreement by failing to pay him his equity awards that accrued in 2016 and 2017. Around $1.5 million was at stake.

The defendants argued that “accrued Incentive Compensation” was limited to cash compensation and thus excluded equity awards. The defendants relied on Section 1(f), which defined “Incentive Compensation” as “any compensation, variable compensation, bonus, benefit or award paid or payable in cash under an Incentive Compensation Plan.”  According to the defendants, Section 1(f)’s phrase “paid or payable in cash” modifies all preceding nouns (“compensation, variable compensation, bonus, benefit or award”). In the alternative, the defendants argued that they prevail even if “paid or payable in cash” modifies only the nearest noun, “awards,” because equity awards are “awards” and thus subject to the cash limitation. To bolster their interpretation, the defendants point to the definition of “Incentive Compensation Award,” which too is limited to “cash payment or payments awarded to [Batty] under any Incentive Compensation Plan.”

The Court noted the defendants’ interpretation of Section 2(a)(ii) was reasonable, but that it was not the only reasonable interpretation. Just as conceivable, according to the Court, was that the term “Incentive Compensation” could mean certain items that may be paid in cash or equity (“compensation, variable compensation, bonus, benefit”) as well as one item that is only paid or payable in cash (“award”). According to the Court, under this interpretation, regardless of whether the equity awards are “paid or payable in cash,” they would be included in Batty’s accrued Incentive Compensation.

The Court noted it could not grant the defendant’s motion to dismiss because it may not “choose between two differing reasonable interpretations of ambiguous provisions.” Rather, “any ambiguity must be resolved in favor of the nonmoving party.”  The Court said the defendants are “not entitled to dismissal under Rule 12(b)(6) unless the interpretation of the contract on which [its] theory of the case rests is the ‘only reasonable construction as a matter of law.” According to the Court, because Section 2(a)(ii) is susceptible to multiple reasonable interpretations, the defendants’ motion to dismiss failed.

While many will find the Court’s decision as unsatisfying or possibly wrong, it highlights the need for careful drafting to avoid disputes.

The SEC charged fifteen individuals with acting as unregistered brokers or aiding-and-abetting such activity in connection with Intertech Solutions, Inc.’s fraudulent and unregistered securities offerings.

The SEC’s complaints allege that the charged individuals were hired by Intertech Solutions to engage in or facilitate cold-call solicitations of hundreds of prospective investors throughout the United States and Canada from at least February 2014 through December 2016. The complaints allege that, as a result of the defendants’ conduct, Intertech Solutions raised over $7 million from retail investors.

According to the complaints, Intertech Solutions paid the defendants exorbitant commissions ranging from 35% to 50% of the funds provided by each investor. The complaints allege that the defendants did not disclose their commission rates to investors and instead distributed private placement memoranda that indicated that only 10% of investor proceeds would be used as commissions. The SEC previously charged Intertech Solutions and its control persons with orchestrating the fraudulent and unregistered offerings.

The SEC’s complaints, filed in federal district courts in Nevada, Texas, and Florida, charge the defendants with either direct or indirect violations of the broker-dealer registration provisions of Section 15(a)(1) of the Securities Exchange Act of 1934. Twelve of the defendants are also charged with the securities registration and antifraud provisions of Sections 5(a), 5(c), and 17(a) of the Securities Act of 1933, and one defendant is also charged with violating the securities registration provision of Section 5(a) and (c) of the Securities Act.

The complaints appear to rely primarily on the receipt of transaction based compensation for violations of the broker-dealer registration provisions.  Other conduct the SEC may rely on include providing information about Intertech Solutions’ business, discussing the valuation of an investment with Intertech Solutions, mailing or emailing offering documents, and directing investors to sign subscription agreements and providing related payment instructions.

Without admitting or denying the SEC’s allegations, eleven of the defendants have agreed to the entry of final judgments. These settlements are subject to court approval. It is important to note that no court has determined the non-settling defendants engaged in unlawful conduct.

The SEC has approved amendments to Sections 312.03 and 312.04 of the NYSE Listed Company Manual that modify the price requirements for certain exceptions to shareholder vote requirements related to issuances of securities set forth in Section 312.03. The amendments replace the former “book and market value” minimum pricing threshold with a new defined Minimum Price threshold. The revised Rules are similar in principle to those approved by the SEC last year relating to NASDAQ Rule 5635(d).

Among other things, NYSE Rule 312.03(b) requires that shareholder approval be received prior to the issuance of securities to designated related parties when the issuance involves greater than one percent of the number or voting power of the common stock outstanding before the issuance. However, under the revised rules, sales to a “Related Party” purchaser do not require shareholder approval if the purchaser falls in the definition of a “Related Party” because it is a “substantial security holder” (greater than 5%) of the company so long as the sale of stock will be for cash at a price greater than the Minimum Price and the amount sold does not exceed five percent of the number or voting power of common stock outstanding before the issuance.

Similarly, amended Rule 312.03(c) incorporates the new Minimum Price threshold into the exception to shareholder approval requirements for a 20% Issuance made as a bona fide private financing at or above the Minimum Price. A 20% Issuance in this case means any offering of securities (that is, common stock, or securities convertible or exercisable into common stock) in number or voting power equal to or greater than 20% of pre-issuance number or voting power.

For each amended exception, “Minimum Price” means the lower of: (i) the Official Closing Price immediately preceding the signing of the binding agreement; or (ii) the average Official Closing Price for the five trading days immediately preceding the signing of the binding agreement. “Official Closing Price” is the price reported most recently on the NYSE consolidated tape.

The revised rules no longer include a requirement that the price exceed the book value of the common stock. The NYSE also eliminated the statement that average price over time is not acceptable as a measure of market value, as inconsistent with the new formulation of the Minimum Price threshold. Finally, the new rules change previous references to “entering into” a binding agreement to “signing,” to conform the language throughout the rule without altering the interpretation.

In Olenik V. Lodzinski et al, the Delaware Supreme Court reversed the Court of Chancery finding the conditions required for business judgment review of a transaction with a controlling shareholder had not been conducted in accordance with Kahn v. M&F Worldwide Corp. from the outset and therefore the entire fairness standard applied. In MFW the Delaware Supreme Court held that the business judgment standard of review governs mergers proposed by a controlling stockholder and its corporate subsidiary when subject to the following two procedural protections from the beginning:

  • the approval of an independent, adequately-empowered Special Committee that fulfills its duty of care; and
  • the uncoerced, informed vote of a majority-of-the-minority of stockholders.”

The Delaware Supreme Court noted that while the parties briefed this appeal the Supreme Court decided Flood v. Synutra International, Inc.  Under Synutra, to invoke the MFW protections in a controller led transaction, the controller must “self-disable before the start of substantive economic negotiations.”  The controller and the board’s special committee must also bargain under the pressures exerted on both of them by the MFW protections.” In Synutra, the Delaware Supreme court cautioned that the MFW protections will not result in dismissal when the “plaintiff has pled facts that support a reasonable inference that the two procedural protections were not put in place early and before substantive economic negotiations took place.”

The complaint challenged a business combination between Earthstone Energy Inc. and Bold Energy III LLC and alleged EnCap Investments L.P. controlled Earthstone and Bold.  The Supreme Court held, based on its review of the complaint, the well pled facts support a reasonable inference that the MFW requirements were not put in place early and before substantive economic negotiation took place.

According to the Court, presentations made by Earthstone to EnCap, Earthstone management valued Bold at $305 million in an initial presentation and $335 million in a second presentation. Based on these facts, the Court found it was reasonable to infer that these valuations set the field of play for the economic negotiations to come by fixing the range in which offers and counteroffers might be made.  According to the complaint, that generally turned out to be the case. Earthstone’s first formal offer—the one in which the MFW conditions were finally mentioned—reflected an equity valuation for Bold of about $300 million, and the final deal reflected an equity valuation for Bold of around $333 million.

Wow, it finally happened. The SEC granted long awaited guidance on when tokens are not securities in the form of a no-action letter.  The no-action letter finds the specific tokens at issue were not securities because:

  • TKJ will not use any funds from Token sales to develop the TKJ Platform, Network, or App, and each of these will be fully developed and operational at the time any Tokens are sold;
  • The Tokens will be immediately usable for their intended functionality (purchasing air charter services) at the time they are sold;
  • TKJ will restrict transfers of Tokens to TKJ Wallets only, and not to wallets external to the Platform;
  • TKJ will sell Tokens at a price of one USD per Token throughout the life of the Program, and each Token will represent a TKJ obligation to supply air charter services at a value of one USD per Token;
  • If TKJ offers to repurchase Tokens, it will only do so at a discount to the face value of the Tokens (one USD per Token) that the holder seeks to resell to TKJ, unless a court within the United States orders TKJ to liquidate the Tokens; and
  • The Token is marketed in a manner that emphasizes the functionality of the Token, and not the potential for the increase in the market value of the Token.

Technically no-action letters are applicable only to the recipients and are not binding on courts.

At about the same time, the SEC also published a Framework for “Investment Contract” Analysis of Digital Assets. The framework is not intended to be an exhaustive overview of the law, but rather, an analytical tool to help market participants assess whether the federal securities laws apply to the offer, sale, or resale of a particular digital asset.  This framework represents Staff views and is not a rule, regulation, or statement of the Commission.  The Commission has neither approved nor disapproved its content.  This framework, like other Staff guidance, is not binding on the Divisions or the Commission.

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. The amendments are also intended to improve the readability and navigability of disclosure documents and discourage repetition and disclosure of immaterial information.

The authors believe that the FAST Act changes primarily benefit registrants that file confidential treatment requests, or CTRs, for material contracts. For other registrants, the benefits are marginally incremental, offset by increased regulatory burdens.

Set forth below is a summary of key changes for domestic operating company registrants (i.e., not including changes applicable to foreign private issuers or investment companies or changes that affect registration statements) in key forms typically filed by domestic operating company registrants. Where a FAST Act change does not affect existing practice, it is not highlighted. For instance, the FAST Act changes revise the risk factor disclosure to be codified in Item 105 of Regulation S-K and eliminate references in the rule to certain specifically identified risk factors, but the change does not affect existing practice as the risk factor rule remains a principle-based rule.

This summary should be read in conjunction with our full analysis of the FAST Act changes which can be found here.

Timing

Changes with respect to CTRs are now effective. Changes to SEC forms and disclosure requirements are effective as of May 2, 2019. Cover page tagging requirements are subject to phased compliance dates set forth below.

Confidential Treatment Requests

  • CTRs are no longer required for material contracts filed pursuant to Item 601(b)(10) of Regulation S-K. Instead, the registrant may redact provisions or terms of exhibits required to be filed if those provisions or terms are both not material and would likely cause competitive harm to the registrant if publicly disclosed. If it does so, the registrant must mark the exhibit index to indicate that portions of the exhibit or exhibits have been omitted and include a prominent statement on the first page of the redacted exhibit that certain identified information has been excluded from the exhibit because it is both not material and would likely cause competitive harm to the registrant if publicly disclosed. The registrant also must indicate by brackets where the information is omitted from the filed version of the exhibit.
  • In addition to the FAST Act rules, the SEC has released additional guidance regarding the processing of redacted information on exhibits:
    • General Compliance Review Process. The SEC intends to review registrant filings for compliance with the new rules. To initiate a redacted exhibit review, the SEC will send a letter with a request that the registrant provide the SEC a paper copy of the unredacted exhibit marked to highlight the redacted information. The SEC may or may not ask for further substantiation of the registrant’s redaction decisions upon review of the unredacted exhibit. If the SEC’s review of the unredacted exhibit does not lead to comments, the SEC will send a letter indicating that its compliance review is complete.  If the SEC’s review of the unredacted exhibit leads to questions about immateriality or claims of competitive harm, the SEC will provide the registrant with comments separate and apart from any comments on the associated filing. When the SEC’s questions are resolved, the SEC will send the registrant a letter indicating that its compliance review is complete.
    • Completion of Review Process. The SEC will make its initial request for an unredacted exhibit and the closing of review letter for that exhibit publicly available on EDGAR following the closing of that review. If that review was done in conjunction with a regular filing review, the SEC will post the initial request and closing of review letter at the time the SEC posts the other correspondence related to the filing review. These letters will only note the existence of an opened and a closed redacted exhibit compliance review. In order to avoid public disclosure of competitively harmful information, the SEC will not make public its comments regarding redacted exhibits, nor registrant responses to staff requests or comments related to that topic.

Other Matters Related to Exhibits

  • Under existing rules in Item 601 of Regulation S-K, registrants generally must file complete copies of any required exhibits. Very often, these exhibits include a number of schedules, appendices, and other similar attachments which can be quite lengthy but not necessarily material to investors. Similar to current Item 601(b)(2), new Item 601(a)(5) permits registrants to omit entire schedules and similar attachments to required exhibits, provided:
    • they do not contain material information;
    • they were not otherwise disclosed in the exhibit or the disclosure document; and
    • the filed exhibit contains a list briefly identifying the contents of any omitted schedules and attachments.
  • The amended rules confirm that personally identifiable information (PII) may be redacted without a CTR submission, codifying current practice.
  • As now defined in the FAST Act Rules, Item 601(b)(10)(i) requires registrants to file every material contract not made in the ordinary course of business if such contract must be performed in whole or in part at or after the filing of the registration statement or report. The two-year look-back exhibits has been eliminated, other than for newly reporting registrants.
  • Item 10(d) of Regulation S-K was eliminated together with the prohibition on incorporation by reference for documents that were filed with the SEC more than five years ago. Other provisions of Item 10(d) were incorporated in other revised rules (i.e. Rule 411(e) and Rule 12b-23(e)).
  • Rule 12b-23 was revised to require hyperlinks to information that is incorporated by reference if that information is available on EDGAR. Registrants are not required to refile information that is incorporated by reference from a document that was previously filed with the SEC in paper.

Form 10-K

  • 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 current 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:

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 subject to the following compliance schedule:
    • Large accelerated filers that prepare their financial statements in accordance with U.S. GAAP – Reports for fiscal periods ending on or after June 15, 2019
    • 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.
  • 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.”

Form 10-Q

  • Include the Trading Information Table.
  • Comply with the new requirements for “Exhibits” set forth above.
  • The cover page must comply with the Cover Page Tagging Requirements, subject to the phased compliance dates.

Form 8-K

  • Include the Trading Information Table.
  • Comply with the new requirements for “Exhibits” set forth above.
  • The cover page must comply with the Cover Page Tagging Requirements, subject to the phased compliance dates.

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.
  • The new rules 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, registrants can eliminate some questions from directors and officers questionnaires pointed towards 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.

The SEC’s Division of Trading and Markets is seeking a Crypto Specialist to coordinate activities regarding crypto and digital asset securities.

Job responsibilities include:

  • Coordinating with TM staff to establish a comprehensive plan to address crypto and digital asset securities and engaging with other Divisions and Offices on such matters
  • Serving as the TM’s point of contact for domestic and international regulators, market participants, and the public.
  • Providing expert level comment on policy and workstreams.
  • Developing and maintaining expert-level industry knowledge of crypto and digital asset securities and products, as well as legal and policy developments occurring in domestic and foreign jurisdictions;
  • Applying knowledge of federal securities laws to digital asset securities and crypto matters, i.e., broker-dealer, exchange, clearing agency and transfer registrations, exchange product applications, sales and trading practices, etc.
  • Conducting periodic meetings with Division and agency staff to foster collaboration, open communications and a common understanding of key issues, and relevant industry, legal and policy developments;
  • Serving as the Division’s lead representative in the SEC’s FinTech Working Group and as liaison with the FSOC’s Digital Assets Working Group;
  • Interacting with relevant Division staff, brief Chairman’s Office and Commissioner offices about salient developments, and represent the Division and agency at conferences and meetings with industry and public stakeholders.

SEC Chairman Jay Clayton gave his views on appropriate disclosures related to human capital in opening remarks before a meeting of the SEC Investor Advisory Committee.

Chairman Clayton believes that the strength of our economy and many of our public companies is due, in significant and increasing part, to human capital, and for some of those companies human capital is a mission-critical asset. Accordingly, disclosure should focus on the material information that a reasonable investor needs to make informed investment and voting decisions although this is not a simple task.  According to Chairman Clayton, the historical approach of disclosing only the costs of compensation and benefits often is not enough to fully understand the value and impact of human capital on the performance and future prospects of an organization.

Chairman Clayton expressed his view that to move the SEC’s disclosure framework forward the SEC should not attempt to impose rigid standards or metrics for human capital on all public companies. Rather, investors would be better served by understanding the lens through which each company looks at its human capital. Relevant questions to ask are: what questions do boards ask their management teams about human capital and what questions do investors—those who are making investment decisions—ask about human capital? For example, how do investors use human capital information to make relative capital allocations among similar organizations? Armed with general and sector-specific answers to these questions, the SEC can better craft rules and guidance.

 

 

The U.S. Supreme Court considered the extent of liability under Rule 10b-5 and other rules of the Securities and Exchange Commission and related statutes in Lorenzo v. Securities and Exchange Commission.  The facts of the case were undisputed.  Francis Lorenzo, while the director of investment banking at an SEC-registered brokerage firm, sent two e-mails to prospective investors. The content of those e-mails was cut and pasted from materials which Lorenzo’s boss supplied, and described a potential investment in a company with “confirmed assets” of $10 million. In fact, Lorenzo knew the company had recently disclosed that its total assets were worth less than $400,000.

In what many view as a departure from existing precedent set forth in the U.S. Supreme Court case of Janus Capital Group, Inc. v. First Derivative Traders, the Supreme Court found that Lorenzo violated Rule 10b-5(a) and (c), Section 10(b) of the Exchange Act and Section 17(a)(1) of the Securities Act.  The case has important implications for those who assist in drafting offering documents, including officers of companies issuing securities, investment bankers, lawyers and law firms.

Lorenzo’s primary argument was that under Janus he could not be held liable under subsection (b) of Rule 10b-5 as he was not the “maker” of the statement.  Janus held that held that the “maker of a statement is the person or entity with ultimate authority over the statement, including its content and whether and how to communicate it.”  On the facts of Janus, this meant that an investment adviser who had merely participated in the drafting of a false statement “made” by another could not be held liable in a private action under subsection (b) of Rule 10b-5.

The Supreme Court agreed with the SEC and saw it differently.  The Court reviewed the relevant provisions of Rule 10b-5 and related statutes. The Court noted subsection (a) of the Rule makes it unlawful to “employ any device, scheme, or artifice to defraud.” Subsection (b) makes it unlawful to “make any untrue statement of a material fact.” And subsection (c) makes it unlawful to “engage in any act, practice, or course of business” that “operates . . . as a fraud or deceit.” [1]. Section 10(b) of the Securities Exchange Act makes it unlawful to “use or employ . . . any manipulative or deceptive device or contrivance” in contravention of SEC rules and regulations. Finally, the Court reviewed Section §17(a)(1) of the Securities Act which makes it unlawful to “employ any device, scheme, or artifice to defraud.”

The Court found dissemination of false or misleading statements with intent to defraud can fall within the scope of subsections (a) and (c) of Rule 10b-5, as well as the relevant statutory provisions. In the Court’s view, that is so even if the disseminator did not “make” the statements and consequently falls outside of subsection (b) of the Rule.

According to the Court, it was obvious that the words in these provisions are, as ordinarily used, sufficiently broad to include within their scope the dissemination of false or misleading information with the intent to defraud. By sending emails he understood to contain material untruths, Lorenzo “employ[ed]” a “device,” “scheme,” and “artifice to defraud” within the meaning of subsection (a) of the Rule, §10(b), and §17(a)(1). By the same conduct, he “engage[d] in a[n] act, practice, or course of business” that “operate[d] . . . as a fraud or deceit” under subsection (c) of the Rule. The Court said “Under the circumstances, it is difficult to see how his actions could escape the reach of those provisions.”  It is also important to note that Lorenzo did not, before the Supreme Court, challenge that he acted with scienter, so the Court took for granted that he sent the emails with “intent to deceive, manipulate, or defraud” the recipients.

The Court rejected Lorenzo’s argument that, despite the natural meaning of these provisions, they should not reach his conduct. According to Lorenzo, the only way to be liable for false statements is through those provisions that refer specifically to false statements. The provisions other than Rule 10b-5(b) concern “scheme liability claims” and are violated only when conduct other than misstatements is involved. Lorenzo noted that holding to the contrary would render subsection (b) of Rule 10b-5 superfluous.  The Court rejected this argument, noting that the Court and the SEC have long recognized considerable overlap among the subsections of the Rule and related provisions of the securities laws. Lorenzo’s conduct, though plainly fraudulent, might otherwise fall outside the scope of the Rule. According to the Court, accepting Lorenzo’s view that subsection (b), the making-false-statements provision, exclusively regulates conduct involving false or misleading statements would mean those who disseminate false statements with the intent to cheat investors might escape liability under the Rule altogether.

According to the dissent, under the Court’s ruling, a person who has not “made” a fraudulent misstatement within the meaning of Rule 10b-5(b) nevertheless could be held primarily liable for facilitating that same statement; the SEC or plaintiff need only relabel the person’s involvement as an “act,” “device,” “scheme,” or “artifice” that violates Rule 10b-5(a) or (c). And a person could be held liable for a fraudulent misstatement under §17(a)(1) even if the person did not obtain money or property by means of the statement, which is governed by §17(a)(2).

The dissent noted that its interpretation would not allow people who disseminate false statements with the intent to defraud to escape liability under Rule 10b-5. If a person’s only role is transmitting fraudulent misstatements at the behest of the statements’ maker, the person’s conduct would be appropriately assessed as a matter of secondary liability under existing securities law.  In addition to rendering Janus a dead letter, the dissent noted the majority fails to maintain a clear line between primary and secondary liability in fraudulent misstatement cases. Maintaining this distinction is important because there is no private right of action against mere aiders and abettors.

Given the unique facts of Lorenzo we believe Janus will remain a strong and viable defense for most offering participants.  Lorenzo expands potential liability for those who assist in drafting offering documents, including officers of companies issuing securities, investment bankers, lawyers and law firms. It is unclear from Lorenzo what action is necessary other than hitting the “send” button on an email to impose primary liability under Rule 10b-5(a) or (c), other than acting with scienter. While in our experience, offering participants go to great lengths to insure the truth and accuracy of offering documents, and therefore do not act with scienter, offering participants will nonetheless be attractive defendants in litigation involving offerings following the Court’s ruling in Lorenzo.

[1] Rule 10(b)-5 provides as follows:

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,

(a) To employ any device, scheme, or artifice to defraud,

(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or

(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person in connection with the purchase or sale of any security.

 

The Fixing America’s Surface Transportation Act, or FAST Act, required the SEC to consider ways to streamline SEC regulations. Accordingly, the SEC has 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. The amendments are also intended to improve the readability and navigability of disclosure documents and discourage repetition and disclosure of immaterial information.  The new rules will generally be effective 30 days after publication in the Federal Register with special transition provisions for certain items. In addition, amendments to the rules governing redaction of confidential information in material contracts are effective upon publication in the Federal Register.

MD&A

Required MD&A disclosure is currently set forth in Item 303(a) of Regulation S-K.  Instruction 1 to Item 303(a) currently provides that the discussion and analysis shall be of the financial statements and other statistical data that the registrant believes will enhance a reader’s understanding of its financial condition, changes in financial condition, and results of operations. This instruction also provides that, generally, the discussion shall cover the three-year period covered by the financial statements and either use year-to-year comparisons or any other format that in the registrant’s judgment would enhance a reader’s understanding. The instruction also states that reference to the five-year selected financial data may be necessary where trend information is relevant.

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 will now state 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.

Redaction of Confidential Information in Material Contract Exhibits

Current SEC rules allow registrants to redact information from material contracts filed as exhibits if the information is not material and is covered by an exemption from the Freedom of Information Act.  However, the registrant must file a confidential treatment request, or CTR, which the SEC must approve.

Under the revised rules, CTRs will no longer be required for material contracts filed pursuant to Item 601(b)(10) of Regulation S-K. Instead, the registrant may redact provisions or terms of exhibits required to be filed if those provisions or terms are both not material and would likely cause competitive harm to the registrant if publicly disclosed. If it does so, the registrant must mark the exhibit index to indicate that portions of the exhibit or exhibits have been omitted and include a prominent statement on the first page of the redacted exhibit that certain identified information has been excluded from the exhibit because it is both not material and would likely cause competitive harm to the registrant if publicly disclosed. The registrant also must indicate by brackets where the information is omitted from the filed version of the exhibit. The SEC intends to police this provision through its filing review process.

The SEC also adopted changes to Form 8-K to clarify that the accommodations to the exhibit filing requirements extend to Item 1.01 of Form 8-K as well, to the extent such exhibits are filed with the intention of being incorporated into future filings in satisfaction of Item 601(b)(10).

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. The final rules also provide a uniform standard of disclosure based on materiality for non-industry specific properties. In some cases, application of this analysis may result in a description of property on an individual basis or on a collective basis, or may result in no disclosure.

Directors, Executive Officers, Promoters, and Control Persons

Item 401 of Regulation S-K sets forth disclosure requirements about the identity and background information of a registrant’s directors, executive officers, and significant employees.  Instruction 3 to Item 401(b) allows registrants to include required information about their executive officers in Part I of Form 10-K. If a registrant chooses this alternative, Instruction 3 states that the registrant is not required to repeat that information in its definitive proxy or information statement.

To make clear that Instruction 3 applies to any executive officer disclosure required by Item 401, and therefore registrants need not duplicate such disclosure in their definitive proxy or information statement if they have already provided it in their Form 10-K, the revised rules clarify the scope of the instruction by moving it from Item 401(b) and making it a general instruction to Item 401. The revised rules also require the caption for the disclosure if it is 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.”

Compliance with Section 16(a) of the Exchange Act

Item 405 of Regulation S-K requires registrants to disclose each reporting person who failed to file Section 16 reports on a timely basis during the most recent fiscal year or prior fiscal years. The revised rules eliminate the requirement in Rule 16a-3(e) that reporting persons furnish Section 16 reports to the registrant. The revised rules also amend Item 405 to:

  • 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.
  • 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.
  • Eliminate the checkbox on the cover page of Form 10-K (and the related instruction in Item 10 of Form 10-K) whereby the registrant indicates that there is no disclosure of delinquent filers in the Form 10-K and, to the best of the registrant’s knowledge, will not be included in a definitive proxy or information statement incorporated by reference.

Audit Committee Discussions with Independent Auditor

Under existing Item 407(d)(3)(i)(B) of Regulation S-K, when a registrant files a proxy or information statement relating to an annual or special meeting of security holders at which directors are elected or written consents are provided in lieu of a meeting, a registrant’s audit committee must state whether it has discussed with the independent auditor the matters required by AU section 380, Communication with Audit Committees (“AU sec. 380”).  The reference to AU sec. 380 has become outdated and the revised rules replace the outdated reference with “the applicable requirements of” the Public Company Accounting Oversight Board (“PCAOB”) and the Commission.”

Exhibits

Description of Registrant’s Securities

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.

Additional Information Omitted From Exhibits

Schedules and Attachments to Exhibits

Under existing rules in Item 601 of Regulation S-K, registrants generally must file complete copies of any required exhibits. Very often, these exhibits include a number of schedules, appendices, and other similar attachments which can be quite lengthy but not necessarily material to investors. Except for paragraph (b)(2) of Item 601, which applies only to material plans of acquisition, reorganization, arrangement, liquidation, or succession, registrants must file every required exhibit under Item 601 in its entirety, irrespective of the materiality of particular information in the exhibits. Because the information in certain schedules or similar attachments to the exhibits may not be material to investors, the SEC believes a uniform filing requirement for this information is not commensurate with the corresponding costs and burden imposed on registrants, particularly when the schedules, appendices, and other attachments contain proprietary or otherwise sensitive information.

In the revised rules Item 601(a)(5) expands the existing accommodation in Item 601(b)(2) to include all exhibits filed under Item 601. Similar to current Item 601(b)(2), proposed Item 601(a)(5) would permit registrants to omit entire schedules and similar attachments to required exhibits, provided:

  • they do not contain material information;
  • they were not otherwise disclosed in the exhibit or the disclosure document; and
  • the filed exhibit contains a list briefly identifying the contents of any omitted schedules and attachments.

Personally Identifiable Information

Exhibits filed pursuant to Item 601 of Regulation S-K may include sensitive personally identifiable information, such as bank account numbers, social security numbers, home addresses, and similar information, or PII.  As a matter of practice, the staff generally does not object where a registrant omits PII from exhibits without also submitting a CTR. To codify this current staff practice, the revised rules include new Item 601(a)(6) to allow registrants to omit PII from their required Item 601 exhibits without submitting a CTR.

Material Contracts

Item 601(b)(10)(i) requires registrants to file every material contract not made in the ordinary course of business, provided that one of two tests is met:

  • the contract must be performed in whole or in part at or after the filing of the registration statement or report; or
  • the contract was entered into not more than two years before that filing.

The proposed rules revise Item 601(b)(10)(i) to limit the two-year look back test set forth in the second bullet to “newly reporting registrants,” which is a term that is defined in the new revision to Instruction 1 of Item 601(b)(10).

Incorporation by Reference

Item 10(d).  Item 10(d) of Regulation S-K states that where rules, regulations, or instructions to the forms permit incorporation by reference, a document may be incorporated by reference to the specific document and to the prior filing or submission in which that document was physically filed or submitted. Item 10(d) generally prevents registrants from incorporating by reference a portion of a document that itself also incorporates pertinent information by reference. It also prohibits incorporating documents by reference if they have been on file with the Commission for more than five years and do not fall within one of the exceptions provided in the rule. The revised rules eliminate the five-year limit in Item 10(d).

Exhibit and Other Filing Requirements. Rule 12b-23(a)(3) under the Exchange Act requires that copies of any information incorporated by reference must be filed as an exhibit, with limited exceptions. Rule 411(b)(4) under the Securities Act, which is more limited and pertains to non-prospectus information that is incorporated by reference, requires that the incorporated information be filed as an exhibit if it does not comply with the five-year limit in Item 10(d).  The revised rules eliminate these provisions, because most Exchange Act filings are made publicly available on EDGAR, and the SEC does not have similar exhibit filing requirements for Securities Act registration statements.

The revised rules also eliminate the requirement in Item 601(b)(13) to file a Form 10-Q as an exhibit when it is specifically incorporated by reference into a prospectus. This provision is no longer necessary because under the revised rules a registrant is required to include a hyperlink to any information that is incorporated by reference to a document available on EDGAR.

Hyperlinks.  Rule 411 and Rule 12b-23 have been revised to require hyperlinks to information that is incorporated by reference if that information is available on EDGAR.  Registrants are not required to refile information that is incorporated by reference from a document that was previously filed with the SEC in paper given that electronic filing has been required for over two decades and paper filings are currently made in very limited circumstances.

The new rules do not require registrants to file an amendment to a document solely to correct an inaccurate hyperlink, unless that hyperlink was included in a pre-effective registration statement, similar to the existing requirements for exhibit hyperlinking.  An inaccurate hyperlink alone would neither render the filing materially deficient nor affect a registrant’s eligibility to use Form S-3. Unlike the requirements for exhibit hyperlinking, a registrant is not required to correct inaccurate hyperlinks to information incorporated by reference in an effective registration statement by including a corrected hyperlink in a subsequent periodic report or a post-effective amendment.

Tagging Cover Page Data 

Current rules require certain specific data points on the cover of certain Exchange Act forms to be tagged in XBRL including form type, company name, filer size, and public float.  The revised rules require all of the information on the cover pages of Form 10-K, Form 10-Q and Form 8-K to be tagged in Inline XBRL.  The revised rules also require the cover pages of these forms to include the trading symbol for each class of securities registered pursuant to Section 12(b) of the Exchange Act.  The revised rules also require Form 10-Q and Form 8-K to disclose the title of each class of similarly registered securities and each exchange on which they are registered.

The cover page tagging requirements are subject to phased compliance dates.  The dates are the same as the phased compliance dates for Inline XBRL.  Accordingly, large accelerated filers must begin compliance with these requirements for fiscal periods ending on or after June 15, 2019.

Registration Statement and Prospectus Provisions

Outside Front Cover Page of the Prospectus

Item 501(b) of Regulation S-K sets forth disclosure requirements related to the outside front cover page of prospectuses. The revised rules eliminate a statement in an instruction to Item 501(b) that indicates that the registrant may be required to change its name if disclosure is insufficient to eliminate confusion because a registrant’s name is the same as that of a “well known” company, or if the name leads to a misleading inference about the registrant’s line of business.

Offering Price of the Securities

Item 501(b)(3) of Regulation S-K requires disclosure on the prospectus front cover page of the price of the securities being offered. In situations where it is not practicable to provide a price for the securities, Instruction 2 to Item 501(b)(1)(3) permits registrants to explain the method by which the price is to be determined. The revised rules amend Instruction 2 to explicitly allow registrants to include a clear statement on the cover page, when applicable, that the offering price will be determined by a particular method or formula that is more fully explained in the prospectus.

Market for the Securities

Item 501(b)(4) of Regulation S-K requires a registrant to disclose on the prospectus cover page the name of any SEC registered national securities exchange that lists the securities being offered and the trading symbols for those securities.  The revised rules expand the scope of the disclosure to any principal United States markets where the registrant, through the engagement of a registered broker-dealer, has actively sought and achieved quotation.

Prospectus “Subject to Completion” Legend

Item 501(b)(10) of Regulation S-K requires a registrant that is using a preliminary prospectus to include a legend that states, among other things, that the prospectus is not an offer to sell or a solicitation of an offer to buy securities in any state where the offer or sale is not permitted.  The revised rules permit registrants to exclude from the prospectus the portion of the legend relating to state law for offerings that are not prohibited by state blue sky laws.

Risk Factors

Item 503(c) of Regulation S-K requires disclosure of the most significant factors that make an offering speculative or risky. This risk factor disclosure was initially called for only in the offering context, but in 2005 the risk factor disclosure requirements were extended to periodic reports and registration statements on Form 10. Consistent with this change, the revised rules relocate Item 503(c) to new Item 105, as Subpart 100 of Regulation S-K covers a broad category of business information and is not limited to offering-related disclosure. Because the risk factor rule is principles-based, the revised rules eliminate the specific risk factor examples that are currently enumerated in Item 503(c).

Plan of Distribution

Item 508 of Regulation S-K requires disclosure about the plan of distribution for securities in an offering, and permits disclosure if a dealer is paid any additional discounts or commissions for acting as a “sub-underwriter.”  The revised rules define “sub-underwriter” as a dealer that is participating as an underwriter in an offering by committing to purchase securities from a principal underwriter for the securities but is not itself in privity of contract with the issuer of the securities.

Undertakings

Item 512 of Regulation S-K provides undertakings that a registrant must include in Part II of its registration statement, depending on the type of offering.  The revised rules eliminate undertakings that are duplicative of other rules or that have become unnecessary due to developments since their adoption.