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

For those who want to start preparing for the 2019 proxy season, our preliminary list of important considerations is set forth below:

Review 162(m) Disclosures in Proxy Statements

We recommend issuers review their Section 162(m) disclosures in proxy statements. As noted on our Benefits Notes blog, on August 21, 2018, the IRS issued its initial guidance on the amendments to Section 162(m) made by the Tax Cuts and Jobs Act, in the form of Notice 2018-68. The guidance is fairly limited and does not completely address some of the questions it takes on. Notably, the guidance on what compensation will not be subject to the amended Section 162(m) under the grandfather rule may be very restrictive with respect to performance-based compensation that is subject to negative discretion, depending on the extent to which that discretion may be exercised under applicable law.

Directors’ and Officers’ Questionnaires

We are not aware of any corporate governance changes that would require directors’ and officers’ questionnaires to be updated.  As a result of the changes to Section 162(m) noted above, questions arise as to whether questions in directors’ and officers’ questionnaires related to §162(m) for compensation committee members can be eliminated. Potentially that is possible if it is clear the compensation committee is not required to administer any compensation arrangements under the grandfather rule.  We urge caution in that regard, and Notice 2018-68 referred to above should be reviewed before making any changes to the questionnaire.

Determine Your Status as an Issuer

The SEC has 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.  Some smaller reporting companies may not be required to transition as a result of the more generous rules, and others who did not previously qualify as a smaller reporting company may wish to avail themselves of the scaled disclosure option.

A reporting company will 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, 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. 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.

In the release revising the thresholds for SRC eligibility, the SEC did not did not raise the accelerated filer public float threshold or otherwise modify the Section 404(b) requirements (which include mandatory auditor attestation of internal controls) for registrants with a public float between $75 million and $250 million.

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 is closing for some.

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

The SEC also adopted final rules to require the use of Inline XBRL. Currently, data in XBRL format is 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.

The use of Inline XBRL will not be required in Form 10-Ks for the calendar year ended December 31, 2018. Large accelerated filers will be required to use Inline XBRL beginning with their first Form 10-Q filing for a fiscal period ending on or after June 15, 2019.

Changes to Form 10-K Cover Page

The adoption of rules related to expanded SRC status and Inline XBRL will require changes to the applicable selection boxes on the cover page of Form 10-K.  Changes related to SRC status are effective as of September 10, 2018.  Changes related to Inline XBRL are effective September 17, 2018.

Disclosure Simplification

The SEC’s new rules implementing disclosure simplification mostly address accounting matters in Regulation S-X, but provide some modest relief for Form 10-Ks.  Among other things, certain previously-required disclosures are eliminated from the required business description, and issuers are no longer required to provide a history of stock prices and dividend history in their Form 10-K.

Form 10-K – Selected Financial Date

The SEC has confirmed in its Financial Reporting Manual (paragraph 11110.1) that issuers that adopt the new revenue recognition standard using the full retrospective method do not need to apply the new revenue standard when reporting selected financial data (S-K Item 301) for periods prior to those presented in its retroactively-adjusted financial statements. However, such issuers must provide the information required by Instruction 2 to S-K Item 301 regarding comparability of the data presented. Instruction 2 requires issuers to briefly describe, or cross-reference to, a discussion thereof, factors such as accounting changes, business combinations or dispositions of business operations, that materially affect the comparability of the information reflected in selected financial data.

Pay Ratio Disclosure

Pay ratio disclosure appears to be here to stay. In general, the “pay ratio” rule requires public companies to disclose the median of the annual total compensation of all employees of a registrant (excluding the chief executive officer), the annual total compensation of that registrant’s chief executive officer, and the ratio of the median of the annual total compensation of all employees to the annual total compensation of the chief executive officer.

We have drafted a checklist outlining the disclosure requirements of the pay ratio rule.

Critical Audit Matters

The Public Company Accounting Oversight Board adopted a new auditor reporting standard that will require more information about the audit, including critical audit matters. The new standard has been approved by the SEC. However, it will not be effective for calendar year issuers this year. The new standard will be applicable for large accelerated filers for audits for fiscal years ending on or after June 30, 2019.  As a result, we encourage issuers to continue monitoring implementation of the new auditor reporting standard with their audit committee and auditors.

ISS Proxy Voting Policies

ISS is in the process of formulating changes to its voting recommendation policies and has released its 2019 Governance Principles Survey and the accompanying Policy Application Survey.  The surveys generally foreshadow changes to policies for the upcoming proxy season.  This year’s Governance Principles Survey focuses on auditor ratification, director accountability and track records, gender diversity on boards and the one-share, one-vote principle.  This year’s Policy Application Survey focuses on independent chair shareholder proposals, disclosure of directors’ skills, quantitative pay-for-performance screens, director pay and minimum stock ownership requirements for binding bylaw amendments. We recommend that issuers monitor ISS’ new and updated policies, including ISS’s official proxy voting guidelines, which are typically issued in December for the upcoming proxy season.

Perq Disclosures

We recommend public companies take steps to ensure that all staff are appropriately trained when compiling compensation disclosures. In a settled enforcement action, the SEC targeted an issuer for using the wrong standard for disclosures of perqs in the summary compensation table.  In addition, the SEC alleged the issuer did not adequately train employees in key roles, including those tasked with drafting the CD&A section of the proxy statement and compiling the executive compensation tables, to ensure that the proper standard was applied for perquisites disclosure.  The SEC also alleged the issuer had inadequate processes and procedures to ensure proper reporting of perquisites. The issuer’s personnel compiled the executive compensation table from a variety of sources without ensuring that the amounts reported were consistent with the Commission’s perquisite disclosure rules.  The issuer, which did not admit or deny the SEC’s findings, agreed to pay a civil money penalty in the amount of $1,750,000.  Among other things, the issuer also agreed to retain at its own expense an independent consultant, not unacceptable to the staff of the Commission, for a period of one year, to conduct a review of the issuer’s policies, procedures, controls, and training relating to the evaluation of whether payments and other expense reimbursements should be disclosed as perquisites under the securities laws, including the Commission’s rules and standards.

Cybersecurity Disclosures

In February 2018, the SEC outlined its views with respect to cybersecurity disclosure requirements under the federal securities laws as they apply to public reporting companies. We have developed a comprehensive checklist based on the SEC’s views.

SEC Issues Compensation Plan C&DIs

The SEC issued a series of Compliance and Disclosure Interpretations, or CD&Is, on proxy statements and proxy solicitations. The CD&Is in general replaced previously issued telephone interpretations. A number of the CD&Is address Item 10 of Schedule 14A, which sets forth disclosure requirements when compensation plans are submitted for shareholder approval. Issuers that will have a compensation plan on their ballot may find these CD&Is to be a useful resource.

Other Regulatory Initiatives

Proposed rules have been issued on the following topics, but final rules have not been adopted:

Similarly, press reports speculate that the SEC has deferred plans to implement its proposed universal proxy rules.  However, a universal proxy card was first used in 2018 by a U.S.-incorporated company.  If speculation in the press is accurate, it appears that private ordering, and not regulatory action, will be the primary force behind the use of universal proxy cards going forward.

Shareholder Proposals

Observations from the 2018 season:

  • An increase in the number of environmental/social/political (“ESP”) proposals withdrawn suggests that companies may be adopting a strategy of shareholder engagement to address ESP issues.
  • A lower number of governance proposals passed this year than in 2017, reflecting a reduced number of proposals submitted with respect to common governance issues (e.g., proxy access, majority voting, board declassification, supermajority vote).
  • 2018 reflected an increase in the submission of proposals focusing on the thresholds for calling a special meeting, the right to act by written consent, appointing an independent chair, and an increase in the relative level of shareholder support for these matters.
  • Fewer proposals focused on adopting and revising proxy access were submitted in 2018 and few were put to a shareholder vote.
  • Despite the SEC staff’s release of “issuer-friendly” shareholder proposal guidance in the fall of 2017, issuers’ inclusion of the board’s analysis of a proposal’s significance (in relation to the ordinary business and economic relevance bases for exclusion) did not yield overwhelmingly positive results for issuers in no-action requests in 2018. Still, issuers considering this strategy should not be dissuaded, as several of these requests did not fully adhere to the staff’s guidance and the staff’s responses in other requests provided additional clarity on what could make for a successful argument.

Proxy Modifications on the Horizon

Following up on its 2010 Concept Release seeking public comment on the mechanics of communications and voting under the SEC’s proxy rules, the SEC’s Chairman has announced that the staff will host a roundtable this fall to hear from investors, issuers, and other market participants on possible refinement to the SEC’s proxy rules with a focus on the following topics: the proxy voting process, retail shareholder participation, shareholder proposals, and proxy advisory firms.

Time will tell whether any of these discussion points will find their way into future Commission rulemakings in a more substantive manner than in the 2010 concept release.

 

The SEC has adopted amendments to its rules to simplify disclosures in filings with the SEC.  The amendments eliminate certain:

  • Redundant and duplicative requirements, which require substantially similar disclosures as GAAP, International Financial Reporting Standards (IFRS), or other Commission disclosure requirements.
  • Overlapping requirements, which are related to, but not the same as GAAP, IFRS, or other Commission disclosure requirements.
  • Outdated requirements, which have become obsolete because of the passage of time or changes in the regulatory, business, or technological environment.
  • Superseded requirements, which are inconsistent with recent legislation, more recently updated Commission disclosure requirements, or more recently updated GAAP.

The amendments contain a mind-numbing level of detail, particularly with respect to the accounting rules in Regulation S-X.  However, set forth below are the basic changes that will affect typical disclosures made in the body of Form 10-Ks, proxy statements and registration statements outside of the financial statements.

Description of Business.  The amendments revise Item 101 of Regulation S-K to eliminate required disclosures in the business description regarding:

  • Financial information about segments.
  • Research and development spending.
  • Financial information about geographic areas, such as revenues from external customers in the issuers country of domicile and foreign countries, but where material must be covered in the MD&A.
  • Risks attendant to the foreign operations and any dependence on one or more of the registrant’s segments upon such foreign operations, but where material should be covered in risk factors.

Internet Address.  Disclosure of the issuer’s internet address is now mandatory if the issuer has one.  Previously the rule “encouraged” disclosure.

Public Reference Room:  The amendments eliminate required disclosures for registration statements about SEC filings being available in the public reference room at the SEC’s headquarters.

Trading Markets and Dividends.  The identification of trading markets for equity securities must now be accompanied by the trading symbols for such securities.  Disclosure of high and low trading prices for each quarter in the last two full fiscal years and interim periods is no longer required.  In addition, the dividend history for the previous two fiscal years and interim periods is also eliminated.  Restrictions on ability to pay dividends has now been consolidated into Regulation S-X, so if included in the financial statements such restrictions no longer need to be disclosed in the body of the Form 10-K or other applicable filing.

Ratio of Earnings to Fixed Charges.  The required disclosure of the ratio of earnings to fixed charged and the related exhibit requirement have been deleted.

Some merger agreements are starting to include representations and warranties regarding the absence of allegations of sexual harassment against senior officials. Some examples follow.

Brookfield Asset Management’s acquisition of Forest City Realty

To the Knowledge of the Company, in the last five (5) years, no allegations of sexual harassment have been made to the Company against any individual in his or her capacity as an employee of the Company or Forest City Employer, LLC at a level of Senior Vice President or above.

Del Frisco’s Restaurant Group, Inc.’s acquisition of Barteca Holdings, LLC

Except as set forth on Schedule 2.12(j), none of the Barteca Entities is party to a settlement agreement with a current or former officer, employee or independent contractor of any Barteca Entity resolving allegations of sexual harassment by either (i) an officer of any Barteca Entity or (ii) an employee of any Barteca Entity. There are no, and since January 1, 2015 there have not been any Actions pending or, to the Company’s Knowledge, threatened, against the Company, in each case, involving allegations of sexual harassment by (A) any member of the Senior Management Team or (B) any employee of the Barteca Entities in a managerial or executive position.

Genuine Parts Company Spin-off/Merger with Essendant Inc.

To the knowledge of GPC, in the last five (5) years, no allegations of sexual harassment have been made against any current SpinCo Business Employee who is (i) an executive officer or (ii) at the level of Senior Vice President or above.

AMC Networks Inc. acquisition of RLJ Entertainment, Inc.

To the Company’s Knowledge, in the last ten (10) years, (i) no allegations of sexual harassment have been made against any officer of the Company or any of its Subsidiaries, and (ii) the Company and its Subsidiaries have not entered into any settlement agreements related to allegations of sexual harassment or misconduct by an officer of the Company or any of its Subsidiaries.

 

We recently noted a shareholder proponent had been making aggressive use of Notices of Exempt Solicitation on EDGAR.

Exchange Act Rule 14a-6(g)(1) requires that any person who engages in a solicitation pursuant to Exchange Act Rule 14a-2(b)(1) and beneficially owns over $5 million of the class of securities that is the subject of the solicitation to furnish or mail to the Commission a statement containing the information specified in the Notice of Exempt Solicitation (Exchange Act Rule 14a-103) no later than three days after the date the written solicitation is first sent or given to any security holder.

The SEC has provided two new Compliance and Disclosure Interpretations on exempt solicitations. In new CD&I 126.06, the SEC confirms that a Notice of Exempt Solicitation may be provided on a voluntary basis. Thus filers of a Notice do not have to own $5 million of the relevant securities. However, the Notice must specifically state it is being provided on a voluntary basis.

New CD&I 126.07 provides all of the information required by Rule 14a-103 must be presented in the submission before any written soliciting materials (including any logo or other graphics used by the soliciting party) are presented. Rule 14a-103 requires the name of the registrant and the name and address of the person making the solicitation be presented. To the extent that the notice itself is being used as a means of solicitation, the failure to present Rule 14a-103 information in this manner may, depending upon the particular facts and circumstances, be misleading within the meaning of Exchange Act Rule 14a-9.

In 2010, the SEC issued a concept release seeking public comment on whether the U.S. proxy system as a whole operates with the accuracy, reliability, transparency, accountability, and integrity that shareholders and companies should expect. In light of the many changes in our markets, technology, and how companies operate since then, SEC Chairman Jay Clayton issued a statement noting SEC staff will host a roundtable this fall to hear from investors, issuers, and other market participants about whether the SEC’s proxy rules should be refined.

The statement said SEC staff will announce the roundtable agenda items shortly. As they develop that agenda, Chairman Jay Clayton has requested that staff consider certain topics, highlights of which are noted below.

Voting Process: Potential topics include the potential for over-voting and under-voting of securities by broker-dealers and practical difficulties in confirming whether an investor’s shares have been voted in accordance with the investor’s instructions.

Retail Shareholder Participation: Potential topics include reasons for the relatively low retail vote participation and how existing rules or market practices affect the ability of individuals who invest in the public markets through investment vehicles such as mutual funds and pension funds to participate in the governance of public companies in which they have an interest.

Shareholder Proposals:  Potential topics include whether the current thresholds for minimum ownership (e.g., shares held and length of time) to submit a proposal to be included in the company’s proxy statement appropriately consider the interests of all shareholders.

Proxy Advisory Firms:  Potential topics include whether various factors, including legal requirements, have resulted in investment advisers to funds and other clients relying on proxy advisory firms for information aggregation and voting recommendations to a greater extent than they should and whether issuers are being given an appropriate opportunity to raise concerns if they disagree with a proxy advisory firm’s recommendations.

ISS has launched its annual global policy survey which often foreshadows changes to its voting guidelines. As in 2017, this year’s survey is being conducted in two parts, starting with a high-level ISS Governance Principles Survey covering a small number of global high-profile governance topics. The second part of the survey is the ISS Policy Application Survey, a more expansive and detailed set of questions, broken down by region.

Highlights of the Governance Principles Survey include:

Auditor Ratification.  The survey notes in a number of developed markets around the world, investors and regulatory bodies have started to focus on additional indicators of audit quality and auditor independence. Auditor ratification, appointment, disclosure and rotation requirements differ widely by market, but nonetheless ISS would like to assess investor and other market participants’ views in this area. The survey solicits views on what other audit-related factors could be considered in evaluation of the independence and performance of the external auditor.

Director Accountability and Track Records.  The survey notes some institutional investors are interested in tracking individual directors who have been involved in controversies with respect to one or more of their past or present directorships, particularly where concerns have been raised about shortfalls in oversight. Where identified, such concerns about oversight shortfalls may trigger negative recommendations under current ISS policy for directors who held boardroom leadership roles or served on committees with direct responsibility for overseeing the activities that triggered the controversy.  The survey solicits views regarding whether a negative ISS vote recommendation regarding a director oversight failure resulting in a negative vote recommendation should be noted in the proxy research of other companies where that director serves on the board.

Gender Diversity on Boards.  The survey notes that last year ISS asked respondents if they considered it problematic if there are zero female directors on a public company board.  ISS is revisiting the same questions that were asked in last year’s policy survey with respect to gender diversity on boards to identify changes, if any, in investor and non-investor views on this topic.

One-Share, One-Vote Principle.  Some companies have accessed public capital markets with significant differential voting rights. ISS is considering whether to provide in the future an adjusted analysis of shareholder vote results to show what the results would have been if all votes had been counted under the one-share, one-vote principle.

Previously, the Bats BZX Exchange, Inc. filed a proposed rule change with the Commission, seeking to list and trade shares of the Winklevoss Bitcoin Trust. The SEC Division of Trading and Markets disapproved the proposed rule change. BZX then filed a petition seeking review of the disapproval. The Commission granted BZX’s Petition for Review, seeking public comment. The Commission issued a 96 page order that set aside the previous disapproval, but the order also disapproved BZX’s proposed rule change.

Among other things, the Commission noted:

  • The record does not support BZX’s assertion that that bitcoin and bitcoin markets, including the Gemini Exchange, are uniquely resistant to manipulation.
  • The record does not support BZX’s assertion that “traditional means” of identifying and deterring fraud and manipulation are sufficient to meet the requirements of Exchange Act.
  • Where a listing exchange fails to establish that other means to prevent fraudulent and manipulative acts and practices will be sufficient, the listing exchange must enter into a surveillance-sharing agreement with a regulated market of significant size.

Commissioner Hester M. Peirce registered her dissent. She noted the disapproval order demonstrates a skeptical view of innovation, which may have an adverse effect on investor protection, efficiency, competition, and capital formation well beyond the particular product. She believes the disapproval order’s broad interpretation of the Commission’s statutory mandate signals that the Commission reserves for itself the authority to judge when an innovation is ripe enough, respectable enough, or regulated enough to be worthy of the securities markets. By suggesting that bitcoin, as a novel financial product based on a novel technology that is traded on a non-traditional market, cannot be the basis of an ETP, she believes the Commission signals an aversion to innovation that may convince entrepreneurs that they should take their ingenuity to other sectors of our economy, or to foreign markets, where their talents will be welcomed with more enthusiasm.

We have noted an aggressive use of exempt solicitations by a shareholder proponent following the annual meeting when the solicitation is complete or making preemptive strikes before the proxy is published. You can find an example here.  We are not publishing more of the filing so that we do not aide the proponent in his efforts.

Who knows what will be next.

Query whether the exempt solicitation rules were meant to give proponents a year-round soap box to further their agenda.

For those of you who still have time or can tweak your second quarter 10-Q, we have noticed these recent comments on revenue recognition:

Netflix, Inc.

Please provide us with your analysis regarding payments made to partners. Describe in detail the nature of these payments and further clarify when payments are classified as marketing expenses and when payments are recognized as a reduction in revenue. Refer to ASC 606-10-32-25 and 26.

GreenSky, Inc.

Please explain to us the process by which interchange fees are earned and explain Greensky’s role in the payment processing system. Tell us whether a portion of the interchange fee received by the company is remitted to a third party. If so, tell us whether revenue from these fees is presented net or gross of the amounts remitted to the third party and explain how you arrived at that determination.

Social Reality, Inc.

Your disclosures on pages 13 and 15 suggest that you did not adopt ASC 606 as of January 1, 2018. If true, please refer to ASC 606-10-65-1(a) and tell us why you did not adopt during the first quarter of 2018. If you adopted ASC 606 as of January 1, 2018, please refer to Rule 10-01(a)(5) of Regulation S-X and revise your filing to provide the disclosures required by ASC 606-10-50.

Iterum Therapeutics Ltd.

Please tell us whether the adoption of ASC 606 on January 1, 2018 impacted your accounting for grant awards and revise your disclosure accordingly. In your response, please explain how you considered the guidance in ASC 606-10-05-4 in determining the appropriate accounting for such awards.

At an open meeting on July 18th, the SEC agreed to issue a concept release exploring modifications and modernization of Rule 701 and Form S-8 for certain offerings for employees, in conjunction with its increase to the threshold for expanded disclosure required under Rule 701(e) as mandated by Congress.

Rule 701 and Form S-8 are alternating methods for a company to offer or sell securities to its own employees. Rule 701 provides an exemption from registration for securities issued by non-reporting companies pursuant to compensatory arrangements while Form S-8 provides the means by which a public company registers certain compensatory offerings.

Among the interesting modifications to Rule 701 contemplated by the release, the staff is seeking specific comment on the following topics:

  • Expanding Rule 701 to allow use by public companies;
  • Modifying the timing and methods of providing the enhanced disclosures required under Rule 701(e) if an offering exceeds the newly revised $10 million threshold and the consequences of not providing such information within the timeframe specified by the rule;
  • Modifying the type and frequency of financial statement required to be provided under Rule 701(e) and whether alternate presentations should be permitted;
  • Modifying timing requirements for enhanced disclosure under Rule 701(e) and whether the current standard requiring disclosure “a reasonable period of time before the date of sale” should be further clarified or modified;
  • Modifying Rule 701 and Rule 701(e) to address when and what type of disclosure should be provided in connection with grants of restricted stock units (RSUs); and
  • Increasing availability of Rule 701 for securities issued to non-traditional workers receiving compensation for sale of goods or services rendered through the use of Internet “platforms” such as, for example, those offering ride-sharing, food delivery, household repairs, dog-sitting, and tech support or hand-made craft objects or lodging (referred to as “gig economy” relationships).

The staff is also seeking comment on a number of topics with respect to use of Form S-8 including:

  • Eliminating Form S-8, allowing public companies to rely on Rule 701, and providing resale of restricted or control shares issued under employee benefits plans via Form S-3;
  • Simplifying requirements for Form S-8 including whether a specific amount of shares should be required to be disclosed, how additional shares may be added to Form S-8, and implementing a “pay-as-you-go” fee structure; and
  • Expanding availability of Form S-8 for securities issued to participants in “gig economy” relationships with the Company and whether such increased availability should match any similar changes to Rule 701.