August 2011

The Dodd-Frank Act mandated the SEC to adopt rules to require reporting companies to make certain “social disclosures.” For example, Section 1502 of Dodd-Frank requires the SEC to adopt disclosure rules that will require reporting companies to make certain disclosures if “conflict minerals” are “necessary to the functionality or production” of its manufactured products. Metals and ores currently classified as “conflict minerals” are (1) Tin – Cassiterite, (2) Tantalum – Columbite-tantalite, (3) Tungsten – Wolframite and (4) Gold. Congress’ intention in enacting Section 1502 was to attempt to stop the national army and rebel groups in the Democratic Republic of the Congo from using illicit profits from the minerals trade to fund their military efforts. These types of disclosures are often referred to as “social disclosures” because they are intended to effect social changes.

In an effort to expand reporting companies’ duty to make disclosures relating to social issues, Representative Carolyn Maloney (D-NY) introduced a bill on August 1, 2011 that would “require companies to include in their annual reports to the Securities and Exchange Commission a disclosure describing any measures the company has taken during the year to identify and address conditions of forced labor, slavery, human trafficking, and the worst forms of child labor within the company’s supply chains.” This bill, entitled the “Business Transparency on Trafficking and Slavery Act” (H.R. 2759), is intended to curb reliance on a loophole in the Smoot-Hawley Tariff Act of 1930 which prohibits importation of goods made with forced labor or convict labor but has a broad exception for goods that cannot be produced in the United States in sufficient quantities to meet the demands of American consumers.

 This proposed legislation is part of a current trend of increasing disclosure burdens of public companies related to social issues. Although required social disclosures may be well-intentioned, such requirements seem to be inconsistent with the fundamental purpose of Federal securities laws (i.e. investor protection) and such disclosures will likely result in an increased costs borne by companies and shareholders without providing additional information that is useful or beneficial to the investing public.

To view H.R. 2759, click here.

 On August 16, 2011, the PCAOB issued a concept release seeking comments on ways that auditor independence, objectivity, and professional skepticism could be enhanced.  While the PCAOB seeks advice on any approach, the concept is focused on mandatory audit firm rotation.  Consequently, the release could lead to companies having to change their auditors every few years. 

The ill advised concept of mandatory audit firm rotation has been considered since at least the late 1970s.  While this is merely a concept release, this release should concern public companies as this is a “one size fits all” approach that doesn’t appropriately weigh the costs and benefits.  In fact, the PCAOB admits to having “little or no relevant empirical data on mandatory audit rotation.”  While no one discounts the key role independent auditors play in relation to the efficiency of the capital markets, independence has been maintained through mandatory audit partner rotation, second partner review, PCAOB inspections, as well as the audit firms’ fear of reputation loss though litigation, restated financial statements, and Department of Justice proceedings.  Adding mandatory audit firm rotations will merely increase the cost of audits as new firms will have to “get up to speed” every few years rather than increase the independence of auditing firms.

The deadline to submit comments to the PCAOB is December 14, 2011.  To view the concept release, click here.

On July 26, 2011, the SEC approved amendments to eligibility criteria for use of the short form registration statement on Form S-3.

To use the short form registration statement, a proposed offering must meet both the issuer eligibility requirements and a transaction eligibility requirement.  While there are several available transaction eligibility standards, a frequently relied on standard had been for the issuer to issue “investment grade securities,” which meant that at least one of the nationally recognized statistical rating organizations had rated the offered security as investment grade.  Pursuant to Section 939A of the Dodd-Frank Act, all federal agencies must remove references to credit ratings in their regulations to avoid any inference that the U.S. government is giving a “seal of approval” on the quality of any particular credit rating or rating agency. The amendment eliminates the use of credit ratings as a transaction eligibility standard and replaces it with an alternative set of standards.  The new standards allow an eligible issuer to meet the transaction test if it has either (i) issued at least $1 billion in non-convertible securities, other than common equity, in primary offerings for cash, not exchange, registered under the Securities Act, over the prior three years or (ii) outstanding at least $750 million of non-convertible securities, other than common equity, issued in primary offerings for cash, not exchange, registered under the Securities Act.  Securities of wholly-owned subsidiaries of a well-known seasoned issuer or of a majority-owned operating partnership of a REIT that qualifies as a well-known seasoned issuer would also be eligible.  The amendment will be effective in mid-September (30 days after the rule is published in the federal register). 

The SEC has also provided for a three year grandfathering provision. For three years after the amendment is effective, issuers that would have been eligible to use Form S-3 as of the effective date of the amendment may use Form S-3 to register a primary offering of investment grade non-convertible securities if:

  • The issuer had a reasonable belief that it would have been eligible to use Form S-3 prior to the amendment becoming effective;
  • The issuer discloses this belief and the basis for its reasonable belief in its registration statement (examples of evidence of an issuer’s reasonable belief include, but are not limited to, an investment grade issuer credit rating, a preliminary investment grade credit rating, or an investment grade credit rating on a security that the issuer offered earlier in a similar offering and that has not been downgraded or put on a watch list since its issuance); and
  • The issuer files a prospectus for the offering prior to three year anniversary of the effective date of the amendment.

On August 2, 2011, the Securities and Exchange Commission (the “SEC”) released a revised Dodd-Frank rulemaking calendar. The new calendar indicates that rulemaking pertaining to the following sections of the Dodd-Frank Act will be delayed until the first half of 2012:

  • §§953 and 955: Adopt rules regarding disclosure of pay-for-performance, CEO pay ratios, and hedging by employees and directors.
  • §954: Adopt rules regarding recovery of executive compensation (clawbacks); and
  • §956: Adopt rules (jointly with others) regarding disclosure of, and prohibitions of certain executive compensation structures and arrangements.

This begs the question whether the SEC will enact rules immediately prior to the beginning of the 2012 proxy season as it did with the “say on pay” advisory vote rules in the 2011 proxy season. While it seems unlikely that all of these items will be applicable in 2012, it is possible that some of these new rules will be effective. Because the SEC must first propose rules and receive public comments on the proposed rules before adopting them, issuers will know in advance which rules might in fact become applicable before drafting their proxy statements. Publicly held companies should carefully monitor the rulemaking progress of the SEC.