SEC Rule 701 exempts non-reporting companies from registering securities offered or sold to employees, officers, directors, partners, trustees, consultants, and advisors under compensatory benefit plans or other compensation agreements. As discussed in an earlier post, under the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA) passed by Congress in 2018, the threshold for the aggregate sales price of securities sold during any consecutive 12-month period that triggers additional disclosure requirements under Rule 701 was increased from $5 million to $10 million. What may have gone unnoticed was that the SEC has adopted final rules to implement EGRRCPA and has published a concept release “soliciting comment on possible ways to modernize rules related to compensatory arrangements in light of the significant evolution in both the types of compensatory offerings and the composition of the workforce since the Commission last substantively amended these rules in 1999.”
As securities lawyers know, disclosure is generally regarded as the best disinfectant. However, in a recent enforcement action, the SEC determined that disclosure is not always enough. Specifically, when it comes to internal controls over financial reporting, or ICFR, companies need to actually fix the problems they disclose.
In the action, the SEC cited four companies for failing to maintain ICFR for periods ranging from seven to 10 consecutive annual reporting periods. While each of the companies disclosed material weaknesses in ICFR, it took them months or years to remediate the weaknesses – even after being contacted by the SEC! (I don’t usually use exclamation points in my postings, but this calls for an exception to my usual policy.) As noted in the SEC’s press release on the action, “[c]ompanies cannot hide behind disclosures as a way to meet their ICFR obligations. Disclosure of material weaknesses is not enough without meaningful remediation.”
Others have noted that the cases in question are outliers. That’s undoubtedly true — at least I hope so, because it’s hard to imagine hearing from the SEC and doing nothing about it, much less over a period of years). However, the moral of the story remains unchanged: if you’re going to disclose an ICFR problem, you better fix it, too.
On December 19, 2018, the SEC adopted final rules allowing reporting companies to rely on the Regulation A exemption.
How did we get here?
The SEC adopted a new – and greatly improved – Regulation A, known as Reg A+, in 2015. As noted in previous posts (see here and here) Reg A, provides an exemption from registration under the Securities Act for smaller public offerings, but for many years was seldom used due to cost restraints and small financing caps. The 2015 amendments, adopted in response to the JOBS Act, remedied these shortcomings, updating Reg A to make it a more viable capital-raising tool.
The main benefits of Reg A+ include the following:
- Companies can raise up to $50 million every 12 months via two overlapping tiers.
- Tier 1: offerings of up to $20 million in a 12-month period.
- Tier 2: offerings of up to $50 million in a 12-month period.
- Insiders can sell their shares in a Reg A+ offering.
- Investors in a Reg A+ offering have immediate liquidity – they can sell their shares once the offering is completed and don’t have to hold them for a period of time.
- Some Reg A+ offerings are exempt from state securities or “blue sky” laws.
- Some Reg A+ offerings are easier to list on an exchange.
- Reg A+ can be used for merger and acquisition transactions.
Following a tweet from the President last August, the SEC has begun the process of reviewing the existing quarterly reporting regime and will be further exploring possible changes that may ease administrative and other burdens on public companies. Specifically, the President “asked the SEC to study!” whether less frequent reporting for publicly traded companies would “allow greater flexibility and save money.” This is not a new issue on the SEC’s radar screen, but it has recently regained traction– the SEC issued a concept release in 2016 soliciting public comments more specifically on reporting frequency and the current quarterly reporting process.
The request for comments, which can be viewed here, asks for public input on several questions related to the existing reporting regime. One of the more interesting questions on which the SEC is seeking input is whether the practice of public companies issuing forward earnings guidance places undue pressure and focus on short-term results and negatively impacts long-term results. Several commentators have expressed concern on this issue over the years and believe management teams with a longer-term view would be better stewards of investor capital. Many of the other specific questions asked by the SEC in its request for comments relate directly to the current reporting process and whether changes could be made that balance the interests of investors while making the reporting process more efficient, including, among other things: Continue Reading SEC seeks public comments on quarterly reporting for public companies
The SEC recently settled charges against two prominent celebrities in connection with the promotion of initial coin offerings. Boxer Floyd Mayweather Jr. and music producer and social media star DJ Khaled were charged in separate incidents with failing to disclose that they had received payments for promoting ICOs. While the SEC has provided prior guidance and warnings regarding the ICO and cryptocurrency markets, I believe that these are the first situations in which the SEC has actually brought enforcement actions and levied substantial monetary penalties in connection with such promotional activities.
Mayweather and Khaled each made endorsements of ICOs, primarily through their social media platforms. This allowed them to immediately convey their endorsements to their numerous social media followers. Each individual was paid a fee for making these ICO endorsements, but neither individual disclosed that he was being compensated for these promotional activities. The SEC charged each individual with violating Section 17(b) of the Securities Act of 1933, which prohibits anyone from promoting a security without fully disclosing that they are being compensated for such endorsement and the amount of the payment.
The SEC’s prime concern here appeared to be that investors who are unaware of these compensation arrangements might think that Mayweather’s and Khaled’s endorsements were independent and were not influenced by this compensation. In its November 29, 2018 press release regarding this matter, the SEC stressed the “importance of full disclosure to investors” and said that “investors should be skeptical of investment advice posted to social media platforms and should not make decisions based on celebrity endorsements”. For further discussion of the SEC’s positions in the ICO and cryptocurrency areas, you can access SEC Release No. 81207 (July 25, 2017) here.
The SEC is right in its actions in these situations. It’s clear that athletes like Mayweather and music industry leaders like Khaled exert significant influence over their fans, and this is magnified on social media. For example, Khaled is a well-known and powerful social media influencer who is sometimes called the “King of Snapchat”. When such powerful social media influence enters the securities offering and disclosure area, it’s important for the SEC to take the steps necessary to ensure that the correct investor safeguards are in place even though the investor context is not the traditional one.
Neither Mayweather nor Khaled admitted or denied the SEC’s charges in this matter, and I’m not imputing bad motives to either man. Each agreed, however, to pay fairly substantial amounts for disgorgement, penalties and interest. Mayweather paid over $600,000, while Khaled paid over $150,000, and each agreed to not promote any securities (digital or otherwise) for three years (Mayweather) and two years (Khaled).
This situation demonstrates the SEC’s commitment to carefully regulate the ICO and cryptocurrency areas and its willingness to take firm and swift action when it discovers problem situations. ICO issuers and promoters should carefully plan their actions and strategies to ensure that they comply with SEC laws and regulations.
No, this is not a riff on Hamlet’s soliloquy. It’s about the current kerfuffle (one of my favorite words) about stock buybacks. In case you’ve not heard, some (but not all) of the concerns about stock buybacks are as follows:
- Plowing all that cash into buying back stock means that it’s not going into plant and equipment, R&D or other things that facilitate longer-term growth and job creation.
- Companies are using the windfall from the 2017 tax act to buy shares back rather than to make investments that will create jobs and longer-term growth.
- Stock buybacks artificially inflate stock prices and earnings per share, which contributes to or results in additional (i.e., excessive) executive compensation.
- By reducing the number of shares outstanding, buybacks mask the dilutive effects of equity grants to senior management.
And now there’s another concern. Specifically, in a recent speech, new SEC Commissioner Jackson announced that stock buybacks are being used by executives to dispose of the shares they receive in the equity grants referred to above. And one of his proposed solutions is that compensation committees engage in more active oversight – or, rather, that compensation committees should be required to engage in more active oversight – of insider trades “linked” to buybacks.
If you find the title of this posting confusing, let me explain: On June 28, the SEC announced revisions to the definition of “smaller reporting company”that will significantly expand the number of companies that fit within that category (i.e., “smaller gets bigger”). As a result, more public companies will be able to reduce the disclosure they are required to provide under SEC rules (i.e., “which means less”). The new definition will go into effect 60 days after publication in the Federal Register.
The SEC adopted the reduced disclosure requirements applicable to smaller reporting companies, or SRCs, in 2007. These reduced requirements were intended to ease the costs and other burdens of disclosure for small companies. The reduced requirements enabled SRCs, among other things, to:
- present only two (rather than three) years of financial statements and the related management’s discussion and analysis;
- provide executive compensation for only three (rather than five) “named executive officers”;
- omit the compensation discussion and analysis in its entirety;
- present only two (vs. three) years of information in the summary compensation table; and
- omit other compensation tables, pay ratio disclosure, and narrative descriptions of various compensation matters.
In addition, SRCs that are not “accelerated filers” (companies that must file their Exchange Act reports on an accelerated basis) need not provide an audit attestation of management’s assessment of internal controls, required by the Sarbanes-Oxley Act. More on this below. Continue Reading Smaller gets bigger, which means less (the new definition of “smaller reporting company”)
A few weeks ago, I attended the “spring” meeting of the Council of Institutional Investors in Washington (the quotation marks signifying that it didn’t feel like spring – in fact, it snowed one evening). These meetings are always interesting, in part because over the 15+ years that I’ve been attending CII meetings, their tone has changed from general hostility towards the issuer community to a more selective approach and a general appreciation of engagement.
So what’s on the mind of our institutional owners? First, an overriding concern with capital structures that limit or eliminate voting rights of “common” shareholders. CII’s official position is that such structures should be subject to mandatory sunset provisions; that position strikes me as reasonable (particularly as opposed to seeking their outright ban), but it’s too soon to tell whether it will gain traction.
On February 21 the SEC issued a “Commission Statement and Guidance on Public Company Cybersecurity Disclosures”. The Release contains new guidelines and requirements regarding public companies’ disclosure responsibilities for cybersecurity situations. No new rules or regulations have been issued at this point, but the Release contains some valuable guidance. It is also clear that cybersecurity is a hot button for the SEC and for Chair Clayton, and I believe that cybersecurity disclosure issues will be subject to more rigorous scrutiny going forward. All public companies should carefully review the Release and evaluate their disclosure obligations in connection with cybersecurity.
The Release updates the SEC’s position on cybersecurity. The SEC’s previous guidance in this area was primarily a Corporation Finance Division Release issued in 2011 that did not contain specific disclosure requirements. The cybersecurity landscape has changed radically since then. The substantial increases in the number and severity of cybersecurity incidents, coupled with the growing dependence of businesses on cyber systems and the associated problems that arise in a cybersecurity incident, have clearly convinced the SEC that additional disclosure is required. Continue Reading SEC issues guidance on cybersecurity disclosure obligations (and more)
For the first time since 2015, the SEC has its full complement of five commissioners. That’s a good thing. And at least one new Commissioner – Robert Jackson – seems to have hit the ground running. For example, he made a speech in San Francisco just the other day in which he expressed his disfavor of dual-class stock, suggesting that it would create “corporate royalty”. Specifically, because shareholders in at least some dual-class companies have no voting rights, leadership of the company could be passed down through the generations in perpetuity.
Commissioner Jackson is a smart man – I’ve seen him speak at a number of programs, and he’s demonstrated his intelligence as well as his telegenic appearance. His use of the “corporate royalty” meme also shows that he’s witty, though don’t think we need to worry too much about CEO titles becoming hereditary.
What I do think we may need to worry about is where he goes with his concerns. Specifically, the point of his speech is to suggest that exchanges adopt mandatory sunset provisions so that their dual-class structures would fade away over time.