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.


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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.

Background

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.
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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.


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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.
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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.


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Photo by Allen

Now that “An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018” (the official name of the 2017 tax reform act – fitting for a “simplification” of the tax code!) has passed, issuers are faced with reviewing the impact of the tax reform act on its balance sheet, specifically deferred tax assets and deferred tax liabilities.

For those of us who have ignored those lines on the balance sheet, here is a quick primer: US GAAP and the US tax code have different requirements as to when to recognize income and expenses. These timing differences result in either deferred tax assets or deferred tax liabilities. In other words, if the US tax code requires recognition of income this year, but GAAP does not recognize the income yet, an issuer will need to pay the tax on the income now (the government doesn’t like to wait for its money). That’s an asset from a GAAP perspective – the issuer essentially “prepaid” income taxes that weren’t yet due as far as GAAP is concerned. From a GAAP perspective, that deferred tax asset will be used to offset GAAP tax expense in future years. The opposite is true with respect to deferred tax liabilities.

When the corporate tax rate changes (in this case, from a maximum of 35% to a maximum of 21%) the deferred tax assets aren’t as valuable anymore because the issuer won’t be subject to as much tax as it originally thought. Therefore, the tax asset needs to be written down to some lower value. That write down hits the bottom line and will have a significant adverse impact on the issuer’s quarterly results. Again, for those issuers “lucky” enough to have had significant deferred tax liabilities, those issuers will have significant gains in the quarter caused by, in essence (by lowering the tax rate), the US government partially forgiving the payment of those accrued tax obligations.

Issuers over the past week have begun to provide guidance as to what they expect the effect of the tax cut to be for their deferred tax assets and deferred tax liabilities.  However, there is no black and white rule requiring disclosure in this case.  While Item 2.06 (Material Impairments) of Form 8-K may initially have been of some concern for those issuers who need to write off tax assets, Corp Fin put those concerns to rest when issuing a new CD&I last week (Question 110.02). Consequently, it comes down to anti-fraud concerns as to when and what to disclose. 
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Initial coin offerings have taken off in 2017.

The SEC took two strong steps this week toward increased regulation of the cryptocurrency markets and specifically regulation of Initial Coin Offerings (“ICOs”). These steps included the halting of an ongoing ICO and a strong statement by the SEC’s chairman regarding ICOs and their status under the Federal securities laws. These steps were the SEC’s strongest actions to date regarding ICOs, but what is the probable long-term result here? This is getting very interesting as you pit the regulators and their application of traditional securities law concepts against an increasing strong demand in the investment community to invest in these cryptocurrency vehicles.

An ICO involves the offering of a token, “coin” or other digital product. In exchange for their investment, investors receive these tokens or coins. The company then uses the proceeds of the ICO for various corporate purposes similar to a regular offering of securities. ICOs have generally not been registered with the SEC.

On December 11, 2017, the SEC halted the ICO that was being conducted by Munchee Inc., a company that developed a restaurant review app. This action was based on the fact that the company had not registered this offering with the SEC. This ICO involved the issuance of MUN Tokens by Munchee, which the company said might increase in value. Munchee planned to raise about $15 million in this ICO. The SEC said that an investor could reasonably expect to earn a return on these Tokens, and accordingly the Tokens issued in the ICO were “securities” and should have been registered under the Federal securities laws. Munchee accepted the SEC’s findings without admitting or denying anything. The company agreed to halt the offering and to return all proceeds that it had received from investors in the offering.

The investigation of this matter was conducted in part by the SEC’s new Cyber Unit (a division of its Enforcement Section). The SEC had also issued other materials regarding concerns with cryptocurrencies and ICOs, including an Investor Bulletin issued on July 25, 2017 and a Report of Investigation issued on the same date.
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This is a first for The Securities Edge – a book review.  The book in question is The Chickenshit Club – Why the Justice Department Fails to Prosecute Executives by Jesse Eisinger.  Mr. Eisinger is a writer for Pro Publica.  He’s a very smart man and a good (even great) reporter; among other things, he’s won the Pulitzer Prize.  I met him once and was impressed by his intellect and commitment.

However, the book bothers me greatly, and that’s why I’ve decided to post this review.  As indicated by his title, he is concerned with the failure to prosecute executives, both generally and in connection with the financial collapse.  That concern is legitimate; many people – including people in business – share it, and some hold the failure at least partially responsible for our political situation today.  The problem with the book is that in Mr. Eisinger’s view there are heroes and villains and nothing in between; those who prosecute are good, and those who don’t (or who do so halfheartedly) are bad – and the businessmen themselves are the worst of all.

For example, among the people he idolizes is Stanley Sporkin, a retired USDC judge who previously served as the SEC’s Director of Enforcement. Mr. Sporkin’s integrity may be beyond question, but in Mr. Eisinger’s view, his judgment is (and was) as well.  Those of us who practiced during Mr. Sporkin’s tenure at Enforcement may have a different view.  Among other things, Mr. Sporkin was responsible for pursuing insider trading cases against Vincent Chiarella and Ray Dirks.   Mr. Eisinger lauds Mr. Sporkin for going after Mr. Chiarella – a typesetter for a financial printer who saw some juicy (nonpublic) information and traded on it.  Did he trade on the basis of inside information?  Yes, but at the end of the day he was a schnook who should have gotten a slap on the wrist rather than being subjected to a (literal) full court press by the federal government.  The courts apparently felt the same way, and, as courts often do, they found a way to let him off the hook by developing a strained approach to insider trading law that continues to haunt us today.  (Mr. Eisinger doesn’t mention the equally ill-advised insider trading prosecution of Ray Dirks, which also contributed to the current garbled state of affairs in insider trading law.)


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Some of you may remember Christopher Cox, who served as SEC Chair from 2005 to early 2009, when he was succeeded by Mary Schapiro.  His name doesn’t come up often, perhaps because his legacy was a weakened Commission tarnished by, among other things, the financial crisis and the Madoff scandal.

While Chairman Cox may not have been responsible for either of those debacles, he did leave another unpleasant legacy – XBRL.  He was among the biggest cheerleaders for XBRL, claiming that it would enable investors to compare companies within and across industries and would perform various other miracles.  Suffice it to say it hasn’t done that.  Aside from the fact that it’s time-consuming, it has failed to provide the benefits of comparability.  As a client recently said,

“[E]ven if two companies use the same taxonomy/tagging for Cost of Sales, they probably are not consistent in the underlying details that go into Cost of Sales.  One company might classify certain components as G&A instead.  There are many other examples.  Consistency is very important for one company’s reporting from period to period, however comparisons of competitors’ financials will always be approximations at best.”


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The young ones among you may not be familiar with Harvey Pitt, but he is an incredibly smart man and a gifted attorney who chaired the SEC some years back.  He made some political gaffes in that role, but that doesn’t diminish his understanding of the securities laws and how disclosure works.

A few weeks ago, he was quoted in The Wall Street Journal on the subject of disclosure (“Harvey Pitt Envisions a New Form of Corporate Disclosure”).  Specifically, he points out that “[d]isclosure is supposed to be for the purpose of informing…but…it’s become for the purpose of providing a defense”.  He also says “…when you have proxy statements that run hundreds of pages…it’s impossible to expect any normal individual to put in the time to read all of those pages”.  As I said, he’s an incredibly smart man.

So what is his solution?  He suggests a “summary disclosure document the way disclosure used to be” – say five or six pages – and that more detailed information be available by hyperlink for the investors who want to dig deep.  At the same time, companies could track how many people actually make that deep dive and make judgments as to eliminating information that no one seems interested in.


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