Chairman Gensler Addresses Key Elements of his Agenda

Yesterday, SEC Chairman Gensler addressed key elements of his agenda in a speech before the SEC’s Investment Advisory Committee, which subsequently approved two non-binding recommendations.  Gensler focused on:

• Digital engagement practices (DEPs) used by online trading platforms. The SEC recently announced requests for information and comment in light of potential conflicts of interest between the platform and investors when DEPs are designed to optimize platform revenues, data collection or investment behavior.  The SEC is also focusing on effects on investment advice and fairness of access and pricing, including for protected characteristics such as race and gender.
• Rule 10b5-1 plans. As we’ve previously blogged, Gensler believes the Rule 10b5-1(c) affirmative trading defense has potential gaps and has asked the Staff to focus on (1) mandatory cooling off periods before the first trade; (2) prohibitions against having multiple plans at the same time; and (3) enhanced public disclosure of such plans. The committee’s recommendations address those topics, including:
  • Cooling off period of at least four months
  • Prohibition on overlapping plans
  • Require electronic submission of Form 144
  • Proxy statement disclosure of number of shares covered by NEO or issuer plans
  • Form 8-K disclosure of adoptions, modification or cancellation of plans and the number of shares covered
  • Enhanced disclosure of 10b5-1 trades, including adding modifying Form 4 to indicate plan trades and the date of plan adoption or modification
  • Require all companies listed on U.S. exchanges (including foreign private issuers)
    

Reverses Position on $120,000 Threshold

On August 19, 2021, the New York Stock Exchange further revised its definition of a “related party transaction” to include the $120,000 quantitative threshold under Item 404 of SEC Regulation S-K that had been expressly excluded from the definition approved four months earlier.

In April, the Securities and Exchange Commission approved revisions to Section 314.00 of the NYSE Listed Company Manual requiring the audit committee of NYSE listed companies to conduct a reasonable prior review and oversight of all related party transactions for potential conflicts of interest. See NYSE Revises Related Party Transaction Approval Rule. The NYSE rule approved in April defined related party transactions as “transactions required to be disclosed pursuant to Item 404 of Regulation S-K under the Securities Exchange Act (but without applying the transaction value threshold of that provision).” As a result of the exclusion of the $120,000 transaction value threshold from the rule approved in April, the universe of related party transactions requiring review and approval by the audit committee of NYSE listed companies could have been broader than related party transactions requiring proxy statement disclosure under Item 404.

Recognizing this, on August 19, 2021 the NYSE further revised Section 314.00 to delete the parenthetical underlined above, thereby providing that the $120,000 value threshold for disclosure purposes also applies to the prior review and approval requirement under the NYSE rules. The NYSE noted that:

In the period since the adoption of [the April] amendment, it has

Companies listed on the New York Stock Exchange should review their policies on related party transactions and related processes to confirm they are consistent with recent revisions to the applicable NYSE rules.

Longstanding NYSE rules required that “an appropriate body” within listed companies review related party transactions, but did not expressly define what constituted a related party transaction. The conventional wisdom was that related party transactions referred to transactions required to be disclosed under Item 404 of Regulation S‑K, which generally requires disclosure of transactions in which (i) the amount involved exceeds $120,000 and (ii) a related party has a direct or indirect material interest.

In April, the Securities and Exchange Commission approved amendments to Section 314.00 of the NYSE Listed Company Manual. The revised NYSE rule expressly:

• Defines a related party transaction as a transaction required to be disclosed under Item 404 of Regulation S-K without applying the $120,000 threshold thereunder;
• Provides that the audit committee or comparable independent body of the board must conduct an independent prior review of all related party transactions; and
• Requires that the audit committee (or comparable independent body) prohibit related party transactions it determines to be inconsistent with the interests of the company and its shareholders.

As a result of the NYSE’s exclusion of the $120,000 transaction value threshold, for some companies the scope of related party transactions requiring review and approval by the audit committee under the NYSE rule may be broader than the related

On June 15, 2021, the SEC announced that it had settled charges against First American Financial Corporation for failures in First American’s disclosure controls and procedures.  Rule 13a-15(a) under the Exchange Act requires issuers to maintain disclosure controls and procedures designed to ensure that information required to be disclosed by an issuer in reports it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. 

According to the SEC’s order, in May 2019, company management learned from a journalist that the company was experiencing a cybersecurity vulnerability that had resulted in the inadvertent public availability of customers’ personal data.  First American responded by issuing a statement to the press explaining that the company had learned of a design defect that had resulted in “possible unauthorized access to customer data” and had taken “immediate action to address the situation and shut down external access” to the data.  A few days later, First American issued a press release that was also furnished on Form 8-K.  In the release, the company reported that there was “[n]o preliminary indication of large-scale unauthorized access to customer information.”

Contrary to these disclosures, the SEC found that the vulnerability had exposed sensitive personal data, including social security numbers, in over 800 million images of customer documents for a period dating back to as early as 2003.  The SEC also found that the senior executives of the company who were

Today SEC Chair Gensler announced that he has directed the staff to make recommendations on “how we might freshen up Rule 10b5-1” in order to address “real cracks in our insider trading regime.”   As discussed in our March 11, 2021 post, “Wait Continues for Any SEC Public Response to Senators’ Urgent Call for Rule 10b5-1 Reform,” earlier this year several Democratic members of the Senate Committee on Banking, Housing, and Urban Affairs submitted a letter urging the SEC to consider 10b5-1 plan reforms.   That wait ended with Gensler’s announcement.      

Gensler identified four key areas of concern:

• No cooling off period before the first trade. Gensler supports consideration of proposals to mandate four- to six-month cooling off periods, citing research showing 14% of sales of restricted stock occur within 30 days of plan adoption and approximately 40% within the first two months.
• No limits on termination of plans. Gensler believes that termination of plans while insiders are aware of material nonpublic information may be “as economically significant as carrying out an actual transaction” and “undermines investor confidence.”
  • Consistent with Exchange Act Rule CDI 120.18, Gensler noted that “cancelling or amending any 10b5-1 plans calls into question whether they were entered into in good faith. If insiders don’t act in good faith when using 10b5-1 plans, those plans will not offer them an affirmative defense.”
• No mandatory disclosure requirements. Gensler believes “more disclosure regarding the adoption, modification, and terms of Rule 10b5‑1 plans
  

A trio of recent developments illustrate growing support for Environmental Social and Governance (ESG) initiatives in the U.S., as well as abroad. ESG regulatory and legal risks now appear top of mind for institutional investors, as evidenced by the events described below.

Jessica Wirth Strine of Sustainable Governance Partners (formerly with Vanguard and Blackrock) in a recent video interview noted that investors now are more aggressively voting for environmental policy change, rather than working through engagement behind the scenes.  Investors are also evaluating the interplay between ESG and EPS (Earnings Per Share).  Examples include:

• ExxonMobil announced on June 2, 2021 updated preliminary voting results, stating that a third nominee of activist hedge fund Engine No. 1 appears to have won a third board seat, in addition to the two seats announced at the May 26 annual meeting, for control of one-fourth of the company’s 12-member board. Engine No. 1 waged a campaign to force the company to adopt a “climate transition” plan resulting in net-zero emissions from the company – and its products – by 2050. Institutional investors Blackrock and Vanguard each posted voting bulletins following the meeting explaining why they voted for the dissident nominees, citing industry experience, among other things.  Shareholders also approved proposals seeking more information on lobbying activities, including climate lobbying.
• A Dutch court ordered Royal Dutch Shell to reduce its greenhouse gas emissions by 45% (compared to 2019 emissions) by 2030 and to become aligned with the climate goals of the Paris
  

SEC Chair Gary Gensler testified yesterday before the House Committee on Financial Services about the SEC’s efforts to assess and address the market volatility that occurred in GameStop and other “meme stocks” resulting in significant price volatility and trading volume spikes earlier this year. 

Gensler said the SEC is working to determine, in the face of changes in technology and finance, how to continue to achieve core public policy goals while ensuring that the markets work for everyday investors.  Gensler cited seven factors that were at play during the volatile trading periods:

• Gamification and User Experience:  Mobile apps expanded access to capital markets, making it easy for investors to sign up, start trading, get wealth management advice, and learn about investing. The apps use a host of familiar online features, such as gamification (points, rewards, leaderboards, bonuses, and competitions), behavioral prompts and differential marketing, to increase customer engagement.
  • Gensler said the staff is preparing a request for public input to consider these issues and determine how to ensure investors using apps with these types of features are appropriately protected and how SEC rules, including Regulation Best Interest, apply in these situations. Gensler noted that many SEC regulations were written well before today’s technologies and communication practices existed and need to be re-evaluated to protect the futures, retirements and education of the investing public.

• Payment for Order Flow:  Gensler noted that in the last few years, most retail broker-dealers stopped charging fees for trades
  

The House Committee on Financial Services met virtually on April 20, 2021 to consider legislation that, among other things, would require public companies to annually disclose the voluntarily, self-identified gender, race, ethnicity and veteran status of their board directors. The Committee cited a 2017 board diversity survey finding that increased board diversity improves companies’ ability to innovate and enhances overall business performance.

In the meantime, the wait continues for an SEC decision on Nasdaq’s proposed “comply or explain why not” mandate that would require public disclosure of board diversity statistics for most Nasdaq-listed companies, initially proposed in December 2020.   The SEC most recently acted on these rules on March 10, 2021, when it issued an “Order Instituting Proceedings to Determine Whether to Approve or Disapprove Proposed Rule Changes, as Modified by Amendment No. 1” (the “Order”).  The Order postponed the date, which had already been extended, by which the SEC is required to make its decision regarding the proposed rules, as amended, until possibly as late as August 2021. 

Some speculated that the delay was, at least in part, to allow time for Gary Gensler to be named SEC Chair.  The Senate confirmed Gensler’s nomination on April 14, 2021, and he was sworn in as a member of the SEC on April 17, 2021, so many expect movement on the Order this summer.  Comments continue to trickle in to the SEC website, and the SEC Office of the Investor Advocate continues to meet by telephone

Last week the Staff of the Division of Corporation Finance issued a statement addressing a variety of accounting, financial reporting and governance issues that a private operating company should consider before undertaking a business combination with a special purpose acquisition company (a “SPAC”), shortly followed by one by the Acting Chief Accountant addressing financial reporting and auditing considerations for companies considering merging with SPACs.

The Corporation Finance statement addressed:

• Ineligibility for
  • The 71-day extension for target company financials, which must be filed on Form 8-K within four business days of closing the de-SPAC transaction
  • Incorporation of 1934 Act filings on Form S-1 until three years after closing 
  • Use of Form S-8 to register equity plans until 60 days after filing the “Super 8-K” containing required “Form 10 information” 
  • WKSI status, use of free writing prospectuses and certain other less strict requirements for public offerings 
• Public company reporting requirements applicable to the SPAC before, and the combined company after, closing including
  • Books and records requirements
  • SEC reporting and disclosure requirements 
  • The Staff noted that in the limited circumstances described in S-K CDI 215.02, it would not object if the combined company were to exclude management’s assessment of internal control over financial reporting in the Form 10-K covering the fiscal year in which the transaction was consummated 
  • New accounting requirements
• Stock exchange listing standards, including quantitative as well as corporate governance
  

The SEC recently announced its adoption of interim final amendments to certain forms, including Form 10-K and Form 20-F, to implement the congressionally mandated document submission and disclosure requirements of the Holding Foreign Companies Accountable Act (the “HFCA Act”) that became effective in December 2020.  The amendments will become effective 30 days after publication in the Federal Register.  They apply to public companies (each, a “Commission-Identified Issuer”) that are identified by the SEC as having filed an annual report that includes an audit report issued by a registered public accounting firm that (1) has a branch or office located in a foreign jurisdiction and (2) the PCAOB has determined it is unable to inspect or investigate completely because of a position taken by an authority in that jurisdiction.  The SEC will be responsible for identifying such companies, and the PCAOB will be required to identify audit firms that have a location in such a foreign jurisdiction.

Annual Report Amendments.  The new requirements will be implemented (1) with respect to Form 10-K, by the addition of Part II, Item 9C, and (2) with respect to Form 20-F, by the addition of Part II, Item 161.  Each new item will be captioned “Disclosure Regarding Foreign Jurisdictions that Prevent Inspections.”

New Submission Requirement – Commission-Identified Issuers.  The new rules refer to any year in which the SEC identifies a company as a Commission-Identified Issuer as a “non-inspection year.”  The interim final amendments will require that each Commission-Identified Issuer submit, on or