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Risk factor reminders for upcoming 10-Qs

As companies prepare upcoming periodic reports, they should focus on carefully reviewing and updating their risk factors. Some of the considerations may include:

  • COVID Risks. As a number of business sectors improve, it may be advisable to revise COVID-related risk factors to reflect the changing economic climate.  In some cases, the focus may need to shift to address challenges in increasing production, managing supply chains, hiring workers or otherwise responding to increasing customer demand.  In other cases, companies that benefited from dramatic changes in the economy during the pandemic peak may need to address potential risks associated with a return to normalcy.  For example, consider whether recent growth trends are viewed as sustainable in light of the MD&A requirement to discuss “known trends or uncertainties” that the company “reasonably expects will have a material favorable or unfavorable impact on net sales or revenues or income.”  At the same time, it may be appropriate to continue to caution investors as to uncertainties as to the future course of the pandemic – particularly as concern with the impact of variants evolves.
  • Labor Markets. Many sectors and regions are experiencing labor shortages. To the extent material, companies should consider disclosing in MD&A the effect of labor market conditions on their results of operations, and discussing possible future impacts in risk factors. 
  • Hypothetical Risks. Risk factors typically include a wide range of topics intended to warn investors of potential adverse events, most of which may not have not ever materialized. These are included

New SEC Chair directs staff to propose reforms for Rule 10b5-1 plans

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

SEC announces re-examination of proxy advisor rules and interpretations

Newly installed Chairman Gary Gensler announced on June 1, 2021 that he is directing the SEC staff to consider whether to revisit its recent actions with respect to proxy voting advice businesses, including:

  • The SEC’s 2020 proxy rule amendments
    • As discussed in our July 24, 2020 blog, the amendments codified the SEC’s interpretation that the definition of solicitation encompassed proxy voting advice and established requirements for exemptions from the information and filing requirements.
  • The SEC’s 2019 interpretation and guidance regarding solicitation
    • As discussed in our October 2019 newsletter, the SEC stated its view that proxy voting advice generally constitutes a “solicitation” subject to the federal proxy rules and explained what proxy advisers should consider disclosing in order to avoid a potential violation of Rule 14a-9 where the failure to disclose such information would render the advice materially false or misleading.

As a result of the Chairman’s announcement, the SEC staff announced later on June 1 that it has decided that it will not recommend enforcement action based on the 2019 interpretation and guidance or the 2020 amendments during this period of staff review.

In addition, the SEC staff announced that if the 2020 amendments ultimately remain in place, it will not recommend enforcement action based on their conditions for a reasonable period after any resumption by ISS of its litigation challenging the 2020 amendments and 2019 interpretation and guidance.

Following these announcements, Commissioners Pierce and Roisman

SEC staff announces guidance for SPACs

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

SEC Acting Chair Announces Sweeping Climate and ESG Initiatives, New Regulatory Priorities and Potential Rollback of Recent Rule Changes

In a speech on March 15, 2021, Allison Herren Lee, Acting Chair of the SEC, reported on the steps the SEC is taking to meet investors’ growing demand for climate and ESG information, stating that “no single issue has been more pressing for me” and that “climate and ESG are front and center for the SEC.”  She observed that there has been a shift in capital towards ESG and sustainable investment strategies, and that ESG risks and metrics increasingly affect investment decision-making.

Lee indicated that the SEC will devote substantial resources to investor protection initiatives that extend beyond, but are mutually reinforcing of, the SEC’s climate and ESG initiatives.  She noted that these other initiatives include, among others, ensuring strong and clear standards for broker-dealers, taking a “hard look” at the effects of the continuing flow of capital away from the public markets and proceeding with equity market structure reforms.  Reflecting the change in administration and SEC leadership, she noted that this may result in undoing some recently adopted rules and/or guidance.

Highlights of Acting Chair Lee’s speech follow:

Improving Climate and ESG Disclosures.  Lee noted that the SEC’s fundamental role with respect to climate and ESG is helping ensure that material information gets into the market in a timely manner.  She believes the SEC’s current voluntary framework for climate and ESG disclosures neither ensures that result nor meets investor demands; as a result, the SEC has begun taking steps to create a mandatory and comprehensive ESG disclosure framework

SEC Acting Director Coates proposes framework for future ESG rulemaking

Yesterday, John Coates, the acting director of the SEC’s Division of Corporation Finance, announced a proposed framework for considering new ESG disclosure requirements, recognizing that while the scope of ESG issues is very broad, specific ESG issues affect particular companies differently based on industry, geography and other factors.

Need for “adaptive and innovative” policy

Coates compared ESG issues to asbestos-related risks, which evolved from invisible “non-financial” risks that were not addressed in SEC filings to visible and eventually clear financial risks that were increasingly disclosed in companies’ filings.  He believes that SEC policy needs to be adaptive and innovative and, for example, respond to climate risks that were formerly peripheral and now have greater significance.

Effective ESG disclosure system

Coates believes some of the questions the SEC should consider include:

  • What disclosures are most useful?
  • What is the right balance between principles and metrics?
  • How much standardization can be achieved across industries?
  • How and when should standards evolve?
  • What is the best way to verify or provide assurance about disclosures?
  • Where and how should disclosures be globally comparable?
  • Where and how can disclosures be aligned with information companies already use to make decisions?

Costs from having no ESG requirements

Although recognizing that disclosure requirements impose costs on companies, Coates believes that failing to establish ESG requirements is itself costly – that the lack of consistent, comparable and reliable ESG data discourages investment and voting decisions.  Companies incur higher costs in responding to multiple, conflicting or redundant investor

Nasdaq amends its board diversity proposal

On Friday, Nasdaq submitted a revised proposal that addresses board diversity membership for listed companies.  As discussed in our prior alert, Nasdaq had originally called for public companies – over a two-to-four year phase-in period — to include two diverse directors on their boards and to disclose in a “diversity matrix” certain anonymous aggregate data regarding gender identity, race, ethnicity and sexual orientation.

Based on comments, including criticism as discussed here, Nasdaq has modified the proposal in a variety of areas:

  • Smaller boards. Companies with five or fewer directors would only need to include one diverse director, instead of two.
  • Grace period for vacancies. A one-year grace period would be provided for companies that no longer meet the diversity objective as a result of a vacancy on the board.
  • Timing of disclosure. Diversity information would need to be made publicly available before annual shareholder meetings, to align with disclosures for other proxy-related governance matters.
  • Extra time for newly-listed companies. Newly-listed companies that become listed after the phase-in period for the new rules ends would have an additional two-year period after the phase-in period to fully meet the diversity objective.
  • Trigger date. The operative date for disclosure would be the later of (1) one calendar year from the date of SEC approval of the revised proposal or (2) the date the proxy statement is filed for a company’s annual meeting during the calendar year of such SEC approval date.
  • Location of disclosure. Companies could choose to disclose

SEC guidance targets disclosures during “meme stock” volatility

February 9, 2021

Categories

Yesterday, the SEC’s Division of Corporation Finance issued guidance on securities offering disclosure during times of extreme price volatility, which it viewed as characterized by:

  • recent stock run-ups or recent divergences in valuation ratios relative to those seen during traditional markets,
  • high short interest or reported short squeezes, and
  • reports of strong and atypical retail investor interest (whether on social media or otherwise)

The guidance was issued in the form of a sample comment letter to address topics such as:

  • On the prospectus cover page
    • recent price volatility and any known risks of investing under these circumstances
    • comparative market prices before and after the volatility
    • whether any recent changes in financial condition or results of operations are consistent with the stock price changes
  • Risk factors that address
    • recent extreme volatility
    • the effects of a potential short squeeze, including on purchasers in the offering
    • the effect of the number of shares being offered relative to the number outstanding, including on stock prices and investors
    • the potential dilutive effect of future offerings, if contemplated
  • Priorities for use of proceeds, insofar as the targeted proceeds are based on a current stock price that significantly exceeds the company’s historic average price per share, in the event the actual proceeds are less than expected

The staff noted that the sample comments do not constitute an exhaustive list of the issues that companies should consider.

Court ruling highlights confidentiality risks for non-employee directors who use outside email addresses

A recent decision by the Delaware Court of Chancery highlights risks for outside directors in using third-party email systems when communicating about confidential company matters.  In that case, the court ruled that attorney-client privilege was lost because of the lack of a reasonable privacy expectation.

The case arose out of a tender offer by Softbank for shares of WeWork that was oversubscribed but terminated prior to closing. During discovery, the plaintiffs sought documents from Softbank in the custody of “dual hat” employees of Softbank and its majority-owned subsidiary, Sprint.  The documents – which related to Softbank and not Sprint – were sent to or from Sprint email accounts but withheld by Softbank on the basis of its attorney-client privilege. 

The court explained that the privilege issue turned on whether the employees had a reasonable expectation of privacy in their work email accounts, which must be decided on a case-by-case basis, and applied the four-factor test established in In re Asia Global Crossing, Ltd.:

(1) does the corporation maintain a policy banning personal or other objectionable use, (2) does the company monitor the use of the employee’s computer or e-mail, (3) do third parties have a right of access to the computer or e-mails, and (4) did the corporation notify the employee, or was the employee aware, of the use and monitoring policies? [322 B.R. 247, 257 (Bankr. S.D.N.Y. 2005)]

In this case, the court found that a number of factors supported production of the documents:

  • Although

SEC Rule 144 Proposals Target “Toxic” Convertible Securities and Paper Filings

Last week the SEC proposed to amend Rule 144 in order to:

  • Eliminate tacking for shares underlying market-adjustable securities of unlisted companies
  • Update and simplify certain filing requirements, including mandating electronic filing of Form 144s

Elimination of tacking for shares underlying market-adjustable securities of unlisted companies

The proposals would amend Rule 144(d)(3)(ii) to eliminate “tacking” for securities acquired upon the conversion or exchange of the market-adjustable securities of an unlisted company – that is, a company without any securities listed, or approved for listing, on a national securities exchange. As a result, the holding period for the underlying securities — either six months for securities issued by a reporting company or one year for securities issued by a non-reporting company — would not begin until the conversion or exchange of the market-adjustable securities.

In the SEC’s view, the change is needed because applying Rule 144 “tacking” provisions to market-adjustable securities undermines one of the key premises of Rule 144, which is that holding securities at risk for an appropriate period of time prior to resale can demonstrate that the seller did not purchase the securities with a view to distribution and as a result is not an underwriter for the purpose of Securities Act Section 4(a)(1).

In transactions involving market-adjustable securities, the discounted conversion or exchange features in these securities typically provide holders with protection against investment losses that would occur due to declines in the market value of the underlying securities prior to conversion or exchange. Often,

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