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Key issues for upcoming Q3 10-Q filings

As public companies prepare their Q3 releases and filings, some of the key issues they should consider include:

  • MD&A – as we reported last quarter, the SEC Staff issued COVID-19 guidance in June calling for companies to disclose the impact of the pandemic through the eyes of management, including, to the extent material:
    • The effects of the pandemic on a company’s operations, liquidity and capital resources; the short- and long-term impact of any federal relief received under the CARES Act; and the company’s ability to continue as a going concern
    • Operational changes as a result of the pandemic – from converting to telework to modifying supply chain and customer contracts, and now converting to the return to the workplace and business reopenings
    • Trends, events or uncertainties (such as possible events of default, breach of covenants, etc.), unless a company can conclude either that it is not reasonably likely that the trend, uncertainty or other event will occur, or that a material effect on the company’s liquidity, capital resources or results of operations is not reasonably likely to occur
  • Non-GAAP Financial Measures – as we recently noted, it appears few companies are jumping on the EBITDAC bandwagon; however, the SEC staff has issued comments on such measures that include adjustments for COVID-19, as in Comment 6 here. Accordingly, companies should be prepared to explain the quantification of any such adjustments and their rationale, consistent with the guidance described in our earlier

SEC Puts SAFT Issuers On Notice (Again)

For the second time this year (see our previous reported here), a judge in the U.S. District Court for the Southern District of New York determined that an initial coin offering (“ICO”) involving the Simple Agreement for Future Tokens (“SAFT”) framework constituted an unlawful unregistered securities offering, establishing a daunting precedent for both potential and past SAFT issuers.  The most recent such ruling came on September 30, 2020, in response to dueling Motions for Summary Judgment in the SEC v. Kik Interactive Inc. case, as profiled further here.

SEC Proposes Limited Exemption for Persons Acting as “Finders” in Private Capital Transactions to Accredited Investors

The SEC announced on October 7, 2002 that it had approved, by vote of 3-2, a proposed limited conditional exemption for individuals acting as “finders” in private market transactions with accredited investors.  The text of the proposed exemption can be found here.

When small businesses engage in capital raising transactions in reliance on exemptions from registration under the Securities Act of 1933 (the “1933 Act”), they often look to “finders” to assist in identifying and, in some cases, soliciting potential investors.  Such finders (and issuers using them) must determine whether they are required to register as “broker dealers” under the Securities Exchange Act of 1934 (the “1934 Act”). In making that assessment, finders and issuers (and their legal counsel) have been left to parse through various no-action letters and SEC enforcement actions to discern the SEC’s regulatory position.  In that context, certain activities, as well as the presence of “transaction-based compensation” in these arrangements, have proved to be particularly nettlesome. The proposal would provide a non-exclusive safe harbor from broker registration, and would enable those who qualify to receive transaction-based compensation.

The proposal would be limited to natural persons, and would create two categories: Tier I Finders and Tier II Finders.  Both tiers would be subject certain conditions:

  • the issuer must not be required to file reports under the 1934 Act and must be conducting the offering in reliance on an applicable exemption from registration under the 1933 Act;
  • the finder must not engage in a “general

Red flags for directors: SEC may take magnifying glass to disclosures involving significant judgments in COVID-19 era

In a fast-paced webinar, the Heartland NACD chapter recently explored the board’s role in SEC inquiries and discussed red flags for directors, as well as SEC trends and developments. Panelists included Terri Vaughan, a seasoned board leader; Lory Stone, an SEC enforcement attorney; and Terry Pritchard, an experienced securities litigator at Bryan Cave Leighton Paisner LLP.

During a discussion of red flags that should draw directors’ attention, Ms. Stone noted that the SEC may take a magnifying glass to disclosures involving significant judgements and estimates, particularly in the current economic conditions.  She quoted her former colleague Steven Peikin, previous Co-Director of the Division of Enforcement, who stated in a speech at a recent securities enforcement forum:

Recognizing that the economic impacts of any downturn may vary across different industries and sectors, the [SEC’s Coronavirus] Steering Committee has developed a systematic process to review public filings from issuers in highly-impacted industries, with a focus on identifying disclosures that appear to be significantly out of step with others in the same industry. We are also looking for disclosures, impairments, or valuations that may attempt to disguise previously undisclosed problems or weaknesses as coronavirus-related.

Other red flags discussed during the webinar included:

  • Tips/hotline reports, which should be closely examined by the board;
  • “Domineering” CEOs who may have unchecked power;
  • Auditor resignations, which should prompt the board to understand the reason for the resignation;
  • Management shake-ups, with abrupt terminations or resignations;
  • Government investigations;
  • Financial restatements;
  • Practice changes in judgment areas (debt restructuring, revenue recognition practices);

SEC Announces Charges Against Fulton Financial Corporation and Interface, Inc., in Bellwether of Increased Earnings Management Enforcement Activity

On September 28, the SEC announced charges against two public companies, Interface, Inc. (“Interface”) and Fulton Financial Corporation (“Fulton”), for violations related to the reporting of improperly calculated earnings per share (“EPS”) that enabled the companies to meet or exceed consensus analyst estimates.  In the case of Interface, charges were also levied against the company’s former Chief Financial Officer (“CFO”) and Chief Accounting Officer (“CAO”) for directing subordinates to book unsupported, manual accounting entries that did not comply with generally accepted accounting principles (“GAAP”). These enforcement actions are a result of the implementation of an “EPS Initiative” by the Division of Enforcement that seeks to leverage risk-based data analytics to identify potential instances of accounting and disclosure violations, including those resulting from earnings management practices.

The SEC focused on accounting entries recorded on Interface’s books during the period from the second quarter of 2015 through the second quarter of 2016. The SEC alleged that Interface reported financial results that did not accurately reflect the company’s actual performance, and, instead, inflated income and EPS figures to show consistent earnings growth.  The alleged misstatements were found to be materially misleading because the earnings reported in two quarters enabled the company to meet consensus analyst EPS estimates when, had the unsupported accounting entries not been made, the company would have delivered results below analyst estimates. The SEC alleged that a lack of adequate internal controls over financial reporting created an environment in which the CFO and CAO (then-Corporate Controller) were able to direct

SEC Amends Whistleblower Award Program Rules to Add Clarity, Efficiency and Transparency

On September 23, 2020, the SEC voted 3-2 to adopt long-awaited amendments to rules governing its Whistleblower Program. The amendments’ stated purpose is to provide greater clarity to whistleblowers, and increase the whistleblower program’s efficiency and transparency.  In addition, according to SEC Chairman Jay Clayton, the “rule amendments will help us get more money into the hands of whistleblowers, and at a faster pace.” Click here to read the Alert in full.

SEC Issues New COVID-19 Guidance: Health-Related or Personal Transportation Benefits May Be Perqs

The SEC Division of Corporate Finance yesterday issued new Regulation S-K guidance, CD&I 219.05, to help public companies determine whether benefits provided to executive officers because of COVID-19 should be disclosed as perquisites or personal benefits for purposes of executive compensation proxy disclosures.  Consistent with Release 33-8732A, the guidance confirms that an item provided because of the COVID-19 pandemic is not a perquisite or personal benefit if it is “integrally and directly related to the performance of the executive’s duties,” which depends on the particular facts.

The CD&I states:  “In some cases, an item considered a perquisite or personal benefit when provided in the past may not be considered as such when provided as a result of COVID-19. For example, enhanced technology needed to make the NEO’s home his or her primary workplace upon imposition of local stay-at-home orders would generally not be a perquisite or personal benefit because of the integral and direct relationship to the performance of the executive’s duties. On the other hand, items such as new health-related or personal transportation benefits provided to address new risks arising because of COVID-19, if they are not integrally and directly related to the performance of the executive’s duties, may be perquisites or personal benefits even if the company would not have provided the benefit but for the COVID-19 pandemic, unless they are generally available to all employees.”

Perqs have been, and will continue to be, an area of SEC focus.  We urge companies to carefully give thought

Kodak Releases Special Committee Report – Details Failures in Corporate Governance Practices

We previously blogged about the myriad issues arising in connection with the botched announcement by Kodak of a potential $765 million loan from the federal government as part of its coronavirus response measures, as well as insider stock transactions preceding and immediately following the announcement.  Kodak’s board formed a special committee to conduct an internal investigation.  Akin Gump, retained by the special committee to conduct the investigation, last week delivered its report of over 70 pages of factual findings and legal analysis, concluding that there were no violations of law or company policy, but identifying corporate governance issues requiring attention and remediation.  The company has posted the report on its website.

As we previously blogged, on July 27 the internal public relations team at Kodak released an alert to local media that Kodak would be making a big announcement the following day concerning a major initiative between Kodak and the federal government.  Stories immediately started circulating on social media and the websites of local network affiliates. Kodak then contacted the recipients of the advisory to tell them it was meant only as background and was not intended for publication.  The formal announcement followed before the market open on July 28 when Kodak and the U.S. International Development Finance Corp (DFC) jointly announced a ”letter of interest” contemplating a $765 million loan to Kodak to launch a new pharmaceutical business. Although the press release made clear that this was only a letter of interest and the loan was subject

CFTC Report: Climate Change Poses Major Risks to U.S. Financial System

Includes recommendations for action by SEC and other financial regulators

Last week, a subcommittee of the Commodity Futures Trading Commission issued a sweeping report addressing climate change risks, concluding that they pose both major systemic and sector/regional-level risks to the stability of the U.S. financial system and its ability to sustain the American economy.  Further, it concludes that such risks are increasing rapidly, economic incentives are misdirected and immediate action across the global financial system is required.

The report is wide-ranging with a number of specific, detailed recommendations.  Its length and complexity make it impractical to summarize for this blog, but fortunately, the report does include a well-organized executive summary (beginning on page i).

Some of the report’s key points include:

  • The United States should establish a price on carbon. A fair, economy-wide carbon pricing regime is necessary to fix a fundamental market flaw in the economic system to ensure that appropriate incentives are in place for the efficient allocation of capital
  • U.S. regulators should use their broad, flexible authority to start addressing the risks now
  • Research arms of federal financial regulators should study the financial implications of climate-related risks, including the potential for and implications of climate-related “sub-systemic” shocks to financial markets and institutions in particular sectors and regions of the United States (e.g., agricultural and community banks and financial institutions serving low-to-moderate income or marginalized communities)
  • Financial regulators, in coordination with the private sector, should work together to rapidly improve the quality of data, analytics

SEC Staff Provides Roadmap for Extending Confidential Treatment Orders

The SEC staff amended CF Disclosure Guidance: Topic No. 7 on September 9, 2020 to address the options for companies with confidential treatment orders that are about to expire.  The guidance explains that companies have three choices:

  • Refile the unredacted exhibit. If the contract is still material and none of the redacted information still needs to be protected, the company should refile it in complete, unredacted form.
  • Extend the confidential period pursuant to Rules 406 or 24b-2. If the contract continues to be material, and the previously redacted information continues to be confidential, the company may request to extend the period of confidential treatment by filing an application under Rule 406 of the Securities Act of 1933 or Rule 24b-2 of the Securities Exchange Act of 1934.
    • Short-form application for orders about to expire and initially issued less than three years ago.  If the order is about to expire and was initially issued less than three years ago, companies may use the short-form application, which provides a streamlined process to file an application to extend the time for which confidential treatment has been granted. If the company reduces the extent of omitted information, it must file the revised redacted version of the exhibit on Edgar when submitting the application.

Short-form applications should be submitted to CTExtensions@sec.gov. That email address should not be used for any other confidential treatment request.

    • New application for orders about to
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