SEC Disclosure Effectiveness Initiative Archives

Guidance On New Exhibit Rules In SEC Filings

Posted by Securities Attorney Laura Anthony | November 14, 2017 Tags: ackground on the New Exhibit Rule, Guidance On New Exhibit Rules In SEC Filings, Item 601 Of Regulation S-K, Rule 102(d) of Regulation S-T, Rule 601(a)(2) of Regulation S-K, SEC, SEC Disclosure Effectiveness Initiative, XBRL exhibits

On March 1, 2017, the SEC passed a final rule requiring companies to include hyperlinks to exhibits in filings made with the SEC. The amendments require any company filing registration statements or reports with the SEC to include a hyperlink to all exhibits listed on the exhibit list. In addition, because ASCII cannot support hyperlinks, the amendment also requires that all exhibits be filed in HTML format. The rule change was made to make it easier for investors and other market participants to find and access exhibits listed in current reports, but that were originally provided in previous filings. A summary of the rule can be read HERE.

The new Rule went into effect on September 1, 2017, provided however that non-accelerated filers and smaller reporting companies that submit filings in ASCII may delay compliance through September 1, 2018.

In addition to the filing of exhibits and schedules, Item 601 of Regulation S-K requires each company to include an exhibit index list that lists each exhibit included as part of the filing. The list is cumulative. For example, the company’s articles of incorporation are required to be included as an exhibit with every 10-Q and 10-K filing. Once an exhibit has been filed once, the company could historically incorporate by reference by including a footnote as to which filing the original exhibit can be found in. Unfortunately, I find that companies often will indicate that an exhibit has been previously filed, without giving a specific reference as to which filing or when, leaving an investor or reviewer to go fish. The SEC rightfully asserts that requiring companies to include hyperlinks from the exhibit index to the actual exhibits filed would allow much easier access to these filings.

The new rule requires companies to include a hyperlink to each filed exhibit on the exhibit index as required by Item 601 of Regulation S-K, for virtually all filings made with the SEC, including XBRL exhibits. An active hyperlink will now be required in all filings made under the Securities Act or Exchange Act, provided however that if the filing is a registration statement, the active hyperlinks need only be included in the version that becomes effective.

The new rule also amends Rule 102(d) of Regulation S-T and Rule 601(a)(2) of Regulation S-K to require the exhibit index to “appear before the required signatures in the registration statement or report.” Previously, an exhibit index was to “precede immediately the exhibits filed with such registration statement.” This requirement has raised a question as to whether a historical exhibit index would need to appear twice, both combined with the full cumulative list before the required signatures and before the exhibits themselves. In practice, many companies have indeed included two lists.

As learned from a blog written by the excellent CorporateCounsel.Net, a fellow practitioner has contacted the SEC, who in turn informally confirmed that it is permissible to combine the exhibit table with the exhibit index and only present one list of exhibits with hyperlinks. A separate exhibit index is not required.

Further Background on the New Exhibit Rule

On April 15, 2016, the SEC issued a 341-page concept release and request for public comment on sweeping changes to certain business and financial disclosure requirements in Regulation S-K (“S-K Concept Release”). The S-K Concept Release contained a discussion and request for comment on exhibit filing requirements. Item 601 of Regulation S-K specifies the exhibits that must be filed with registration statements and SEC reports. Item 601 requires the filing of certain material contracts, corporate documents, and other information as exhibits to registration statements and reports.

A particular area of discussion recently has been the need to file schedules to contracts. These schedules can be lengthy and lack materiality. Likewise, a recent area of discussion has been the necessity of filing an immaterial amendment to a material exhibit. The S-K Concept Release contains a lengthy discussion on exhibits, including drilling down on specific filing requirements. Many of the exhibit filing requirements are principle-based, including, for example, quantitative thresholds for contracts. Consistent with the rest of the S-K Concept Release, the SEC discusses whether these standards should be changed to a straight materiality approach. The SEC also discusses eliminating some exhibit filing requirements altogether, such as where the information is otherwise fleshed out in financial statements or other disclosures (for example, a list of subsidiaries).

Currently companies are allowed to reference exhibits filed in prior filings as opposed to refiling the exhibit with the SEC. The better practice has always been to include a specific reference to the filing, including the date of the filing, and where the original exhibit can be located. However, many companies do not do so, leaving the public to search through prior filings to find the listed exhibit. Moreover, as time goes by and companies switch counsel, some choose not to spend the time and funds to have new counsel update an exhibit list to include a full reference. The new rule will require them to do so. The rule amendment is limited to the presentation of the exhibit list and requires including a hyperlink to the actual filed exhibit.

Further Reading on the SEC Disclosure Effectiveness Initiative

I have been keeping an ongoing summary of the SEC ongoing Disclosure Effectiveness Initiative. The following is a recap of such initiative and proposed and actual changes. Although the rate of changes has slowed down since the election and change in SEC control regime, I expect it to pick up again. In an upcoming blog, I will be writing about the SEC’s announced Regulatory Flex Agenda. The Agenda lists regulations the SEC expects to propose or finalize in the next 12 months. This year’s Agenda only incudes 33 rules (last year’s contained 62), at least 8 of which are related to disclosure requirements.

As discussed in this blog, on March 1, 2017, the SEC passed final rule amendments to Item 601 of Regulation S-K to require hyperlinks to exhibits in filings made with the SEC. The amendments require any company filing registration statements or reports with the SEC to include a hyperlink to all exhibits listed on the exhibit list. In addition, because ASCII cannot support hyperlinks, the amendment also requires that all exhibits be filed in HTML format.

On August 25, 2016, the SEC requested public comment on possible changes to the disclosure requirements in Subpart 400 of Regulation S-K. Subpart 400 encompasses disclosures related to management, certain security holders and corporate governance. See my blog on the request for comment HERE.

On July 13, 2016, the SEC issued a proposed rule change on Regulation S-K and Regulation S-X to amend disclosures that are redundant, duplicative, overlapping, outdated or superseded (S-K and S-X Amendments). See my blog on the proposed rule change HERE. This proposal is slated for action in this year’s SEC regulatory agenda.

That proposed rule change and request for comments followed the concept release and request for public comment on sweeping changes to certain business and financial disclosure requirements issued on April 15, 2016. See my two-part blog on the S-K Concept Release HERE and HERE.

As part of the same initiative, on June 27, 2016, the SEC issued proposed amendments to the definition of “Small Reporting Company” (see my blog HERE). The SEC also previously issued a release related to disclosure requirements for entities other than the reporting company itself, including subsidiaries, acquired businesses, issuers of guaranteed securities and affiliates. See my blog HERE. Both of these items are slated for action in this year’s SEC regulatory agenda.

As part of the ongoing Disclosure Effectiveness Initiative, in September 2015 the SEC Advisory Committee on Small and Emerging Companies met and finalized its recommendation to the SEC regarding changes to the disclosure requirements for smaller publicly traded companies. For more information on that topic and for a discussion of the Reporting Requirements in general, see my blog HERE.

In March 2015 the American Bar Association submitted its second comment letter to the SEC making recommendations for changes to Regulation S-K. For more information on that topic, see my blog HERE.

In early December 2015 the FAST Act was passed into law. The FAST Act requires the SEC to adopt or amend rules to: (i) allow issuers to include a summary page to Form 10-K; and (ii) scale or eliminate duplicative, antiquated or unnecessary requirements for emerging-growth companies, accelerated filers, smaller reporting companies and other smaller issuers in Regulation S-K. The current Regulation S-K and S-X Amendments are part of this initiative. In addition, the SEC is required to conduct a study within one year on all Regulation S-K disclosure requirements to determine how best to amend and modernize the rules to reduce costs and burdens while still providing all material information. See my blog HERE. These items are all included in this year’s SEC regulatory agenda.

The Author

Laura Anthony, Esq.
Founding Partner
Legal & Compliance, LLC
Corporate, Securities and Going Public Attorneys
330 Clematis Street, Suite 217
West Palm Beach, FL 33401
Phone: 800-341-2684 – 561-514-0936
Fax: 561-514-0832
LAnthony@LegalAndCompliance.com
www.LegalAndCompliance.com
www.LawCast.com

Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded issuers as well as private companies going public on the NASDAQ, NYSE MKT or over-the-counter market, such as the OTCQB and OTCQX. For nearly two decades Legal & Compliance, LLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions as well as registration statements on Forms S-1, S-8 and S-4; compliance with the reporting requirements of the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; Regulation A/A+ offerings; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers, ; applications to and compliance with the corporate governance requirements of securities exchanges including NASDAQ and NYSE MKT; crowdfunding; corporate; and general contract and business transactions. Moreover, Ms. Anthony and her firm represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. Ms. Anthony’s legal team prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the OTC Market’s top source for industry news, and the producer and host of LawCast.com, the securities law network. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Las Vegas, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.

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SEC Proposes Rules to Modernize and Simplify Disclosures

Posted by Securities Attorney Laura Anthony | October 31, 2017 Tags: Fast Act, Fixing America’s Surface Transportation Act, Regulation S-K, Regulation S-X, SEC Disclosure Effectiveness Initiative, SEC Proposes Rules to Modernize and Simplify Disclosures

On October 11, 2017, as part of the ongoing SEC Disclosure Effectiveness Initiative, the SEC published proposed rule amendments to modernize and simplify disclosure requirements for public companies, investment advisers, and investment companies. The proposed rule amendments implement a mandate under the Fixing America’s Surface Transportation Act (“FAST Act”).

The FAST Act, passed in December 2015, contains two sections requiring the SEC to modernize and simplify the requirements in Regulation S-K. Section 72002 requires the SEC to amend Regulation S-K to “further scale or eliminate requirements… to reduce the burden on emerging growth companies, accelerated filers, smaller reporting companies, and other smaller issuers, while still providing all material information to investors.” In addition, the SEC was directed to “eliminate provisions… that are duplicative, overlapping, outdated or unnecessary.” In accordance with that requirement, On July 13, 2016, the SEC issued proposed rule change on Regulation S-K and Regulation S-X to amend disclosures that are redundant, duplicative, overlapping, outdated or superseded. See my blog on the proposed rule change HERE. This proposal is slated for action in this year’s SEC regulatory agenda.

Section 72003 required the SEC to conduct a study on Regulation S-K and, in that process, to consult with the SEC’s Investor Advisory Committee (the “IAC”) and the Advisory Committee on Small and Emerging Companies (the “ACSEC”) and then to issue a report on the study findings, resulting in the report issued on November 23, 2016. Section 72003 specifically required that the report include: (i) the finding made in the required study; (ii) specific and detailed recommendations on modernizing and simplifying the requirements in Regulation S-K in a manner that reduces the costs and burdens on companies while still providing all material information; and (iii) specific and detailed recommendations on ways to improve the readability and navigability of disclosure documents and to reduce repetition and immaterial information. The proposed amendments seek to implement the various findings and recommendations in the November report.

As further discussed in this blog, the proposed amendments would: (i) revise forms to update, streamline and improve disclosures including eliminating risk factor examples in form instructions and revising the description of property requirement to emphasize a materiality threshold; (ii) eliminate certain requirements for undertakings in registration statements; (iii) amend exhibit filing requirements and related confidential treatment requests; (iv) amend Management Discussion and Analysis requirements to allow for more flexibility in discussing historical periods; and (v) incorporate more technology in filings through data tagging of items and hyperlinks.

Proposed Amendments

A. Description of Property (Item 102)

Item 102 requires disclosure of the location and general character of the principal plants, mines, and other materially important physical properties of the company and its subsidiaries.The instructions to Item 102 require the company to disclose information reasonable to inform investors as to the suitability, adequacy, productive capacity and utilization of facilities. The proposed amendment will emphasize materiality and require a company to disclose physical properties only to the extent that such properties are material to the company.

B. Management’s Discussion and Analysis (MD&A) (Item 303)

Item 303(a) requires a company to discuss their financial condition, changes in financial condition, and results of operations using year-to-year comparisons. The discussion is required to cover the period of the financial statements in the report (i.e., 2 years for smaller reporting companies and emerging growth companies and 3 years for others). Where trend information is relevant, the discussion may include 5 years with a disclosure of selected financial data.

The proposed amendment would allow the company to eliminate the earliest year in its discussion as long as (1) the discussion is not material to an understanding of the current financial condition; and (ii) the company has filed a prior Form 10-K with an MD&A discussion of the omitted year. The proposed amendment will also eliminate the reference to a five-year look-back in the instructions, but rather a company will be able to use any presentation or information that it believes will enhance a reader’s understanding. The amendments will flow through to foreign private issuers as well with conforming changes to the instructions for Item 5 of Form 20-F.

C. Directors, Executive Officers, Promoters and Control Persons (Item 401)

Item 401 requires disclosure of identifying and background information about a company’s directors, executive officers, and significant employees. The proposed amendments will clarify the instructions to Item 401 to clarify that the information is not required to be duplicated in various parts of a Form 10-K and/or proxy statement, but need only appear once and may be incorporated by reference in other parts of the documents.

D. Compliance with Section 16(a) (Item 405)

Section 16(a) of the Exchange Act requires officers, directors, and specified types of security holders to report their beneficial ownership of a company’s equity securities using forms prescribed by the SEC, such as an initial Form 3, amendments on Form 4 and annual Form 5. Item 405 requires the company to disclose each person who failed to timely file a Section 16 report during the most recent fiscal year or prior years. Section 16 reporting persons are required to deliver a copy of their reports to the company, though in practice, this is rarely done. The proposed amendments remove this requirement and allow the company to review EDGAR filings for compliance with Section 16(a).

In addition, the proposed amendment would eliminate the need to include the heading at all if there are no delinquencies to report, rather than include the heading with a statement such as “none” and remove the checkbox on the cover page of Form 10-K related to the disclosure. The proposed amendment includes several changes to make the instructions and title of this section conform to the SEC’s “plain English” requirements.

E. Corporate Governance (Item 407)

The proposed amendment will update the instructions and information required under Item 407 to remove reference to an obsolete audit standard and rather just refer broadly to applicable PCAOB and SEC requirements. EGC’s and smaller reporting companies are both exempted from the Item 407 requirements, and the proposed amendment clarifies the instruction language accordingly.

F. Outside Front Cover Page of the Prospectus (Item 501(b))

The proposed amendments are designed to streamline the front cover page of a prospectus and give a company flexibility in designing the page to tailor to their business and particular offering. The proposed changes include (i) eliminating instructions related to changing or clarifying a name that may be confused with a well-known company; (ii) allowing for a statement that the offering price will be determined by a particular method or formula that is more fully explained in the prospectus with a cross-reference to the page number; (iii) requiring the disclosure of the principal trading market and company symbol, even if such trading market is not a national exchange; and (iv) streamlining the “subject to completion” legend.

G. Risk Factors (Item 503(c))

A company is required to disclose the most significant factors that make an offering speculative or risky. Although the disclosure is intended to be principals-based, many examples are included in the instructions. The proposed amendments would move Item 503(c) to Subpart 100 to clarify that risk factors are also required in a Form 10 and Exchange Act periodic reports and not just offering-related disclosures. The proposed amendment would also eliminate the risk factor examples from the instructions.

H. Plan of Distribution (Item 508)

Item 508 requires disclosure about the plan of distribution for securities in an offering, including information about underwriters. The term “sub-underwriter” is referred to in the rule; however, it is not defined. The proposed rules will define a “sub-underwriter” as “a dealer that is participating as an underwriter in an offering by committing to purchase securities from a principal underwriter for the securities but is not itself in privity of contract with the issuer of the securities.”

I. Undertakings (Item 512)

Item 512 provides undertakings that a company must include in Part II of its registration statement, depending on the type of offering. The proposed amendments simplify the undertakings requirements and eliminate provisions that are duplicative because the requirement already exists, or that are obsolete due to changes in the law. For example, Items 512(d), 512(e) and 512(f) are all obsolete and should be eliminated. Item 512(c) related to unsold rights offerings that are then offered to the public, can be eliminated as other provisions of the law would require the company to update the (or complete a new) registration statement regardless.

J. Exhibits (Item 601)

The proposed amendment makes several changes to the exhibit filing requirements to streamline and reduce the volume of documents, many of which may not be material, which are required to be filed. The proposed amendments also make at least one addition to the exhibit requirements and in particular, a company must disclose a subsidiaries LEI number if one has been issued. For information on a LEI, see HERE.

The proposed amendment add exhibits related to Item 202 disclosures (registered capital stock, debt securities, warrants, rights, American Depository Receipts, and other securities) to Exchange Act periodic reports on Form 10-K and 10-Q. Such exhibits are currently only required in registration statements, Form 8-K and Schedule 14A.

The proposed amendment also clarifies that schedules and exhibits to exhibits need not be filed unless they are, in and of themselves, material to an investment decision. Although historically the SEC did not object to the omission of schedules and exhibits to exhibits with personally identifiable information, the rules generally require the filing of a confidential treatment request for most omissions. The proposed amendments allow a company to omit schedules and exhibits to exhibits as long as a brief description of the omitted documents is included. In addition, a copy of the omitted items must be provided if requested by the SEC, though a confidential treatment request could also be made at that time. Likewise the proposed amendments will allow a company to redact information that is both (i) not material, and (ii) competitively harmful if disclosed.

K. Incorporation by Reference

Currently rules related to incorporation by reference are spread among a variety of regulations, including Regulation S-K, Regulation C, Regulation 12B and numerous forms. The proposed amendments would revise Item 10(d), Rule 411, and a number of SEC forms to simplify and modernize these rules while still providing all material information. Rule 12b-23 is proposed to be rescinded. The amendments streamline the rules and further allow for incorporation by reference to eliminate duplicative disclosure. The proposed rules will require a hyperlink to information that is incorporated by reference if the information is available on EDGAR.

The proposed rules specifically do not add or change the rules related to cross-references or other incorporation within the financial statements to other disclosure items. There is a concern as to the impact on auditor review requirements if such links or changes are added.

L. Forms

The proposed amendments include several amendments to forms to conform with and implement all the changes in the rules.

M. XBRL

The proposed amendments would require all of the information on the cover pages of Form 10-K, Form 10-Q, Form 8-K, Form 20-F, and Form 40-F to be tagged in Inline XBRL in accordance with the EDGAR Filer Manual.

Further Reading on the FAST Act

I’ve blogged several times on the FAST Act since its initial passing on December 15, 2015. An initial discussion and summary of the FAST Act can be read HERE. A summary of the SEC guidance on the FAST Act as relates to savings and loan companies can be read HERE.

On January 13, 2016, the SEC issued interim final rules memorializing two provisions of the FAST Act. In particular, the SEC revised the instructions to Forms S-1 and F-1 to allow the omission of historical financial information and to allow smaller reporting companies to use forward incorporation by reference to update an effective S-1. A summary can be read HERE. On May 3, 2016, the SEC issued final amendments to revise the rules related to the thresholds for registrations, termination of registration, and suspension of reporting under Section 12(g) of the Securities Exchange Act of 1934. The amendments mark the final rule making and implementation of all provisions under the JOBS Act, and implement further provisions under the FAST Act. A summary can be read HERE.

On August 17, 2017, the SEC issued guidance on financial statement requirements for confidential and public registration statement filings by both emerging growth companies (EGC) and non-emerging growth companies. The new Compliance and Disclosure Interpretations (C&DI’s) follow the SEC’s decision to permit all companies to submit draft registration statements, on a confidential basis. For a summary see HERE and HERE.

As required by Section 72003 of the Fixing America’s Surface Transportation Act (the “FAST Act”), on November 23, 2016, the SEC issued a Report on Modernization and Simplification of Regulation S-K including detailed recommendations for changes. For a summary see HERE.

Further Background on SEC Disclosure Effectiveness Initiative

I have been keeping an ongoing summary of the SEC ongoing Disclosure Effectiveness Initiative. The following is a recap of such initiative and proposed and actual changes.

On March 1, 2017, the SEC passed final rule amendments to Item 601 of Regulation S-K to require hyperlinks to exhibits in filings made with the SEC. The amendments require any company filing registration statements or reports with the SEC to include a hyperlink to all exhibits listed on the exhibit list. In addition, because ASCII cannot support hyperlinks, the amendment also requires that all exhibits be filed in HTML format. The new Rule goes into effect on September 1, 2017, provided however that non-accelerated filers and smaller reporting companies that submit filings in ASCII may delay compliance through September 1, 2018. See my blog HERE on the Item 601 rule changes.

On November 23, 2016, the SEC issued a Report on Modernization and Simplification of Regulation S-K as required by Section 72003 of the FAST Act. A summary of the report can be read HERE.

As part of the ongoing disclosure effectiveness intiiactive, in September 2015 the SEC Advisory Committee on Small and Emerging Companies met and finalized its recommendation to the SEC regarding changes to the disclosure requirements for smaller publicly traded companies. For more information on that topic and for a discussion of the reporting requirements in general, see my blog HERE.

In March 2015 the American Bar Association submitted its second comment letter to the SEC making recommendations for changes to Regulation S-K. For more information on that topic, see my blog HERE.

The Author

Contact Legal & Compliance LLC. Technical inquiries are always encouraged.

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NASDAQ Issues Report Advocating for The U.S. Public Markets

Posted by Securities Attorney Laura Anthony | October 24, 2017 Tags: NASDAQ Issues Report Advocating for The U.S. Public Markets, SEC Disclosure Effectiveness Initiative, The NASDAQ Paper, The Promise of Market Reform: Reigniting American’s Economic Engine

Before SEC Commissioner Michael Piwowar’s May 16, 2017, speech at the SEC-NYU Dialogue on Securities Market Regulation regarding the U.S. IPO Market (see summary HERE), and SEC Chair Jay Clayton’s July 12, 2017, speech to the Economic Club of New York (see summary HERE), the topic of the U.S. IPO market had already gained significant market attention. Earlier this year, NASDAQ issued a paper titled “The Promise of Market Reform: Reigniting American’s Economic Engine” with its views and position on how to revitalize the U.S. equities and IPO market (the “NASDAQ Paper”). This blog summarizes the NASDAQ Paper.

The NASDAQ Paper begins with a statement by Adena Friedman, President and CEO of NASDAQ. The statement begins with a decidedly positive outlook, noting that “The U.S. equities markets exist to facilitate job creation and wealth creation for millions of people, ultimately driving economic growth for our country.” Ms. Friedman adds that “[E]xceptional market returns in recent years reflect the growing strength of the U.S. and global economy and continued confidence in the health of U.S. markets.”

However, on the other side she points out that there are structural issues that need to be addressed, noting that markets have become more complex and costly for companies that are already public or considering going public. The problem runs deep. Again quoting Ms. Friedman: “[I]f the volume of IPOs continues to fall and more companies choose to stay or go private, job creation and economic growth could suffer, and income inequality could worsen as average investors become increasingly shut out of the most attractive offerings.” In that regard, NASDAQ has issued its Paper setting out reforms that it advocates for to improve interest in the U.S. public markets.

The NASDAQ Paper

Following an Executive Summary, the NASDAQ Paper is broken down into three sections: (i) Reconstructing the Regulatory Framework; (ii) Modernizing Market Structure; and (iii) Promoting Long-Termism.

Executive Summary

Like Ms. Friedman’s statement, the executive summary at the beginning of the NASDAQ Paper touts the importance of robust U.S. public markets to our economy, a message I have reiterated in many blogs over the years. Citing the SEC’s own statistics, the NASDAQ Paper points out that since 1970, 92% of job creation has come from public companies and that the vast majority of Americans are invested in public companies either directly or indirectly through pension funds, mutual funds and other retirement accounts. Furthermore, index funds have gained in popularity, but for an index strategy to work, there needs to be a healthy selection of public companies to comprise these indexes and provide diversification and profitability.

Although many pension funds invest in private equity firms that in turn invest in private companies, these private investments are illiquid and hard to value. Accordingly, public markets remain and will continue to remain the investment of choice for U.S. retirement accounts.

However, with the necessary transparency of public companies comes greater obligations and compliance costs. Over the years the U.S. has continued to add layers of regulation such that the burdens of being public can outweigh the benefits. I note this is more so for larger companies that do not qualify as emerging growth or smaller public companies and are required to comply with even greater levels of disclosure, including compliance with Sarbanes-Oxley Act Section 404. For more on public company disclosure requirements, see HERE and HERE. A summary of the ongoing SEC Disclosure Effectiveness Initiative is at the end of this blog.

The NASDAQ Paper cites many reasons for the slowdown in the U.S. IPO market, including: (i) shareholder activists; (ii) frivolous shareholder lawsuits; (iii) pressure to prioritize short-term returns over long-term strategic growth; (iv) burdensome costs and headaches of the proxy process; and (v) irrelevant disclosure obligations. Moreover, the better companies have no problem finding private equity and often choose that route.

In addition to the direct causes for the slowdown, NASDAQ has three main concerns over the U.S. public markets, including: (i) complex regulations disincentivize market participation; (ii) a one-size-fits-all market structure does not work for small and emerging growth companies; and (iii) a culture in the investment community and media that prioritizes short-term return over long-term growth. NASDAQ offers its view and suggested solutions for each of these issues.

Reconstructing the Regulatory Framework

Although regulations and oversight are obviously a necessity, regulations which were put into place as a result of the financial crisis now need to be reviewed and particularly in relation to the burdens they impose on public companies and those considering entering the public markets. Moreover, years of layering of regulations, without a top-down view, has created unnecessary complexities for companies.

NASDAQ points to the proxy process as an area needing crucial regulatory reform. Although shareholders should have an ability to raise legitimate concerns, the proxy process is being used for nuisance value at a significant cost to companies. NASDAQ suggests that the SEC:

(i) Raise the minimum ownership amount and holding period to ensure that proposals have meaningful shareholder backing. Currently, the SEC rules allow a shareholder holding $2,000 or more of company stock for a period of one year or longer, to include issues in a company proxy statement, regardless of materiality, subject to the company’s ability to seek SEC no-action letter redress, which of course requires time and expense. For more on this process, see HERE. NASDAQ suggests increasing the minimum ownership to at least 1% of the company’s outstanding stock and increasing the minimum holding period to 3 years.

(ii) Update the SEC process for removing repetitive, unsuccessful proposals from proxies. NASDAQ backs the Financial Choice Act proposal, which would significantly increase the level of shareholder support a rejected proposal would need to have to be reintroduced at a future meeting. Moreover, the topics of shareholder proposals should be better identified to ensure that only matters that are meaningful to the shareholders are considered at annual meetings.

(iii) Create transparency and fairness in the proxy advisory industry. Due to the large number of proxies to consider each year, institutional investors rely on proxy advisory firms, which are unregulated and “rife with opacity, lack of accountability and conflicts of interest.” NASDAQ suggests that voting is often at the whim of these advisory firms, with no obligation to provide information related to their analysis, financial interests, or stock ownership (including long or short positions).

NASDAQ also advocates changes in corporate disclosure requirements. Although transparency is critically important, companies should have the flexibility to provide full disclosure that is shareholder-friendly (readable) and less burdensome on companies. I’ve included more information on the SEC’s Disclosure Effectiveness Initiative at the end of this blog. NASDAQ has strong views in this regard, and suggests the following changes:

(i) Offer flexibility on quarterly reporting. NASDAQ suggests allowing companies to file semiannual reports with material interim updates via press releases and Form 8-K’s.

(ii) Streamline quarterly reporting obligations for small and medium growth companies. NASDAQ suggests that “if companies report all key financial and business details in quarterly press releases, we should consider eliminating the archaic 10-Q form, which is duplicative and bureaucratic. We should also study options that allow for greater flexibility in reporting schedules, so that as long as companies are transparent with shareholders, they have the flexibility to report on a less-rigid structure. This would also promote our third goal of promoting long-termism.” In addition, NASDAQ questions the usefulness of XBRL, noting that many analysts use their own technology in any event.

(iii) Expand classifications for disclosure relief. In particular, NASDAQ suggests expanding the class of companies that will qualify as a “smaller reporting company” and “emerging growth company” to take advantage of the scaled-down disclosure requirements available to these companies.

(iv) Expand the ability to “test the waters” for emerging growth companies. For more information on test-the-waters provisions, see HERE and HERE.

(v) Allow all companies to file confidential draft registration statements. Since the time that NASDAQ issued its Paper, the SEC has, in fact, implemented this change. See HERE for more information.

(vi) Increase the definition of emerging growth company from the current $1,070,000,000 to $1.5 billion and eliminate the five-year phase-out period,

(vii) Harmonize the definitions and obligations of smaller reporting company with non-accelerated filer and emerging growth company. For more on the distinctions between these categories, see HERE. Also, for a summary of the current proposed changes to the definition of a smaller reporting company, see HERE.

(viii) Allow all companies to use shelf registrations regardless of size.

(ix) Roll back politically motivated disclosure requirements such that disclosures are only required that help investors evaluate a company’s financial performance and economic prospects. Examples of politically motivated disclosures include the conflict mineral disclosures and executive pay ratio.

(x) The SEC should complete its Disclosure Effectiveness Initiative to strip out unnecessary requirements and simplify the process all around.

NASDAQ suggests the need for comprehensive litigation reform. There has been a record rate of securities class actions, many of which are dismissed and are clearly filed for nuisance value. In fact, NASDAQ suggests, and I agree, that class actions have become a method of negotiation and ordinary standard business practice. However, the cost to companies to defend frivolous lawsuits is huge, as is the deterrent to entering the public arena. NASDAQ has several suggestions in this regard, including, for example: (i) ease the standards for imposing sanction on lawyers for bringing frivolous lawsuits; (ii) tighten the requirements for granting class certification; (iii) allow interlocutory appeals of decisions; (iv) require disclosure of third-party financing of the litigation; (v) limit plaintiffs’ legal fees; (vi) allow a plaintiff to amend its complaint only once; (vii) further codify the standards for pleading with respect to scienter and loss causation, and clarify the exclusive nature of federal jurisdiction over securities claims; (viii) increase the burden of proof; (ix) require the loser to pay the legal fees of the winner and require plaintiffs to post a bond to ensure this right; and (x) allow enforceable arbitration provisions for shareholder matters.

NASDAQ also supports tax reform and, in particular, is supportive of the current administration’s efforts to reduce corporate tax rates for U.S. companies as well as territorial taxation for foreign corporate earnings. The exchange also advocates for lower individual taxes specifically related to gains from investments in public companies. In particular, NASDAQ suggests:

(i) Exploring a system that would create a tax structure for individual investors that ties a low level of taxes on investments to the overall value of the account, rather than a higher dividends and capital gains tax on earnings within the account. Sweden introduced such a system in 2012, and since that time approximately 16% of the total Swedish population has taken advantage of this system and the number of Swedish IPO’s has doubled.

(ii) Expand the tax exemption on the sale of small business stock in the secondary market. The tax code currently has a narrow exemption that only benefits venture capitalists and private equity investors.

(iii) Enact a 100% dividends received deduction for holders of corporate stock, avoiding double taxation of corporate profits.

(iv) Eliminate the net investment income tax, which was enacted in 2013 and invokes a 3.8% surcharge on dividends and capital gains.

(v) Exclude dividends and capital gains from income for purposes of determining the phase-out of itemized deductions.

Modernizing Market Structure

The NASDAQ Paper states the obvious: the current market structure needs to be updated for technological advances. A particular problem is the illiquidity faced by small public companies, a problem which NASDAQ believes can be addressed through market reforms leveraging new technology. NASDAQ is particularly critical of Regulation NMS. NASDAQ specifically recommends:

(i) Strengthen markets for smaller companies. Small and medium companies face liquidity issues that also result in market volatility. When a buy or sell order is placed on a stock with low trading volume, it can create dramatic price movements which do not reflect underlying value. NASDSAQ suggests that the problem stems from fragmentation with trading spread among too many trading venues. Interestingly, 15 years ago, 90% of trading was on a single exchange, but today there are 12 exchanges and 50 or more trading venues. Although most OTC Market securities would not qualify for an exchange listing, even if they wanted to, NASDAQ cites the existence of this and other alternative trading systems as also causing a spread-out of liquidity. NASDAQ believes concentrating that disaggregated liquidity onto a single exchange, with limited exceptions, will allow investors to better source liquidity.

I can’t say I agree with NASDAQ on this one. The OTC Markets provides a much-needed source of capital raising and secondary market trading for small and emerging growth companies, where no other option exists. I am, and continue to be, an avid supporter of the OTC Markets and advocate for its recognition as a venture exchange. A legislatively supported venture market would improve the system dramatically. See my article HERE. I also note that the OTC Markets has a platform in place and a desire to be such a venture market. However, as of today, it has failed to receive the legislative support necessary to make the effective changes needed to the system.

(ii) Give issuers a choice to consolidate liquidity and improve trading quality. NASDAQ advocates reducing Unlisted Trading Privileges (UTP) but at the same time creating an exchange that small and medium companies can trade on. However, from my viewpoint such a route would reduce the number of publicly traded securities, which of course would increase supply and demand for traded securities, but would leave many small and emerging growth companies with no access to public capital or secondary markets.

NASDAQ is careful not to suggest eliminating off-exchange (OTC Markets) trading, noting that “[O]ff-exchange trading represents 38.4% of small and medium growth company trading volume today. While there are great benefits to consolidating on-exchange trading, there is also important value provided by off-exchange trading that merit consideration, especially block trades and price-improved trades. The network of off-exchange brokers also supports systemic resiliency for the trading of these securities.We want to work with the industry towards constructive solutions that balance on- and off- exchange activities.” However, it continues arguing in favor of consolidation. In reading the Paper, I wonder if NASDAQ is ultimately suggesting that OTC Markets be turned into a national exchange and run by NASDAQ itself.

(iii) Deploy intelligent tick sizes for small and medium growth companies. NASDAQ cites research that a one-size-fits-all approach to tick size is suboptimal for many (particularly small and medium growth) companies, which should trade in a suitable tick regime determined by their listing exchange. NASDAQ believes trading could be on sub-penny, penny, nickel or dime increments. For information on the SEC tick size pilot program, see HERE.

(iv) Cultivate innovative market-level solutions that improve the trading of small and medium growth companies. NASDAQ advocates eliminating or greatly reducing Regulation NMS. Regulation NMS (National Market System) is a set of rules and regulations governing fairness in price execution, quote displays and access to market data. NASDAQ believes that these rules are restrictive to the market as a whole and negatively impact the liquidity of lower-priced securities.

(v) Implement an intelligent rebate/fee structure that promotes liquidity and avoids market distortion. In this recommendation, NASDAQ is suggesting plans for incentivizing market making in less liquid stocks.

(vi) Ensure fair and reasonable pricing for participants in the context of limiting exchange competition. Of course, if competition is eliminated, there must be rules in place to ensure that “the house” doesn’t win all! (My words, not NASDAQ’s.)

Promoting Long-termism

Companies are under increasing pressure to realize short-term profits for shareholders to the detriment of sustainable long-term growth. NASDAQ particularly points the blame finger at activist investors. Furthermore, unlike many investor groups, NASDAQ supports dual class structures which allow the entrepreneurs and internal management to invest in a motivating fashion along with external investors. NASDAQ’s specific recommendations include:

(i) Address concerns regarding activist investors. As shareholder activism has grown, its definition and purpose have become more muddled. Activism is a term used as an investment strategy that may or may not have any benefit to the company and its other shareholders. In addition to a need for dialogue and research in this area, NASDAQ advocates for further transparency and disclosure around arrangements and motivations by activists, including conflicts of interest.

(ii) Equalize short interest transparency. Short interest disclosures should tie in with Section 13 long position disclosure requirements. The NASDAQ Paper hits the nail on the head: “the asymmetry of information between long investors and those with short positions deprives companies of insights into trading activity and limits their ability to engage with investors and it deprives investors of information necessary to make meaningful investment decisions.”

(iii) Continue to support a dual class structure. Each public company, and their entrepreneurs and innovators, should have the flexibility to determine the best class structure for that company.

(iv) Encourage, rather than mandate, ESG disclosure. ESG stands for environmental, social and governance disclosures.

Further Reading on the SEC Disclosure Effectiveness Initiative

I have been keeping an ongoing summary of the SEC ongoing Disclosure Effectiveness Initiative. The following is a recap of such initiative and proposed and actual changes. Although the rate of changes has slowed down since the election and change in SEC control regime, I expect it to pick up again. In an upcoming blog, I will be writing about the SEC’s announced Regulatory Flexibility Agenda. The Agenda lists regulations the SEC expects to propose or finalize in the next 12 months. This year’s Agenda only includes 33 rules (last year’s contained 62), at least 8 of which are related to disclosure requirements.

In March 2015 the American Bar Association submitted its second comment letter to the SEC making recommendations for changes to Regulation S-K. For more information on that topic, see my blog HERE.

In early December 2015 the FAST Act was passed into law. The FAST Act requires the SEC to adopt or amend rules to: (i) allow issuers to include a summary page to Form 10-K; and (ii) scale or eliminate duplicative, antiquated or unnecessary requirements for emerging growth companies, accelerated filers, smaller reporting companies and other smaller issuers in Regulation S-K. The current Regulation S-K and S-X Amendments are part of this initiative. In addition, the SEC is required to conduct a study within one year on all Regulation S-K disclosure requirements to determine how best to amend and modernize the rules to reduce costs and burdens while still providing all material information. See my blog HERE. These items are all included in this year’s SEC regulatory agenda.

The Author

Contact Legal & Compliance LLC. Technical inquiries are always encouraged.

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SEC Announces Regulatory Agenda

Posted by Securities Attorney Laura Anthony | September 12, 2017 Tags: SEC, SEC Announces Regulatory Agenda, SEC Disclosure Effectiveness Initiative, SEC Disclosure Effectiveness Initiatives, SEC Flex Regulatory Agenda

In July 2017 the SEC posted its latest version of its semi-annual regulatory agenda and plans for rulemaking with the U.S. Office of Information and Regulatory Affairs. The agenda is as interesting for what’s on it, as for what isn’t. The semi-annual list only contains 33 legislative action items that the SEC intends to propose or finalize in the next 12 months. The fall 2016 list contained 62 items. As further discussed in this blog, the list does not include proposals on executive compensation, or many other Dodd-Frank mandated rules.

In the preamble to the list it indicates that it was completed in March, when Michael Piwowar was acting Chair of the SEC. Chair Jay Clayton and now Commissioner Michael Piwowar have been publicly like-minded, with a goal of directing the SEC towards assisting in small and emerging business growth and capital raise activities, while remaining tough on fraud. A summary of Chair Clayton’s first public speech as head of the SEC can be read HERE and a summary of Commissioner Piwowar’s words on the U.S. IPO market can be read HERE.

The Unified Agenda of Regulatory and Deregulatory Actions

The Office of Information and Regulatory Affairs, which is an executive office of the President, publishes a Unified Agenda of Regulatory and Deregulatory Actions (“Agenda”) with actions that 60 departments, administrative agencies and commissions plan to issue in the near and long term. The Agenda is published twice a year, though the fall edition contains statements of regulatory priorities and additional information about the most significant regulatory activities planned for the coming year.

The Office of Information and Regulatory Affairs states that the current Agenda “represents the beginning of fundamental regulatory reform and a reorientation toward reducing unnecessary regulatory burden on the American people.” Furthermore, the Office states, “[B]y amending and eliminating regulations that are ineffective, duplicative, and obsolete, the Administration can promote economic growth and innovation and protect individual liberty.”

Executive Orders 13771 and 13777 require agencies to reduce unnecessary regulatory burden and to enforce regulatory reform initiatives. Each agency was requested to carefully consider the costs and benefits of each regulatory or deregulatory action and to prioritize to maximize the net benefits of any regulatory action. The SEC is not the only agency with a reduced Agenda. In total, agencies withdrew 469 actions that were initially proposed in the fall 2016 Agenda. Agencies moved 391 actions to either long-term or inactive. There are only 58 proposed economically significant regulations, about half from last year. Also, adding transparency for those of us who like to stay up on these matters, for the first time, the agencies will post and make public their list of “inactive” rules.

SEC Flex Regulatory Agenda

As mentioned, in the preamble to the list it indicates that it was completed in March, when Michael Piwowar was acting Chair of the SEC, and reflects his priorities. The preamble to the newest agenda is short. The fall 2017 agenda will reflect the priorities of Chair Jay Clayton and contains more information, including “The Regulatory Plan” of the SEC with a statement of regulatory priorities for the coming year.

The newest agenda is in line with the SEC’s new leader’s promise of support to small and emerging companies. It is also in line with the current administration’s lack of support for Dodd-Frank. The list does not include proposed regulatory actions related to pay for performance (see HERE), executive compensation clawback (see HERE), hedging (see HERE), universal proxies (see HERE), and clawbacks of incentive compensation at financial institutions, although many of these items remain on the “long-term actions” schedule.

The SEC rulemaking agenda may not include further rulemaking on many Dodd-Frank rules, but it also does not include specific rulemaking to repeal existing regulations, such as the pay ratio disclosure rules which were adopted in August 2015 and initially applies to companies for their first fiscal year beginning on or after January 1, 2017. See HERE for more information on this rule. The pay ratio rules do not apply to emerging-growth companies, smaller reporting companies, foreign private issuers, U.S-Canadian Multijurisdictional Disclosure System filers, and registered investment companies. All other reporting companies are subject to the new rules. In October 2016 the SEC published five new compliance and disclosure interpretations (C&DI’s) on certain aspects of the final rules. The C&DI’s covered two main topics: (i) the use of a consistently applied compensation measure in identifying a company’s median employee; and (ii) the application of the term “employee” to furloughed employees and independent contractors or “leased” workers.

Interesting items in the final rule stage include disclosure update and simplification (again see summary at end of this blog), simplification of disclosure requirements for emerging-growth companies and forward incorporation by reference on Form S-1 for smaller reporting companies (see HERE), Form 10-K summary, amendments to smaller reporting company definition (see HERE), and regulation of NMS Stock Alternative Trading Systems.

Items of interest in the proposed rule stage include amendments to the interactive data (XBRL) program, amendments to financial disclosures about entities other than the registrant (see HERE), business and financial disclosure required by Regulation S-K (see end of this blog for the most recent summary on Regulation S-K changes), reporting on proxy votes on executive compensation (i.e., say-on-pay – see HERE), transfer agents (see HERE), implementation of FAST Act report recommendations (see HERE), and concept release on possible audit committee disclosures.

Also interesting is the many items that appeared on the proposed rule list in fall 2016 that have now been moved to “long-term actions.” Items moved from proposed to long-term include registration of security-based swaps, universal proxy, corporate board diversity, investment company advertising, personalized investment advice standard of conduct, stress testing for large asset managers, prohibitions of conflicts of interest relating to certain securitizations, commission guidance on definitions of mortgage-related security and small-business-related security, standards for covered clearing agencies, and risk mitigation techniques.

Other items on the long-term action list include pay versus performance, amendments to Regulation D, Form D and Rule 156, hedging disclosures, several securities-based swaps regulatory actions, exchange traded products, and disclosures of payments by resource extraction issuers.

Further Reading on the SEC Disclosure Effectiveness Initiative

I have been keeping an ongoing summary of the SEC’s ongoing Disclosure Effectiveness Initiative. The following is a recap of such initiative and proposed and actual changes. Although the rate of changes has slowed down since the election and change in SEC control regime, I expect it to pick up again. In an upcoming blog, I will be writing about the SEC’s announced Regulatory Flexibility Agenda. The Agenda lists regulations the SEC expects to propose or finalize in the next 12 months. This year’s Agenda only incudes 33 rules (last year’s contained 62), at least 8 of which are related to disclosure requirements.

In March 2015 the American Bar Association submitted its second comment letter to the SEC making recommendations for changes to Regulation S-K. For more information on that topic, see my blog HERE.

In early December 2015 the FAST Act was passed into law. The FAST Act requires the SEC to adopt or amend rules to: (i) allow issuers to include a summary page to Form 10-K; and (ii) scale or eliminate duplicative, antiquated or unnecessary requirements for emerging-growth companies, accelerated filers, smaller reporting companies and other smaller issuers in Regulation S-K. The current Regulation S-K and S-X Amendments are part of this initiative. In addition, the SEC is required to conduct a study within one year on all Regulation S-K disclosure requirements to determine how best to amend and modernize the rules to reduce costs and burdens while still providing all material information. See my blog HERE . These items are all included in this year’s SEC regulatory agenda.

The Author

Contact Legal & Compliance LLC. Technical inquiries are always encouraged.

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