In the following guest post, Jay Knight, Taylor Wirth and Chris Johnson of the Bass, Berry & Sims law firm review the key developments at the Securities and Exchange Commission (SEC) during 2019, and consider what to expect in the months ahead. I would like to thank the authors for allowing me to publish their article as a guest post on my site. I welcome guest post submissions from responsible authors on topics of interest to this blog’s readers. Please contact me directly if you would like to submit a guest post. Here is the authors’ article.
For public companies and securities practitioners alike, the decade ended with a bang, with changes to certain long-standing practices and several novel. This article highlights a few of the key takeaways from 2019, and what to expect from the SEC moving forward.
1. Proxy Advisory Firms Face Proposed Rules
The SEC continued its focus on proxy advisory firms in 2019, including the release by the SEC of interpretive guidance providing that proxy advice produced by such firms, such as Institutional Shareholder Services (ISS) and Glass Lewis, is subject to the federal proxy rules, including Rule 14a-9. In response, ISS filed a lawsuit challenging the guidance on procedural and substantive grounds. Nonetheless, the SEC proposed new rules in November 2019, which, if adopted, would create a new framework governing proxy advice communications among public companies and their shareholders, and the proxy advisory firms.
In summary, the rules would require, among other things: (1) proxy advisory firms to distribute recommendations for voting in advance to all companies, providing such subject company an opportunity to review and respond; (2) the inclusion of the company’s response in the proxy advisory firm’s proxy voting recommendations in the form of a hyperlink to the company’s statement; and (3) disclosure in the proxy advice of any misleading disclosure or conflicts of interest, including between the proxy advisory firm and the subject company.
The proposed rules also would codify the SEC’s August 2019 interpretive guidance that proxy voting advice constitutes non-exempt proxy solicitation under Rule 14a-9, which would subject the firm to enforcement action by the SEC for false or misleading statements in a proxy solicitation.
The proposed rules are hotly contested by the major proxy advisory firms, on constitutional law grounds—under the argument that such rules violate their free speech rights–and on the business and practical fronts—the obligations under the rules overburden proxy advisory firms and smaller investment and asset management firms from a cost and time perspective.
The comment period for the SEC’s November 2019 proposed rules concluded on February 3, 2020. The proposed rules were opposed, on a 3-2 vote, by the SEC’s Democratic commissioners, and the ultimate resolution remains open.
2. Lessons Learned from the 2018-2019 Government Shutdown
For 35 days during the 2018-2019 holiday season, the U.S. government experienced its longest shutdown. During this time, nine executive agencies, including the SEC, were closed. The fallout over the shutdown was felt by public companies and securities practitioners alike as the SEC remained unresponsive to no-action requests, requests for acceleration of registration statements, and other related correspondence. Only a handful of staff members were present to address critical issues. At the time, issuers were in a state of semi-paralysis not knowing when the government may reopen and what to expect when the SEC’s operations resumed.
Staff members of the Division of Corporation Finance, who typically review no-action requests to exclude proposals submitted by shareholders for inclusion in the annual proxy statement, were impacted. This left issuers scratching their heads with proxy statement print deadlines approaching—should they exclude the proposal without hearing back from the staff, risking an injunction or enforcement action should the government reopen? After the government reopened and the dust had settled, the SEC saw a 17% year-over-year decline in shareholder proposal no-action letters.
The stakes for companies were somewhat low with respect to run of the mill preliminary proxy statements or shelf registration statements, where companies waited out the 10-day review period or amended outstanding registration statements to remove the Section 8(a) delaying amendment language, thus allowing the registration statement to go effective 20 calendar days thereafter. The treatment of proxy statements and prospectuses pursuant to registration statements on Form S-4, however, resulted in a high stakes guessing game for merger parties. They, too, could wait out the SEC’s review period and/or remove the delaying amendment language; but would the SEC reopen the next day and restart the clock or require a document to be refiled? Many companies took the chance to move forward with multi-million or multi-billion-dollar transactions in the absence of explicit SEC approval.
Approximately one year after the government reopened, the operations at the SEC have returned to relative normalcy. In addition, as we address later in this article, in the fall of 2019 the staff issued guidance announcing a new policy that some 14a-8 no-action requests would be answered orally, thus allowing the staff a more efficient method to respond to such requests. This new policy may be another impact from the government shutdown. If another government shutdown comes, companies will know what to expect.
3. Realignment of Division of Corporation Finance
In September 2019, the SEC’s Division of Corporation Finance undertook a disclosure program realignment meant to improve collaboration, transparency and efficiency. The primary impact to the disclosure program was a reduction in the number of industry-focused offices within the Division of Corporation Finance from 11 to seven, and issuers were accordingly reassigned to new disclosure review offices. According to the SEC’s press release, the Division’s disclosure operations program is now organized in four groups:
- Disclosure Review Program: Selective and required review of filings across seven industry groups: (1) energy and transportation, (2) finance, (3) life sciences, (4) manufacturing, (5) real estate and construction, (6) technology, and (7) trade and services.
- Specialized Policy and Disclosure: Oversight of international corporate finance, M&A and structured finance.
- Office of Risk and Strategy: Provision of guidance on developing risks and evolving disclosures, such as LIBOR transition and cyber-security matters.
- Office of Assessment and Continuous Improvement: Self-evaluation of the disclosure review program.
Although the Division of Corporation Finance does not regularly reorganize its internal structure, such changes do occur from time to time to address changes to the market, trends among public companies, and the need for the SEC to effectively promote its mission to facilitate capital formation and protect investors.
4. FAST Act Updates
On March 20, 2019, the SEC adopted amendments for reporting companies, as mandated by the 2015 Fixing America’s Surface Transportation Act (the FAST Act), to simplify and modernize disclosure obligations. Companies should be mindful of these changes going into the 2020 Form 10-K and proxy season. Among many other items, some key amendments are as follows:
Changes to MD&A
- Companies are generally able to exclude a discussion of the earliest of three years in the MD&A if they have already included the discussion in a prior filing. If the third-year information is excluded, companies must indicate where in such prior filings the omitted discussion may be found.
Changes to Exhibit Filings and Confidential Treatment
- Under Item 601(a)(5) of Regulation S-K, companies are no longer required to file schedules and exhibits to their material agreements if such schedules and exhibits do not contain material information.
- Under Items 601(b)(2) and (b)(10) of Regulation S-K, companies are able to omit confidential information in material contracts and certain other exhibits without submitting a confidential treatment request to the SEC, so long as the information is (1) not material and (2) would likely cause competitive harm to the company if publicly disclosed.
- Under Item 601(b)(4) of Regulation S-K, companies must provide a detailed description of any securities registered under Section 12 of the Securities Exchange Act of 1934. This disclosure was previously only required for registration statements, but is now a required exhibit filing on a Form 10-K.
Data Tagging and Additional Hyperlinking Requirements
- The amendments seek to further incorporate technology to improve access to information for investors by requiring data tagging for items on the cover page of certain filings and using hyperlinks for information that is incorporated by reference and available on EDGAR. In essence, the new rules on hyperlinking build and expand on the SEC’s recent rules in this area related to the hyperlinking of exhibits, and will now generally require companies to hyperlink all of the information that is incorporated by reference if that information is available on EDGAR (e.g., the incorporation by reference sections in Form S-3).
The full text of the SEC’s adopting release can be found here.
5. Shareholder Proposal Developments
2019 saw a flurry of activity in the area of shareholder proposals governed by Rule 14a-8. First, as previously mentioned in this article, the staff issued guidance announcing a policy of issuing informal oral responses to 14a-8 no-action requests. The stated purpose of this new policy is to operate more efficiently, and the staff will now respond to no-action requests orally rather than in writing, unless responding with a formal, written letter would provide value, such as more broadly applicable guidance regarding compliance with Rule 14a-8. The uncertainties faced by companies during the government shutdown may have been a contributing factor to the SEC’s decision to loosen the Rule 14a-8 process to allow for more flexibility in responding to companies.
Second, in November 2019, the SEC voted to propose amendments to Rule 14a-8, which, if adopted, would revise the eligibility requirements for shareholders to submit proposals to be included in a company’s proxy materials, the one-proposal limit, and resubmission thresholds. The proposed changes are summarized below:
- Proposed Shareholder Eligibility Requirements
- Eliminate the current threshold for shareholders to submit proposals, which requires a shareholder to hold at least $2,000 or 1% of a company’s securities for at least one year, and replace the threshold with the following three alternatives:
- Continuous ownership of at least $2,000 of the company’s securities for at least three years.
- Continuous ownership of at least $15,000 of the company’s securities for at least two years.
- Continuous ownership of at least $25,000 of the company’s securities for at least one year.
- Proposed Changes to One-Proposal Limit
- Apply the one-proposal limit to “each person” rather than “each shareholder” who submits a proposal.
- The proposed change would prohibit a shareholder from submitting one proposal in his or her name while serving as a representative to submit a separate proposal on another shareholder’s behalf.
- Proposed Changes to Resubmission Thresholds
- Currently, a shareholder may not resubmit proposals at subsequent meetings unless the proposal received the support of at least 3%, 6% or 10% for matters voted on once, twice or three or more times, respectively. The proposed thresholds for resubmission would be 5%, 15% and 25%, respectively.
6. Scrutiny of Non-GAAP Measures Continues
In 2019, the SEC continued its focus of scrutinizing the use of non-GAAP financial disclosures. For example, around the beginning of the year, the SEC brought an enforcement action against ADT Inc. for its use of non-GAAP financial measures in two earnings releases. Specifically, ADT presented EBITDA in a headline to its full year financial results headline for 2017, and adjusted EBITDA, adjusted net income and adjusted net income per share in the highlights section of its 2018 first quarter earnings release without preceding such disclosure with the most directly comparable GAAP financial measures. ADT agreed to pay a civil penalty of $100,000 to settle the enforcement action.
The ADT enforcement action signaled a departure from the SEC’s recent past practice of generally using comment letters to address technical rule violations, and demonstrated the SEC’s willingness to utilize enforcement actions, when appropriate, to address noncompliant disclosures of non-GAAP financial measures. Stay tuned for further developments in this area, as we have been hearing that plaintiff’s lawsuits are now being filed against issuers alleging non-GAAP presentation violations.
7. Continued Focus on ESG Matters
Companies are increasingly disclosing and adopting environmental, social and governance (ESG) policies in response to pressure from regulators and activist investors. Moreover, entire funds have been created that invest in companies who have high ESG standards.
ISS data indicates that in 2017 and 2018, ESG-centric shareholder proposals accounted for the majority of shareholder-submitted proposals. ISS and Glass Lewis each have policies to ensure that companies are properly managing their ESG risks and may issue negative recommendations for a company’s failure to manage or mitigate environmental or social risks. Given the growing importance of ESG, many companies are adding ESG-centric risk factors to their periodic reports, including regarding the effects of climate change, human capital management, and other working and safety conditions. Companies should consider how ESG applies to their specific industry and operations, and boards must consider how they will properly manage their respective company’s ESG risks moving forward. Moreover, ESG matters continue to be an area of focus by the SEC, and Chairman Jay Clayton in January 2020 issued a statement that encouraged market participants to continue to engage with the SEC in this area.
Jay H. Knight is a member at Bass, Berry & Sims, where he focuses his practice on securities offerings, mergers and acquisitions, real estate capital markets, structured finance, and the general representation of public companies and underwriters. Prior to joining Bass, Berry & Sims in 2012, Jay served in several positions in the Division of Corporation Finance at the SEC over a period of approximately five years, most recently serving as special counsel. He is the co-editor of the firm’s Securities Law Exchange blog featuring commentary and practical insight on SEC updates. He can be reached at firstname.lastname@example.org.
Taylor K. Wirth and Chris Johnson are associates at Bass, Berry & Sims where they counsel clients on corporate and securities issues including mergers and acquisitions, capital markets transactions, and securities regulations matters and filings. They can be reached at email@example.com and firstname.lastname@example.org.