Whistleblower tips and awards for securities law violations have increased dramatically over the past year, according to the staff of the SEC Enforcement Division’s Office of the Whistleblower. Also during that time, the Whistleblower Office has stepped up its vigilance over retaliation by companies against whistleblowers, imposing penalties against companies more frequently and expanding the scope of what constitutes illegal retaliation. Furthermore, there is so far no reason to think the new Trump Administration will seek to reverse this trend.
Direct retaliation can take many forms, most of which are recognizable by attentive management. Note, however, that certain less obvious behaviors may also be deemed retaliatory. For example, in one case an employee submitted a complaint about the company’s accounting practices through its internal procedures and to the SEC. When the SEC notified the company of its decision to investigate that complaint, the company was able to determine the whistleblower’s identity and revealed it in an internal email related to the investigation. The Fifth Circuit Court of Appeals in Halliburton, Inc. v. Administrative Review Board, United States Department of Labor concluded that illegal retaliation had occurred, stating that the “undesirable consequences” of being revealed to one’s colleagues as having accused them of fraud were “obvious.” (See this Doug’s Note.)
The SEC has also focused recently on indirect forms of illegal retaliation embedded in company policies and agreements. Provisions in such documents may inadvertently violate Rule 21F-17(a) under the Securities Exchange Act, which provides that:
“No person may take any action to impede an individual from communicating directly with the Commission staff about a possible securities law violation, including enforcing, or threatening to enforce, a confidentiality agreement….”
Essentially, language that prohibits an employee from disclosing confidential information without an express carve-out for reports to a government agency or that prohibits the recovery of monetary damages or awards may violate Rule 21F-17(a).
In addition, the SEC continues to expand the scope of its retaliation oversight. Examples include recent enforcement actions for retaliation where the whistleblower only reported internally, rather than to the SEC, and where the SEC elected not to pursue the company’s alleged securities law violation itself.
Penalties for violations are likely to include:
- Hundreds of thousands of dollars of monetary fines,
- Amending the relevant documents, and
- Contacting all affected persons to inform them as to their revised rights.
Action Steps read more…
In 2012, the Jumpstart Our Business Startups (JOBS) Act created a new category of companies known as “emerging growth companies (EGCs).” The JOBS Act also requires that, once every five years, the SEC indexes various EGC thresholds to reflect changes in the Consumer Price Index for All Urban Consumers. Last week, those new thresholds became effective upon their publication in the Federal Register.
The SEC simultaneously revised the cover pages of various Securities Act and Exchange Act forms used by virtually all public companies. Two new check boxes must now appear on the covers of:
- Forms S-1, S-3, S-4, S-8, S-11 and the corresponding foreign private issuer “F” forms, and
- Forms 10-K, 10-Q, 8-K and 10.
The new boxes must indicate:
- Whether the person filing the report is an EGC, and
- If so, whether the company has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 7(a)(2)(B) of the Securities Act.
The takeaways read more…
The conflict minerals saga continues.
In April 2014, the Court of Appeals for the D.C. Circuit in National Association of Manufacturers v. SEC held that the conflict minerals rule’s requirement that companies state that their products have not been found to be “DRC conflict free” violated the First Amendment. Subsequently, the SEC staff released guidance relieving issuers of the obligation to put those labels in their reports. The case was subsequently remanded to the district court for further consideration, and on August 18, 2015, the Court of Appeals reaffirmed its prior decision.
In response to these developments, Acting SEC Chairman Michael S. Piwowar issued a statement in January 2017 declaring that he had “directed the staff to reconsider whether the 2014 guidance on the conflict minerals rule is still appropriate and whether any additional relief is appropriate.” (See this Doug’s Note.)
Last week, the D.C. Circuit Court entered final judgment in the case, which upheld its prior rulings, and remanded it to the SEC for appropriate action.
This past Friday, the SEC issued a statement noting that the D.C. Circuit’s remand to the SEC has “presented significant issues for the Commission to address” and that several comments were received in response to Acting Chairman Piwowar’s January request. Therefore, “in light of the uncertainty regarding how the Commission will resolve those issues,” the Division of Corporation Finance will not recommend enforcement action if companies “only file disclosure under the provisions of paragraphs (a) and (b) of Item 1.01 of Form SD,” which conspicuously excludes the need to comply with paragraph (c).
What does this mean?
Companies that use conflict minerals that are necessary to the functionality or production of products manufactured (or contracted to be manufactured) still must comply with Item 1.01(a), which requires that they:
- conduct a good faith reasonable country of origin inquiry (RCOI), and
- file a Form SD with the SEC not later than May 31st.
Companies that conclude that their conflict minerals do not come from a covered country (or come from recycled or scrap materials) still must comply with the Item 1.01(b) requirement to disclose that conclusion on Form SD and on its website.
Paragraph (c) of Item 1.01, on the other hand, relates to the requirement to conduct due diligence on the source and chain of custody of conflict minerals and the need for a related independent private sector audit. If a company’s RCOI gives it reason to believe that its conflict minerals may have originated in a covered country (and are not from recycled or scrap materials), then it must conduct due diligence on the chain of custody and describe those efforts in a report attached to Form SD.
By eliminating the need to comply with Item 1.01(c), the SEC is saying that companies with conflict minerals do not have to:
- trace the smelters or refiners used by suppliers,
- provide the related chain of custody disclosures, or
- have such disclosures audited by a third party.
What should you do? read more…
Not long ago, I wrote about the growth of sustainability reporting among public companies. (See this Doug’s Note.) It is now widely believed that effective sustainability reporting, also called “corporate social responsibility” reporting, facilitates a perception among investors, employees, customers, suppliers and other stakeholders that a company is committed to operational, compliance and governance values that enhance its reputation and increase shareholder value. This increase in quantity and quality of reporting has been encouraged by various non-profit organizations formed to flesh out and standardize disclosures.
It is important to remember, however, that the evolution of CSR reporting from fringe puff pieces to mainstream disclosure means that companies must also be alert to possible liability for misstatements or other inaccuracies. In fact, the last few years have seen a rise in the number of law suits claiming violations of securities or consumer protection laws due to CSR statements.
Basically, companies must analyze all CSR communications, whether in an SEC report, on their websites, in a special report, or otherwise, in accordance with their established disclosure controls and procedures. Resist the temptation to treat CSR disclosures as nothing more than soft marketing or public relations materials unrelated to the company’s “real” disclosures. Be sure that they are thoroughly reviewed prior to dissemination and are subject to the same layers of scrutiny, which may include the disclosure committee, chief risk officer, chief compliance officer, board risk oversight committee and other persons performing similar duties.
Here are some tips to keep in mind: read more…
Last September, the SEC proposed rules that would shorten the standard settlement period for securities transactions from three business days (T+3) to two business days (T+2). As predicted, the rules have now been finalized in short order and without controversy.
This is the latest, though probably not the last, step in the evolution of trade settlements. Trades actually settled on a T+5 cycle until 1993, when the adoption of Rule 15c6-1 mandated T+3 in an effort to reduce credit risk (the risk that the credit quality of one party to the transaction will deteriorate) and market risk (risk that the value of traded securities will change between trade execution and settlement).
Since then, the settlement cycle has been stuck on three business days despite dramatic advances in technology, multiple industry-driven recommendations to shorten the cycle and the adoption of a shorter settlement cycle in almost every other significant non-U.S. trading market. For example, T+2 (or less) already exists in most European markets, the U.K, Israel, Saudi Arabia and China, while others markets, like Australia, New Zealand, Japan and Canada, are expected to adopt T+2 in the near future.
The SEC actually considered T+1 and T+0 settlement cycles in its deliberations, but rejected them as requiring more extensive changes to technology and post-trade processes that would delay the benefits of moving to a T+2 cycle. Nevertheless, it would be reasonable to expect movement toward shorter trade settlements in the U.S. in the future.
The amended rule
Exchange Act Rule 15c6-1(a) has been amended to prohibit a broker-dealer from entering into a contract for the purchase or sale of a security (subject to certain exceptions) that provides for payment of funds and delivery of securities later than two business days after the trade date (known as “T”), unless otherwise expressly agreed to by the parties at the time of the transaction.
The T+2 requirement generally will apply to the same securities transactions currently covered by the T+3 settlement period. The T+2 will not apply to certain specified categories of securities, including, for example, exempted, government and municipal securities.
The shift from T+3 to T+2 will be effective on September 5, 2017, which the SEC noted was sufficient time to plan for, implement and test changes to the various systems, policies and procedures necessary for an orderly transition. One commenter on the proposed rules also helpfully noted that September 5th effectiveness has the advantage of letting everyone work through the Labor Day weekend to deal with last-minute bugs. read more…
The proxy rules require that public companies submit a nonbinding proposal to their shareholders every six years regarding how often they should hold say-on-pay votes, known as “say-on-frequency.” Most companies held their first say-on-frequency vote in 2011 and will be including another vote in their 2017 proxy statements. (“Smaller reporting companies” were not required to hold their first say-on-frequency vote until 2013, meaning that they won’t have to do it again until 2019, and there are special rules for “emerging growth companies.”) Shareholders may choose to vote on executive compensation every year, every two years or every three years, or they may choose to abstain.
Though the vote is nonbinding, the charter of most compensation committees requires them to consider the outcome of the shareholder vote when deciding how best to proceed. Indeed, companies must amend their initial post-meeting Item 5.07 Form 8-K (which reports voting results) no later than 150 calendar days after the end of the shareholder meeting at which the vote was taken in order to “disclose the company’s decision in light of such vote as to how frequently the company will include a shareholder vote on the compensation of executives in its proxy materials….”
Back in 2011 when these rules were still new, more than a few companies failed to make the necessary Form 8-K disclosures. While this may not sound like a big deal, in fact it is. A missed Form 8-K filing can render a company ineligible to use Form S-3 during the 12 months following the date that the Form 8-K should have been filed. For companies planning to raise capital in the public markets, that could be a major problem.
A practical way to be sure this filing doesn’t fall through the cracks is to include the required disclosure in the initial post-meeting Item 5.07 Form 8-K (filed within four business days after the meeting), rather than waiting until after consideration at a subsequent compensation committee meeting. Because the overwhelming majority of companies will be recommending annual consideration of executive compensation and because most institutional shareholders and proxy advisory firms prefer annual frequency, it is safe to assume that shareholders will strongly support the board’s recommendation. read more…
Several years ago, voluntary sustainability reporting in proxy statements, annual reports to shareholders, websites and special sustainability reports to various stakeholders began to take hold, even as the SEC continued to resist calls for mandatory sustainability reporting and even in the general absence of guidance regarding what to disclose and how. (See this Doug’s Note.) Around the same time, several non-profit organizations formed for the purpose of bringing order to these disclosures. Among them was the Sustainability Accounting Standards Board (SASB), which enjoys a board of directors made up of a particularly distinguished list of executives, investors, professionals and academics, and chaired by Michael Bloomberg.
Since then, sustainability reporting has continued to increase in quantity and quality, and SASB has maintained its position as a well-known, respected standard-setter. In keeping with the maturation of these disclosures, SASB recently published an interesting and detailed “staff bulletin” describing its Approach to Materiality for the Purpose of Standards Development.
The bulletin explains the SASB’s efforts to align its disclosure standards with existing federal securities law concepts of materiality (as set forth, for example, in TSC Industries v. Northway, Basic v. Levinson and the SEC’s MD&A rules and guidance). It caught my eye because the alignment of mandatory SEC reporting and voluntary sustainability reporting is essential not only to effective disclosure controls and procedures, but also to consistent and meaningful stakeholder communications. read more…
Last August, the SEC proposed rule amendments that would require companies to include a hyperlink to each exhibit listed in the exhibit index of a registration statement, periodic report or current report. At the time, I wrote that “these amendments are unlikely to be controversial, and you should expect them to be final in short order.” (See this Doug’s Note.) And while that observation admittedly did not require special powers of clairvoyance, it nevertheless turned out to be true.
This week the SEC issued final rules designed to make it easier to access and retrieve exhibits to company filings through the use of hyperlinks. This will avoid the cumbersome process of first determining the filing in which an incorporated-by-reference exhibit physically appears and then searching through the company’s EDGAR filings to locate the relevant document.
Item 601 of Regulation S-K requires companies to include an exhibit index that lists each exhibit included with the filing. Item 601 has now been amended to require that each exhibit to Forms S-1, S-3, S-4 and S-8 (among others) under the Securities Act and Forms 10, 10-K, 10-Q and 8-K (among others) under the Exchange Act include an active hyperlink to the particular document. This applies whether or not the exhibit is incorporated by reference.
For periodic reports, an active hyperlink must be included for each exhibit listed when the report is filed. For registration statements, a hyperlink must be included in the initial filing and in each amendment (pre-effective and post-effective) thereafter. (This is a change from the proposed rule, which limited hyperlinks to the registration statement that becomes effective.) read more…
Earlier this month, the staff of NYSE Regulation issued its annual guidance memorandum, which highlights recent NYSE developments and other points of emphasis for the coming year. This year’s guidance includes nearly twenty items that the staff deemed noteworthy. Borrowing the guidance memorandum’s main headings, I have summarized below those items that seem particularly worthy of attention.
What’s New for 2017?
- In October 2016, NYSE began a multi-stage rollout of what it calls “Listing Manager,” which “allows listed companies to manage their entire lifecycle” via a login section at www.nyse.com. The various compliance modules currently available through egovdirect.com will transition to Listing Manager over time, beginning with cash and stock distribution notifications, which are already functional on Listing Manager.
- As of September 30, 2016, companies are no longer required to report their shares issued and outstanding, which will instead be reported to NYSE by company transfer agents.
- NYSE expects the transition from T+3 to T+2 (see this Doug’s Note) to be effective on September 5, 2017, though the actual date is contingent on various factors.
Important Reminders. read more…
Dating back to their adoption in August 2015, as mandated by Dodd-Frank’s Section 953(b), the pay ratio rules have led a strange existence. For a while, companies generally ignored them because their effective date was so far in the future—for calendar-year companies, disclosures are first required in spring 2018 proxy statements regarding 2017 compensation. Furthermore, it was widely speculated that Dodd-Frank would, in the meantime, be revised to modify or eliminate what was broadly perceived to be a fundamentally flawed effort to contain executive compensation. It could even be argued that the SEC itself dragged its feet on pay ratio rulemaking to allow time for this to occur. (See this Doug’s Note.) Yet, as the effective day eventually rounded into view, highlighted by new guidance from the Division of Corporation Finance regarding some of the rule’s vaguer points, the reality of looming implementation overtook most companies.
But now, the long-awaited cracks in pay ratio’s foundation may be appearing. Last week, Acting SEC Chairman Michael Piwowar issued yet another statement (see this Doug’s Note regarding his earlier conflict minerals statement) directing the SEC staff to take a fresh look at the rule. Chairman Piwowar noted that companies “are now actively engaged in the implementation and testing of systems and controls designed to collect and process the information necessary for compliance.” (One certainly hopes that is the case, given the potentially enormous scope of the task.)
Chairman Piwowar then stated his understanding that some companies “have begun to encounter unanticipated compliance difficulties that may hinder them meeting the reporting deadline.” While it would be quibbling to question whether such compliance difficulties are truly “unanticipated,” it nevertheless seems accurate to say that the process probably won’t go smoothly and that the resulting proxy statement disclosures are likely to be all over the board.
He is, therefore, seeking public comment within the next 45 days on any “unexpected challenges” that companies have experienced and whether relief is needed and has directed the SEC staff to take those comments into consideration. Finally, Chairman Piwowar acknowledged that any further staff action regarding pay ratio will need to be taken as soon as possible to allow companies time to “plan and adjust their implementation processes accordingly.”
What does this mean? read more…