June 01, 2020

MONTH-IN-BRIEF: Securities Law

Alan J. Wilson, Rani Doyle

Securities Regulation

Developments Relating to Investments in Emerging Markets

By Thomas W. White, Retired Partner, WilmerHale

Issues related to investments in securities of companies based in or with significant operations in emerging markets continue to be a focus of the Securities Exchange Commission (“SEC”) as well as Congress.  Although they address emerging markets generally, these actions appear to specifically target China, the largest emerging market and the world’s second largest economy.

In April, SEC Chairman Jay Clayton, PCAOB Chairman William Duhnke and several members of the SEC Staff issued a public statement about emerging market investments.  Following up on this statement, Chairman Clayton announced on May 4 that the SEC staff will hold a roundtable on the risks of investing in emerging markets, including China.  The roundtable will be held by remote means on July 9. 

In announcing the roundtable, Chairman Clayton noted that “significant barriers to effective inspections and regulatory oversight continue to exist in many emerging markets, including China.”  The purpose of the roundtable will be “to hear the views of investors, other market participants, regulators, and industry experts on how we can continue to raise investor awareness of these risks and explore potential additional steps that can be taken to mitigate them.”

Meanwhile, on May 20, the Senate passed a bill aimed at the PCAOB’s inability to inspect accounting firms in China.  The bill would require the SEC to prohibit trading of any company that is audited by a foreign accounting firm that the Board has been unable to fully inspect or investigate for three consecutive years.

SEC Adopts Disclosure Relief for Business Acquisitions and Dispositions

By Alan J. Wilson, WilmerHale

In a three-to-one vote (Commissioner Allison Herren Lee dissenting), the SEC voted to amend its financial disclosure requirements regarding acquired and disposed businesses in Regulation S-X Rules 3-05, 3-14, 8-04, 8-05, 8-06, and Article 11, as well as in other related rules and forms.  This is the first comprehensive update to these rules since they were adopted over 30 years ago.  The amendments are designed to eliminate costs and burdens associated with providing such financial statements, while enhancing the quality of information provided to investors.

Among the more significant changes, the amendments revise the three significance tests that are used to determine the number of years of financial statements that are required.  The investment test now incorporates an “aggregate worldwide market value” concept, and the income test now includes a revenue component.  No substantial changes were made to the asset test.  Pro forma financial information may also be used in an expanded number of circumstances to determine significance.  

Additionally, the amendments limit the number of years of acquired business financial statements that are required.  No more than the two (instead of three) years of audited annual financial statements are required under the amendments, regardless of significance.  Moreover, the requirement to provide historical financial statements for acquisitions of individually insignificant businesses has been eliminated in certain circumstances, with the addition of an expanded pro forma requirement.

The amendments include a number of other conforming, clarifying and revisionary changes, many of which are highlighted in the SEC’s press release.

The amendments become effective on January 1, 2021, and voluntary early compliance is permitted.

SEC Announces Temporary Rules for Certain Regulation Crowdfunding Offerings

By Melissa Sanders, Fox Rothschild LLP

In response to the economic impact of COVID-19, the SEC recently announced temporary rules that will allow small businesses to undertake Regulation Crowdfunding offerings on an expedited timeframe under certain conditions.  In order to utilize the temporary rules, companies must meet both the existing eligibility requirements for Regulation Crowdfunding offerings and additional eligibility requirements.  Notably, companies that have been in operation or were formed less than 6 months before the offering commenced are not eligible to utilize the temporary rules.  The temporary rules provide a number of temporary changes that may be beneficial to small businesses, including allowing shorter timeframes for how quickly a company may accept commitments and allowing closings on an expedited timeframe.  Companies that are raising more than $107,000 but no more than $250,000 during a 12-month period also have less stringent financial statement requirements.  Further, investors have a potentially shorter timeframe to cancel investment commitments for qualifying offerings. 

Update on SEC Division of Enforcement Activities Amidst COVID-19

By Alan J. Wilson, WilmerHale

In a May 12 keynote address, SEC Co-Director of Enforcement Steven Peikin provided an update on how the SEC Division of Enforcement was responding during the ongoing COVID-19 pandemic.  While noting that COVID-19 matters remain a “top priority,” the Division’s other priorities remain in place.

On the COVID-19 front, Mr. Peikin outlined the responsibilities of the Division’s Coronavirus Steering Committee, which is addressing a number of enforcement issues, including microcap fraud, insider trading, accounting or other disclosure improprieties, and market-moving announcements by issuers in industries particularly impacted by the COVID-19 pandemic. Notably, the Coronavirus Steering Committee has “developed a systematic process to review public filings from issuers in highly-impacted industries, with a focus on identifying disclosures that appear to be significantly out of step with others in the same industry.”  

In terms of ongoing non-COVID-19 work, the Division recognizes the challenges presented by the pandemic.  Enforcement staff have “been directed to work with counsel and others to reach reasonable accommodations wherever possible.”  Of course, Mr. Peikin affirmed “we cannot permit the crisis to be used as a cover for gamesmanship.”  Predictably, the Division is “keenly focused on matters where we face expiring statutes of limitations that may result in the Commission losing claims or potential remedies, such as the ability to seek penalties or disgorgement.”

Looking forward, much remains uncertain, though Mr. Peikin offered his prediction that “there will be more trading suspensions related to COVID-19 and more fraud cases related to potential COVID-19 investment scams.”

SEC Brings COVID-19-Related Securities Fraud Claims

By Melissa Sanders, Fox Rothschild LLP and Alan J. Wilson, WilmerHale

In the early stages of the coronavirus pandemic, the SEC indicated that it would closely monitor and provide guidance as necessary with regards to the potential effects of the pandemic.

In the wake of its targeted oversight, the SEC has begun bringing COVID-19-related securities fraud claims against issuers, filing at least three complaints in federal court against microcap and penny stock issuers alleging securities fraud violations under Section 10(b) of the Securities Exchange Act.

In a May 14 press release, the SEC announced charges in two cases involving claims against two companies and one company’s CEO for misleading claims in press releases issued in late March and early April 2020 about products that promised to combat COVID-19.  SEC Co-Director of Enforcement Steven Peikin described the actions as “demonstrat[ing] the SEC’s vigilance over public companies that make materially misleading claims in press releases.”  Those cases (which can be found here and here) provide instructive context for any company issuing public disclosures related to COVID-19 and an initial view of the SEC’s COVID-19-related securities fraud enforcement activity. 

California District Court Rejects Standing Arguments Arising from Slack Direct Listing

By Lisa R. Stark, K&L Gates LLP

In an order issued on April 21, 2020, the District Court for the Central District of California granted in part and denied in part defendants’ motion to dismiss securities class action claims brought under Sections 11, 12(a)(2), and 15 of the Securities Act of 1933 (the “Act”) by an investor who acquired Slack common stock on the first day of its direct, public listing.  Slack, a cloud-based computing company, listed its shares on the New York Stock Exchange through a direct listing in June 2019.  Unlike a traditional IPO, in which a company will offer a certain amount of new and/or existing shares to the public to help raise additional capital, in a direct listing, no new shares are issued.  Rather, insiders and early investors of the company are able to sell their shares to the public.

In the action, the plaintiff alleged that the registration statement and prospectus for Slack’s direct listing contained misstatements and omissions regarding Slack’s operations, prospects and strategy for future growth.  In their motion to dismiss plaintiff’s action, defendants argued, among other things, that due to the unique nature of a direct listing, the plaintiff did not possess standing to bring a claim under Section 11 of the Act because of case law holding that a plaintiff’s purchased shares must be traced to the defective registration statement and plaintiff could not establish damages.  Defendants also argued that the plaintiff failed to allege material misstatements or omissions.  The District Court rejected all of defendants’ threshold arguments relating to the plaintiff’s standing to bring claims under Section 11 of the Act, but found plaintiffs had failed to adequately plead some alleged misstatements.  Importantly, the District Court found that in the context of direct listing in which shares registered under the Act become publicly tradeable on the same day that unregistered shares become tradeable, a plaintiff does not lack standing to sue under Section 11 even though the plaintiff cannot show that her shares were registered under a misleading registration statement.

Alan J. Wilson

Senior Associate, WilmerHale

Alan J. Wilson is a Senior Associate in WilmerHale’s Transactional Department who routinely counsels public company clients on a variety of matters concerning corporate governance and compliance with federal securities laws, particularly with regards to the intersection between law and accounting.  He also advises public and private companies from a range of industries on navigating transactional and strategic matters, including securities offerings, mergers and acquisitions, joint ventures, and activist shareholder engagement.

Rani Doyle

Executive Director, EY Center for Board Matters

Rani is an executive director in the EY Center for Board Matters.  She has extensive experience working with executive management and boards at public and private companies on a wide range of corporate governance and business matters.