September 02, 2020

MONTH-IN-BRIEF: Securities Law

Alan J. Wilson, Rani Doyle

Securities Regulation

SEC Amends Regulation S-K Disclosure Requirements

By Thomas White, WilmerHale, Retired Partner

On August 26, the Securities and Exchange Commission (“SEC”) adopted amendments to certain disclosures prescribed by the SEC’s Regulation S-K.  The amendments are designed to “modernize” required disclosures regarding description of business, legal proceedings and risk factors.  SEC Chairman Jay Clayton explained, “Building on our time-tested, principles-based disclosure framework, the rules we adopt today are rooted in materiality and seek to elicit information that will allow today's investors to make more informed investment decisions.”

The major changes to the disclosure requirements include:

  • Description of Business—General Development of Business (Item 101(a)): This item will be more principles-based, requiring disclosure of information material to an understanding of the general development of the business.  The current requirement that the discussion cover the prior five years is eliminated.   Subsequent filings will need to update only the most recent full discussion.
  • Description of Business—Narrative Description of Business (Item 101(c)): This item also will be more principles-based.  It will provide a nonexclusive list of disclosure topic examples (drawn in part from topics currently contained in Item 101(c)).  The item adds “human capital resources” as a discussion topic to be included if material.  It also modifies the regulatory compliance disclosure topic to cover all material government regulations, not just environmental laws.  The item immediately below noting these amendments addresses related developments that may continue to impact disclosure on these two topics.
  • Legal Proceedings (Item 103): The revised item will expressly state that required disclosure may be linked or cross-referenced to legal proceedings disclosures located elsewhere in the document.  The quantitative thresholds for disclosure of environmental proceedings are changed.
  • Risk Factors (Item 105): Registrants will be required to include a two-page summary of risk factors where the full discussion of risk factors exceeds 15 pages.  The standard for what risk factors should be disclosed is changed from “most significant” risks to “material” risks.  Registrants will be required to organize their risk factors under appropriate headings and subheadings.

Environmental and Human Capital Disclosures:  Regulation S-K Amendments and Private Market Initiatives

By Rani Doyle, EY*

Regulation S-K Item 101(c)(2) calls for principles and materiality-based disclosures about two ESG issues – the environment and human capital.  As noted above, the amendments to Item 101(c) expand the requirement that companies disclose the material effects that compliance with environmental laws may have on their capital expenditures, earnings and competitive position to also require disclosure of the material effects of compliance with government regulations generally.  The SEC did not expand the current requirements for environmental disclosures, even though it is aware that issues of environmental and climate-related securities law disclosures are receiving more attention from investors, other market participants, non-market participants and regulators.  On this point, in January 2020, SEC Chair Clayton expressed reasons for his personal view that the SEC was not currently well-positioned to craft or review environmental and climate-related matters.  Yet private market initiatives, driven by investors like BlackRock and companies in the World Business Council for Sustainable Development, that are calling for public companies to disclose such matters continue to gain support, influence and traction. Companies therefore will need to continue to engage with investors and other key stakeholders to see how to meet their needs for information on environmental and climate-related matters.

Similarly, in adopting new human capital disclosure requirements, the SEC did not issue prescriptive disclosure requirements relating to human capital composition, human capital management objectives, policies and practices or human capital resources, measures or metrics. The SEC also did not, as some requested, define the term “human capital.”  Noting that several commenters, including investors, argued that prescriptive disclosure requirements were needed to help investors better assess the value of human capital, the SEC explained that its principles-based approach would allow registrants to provide human capital disclosures in accordance with any current or future standard or framework.  Such frameworks are being or have been developed by the Sustainability Accounting Standards Board, the Embankment Project for Inclusive Capital, the World Economic Forum and others.  Investors, such as BlackRock, and other corporate stakeholders are increasing demands that public companies disclose more human capital information and a growing number of studies show that more public companies are seeking to meet these demands.  Companies therefore will need to continue to engage with investors and other key stakeholders to see how to meet their needs for information on human capital matters.     

SEC Amends Accredited Investor Definition

By Alan Wilson, WilmerHale 

On August 26, the SEC adopted amendments to the definition of “accredited investor,” which is a principal test for determining the eligibility of participants in private capital markets transactions.  The amendments are, as SEC Chairman Jay Clayton noted, “the product of years of effort by the Commission and its staff to consider and analyze approaches to revising the accredited investor definition.”  A greater number of individual and entity investors will for the first time be able to participate in private capital markets.  Specifically, under Rule 501(a) under the Securities Act of 1933, “accredited investors” will now include the following:

  • Natural persons with certain professional certifications, designations or credentials, designated by the SEC. Holders in good standing of the Series 7, Series 65, and Series 82 licenses were designated by the SEC as qualifying natural persons in conjunction with the amendments. 
  • In the context of investments in a private fund, “knowledgeable employees” of such fund.
  • Additional categories of entities, including limited liability companies with $5 million in assets, SEC-and state-registered investment advisers, exempt reporting advisers, rural business investment companies, entities that own qualifying “investments” in excess of $5 million and that were not formed for purposes of investing in the offered securities (e.g., Indian tribes, governmental bodies, funds, and entities organized under laws of foreign countries), and “family offices” with at least $5 million under management and their “family clients.”

The amendments also permit “spousal equivalents” to pool their finances for satisfying the accredited investor test.  Notably, the amendments leave unchanged the thresholds under the long-standing income and net worth tests.

President’s Working Group on Financial Markets Releases Report on Protecting U.S. Investors from Significant Risks from Chinese Companies

By Ryan Castillo & Gonzalo Go, Mayer Brown

On August 6, 2020, the President’s Working Group on Financial Markets (“Working Group”) released its Report on Protecting United States Investors from Significant Risks from Chinese Companies (“Report”) (see the Treasury Department’s press release here).  The Working Group is chaired by the Secretary of the Treasury, and includes the Chairman of the Board of Governors of the Federal Reserve System, the Chairman of the SEC and the Chairman of the Commodity Futures Trading Commission.  In preparing the Report, the Working Group also consulted the Federal Reserve Bank of New York, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation.

The Report recommended:

  • enhancing listing standards of U.S. securities exchanges by requiring, as a condition to initial and continued exchange listing, Public Company Accounting Oversight Board’s (“PCAOB”) access to work papers of the principal audit firm of the listed company or, if companies are unable to do so due to governmental restrictions, the company may provide a co-audit from an audit firm with comparable resources and experience where the PCAOB determines it has sufficient access to audit work papers and practices to conduct an appropriate inspection of the co-audit firm;
  • enhancing issuer disclosures on the risks of investing in certain jurisdictions (including China) that do not cooperate with U.S. regulators or that do not currently provide the PCAOB with the ability to inspect public accounting firms or sufficient access to conduct inspections and investigations of audits of public companies (“Non-Cooperating Jurisdictions”);
  • reviewing the risk disclosures of registered funds that have exposures to issuers in Non-Cooperating Jurisdictions and issuing interpretative guidance to enhance these disclosures;
  • encouraging or requiring registered funds to conduct greater due diligence of indexes and their index providers before selecting any index to implement a particular investment strategy or objective; and
  • issuing guidance to investment advisers on their fiduciary obligations when considering investments in Non-Cooperating Jurisdictions.

Delaware Limits Stockholders’ Ability to Pursue Books and Records Demands in Other States

By Lisa R. Stark, K&L Gates LLP

In a recent action, JUUL Labs, Inc. v. Grove, the Delaware Court of Chancery held that a stockholder of a Delaware corporation could not seek to inspect the books and records of such corporation under Section 1601 of the California Corporations Code.  Section 1601 purports to grant inspection rights to any stockholder in a corporation with its principal executive office in California, regardless of the corporation’s state of incorporation.  Delaware has its own inspection statute, Section 220 of the General Corporation Law of the State of Delaware (Section 220), and the Court held that the stockholder must pursue its books and records under Section 220.  The Court reasoned that Delaware law governs the internal affairs of a Delaware corporation and the scope of a stockholder’s inspection rights under Section 220 is a matter of internal affairs.  As articulated by the Delaware Supreme Court in VantagePoint Venture P’rs 1996 v. Examen, Inc., “the internal affairs doctrine applies to those matters that pertain to the relationships among or between the corporation and its officers, directors, and shareholders.” According to the Court of Chancery, through its Section 220 jurisprudence, Delaware seeks to maintain a balance between the interests of stockholders to obtain information and the right of the corporation to deny unwarranted and burdensome requests.  The Court’s decision means that stockholders of Delaware corporations cannot strategically seek inspection under other states’ laws that provide broader inspection rights than those afforded under Delaware law.

SEC Approves NYSE’s Direct Listings Proposal

By Alan Wilson, WilmerHale 

On August 26, the SEC approved the New York Stock Exchange’s (“NYSE”) proposal permitting private companies to issue new shares when conducting a direct listing, rather than conducting a traditional IPO.  Prior to the rule change, direct listings were limited to secondary sales by existing shareholders.  Under the amended rule, companies undertaking a direct listing need to either (a) sell $100 million of shares in the NYSE’s opening auction for the shares or (b) if a lesser amount is to be sold, have at least $250 million of the company’s shares publicly held.  These amendments, provided they take effect, will provide another potential pathway for private companies to consider when planning to go public.  On August 31, the SEC notified NYSE that approval of the proposal had been stayed until further notice in light of the SEC’s receipt of a notice of intention to petition for review of the delegated action.

PCAOB Shares Insights on Its Conversations With Audit Committee Chairs

By Alan Wilson, WilmerHale

On July 31, the PCAOB shared additional insights regarding its latest conversations with audit committee chairs – Conversations with Audit Committee Chairs: COVID-19 and the Audit (the “Summary”).  The Summary supplements the highlights shared regarding conversations that the PCAOB held in 2019 with nearly 400 audit committee chairs of U.S. issuers whose audits were inspected by the PCAOB. 

Predictably, the PCAOB’s recent discussions involved questions about the effects of COVID-19 on financial reporting and auditing.  Consistent with broader market trends, the level and nature of the impact of COVID-19 varies across different industries and issuers.  The Summary offered some questions that audit committees may consider discussing with their auditors and highlighted some common COVID-19 themes.  A majority of audit committee chairs that recently met with the PCAOB cited COVID-19 as a basis for more frequent communication between auditors and audit committees.  Audit committee chairs also frequently discussed their handling of risks regarding remote work arrangements of employees and outside auditors, and audit committee chairs described the rapid shift to remote work arrangements as “effective.”  

*Material included in this Month-In-Brief publication is for general informational purposes only and does not represent the advice of Ernst & Young LLP or any of its professionals as to any client or particular set of facts; nor does it represent any undertaking to keep recipients advised of all legal developments. Prior results do not guarantee a similar outcome.

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.