January 2023 in Brief: Securities Law

Securities Regulation

Congress Tightens Holding Foreign Companies Accountable Act

By Thomas W. White, Retired Partner, WilmerHale

The omnibus appropriations act passed by Congress and signed by President Biden at the end of 2022 contains an amendment to the Holding Foreign Companies Accountable Act (HFCAA). The HFCAA, which was enacted in late 2020, threatened to impose U.S. trading prohibitions on the securities of Chinese issuers whose auditors could not be fully inspected or investigated by the Public Company Accounting Oversight Board for three consecutive years as a result of restrictions imposed by Chinese regulatory authorities. The amendment changes section 104(i)(3)(A) of the Sarbanes-Oxley Act to reduce from three to two the number of consecutive non-inspection years that will trigger a trading prohibition of a covered issuer.

This amendment has no immediate effect, in light of the PCAOB’s determinations that in 2022 it was able to conduct inspections and investigations completely of registered public accounting firms headquartered in mainland China and Hong Kong and that the Chinese authorities had not taken a position to restrict PCAOB access or otherwise impair its ability to conduct its planned inspections and investigations. (See prior note on the PCAOB determinations.) However, the shortened time frame for triggering a trading prohibition should maintain pressure on the Chinese regulatory authorities to continue to permit full PCAOB inspections and investigations in 2023 and subsequent years.

Nasdaq Receives Approval for Rule Change Providing More Flexibility for Direct Listings with Capital Raise

By Brian Hirshberg, Mayer Brown

On December 2, 2022, Nasdaq received approval from the Securities and Exchange Commission (SEC) to modify certain pricing limitations for companies undertaking a direct listing involving sales of the company shares in the opening auction on the first day of trading on Nasdaq.

Prior to the rule change, in order for a company to sell shares concurrent with a direct listing, the actual price must have been set at or above the lowest price and at or below the highest price of the price range established by the company in its effective registration statement. This provided less flexibility than a company has in a traditional IPO.

The rule change modifies this pricing limitation in order to provide that Nasdaq would release the security for trading if (i) the actual price is set at or above the price that is 20% below the lowest price of the disclosed price range or (ii) the actual price is set at or below the price that is 80% above the highest price of the disclosed price range. In order to rely on the extended pricing flexibility, the company is required to publicly disclose and certify to Nasdaq that the company does not expect such price would materially change the company’s previous disclosure in its effective registration statement and that its effective registration statement contains a sensitivity analysis explaining how the company’s plans would change if the actual proceeds from the offering are less than or exceed those which would be generated if the offering were to proceed at a price within the disclosed price range. Nasdaq will calculate the 20% threshold below the disclosed price range and the 80% upside limit based on the high end of the price range in the registration statement at the time of effectiveness.

As part of the rule change, Nasdaq will require that the company listing securities in connection with a direct listing with a capital raise retain an underwriter with respect to the primary sales of shares by the company and identify the underwriter in its effective registration statement. The requirement to include an underwriter likely mitigated the SEC’s concerns relating to traceability and the perceived lack of a “gatekeeper” that often arise in connection with a direct listing with a capital raise.

The SEC’s approval can be found here.

NYSE Receives Approval for Rule Change Providing More Flexibility for Direct Listings with Capital Raise

By Brian Hirshberg, Mayer Brown

On December 15, 2022, the New York Stock Exchange (NYSE) received approval from the SEC to modify certain pricing limitations for companies undertaking a direct listing involving sales of company shares in the opening auction on the first day of trading on the NYSE. The approval and related conditions are consistent with the approval granted by the SEC to Nasdaq on December 2, 2022.

The rule change provides that a direct listing with a primary offering may proceed so long as (i) the actual price is set at or above the price that is 20% below the lowest price within the disclosed price range or (ii) the actual price is set at or below the price that is 80% above the highest price of the disclosed price range. In order to rely on the additional pricing flexibility, the company is required to publicly disclose and certify to the NYSE that the company does not expect that such price would materially change the company’s previous disclosure in its effective registration statement and that its effective registration statement contains a sensitivity analysis explaining how the company’s plans would change if the actual offering proceeds are less than or exceed those that would be raised if the offering were to proceed at a price within the disclosed price range.

As part of the rule change, the NYSE also requires that the company retain an underwriter with respect to the primary sales of shares and identify the underwriter in its effective registration statement. While the requirement to include an underwriter mitigated the SEC’s concerns relating to traceability and the perceived lack of a “gatekeeper” that often arise, the perception of increased securities liability for the identified underwriter will likely increase the costs associated with conducting a direct listing with a capital raise and potentially diminish the likelihood that this alternative to a traditional IPO will be pursued.

A link to the SEC’s approval can be found here.

SEC Proposes Rule to Prohibit Conflicts of Interest in Certain Securitizations

By Jason Hyatt, Latham & Watkins

On January 25, 2023, under mandate from the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”), the SEC proposed a rule to implement Section 27B (“Section 27B”) of the Securities Act of 1933 (the “Securities Act”). The SEC initially proposed this rule in 2011 and has now re-proposed this rule to implement Section 27B while addressing comments received during the 2011 public comment period and seeking additional comments with respect to a number of questions enumerated in the rule proposal.

The purpose of the proposed rule is “intended to prevent the sale of ABS [(asset-backed securities)] that are tainted by material conflicts of interest” and designed to “prohibit[] securitization participants from engaging in certain transactions that could incentivize a securitization participant to structure an ABS in a way that would put the securitization participant’s interests ahead of those of ABS investors.”

Under the proposed rule, a securitization participant would be prohibited—for a period commencing on the date on which a person has reached, or has taken substantial steps to reach, an agreement that such person will become a securitization participant with respect to an ABS and ending on the date that is one year after the date of the first sale of such ABS—from directly or indirectly engaging in any transaction that would involve or result in any material conflict of interest between the securitization participant and an investor in such ABS, subject to certain exceptions. The SEC refers to this type of transaction as a “conflicted transaction.”

A conflicted transaction, as set forth in the proposed rule, is comprised of two main components. One main component is whether a transaction is:

• a short sale of the relevant ABS;
• the purchase of a credit default swap or other credit derivative pursuant to which the securitization participant would be entitled to receive payments upon the occurrence of a specified adverse event with respect to the relevant ABS; or
• the purchase or sale of any financial instrument (other than the relevant ABS) or entry into a transaction through which the securitization participant would benefit from the actual, anticipated or potential:
  • adverse performance of the asset pool supporting or referenced by the relevant ABS;
  • loss of principal, monetary default, or early amortization event on the relevant ABS; or
  • decline in the market value of the relevant ABS.

The second main component is materiality: “whether there is substantial likelihood that a reasonable investor would consider the relevant transaction important to the investor’s investment decision, including a decision whether to retain the ABS.”

An ABS is defined under the proposed rule using the same definition of an ABS under Section 3 of the Securities Act and is also defined to include synthetic ABS and hybrid cash and synthetic ABS.

The proposed rule notes that ABS sold in registered and unregistered offerings would be subject to the proposed rule. Furthermore, disclosure of any potential conflict of interest would not exempt such a transaction from being prohibited under the proposed rule, including in instances where an investor was involved in selecting the underlying assets of the ABS.

A securitization participant is an underwriter, placement agent, initial purchaser or sponsor, or any affiliate or subsidiary of any such entity. The definitions of “underwriter,” “placement agent,” “initial purchaser,” and “sponsor” are all generally defined using existing definitions under the federal securities laws, subject to come exceptions. The SEC has specifically requested comments regarding whether certain affiliates or subsidiaries utilizing information barriers should be excluded as a securitization participant.

The proposed rule carves out certain risk-mitigating hedging activities, liquidity commitments, and bona fide market-making activities from the prohibition. A securitization participant who intends to rely on any of the exceptions would be required to implement programs to ensure compliance with the requirements applicable to the exceptions, including adopting certain written policies and procedures.

Any transaction specifically designed to circumvent the prohibition will be deemed to have violated the rule and thus would be a prohibited transaction.

The vote to issue the proposed rule for comment was unanimous; however, Commissioners Hester Pierce and Mark Uyeda expressed their concerns about whether the proposed rule, as drafted, may be overly broad and whether it correctly strikes the balance between protecting investors from harmful conflicts and ensuring that market participants can engage in transactions that do not cause such harm, and encouraged comments to help refine the rule.

The public comment period will remain open for thirty days following publication of the proposing release in the Federal Register or March 27, 2023, whichever is later.