Tuesday, May 11, 2021

Industry groups call for more diversity in advisory firms

By Amy Leisinger, J.D.

A new study by Cerulli Associates and the Investment Adviser Association has found that the investment advisory industry has made steps toward increased diversity but that the pace has been slow. While diversity covers a range of dimensions, the study specifically focuses on industry efforts to expand gender and racial/ethnic diversity among financial advisors. Women and minorities make up small numbers in both management and advisory roles, and more needs to be done, according to the report.

By the numbers. The groups found that gender and racial/ethnicity disparities among independent and hybrid registered investment advisers remain pervasive. Women comprise only 16 percent of advisers, just shy of 4 percent identify as Hispanic, and just over 2 percent identify as black or Asian, respectively. While slightly more than half reported that their firms were working to increase diversity, only 35 percent thought the efforts have been successful.

"Our profession has a long way to go in matters of diversity, equity and inclusion," said IAA President & CEO Karen Barr. "It is imperative that we step up and confront these issues."

"Parity remains an uphill climb for women and Black, Indigenous, and People of Color (BIPOC) financial advisors," said Marina Shtyrkov, senior analyst at Cerulli. With evolution, the advisory industry will be able to better serve clients in a way that accurately reflects diversity in markets, she said.

What needs to change. The study also identifies challenges to encouraging diverse candidates from entering the industry. It suggests means by which to address barriers and outlines firm resources and potential initiatives to increase gender and racial/ethnic diversity. The groups also found that work-life imbalance and limited representation in leadership are significant challenges facing diverse advisers, and that training, scholarships, and partnerships with community organizations will be crucial to turning the tide regarding diversity.

Diversity in management and ownership is lacking, and gender and racial disparities among advisors remain pervasive, according to the study. Advisory firms are increasing efforts to improve diversity, but results are not immediate. If efforts to attract more diverse candidates to the industry are successful, firms will also likely experience an organic shift in culture that results from greater visibility and networking among diverse advisors, they said.

The study found that women and BIPOC advisors consider unstable compensation, pressure to meet revenue or production goals, and lack of familiarity with the profession to be the top factors that discourage diverse advisors from entering the industry.

The groups encourage industry professionals to mentor diverse advisors and engage in community activities to build awareness of the profession.

"Speak up and speak out to advocate for change in the financial advice profession," they urge.

Monday, May 10, 2021

After the Biden Administration’s first 100 days, CFTC leadership remains in holding pattern

By Lene Powell, J.D. and Brad Rosen, J.D.

While the Biden Administration has come flying out of the gate on multiple fronts during its first 100 days—public health, the economy, climate change, and infrastructure among other areas, it has largely ignored the Commodity Futures Trading Commission, the independent agency that regulates the nation’s futures and derivatives markets. Unlike over at the SEC, the administration has not yet nominated nor confirmed a permanent chairperson. Moreover, a number of key staff leadership appointments made under the Trump Administration remain in place, and a Republican commissioner whose term expired in April 2020, continues to sit on the Commission. The authors survey the agency’s leadership as well as the overall current landscape at the CFTC in their article segment titled Commodities & Derivatives: The Biden Administration’s first 100 days at the CFTC— the sound of one hand clapping.

The article also examines a number of pressing issues and controversies that the agency will likely be grappling with through the lens of the individual commissioners, by reviewing their public statements and pronouncements. These hot topics include the oversight of cryptocurrency markets, climate change policies, the implementation of the recently adopted position limit rule, the approval of NFL gaming related futures contracts, as well as the Commission’s policy dealing with family offices. Finally, the authors explore the CFTC’s enforcement priorities, which include the Division of Enforcement’s heightened scrutiny of matters involving the Foreign Corrupt Practices Act, insider trading, and fraud schemes utilizing digital assets.

For a more comprehensive look at what to expect from the new administration, spanning multiple subject areas, click here to read the Special Report, Sprinting to 100-day mark, White House shifts regulatory landscape.

Friday, May 07, 2021

PCAOB shares observations on the use of tech tools in audits

By Amanda Maine, J.D.

Auditing firms continue to use technology-based auditing tools even in the absence of specific auditing standards related to the use of these tools, according to a new Spotlight issued by the PCAOB. The document (which is not intended as staff guidance), titled Data and Technology Research Project Update, May 2021, details observations by the staff from its research and outreach activities as well as the work of its Data and Technology Task Force. PCAOB staff will continue to conduct research and engage in outreach focusing on the use of technology in auditing and financial reporting, including how PCAOB standards affect the use of technology by auditors.

General observations. Reiterating a point made in its Spotlight from May 2020, the PCAOB noted that its auditing standards do not preclude audit firms from using technology-based tools when conducting an audit. However, the PCAOB acknowledged that the standards also do not explicitly encourage the use of these tools. The PCAOB said that it will continue to gather input on the use of technology in conducting audits.

The most recent Spotlight also observed that both large and small audit firms have made use of audit tools. Some audit firms have invested in developing their own tools internally, while others have partnered with software companies to develop customized tools or have purchased "off the shelf" tools. In addition, audit firms have been developing their own tools that are tailored for specific industries, such as healthcare, or for specific components of an audit, such as general ledger, inventory management, or payroll.

Another audit technology use cited by the PCAOB is the use of tools to automate certain aspects of repetitive or less complex audit procedures. These include reconciling account balances to the general ledger, vouching sales transactions to cash receipts, or preparing third-party confirmations.

Risk of material misstatement. Auditing Standard AS 2301 outlines the requirements regarding designing and implementing appropriate audit responses to the risks of material misstatement. The Spotlight described several observations related to the use of technology-based audit tools in the auditor’s overall audit responses. Some firms are using these tools to aid its audit professionals in evaluating unpredictability in the nature and extent of audit procedures, such as identifying transactions outside of the traditional selection criteria. These tools have also been used to analyze transactions that have occurred in new or unexpected ways, which helps thwart management attempts to anticipate the auditor’s procedures, the PCAOB said. In addition, some technology-based tools are used to analyze data for indications of management bias, such as when management consistently selects prices from the upper end of a range when valuing securities.

The Spotlight also makes observation on how technology-based audit tools affect the nature, timing, and extent of audit procedures performed to address risks of material misstatement. These include:
  • Refinement of selection criteria within an audit procedure (for example, using a tool to detect items affected by identified risks of material misstatements and then refining the selection criteria);
  • Disaggregation of data to improve the precision of an audit procedure;
  • Testing data (which can help enable auditors to compare current and prior period data to identify changes in specific attributes);
  • Substantive procedures for significant accounts such as revenue, cash, and inventory (for example, using tools to test the occurrence of revenue by comparing quantity of items ordered to those shipped and invoiced); and
  • Evaluating disclosures, such as comparing notes to the financial statements to prior periods.
Using tools to audit inventory. Noting that preparers are increasingly using advanced inventory management systems to monitor and facilitate the movement, counting, and recording of inventory, the PCAOB observed that auditors are also using technology-based tools to assist in auditing inventory. Some firms have used these systems to reassess the design and frequency of inventory counts based upon the enhanced accuracy of perpetual inventory systems. Other firms use technology-based tools to make test count selections, document the test counts within the tool, and generate the resulting audit documentation.

The Spotlight also notes that under the restrictions of the COVID-19 pandemic, tools such as location cameras and drones have been used to virtually observe inventory and physical assets by both companies and by audit firms. In addition, technology-based tools have been used by auditors to perform analytical procedures related to inventory, such as analyzing how inventory composition has changed over time.

Confirmation process. The PCAOB also highlighted how audit firms have used technological tools in the confirmation process, including facilitating the administrative aspects of the process, such as preparing, distributing, receiving, and tracking confirmations. The PCAOB notes, however, that the use of technology generally does not affect the design of the auditor’s confirmation request because many of the factors that affect the reliability of paper confirmations are also relevant to electronic confirmations.

Similarly, many of the same risks associated with paper confirmations, such as false mailing addresses or responses received from someone other than the intended recipient, also exist with electronic confirmations, although they may take a different form like false email addresses or confirmation emails caught in a spam filter. Regardless of the form of the confirmation, auditors should still perform procedures to assess the reliability of the response, such as a telephone call to the intended recipient of verifying the validity of a business, the PCAOB advised.

Nature of Spotlight. The PCAOB noted that the Spotlight is not intended to be read as staff guidance, only to highlight observations of its staff during the course of its interactions with auditors and other stakeholders. The observations should not be viewed as a recommendation for the use of any particular technology-based audit tool, according to the Spotlight.

Thursday, May 06, 2021

First 100 days of 117th Congress show greater oversight and more probes of the private sector to be expected

By Margaret E. Krawiec, David B. Leland, and Annamaria Kimball, Skadden, Arps, Slate, Meagher & Flom LLP

With Democratic control of both chambers of Congress and the executive branch, congressional oversight of the private sector has ramped up over the first 100 days of the 117th Congress. Moreover, companies can expect more investigations from both the House and Senate according to Skadden Arps attorneys in their article titled The First 100 Days: Congressional Investigations under the 117th Congress.

The authors note that the House of Representatives approved a rules package in January which reinforces the investigative capacities of various committees, while some of those committees have already begun issuing requests for information from private sector companies in the first few weeks of the session. The article also points to a number of House hearings and press conferences on topics impacting the private sector which provide clues regarding investigatory agendas and can assist companies in understanding industrywide priorities when reviewing their compliance practices.

With regard to the Senate, the authors observe that unlike in the House, the legislative body has not yet issued rules or policies as the Democrats assumed control over Senate committees for the first time in six years. They further note that the lull in investigatory actions may be due to a delay in establishing a power-sharing agreement between Democrats and Republicans as they grapple with a 50-50 Senate split. Nonetheless, Senate committees have held hearings on a number of topics impacting the private sector, which the authors observe will likely to translate into investigations as the session progresses.

To read the entire article, click here.

Wednesday, May 05, 2021

Senator Kennedy introduces bill to require SPACs to better explain sponsor compensation to investors

By Lene Powell, J.D.

As the spike in SPAC offerings continues, a new bill introduced by Sen. John Kennedy (R-La) would require the SEC to adopt specific disclosures for special purpose acquisition companies (SPACs). According to Kennedy, the risks that can come with SPACs are not clear to most everyday investors. The Sponsor Promote and Compensation (SPAC) Act would require SPACs to clearly explain risks to investors, particularly retail investors. SPACs would be required to disclose specifics about how their sponsors get paid and how the compensation affects the value of their public shares.

SPAC boom. According to the press release, half of all U.S. IPOs in 2020 involved SPAC structures. SPACs raised $82 billion last year, and have already raised $95 billion in the first three months of this year, outpacing traditional IPOs. The last week of April was the first week since December 2020 to feature no deals by blank check companies.

What is behind the SPAC frenzy? According to David Alan Miller, managing partner of Graubard Miller and co-creator of the SPAC structure, private targets have realized that SPACs are a better path to going public than traditional IPOs for many reasons, including lower cost, faster speed to market, and more reliable valuation.

But do investors understand the considerations involved in investing in SPACs? This year the SEC’s Office of Investor Education and Advocacy (OIEA) has issued both an investor bulletin providing an overview and an investor alert warning investors not to rely on celebrity endorsements as an indicator of the quality of a SPAC investment.

Explaining risks to investors. Senator Kennedy wants the SEC to go further. The Senator is concerned that investors might not fully grasp the impact of many SPAC compensation structures on the value of their shares. According to Kennedy, most SPAC sponsors award themselves "founder shares" that convert into public shares after the merger between the SPAC and a private company. When the sponsors convert the shares they receive in the merged company, the public’s shares of that company are diluted and lose value. If a SPAC sponsor chooses a weak company with which to merge, the valuation of SPAC shares may fall even further, said Kennedy.

According to Kennedy, the founder shares typically represent as much as 20 percent of the total share value of the company. To protect retail investors, some market experts have called for SPACs to make their compensation structures more explicit.

Proposed new disclosures. The bill would require the SEC to issue rules to enhance SPAC disclosure requirements. SPACs would need to disclose:
  • The amount of cash per share expected to be held by the blank check company immediately prior to the merger under various redemption scenarios;
  • Any side payments or agreements to pay sponsors, blank check company investors, or private investors in public equity for their participation in the merger, including any rights or warrants to be issued post-merger and the dilutive impact of those rights or warrants;
  • Any fees or other payments to the sponsor, underwriter, and any other party, including the dilutive impact of any warrant that remains outstanding after blank check company investors redeem shares pre-merger.

Tuesday, May 04, 2021

Supreme Court will not take suggested opportunity to clarify Dudenhoeffer's application

By Rodney F. Tonkovic, J.D.

The Supreme Court has denied certiorari for a petition asking it to clarify what it takes to allege a breach of ERISA’s duty of prudence. The petition argued that divergent interpretations of the court's decision in Dudenhoeffer have led to some circuits holding that ESOP fiduciaries are effectively immunized from certain duty-of-prudence claims based on the failure to disclose potentially harmful inside information (Allen v. Wells Fargo & Company, December 23, 2020).

Wells Fargo fraud. The plaintiffs in this action were Wells Fargo employees who had participated in the firm's 401(k) defined contribution plan. A large proportion of the plan's assets were invested in Wells Fargo common stock, and when the news broke that Wells Fargo had concealed a years-long massive fraud involving the opening of accounts without customer authorization, its stock price collapsed, and employees invested in the ESOP lost their retirement savings. While private investors were able to reach a settlement, the employees were limited to ERISA for their recovery.

Before the Eighth Circuit. The employees brought suit alleging that the defendants breached duties of prudence and loyalty to the ESOP. The district court granted Wells Fargo's motion to dismiss, and the Eight Circuit affirmed. On appeal, the employees argued that the plan fiduciaries knew or should have known that public disclosure of the fraud was inevitable and that, based on general economic principles, the longer the fraud was concealed, the greater the harm to the company's reputation and stock price. The Eight Circuit noted that most circuits have rejected this argument and held that in cases where ESOP fiduciaries know about a regulatory investigation, it is prudent to wait for the investigation to be completed. The panel recognized that earlier disclosure may have ameliorated some harm, that course of action was not clear. The panel also dismissed the duty of loyalty claims, refusing to permit any loyalty-based claims that would impose an affirmative duty to disclose non-public information.

Circuit split. The petition asked the Supreme Court to resolve a circuit split over what a plaintiff must plead to plausibly allege an ESOP duty-of-prudence claim. At issue was the interpretation of the Court's holding in 2014's Fifth Third Bancorp v. Dudenhoeffer. Specifically, the petition asked whether ESOP fiduciaries are effectively immune from duty-of-prudence liability for the failure to publicly disclose inside information and whether Dudenhoeffer applies to duty-of-loyalty claims.

According to the petitioners, the Eighth, Fifth, and Sixth Circuits have constructed a "a nearly insurmountable bar for pleading duty-of-prudence claims, while the Second Circuit has followed Dudenhoeffer in refusing to do so." The petitioners favored the Second Circuit's context-specific approach in Jander, where a reasonable executive could plausibly foresee that a fraud would be disclosed and that no prudent fiduciary would conclude that earlier disclosure would do more harm than good. The Eight, Fifth, and Sixth Circuits, on the other hand, have, in various ways, more stringent standards that require a plaintiff to show that a proposed alternative action was so clearly beneficial that no prudent fiduciary could have opted against it. Under these standards, the petition says, it is unclear what, if any, ESOP duty-of-prudence claim could survive.

The petition also noted that the issue had previously arrived before the court in Retirement Plans Committee of IBM v. Jander. That case, however, was ultimately sent back to the Second Circuit to consider arguments raised during merits briefing; the circuit court in turn remanded the case to the trial court. The petition argued that the Court should have ruled on what should have been decided in Jander: "ERISA imposes no heightened pleading standard on duty-of-prudence claims against ESOP fiduciaries, but simply calls for a careful, context-specific application of the ordinary pleading standards."

In conclusion, the petition asserted that if left standing, the Eighth Circuit's approach incongruously treats ERISA participants and beneficiaries less favorably than private investors. In this case, the petitioners said, every shareholder but Wells Fargo's own employees had a means to recover.

Read the Docket. These cases, and others before the Court may be referenced in the latest version of the Supreme Court Docket, a regular feature of Securities Regulation Daily. Issued opinions, granted petitions, pending petitions, and denied petitions are listed separately, along with a summary of the questions presented and the current status of each appeal.

The petition is No. 20-866.

Monday, May 03, 2021

NYU conference panel addresses ESG disclosure best practices

By Jay Fishman, J.D.

An "Insights from Finance" panel, one of several panels comprising an April 30, 2021 New York University (NYU) conference on Environmental, Social and Governance Disclosures (ESG), asked participants to address ESG disclosures’ impact on corporations globally. The conference itself arose from President Biden’s 2021 appointment of Gary Gensler as SEC Chair, Gensler’s having made ESG Disclosures one of his priorities, and the Commission’s determination to mandate ESG disclosures for companies.

Overall theme of conference. To address these priorities, the conference broadly asked the expert-participants to consider how companies can promote corporate cultures of compliance and meet regulators’ and stakeholders’ expectations about ESG initiatives. To dissect this broad question, each panel focused on one of the following questions: (a) What are the best practices for ESG disclosure?; (b) What are the most sophisticated asset managers looking for?; (c) What are the most forward thinking companies currently providing?; and (d) What can finance scholarship tell us about what the market uses?.

Insight from finance. Moderator April Klein, an accounting professor at NYU’s Stern School of Business, covered this last question in her panel: "What can finance scholarship tell us about what the market uses?" To address this question, Klein asked the panelists to specifically remark upon: (1) the usefulness and reliability of ESG disclosures for investors and companies; (2) whether ESG disclosures should be voluntary or mandatory—the SEC’s disclosure for U.S. companies is currently voluntary; and (3) what recommendations would they make to the SEC about ESG disclosures.

Usefulness of ESG disclosures. Klein asked Christian Leuz, a professor of international economics, finance, and accounting at the University of Chicago’s Booth School of Business to speak about the usefulness of ESG disclosures. Leuz said that a corporation’s ESG disclosures can be material to investors by providing useful information about a company’s corporate social responsibility (CSR). Investments in CSR, like other investments, are associated with future cash flows and risks. Standardized CSR disclosures could help the market gain a clearer picture of a company’s risks and value, making it possible to compare one company’s CSR activities with another’s, and helping investors monitor these activities (or the lack of them). Furthermore, Leuz proclaimed, these disclosures, if they are informative, could show investors a firm’s increase in liquidity of secondary securities markets, just as the usual financial information does. Conversely, uncertainty about a firm’s value could evidence a lower cost of capital.

Answering Klein’s follow-up question whether investors see ESG exposures as more of a performance or risk driver, Leuz indicated that CSR reporting could help shareholders drive a company to act in more responsible and sustainable ways. CSR disclosures could make a company more inclined to, for example, stop polluting. But disclosures upon which a company does not act could result in investors pulling out of that company and, instead, backing companies that either use renewable energy or purchase ethically sourced materials.

The second panelist, Marcin Kacperczyk, a finance professor at Imperial College London, limited his remarks to climate change disclosure. He emphasized that climate change disclosures are not only useful but imperative now in order to sustain the planet into the foreseeable future. He specifically asserted that firms must disclose their respective carbon emission amounts, which need to be zero by 2050 to bring Earth’s temperature down to a sustainable level. Kacperczyk said that, unfortunately, most companies are not disclosing their carbon emission amounts because of the financial and social cost of revealing this information.

Voluntary vs. mandatory disclosures. Concerning the question whether the disclosures should be voluntary or mandatory, Kacperczyk said the good news for advocating mandatory disclosure of a company’s carbon emissions is that the data is objective and, therefore, cannot be easily manipulated by a company. On the positive side, he stated that mandatory disclosure results in a higher emissions benefit for companies required to disclose. But whether mandatory or voluntary, Kacperczyk proclaimed that financial markets do value disclosure.

Lucretzia Reichlin, an economics professor at the London Business School and chair of the European Corporate Governance Institute (ECGI) (an international scientific non-profit association providing a forum for debate and dialogue between academics, legislators and practitioners, focusing on major corporate governance issues and thereby promoting best practice), declared that we not only need mandatory disclosure but we need a global mandatory standard. She said, moreover, that a global standard addresses the "reliability of ESG disclosures" issue by focusing on the materiality of the disclosures.

Regarding how to create this global mandatory standard, Reichlin said there is already a lot of material on the subject that needs to be consolidated. The standard must come from a common baseline with flexibility that depends on each country’s needs. Reichlin made the following points: (1) there is already support for a global mandatory standards from U.S. Treasury Secretary Janet Yellin and European Central Bank President Christine Lagarde; (2) the ECGI could help define the global baseline; and (3) a global mandatory standard would be important to investors and asset managers.

On the voluntary vs. mandatory disclosure question, panelist Leuz chimed in that if materiality drives ESG disclosures, voluntary disclosure will not work. Only mandatory disclosure, he said, would ensure that disclosures material to investors and other stakeholders are made. Leuz similarly stated that if the goal of ESG disclosures is to force or incentivize a company to change its behavior, then voluntary disclosure will also not work, but mandatory disclosure will be complicated by having to decide who will create a mandatory standard to get companies to comply.

Reliability of ESG disclosures. The last panelist to speak was Sara DeSmith, an ESG specialist and partner in PricewaterhouseCooper’s (PwC) sustainability assurance practice, who spoke about the reliability of ESG disclosures. She said the problem today is that since an ESG global mandatory standard does not exist, whether or not disclosures are made varies by company. Furthermore, for companies that do make ESG disclosures, the information is not only inconsistent from one organization to the next but the information is often not reviewed by the firm’s auditors or chief financial officer.

Concerning companies that make ESG disclosures, DeSmith declared that PwC will issue a "limited assurance report" that goes toward the reliability of the information. Noting that companies rely on credit rating agencies to evaluate their ESG disclosures, she proclaimed that what is really needed to ensure full reliability is a move away from credit ratings toward a global standard that applies Generally Accepted Accounting Principles and Generally Accepted Auditing Standards. DeSmith emphasized that these high standards would ensure ESG disclosure reliability by putting ESG disclosures through the same review as financial statements.

Recommendations to SEC. Klein, in lastly posing to the panel the question "What recommendations would you make the SEC," remarked that Commissioner Hester Peirce does not support a world-wide standard for ESG disclosures. Nevertheless, all the panelists agreed that a global standard is, indeed, needed. Kacperczyk, furthermore, declared that on climate change, the SEC must do something now about company carbon emissions because there is no time to wait. DeSmith similarly proclaimed that a global standard on all ESG disclosures is imperative because time is of the essence. Leuz said that because the entire ESG disclosure issue is complicated, perhaps the SEC could be quick on climate change disclosures but slower on other ESG disclosures, e.g., those pertaining to accounting and finance. Reichlin reiterated that while the ECGI cannot determine a country’s (or the world’s ESG disclosure standard) it can work with the SEC and other country financial agencies to define the global baseline. nce issues. ECGI is an international scientific non-profit association providing a forum for debate and dialogue between academics, and practitioners, focusing on major corporate governance issues.

Friday, April 30, 2021

Special report: Sprinting to 100-day mark, White House shifts regulatory landscape

By Mark S. Nelson, J.D.

Wolters Kluwer Legal & Regulatory U.S. staff legal analysts from across numerous practice areas have produced a new Special Report on President Biden's first 100 days in in office. The Special Report includes analysis of significant actions taken by acting and newly confirmed permanent chairs at the SEC and the CFTC. These actions cover a range of topics such as market instability, climate change, enforcement, cryptocurrencies, and position limits. The Special Report explains the latest developments and what regulators may emphasize going forward.

The list of practice areas covered by the Special Report includes:
  • Tax
  • Securities & Corporate Governance
  • Labor & Employment
  • Employee Benefits
  • Retirement Benefits
  • Health & Life Sciences
  • Antitrust & Competition Law
  • Intellectual Property & Technology
  • Cybersecurity & Privacy
  • International Trade
  • Banking & Financial Services
  • Commodities & Derivatives
  • Government Contracts
To read the Special Report, please click here: Sprinting to 100-day mark, White House shifts regulatory landscape.

Thursday, April 29, 2021

As ESG bandwagon picks up speed, heightened disclosure obligations await just down the road

By Alexandra M. MacLennan, Squire Patton Boggs

With the proliferation of recent ESG related pronouncements and activities at the SEC, including the creation of a Climate and ESG Task Force within the agency’s Division of Enforcement, public issuers and asset managers of all stripes will need to consider how to address enhanced reporting and disclosure obligations that are likely to be issues. The author explores these complex issues and reflects on the ESG phenomena in an article titled The ESG Bandwagon in the United States.

The article notes that despite the newly launched SEC enforcement task force, there is currently no specific securities law or regulation that identifies ESG as a separately identifiable topic with respect to risk disclosure. The article also identifies the two main drivers of the ESG bandwagon: the credit driver who is grounded in the desire for good solid disclosure regarding ESG risks, and the so-called value-based investor who is motivated by sustainable investing in vehicles that are consistent with the investor’s own value system. Finally, the piece considers the disclosure and reporting obligations for those promoting ESG labelled securities compared to those corporations not claiming to promote sustainable concepts.

To read the entire article, click here.

Wednesday, April 28, 2021

Blank check deals fall, non-U.S. companies rise in IPO market

By John Filar Atwood

Last week’s IPOs included no deals by blank check companies, something that has not happened since the last week of December. As the momentum behind blank check companies slows, it has started to pick up for foreign registrants of U.S. offerings. Ten of last week’s preliminary registrants were based outside the U.S., and included companies from Cyprus, Sweden, Germany, Switzerland, China, the Netherlands and the U.K. Among completed offerings, China added Infobird to its list of 2021 new issuers. Four China-headquartered companies have begun trading in the U.S. so far in April. The high-tech sector saw its third $1 billion+ deal in the past two weeks with the $1.3 billion debut of UiPath. Morgan Stanley served as first lead manager for all three of the offerings. JPMorgan led the offerings of NeuroPace, Zymergen, and Treace Medical Concepts. NeuroPace and Treace are both surgical and medical apparatus (SIC 3841) companies. Two Minnesota-based companies, SkyWater Technology and Agiliti, went public last week. Minnesota was the headquarter location of two IPO companies in all of 2020. DoubleVerify Holdings and Rain Therapeutics completed deals led by Goldman Sachs. Along with Rain Therapeutics, the week’s pharmaceutical preparations (SIC 2834) new issuers included Impel NeuroPharma. SIC 2834 companies have completed IPOs in each of the past three weeks. Troika Media Group began trading, becoming the fifth company for which Kingswood Capital has served as lead underwriter this year. Kingswood did not have any completed first lead manager assignments in 2020. Latham Group and KnowBe4 also began public trading last week. Residential pool designer Latham debuted 22 days after publicly registering.

New registrants. The week’s activity included 17 new registrations. Cyprus-headquartered Camposol Holding filed a second attempt at an IPO, having withdrawn its prior registration in 2018. The global provider of fresh foods is making concurrent offerings internationally and to institutional investors in Peru. Sweden’s Oatly Group, Netherlands-based hear.com, and England’s Centessa Pharmaceuticals hired Morgan Stanley to lead their IPOs. Oatly, whose investors include a Blackstone Capital affiliate, makes oatmilk-based dairy alternatives. Centessa offers an asset-centric R&D platform to drug makers, while hear.com is a global online provider of medical-grade hearing care. European biopharmaceutical companies ATAI Life Sciences and Molecular Partners filed their IPO plans. ATAI, a developer of treatments for mental health disorders, is based in Germany and incorporated in the Netherlands. Switzerland’s Molecular Partners is developing therapies for infectious diseases, including a COVID-19 treatment in partnership with Novartis. Brazil is home to new filers PicS and Crescera Capital Acquisition. PicS’ online platform provides financial, communication, and consumer services to registered users. Blank check Crescera will target technology, healthcare, education services, consumer, and retail companies in Brazil. Software developer Hello and blank check SPK Acquisition operate out of China. Hello’s platform offers two-wheeler services, a carpooling marketplace, ride-hailing, hotel reservations, and online advertising services. SPK will search for an Asian telecom, media, and technology business. Ascendant Digital Acquisition III, Focus Impact Acquisition, and Agrico Acquisition joined 2021’s list of SIC 6770 public registrants. Ascendant will focus on digital entertainment, film/television, music, print and digital books, e-sports, and consumer entertainment companies. Focus Impact plans to acquire a socially aware high-growth target, and Agrico will pursue agriculture, horticulture, and aquaculture businesses. Goldman Sachs, lead manager for Ascendant Digital, also was selected to lead the planned offering by Paycor HCM. Paycor provides software-as-a-service human capital management solutions for small and medium-sized businesses. Genworth Mortgage Holdings, a North Carolina-based private mortgage insurance provider, also registered to go public. The company is a wholly-owned subsidiary of Genworth Financial, which will retain control following the IPO. Vera Therapeutics, a maker of therapies for immunological diseases, and cancer treatment developer TScan Therapeutics registered. Vera licenses its lead product candidate from Ares Trading, an affiliate of Merck.

Withdrawals. No companies elected to withdraw their IPO registrations during the week.

The information reported here is gathered using IPO Vital Signs, a Wolters Kluwer Regulatory U.S. database that includes all SEC registered IPOs, including REITs and those non-U.S. IPO filers seeking to list in the U.S. markets. IPO Vital Signs does not track closed-end funds, best efforts or non-underwritten deals, or IPO offerings for amounts less than $5 million.

Tuesday, April 27, 2021

TD Ameritrade overturns class certification in best execution fraud suit

By John M. Jascob, J.D., LL.M.

The Eighth Circuit Court of Appeals has reversed an order certifying the class in a suit alleging that TD Ameritrade’s order routing practices violated the broker-dealer’s duty of best execution. The plaintiff failed to establish the predominance requirement for certifying a class under Federal Rule of Civil Procedure 23 because the algorithm proposed by the plaintiff’s expert to assess execution quality would still not account for all unusual market conditions that might cause transactions to depart from the best available price. Accordingly, common issues did not predominate over individual questions of fact because determining whether each customer suffered economic loss as a result of the order routing practices would entail an order-by-order inquiry (Ford v. TD Ameritrade Holding Corp., April 23, 2021, Colloton, S.).

A customer of TD Ameritrade sued as lead plaintiff for a group of investors who purchased and sold securities through TD Ameritrade between 2011 and 2014. The plaintiff alleged that TD Ameritrade’s order routing practices violated the company’s duty of best execution by systematically sending customer orders to trading venues that paid the company the most money, rather than to venues that provided the best outcome for customers. Specifically, the plaintiff alleged that TD Ameritrade, its parent company, and its chief executive officer violated Exchange Act Section 10(b) and Rule 10b-5 by leaving orders unfilled, filling orders at a sub-optimal price, and filling orders in a manner that adversely affected performance after execution, causing customers to suffer economic loss.

On reviewing the motion for class certification, a magistrate judge recommended denying certification, concluding that the proposed class did not satisfy the predominance requirements of Rule 23(b)(3) because determining whether each TD Ameritrade customer suffered economic loss as a result of the company’s order routing practices would entail individualized inquiries. The district court, however, issued an order certifying the class, determining that the plaintiff’s expert had developed an algorithm that could solve the predominance problem by making automatic determinations of economic loss for each customer.

No technological solution. On appeal, the Eighth Circuit panel observed that the expert’s algorithm proposed to assess execution quality by using class trading history data provided by TD Ameritrade and data about the state of the market at the time of each trade. The expert proposed to establish that a “better” price was obtainable for each executed trade by comparing the trade’s actual price with the National Best Bid and Offer (NBBO) price. The experts for the parties agreed, however, that certain transactions required exclusion from the algorithm’s analysis to account for instances when TD Ameritrade could not have prevented execution at a price inferior to the NBBO due to volatile or otherwise unusual market conditions.

While the plaintiff’s expert contended that his algorithm could filter out these transactions by using third-party historical stock market information that identifies periods when stocks were traded during unusual market conditions, the court observed that there is no definitive list of unusual market conditions that account for transactions that depart from the best available price. As a result, the algorithm’s use of published market data would not identify all legitimate exclusions, leaving the trier of fact to resolve disputes among the experts through individualized determinations about the appropriateness of particular exclusions. “Despite advances in technology,” the court stated, “individual evidence and inquiry is still required to determine economic loss for each class member.”

In addition, the court opined, the class as defined by the district court constituted an impermissible “fail-safe class.” By defining the class to include only those customers who were harmed by TD Ameritrade’s alleged failure to seek best execution, the district court certified a class in which membership depends upon having a valid claim on the merits. This sort of class is impermissible, the court stated, because it allows putative class members to seek a remedy but not be bound by an adverse judgment.

Accordingly, the appellate panel reversed the district court’s order certifying a class and remanded the matter for further proceedings.

The case is No. 18-3689.

Monday, April 26, 2021

CRS report surveys SEC’s current guidance on climate risk disclosures

By Brad Rosen, J.D.

Observing that potential risks to the U.S. financial system from climate change have attracted growing attention in government, academia, and media, as well as raising questions about the roles of financial regulators in addressing such risks, the Congressional Research Service (CRS) issued a report titled Climate Change Risk Disclosures and the Securities and Exchange Commission. The CRS paper points to the groundbreaking report, Managing Climate Risk in the U.S. Financial System, issued by CFTC’s Market Risk Advisory Committee September 2020. That report concluded the SEC’s 2010 climate change guidance has not resulted in high-quality disclosure of climate change risks across U.S. publicly listed firms, and that it should be updated in light of global advancements over the preceding 10 years.

The CRS paper focuses on the SEC’s current guidance and standards for climate change risk disclosures as well as the agency’s application of the "materiality" standard for disclosure of material risks under federal securities laws. The report also provides an analysis of how the SEC is addressing climate change’s impact on global supply chain risk, together with an overview of the SEC’s current regulation for investment management companies and environmental, social, and governance (ESG) funds relating to climate change.

The 2010 SEC climate change guidance and its limitations. In 2010, the SEC issued Guidance Regarding Disclosure Related to Climate Change (the "Guidance"). Key points expressed in the Guidance include the need to disclose, if material:
  • the impact of climate change legislation and regulation;
  • the impact of international accords on climate change;
  • climate change-based disruptions in supply chains;
  • indirect consequences of regulation or business trends; and
  • physical impacts of climate change.
Although the Guidance has been central to policy on corporate reporting of climate-related risks, its efficaciousness has been limited. In 2018, agency senior staff told the Government Accountability Office (GAO) that they had no expectations the Guidance would result in changes to companies’ climate-related disclosures because the Guidance did not involve new disclosure requirements. In January 2020, then-SEC Chairman Jay Clayton observed that SEC staff had issued comments questioning the sufficiency and consistency of the disclosures in certain instances,

In February 2021, Acting SEC Chair Allison Herren Lee stated that investors are increasing their consideration of climate-related issues when making their investment decisions, and that it was the SEC’s responsibility to ensure that the investors had access to material information when planning for their financial future. As part of these efforts, Lee then directed the Division of Corporation Finance to enhance its focus on climate-related disclosure in public company filings, including review of the extent to which public companies were addressing the topics identified in the Guidance. She also indicated that the SEC staff would be moving to update the 2010 Guidance to reflect developments in the past decade.

Materiality and climate change risk disclosure. While federal securities law does not explicitly require disclosure of specific climate-related risks, the SEC’s 2010 Guidance provides that a public company may need to disclose climate-related risks that are "material" to investors. Generally, publicly traded companies must disclose in their periodic filings certain information such as financial statements and other business information specified by SEC regulations. SEC regulations also require disclosure of "such further material information, as may be necessary to make the required statements, in light of the circumstances under which they are made, not misleading." The U.S. Supreme Court has defined a material fact as follows: "An omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote." The Court explained "there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available."

Case-by-case inquiries and a lack of consistency. The courts and the SEC make materiality determinations on a case-by-case basis, using a principles-based approach rather than prescribing bright-line rules. As such, courts have not identified a quantitative threshold for the impact of a misstatement or omission in order to make it material. Even so, the SEC’s default position has been that the materiality standard should be understood in terms of the information’s economic or financial impact.

There have been relatively few decisions specifically analyzing the materiality of a company’s disclosures concerning the impacts of climate change. However, in two relatively recent cases, courts have analyzed the materiality of Exxon Mobil Corporation’s (Exxon’s) disclosures and omissions relating to its "proxy cost of carbon" measure—a metric which, in this situation, approximates the cost of potential government-related climate change actions in connection with certain transition risks in financial projections. In each of those cases, the plaintiff alleged that Exxon’s public disclosures of its proxy cost of carbon were materially misleading because they differed from some of Exxon’s internal estimates of the relevant costs. The courts, opining at different stages of the litigation process, reached disparate results as to the misstatements’ and omissions’ materiality.

Investment manager climate-related disclosure requirements lack clarity. ESG funds are portfolios of equities and/or bonds for which environmental, social, and governance factors have been integrated into the investment process. Investor interest in these vehicles has grown significantly over the years. For example, according to Morningstar, the mutual fund researcher, ESG mutual funds received $51.1 billion of net new funding from investors in 2020. That reportedly represented the fifth consecutive annual increase, and more than double the $21 billion in 2019.

As is the case with its approach to reporting companies, the SEC does not have rules, regulations, or requirements that specifically govern investment companies’ or investment advisers’ use of ESG principles or their disclosures of ESG-related strategies that may impact climate change. There is no universally agreed-upon, or legally-binding, definition of what constitutes ESG, or an ESG fund. While no standardized requirements currently exist for such ESG funds’ investments, there are certain fundamental regulations within the federal securities laws that have an indirect impact on ESG disclosure-related practices. For example, if an investment company’s manager, an SEC-registered investment adviser, incorporates ESG principles as a primary investment strategy, disclosure of the strategies and risks associated with them must be in the investment company’s registration statements under the Investment Company Act of 1940.

The SEC recently announced creation of an ESG Task Force to analyze disclosure and compliance issues relating to ESG strategies. In April 2020, the SEC’s Division of Examinations warned that its review of ESG funds had found a number of misleading statements regarding ESG investing processes and adherence to global ESG frameworks, among other issues. In today’s environment, the SEC’s increased involvement and scrutiny with respect to issues around climate-related risks and disclosures appears to be a certainty.

Friday, April 23, 2021

NASAA applauds House efforts to push ESG, diversity reforms

By Amy Leisinger, J.D.

The North American Securities Administrators Association has provided views on several legislative proposals regarding environmental, social, and governance (ESG) disclosures, as well as diversity and inclusion. According to the organization, recently proposed bills would make strides toward offering information that investors may consider important in making decisions regarding their money.

Diversity. The amended Improving Corporate Governance Through Diversity Act of 2021 (H.R. 1277) would mandate that public companies make disclosures about the racial, ethnic, gender, and veteran status of their directors, director nominees, and executives. The bill also would require companies to disclose whether their boards have adopted any plans to promote diversity among these bodies and instruct the SEC Office of Minority and Women Inclusion (OMWI) to develop and publish "best practices" and establish a new Diversity Advisory Group made up of public and private representatives to study issues related to diversity and inclusion.

NASAA noted it has repeatedly called on Congress to examine corporate board composition with an eye toward encouraging diversity. Research indicates that greater board diversity is an indication of good governance, which improves both performance and investor relations, the organization said. NASAA congratulated the legislative committee for its decision to prioritize H.R. 1277 and urged its passage.

The Diversity and Inclusion Data Accountability and Transparency Act would amend the Dodd-Frank Act to require that regulated financial firms with 100 employees or more disclose diversity data. The legislation is designed to strengthen provisions enacted in 2010 that have failed to meet policy goals.

"It is striking and unfortunate that, despite relatively overwhelming evidence that a diverse workforce enhances a company’s ability to employ top talent, build employee engagement, innovate, and ultimately succeed, the financial services industry continues to significantly lag behind other large segments of our economy regarding the inclusion of women and people of color," NASAA stated.

By empowering the OMWI to require large, regulated firms to disclose their diversity data, the bill makes a step forward in giving regulators the tools to better understand practices related to diversity and inclusion in institutions they supervise, NASAA stated, and offered strong support for the legislation.

ESG. Under the amended ESG Disclosure Simplification Act of 2021 (H.R. 1187), the SEC would be directed to adopt rules to implement an ESG disclosure regime for public companies. Specifically, any registered or reporting company would have to disclose in its proxy statement or solicitation: (1) a clear description of the company’s views regarding the link between ESG metrics and long-term business strategy; and (2) a description of the process the company used to determine the impact of ESG metrics on long-term business strategy.

Investors are increasingly looking at ESG practices as a material metric in making investment decisions, NASAA said. However, there are no uniform standards for the reporting on these factors, and, as such, public companies lack certainty when making ESG disclosures, the organization explained. Investors should be entitled to understand factors relating to a company’s ESG profile and weigh ESG risks, NASAA opined.

NASAA has previously called for Congress to enact legislation that would direct the SEC to develop a uniform standard to ensure firm and investment comparability. This bill presents an opportunity to "move the ball forward," the organization concluded.

Thursday, April 22, 2021

House FSC reports securities bills on ESG and diversity and inclusion

By Mark S. Nelson, J.D.

The House Financial Services Committee reported four securities bills, including bills on environmental, social, and governance (ESG) metrics, diversity and inclusion, and corporate political spending disclosure. The committee also marked up its budget views and reauthorized committee task forces on fintech and artificial intelligence. With the exception of one of the diversity and inclusion bills dealing with boardroom diversity, votes on the four securities bills and four additional banking bills were along party lines. In early reaction to the markup, the North American Securities Administrators Association, Inc. expressed support for the ESG, board diversity, and diversity data bills.

Budget views. With respect to securities regulation, the House FSC’s budget views call for "robust funding" of the SEC in FY22 and for the SEC to finish its Dodd-Frank Act rulemakings. Perhaps with GameStop’s January 2021 trading volatility in mind, the committee majority specifically cited Dodd-Frank Act Section 929X(a) as a provision on which the Commission should act. That provision directs the Commission to adopt rules mandating public disclosure of the name of the issuer and the title, class, CUSIP number, aggregate amount of the number of short sales of securities.

Although the committee majority also sees room for the SEC to address proxies, especially in light of the Clayton-era SEC’s imposition of new requirements on proxy advisers and increased shareholder proposal eligibility requirements, the majority called on the Commission to deal with personnel cuts imposed by the Trump Administration. The majority said the SEC should hire new employee with expertise in climate change and cybersecurity and seek to expand the role of the SEC’s Office of Minority and Women Inclusion (OMWI). Representative Joyce Beatty (D-Ohio) offered the Diversity and Inclusion Data Accountability and Transparency Act of 2021 (H.R. 2123), which would require entities with 100 or more employees to provide needed diversity data to agency OMWIs. The bill was reported by the House FSC by a vote of 30-23.

Moreover, the majority cited a need to protect investors from the "gap between regulation and innovation" and urged the SEC to hire persons with "specialized expertise" to foster an environment conducive to "responsible innovation."

The committee approved the budget views by a vote of 30-23, but only after rejecting all but two of eight Republican amendments. An amendment offered by Rep. Blaine Luetkemeyer (R-Mo) was agreed to by voice vote and would have the committee continue its oversight of safety and soundness regarding consumers and businesses affected by the COVID-19 pandemic; the committee, however, rejected another amendment by Rep. Andy Barr (R-Ky) that would have had the committee conduct the same oversight of the Biden Administration’s American Recovery Plan Act as it did over the Trump-era Coronavirus Aid, Relief, and Economic Security (CARES) Act.

With respect to climate change, the committee also approved an amendment offered by Delegate Michael San Nicolas (D-Guam) to an amendment originally offered by Ranking Member Patrick McHenry (R-NC). The McHenry amendment would have commended the Biden Administration for supporting nuclear energy, but Democrats objected to the original language and instead substituted the word "acknowledge" for "commend." Ranking Member McHenry said he believes climate change is "real" and that the U.S. can balance its climate goals with economic growth, but he worried that the Democrat amendment left the door open to the Green New Deal sponsored by, for example, Rep. Alexandria Ocasio-Cortez (D-NY). Representative Ocasio-Cortez and Sen. Bernie Sanders (I-Vt) recently announced legislation advocating a Green New Deal for public housing.

Meanwhile, the committee majority rejected, among other things, Republican amendments to: (1) seek curbs on funding for the Consumer Financial Protection Bureau (Rep. Barr); (2) expand the SEC’s definition of accredited investor to allow more retail investors to participate in private, exempt offerings (Rep Bill Huizenga (R-Mich)) (Rep. Anthony Gonzalez (R-Ohio) had argued in support of the amendment that many people were now excluded from recent growth in private markets); (3) oppose legislation that would impose a financial transaction tax (FTT) (Rep. McHenry) (Rep. Peter DeFazio (D-Ore) has introduced the Wall Street Tax Act of 2021 (H.R. 328), which would impose an FTT).

Fintech/AI task forces reauthorized. The House FSC also reauthorized two task forces that were well-received by members when they were originally created during the 116th Congress. The Task Force on Artificial Intelligence will again be led by Rep. Bill Foster (D-Ill); Rep Gonzalez will lead the Republican contingent. The Task Force on Financial Technology likewise will be led again by Rep. Stephen Lynch (D-Mass), while Rep. Tom Emmer (R-Minn), who has previously sponsored numerous blockchain bills, will lead the Republican members on the task force.

ESG disclosure. Under the amended ESG Disclosure Simplification Act of 2021 (H.R. 1187), sponsored by Rep. Juan Vargas (D-Calif), the Commission would be directed to adopt rules to implement an ESG disclosure regime for public companies. Specifically, any company with securities registered under Exchange Act Section 12 or which reports to the Commission under Exchange Act Section 15(d) would have to disclose in its proxy statement or solicitation: (1) a clear description of the company’s views regarding the link between ESG metrics and long-term business strategy; and (2) a description of the process the company used to determine the impact of ESG metrics on long-term business strategy.

A sense of Congress included in the bill would state that ESG disclosures are de facto material. This is significant because, under existing the SEC’s disclosure regime, materiality is the key touchpoint for disclosures of all types and ESG disclosures may or may not always be material. The bill would clarify how ESG disclosures are treated in the context of materiality. ESG disclosures may be located in the notes section of a filing.

Speaking in support of the bill, Rep. Vargas reminded committee members that newly sworn-in SEC Chair Gary Gensler had testified at his confirmation hearing that materiality of disclosures is ultimately up to investors. The representative reiterated that the SEC can require disclosure in the public interest and that, in his view, ESG disclosures are material.

The bill also would define "ESG metrics" by reference to rules the Commission will develop if the bill becomes law. The Commission would have discretion to incorporate international ESG standards. The Commission also would have discretion to delay the disclosure requirement for small issuers.

The Vargas bill also would create the Sustainable Finance Advisory Committee within the SEC to make recommendations about ESG disclosure to the Commission. "Sustainable finance" would mean "the provision of finance with respect to investments taking into account environmental, social, and governance considerations." The Commission would have to respond to a report issued by the committee within six months.

The bill, which was first introduced in the last Congress, won committee approval by a vote of 28-22. Democrats turned away Republican amendments to: (1) reiterate the need for ESG disclosures to follow the SEC’s materiality framework (Rep. Bryan Steil (R-Wis)); (2) strike the Congressional findings, which purportedly denied that materiality was already part of the SEC’s disclosure regime (Rep. Huizenga); and (3) replace the operative text of the bill with a study (Rep. French Hill (R-Ark)).

Diversity and inclusion. The amended Improving Corporate Governance Through Diversity Act of 2021 (H.R. 1277), sponsored by Rep. Gregory Meeks (D-NY), would mandate that public companies make disclosures about the racial, ethnic, gender, and veteran status of their directors, director nominees, and executives. A version of the bill passed the House in the 116th Congress by a vote of 281-135. The bill was the only one garnering significant bipartisan support on the House FSC and was reported by voice vote.

Representative Meeks said the SEC’s lack of a definition of diversity has become a hindrance to better disclosure by companies. According to Rep, Meeks, the bill tracks an earlier recommendation by an SEC advisory committee, which the SEC never adopted. Representative Meeks also said the bill could address a larger conversation in the U.S. regarding racial justice and the lack of opportunity for of persons of color.

Under the latest version of the bill, companies would have to disclose in a proxy statement:
  • Data regarding the voluntary, self-identified racial, ethnic, and gender composition of the board of directors, board nominees, and executives;
  • The voluntary, self-identified status of directors, director nominees, and executives as veterans; and
  • Whether the board or a board committee of the company has, as of the date of the disclosure, adopted any policy to promote racial, ethnic, and gender diversity among directors, director nominees, and executives.
If a company has not filed a proxy statement in a one-year period, the company would make the disclosure in its first annual report after that period. The SEC would have to report to Congress annually regarding an analysis of the information disclosed by companies and any trends suggested by that information.

The bill also would require the director of the SEC’s OMWI, within three of enactment, to publish best practices for complying with the disclosure requirement. The director may ask for public comments regarding best practices.

Lastly, the bill would establish within the SEC the Diversity Advisory Group to study issues related to diversity and inclusion and report to the SEC and Congress on its recommendations for increasing gender, racial, and ethnic diversity among public company directors. The SEC also would have to report to Congress annually on the status of gender, racial, and ethnic diversity on public company boards.

Political donations. The amended Shareholder Political Transparency Act of 2021 (H.R. 1087), sponsored by Rep. Foster, would require quarterly and annual reporting by companies of their political donations. The SEC would have to adopt rules to implement the bill within 180 days of enactment. The bill has been previously introduced in various forms, but this time, with a Democrat White House and Congress, it is possible that an appropriations policy rider will be dropped from FY22 appropriations legislation thereby freeing the SEC to implement a political spending disclosure regime should Congress enact one. The Foster bill was reported out of committee by a vote of 28-23.

According to Rep. Foster, the January 6, 2021 Capitol insurrection and the recent passage in some states of restrictive voting laws had made it clear that many companies consider political spending to be a material disclosure item. In the wake of these events, some companies suspended campaign contributions to members of Congress and some have spoken out publicly against voter suppression.

Under the Foster bill, quarterly reports would be mandatory for any company with securities registered under Exchange Act Section 12. Specifically, such reports would have to disclose:
  • A description of expenditures on political activities in the prior quarter;
  • The date of each expenditure;
  • The amount of each expenditure;
  • If an expenditure was made to support/oppose a candidate, the name of the candidate, office sought, and the candidate’s political party affiliation; and
  • The name of any trade association or other organization exempt under Internal Revenue Code Sections 501(a) and 501(c) which received dues that are or could be reasonably anticipated to be transferred to another association or organization for political expenditures or electioneering communications.
With respect to exempt organizations, the disclosure requirement would not apply to direct lobbying via registered lobbyists hired by a company, communications by an issuer to shareholders or executives and administrative staff and their families, or the creation and funding of a separate segregated fund used for corporate political purposes. Quarterly reports would be publicly available on the SEC’s website and via EDGAR. The term "issuer" would not include registered investment companies.

In the case of annual reports, a company would have to disclose: (1) a summary of the prior year’s expenditures that were over $10,000 and expenditures for a particular election that were over $10,000; (2) a description of the specific nature of expenditures planned for the next fiscal year; and (3) the total expenditures planned for the next fiscal year.

The SEC would have to report to Congress annual regarding the implementation of the bill and the GAO would have to periodically report to Congress on the SEC’s oversight of the bill.

Representative Steil, as he had regarding the ESG bill, offered an amendment to clarify that the SEC’s materiality framework still applies to political spending disclosures. Representative Steil also cited what he described as First Amendment right of corporations to speak via political donations. Democrats rejected the amendment.

Wednesday, April 21, 2021

Stump cautions against 'regulatory grab' in bitcoin, other cash markets

By Anne Sherry, J.D.

CFTC Commissioner Dawn Stump, in virtual remarks at Texas A&M’s Bitcoin Conference, spoke about the need for clarity about the CFTC’s role in regulating bitcoin-based derivatives and enforcing the underlying cash markets. Stump also emphasized the agency’s role in enabling innovation in the financial markets and praised SEC Commissioner Hester Peirce’s work towards balancing investor protection with regulatory flexibility to allow room for innovation.

Defining the CFTC’s role. Stump began by clarifying the CFTC’s jurisdiction over bitcoin. As she explained, the CFTC regulates commodity futures, even where another regulatory body has jurisdiction over the underlying commodity itself. "We regulate futures on bitcoin because bitcoin is a commodity—but we do not regulate bitcoin itself, much like we regulate cattle futures because cattle are commodities, but we do not regulate the sale of cattle at auction barns throughout the country," Stump said. However, while the CFTC does not regulate the cash market in the underlying commodity, it does have enforcement authority to bring civil actions for fraud or manipulation in these markets, including the bitcoin cash market.

The commissioner said that the agency’s broader enforcement authority makes sense because transactions in the cash market may be a way to manipulate prices of CFTC-regulated derivatives. What worries Stump is when the public conflates the agency’s enforcement authority with regulatory authority and takes away the impression that the CFTC is the frontline regulator of the underlying cash market. This may give a false sense of security that transactions in digital assets are subject to CFTC regulation when they are not. Last month, Stump concurred in an action against Coinbase, writing separately to make a clear statement that the CFTC does not regulate digital asset exchanges.

Furthermore, confusion between enforcement and frontline regulation may "potentially lead to a slippery slope of ever-expanding and ill-defined priorities for the CFTC," Stump said. The commissioner pushed back on suggestions that the CFTC should regulate benchmarks on cash aluminum or the cash market for RINs on ethanol production. "This is not what the CFTC is designed to oversee, and regulatory grab is not the objective," she said.

Encouraging innovation. In contrast to what the CFTC is not about, Stump turned to its role in encouraging innovation in the financial markets. The futures market itself began as an innovative solution to problems of commodity trading and delivery, and innovation continues to drive demand in the markets, as seen in 2017 when two exchanges listed bitcoin futures. The exchanges used the self-certification process, an alternative to the other route for listing, which is asking the CFTC to approve the new product. But even self-certification is not a hands-off process, Stump said: CFTC staff still work with registrants to answer the questions that the agency and the listing exchanges are required to consider. While Stump is always open to suggestions about making the self-certification process more workable, she said that people should not judge it without understanding why it exists in the first place.

Stump observed that the bitcoin market is global and that coordination between IOSCO and the Financial Standards Board is an important way to understand each jurisdiction’s approach and receptiveness to innovation. But she cautioned against generalizing regulators’ positions because the finer details of their positions can be misreported. The role of U.S. regulators in encouraging innovation requires them to be active participants abroad, whether in a position of leadership, as with the CFTC’s work with IOSCO, or a supporting role as in talks about privacy and other issues at the 2019 G-7 summit.

Stump closed her speech by mentioning the SEC’s litigation against Ripple and two executives for conducting an unregistered $1.38 billion securities offering of XRP tokens. The commissioner is watching the case closely because the determination of whether XRP is a security will help establish the scope of SEC authority over digital assets. In particular, Stump highlighted the work of SEC Commissioner Hester Peirce in discussing the application of the Howey test to digital assets. Stump also praised Peirce’s conception of a safe harbor that balances investor protection with regulatory flexibility to encourage innovation.

Tuesday, April 20, 2021

House proposal would clarify use of fallback benchmark rate language in contracts

By Mark S. Nelson, J.D.

A discussion draft of the Adjustable Interest Rate (LIBOR) Act of 2021, published by Rep. Brad Sherman (D-Calif), would ease the transition from LIBOR to another benchmark rate, the Secured Overnight Financing Rate (SOFR), under current contracts with fallback language and under contracts that do not provide for a fallback benchmark rate. The discussion draft also would clarify the tax treatment of benchmark replacements and provide for related rulemaking by the Federal Reserve and the Treasury Department.

Key provisions. The impending discontinuance of LIBOR raises many issues about how the transition to a new standard should work. The discussion draft defines key terms and provides for safe harbor regarding legal liability for contracts that have or will need to specify a benchmark replacement.

Specifically, the discussion draft provides that the selection or use of a Fed-selected benchmark replacement (i.e., based on SOFR) as a benchmark replacement would be deemed to be:
  • a commercially reasonable replacement for and a commercially substantial equivalent to LIBOR;
  • a reasonable, comparable, or analogous term for LIBOR;
  • a replacement that is based on a methodology or information that is similar or comparable to LIBOR; and
  • substantial performance by any person of any right or obligation relating to or based on LIBOR.
The discussion draft also would make conforming amendments to the Trust Indenture Act. With respect to taxation, the discussion draft would provide that the use of a Fed-selected benchmark replacement as a benchmark replacement would not be treated as a sale, exchange or other disposition of property under the Internal Revenue Code.

New York, being one of the U.S. centers for financial contracts, has pursued similar legislation. Governor Andrew Cuomo signed into law in early April S 297/A164B, which seeks to provide clarity on the transition from LIBOR to a new standard. The Alternative Reference Rates Committee (ARRC) had previously expressed support for the New York bills and likewise supported Cuomo’s decision to sign the final version of the legislation into law. Representative Sherman’s discussion draft, however, would supersede state laws and preempt any contrary state laws.

House FSC hearing. The discussion draft also was the subject of a hearing held by the House Financial Services Committee’s Subcommittee on Investor Protection, Entrepreneurship and Capital Markets, which is chaired by Rep. Sherman. House FSC Chairwoman Maxine Waters (D-Calif) observed in her opening remarks that LIBOR will cease to exist in 2023 and that a smooth transition to a new standard is also important for consumers.

"LIBOR proved to be easily manipulated when banking authorities around the globe found extensive collusion by megabanks like JPMorgan, Citigroup, Barclays, Deutsche Bank, UBS, and the Royal Bank of Scotland, to fix the LIBOR to their own advantage," said Rep. Waters. "These institutions paid billions of dollars in fines to settle their fraud, but now we need to protect consumers, investors, and the United States financial system as the markets transition away from the LIBOR."

John Coates, Acting Director of the SEC’s Division of Corporation Finance, testified that the SEC’s several divisions, including the Division of Trading and Markets and the Division of Examinations, were monitoring different types of market participants, exchanges, and counterparties. With respect to Regulation Best Interest, which broker-dealers have been required to comply with since late June 2020, Coates cautioned that broker-dealers may need to consider whether LIBOR-linked securities recommended to retail customers have sufficient fallback language regarding the LIBOR transition.

The Securities Industry and Financial Markets Association, although not appearing at the hearing alongside federal regulators, nevertheless submitted testimony for the record in support of federal legislation to aid the transition away from LIBOR. SIFMA, among other things, explained that contracts related to legacy transactions are difficult to amend because of the lack of homogeneity in cash market transactions versus swaps and futures and because of the number of negotiations that would have to occur, which may number in the hundreds or thousands.

The U.S. Chamber of Commerce also submitted comments to the subcommittee hearing. According to the Chamber, Congress should pass LIBOR transition legislation with provisions to help protect nonfinancial corporates, which the organization said have been unable to obtain SOFR-based loans from banks.

Monday, April 19, 2021

Petitioner asks SEC to clarify when NFTs are securities, recommends NFT rulemaking

By John Filar Atwood

Like initial coin offerings (ICOs) before them, non-fungible tokens (NFTs) have grown in popularity very quickly, and Arkonis Capital believes it is now time for the SEC to step in and provide guidance on whether NFTs are securities. In a rulemaking petition, Arkonis said that a concept release on how to regulate NFTs is a meaningful first step in providing guidance, but that it would only prove beneficial if it is followed by an SEC rulemaking on the regulation of NFTs.

NFTs are digital assets that use blockchain technology to establish authenticity, ownership, and transferability. NFTs can be purchased and sold peer-to-peer or on dedicated platforms but differ from other digital assets such as bitcoin because they are not fungible. Arkonis noted that NFTs are commonly associated with art, gaming, and digital collectibles.

Is it a security? The issue of when an NFT is a security is unclear, according to Arkonis. The SEC evaluates digital assets in the same manner as traditional assets to determine whether they are securities, the company noted, but unlike ICOs, NFTs have not been the subject of SEC interpretative guidance. In addition, the SEC has not initiated an enforcement action against the creator of an NFT or the operator of a platform that facilitates the offer and sale of NFTs.

According to Arkonis, the current guidance on the regulation of digital assets as securities requires a facts and circumstances-based analysis by qualified counsel to determine if an NFT is a security and if a firm’s activities require it to register as a broker-dealer, an exchange, or an ATS. This analysis is cost prohibitive to early stage companies that drive much of the innovation in the fintech space, Arkonis argued.

While the SEC has not provided guidance on when an NFT is a security, Arkonis noted that in its framework of investment contract analysis of digital assets, the SEC staff said: "The main issue in analyzing a digital asset under the Howey test is whether a purchaser has a reasonable expectation of profits (or other financial returns) derived from the efforts of others. A purchaser may expect to realize a return through participating in distributions or through other methods of realizing appreciation on the asset, such as selling at a gain in a secondary market."

Under this analysis, Arkonis argued that if an NFT relates to an existing asset and is marketed as a collectible with a public assurance of authenticity on the blockchain, it should not be deemed a security. However, if an NFT promises a return on investment from the efforts of others, the NFT could be deemed a security. If NFTs are deemed securities, Arkonis continued, then a platform facilitating the sale and secondary trading of NFTs may have to register with the SEC as an exchange.

Recommendations. All of this has created a situation that calls for the SEC to step in and provide clarity and guidance, in the company’s view. Specifically, the company recommended that the Commission publish a concept release on the regulation of NFTs. Arkonis believes that SEC rulemaking paired with an opportunity for public comment will provide guidance to parties looking to create NFTs and to facilitate the sales of NFTs.

Arkonis likened the proliferation of NFTs to the rapid rise of ICOs. However, unlike ICOs, the SEC has not published guidance on the regulation of NFTs as digital asset securities. The regulation of NFTs presents the SEC with an opportunity, Arkonis said, to satisfy its statutory duties of protecting investors, maintaining fair, orderly, and efficient markets, and facilitating capital formation by engaging in a constructive dialogue with the fintech industry on how to regulate NFTs.

Arkonis went one step further in its petition. It also requested that the Commission propose new rules to address when NFTs are securities. While SEC enforcement actions have provided some guidance on when digital assets are securities, the actions have not addressed the needs of fintech firms dealing with NFTs, the company argued. Rulemaking in this area will provide much needed clarity to the industry and would promote market integrity, capital formation, and protection of investors, Arkonis concluded.

Friday, April 16, 2021

Rapid financial collapse was enough to show SPAC misled about value

By Rodney F. Tonkovic, J.D.

A company's loss of most of its value after less than a year of existence helped persuade a district court that there was severe recklessness. The complaint said that a SPAC overstated the value of two target companies to secure approval of a merger and continued to inflate estimates afterwards. After barely a year in existence, the combined company disclosed a write-down of over 80 percent of its value. The court found that the size and seriousness of the write-down combined with other factors was sufficient to show that signers of the company's initial Form 10-K, which denied any overvaluing, acted with severe recklessness (Camelot Event Driven Fund, A Series Of Frank Funds Trust v. Alta Mesa Resources, Inc., April 14, 2021, Hanks, G.).

This action arose out of the collapse of Alta Mesa Resources, Inc. In March 2017, a special purpose acquisition company ("SPAC") called Silver Run Acquisition Corporation II completed its IPO. Under the terms of its prospectus, Silver Run had two years to acquire a target business with a value of at least 80% of the IPO proceeds ($1.035 billion). The SPAC's management targeted two oil-and-gas companies: Alta Mesa Holdings, LP ("AMH") and Kingfisher Midstream LLC in a transaction valued at $3.8 billion. The merger proxy stated that AMH and Kingfisher were "poised for accelerating growth" with significant increases in production and earnings expected by 2019. The merger was approved in early 2018 and the new combined company became known as Alta Mesa Resources.

Earnings and value plummet. Less than two months after the merger closed, Alta Mesa filed a Form 10-K and earnings release disclosing that the EBITDA and production estimates in the proxy had been nearly halved. Alta Mesa's executives nevertheless denied that this meant that AMH and Kingfisher had been overvalued in the proxy. Alta Mesa continued to post similar disappointing news as 2018 marched on, with each disclosure followed by a drop in share price. In February 2019, Alta Mesa announced that it would record impairment charges totaling $3.1 billion. After a number of delinquent filings and reports of material weaknesses in internal controls, the company filed for bankruptcy in September 2019, and the AMH and Kingfisher assets ultimately sold for $320 million.

Intentional inflation. The plaintiffs sued a total of 18 defendants including Alta Mesa and Silver Run executives and four business entities. The complaint essentially argued that the defendants intentionally overstated the value of AMH and Kingfisher's assets, using misleading reserve and financial projections to secure the approval of Silver Run's shareholders. Among other allegations, the plaintiffs said that Alta Mesa used non-standard, unsustainable drilling techniques to inflate short term profits, such as drilling too many wells too close together. These practices, and their distorting effects, continued after the merger as the company scrambled to increase production. According to the plaintiffs, Alta Mesa hoped to inflate Kingfisher's value in order to quickly spin it off in an IPO.

Enormous write-down. The fraud claims were based mainly on Alta Mesa's first Form 10-K and the later write down equivalent to over 80 percent of the company's value. The court said that the "enormity" of the write down over such a short period was sufficient for the case to proceed. Plus, the write down arrived simultaneously with news that Alta Mesa's accountants had identified sixteen material weaknesses in its internal control over financial reporting (which the SEC is investigating). The facts pleaded sufficiently showed that the defendants who signed the initial Form 10-K acted with severe recklessness, the court said. The same circumstances also satisfactorily pleaded proxy claims against five defendants who participated in the preparation and dissemination of the proxy.

The case is No. 4:19-cv-957.

Thursday, April 15, 2021

Commissioner Peirce revisits safe harbor for digital tokens

By Amy Leisinger, J.D.

SEC Commissioner Hester Peirce has released a statement on GitHub providing an updated version of her token safe-harbor proposal from February 2020. According to the commissioner, the safe harbor is designed to provide network developers with a three-year grace period within which they can facilitate participation in and the development of a decentralized network while exempted from registration provisions.

"The updated version reflects constructive feedback provided by the crypto community, securities lawyers, and members of the public," she said.

Proposal. Last year, Commissioner Peirce laid out plans for a safe harbor for network developers and tokens to address the difficulties of distributing tokens without implicating the federal securities laws. The safe harbor would allow a three-year registration exemption for network development. In a speech, the commissioner considered the issues associated with crypto-entrepreneurs building decentralized networks while attempting to ensure that their token distributions do not fall under registration obligations.

According to Peirce, the Commission’s approach made it difficult for a company to distribute a token without running into registration questions. As such, the commissioner proposed a safe harbor to address the uncertainty applicable to tokens while still protecting investors. Peirce noted that crypto-entrepreneurs are seeking to build decentralized networks in which a token serves as a means of exchange or a function on the network and that they need to get the tokens out to others.

However, she said, as the SEC applies the Howey test to determine whether a security is involved in a transaction, the distinction between the token and a potential investment contract gets blurred.

"We have created a regulatory Catch 22," Peirce opined. Networks cannot get their tokens to others because they may be deemed securities, but they cannot mature into functional, decentralized networks efforts unless the tokens are distributed and transferable, the commissioner stated.

According to Peirce, a safe harbor for networks would address the uncertainty of the application of the securities laws to tokens and achieve investor protection while still providing sufficient regulatory flexibility to support innovation. The developers would be required to undertake good faith efforts to reach network maturity and would have to disclose key information on a freely accessible website, Peirce noted. Among other things, the safe harbor requires source code and transaction history to be publicly available, she said, and the development team would have to describe the number of tokens to be issued in the initial allocation and the total number created and/or outstanding, as well as the token release schedule.

"Once the network cannot be controlled or unilaterally changed by any single person, entity, or group of persons or entities under common control, the token that operates on that network will not look like a security," she explained.

Updates. However, there is more work to be done, Peirce said. Three changes mark the updated version, according to the official. To enhance token purchaser protections, the safe-harbor proposal now requires semi-annual updates to the plan of development disclosure and a block explorer. In addition, the safe harbor proposal now includes an exit report requirement to include either an analysis by outside counsel explaining why the network is decentralized or functional or an announcement that the tokens will be registered, the commissioner explained. The exit report also would require guidance on outside counsel’s analysis on decentralization. The goal is to strike a balance between providing a manageable number of guideposts while maintaining sufficient flexibility, Peirce stated.

"Now, as a new Chairman is coming into the SEC with a new agenda, is the perfect time for the Commission to consider afresh how our rules can be modified to accommodate this new technology in a responsible manner," she concluded.

Wednesday, April 14, 2021

Squire Patton Boggs lawyers explore the emergence PropTech advancements during the time of pandemic

By Bradley Wright and Christopher Senn

As work from home arrangements have proliferated as a result of COVID-19’s social distancing realities in the past year, residential real estate markets across the nation have shown signs of resilience and growth. The authors look at how various applications and technology platforms have supported and facilitated robust activity in residential markets in an article titled COVID-19’s Acceleration of PropTech.

The authors consider various tech tools that have assisted real estate professionals and their clients in mitigating or eliminating their chances of contracting COVID-19 while searching for and showing homes during these challenging times. Some of the areas explored in the article include home matching, virtual tours, and streamlining the loan application process.

To read the entire article, click here.