Friday, October 15, 2021

CorpFin officials provide updates on Division’s powerhouse agenda

By Lene Powell, J.D.

SEC officials from the Division of Corporation Finance provided updates at the SEC Speaks conference on the Division’s jam-packed agenda, including in the areas of SPACs, issues around Chinese companies, 10b5-1 trading plans, proxies and proxy advice, and disclosures relating to climate, human capital and diversity, among many other topics.

The SEC Speaks conference was sponsored by the Practising Law Institute (PLI). The Division of Corporation Finance panel was held October 12 and was moderated by Renee Jones, director. Panelists included Tamara Brightwell, associate director; Lisa Kohl, acting deputy director; Betsy Murphy, associate director; Michelle Anderson, associate director; and Michael Seaman, acting chief counsel.

SPACs. SPACs are a major area that the SEC is looking at for rulemaking, given a large rise in the number of these public offerings. Michelle Anderson noted that Chair Gensler is concerned whether SPAC investors, particularly retail investors, are appropriately protected in the current regime.

Given the complexity of information in this area, staff is looking at:
  • Are investors able to understand the cost of investing in SPACs?
  • Are SPAC providing clear disclosure about how the SPAC will seek to identify acquisition targets and evaluate the period of time in which it intends to complete a business combination transaction, and any conflicts of interest that may be present?
  • Are SPACs providing clear disclosure about fees the SEC sponsors and affiliates are receiving the value of the sponsors’ interest in the combined company, and the potential dilution that investors will face at various levels of redemption? In particular, SPACs should describe how the terms of warrants issued to sponsors differ from those of public warrants included in the offered IPO units, and the dilutive effects of sponsors warrants. Also, if a SPAC plans to seek or has obtained additional funding by selling securities and private offerings, it should disclose how the terms of those securities issued or to be issued compared to the terms of the securities offered in the IPO.
  • Are investors able to understand the risks associated with the potential conflict of interest and incentives of the SPAC sponsors and other SPAC insiders?
  • Are there ways to improve the quality of other disclosures, including the use of projections?
  • What is the potential for regulatory arbitrage associated with going public via de-SPAC, and the lack of traditional gatekeepers that are normally present in traditional methods of going public?
China. According to Renee Jones, the SEC is focused on making sure that the filings of China-based issuers contain clear and prominent disclosure about the risks associated with investing in those companies. In particular, there are special disclosure considerations when there are Variable Interest Entities (VIE) involved.

Lisa Kohl noted that Chair Gensler issued a statement at the end of July on investor protection issues, highlighting recent regulatory developments and the continued use of the VIE structure. Companies often use VIEs to structure around restrictions on foreign ownership in certain industries and businesses in China. Investors may not understand VIEs well, and the SEC is trying to elicit better disclosure on that.

SEC staff has been issuing several areas of comments about the Chinese regulatory environment and the VIE structure, said Kohl.
  • On the Chinese regulatory environment, the SEC is looking for disclosures around recent government led cybersecurity reviews. The SEC is also asking companies to state explicitly whether they have all requisite permissions necessary to operate from entities like the CSRC and the cyberspace administration of China, and to state explicitly whether any permissions have been denied.
  • Another regulatory aspect is limitations on the PCAOB’s ability to inspect China based issuers auditing firms. Under the Holding Foreign Companies Accountable Act (HFCAA), the trading prohibitions that companies using audit firms and jurisdictions that the PCAOB determined that cannot fully inspect and investigate will incur starting in 2024. The SEC is looking for disclosure around this.
  • Further on the HFCAA, the PCAOB adopted a new rule at the end of September which sets forth the framework that the PCAOB will use to determine which jurisdiction is enabled to investigate and inspect completely. That rule now moves to the commission for approval under the 19d-4 process. Chair Gensler has been clear that expects that those determinations should be able to be made by the end of this calendar year, and that there will be list of the jurisdictions that the PCAOB determines they cannot effectively investigate completely.
  • In addition, the Commission adopted interim final amendments to implement the disclosure and submission requirements and the HFCAA. Kohl would expect that the Commission will come up with the list of identified issuers in 2022 once the 2021 annual reports are filed.
  • On VIEs, given the importance of the VIE structure and attendant risks, the SEC is looking for prominent disclosure earlier in the document.
  • The disclosure should allow investors to understand that oftentimes they are investing in a shell company incorporated often in the Cayman or British Virgin Islands, and that this shell company listed company often has only service and other contractual arrangements with the Chinese operating company.
  • The disclosure should also highlight that regulatory authorities in China could disallow this structure, which would result in a material change to the company's operations, and very likely a material adverse effect on a company's share price.
  • The price of ADS is a related issue for the VIE structure. The SEC is asking companies to provide more disclosure about how cash and earnings are transferred through the organization, and an explicit disclosure about whether transfers dividends or distributions have been made to date from the VIE. The SEC wants it to be readily apparent to investors where the assets of the collective company structure are and how hard they would be to reach if, for example, the VIE structure was disallowed.
Climate. Kohl noted that former Acting Chair Allison Herren Lee had instructed the staff to review companies’ climate-related disclosures. Betsy Murphy expanded on this public comment, that the SEC received more than 550 unique comment letters in response. Most of commenters supported mandated climate disclosure rules, and many cited a need for more consistent and comparable disclosure on climate-related risks and opportunities.

Following on the request for public input on climate, Chair Gensler has said he wants to have a proposed rule available. He has asked staff to specifically consider, consistent with commentary input, a number of areas in formulating recommendations. For example:
  • Whether the disclosures should be included in a company's annual report on Form 10k;
  • How qualitative disclosures could answer key questions about how a company's leadership manages climate-related risks and opportunities, and how these factors feed into the company's strategy.
  • The types of quantitative disclosures that the rules should require, such as those related to greenhouse gas emissions, financial impacts of climate change and progress towards climate related goals and greenhouse gas emissions disclosure.
  • How companies might disclose their Scope One and Scope Two emissions, and whether they should have to disclose Scope Three emissions as well.
  • Whether there should be industry specific metrics, such as for the banking, insurance or transportation industries.
  • Whether companies should provide scenario analyses on how their businesses might adapt to the range of possible physical, legal market and economic changes that they might have to contend with in the future.
Turning to currently existing disclosures, Kohl noted that staff released a “Dear Issuer” letter that provided examples of the types of climate related comments that staff may issue in the course of filing reviews. Although the sample comments are not an exhaustive list, a particular area of focus is if companies provide more expansive disclosure in Corporate Social Responsibility reports or CSR report, than in Commission filings. Staff is looking to see if a company has not provided disclosure about applicable legislative and regulatory developments or climate-related expenditures, and if those perhaps might be important to the company. This may arise when many of the companies in the same industry discuss or disclose a particular regulation. If a company that hasn't mentioned it, staff may ask for analysis on that, said Kohl.

Kohl also highlighted as a practice point that as companies craft their disclosures, they really should consider the commission’s 2010 guidance on climate. Many of the comments in “Dear Issuer” letter really track and are consistent with issues that the Commission raised in 2010, said Kohl.

Anderson noted that the SEC’s International Corporate Finance Office (OICF) has been actively engaged in the initiative of the International Financial Reporting Standards or IFRS foundation to establish an International Sustainability Standards Board, through the SEC's membership and participation in IOSCO. The SEC’s participation at this point involves technical preparatory work, such as providing guidance on the development of a prototype that could serve as a basis for reporting standards. However, any disclosure standards eventually to be issued by the Standards Board would be subject to its own due process, said Anderson.

Human capital and diversity. Turning to another area of ESG disclosures, Murphy said staff is working hard to develop recommendations on human capital disclosure. As with climate, the SEC has heard that investors want more consistent and comparable disclosures to enable them to compare company's management of their human capital resources. Some of the factors the SEC is considering for more tailored disclosure include workforce turnover, skills and development training, compensation benefits, workforce demographics, including diversity, health and safety.

Another area in the “Social” column of ESG relates to diversity of board members and nominees. Some investors have called for enhancement of the Reg S-K Item 407 disclosure. Currently, the rule requires information about whether and if so, a board’s nominating committee considers diversity in identifying director nominees. This item requires additional disclosure if the company has a policy regarding its consideration of diversity. Some institutional investors have asked for rule changes that would require companies to present information about their director nominees’ gender, race and ethnicity in a structured format, said Murphy.

Cybersecurity. The Division is also considering recommendations in the area of cybersecurity, said Murphy. Given the frequency, magnitude and cost of cybersecurity incidents, it is critical that companies inform their investors about their cybersecurity risk governance practices and provide timely disclosure about material cyber security risks and incidents. Both the division and the commission have issued interpretive guidance on cyber security in the past, and the Division is considering whether the commission should adopt rules that would be helpful in this area, said Murphy.

10b5-1 trading plans. Murphy explained that about 20 years ago, the Commission adopted Exchange Act Rule 10b5-1, which provides an affirmative defense for corporate insiders and companies to buy and sell stock under prearranged trading plans, as long as they adopt these plans in good faith before becoming aware of material nonpublic information.

Currently there are no mandatory disclosure requirements, said Murphy. Chair Gensler has expressed concern that these plans have led to gaps in the SEC's insider trading enforcement regime. Accordingly, the Division is considering whether more disclosure regarding the adoption and modification of Rule 10b5-1 plans by individuals and companies could enhance investor confidence.

Staff is considering several recommendations in this area, including:
  • Whether there should be a limit on the number of 10b5-1 plans that insiders can maintain.
  • Whether there should be a “cooling off” period. Sometimes insiders or companies trade as early as the same day they adopted the 10b5-1 plan. Staff will consider whether they should be subject to mandatory cooling off period before they can make their first trade. Some have suggested four to six months is the appropriate length of a cooling off period, said Murphy.
Proxies and proxy advice. Michelle Anderson gave an update on rulemaking work in the area of proxies and proxy advice.

Regarding universal proxies, the adoption of final rule for universal proxies is on the Commission's short term Regulatory Flexibility agenda, said Anderson. The Commission proposed rules back in 2016 that would require that all issuer and dissident nominees be presented on a universal proxy card, allowing shareholders to vote by proxy for any mix of director nominees—just as they could if they attended the meeting in person. The proposed rules also would establish new procedural and other requirements for director elections.

Given developments in corporate governance since 2016, the Commission reopened the comment period for the 2016 proposal earlier this year to solicit additional public input on the proposed rules. The SEC received more than 30 comment letters. Most commenters generally supported the adoption of the universal proxy rules, including a mandatory use of universal proxy cards. Support for universal proxy cards appears to have grown since 2016, said Anderson.

The minimum solicitation threshold for using universal proxy cards continues to be an area of commentary, with some commenters recommending a threshold greater than what was proposed back in 2016, which was a majority of voting power entitled to vote on the election. The SEC also received strong views on whether investment companies and business development companies should be subject to the final universal proxy rules. Staff is considering all of these views and actively working on finalizing the rules for the Commission's consideration, said Anderson.

Turning to proxy advice rules, Anderson noted that Chair Gensler has directed staff to review the rules for proxy voting advice that the Commission adopted in 2020. The 2020 rules were designed to ensure that clients of proxy voting advice businesses have reasonable and timely access to transparent, accurate and materially complete information on which to make voting decisions. However, some commenters continue to express concerns that the 2020 rules expose proxy voting advice providers to increase litigation risks, impose increased compliance costs on those businesses, and impair the independence of proxy voting advice. Staff is considering these views and formulating recommendations for next steps.

Other rulemakings. Other areas of rulemaking include:
  • Share repurchases. Currently, the SEC requires quarterly disclosure about issuers share repurchases pursuant to Regulation S-K Item 703, which was adopted in 2003 and has remained unchanged since then. Given that share repurchase activity has increased in recent years, staff is considering how to update and enhance this disclosure.
  • Rule 144. Amendments to Rule 144 were proposed in December 2020 regarding Form 144 and well as risk of unregistered distributions in connection with sales of securities acquired Upon the conversion or exchange of certain market adjustable securities. Some comments in response to the release describe market adjustable securities as manipulative and abusive, while others expressed concern about eliminating a source of funding for companies that may not have any other borrowing options.
  • Filing fee disclosure rules and fee payment methods. This would consolidate the filing fee information needed to calculate the fees the companies and funds paid in connection with their registration statements and other transactions. After an extended transition period, the idea would be to require a structuring of that fee information to move the fee process from a highly manual process to an automated one. Also, rather than having the filing fee tables on the cover pages of filings, the Divisions recommended that that information moved to an exhibit to the filings.
  • Clawbacks and pay versus performance. Proposing releases in these areas were issued in 2015. To start the process of implementing those provisions of the Dodd Frank act, staff is considering next steps on both of those sets of rules.
  • Exempt offerings. The Division is considering recommending that the Commission seek public comment on ways to further update the Commission's rules related to exempt offerings.
  • Payments on resource extraction, on which the Commission adopted rules in late 2020.
Beneficial ownership modernization. Chair Gensler has directed staff to consider ways to enhance market transparency, including through revisions to the current beneficial ownership, record reporting requirements and regulation 13d-g. Some view the 10-day initial filing deadline. Another commonly raised issue that some have strong views on is the application of the beneficial ownership rules to security based swaps and other derivatives.