Securities Snapshot: 3rd Quarter 2021
Securities and Exchange Commission Chair Gary Gensler continued to intensify the Commission’s focus on insider trading and other initiatives related to ESG, SPACs, and cybersecurity disclosures in the third quarter of 2021. The Commission's Investment Advisory Committee issued recommendations for reform of Rule 10b5-1 regulation of insider trading plans. The Commission’s Division of Corporation Finance issued a sample comment letter including nine illustrative comments on climate related disclosures. Two Commission subcommittees recommended enhancing review and enforcement around SPAC disclosures. Meanwhile, the NYSE modified its related party transaction rules and Nasdaq’s recent board diversity rules have been challenged in court.
Investor Advisory Committee Recommends “Meaningful Guardrails” for 10b-5 Trading Plans
Chair Gensler warned us back on June 7, 2021 regarding his concerns with insider use of Rule 10b5-1 trading plans: “In my view, these plans have led to real cracks in our insider trading regime.” Responding to his request, on September 9, 2021, the Commission’s Investor Advisory Committee made recommendations for Rule 10b5-1 reform, particularly regarding waiting periods, mandatory disclosure, and limits on cancellation and number of plans. The subcommittee’s draft recommendation outlines three sets of recommended actions.
First, the subcommittee recommended restricting Rule 10b5-1's "affirmative defense" protection, including:
- Require a "cooling off" period of at least four months between the adoption or modification of a Rule 10b5-1 plan and the execution of the first trade under the newly adopted or newly modified plan;
- Prohibit overlapping plans (i.e., a single person or entity may not have more than one Rule 10b5-1 plan at a time).
Second, the subcommittee recommended enhancing disclosure requirements, including:
- Require electronic submission of Form 144;
- Require enhanced public disclosure of Rule 10b5-1 plans, including in proxy statements and Form 8-K;
- Enhance disclosure of 10b5-1 trades on Form 4;
- Ensure all companies with any securities listed on U.S. exchanges (including ADRs and ADSs filing Form 20-Fs) are subject to Form 4 reporting requirements.
Finally, the subcommittee encouraged the Commission to evaluate its access to information necessary to effectively monitor trading plans established under Rule 10b5-1, and to pursue regulatory action to obtain that information if not unduly burdensome to issuers and insiders.
The subcommittee’s recommendations do not apply to company repurchase plans. We could see a rulemaking proposal before the end of the calendar year.
Division of Corporation Finance Issues Sample Comment Letter Regarding Climate Related Disclosures
On September 22, 2021, the Commission’s Division of Corporation Finance published a sample letter to companies regarding climate change disclosure. The letter contains sample comments that the Division may issue to companies regarding climate change disclosure and cites disclosure areas discussed in the Commission’s 2010 Climate Change Guidance including:
- the impact of pending or existing climate-change related legislation, regulations, and international accords;
- the indirect consequences of regulation or business trends; and
- the physical impacts of climate change.
The Division stated that companies must disclose, in addition to the information expressly required by regulation, “such further material information, if any, as may be necessary to make the required statements, in light of the circumstances under which they are made, not misleading.”
The full text of the Commission’s nine sample comments are set forth in Annex A. The first sample comment (issued under the “General” heading) addresses company disclosures in corporate social responsibility reports (CSRs):
“We note that you provided more expansive disclosure in your corporate social responsibility report (CSR report) than you provided in your SEC filings. Please advise us what consideration you gave to providing the same type of climate-related disclosure in your SEC filings as you provided in your CSR report.”
Companies that have already published reports should review their existing disclosures in light the sample letter. The sample letter underscores the importance of adopting a unified approach to ESG disclosure. Whether on the company’s website, in an ESG report, or within a Commission filing, company ESG disclosures need to be prepared in the context of a framework, where the company’s ESG measures are implemented as part of a coordinated plan and integrated into disclosure across various company publications.
The second and third sample comments address risk factors, including the effects of transition risks related to climate change and material litigation risks related to climate change. The bulk of the disclosures addressed are in the fourth through ninth comments which address management’s discussion and analysis of financial condition and results of operations, including legislative developments, capital expenditures, business trends, and compliance costs, among other areas.
The Division has been issuing letters to individual companies about climate change disclosures in their most recent Form 10-K filings. The comments align with the SEC’s 2010 Guidance Regarding Disclosure Related to Climate Change and therefore may not be a complete surprise – especially in light of the statement from Commissioner Lee from earlier this year in which she directed the staff to review these disclosures.
Investor Advisory Committees Recommends Enhanced Focus on SPACs
Consistent with the Commission’s increasing focus on Special Purpose Acquisition Companies (SPACs), two Commission subcommittees have recommended enhancing focus and enforcement around SPAC disclosures.
The Investor as Owner and Investor as Purchaser Subcommittees are clearly concerned that the recent popularity of SPACs has raised investor protection issues. The subcommittees note that the Commission’s 2021 regulatory agenda includes a topic on SPACs, and that Commission staff have already taken steps to address SPAC regulatory and investor protection issues.
On September 9, 2021 the subcommittees recommended that the Commission focus on the adequacy of SPAC disclosures in the following areas:
- The role of the SPAC sponsor (and/or insiders or affiliates such as celebrity sponsors/advisors), including any potential conflicts of interest;
- The economics of the various participants in a SPAC process, including the "promote" (e.g. "founder shares") paid and their impact on dilution;
- The mechanics and timeline of the SPAC process;
- The opportunity set and target company areas of focus;
- The competitive pressure and risks involved in finding appropriate targets and reaching market acceptable prices for those companies;
- The acceptable range of terms under which any additional funding (e.g. public investment in private equity "PIPEs") might be sought at the time of acquisition/redemption;
- The manner in which the sponsor plans to assess the capability of potential targets to be a "‘34 Act company" from a governance and internal control perspective, and whether the sponsor will take any steps to ensure the target company can meet minimum preparedness/quality standards for operating as public company; and
- The minimum pre-de-SPAC diligence the sponsor will commit to regarding the accounting practices used by the target company.
In addition to enhancing focus on disclosure adequacy, the subcommittees recommend that the Commission prepare and publish an analysis of the players in the various SPAC stages, their compensation, and their incentives. Based on the results of the analysis, the Investor Advisory Committee may consider additional recommendations.
NYSE Restores Thresholds for Related Party Transactions
On August 19, 2021, the New York Stock Exchange (NYSE) filed with the Commission an immediately effective rule change restoring a transaction value and materiality threshold for related party transactions that require independent directors’ review.
Addressing concerns raised by NYSE-listed companies following previous amendments to the listing standard approved by the SEC on April 2, 2021, the new rule amends Section 314.00 of the NYSE Listed Company Manual. The previous amendments revised Section 314.00 to (i) require the audit committee or another independent body of the board of directors to conduct “a reasonable prior review and oversight” of related party transactions and (ii) defined related party transactions as transactions required to be disclosed pursuant to Item 404 of Regulation S-K. However, the prior amendments removed the transaction value / materiality thresholds under the respective provisions that excluded small and nonmaterial transactions from the disclosure requirement.
The new rule reinstates those thresholds so that the scope of related party transactions subject to independent directors’ review under Section 314.00 is again aligned with Item 404. As a result, NYSE-listed companies no longer need to identify and submit for independent directors’ review transactions that do not meet the applicable transaction value or materiality thresholds under Item 404.
Commission Approves Nasdaq Board Diversity Listing Rules; Litigation Challenge Follows
On August 7, 2021, the Commission approved Nasdaq’s board diversity listing rules. The rules require Nasdaq-listed companies to have or explain why they do not have at least two diverse directors, including one who self-identifies as female and one who self-identifies as either an underrepresented minority or LGBTQ+. Companies are also required to annually disclose statistical information on board diversity using a standardized board diversity matrix. To assist companies in identifying diverse directors, the Commission also approved rules that provide Nasdaq-listed companies with free access to a variety of board recruiting services. The rules apply to most Nasdaq-listed companies, including smaller reporting companies, and, according to Chair Gensler’s statement, “reflect calls from investors for greater transparency about the people who lead public companies.”
Nasdaq posted updated guidance on how the new listing rules’ disclosure requirements will work and the timeline for its implementation. The rules require compliance on a two-step deferred basis that provides different timeframes based on the company’s listing tier:
- Companies listed on The Nasdaq Global Select Market and The Nasdaq Global Market will need to have, or explain why they do not have, one diverse director by the later of two years of the Commission’s approval date (August 7, 2023), and two diverse directors within four years (August 6, 2025), or the date the company files its proxy statement for its annual meeting in that year. For most companies with a calendar year-end, the rules require compliance by the date on which the company files its proxy statement for its annual meeting in 2024 and 2026.
- Companies listed on The Nasdaq Capital Market will need to have, or explain why they do not have, one diverse director by the later of two years from the SEC’s approval date (August 7, 2023), and two diverse directors within five years (August 6, 2026), or the date the company files its proxy statement for its annual meeting in that year. For most companies with a calendar year-end listed on The Nasdaq Capital Market, the rules require compliance by the date on which the company files its proxy statement for its annual meeting in 2024 and 2027.
- Companies with boards of five or less directors, regardless of listing tier, will need to have, or explain why they do not have, one diverse director by the later of two years from the Commission’s approval date (August 7, 2023) or the date the company files its proxy statement for its annual meeting in that year.
- Smaller reporting companies can meet the diversity objective with two female directors, or with one female director and one director who is an underrepresented minority or LGBTQ+.
Nasdaq’s matrix will apply to proxy statements for annual meetings of calendar year-end companies starting in 2022.
Less than a month after the Commission’s approval of the Nasdaq rule, the Alliance for Fair Board Recruitment, established by legal activist Edward Blum, petitioned a federal court to overturn the Commission's approval of a Nasdaq rule that requires companies listed on its exchange to meet certain board diversity goals or explain why they haven't. Blum's group contends that Nasdaq's diversity rule itself amounts to illegal discrimination.
Commission Charges Pearson plc for Misleading Investors About Cyber Breach and Inadequate Disclosure Controls
On August 16, 2021, the Commission imposed a cease-and-desist order and a $1 million civil penalty on Pearson plc, finding violations of the negligence-based antifraud provisions of the Securities Act.
The Commission’s order finds that Pearson made misleading statements and omissions about a 2018 data breach involving the theft of student data and administrator log-in credentials of 13,000 school, district and university customer accounts. The order notes that while Pearson’s periodic filings with the Commission contained risk-factor disclosure identifying that “malicious attack[s] on our systems” could result in a “‘major data privacy or confidentiality breach,’” the company re-issued that risk-disclosure language without disclosing that precisely such a major breach had occurred just a few months earlier. The SEC also found that Pearson’s response to media inquiries concerning the breach was materially misleading, because its press statement downplayed the scale and seriousness of the breach and implied that certain types of personal data may have been obtained, when Pearson knew that such data had, in fact, been stolen.
The Commission also concluded that Pearson failed to maintain disclosure controls and procedures properly designed to analyze and assess cybersecurity incidents such that management was able to make appropriate and accurate disclosure decisions.
This Commission’s order follows its June 15, 2021 order involving First American Financial we discussed here and underscores the Commission’s focus on cybersecurity disclosures, particularly when a material cyber breach is involved.
Securities and Exchange Commission Division of Corporation Finance Sample Letter to Companies Regarding Climate Change Disclosures
The Commission has stated that a number of its disclosure rules may require disclosure related to climate change. For example and depending on the particular facts and circumstances, information related to climate change-related risks and opportunities may be required in disclosures related to a company’s description of business, legal proceedings, risk factors, and management’s discussion and analysis of financial condition and results of operations.
Companies also must disclose, in addition to the information expressly required by Commission regulation, “such further material information, if any, as may be necessary to make the required statements, in light of the circumstances under which they are made, not misleading.”
The Division of Corporation Finance selectively reviews filings made under the Securities Act and the Exchange Act to monitor and enhance compliance with applicable disclosure requirements. The following illustrative letter contains sample comments that the Division may issue to companies regarding their climate-related disclosure or the absence of such disclosure. The sample comments do not constitute an exhaustive list of the issues that companies should consider. Any comments issued would be appropriately tailored to the specific company and industry, and would take into consideration the disclosure that a company has provided in Commission filings.
We have reviewed your filing and have the following comments regarding compliance with the topics addressed in the Commission’s 2010 Guidance Regarding Disclosure Related to Climate Change, Release No. 33-9106 (Feb. 2, 2010). In some of our comments, we may ask you to provide us with information so we may better understand your disclosure. Please respond to these comments by providing the requested information and/or revising or updating your disclosure as applicable. If you do not believe our comments apply to your facts and circumstances, please tell us why in your response.
- We note that you provided more expansive disclosure in your corporate social responsibility report (CSR report) than you provided in your SEC filings. Please advise us what consideration you gave to providing the same type of climate-related disclosure in your SEC filings as you provided in your CSR report.
- Disclose the material effects of transition risks related to climate change that may affect your business, financial condition, and results of operations, such as policy and regulatory changes that could impose operational and compliance burdens, market trends that may alter business opportunities, credit risks, or technological changes.
- Disclose any material litigation risks related to climate change and explain the potential impact to the company.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
- There have been significant developments in federal and state legislation and regulation and international accords regarding climate change that you have not discussed in your filing. Please revise your disclosure to identify material pending or existing climate change-related legislation, regulations, and international accords and describe any material effect on your business, financial condition, and results of operations.
- Revise your disclosure to identify any material past and/or future capital expenditures for climate-related projects. If material, please quantify these expenditures.
- To the extent material, discuss the indirect consequences of climate-related regulation or business trends, such as the following:
- decreased demand for goods or services that produce significant greenhouse gas emissions or are related to carbon-based energy sources;
- increased demand for goods that result in lower emissions than competing products;
- increased competition to develop innovative new products that result in lower emissions;
- increased demand for generation and transmission of energy from alternative energy sources; and
- any anticipated reputational risks resulting from operations or products that produce material greenhouse gas emissions.
- If material, discuss the physical effects of climate change on your operations and results. This disclosure may include the following:
- severity of weather, such as floods, hurricanes, sea levels, arability of farmland, extreme fires, and water availability and quality;
- quantification of material weather-related damages to your property or operations;
- potential for indirect weather-related impacts that have affected or may affect your major customers or suppliers;
- decreased agricultural production capacity in areas affected by drought or other weather-related changes; and
- any weather-related impacts on the cost or availability of insurance.
- Quantify any material increased compliance costs related to climate change.
- If material, provide disclosure about your purchase or sale of carbon credits or offsets and any material effects on your business, financial condition, and results of operations.
We remind you that the company and its management are responsible for the accuracy and adequacy of their disclosures, notwithstanding any review, comments, action or absence of action by the staff.
Division of Corporation Finance
Should you have any questions or need assistance, please contact us.
James C. Kennedy
F. Mark Reuter
Allison A. Westfall
Christopher S. Brinkman
Michael W. Goldman
KMK Law articles and blog posts are intended to bring attention to developments in the law and are not intended as legal advice for any particular client or any particular situation. The laws/regulations and interpretations thereof are evolving and subject to change. Although we will attempt to update articles/blog posts for material changes, the article/post may not reflect changes in laws/regulations or guidance issued after the date the article/post was published. Please consult with counsel of your choice regarding any specific questions you may have.
© 2023 Keating Muething & Klekamp PLL. All Rights Reserved