Securities Snapshot: 2nd Quarter 2020
In the second quarter of 2020, the U.S. Securities and Exchange Commission and its Division of Corporation Finance continued to develop their views on public company disclosures in response to the COVID-19 pandemic. In this edition of KMK Law’s Securities Snapshot, we review more COVID-19 guidance and other SEC rulemaking related to:
- Annual meetings;
- Earnings guidance;
- Crowdfunding offerings; and
- Financial disclosures for business combinations.
We also review updates from Institutional Shareholder Services (ISS) to its proxy voting guidelines for the 2020 annual meeting season related to COVID-19 developments.
SEC Updates Annual Meeting Guidance
On April 7, 2020, the SEC updated its previous guidance issued on March 13 regarding public company annual shareholder meetings. The SEC encourages issuers to continue providing proxy materials on a timely basis, but in circumstances where delays are unavoidable due to COVID-19, the SEC will not object to an issuer using the “notice-only” delivery option in a manner that will provide shareholders with materials sufficiently in advance of the meeting, so long as the issuer announces the change in the delivery method by following the steps previously described in the March 13 guidance for announcing a change in the meeting date, process (in person, virtual or hybrid), time, or location (including virtual meetings).
The SEC also clarified that the previous guidance relating to changing the date, process, time and location of the annual meeting also applies to special meetings.
The guidance issued by the SEC can be found here.
SEC Guidance Relating to Earnings Disclosures & COVID-19 Impacts
On April 8, 2020, Jay Clayton, Chairman of the SEC, and William Hinman, Director of the SEC’s Division of Corporation Finance, issued a statement discussing the importance of disclosures related to the COVID-19 pandemic in anticipation of earnings releases and investor calls. In order to encourage more robust disclosures and shareholder engagement on this topic, the statement outlines, among others, several areas of observation and concern for companies:
- Disclosures should reflect the general contraction of the economy in response to the pandemic and that economic activity is expected to incrementally grow as additional tools are developed to combat COVID-19.
- Disclosure should be responsive to specific investor concerns relating to the current operational and financial state of the company, the development of the company’s response to COVID-19 (including efforts to protect the health and safety of customers and employees) and how the company’s operations and financial condition may change as the pandemic continues.
- Because robust, forward-looking disclosures will benefit investors, the SEC requests that companies “strive to provide, and update and supplement, as much forward-looking information as is practicable.”
Additionally, the statement encourages companies to provide detailed discussions of current liquidity positions and expected financial resource needs. The statement also advises companies to closely hold relevant information until actual disclosure, and, upon disclosure, to broadly disseminate this information to provide a sufficient level of protection for investors. Finally, the statement supports the continued use of the safe-harbors for forward-looking statements and provided that the SEC would generally not second-guess good faith attempts to provide investors properly-framed forward-looking information during this uncertain time.
The statement can be found here.
SEC Division of Corporation Finance Issues Additional Guidance on COVID-19 Disclosures in Disclosure Guidance Topic 9A
On June 23, 2020, the Division of Corporation Finance issued Disclosure Guidance Topic 9A – Coronavirus (COVID-19) – Disclosure Considerations Regarding Operations, Liquidity and Capital Resources which provides “additional views” of the Division regarding operations, liquidity, and capital resources disclosures companies should consider with respect to business and market disruptions related to COVID-19. The new guidance supplements Topic No. 9 issued in March 2020.
The new guidance provides several questions companies should consider as they prepare reports for quarters ending June 30, 2020 or after:
- What are the material operational challenges that management and the Board of Directors are monitoring and evaluating? How and to what extent have you altered your operations, such as implementing health and safety policies for employees, contractors, and customers, to deal with these challenges, including challenges related to employees returning to the workplace?
- How is your overall liquidity position and outlook evolving? Are any decreases in cash flow from operations having a material impact on your liquidity position and outlook?
- Have you accessed revolving lines of credit or raised capital in the public or private markets to address your liquidity needs?
- Have COVID-19 related impacts affected your ability to access your traditional funding sources on the same or reasonably similar terms as were available to you in recent periods?
- Are you at material risk of not meeting covenants in your credit and other agreements?
- If you include metrics, such as cash burn rate or daily cash use, in your disclosures, are you providing a clear definition of the metric and explaining how management uses the metric in managing or monitoring liquidity?
- Have you reduced your capital expenditures and if so, how? Have you reduced or suspended share repurchase programs or dividend payments? Have you ceased any material business operations or disposed of a material asset or line of business? Have you materially reduced or increased your human capital resource expenditures? Are any of these measures temporary in nature, and if so, how long do you expect to maintain them?
- Are you able to timely service your debt and other obligations?
- Have you altered terms with your customers, such as extended payment terms or refund periods, and if so, how have those actions materially affected your financial condition or liquidity?
- Are you relying on supplier finance programs, otherwise referred to as supply chain financing, structured trade payables, reverse factoring, or vendor financing, to manage your cash flow?
- Have you assessed the impact material events that occurred after the end of the reporting period, but before the financial statements were issued, have had or are reasonably likely to have on your liquidity and capital resources and considered whether disclosure of subsequent events in the financial statements and known trends or uncertainties in MD&A is required?
The new guidance also includes discussion of the impact of CARES Act assistance on companies and going concern considerations. Related questions to consider include:
- How does a CARES Act loan impact your financial condition, liquidity and capital resources? What are the material terms and conditions of any assistance you received, and do you anticipate being able to comply with them? Do those terms and conditions limit your ability to seek other sources of financing or affect your cost of capital?
- Are you taking advantage of any recent tax relief, and if so, how does that relief impact your short- and long-term liquidity? Do you expect a material tax refund for prior periods?
- Does the assistance involve new material accounting estimates or judgments that should be disclosed or materially change a prior critical accounting estimate?
- Are there conditions and events that give rise to the substantial doubt about the company’s ability to continue as a going concern?
The Disclosure Guidance can be found here.
SEC Adopts Temporary Rules to Expedite Regulation Crowdfunding Offerings Amid COVID-19 Pandemic
On May 4, 2020, the SEC announced that it would be providing temporary, conditional relief intended to expedite the offer and sale of securities to be issued by smaller companies affected by COVID-19 that are looking to meet their urgent funding needs through a Regulation Crowdfunding offering. The temporary rules apply to securities offerings initiated under Regulation Crowdfunding between May 4, 2020, and August 31, 2020.
The temporary rules allow issuers offering more than $107,000 but not more than $250,000 in securities within a 12-month period in reliance on Regulation Crowdfunding to submit financial statements and income tax returns certified by the principal executive officer of the company in lieu of financial statements reviewed by an independent public accountant. Such issuers will, however, be required to submit financial statements reviewed by an independent public accountant before the crowdfunding intermediary accepts any investment commitments in the offering. Additionally, the temporary rules eliminate the requirement that an offering statement must be publicly available for at least 21 days before the issuer closes on an investment, further expediting the offering process.
The temporary relief will be available to issuers who meet certain eligibility criteria, including the requirement that the issuer must have been organized and have had operations for no less than six months prior to the commencement of the offering. Issuers are also required to include clear disclosures (among other required disclosures) that the offering is being conducted on an expedited basis due to circumstances relating to COVID-19 and pursuant to the SEC’s temporary regulatory COVID-19 relief.
The temporary rules can be found here.
SEC Scales Back Financial Disclosures for Business Combinations
On May 21, 2020, the SEC adopted amendments to its rules and forms governing the financial information registrants are required to provide for significant acquisitions and divestitures.
The amendments, among other things:
- update the SEC’s significance tests by:
- revising the investment test to compare the registrant’s investments in and advances to the acquired or disposed business to the registrant’s aggregate worldwide market value;
- revising the income test by adding a revenue component;
- expanding the use of pro forma financial information in measuring significance; and
- conforming the significance threshold and tests for disposed businesses to those used for acquired businesses;
- modify and enhance the required disclosure for the aggregate effect of acquisitions for which financial statements are not required by eliminating historical financial statements for insignificant businesses and expanding the pro forma financial information;
- require the financial statements of the acquired business to cover no more than the two most recent fiscal years;
- permit disclosure of financial statements that omit certain expenses for certain acquisitions of a component of an entity;
- permit the use of, or reconciliation to, International Financial Reporting Standards as issued by the International Accounting Standards Board in certain circumstances;
- no longer require separate acquired business financial statements once the business has been included in the registrant’s post-acquisition financial statements for nine months or a complete fiscal year, depending on significance;
- clarify the application of rules regarding:
- the determination of significance;
- the need for interim income statements; and
- the scope of the rule’s requirements;
- amend the pro forma financial information requirements to improve the content and relevance of such information; more specifically, the revised pro forma adjustment criteria will provide for:
- “Transaction Accounting Adjustments” reflecting the application of required accounting;
- “Autonomous Entity Adjustments” to present the company as an autonomous entity if it was previously part of another entity; and
- optional “Management’s Adjustments” depicting synergies and dis-synergies;
- make corresponding changes to the smaller reporting company requirements, which also apply to issuers relying on Regulation A;
- amend the definition of “significant subsidiary” to provide a definition that is specifically tailored for investment companies; and
- add new rules to cover financial reporting for fund acquisitions by investment companies and business development companies.
While the amendments take effect on January 1, 2021, the SEC will permit voluntary compliance with the new rules before then.
The amendments can be found here.
ISS Policy Guidance Addressing the Impact of the COVID-19 Pandemic
On April 8, 2020, ISS announced updated proxy voting guidelines for the 2020 annual meeting season to address the COVID-19 related difficulties faced by companies. The major highlights of the guidelines are as follows:
- Virtual Annual Meetings – ISS does not have a policy to recommend against companies holding virtual-only meetings.
- Poison Pills – ISS emphasized that its current policy on poison pills addresses the need for adopting them in situations involving short-term potential threats—such as a pandemic like COVID-19. Current ISS policy encourages boards to put poison pills to a shareholder vote and to be less than a year in duration. Boards should provide detailed disclosure regarding their choice of duration, or on any decisions to delay or avoid putting plans to a shareholder vote beyond that period.
- Director Attendance – Most markets, including the US, have rules that count telephonic/electronic participation as full participation in board and committee meetings. However, for markets that do not, ISS will look for company disclosures to provide adequate explanations of the alternative form of attendance.
- Changes to the Board and Senior Management – Existing ISS policy provides discretion and flexibility in applying guidelines related to directors’ independence, potential overboarding, board diversity and other attributes. If boards need to fill vacancies due to the disability or incapacity of a director or need to urgently add critical expertise to their board or senior management to address concerns created by the pandemic, appropriate case-by-case consideration will be given, assessing any explanation provided by the company regarding such changes.
- Compensation – ISS encourages boards to provide disclosure to shareholders of rationales for making changes to performance metrics, goals or targets used in short-term compensation plans in response to the market drop and a possible recession. ISS will evaluate changes to long-term incentive awards on a case-by-case basis to determine whether boards exercised appropriate discretion and provided adequate disclosure of the rationale.
- Dividends – ISS will support broad discretion for boards that seek to set payout ratios that may fall below historic levels or customary market practice. In analyzing such proposals, ISS will look at whether boards disclose plans to use any preserved cash from dividend reductions to support and protect their business and workforce.
- Share Repurchases – ISS warns of potential criticism and reputational risk for companies doing share repurchases now and ISS will review board actions taken in 2020 related to share buybacks in advance of 2021 meetings to consider whether directors managed risks appropriately.
The full guidance can be found here.
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