Securities Snapshot: 3rd Quarter 2020
In the third quarter of 2020, the U.S. Securities and Exchange Commission and its Division of Corporation Finance proposed controversial rules related to investment manager reporting and adopted other highly anticipated rules and amendments related to:
- Proxy voting advice;
- Investment adviser voting;
- The definition of “accredited investor”;
- Disclosures related to business, legal proceedings, risk factors and human capital;
- Quotation of over-the-counter securities; and
- Shareholder proposals under Exchange Act Rule 14a-8.
The SEC also approved a proposal from the New York Stock Exchange that would allow companies going public through a “direct listing” to issue and sell new shares on their own behalf in the listing.
SEC Proposes Amendments to Update Institutional Investment Manager Reporting—Amendments Would Eliminate Requirements for 90% of Smaller Managers
On July 10, 2020, the SEC proposed amendments to Form 13F to update the reporting threshold for institutional investment managers and make other “targeted changes.” The SEC adopted Form 13F over 40 years ago for the purpose of requiring institutional investment managers having investment discretion over $100 million or more in publicly-held equity securities to disclose their investment activities and holdings. The SEC’s proposed amendments would increase the reporting threshold to $3.5 billion. According to the SEC’s release, the new threshold would retain disclosure of over 90% of the dollar value of the holdings data currently reported. However, it would eliminate the Form 13F filing requirement and its attendant costs for the nearly 90% of filers that are smaller managers under the proposed investment manager definition. As a result, it is estimated that 4,500 investment managers overseeing $2.3 trillion in assets would no longer have to provide the current disclosure.
The proposal also would direct SEC staff to review the Form 13F reporting threshold every five years and would eliminate the ability of managers to omit certain small positions, thereby increasing the overall holdings information required from larger managers.
The SEC has received an avalanche of comment letters from companies, investors and other constituents concerned that the proposal decreases transparency and lacks sufficient analysis.
SEC Updates Proxy Rules Applicable to Voting Advice
On July 22, 2020, the SEC adopted rules and related guidance on proxy voting advice. The rules purport to take a “principles-based” approach to the regulation of proxy voting advice and respond to calls of companies wanting more opportunity to review and respond to the voting recommendations of proxy advisors. The rules attempt to ensure that clients of proxy advisors have access to company responses prior to shareholder meetings and require proxy advisors to disclose potential conflicts of interest. Among other things, the rules:
- codify the SEC’s longstanding view that proxy voting advice generally constitutes a solicitation under federal proxy rules;
- clarify that the failure to disclose material information about proxy voting advice may constitute a potential violation of antifraud rules; and
- provide that proxy advisory firms have exemptions from certain information and filing requirements if they:
- provide conflicts of interest disclosures in their proxy voting advice or in electronic medium used to deliver the advice; and
- publicly disclose written policies and procedures reasonably designed to ensure that (i) companies that are the subject of proxy voting advice have access to the advice prior to or at the time the advice is disseminated and (ii) their clients have a mechanism by which they can be informed of written statements regarding the proxy voting advice from companies that are the subject of such rule.
The rules provide a non-exclusive “safe harbor” that satisfy this second condition. Specifically, the proxy advisory firms must provide:
- companies with their voting advice, free of charge, no later than when they send it to clients, but may condition this obligation on the requirements that companies (i) file their definitive proxy statements at least 40 calendar days before their shareholder meetings and (ii) use the advice only for their “internal purposes and/or in connection with the solicitation” and will not publish or otherwise share the advice except with the companies’ employees or advisers; and
- notice to their clients on their electronic platforms or through email or other electronic means that a company has filed, or informed the proxy advisory firms of their intention to file, additional solicitation materials setting forth the company’s response to the advice (and hyperlink to these materials if filed on EDGAR).
The safe harbor providing for prior or concurrent review of proxy voting advice will assist companies who meet the 40-calendar day definitive proxy filing schedule. Currently, many companies have to pay for or register to access reports containing proxy voting advice.
Proxy advisory firms have until December 1, 2021 to implement the new procedures. Institutional Shareholder Services continues to press ahead with its lawsuit against the SEC challenging the SEC’s authority to regulate it. As this lawsuit progresses, we may see more developments.
Supplemental Guidance for Investment Adviser Voting
The SEC also issued supplemental guidance (effective now) to investment advisers regarding their proxy voting responsibilities. Prior SEC guidance discussed how rules under the Investment Advisers Act of 1940 relate to an investment adviser’s exercise of voting authority on behalf of its clients.
The supplemental guidance will assist investment advisers in assessing how to consider company responses to recommendations by proxy advisory firms that may become more readily available to investment advisers as a result of the amendments to the solicitation rules under the Exchange Act. This includes circumstances in which the investment adviser utilizes a proxy advisory firm’s electronic vote management system that “pre-populates” the adviser’s ballots with suggested voting recommendations or for voting execution services.
To address this practice of “robovoting,” the guidance reiterates that investment advisers owe a fiduciary duty to disclose all material facts of the investment advisory relationship between the advisers and their clients, and should consider whether the use of automated voting features is a material fact that should be disclosed. The guidance also states that an investment adviser should consider whether its policies and procedures address circumstances where it becomes aware that a company intends to file or has filed additional soliciting materials with the SEC after the investment adviser has received the proxy advisory firm’s voting recommendation but before the submission deadline for proxies to be voted at a shareholder meeting.
SEC Expands Accredited Investor Definition
On August 26, 2020, the SEC adopted a rule amending the definition of “accredited investor” under Rule 501(a) of Regulation D of the Securities Act, which is one of the principal tests for determining who is eligible to participate in private offerings of securities exempt from Securities Act registration.
Specifically, the amendments (i) add new categories of natural persons that may qualify as “accredited investors” based on certain professional certifications or designations or other credentials, or their status as a private fund’s “knowledgeable employee” (as defined in Rule 3c-5(a)(4) under the Investment Company Act of 1940), (ii) expand the list of entities that may qualify as "accredited investors," (iii) add entities owning $5 million in investments, (iv) add family offices with at least $5 million in assets under management and their family clients, and (v) add the term “spousal equivalent” to the definition. The new rule also contains amendments to the “qualified institutional buyer” definition in Rule 144A under the Securities Act, expanding the list of entities that are eligible to qualify as qualified institutional buyers.
Previously, the definition of “accredited investor” generally included individuals who earned $200,000 in income over the previous two years (or $300,000 when combined with a spouse’s income), had at least $1,000,000 of net worth not including the individual’s primary residence, or were a director, executive officer, or general partner of the issuer of the securities being offered or sold. The definition will now include those individuals with certain professional certifications or designations or other credentials, whereby the SEC will consider the following non-exhaustive list of attributes:
- the certification, designation, or credential arises out of an examination or series of examinations administered by a self-regulatory organization (such as FINRA) or other industry body or is issued by an accredited educational institution;
- the examination or series of examinations is designed to reliably and validly demonstrate an individual’s comprehension and sophistication in the areas of securities and investing;
- persons obtaining such certification, designation, or credential can reasonably be expected to have sufficient knowledge and experience in financial and business matters to evaluate the merits and risks of a prospective investment; and
- an indication that an individual holds the certification or designation is made publicly available by the relevant self-regulatory organization or other industry body.
In connection with the adoption of the amendment, the SEC specifically designated the following certifications, designations, or credentials as meeting this new standard: General Securities Representative license (Series 7), the Private Securities Offerings Representative license (Series 82), and the Licensed Investment Adviser Representative (Series 65).
While the SEC was unable to quantify the number of newly eligible individual accredited investors resulting from this change that would not otherwise already meet the definition of “accredited investor,” the SEC does not expect the number to be significant.
SEC Modernizes Disclosures of Business, Legal Proceedings, and Risk Factors; Increases Focus on Human Capital
As part of its “disclosure effectiveness initiative” the SEC introduced in 2016, on August 26, 2020, the Commission amended Regulation S-K’s public company disclosure requirements related to business description, legal proceedings and risk factors. Shifting away from prescriptive disclosures to a more principles-based framework “rooted in materiality,” the amendments attempt to reflect the many changes in capital markets and the domestic and global economy in recent decades. Effective now, the amendments also attempt to reduce duplicative disclosures. According to Commission Chairman Jay Clayton, these are the first significant amendments to such disclosures in over 30 years. As expected, the amendments illustrate the Commission’s increased focus on human capital disclosures.
Description of Business
The new rules amend Regulation S-K’s Item 101(a) provisions applicable to a registrant’s disclosures on the general development of its business by:
- making it largely principles-based, requiring disclosure of information material to an understanding of the general development of the business;
- replacing the previously prescribed five-year look-back timeframe with a materiality framework; and
- permitting a registrant, in filings made after a registrant's initial filing, to provide only an update of the general development of the business focused on material developments that have occurred since its most recent full discussion of the development of its business, which will be incorporated by reference.
Regulation S-K’s Item 101(c) requirements on the narrative description of business are amended by:
- clarifying and expanding the principles-based approach, with a non-exclusive list of disclosure topic examples drawn in part from topics currently contained in the rules;
- including, as a disclosure topic, a description of the registrant's human capital resources to the extent such disclosures would be material to an understanding of the registrant’s business; and
- refocusing the regulatory compliance disclosure requirement by including as a topic all material government regulations, not just environmental laws.
The new rules amend Regulation S-K’s Item 103 disclosure requirements related to a registrant’s legal proceedings by:
- expressly stating that the required information may be provided by hyperlink or cross-reference to legal proceedings disclosure located elsewhere in the document to avoid duplicative disclosure; and
- implementing a modified disclosure threshold for certain governmental environmental proceedings resulting in monetary sanctions that increases the existing quantitative threshold for disclosure of those proceedings from $100,000 to $300,000, but that also affords a registrant some flexibility by allowing the registrant, at its election, to select a different threshold that it determines is reasonably designed to result in disclosure of material environmental proceedings, provided that the threshold does not exceed the lesser of $1 million or one percent of the current assets of the registrant.
The new rules amend Regulation S-K’s Item 105 provisions applicable to a registrant’s risk factors disclosures by:
- requiring summary risk factor disclosure of no more than two pages if the risk factor section exceeds 15 pages;
- refining the principles-based approach by requiring disclosure of "material" risk factors; and
- requiring risk factors to be organized under relevant headings in addition to the subcaptions currently required, with any risk factors that may generally apply to an investment in securities disclosed at the end of the risk factor section under a separate caption.
SEC Enhances Retail Investor Protections and Modernize the Rule Governing Quotations for Over-the-Counter Securities
On September 16, 2020, the SEC issued a final rule Publication or Submission of Quotations Without Specified Information, which amends regulations in Rule 15c2-11 of the Securities Exchange Act of 1934 with respect to the “publication of quotations for [over-the-counter (OTC)] securities in a quotation medium other than a national securities exchange.” The amendments in the final rule “are designed to modernize the Rule, promote investor protection, and curb incidents of fraud and manipulation by, among other things: requiring information about issuers to be current and publicly available for broker-dealers to quote their securities in the OTC market; narrowing reliance on certain exceptions from the Rule’s requirements, including the piggyback exception; adding new exceptions for the quotations of securities that may be less susceptible to fraud and manipulation; removing obsolete provisions; adding new definitions; and making technical amendments.”
The amendments facilitate transparency of OTC issuer information by:
- Requiring to be current and publicly available certain specified documents and information regarding OTC issuers that a broker-dealer or qualified Inter Dealer Quotation System must obtain and review for the broker-dealer to commence a quoted market in an OTC issuer’s security (“information review requirement”);
- Updating the “piggyback” exception, which allows broker-dealers to rely on the quotations of another broker-dealer that initially complied with the information review requirement, to require, among other things, that issuer information, depending on the issuer’s regulatory status, be current and publicly available, timely filed, or filed within 180 calendar days from a specified period; and
- Requiring that issuer information be current and publicly available for a broker-dealer to rely on the unsolicited quotation exception to publish quotations on behalf of company insiders and affiliates of the issuer.
The Rule will become effective 60 days following publication of the amendments in the Federal Register. The Rule will have a general compliance date that is nine months after the effective date as well as a compliance date that is two years after the effective date regarding provisions to require an issuer’s financial information for the last two fiscal years to be current and publicly available.
SEC Approves NYSE Rule Change Permitting Primary Direct Listings
On August 26, 2020, the SEC approved a proposal from the New York Stock Exchange that would allow companies going public through a “direct listing” to issue and sell new shares on their own behalf in the listing. On August 31, 2020, however, the SEC stayed this approval until further notice due to objections from the Council of Institutional Investors. While it is unclear how long the SEC will take to conduct its review, similar reviews have lasted several months.
If ultimately effective, the NYSE proposal would bolster direct listings as an alternative to traditional underwritten initial public offerings. Direct listings offer potential advantages when compared with traditional IPOs, including reduced transaction costs due to the absence of underwriters and corresponding underwriter advisory fees. Direct listings also may result in fewer restrictions on key executives and other insiders in selling their shares, due to the absence of underwriter-imposed lockup periods.
Prior to the NYSE proposal, direct listings were not available to companies seeking to raise new capital. Instead, direct listings were limited to companies seeking to provide liquidity to preexisting investors in a secondary offering. The NYSE amendments would recognize a new category of “primary direct floor listing” that would permit companies to raise capital directly, provided certain requirements were met. In particular, companies would need to meet higher market valuation requirements and satisfy NYSE’s existing initial listing requirements, which may be more difficult to satisfy within the context of a direct listing than an IPO.
To ensure a sufficiently liquid trading market in the absence of the pricing support and stabilization measures traditionally available in underwritten public offerings, companies seeking to directly list would need to meet a market valuation of $100 million to $250 million, compared with the $40 million market valuation that currently applies to IPOs. Companies seeking to directly list would also immediately have to satisfy the NYSE’s initial listing requirements, including that companies have at least 1.1 million publicly held shares, 400 round lot holders (on the NYSE, holders of 100 shares) and a price-per-share of at least $4.00. These thresholds are expected to be challenging for many private companies to satisfy without the assistance of underwriters, which in a traditional IPO ensure these requirements are met prior to listing through the book-building process.
SEC Modernizes Shareholder Proposal Rules
On September 23, 2020, the SEC raised the bar for investors to submit proposals for a vote at companies’ annual meetings by amending shareholder proposal requirements under Rule 14a-8. (The SEC’s fact sheet is here and final rule is here.) The amended rule requires shareholders to hold $25,000 of stock for one year, up from $2,000 for one year currently, in order to submit such proposals. That threshold will fall to $15,000 after two years of ownership and to $2,000 after three years, setting a sliding scale that gives priority to longer-term shareholders.
The new rule raises the percentage of votes that proposals must receive to be resubmitted. The SEC raised the levels of shareholder support a proposal must receive to be eligible for resubmission at the same company’s future shareholder meetings from 3%, 6% and 10% for matters previously voted on once, twice or three or more times in the last five years, respectively, to thresholds of 5%, 15% and 25%, respectively. In other words, a proposal would need to achieve support by at least 5% of the voting shareholders in its first submission in order to be eligible for resubmission in the following three years. Proposals submitted two and three times in the prior five years would need to achieve 15% and 25% support, respectively, in order to be eligible for resubmission in the following three years.
The new rule prohibits multiple shareholders who do not individually meet the minimum thresholds from joining together to submit a proposal. The rule now requires that a shareholder who elects to use a representative for the purpose of submitting a shareholder proposal provide documentation to make clear that the representative is authorized to act on the shareholder’s behalf and to provide a meaningful degree of assurance as to the shareholder’s identity, role and interest in a proposal that is submitted for inclusion in a company’s proxy statement. A shareholder proponent will no longer be permitted to submit one proposal in his or her own name and simultaneously serve as a representative to submit a different proposal on another shareholder’s behalf for consideration at the same meeting. Similarly, a representative will no longer be permitted to submit more than one proposal to be considered at the same meeting, even if the representative were to submit each proposal on behalf of different shareholders.
Under the new rule a shareholder proponent must state that he or she is able to meet with the company, either in person or via teleconference, no less than 10 calendar days, nor more than 30 calendar days, after submission of the shareholder proposal, and provide contact information as well as specific business days and times that the shareholder is available to discuss the proposal with the company.
While the new rules are effective 60 days after publication in the Federal Register, they apply to shareholder proposals submitted for an annual or special meeting held after December 31, 2021. However, the final rules provide for a transition period with respect to the ownership thresholds that will allow shareholders meeting specified conditions to rely on the $2,000/one-year ownership threshold for proposals submitted for an annual or special meeting to be held prior to January 1, 2023.
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