Securities Snapshot: 4th Quarter 2020
In the fourth quarter of 2020, Nasdaq proposed “comply or explain” rules addressing board diversity while the U.S. Securities and Exchange Commission and its Division of Corporation Finance amended Management’s Discussion and Analysis disclosure requirements, financial disclosure rules, and rules related to exempt offerings. The SEC also settled its first enforcement action related to COVID-19 disclosures, proposed amendments to Rule 144, proposed amendments to Rule 701 and Form S-8, and adopted technical updates for electronic signatures. Meanwhile, Institutional Shareholder Services updated its policies on board diversity, exclusive forum bylaws and virtual meetings.
Nasdaq Rule Proposal Regarding Board Diversity
On December 1, 2020, Nasdaq submitted a proposal to the SEC to require a listed company, with some exceptions, to (a) have at least two diverse directors on its board or explain why it does not meet these objectives and (b) provide standardized disclosure on the composition of its board. The proposal would require a listed company to include on its board at least one director who self-identifies as “female” and at least one director who self-identifies as an “underrepresented minority” or “LGBTQ+”. Alternatively, the listed company may provide an explanation as to why it does not meet the composition requirement.
The proposal would require a listed company to disclose directors’ voluntary, self-identified diversity information in a Board Diversity Matrix (or similar format) in its proxy statement or website (with the opportunity to select “undisclosed” if a director declines to self-identify).
If the SEC approves the proposal, (a) the disclosure requirement would be effective one year after approval and (b) a listed company generally would need to have at least one diverse director within two years and the second diverse director within four years (for the Nasdaq Global Select Market or the Nasdaq Global Market) or five years (for the Nasdaq Capital Market) or the company must disclose why it does not meet the composition requirement.
Absent additional extension, the SEC must approve or disapprove of the proposed rules by March 11, 2021. The proposal can be found here.
SEC Rule Amendments to MD&A and Financial Disclosures under Regulation S-K
On November 19, 2020, the SEC amended certain financial disclosure requirements under Regulation S-K. The amendments eliminate the Item 301 requirement to provide selected financial data, replace the Item 302 requirement for tabular supplementary financial information with a principles-based disclosure requirement regarding material retrospective changes, and make significant changes to Item 303’s Management’s Discussion and Analysis (MD&A). The rule is linked here.
The amendments to MD&A and financial disclosure requirements follow recently effective Regulation S-K amendments applicable to the business description (Item 101), legal proceedings (Item 103) and risk factors (Item 105) we described in our third quarter publication linked here.
The SEC’s amendments eliminate the requirement in Item 301 to provide five-year comparative tabular financial data. The SEC encourages registrants to nevertheless consider whether trend information for periods earlier than those presented in the financial statements should be included as part of MD&A’s objective to “provide material information relevant to an assessment of the financial condition and results of operations” and if tabular presentation may improve an investor’s understanding of MD&A.
The amendments to Item 302 replace the current requirement for two-year quarterly tabular disclosure with a principles-based requirement for disclosure regarding material retrospective changes, such as changes in accounting principles, reorganizations, discontinued operations or corrections of errors. The amendments clarify that the disclosure of summary financial information may vary to conform to the nature of the registrant’s business and aims to eliminate duplicative disclosures.
The amendments to Item 303 emphasize the importance of materiality and trend disclosures, better enabling investors to view the registrant through the eyes of management, outline the tests for trend disclosures, and include the following changes, among others:
- Requiring registrants to describe material cash requirements and the anticipated source of funds needed to satisfy such requirements;
- Eliminating the contractual obligations table and requiring discussion of material contractual obligations as part of the discussion of liquidity and capital resources;
- Requiring disclosure of critical accounting estimates, changes in estimates, sensitivity disclosure, and related assumptions and uncertainties; and
- Providing flexibility in the interim period comparison by allowing registrants to compare their most recently completed fiscal quarter to either the corresponding quarter of the prior year or to the immediately preceding fiscal quarter.
The amended rule becomes effective February 10, 2021. Registrants are required to comply with these amendments beginning with the first fiscal year that ends on or after August 9, 2021. As such, year-end registrants will not be required to comply with the amended rules until 2022. Early voluntary compliance is permitted after the effective date as long as the registrant complies with the amended disclosure item in its entirety and in all applicable filings going forward.
For more information, you can read our blog post on the amendments here.
SEC Rule Amendments to Harmonize Exempt Offering Framework
On November 2, 2020, the SEC adopted amendments to rules under the Securities Act of 1933, as amended, in an effort to harmonize registration exemptions. The amendments generally: (a) establish more clearly the ability of issuers to move from one exemption to another; (b) increase the offering limits for Regulation A, Regulation Crowdfunding, and Rule 504 offerings, and revise certain individual investment limits; (c) set clear and consistent rules governing certain offering communications; and (d) harmonize certain disclosure and eligibility requirements and bad actor disqualification provisions. The SEC’s related press release is linked here.
Offering and Investment Limits; Investor Information. The SEC increased the annual limit on Tier 2 Regulation A offerings from $50 million to $75 million. The annual limit of $20 million for Tier 1 Regulation A offerings remains unchanged. The SEC increased the annual limits on crowdfunding campaigns from $1.07 million to $5 million and on Rule 504 offerings from $5 million to $10 million. The SEC eliminated funding limits for accredited investors in crowdfunding campaigns. Additionally, the amendments changed the financial information that issuers must provide to non-accredited investors in Rule 506(b) private placements to align with the financial information that issuers must provide in Regulation A offerings.
“Test-the-Waters” and “Demo Day” Communications. The amendments allow companies to engage in more “testing the waters” communications with investors in Regulation Crowdfunding offerings, and generally permit companies to make investor pitches during “demo days” without violating securities laws prohibitions on general solicitation.
Integration Framework. The amendments make clear that issuers will not be deemed to be in violation of the SEC’s “integration” rules, which are intended to prevent issuers from avoiding registration requirements by conducting large private offerings within a short period of time, if the issuer waits 30 days between offerings and has a reasonable belief that the issuer did not solicit each investor through general solicitation or otherwise established a substantive relationship with the investor prior to the commencement of the offering.
SEC Enforcement Action Regarding COVID-19 Disclosure
On December 4, 2020, the SEC announced that it settled charges in its first enforcement action relating to a public company’s allegedly inadequate and misleading disclosure as to the financial impacts of the COVID-19 pandemic. In a settled administrative order, the Commission found that disclosures in two press releases by The Cheesecake Factory Incorporated violated Section 13(a) of the Exchange Act and Rules 13a-11 and 12b-20. The company agreed to pay a $125,000 penalty and to cease and-desist from further violations. The SEC’s related press release is linked here.
On March 23, 2020, the company furnished a Form 8-K, disclosing that it was withdrawing previously-issued financial guidance due to economic conditions caused by COVID. As an exhibit to the Form-8-K, the company’s press release provided a business update regarding the impact of COVID. The press release reported that the company was transitioning to an “off-premise” model (i.e., delivery and to-go) that would allow the company to “operate sustainably” which was not further described. The release also disclosed a $90 million draw down on the company’s revolving credit facility, and stated that the company was “evaluating additional measures to further preserve financial flexibility.”
On March 27, 2020, the company filed another Form 8-K, disclosing that it was not planning to pay rent in April and that it was in discussion with landlords regarding its rent obligations, including abatement and deferral. The company also disclosed that as of April 1, it had reduced compensation for executive officers, its Board of Directors, and certain employees, and that it furloughed approximately 41,000 employees.
On April 3, 2020, the company furnished another Form 8-K that attached a copy of an April 2, 2020 press release. This press release provided a preliminary Q1 2020 sales update, which reflected the impact of COVID. The release stated that “the restaurants are operating sustainably at present under this [off-premise] model.”
The SEC found that the March 23 and April 3 Form 8-Ks – but not the March 27 Form 8-K – were materially misleading. The company’s disclosures on March 23 and April 3 did not disclose:
- a March 18, 2020 letter from the company to its restaurants’ landlords stating that it was not going to pay its rent for April 2020;
- that the company was losing $6 million in cash per week;
- that it had only approximately 16 weeks of cash remaining even after the $90 million revolving credit facility borrowing; and
- that it was excluding expenses attributable to corporate operations from its claim of sustainability.
In using the word “sustainably” without further qualification or explanation, issuers run the risk of being misunderstood. Clearly, this enforcement action illustrates the importance the SEC is placing on COVID disclosures. Companies should continue monitoring the impacts of COVID on their business and financial condition and craft their disclosure narratives carefully.
SEC Proposes Amendments to Rule 144
On December 22, 2020, the SEC proposed to amend Rule 144 to change the holding period determination for securities acquired upon the conversion or exchange of certain market-adjustable securities for unlisted companies so that the holding period would not begin until conversion or exchange. (The SEC’s related press release is linked here.)
The proposal would amend Rule 144(d)(3)(ii) to eliminate "tacking" for securities acquired upon the conversion or exchange of the market-adjustable securities of an issuer that does not have a class of securities listed, or approved to be listed, on a national securities exchange. As a result, the holding period for the underlying securities, either six months for securities issued by a reporting company or one year for securities issued by a non-reporting company, would not begin until the conversion or exchange of the market-adjustable securities. The proposed amendment would not affect the use of Rule 144 for most convertible or variable-rate securities transactions. Instead, it would apply only to market-adjustable securities transactions in which:
- The newly acquired securities were acquired from an issuer that, at the time of the conversion or exchange, did not have a class of securities listed, or approved for listing, on a national securities exchange registered pursuant to Section 6 of the Exchange Act; and
- The convertible or exchangeable security contains terms, such as conversion rate or price adjustments, that offset, in whole or in part, declines in the market value of the underlying securities occurring prior to conversion or exchange, other than terms that adjust for stock splits, dividends, or other issuer-initiated changes in its capitalization.
The proposal also includes several other amendments relating to Form 144, including: (i) requiring electronic filing of Form 144 for securities of issuers subject to Exchange Act reporting; (ii) eliminating the requirement to file a Form 144 for securities of issuers not subject to Exchange Act reporting; and (iii) amending the filing deadline for Form 144 to coincide with the Form 4 filing deadline.
The proposed amendments are subject to a 60-day public comment period.
SEC Proposes Amendments to Form S-8 Registration Statement and Rule 701 (Compensatory Equity Issuances)
On November 24, 2020, the SEC proposed amendments to Form S-8 (equity plan registration statements) and Securities Act Rule 701 (compensatory equity issuances by non-reporting companies). Some of the proposals would (i) clarify a company’s ability to register multiple incentive plans on a single Form S-8, and (ii) permit companies to add additional securities to Form S-8 via post-effective amendments. The proposed amendments to Rule 701 would increase the exemption limits and amend the current disclosure requirements. For both Rule 701 and Form S-8, the proposed amendments would expand (a) eligibility of certain consultants and advisors and (b) eligibility of former employees. The proposed amendments are subject to a 60-day public comment period. The proposed amendments can be found here.
Technical Updates regarding E-Signature and Form Updates
On November 17, 2020, the SEC amended Regulation S-T and the EDGAR Filer Manual, specifically amending Rule 302(b) to eliminate the requirement for executing and retaining for five years manual signature pages to SEC filings (including Forms 10-K/Q, 8-K, Schedules 13D/G, and Forms 3, 4 and 5) and instead permitting electronic signatures as long as certain procedures are followed. These amendments became effective on December 4, 2020. A link to the amendment can be found here.
Before an electronic signature is first used under the new rules to sign an SEC filing, the signatory must manually sign a consent agreeing that the use of an electronic signature in any SEC filing constitutes the legal equivalent of such individual’s manual signature for purposes of authenticating the signature to any filing for which it is provided. The company must retain this consent for at least seven years and furnish it if requested.
Finally, a reminder that Form 10-Ks filed in 2021 will be required to include an additional check box on the cover page, indicating whether an auditor assessment of the effectiveness of internal control is required.
New ISS Policies: Board Diversity, Exclusive Forum Bylaws, Virtual Meetings
On November 12, 2020, Institutional Shareholder Services (ISS) released updates to its 2021 benchmark proxy voting policies, including new policy positions on board diversity, exclusive forum bylaws, and virtual shareholder meetings. The updates apply to shareholder meetings conducted after January 31, 2021.
Board Composition: Racial/Ethnic Diversity: For 2021, ISS will highlight in its proxy research report whether a board lacks racial and/or ethnic diversity. For 2022, ISS will issue adverse vote recommendations for the chair of the nominating committee where the board has no apparently ethnically or racially diverse directors. ISS will make an exception if there was racial and/or ethnic diversity on the board at the preceding annual meeting and the board makes a firm commitment to appoint at least one racial and/or ethnically diverse member within a year. ISS provides no definitions of race or ethnicity.
Board Composition: Racial/Gender Diversity: ISS has had a policy of making adverse recommendations on the chair of the nominating committee for issuers in the S&P 1500 or Russell 3000 that have no female directors. For 2021, the only mitigating factor that ISS will accept is if an issuer had a female director at the preceding annual meeting and makes a firm commitment to having at least one female director within a year.
Shareholder Litigation Rights: Forum Selection Provisions: A ruling in 2020 by the Delaware Supreme Court allows issuers to designate the U.S. federal courts as the exclusive forum for litigation arising under federal securities laws. ISS issued a new policy in response to this ruling and will generally vote “for” management proposals to adopt a federal forum selection provision that specifies “the district courts of the United States,” but ISS will recommend “against” proposals to adopt a specific district court as the exclusive forum for such disputes.
Virtual Shareholder Meetings: In 2021, ISS will generally recommend a vote “for” management proposals allowing for the convening of shareholder meetings by electronic means, so long as the proposals do not preclude in-person meetings. ISS noted that evolving technological capabilities could provide a virtual meeting experience that sufficiently approximates an in-person meeting. ISS encourages issuers to disclose the circumstances under which virtual-only meetings would be held, and to allow for comparable rights and opportunities for shareholders to participate electronically as they would have during an in-person meeting.
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