Governance & Compliance Insider

The Securities and Exchange Commission has extended an earlier order, so that subject to certain conditions that we reported on here, public companies may have an additional 45 days from the original due date to file their Exchange Act reports that are otherwise due between March 1 and July 1, 2020. Companies relying on this relief, in compliance with the conditions imposed by the order, will preserve their eligibility to use registration statements on Forms S-3, F-3 and S-8, as long as they were current and timely in their Exchange Act filing requirements as of the first day of the 45-day of the relief period, and they file their reports due during the relief period.  In addition, those companies will be permitted to rely on Rule 12b-25 if they are unable to file the required reports on or before the extended due date.  Rule 12b-25 provide an additional 15-calendar day grace period for annual reports, and a five-calendar day grace period for quarterly reports, under certain circumstances.

Last week, the SEC issued a reminder that Regulation FD remains a vital element of the federal securities regulations. In the first enforcement action regarding Regulation FD since 2013, the SEC charged TherapeuticsMD Inc., a pharmaceutical company, with violations of Regulation FD based on its sharing of material, nonpublic information with sell-side research analysts without also disclosing the same information to the public. The SEC’s order found that on two separate occasions in 2017, TherapeuticsMD selectively shared material information with analysts about the company’s interactions with the U.S. Food and Drug Administration (FDA). One day after a publicly-announced meeting with the FDA about a new drug approval, TherapeuticsMD sent private messages to sell-side analysts describing the meeting as “very positive and productive.” TherapeuticsMD’s stock price closed up 19.4 percent on heavy trading volume the next day. At that time, the company had not issued a press release or made any other market-wide disclosure about the meeting. On the morning of July 17, 2017, TherapeuticsMD issued a press release announcing that it had submitted additional information to the FDA, but did not yet have a timeline for its new drug approval. TherapeuticsMD’s stock price declined approximately 16 percent in pre-market trading following the issuance of the press release. TherapeuticsMD held a call with and emailed sell-side analysts after the press release was issued and selectively shared previously undisclosed details about the June FDA meeting. All of the analysts published research notes containing these details, and the stock rebounded to close down only 6.6 percent for the day. The SEC order found that TherapeuticsMD, at the time of the violations, did not have policies or procedures relating to compliance with Regulation FD. Regulation FD prohibits public companies, or persons acting on their behalf, from selectively disclosing material, nonpublic information to certain persons outside the company, including institutional investors, securities analysts, and other securities professionals. Whenever a public company discloses material, nonpublic information to any such person, Regulation FD requires that the company also disclose the information to the public simultaneously. TherapeuticsMD consented to the SEC’s order without admitting or denying the findings and was ordered to cease and desist from future violations of Regulation FD and Section 13(a) of the Securities Exchange Act of 1934. The company agreed to pay a $200,000 penalty. In addition, TherapeuticsMD implemented policies and procedures which, among other things, (a) require public disclosure of material, nonpublic information in connection with Regulation FD, (b) provide examples of types of material, nonpublic information that may arise in light of TherapeuticsMD’s business model, and (c) establish specific review protocols for all external communications, including earnings calls, analyst meetings, and press releases. TherapeuticsMD also now requires Regulation FD training for employees. The TherapeuticsMD order is a good reminder that public companies should establish and follow guidelines for complying with Regulation FD when interacting with market participants, including stockholders, institutional investors, securities analysts, and other securities professionals.

On February 11, 2019, the Staff of the Division of Corporation Finance granted no-action relief permitting Johnson & Johnson to omit a shareholder proposal from its proxy statement.  The shareholder proposal requested mandatory arbitration of shareholder claims arising under the federal securities laws. The Staff relied on Rule 14a-8(i)(2), which permits exclusion of a proposal that, if implemented, would cause the company to violate any state, federal or foreign law to which it is subject.  Johnson & Johnson argued that the proposal, if implemented, would result in a violation of both federal and state law, but the SEC granted no-action relief specifically on the basis of state law.  Among the company's submissions, the Staff recognized of the legal authority of the New Jersey Attorney General, who issued an opinion that implementation of the proposal would result in a New Jersey state law violation. The decision was sufficiently significant that SEC Chair Jay Clayton issued an accompanying statement, noting that mandatory arbitration provisions have garnered a great deal of attention, and that it is a complex matter requiring careful consideration. Chairman Clayton supported the Staff's recommendation, citing the New Jersey Attorney General's submission.  Chairman Clayton also agreed with the Staff's decision not to address the legality of mandatory shareholder arbitration under federal securities laws, and he expressed the view that any SEC policy decision on this subject should be made by the Commission instead of the Staff. Rule 14a-8(i)(2) permits the exclusion of shareholder proposals that would result in a violation of any state, federal or foreign law, including but not limited to corporate and securities laws.  Other examples where the Rule 14a-8(i)(2) exception has been successfully invoked include a written consent proposal that violated state laws requiring unanimous shareholder written consent (Lowe's Companies (March 10, 2011)) and a proposal to amend governing documents to require that at least 50% of board nominees shall be minorities (Safeway Inc. (March 28, 2005)). As with Rule 14a-8(i)(1), which permits exclusion of proposals that are not proper subjects for shareholder action, the company must provide a supporting opinion of counsel when the basis for exclusion is a matter of state or foreign law, and in cases involving Delaware law, the Staff may request a legal interpretation from the Delaware Supreme Court.  The Staff will permit proponents to convert mandatory proposals into precatory proposals if the mandatory nature of the proposal creates the potential violation.

On January 10, 2019, the Division of Corporation Finance of the Securities and Exchange Commission updated its Frequently Asked Questions (FAQs) about how to handle certain filing matters during the U.S. government shutdown, which is now entering its fourth week. (See, sec.gov/page/corpfin-section-landing.) The staff revised questions 4 and 5 and added new questions 6 and 9. Question 4 was revised to emphasize that Rule 430A is only available to add pricing information to registration statements declared effective prior to the government shutdown (i.e., by December 26, 2018). Issuers whose registration statements were not declared effective before the shutdown are not eligible to use Rule 430A. Question 5 was revised to specify the “magic words” that must be included in an amendment to a registration statement to remove the delaying amendment language and start the 20-day clock to take the registration statement effective. The amendment must include the statement: “This registration statement shall hereafter become effective in accordance with the provisions of section 8(a) of the Securities Act of 1933.” Registrants who amended their registration statements to remove the delaying amendment without including the “magic words” will need to file amendments to add them. New question 6 adds clarity for registrants who have unresolved staff comments on their filings and wish to amend their registration statements to remove the delaying amendment. The staff stated that registrants could nevertheless remove the delaying amendment, but reiterated that responsibility for complete and accurate disclosure lies with the registrant and others involved in the preparation of the registration statement. Finally, new question 9 indicates that issuers may request relief under Rule 3-13 of Regulation S-X, which provides that the SEC may permit the omission of one or more of the financial statements required by Regulation S-X or the filing of appropriate substitute financial statements “where consistent with the protection of investors.” During the shutdown, however, such requests must relate to a demonstrable emergency and the protection of a significant property interest. Whether Rule 3-13 proves useful as a practical matter during the shutdown remains to be seen. Below are (1) the revised text of questions 4 and 5 with new language shown in blue text, and (2) the text of the new questions 6 and 9. Question Answer 4.  If my registration statement was declared effective prior to the shutdown (my effective date was December 26, 2018 or earlier) what happens if I don’t price my offering within the 15-day time period provided in Rule 430A?       Because your registration statement was declared effective prior to the shutdown, you are eligible to use Rule 430A and you may file post-effective amendments, as necessary, under Rule 462(c) to restart the 15-business-day period so that, at the time of pricing you will be able to include the pricing information in a 424(b) prospectus supplement. Post-effective amendments filed pursuant to Rule 462(c) are effective upon filing. Alternately, at the time of pricing, you could file a post-effective amendment under Rule 462(c), prior to the time confirmations are sent or given, to include the information omitted under Rule 430A. NOTE: You cannot rely on Rule 462(c), however, to include the pricing information if the post-effective amendment includes substantive changes from, or additions to, the prospectus in the effective registration statement. 5.  Now that the shutdown is in effect, can I file an amendment to my current registration statement to remove the delaying amendment so my registration statement will be effective in 20 days?                   Yes. If you choose to remove the delaying amendment, your registration statement will not become effective until 20 days have passed. If the SEC’s operational status does not change and you wish to further delay the effective date of your registration statement, you may file another pre-effective amendment during the 20-day period. The registration statement would not become effective until 20 days after the latest pre-effective amendment that does not include a delaying amendment. If the SEC’s operating status changes to operational and your registration statement is not yet effective, we would consider a request to accelerate to an earlier date. We may ask you to amend the registration statement to include the delaying amendment. NOTE: Simply omitting the delaying amendment from an amendment will not begin the 20-day period. [Emphasis added.] A company that intends to remove the delaying amendment must amend its registration statement to include the following language provided by Rule 473(b) - “This registration statement shall hereafter become effective in accordance with the provisions of section 8(a) of the Securities Act of 1933.” It must also amend to include all information required by the form, including the price of the securities it will sell. Rule 430A is not available in the absence of a delaying amendment because Rule 430A is only available with respect to registration statements that are declared effective by the Commission or the staff. 6.  Can I amend to remove the delaying amendment while I have outstanding, unresolved staff comments on my filings?   Yes. As in all situations, responsibility for complete and accurate disclosure lies with the company and others involved in the preparation of a company’s filings. If you amend your filing to remove the delaying amendment and our operating status changes prior to your effective date, we may ask you to amend your filing to include the delaying amendment so that we may work with you to resolve outstanding comments. 9.  Will the Division consider a request for emergency relief under Rule 3-13 of Regulation S-X?           During a lapse in appropriations, the Division’s activities are limited. The Anti-deficiency Act generally prohibits agencies from continued operation in the absence of appropriations, but contains exceptions, one of which is for emergencies involving the protection of property. Thus, an agency may act where there is some reasonable likelihood that the protection of property would be compromised, in some significant degree, by delay in the performance of the function in question. In an emergency where Rule 3-13 may provide relief for registrants, the Division may grant an application where consistent with the limitations discussed below [sic]. Submit requests to CFEmergency@sec.gov and describe the emergency and the significant property interest to be protected.   More information about the SEC's plan of operations and the effect on securities offerings, public company reporting, investment companies, and securities markets during the government shutdown can be found in our prior blog post here: governancecomplianceinsider.com/u-s-government-shutdown-impacts-sec-operations-edgar-and-other-filings-enforcement-and-regulatory-activities/, and also on Dorsey's website here: dorsey.com/newsresources/publications/client-alerts/2019/01/government-shutdown-limits-sec-operations.  

On December 26, 2018, the SEC filed a cease-and-desist order and fined ADT Inc. (“ADT”) $100,000 for its use of non-GAAP financial measures without giving equal or greater prominence to the comparable GAAP financial measures. The order serves as a reminder of the importance of the SEC’s “equal or greater prominence” rule when disclosing non-GAAP financial measures, even when comparable GAAP financial measures are also disclosed. Item 10(e)(1)(i)(A) of Regulation S-K states that when a registrant uses a non-GAAP financial measure in an SEC filing, the registrant must also present “with equal or greater prominence, … the most directly comparable financial measure or measures calculated and presented in accordance with Generally Accepted Accounting Principles (GAAP).” The requirements of Item 10(e)(1)(i)(A) are applicable to, among other filings, registration statements, quarterly and annual reports, proxy statements, as well as earnings releases. In the headline of ADT’s earnings release for the fourth quarter and full year 2017 ADT stated that adjusted EBITDA, a non-GAAP financial measure, was up 8% year-over-year. However, in violation of Item 10(e)(1)(i)(A), ADT did not also provide the comparable GAAP financial measure (net income or loss) in the headline. In ADT’s first quarter 2018 earnings release, it again presented non-GAAP measures in the headline and summary bullets without disclosure of the most directly comparable GAAP measures. In the headline of the release, ADT stated that adjusted EBITDA was up 7% year-over-year. Furthermore, in bullet points included at the top of the release under the heading “FIRST QUARTER 2018 HIGHLIGHTS,” ADT stated that its adjusted EBITDA of $620 million was up 7%, adjusted net income of $249 million was up 26%, and adjusted net income per share of $0.34 was up 10%. However, it wasn’t until the second and sixth full paragraphs of the release that ADT disclosed that its GAAP net loss had increased from $141 million for the first quarter of 2017 to $157 million for the first quarter of 2018, which is a significant difference from the non-GAAP results in the headline and summary bullets. As a result of these violations, ADT and the SEC agreed to a cease-and-desist order and an accompanying penalty of $100,000. The full text of the SEC’s cease-and-desist order is available here: sec.gov/litigation/admin/2018/34-84956.pdf.

In response to the U.S. government shutdown that began on December 22, 2018, the U.S. Securities and Exchange Commission and its Divisions of Corporation Finance and Investment Management published public guidance regarding the impacts on their operations. Although electronic filings will continue to be accepted in many cases, as described below, nearly all SEC operations, including the review and processing of filings and enforcement and regulatory functions, will be curtailed. Issuers and practitioners should make contingency plans to address the effects upon ongoing or planned securities offerings, filings, and requests for interpretive guidance, among other things. SEC operational status: Government shutdown impact The SEC published its operations plan under a lapse in appropriations and government shutdown (Securities and Exchange Commission, Operations Plan Under a Lapse in Appropriations and Government Shutdown, https://www.sec.gov/files/sec-plan-of-operations-during-lapse-in-appropriations-2018.pdf), which went into effect on December 27, 2018. During the shutdown, the SEC will have limited operations and limited staff. The SEC will retain only an extremely limited number of excepted staff members available to respond to emergencies involving the safety of human life or the protection of property, including law enforcement. Of the approximately 4,400 staff employees, fewer than 300 excepted staff remain in service during the shutdown. In summary, during the shutdown, while SEC systems will continue to accept various electronic filings and submissions, the SEC staff will discontinue: processing and approvals of ‘33 Act filings and registrations, including review and acceleration of effectiveness of registration statements; ongoing enforcement litigation, except for emergency enforcement matters; all non-emergency rulemaking, interpretive advice, and no-action letters; processing new and pending exemptive relief applications; approving applications for registration by investment advisers; processing proposed self-regulatory organization (SRO) rule changes, including NYSE and Nasdaq rule changes; responding to requests for information under the Freedom of Information Act, absent compelling need; responding to tips, complaints, or referrals, although limited staff will attempt to respond to certain critical matters, including allegations of ongoing fraud and misconduct; and responding to complaints, questions, or requests for information. In addition, while the SEC will continue to accept comment letters, the SEC anticipates that there will be delays in posting them to the SEC website. The public reference room will be closed. EDGAR Filings and Rulemaking.  The shutdown will not affect the ability to submit EDGAR filings. Additionally, SEC personnel will be able to process requests for EDGAR access codes and password resets and answer questions about fee-bearing EDGAR filings and other emergency questions regarding EDGAR submissions. The Divisions of Corporation Finance, Investment Management, and Trading and Markets, and the Office of Compliance Inspections and Examinations, however, will not process filings, provide non-emergency interpretive advice, issue no-action letters, or conduct any other normal Division and Office activities. The SEC will discontinue all non-emergency rulemaking and processing new or pending applications for exemptive relief. New or pending registration statements and applications for exemptive relief will not be processed regardless of the status of any review of those filings. The Division of Corporation Finance also published a set of Frequently Asked Questions (FAQs), discussed below, regarding Issuers’ options with respect to new and ongoing securities offerings during the shutdown. Division of Corporation Finance FAQs.  The SEC’s Division of Corporation Finance (CorpFin) has posted on its website additional guidance regarding the impact of the shutdown (See, https://www.sec.gov/page/corpfin-section-landing). A limited number of CorpFin staff members are available during the shutdown to answer questions relating to fee calculations for EDGAR filings, but will not generally be available to respond to other questions. Issuers and their representatives seeking assistance in calculating a filing fee for a filing during the shutdown should submit their requests to CFEmergency@sec.gov. CorpFin also provided a series of FAQs containing guidance with respect to ongoing and new offerings of securities during the shutdown: If a company with an effective registration statement determines it must update the information in its prospectus before commencing its offering, it should not go forward with the offering without updating the prospectus. The company must decide whether it can update the prospectus without filing a post-effective amendment because the staff will not be in a position to declare that amendment effective. Similarly, a company with a previously qualified Form 1-A that must be updated should not go forward with its offering before updating its offering statement. The staff will not be in a position to qualify a post-qualification amendment filed on EDGAR. If a company does not price its offering within the 15-day time period provided in Rule 430A, the CorpFin FAQs indicate the company may file post-effective amendments under Rule 462(c), which are automatically effective upon filing, to restart the 15-business-day period so that, at the time of pricing, the registrant will be able to include pricing information in a 424(b) prospectus supplement. As an alternative, at the time of pricing, the registrant could file a post-effective amendment under Rule 462(c), prior to the time confirmations are sent or given, to include the information omitted under Rule 430A. Registrants should note, however, that a Rule 462(c) post-effective amendment may not include substantive changes or additions to the prospectus in the registration statement at the time it became effective. The CorpFin FAQs indicate that a registrant may file an amendment to a current registration statement to remove the delaying amendment, in which case the registration statement will be effective in 20 days. The CorpFin staff notes, however, that if the SEC’s operating status changes to operational and the registration statement is not yet effective, the staff will consider a request to accelerate to an earlier date or ask the registrant to amend the registration statement to include the delaying amendment. Companies considering this approach should be aware that Rule 430A is not available in the absence of a delaying amendment. As a result, when a company amends a registration statement to remove the delaying amendment, the registration statement and prospectus must also be amended to include all information required by the applicable form, including the price of the securities being offered. A registrant may also file a new registration statement without a delaying amendment during the shutdown. Again, however, the CorpFin staff notes that, if the SEC’s operating status changes during the 20-day period prior to effectiveness, the staff may ask the registrant to amend the document to include a delaying amendment. Investment Adviser Registration Depository (IARD) system.  The SEC’s IARD system will continue to accept filings, including amendments to Form ADV, Form ADV-W, and Form ADV-E filings, but the Office of Compliance Inspections and Examinations will not approve applications for registration by investment advisers and the Division of Investment Management will not provide interpretive advice regarding the Advisers Act, rules or forms or consider applications for exemptive relief under the Advisers Act. As a result, new or pending investment adviser applications will not be processed. Division of Investment Management FAQs.  The SEC’s Investment Management (IM) also posted additional guidance regarding the impact of the shutdown (See, https://www.sec.gov/investment-management). Investment companies can continue to make filings on EDGAR during the shutdown, but the IM staff will not be available to respond to any questions about pending matters, other than answering questions relating to fee calculations for EDGAR filings. The IM guidance notes that a significant percentage of investment companies’ filings, including post-effective amendments to registration statements, become effective automatically either immediately upon filing or following the passage of a certain number of days. These filings will continue to become effective automatically in accordance with the applicable rules. The IM staff will follow the procedures established by Corp Fin, described above, with regard to the acceleration of initial registration statements and other types of filings made by registered investment companies during the federal government shutdown. Questions relating to calculating filing fees should be directed to IMEmergency@sec.gov. Central Registration Depository (CRD) and Transfer Agent Registration Systems.  The CRD system, used for broker-dealer licensing and registration, will continue to accept filings, but the Division of Trading and Markets and the Office of Compliance Inspections and Examinations will not review pending filings, consider new or pending applications or registrations, provide interpretive advice, or issue no-action letters. In addition, the staff will not be available to conduct any other normal Division and Office activities. Electronic Form Filing System (EFFS).  The EFFS will continue to accept submissions by self-regulatory organizations (SROs), but any SRO proposed rule change submitted through EFFS during the shutdown will have as its filing date the next business day after the shutdown has ended and SEC opens for regular business. Days that the SEC is operating under its shutdown plan (i.e. while the lapse in appropriations continues) will not constitute “business days” under Section 19 of the Exchange Act and Rule 19b-4 thereunder. Enforcement/Litigation.  The Division of Enforcement will have only a limited staff, and ongoing litigation, examinations, and investigative work will be suspended, except for limited emergency enforcement matters, including temporary restraining orders and/or investigative steps necessary to protect public and private property, monitoring the SEC’s “tips, complaints, and referrals” system and web-based investor complaint system, and process referrals from SROs and others to identify matters that are emergencies and take follow-up steps relating to such emergencies. The SEC also will continue Market Watch activities and continue to monitor market technology operations and any broker-dealers reported as being in financial distress. Money market fund surveillance and monitoring will also continue. The staff will also continue monitoring any international market developments that might affect the United States. Emergency Contacts.  Page 16 of the SEC’s shutdown plan contains a list of emergency contact telephone numbers and email addresses to reach an extremely limited number of Commission staff members in each office and division who are available to respond to emergency situations.

The marijuana industry is attracting considerable interest from investors, and unfortunately, scam artists trying to take advantage of those investors. In response to these concerns, on September 5, 2018, the Securities and Exchange Commission’s Office of Investor Education and Advocacy (OIEA) and Retail Strategy Task Force issued an alert to investors warning them about investment schemes involving marijuana-related companies. According to the release, the OIEA has received multiple complaints about marijuana-related businesses and the SEC is pursuing enforcement actions against some of these businesses. The release includes warnings to investors regarding investment fraud and market manipulation. The release warns investors to be wary of (1) unlicensed and unregistered sellers, (2) offers guarantying returns with little to no risk, and (3) unsolicited offers. The release also warns investors that fraud may occur through scam artists manipulating stock prices, particularly for microcap stocks. The release recommends reviewing the registration or license status of any one recommending or selling securities. Investors can utilize the free search tool on investor.gov (https://www.investor.gov/) to verify the registration status of such person. Warning signs relating to microcap marijuana-related companies include whether the SEC has recently suspended trading of the company’s stock; whether the company has changed its name, industry, or business plan multiple times; and press releases reporting information that is difficult to believe. The release also reminded investors that in January 2018, the U.S. Department of Justice issued a marijuana enforcement memorandum, and that if an investor is considering investing in a marijuana-related company, they need to understand that such company may be criminally prosecuted under federal law, and that the prosecution may impact the value of such investment. In conclusion, the SEC is advising investors to take extra precautions in performing due diligence and understanding risks before investing in marijuana-related businesses.

A recent SEC consent order against The Dow Chemical Company reminds companies that when evaluating whether or not to disclose a payment or benefit to an executive as a perk in a proxy statement, the fact that the item has a tangential business purpose, or is convenient for the company, is insufficient grounds to exclude the item as a perk.  In order to be excluded as a perk, the item must be "integrally and directly" related to the performance of the executive's duties.  Examples of items that typically should be classified as perks include country club memberships for mixed business and personal use, commuting expenses, and personal guests who join a business flight on the corporate jet. While companies may perceive individual perks as insignificant or as justifiable business expenses, these items can be significant in the aggregate, in hindsight and through a regulatory lens.  The consistent failure to disclose perks over a period of years may result in Commission sanctions and negative publicity, particularly for larger public companies and for companies who for a variety of reasons are the subject of closer Commission scrutiny. As background, on July 2, 2018, the SEC entered into a consent order against Dow, settling claims that from 2011 through 2015, the company did not adequately evaluate and disclose approximately $3 million in executive perks as "other compensation" in its proxy statements.  These authorized but undisclosed perks included personal use of the Dow aircraft and other expenses.  The consent order notes that though Dow applied procedures regarding the evaluation and disclosure of its executives' perks, it did not follow the Commission's standard regarding disclosure of perks, which provides that: • An item is not a perquisite or personal benefit if it is integrally and directly related to the performance of the executive’s duties. • Otherwise an item is a perquisite or personal benefit if it confers a direct or indirect benefit that has a personal aspect without regard to whether it may be provided for some business reason or for the convenience of the company, unless it is generally available on a non-discriminatory basis to all employees. Instead, the consent order finds, Dow incorrectly applied a standard whereby a business purpose related to the executive’s job was sufficient to determine that a benefit would not be a perquisite that required disclosure. Notably, the consent order also sanctions Dow for its disclosure controls.  According to the order, Dow did not adequately train employees in key roles, including those tasked with drafting the CD&A section of the proxy statement and compiling the executive compensation tables, to ensure that the proper standard was applied for perks disclosure.  Dow also had inadequate processes and procedures to ensure proper reporting of perks.  In addition to a $1.75 million penalty, the consent order requires Dow to hire an independent consultant for one year to review and make recommendations on Dow's policies, procedures, controls and training related to the evaluation of whether payments and other expense reimbursements should be disclosed as perks under securities laws.  

The SEC held a very busy open meeting yesterday, voting on the following final and proposed rules: Adoption of amendments to modernize the definition of “smaller reporting company,” which was established in 2008.  See our previous discussion of the amendments.   Adoption of amendments to require the use of the Inline XBRL format in certain filings, which were proposed in 2017 and have been under study for many years. The amendments require the use of the Inline eXtensible Business Reporting Language (“XBRL”) format for the submission of operating company financial statement information and fund risk/return summary information and make related changes.  Inline XBRL involves embedding XBRL data directly into the filing so that the disclosure document is both human-readable and machine-readable. Phase-in for operating companies: Large accelerated filers that use U.S. GAAP will be required to comply beginning with fiscal periods ending on or after June 15, 2019. Accelerated filers that use U.S. GAAP will be required to comply beginning with fiscal periods ending on or after June 15, 2020. All other filers will be required to comply beginning with fiscal periods ending on or after June 15, 2021. Filers will be required to comply beginning with their first Form 10-Q filed for a fiscal period ending on or after the applicable compliance date. The requirement for operating companies and funds to post XBRL data on their websites will be eliminated upon the effective date of the amendments. A proposal that would permit certain exchange-traded funds to operate without first obtaining a fund-specific exemptive order from the Commission, which is a process that has not changed since the first ETF was approved in 1992.    Adoption of amendments related to disclosures of liquidity risk management for open-end funds, which were proposed earlier this year.    A proposal to amend rules that govern the Commission’s whistleblower program.  It has been seven years since these rules were adopted. The Commission is seeking public comment and data on a broad range of issues relating to the whistleblower program, and will then consider further action on the proposal, which includes provisions: Allowing awards based on deferred prosecution agreements and non-prosecution agreements entered into by the DOJ or a state AG in a criminal case, or a settlement agreement entered into by the Commission. Providing the Commission with flexibility to increase awards on smaller actions, while decreasing larger awards.  In the Wall Street Journal, Stephen Kohn, executive director of the National Whistleblower Center, criticized the proposal, saying that scaling back payouts is tantamount to "killing the goose that lays the golden egg."  The Commission would have discretion to increase awards that could yield a payout of less than $2 million , and establish awards for enforcement actions that do not currently qualify as covered actions because they do not meet the more than $1 million threshold requirement.  Meanwhile, the Commission would have discretion to reduce larger awards, though in no event would awards be adjusted below $30 million, and awards would still be subject to the 10% statutory minimum. The SEC's related Fact Sheet notes that 40% of funds paid out by the Commission to whistleblowers have been paid out in only three awards. Eliminating potential double recoveries under the current definition of "related action." Modifying Rule 21F-2 to comport with the Supreme Court's holding in Digital Realty Trust, Inc. v. Somers, where the Court held that whistleblower provisions of the Exchange Act require that a person report a possible securities law violation to the Commission in order to qualify for protection against employment retaliation under that Rule. Increasing the efficiency of the claims review process. Clarifying and enhancing certain policies and procedures and issuing interpretive guidance to help clarify the meaning of "independent analysis" as that term is defined in Exchange Act Rule 21F-4 and utilized in award applications. An archived webcast of the meeting will be available on sec.gov

Earlier this week, Dorsey hosted a webinar panel presentation on the SEC’s recent guidance on cybersecurity disclosures and policies. The webinar provided a detailed walk-through of the SEC’s guidance, including issues related to enhanced disclosure, insider trading, and Reg FD policies. The panel also discussed the impact of the SEC’s guidance within the changing landscape of cybersecurity and current developments in shareholder litigation, SEC enforcement actions, and other regulatory and legislative initiatives such as the GDPR. The Equifax data breach is used as a case study to illustrate how the SEC’s guidance might play out in this broader context. The webinar recording and presentation materials are available on our website at www.dorsey.com/newsresources/events/videos/2018/06/seminar-playback-sec-guidance-on-cybersecurity.

Scienter has been a critical element of a claim based on Exchange Act Section 10(b) in an SEC enforcement action since the Supreme Court’s decision in Aaron v. SEC, 446 U.S. 680 (1980). It has also been a key element in private damage actions based on the cause of action implied under Section 10(b) and Rule 10b-5 since Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976). Both decisions were based largely on the text and language of Section 10(b). Section 14(e), added to the Exchange Act by the Williams Act in 1968, has also been held to require proof of scienter by the Circuit Courts – the Supreme Court has not considered the questions. Now, however, the decisions by the five Circuit Courts regarding Section 14(e) are being called into question by the Ninth Circuit. That Circuit recently examined the statutory language of Section 14(e), as well as its purpose and history, all of which lead the Court to conclude that the clause prohibiting a misrepresentation/omission only requires proof of negligence. Read more in our recent eUpdate here: www.dorsey.com/newsresources/publications/client-alerts/2018/05/ninth-circuit-rejects-decisions-of-five-other.

The Securities and Exchange Commission (the "SEC") announced Tuesday that Altaba, the entity formerly known as Yahoo! Inc., has agreed to pay a $35 million penalty to settle charges that it misled investors by failing to disclose one of the world’s largest data breaches in which hackers stole personal data relating to hundreds of millions of user accounts. According to the SEC’s order, within days of the December 2014 intrusion, Yahoo’s information security team learned that Russian hackers had stolen what the security team referred to internally as the company’s “crown jewels”: usernames, email addresses, phone numbers, birthdates, encrypted passwords, and security questions and answers for hundreds of millions of user accounts.  Although information relating to the breach was reported to members of Yahoo’s senior management and legal department, Yahoo failed to properly investigate the circumstances of the breach and to adequately consider whether the breach needed to be disclosed to investors.  The fact of the breach was not disclosed to the investing public until more than two years later, when in 2016 Yahoo was in the process of closing the acquisition of its operating business by Verizon Communications, Inc. In the order, the SEC finds that Yahoo's post-breach disclosure in quarterly and annual reports was too general, stating that the company faced only the risk of, and negative effects that might flow from, data breaches.  The company failed to disclose the actual breach or its potential business impact and legal implications. In addition to deficiencies in Yahoo's disclosure to investors, the SEC’s order found that Yahoo did not share information regarding the breach with its auditors or outside counsel in order to assess the company’s disclosure obligations in its public filings. Finally, the SEC’s order found that Yahoo failed to maintain disclosure controls and procedures designed to ensure that reports from Yahoo’s information security team concerning cyber breaches, or the risk of such breaches, were properly and timely assessed for potential disclosure. In its Statement and Guidance on Public Company Cybersecurity Disclosures, released earlier this year, the SEC reiterates that public companies are required to disclose material risks and incidents, including those related to cybersecurity, in their current and periodic reports.  The SEC encourages companies to continue to use current reports to disclose material cybersecurity-related information promptly as this practice reduces the risk of selective disclosure.  Furthermore, beyond requirements explicitly found in SEC regulations, companies are also required to disclose material information and revisit previous disclosure, especially during a cybersecurity investigation, as may be necessary to ensure the company’s filings are not misleading.  Notably, perhaps in recognition of how rapidly the scope of a breach may evolve, the SEC provides that companies “have a duty to correct prior disclosures that the company determines were untrue at the time it was made, or a duty to update a disclosure that becomes materially inaccurate after it is made.”  See our earlier memo for a summary of the SEC's guidance. In evaluating the range of potential disclosure for quarterly and annual reports, companies should consider that cybersecurity breaches or the risk of such breaches may trigger disclosure in the Management's Discussion and Analysis, if the breach presents a material event, trend or uncertainty that has had or is reasonably likely to have a material effect on results of operations, liquidity or financial condition.  Furthermore, financial statements may need to reflect costs incurred, insurance proceeds and contingent liabilities resulting from claims.  A cybersecurity breach may also need to be addressed in the description of business, discussion of legal proceedings and effectiveness of internal controls and disclosure controls and procedures. Even before the next quarterly or annual report, companies should consider whether the information available on the cybersecurity breach is material and should be communicated to investors in a current report in order to reduce the risk of selective disclosure in violation of Regulation FD.  If material information on a cybersecurity breach is not publicly disclosed in a current report, companies should consider whether it is appropriate to impose an event-specific blackout on trading in the company's stock, in accordance with applicable insider trading policies.  Determining the population of employees and other individuals who know, or in hindsight should have known, about the breach, and who should be subject to the event-specific blackout, deserves careful consideration, as demonstrated by the Equifax experience, where high-ranking executives traded in the company's stock after a cybersecurity breach was discovered but before it was announced.      

Insider trading allegations have surfaced at Equifax, a credit rating agency that last week announced a data breach that could potentially affect 143 million consumers in the United States, nearly half of the country’s population. SEC filings show that three Equifax executives sold nearly $2 million in shares of the company’s common stock days after the cyberattack was discovered but before the news was publicly announced. It was unclear whether their share sales had anything to do with the breach. None of the SEC filings list the sales as being conducted as part of pre-established 10b5-1 trading plans. Equifax said in a statement that the three executives sold a “small percentage” of their shares on August 1 and August 2, adding they “had no knowledge that an intrusion had occurred at the time they sold their shares.” Following the company’s announcement of the data breach on September 9, Equifax shares traded down by almost 14 percent. The SEC has not commented on the share sales. The developing circumstances at Equifax serve as a reminder for public companies to consider several important provisions when implementing or revising an insider trading policy. Read more in our eUpdate here: www.dorsey.com/newsresources/publications/client-alerts/2017/09/equifax-data-breach.

On Tuesday, July 25, as many practitioners probably expected, the SEC issued a warning that offers and sales of digital assets (virtual coins or tokens) by organizations using blockchain or distributed ledger technology (often referred to, among other things, as Initial Coin Offerings (“ICOs”) or Token Sales) are subject to the requirements of the federal securities laws. Depending on the offering, investors may use an established currency (e.g., U.S. dollars) or virtual currency (e.g., Bitcoin or Ether) to buy the virtual coins or tokens being offered. After they are issued, the virtual coins or tokens may be resold to others in a secondary market on virtual currency exchanges or other platforms. A blockchain or distributed ledger is an electronic ledger, or list of entries, maintained by participants in a computer network who use cryptography to process and verify transactions on the ledger, providing comfort to users and potential users that entries are secure. Examples of blockchains are Bitcoin and Ethereum, which are used to create and track transactions in the tokens known as Bitcoin and Ether, respectively. ICOs have captured significant attention recently as several enterprises, often start-up or development stage businesses, have attracted substantial investments through internet-based offerings, in some cases generating proceeds in the tens and hundreds of millions of dollars. Promoters of ICOs may tell investors that their investments will fund development of a digital platform, software, or similar projects and that the virtual tokens or coins offered may be used to access the platform, use the software, or otherwise participate in the project. Additionally, promoters and issuers may lead potential investors to expect a return on their investment or to participate in a share of the profits expected from the project. The SEC warned that, depending on the facts and circumstances of each individual ICO, the virtual coins or tokens that are offered or sold may be securities under U.S. law. If so, the offer and sale of these virtual coins or tokens in an ICO are subject to U.S. federal securities laws. Furthermore, promoters and issuers participating in unregistered ICOs may be liable for securities law violations, and any exchange providing for trading in these virtual coins or tokens may need to register as a securities exchange with the SEC. The SEC's warning was made in a Report of Investigation stemming from an Enforcement Division inquiry into whether an organization known as “The DAO” violated federal securities laws with unregistered offers and sales of “DAO Tokens” in exchange for the Ether virtual currency. By the time the offering by The DAO closed, The DAO had raised Ether valued at approximately US$150 million. The DAO has been described as a “crowdfunding contract,” but it would not have met the requirements of the Regulation Crowdfunding exemption because, among other things, it was not a broker-dealer or a funding portal registered with the SEC and FINRA. In its report, the SEC concluded that the tokens offered and sold by The DAO were securities offered and sold in the United States and therefore subject to the U.S. federal securities laws. Under the circumstances, however, the SEC decided not to bring charges or make findings of violations, but rather to caution industry and market participants to be cognizant that U.S. federal securities laws apply to anyone who offers and sells securities in the United States, whether the issuer is a traditional company or a decentralized autonomous organization and regardless of whether purchases are made using U.S. dollars or virtual currencies. Moreover, the report confirms that the use of distributed ledger technology does not affect the determination whether virtual coins or tokens are securities. The SEC's Office of Investor Education and Advocacy also issued an investor bulletin to provide information to investors about ICOs. The bulletin explains that new technologies may be used to perpetrate investment schemes that don’t comply with federal securities laws and highlights several red flags of investment fraud.

On April 10, 2017, the SEC’s Division of Enforcement brought enforcement actions against 27 individuals and entities behind various alleged stock promotion schemes. These actions arose when public companies, through promoters or communications firms, hired newsletter writers to generate publicity for their securities without publicly disclosing that the writers were being paid. While it is not illegal to hire newsletter writers, Section 17(b) of the Securities Act of 1933 (Securities Act) requires that newsletter writers fully disclose both the amount and the nature of the compensation received, including the dollar amount of a cash payment, the number of shares issued, or any other compensation. Additionally, newsletter writers and persons who adopt, approve or authorize the content of a publication may be liable for untrue statements of material facts or omissions for misleading investors. The Internet provides a ready means for fraudulent promotion of securities though social media, newsletters, chat rooms, emails, online blogs, press releases, and other media. The SEC’s Division of Enforcement is focusing attention on companies using stock promotion schemes that lead investors to believe that they were reading independent, unbiased analyses in newsletters, social media, stock forums, or other media when writers are secretly compensated for promoting a company’s securities. The SEC can bring charges against companies and promoters for these types of violations under various provisions of the Securities Act and Securities Exchange Act of 1934 (Exchange Act), including: Securities Act Section 17(a)/ Exchange Act Section 10(b) and Rule 10b-5: For, directly or indirectly, using interstate commerce to offer or sale any securities by: - employing any device, scheme or artifice to defraud; or - obtaining money or property by means of any untrue statement of a material fact or any omission to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading; or - engaging in any transaction, practice, or course of business which operates or would operate as a fraud or deceit upon the purchaser. Section 17(b) of the Securities Act: For, directly or indirectly, using interstate commerce to publish, give publicity to, or circulate any notice, circular, advertisement, newspaper, article, letter, investment service, or communication which, though not purporting to offer a security for sale, describes such security for a consideration received or to be received, directly or indirectly, from an issuer, underwriter, or dealer, without fully disclosing the receipt, whether past or prospective, of such consideration and the amount thereof. Exchange Act Section 20(b):  For aiding and abetting violations of Section 17(a) and Section 17(b) of the Securities Act and Section 10(b) and Rule 10b-5 of the Exchange Act. In addition, violations of securities laws may result in criminal prosecution. Allegations of securities law violations or association with firms that are charged with securities law violations may cause liability and embarrassment to a company and its officers, directors and employees. These violations may result in penalties, fines, imprisonment, or sanctions, including barring persons from serving as an officer or director of a public company or participating in certain securities offerings. Companies may be ultimately responsible for the investor relations work performed by investor relations, communication, social media, marketing, and other firms. Companies can take steps to avoid securities law violations by: Completing due diligence and selecting only reputable investor relations, communication, social media, marketing, and other firms to engage in investor relations activities. Limiting the use of paid newsletter writers and making sure that any compensation paid is properly disclosed. Adopting public communications policies that require authorization of company communications prior to dissemination. Carefully reviewing all materials for accuracy to ensure that the disclosure does not contain untrue statements of a material fact or omissions. Making sure that all content is consistent with the company’s public disclosures filed with regulatory agencies. Including forward looking statement and other disclaimers in all materials that are promotional in nature. Involving legal counsel, auditors and other professionals in the review of investor relations materials.

We get asked from time-to-time whether it is advisable for issuers to pay fees to unregistered “finders” for introducing potential investors in the United States to the issuer in connection with securities offerings. The short answer is “no.” Most finders are engaged by issuers under finder’s, advisory, or other arrangements, which typically require payment of “success fees” upon completion of a financing transaction. While these arrangements are sometimes structured to try to hide or disguise the true intent of the arrangement, payment of transaction-based compensation is treated by U.S. securities regulators as a nearly-conclusive indication that a person is engaged in the securities business and should be registered as a broker-dealer. The relevant U.S. federal broker-dealer laws that should be of concern to an issuer using an unregistered finder include: Section 15(a)(1) of the Securities Exchange Act of 1934 (Exchange Act), which makes it unlawful for a person to “effect a transaction in securities” or “attempt to induce the purchase or sale of, any security” unless they are registered as a broker or dealer under the rules and regulations of the Financial Industry Regulatory Authority, Inc. (FINRA). FINRA is the regulatory organization designated by the Securities and Exchange Commission (SEC) to license and regulate broker-dealers. Section 29(b) of the Exchange Act, which provides that every contract made in violation of any provision of the broker-dealer registration requirements “shall be void” as to rights of persons who made or engaged in the performance of such contract. It results in the underlying purchase of securities becoming a voidable transaction that gives the investor a right of rescission, effectively granting a put right to the investor or purchaser. Section 20(e) of the Exchange Act, under which the SEC may impose aiding-and-abetting liability on any person that knowingly or recklessly provides substantial assistance in a violation of the Exchange Act. The theory behind broker-dealer registration is to provide a gatekeeper to protect investors in the marketplace. FINRA members are required to “observe high standards of commercial honor and just and equitable principles of trade” in the conduct of its business, including determining if an investment is "suitable" for its customer. Finders assisting in transactions rarely make such determinations and view themselves simply as middlemen in making introductions to potential investors. Because unregistered broker-dealers may not adhere to these high commercial standards, the SEC broadly construes the broker-dealer laws and narrowly construes the few permitted exceptions. Under SEC guidance derived from no-action letters, the SEC requires all intermediaries effecting transactions in securities to be licensed, subject to a few limited exceptions. Effecting a securities transaction may include, among other factors, receiving transaction-based compensation, recommending a company or the purchase of its securities, negotiating terms of a securities offering or purchase, attending meetings or presentations where the merits of the investment are discussed, performing or accommodating due diligence efforts, providing valuations or estimates of value, and other activities that facilitate a securities transaction. The consequences of engaging an unlicensed finder can be troublesome: Finder Risks:  Any unlicensed person engaging in activities designed to effect a transaction in securities may violate broker-dealer laws. The SEC or state securities regulators may seek to enjoin the unlawful activities or seek monetary penalties or criminal sanctions. Issuer Risks:  Retaining and permitting an unlicensed intermediary to effect a securities transaction may be a violation of federal and many state laws, and may subject the issuer to possible civil and criminal penalties. Any person that knowingly or recklessly provides substantial assistance in a violation of the Exchange Act may be subject to aiding-and-abetting liability. Rescission Risks:  A violation of broker-dealer laws creates a right of rescission under federal and/or state securities law. The SEC or state securities regulators may require the issuer to offer investors rescission rights, and the issuer may be required to return the investment. State Securities Violations:  Many states have begun reviewing state notice filings on Form D (which report transactions exempt from registration under Regulation D) and actively monitoring finder’s fees paid in connection with securities transactions. Some states have required issuers to provide additional information related to unlicensed broker-dealers and, in some cases, to certify that finder’s fees or commissions have only been paid in compliance with broker-dealer laws. Accounting Liability Risk:  Auditors may raise accounting issues resulting from paying finder’s fees to unregistered broker-dealers and may require an issuer to account for potential liability arising from rescission rights. Bad Actor Consequences:  An issuer or finder that is convicted of any felony or misdemeanor, is subject to any order, judgment, or decree of any court, or is subject to any order of certain regulators may be ineligible to participate in certain types of securities offerings, including Rule 506 of Regulation D offerings and Regulation A offerings. Using an unlicensed finder can result in broker-dealer law violations. Many times the issue arises in the context of state notice filings and direct inquiries from state securities regulators where finder’s fees or commissions are paid in connection with an offering. Other times, they arise from a failed investment where the investor may assert claims related to broker-dealer law violations to establish a right of rescission. Issuers should use caution in determining whether to engage a finder to assist in financing transactions.

In a recent case, Wadler v. Bio-Rad Laboratories, Inc. case number 3:15-cv-02356 (2016), the federal court in the Northern District of California ruled that the plaintiff and former general counsel of Bio-Rad Laboratories could use attorney-client privileged information to support his claim of whistleblower retaliation. The court determined that the Sarbanes-Oxley Act’s whistleblower protections preempt the state ethical rules against disclosure of attorney-client privileged information. In reaching its determination, the court noted that this ruling reflects “a reasonable balancing of conflicting policies to the extent that it protects attorney whistleblowers from retaliation even as it requires them to report violations.” The jury awarded the plaintiff $8 million, including $5 million in punitive damages, finding that the plaintiff’s report of suspected payments in violation of the Foreign Corrupt Practices Act was a substantial motivating factor in Bio-Rad’s decision to terminate him in 2013 after serving as Bio-Rad’s general counsel for nearly 25 years. The SEC filed an amicus brief in support of the plaintiff’s claim, arguing that the federal whistleblower scheme would be “seriously undermined” if attorney-client privilege prevents attorney-whistleblowers from using their reports of potential violations as evidence in anti-retaliation litigation. The Wadler decision may signal a shift in judicial attitude toward the protections afforded in-house attorneys who act as whistleblowers. Previously, courts have not permitted attorney whistleblowers to use attorney-client privileged materials in litigation against their former employers. For example, in 2013, the Second Circuit Court of Appeals ruled that a former general counsel violated New York Rules of Professional Conduct when he used attorney-client privileged materials as evidence in a whistleblower retaliation suit (United States ex rel. Fair Laboratory Practices Associates v. Quest Diagnostics Inc.). The SEC has indicated a willingness to consider the extent of retaliation that a whistleblower suffers when determining the amount of the whistleblower award. In 2015, the SEC announced a maximum whistleblower award payment of 30% of the amounts collected in connection with In the Matter of Paradigm Capital Management, Inc. and Candace King Weir, File No. 3-15930 (June 16, 2014) because the whistleblower was retaliated against as a result of reporting to the SEC. If other courts follow the precedent established in Wadler, employees in general, and in-house attorneys in particular, may find it easier to support claims of whistleblower retaliation.

Over the last few months, the SEC has obtained a string of cease and desist orders against SEC reporting companies, both domestic and foreign, to enforce an often overlooked rule adopted under Dodd-Frank.  Rule 21F-17 provides that “[n]o person may take any action to impede an individual from communicating directly with the [SEC] staff about a possible securities law violation, including enforcing, or threatening to enforce, a confidentiality agreement … with respect to such communications”. Many practitioners thought little about this rule until this summer.  In recent cease and desist orders involving Health Net, BlueLinx and Anheuser-Busch InBev, the SEC has made clear that it believes that a confidentiality clause violates Rule 21F-17 if, read on its face, it would prevent an individual from voluntarily communicating with the SEC regarding potential securities law violations (something that is not “required by law”) or if the clause would require the individual to obtain anyone’s consent or provide notice to anyone in order to engage in such communications.  In other words, the SEC now views “standard” confidentiality clauses included in employment, separation, confidentiality and other agreements and policies entered into with employees and other individuals as violating U.S. federal securities laws unless they include a specific carve out allowing whistleblowing. In recent months, the SEC has imposed fines ranging from $250,000 to more than $6 million on companies using such clauses in their agreements, and required such companies to take remedial actions, including informing current and former employees of their right to communicate with the SEC regarding potential securities law violations.  In several cases, the SEC did not allege that any of the affected persons was a whistleblower or had been impeded from being a whistleblower, just that the language used in the agreements was impermissible.  The SEC has also taken the position in recent actions that any purported waiver of an individual’s right to obtain a whistleblower award from the SEC is impermissible. While the cease and desist orders have, to date, been limited to SEC reporting companies, Rule 21F-17 does not appear limited to public companies.  Accordingly, private companies subject to U.S. jurisdiction should also consider their compliance with Rule 21F-17. Because the offending language is language that many consider “standard” for employment, separation, confidentiality and other agreements, as well as corporate governance policies such as codes of conduct and ethics, many companies will need to modify their corporate governance policies and their existing and template agreements to comply with the new interpretations.  We have developed language for confidentiality clauses and corporate governance policies that is intended to comply with the SEC’s new interpretations, and have worked with a number of companies to implement compliance regimes.  For further information or for assistance in complying with Rule 21F-17, please contact the author or your other Dorsey contacts.