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Clayton Cites Shareholder Proposal and Proxy Advisory Firm Reforms as Priority Items for the SEC

In a wide ranging speech yesterday on SEC rulemaking, Chairman Clayton stated that after disregarding the more “aspirational” approach of past administrations, the SEC’s changed its approach to tailoring the 2018 Regulatory Agenda to the initiatives that the agency could reasonably complete in the next 12 months.  This led to the Commission advancing 23 of the 26 rules cited in the 2018 agenda.

Among the many significant initiatives for 2019 that the Chairman listed as priority items for the Commission included the proxy process, with an indication that he is interested in reforms, as he addressed:

Reviewing the ownership and resubmission thresholds for shareholder proposals.  
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SEC to Consider Request for Comment on Earnings Releases and Quarterly Reports

The SEC issued a Sunshine Act Notice for an open meeting next Wednesday, December 5, where they will consider whether to issue a Request for Comment on the nature and content of quarterly reports and earnings releases issued by reporting companies.  The open meeting will start at 10:00 a.m. (ET) and will be webcast.

As reported by media, President Trump asked the SEC in August to study the possibility of requiring less frequent earnings reporting.  It has also been reported that Chairman Clayton may be inclined to explore reducing the demands on companies with revenues under $1 billion, as part of the SEC’s initiatives to ease burdens on smaller reporting companies.
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Davis Polk Submits Comment Letter on the SEC’s Concept Release on Compensatory Security Offerings Under Rule 701 and Form S-8

Davis Polk has submitted a comment letter on the SEC’s Concept Release on Compensatory Securities Offerings under Rule 701 and Form S-8. Our comment letter focuses on expanding the scope of eligibility for Rule 701 to cover “gig economy” workers and making corresponding changes to the scope of eligibility for Form S-8; streamlining Rule 701 disclosure requirements for foreign private issuers; clarifying disclosure requirements for RSU and profits interests awards made under Rule 701; and simplifying Form S-8 requirements to reduce administrative burdens on issuers.
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Senator Warren Introduces Bill to Mandate Disclosure of Climate Risk in SEC Filings

The Climate Risk Disclosure Act, introduced by Senator Warren, would require the SEC to issue rules for every public company to disclose:

  • Its direct and indirect greenhouse gas emissions
  • The total amount of fossil-fuel related assets that it owns or manages
  • How its valuation would be affected if climate change continues at its current pace or if policymakers successfully restrict greenhouse gas emissions to meet the Paris accord goal; and
  • Its risk management strategies related to the physical risks and transition risks posed by climate change

The SEC can tailor the rules to different industries, and impose additional requirements on companies in the fossil fuel industry.
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Senator Warren’s Accountable Capitalism Act Modeled on the Public Benefit Corporation

The Accountable Capitalism Act, introduced by Senator Warren, would require companies with more than $1 billion in revenue to obtain federal charters from a newly formed Office of United States Corporations at the Department of Commerce.  As explained in a WSJ op-ed, Senator Warren is concerned that companies have shifted to focusing solely, or largely, on being accountable to shareholders through maximizing returns for owners.

Under the federal charter, directors of these companies must consider the interest of all stakeholders, including not only shareholders but also employees, customers and the communities in which the companies operate.  Specifically, a U.S. corporation must have the purpose of creating a “general public benefit,” meaning a material positive impact on society resulting from the business and operations of the company, taken as a whole.
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What Corp Fin’s Two New Interpretations on Exempt Solicitations Tell Us

At the end of July, the SEC Division of Corporation Finance issued two interpretations (known as CDIs) on notices of exempt solicitations.  These are the filings that may suddenly show up on a company’s Edgar page, confusingly called “PX14A6G.”  For example, after filing its proxy statement in April, Facebook received four such notices from different investors.  Three urged the company’s shareholders to support their shareholder proposals while one asked shareholders to withhold on the election of the company’s CEO to the board.

Notices of exempt solicitations have been around for some time, but during this season, the notices submitted by retail investors begin to attract attention. 
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SEC Staff to Host Roundtable on the Proxy Process

SEC staff will host a roundtable this fall to hear from issuers and investors about whether to change the proxy process.  Chairman Clayton has asked the staff to consider the following items as potential topics for consideration, many of which were discussed in the 2010 concept release. No final agenda or date has been announced yet.

Proxy Voting

  • Under- and over-voting, why they occur and how they can be addressed
  • Confirming votes have been cast in accordance with investor instructions
  • Costs and challenges of communicating with beneficial owners, especially through intermediaries

Retail Participation

  • How to increase retail voting from the current participation rate of 29%
  • How to allow retail investors who hold shares through mutual funds or pension funds to affect governance of public companies, such as having a role in how mutual funds vote
  • Whether low retail participation should be a cause for concern and should inform analysis of existing regulation

Shareholder Proposals

  • Whether the current ownership thresholds for submitting proposals should be changed
  • Resubmission thresholds when the same shareholder proposals do not receive requisite levels of approval
  • Possibility of other ways to show meaningful ownership of securities other than ownership amount and length of holding period
  • Whether long-term retail holders who hold through ETFs and mutual funds are appropriately represented

Proxy Advisory Firms

  • Whether factors such as legal requirements have caused overreliance on the firms for data aggregation and voting recommendations
  • Whether companies have sufficient opportunities to raise concerns, especially related to errors
  • Whether there is sufficient transparency so that it is clear how the firms reach their voting recommendations
  • Whether there are conflicts of interest with respect to consulting services and how they are disclosed and mitigated
  • The appropriate regulatory regime for the firms and whether prior staff guidance should be changed

Technology

  • How technology can be used to make the proxy process more efficient
  • Potential benefits and consequences of relying on technology such as blockchain

Other

  • References the 2016 proposed rules on universal proxy cards but left unsaid how the roundtable may address them

Electronic comments may be submitted in advance by using the SEC’s internet submission form or sending an email to rule-comments@sec.gov.  
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SEC Publishes Final Rule and Concept Release on Equity Compensation Offerings

On July 18, 2018, the SEC voted unanimously both to issue a final rule and to solicit public comment through a concept release relating to the federal securities rules that govern the issuance of employer stock pursuant to compensation arrangements. Davis Polk discusses the SEC’s final rule and concept release here.

The final rule and the concept release were published to the Federal Register on July 24, 2018. The final rule is effective as of July 23, 2018, meaning that companies can rely on it immediately as of that date. The SEC is accepting comments relating to the concept release until September 24, 2018.
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House Financial Services Committee Marksup Bills on 10b5-1 Plans, Board Gender Diversity, Multi-Class Companies and IPO Underwriting Fees

Several of the bills marked up recently by the House Financial Services Committee, with all but the last one agreed to by voice vote, impact public companies and IPOs, including:

  • Promoting Transparent Standards for Corporate Insiders Act.  Introduced in July 2018 by Representative Maxine Waters, the SEC would study whether Rule 10b5-1 should be amended to consider changes to restrict practices for plan adoption under the rule, many of which are already being implemented by companies.

Under the bill, the SEC should consider limiting the adoption of plans during times when insiders are permitted to buy or sell securities; limiting the adoption of multiple, overlapping plans; establishing mandatory delays between plan adoption and the first trade; and limiting how often participants can modify or cancel plans. 
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SEC Commissioner Jackson Calls for Restrictions on Stock Buybacks

In a recent speech, Commissioner Jackson called for corporate stock buyback rule reform.  Citing research conducted by his staff on 385 buybacks over the last 15 months, he expressed concern that some executives are using buybacks to “cash out” their stock compensation during the stock price pop that often follows a company’s buyback announcement.  He criticized this trading as evidence that executives “are spending more time on short-term stock trading than long-term value creation.”  He also noted that when executives use buybacks to “cash out” stock compensation it breaks the link between executive pay and long-term corporate performance.

Commissioner Jackson argued that the SEC’s rules should be revised to, at a minimum, deny the Rule 10b-18 safe harbor “to companies that choose to allow executives to cash out during a buyback.”  He also called for an open comment period to generally reexamine stock buyback rules, including considering requiring more frequent disclosure of company share repurchase amounts.
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Everyone Wants to Woo “Main Street,” This Time with Proposed Legislation

It appears that “Main Street” in capital markets is both synonymous with retail investors and private companies, and there is rampant concern that Main Street companies are staying away from IPOs, which is causing Main Street investors to miss out on wealth creation.

On May 23, the House of Representatives Subcommittee on Capital Markets, Securities and Investment, a subcommittee of the House Committee on Financial Services, held a hearing entitled “Legislative Proposals to Help Fuel Capital and Growth on Main Street” to examine 11 bills or discussion drafts of proposed legislation to eliminate perceived regulatory hurdles that harm the ability of Main Street businesses, early-stage companies, smaller companies and emerging growth companies “to access capital, innovate, grow and create jobs.”

The legislation and discussion drafts that have been proposed by the House Committee are set forth below. 
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Proxy C&DIs Updated by SEC Staff

The SEC staff recently updated Compliance and Disclosure Interpretations (C&DIs) on the proxy rules and Schedules 14A/C.  We understand that the SEC staff intends to review and change other C&DIs that interpret the securities laws and SEC regulations.

Few topics, including the revisions, in the proxy C&DIs affect routine annual meetings.  The C&DIs continue to cover fairly specific situations, including the following annual meeting subjects, along with a sampling of the key interpretations, many of which are not new but serve as useful reminders:

  • Exempt solicitations.  Filing of a Schedule 13D precludes reliance on the 10-person solicitation exemption.
  • Use of discretionary authority.  

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SEC Rulemaking Petition Advocates for Retail Investors to Provide Standing Voting Instructions for Corporate Election in Order to Increase Voter Participation

Retail investors own about 30% of shares but only vote 29% of the time, compared to institutional investors voting 91% of the shares they own, according to a rulemaking petition to the SEC by the American Business Conference (ABC) that asks the Commission to facilitate advanced voting instructions (AVI), also known as client directed voting or standing voting instructions. According to its website, ABC was founded in 1981 by Arthur Levitt and is focused on advocating for mid-sized companies.

ABC laments that the views of retail shareholders are not adequately represented even as corporate ballots contain increasingly contentious governance issues.
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SEC Cybersecurity Guidance and Commissioner Comments in the Context of an SEC Cybersecurity Enforcement Case Related to Insider Trading

The SEC cybersecurity guidance, which we discuss in this client memo, reminds companies that their directors, officers and “other corporate insiders” should be aware that they may violate securities laws if they trade company securities while possessing knowledge of a company’s cybersecurity risks and incidents before that becomes public information.

The guidance address some specific actions to review to mitigate the risks of insider trading. It encourages companies to consider (a) how their codes of conduct and insider trading policies take into account and prevent trading on the basis of material nonpublic information about cybersecurity matters; (b) whether and when it may be appropriate to implement restrictions on trading during investigations of cybersecurity incidents before breaches are made publicly known; and (c) adopting “prophylactic measures” through policies and procedures to protect against insider trading in these cases.
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Chairman Clayton’s Roadmap to Finishing the Dodd-Frank Mandates, Including the Executive Compensation Disclosures

In a recent speech, Chairman Clayton discussed completing the rulemaking mandates under Dodd-Frank, in light of his mission to allocate the SEC’s resources to both fulfilling statutory requirements and meeting day-to-day needs. The complexity of the mandates coupled with “mission-critical demands” are key variables that influence the objective of finishing the rules.

In terms of how the SEC should proceed on the remaining Dodd-Frank rules, Clayton declared that the executive compensation rules were particularly challenging, in part because “we are writing on an already very colorful canvas and different constituencies see the rules as serving different, and sometimes inconsistent, goals.” He favors a “serial approach” and pointed out that the recent interpretative guidance on the pay ratio rules managed to comply with the statute, reduce compliance costs and remain practical.
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SEC’s Fall Regulatory Flex Agenda Is Utterly Familiar

Chairman Clayton had previously stated that the SEC’s regulatory flex agenda, when issued, will provide meaningful insight into his objectives for the Commission.

The Fall 2017 agenda was released late last week with a list of 26 items divided into two stages of rulemaking:  proposed rules and final rules.  There are no surprises for corporate issuers in the modest agenda.  It does not include any changes to existing disclosure rules that have not already been suggested by the prior administration and does not address issues like shareholder proposals, proxy plumbing, or more dramatic overhauls to encourage more capital formation.

The final rules include:


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SEC Approves PCAOB Rule Requiring Disclosure of Critical Audit Matters

The SEC has approved the PCAOB proposal to adopt AS 3101, The Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion, largely as proposed.  Our memo on the proposed rules is here and we will issue an update shortly.

The rule is controversial primarily for requiring the auditor to communicate in the auditor’s report any critical audit matters (CAMs) arising from the current period’s audit, or state in that report that the auditor determined that there are no CAMs.  The staggered effective date reflects the debate surrounding CAMs, so that:

  • For all paragraphs, except the paragraphs related to CAMs:  all audits of fiscal years ending on or after December 15, 2017; and
  • For all paragraphs related to CAMs:
    • For audits of large accelerated filers: fiscal years ending on or after June 30, 2019; and
    • For audits of all other companies to which the requirements apply: fiscal years ending on or after December 15, 2020.

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Seven Key Ways the SEC’s Disclosure Proposal May Affect Your Periodic Reporting

On Wednesday, the SEC proposed amendments to its disclosure requirements for public companies based on recommendations in the staff’s FAST Act Report and as part of a broader review of the disclosure system.  The comment period is open for sixty days.

The WSJ fairly characterized the changes as “modest and technical,” and Commissioner Piwowar is quoted as saying the amendments are intended to be incremental.  Our client memo describing all of the proposed reforms will be issued shortly.  The main areas that would impact periodic reporting and do not relate to securities offerings include:

You may not need to describe any properties
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Keeping Track of the SEC Disclosure Effectiveness Projects as They Gain Traction

Through the SEC open meeting announcement and Chairman Clayton’s recent testimony, it appears that the SEC is ramping up efforts to modernize public disclosure and finally implement the disclosure effectiveness initiatives for which the prior administration started laying the groundwork two years ago.

Even those who are fairly informed of recent developments may be unable to recall the different proposals that the SEC has issued. As the SEC’s own webpage on disclosure effectiveness shows, myriad staff reports, proposed and final rules, requests for comments and concept releases all touch on different, and sometimes similar or even overlapping, requirements under Regulation S-K and Regulation S-X. 
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SEC Open Meeting to Consider Proposed Rules to Largely Technical Regulation S-K Changes Recommended by SEC Staff Under the FAST ACT

The SEC will hold an open meeting on Wednesday, October 11 at 10:00 a.m. to consider whether to propose amendments based on the recommendations in the staff’s Report on Modernization and Simplification of Regulation S-K.  The report was required by the FAST Act and issued in November 2016.  Some of the suggestions are fairly technical, and some have been incorporated in the recent adoption of the requirements to include hyperlinked exhibits.  Others, including those related to MD&A disclosure, are more meaningful.  A brief summary of the main points are set forth below, with the relevant rules listed.

General

  • Permit incorporation by reference of documents that have been on file with the Commission for more than five years, but require specific descriptions of the locations of such documents and a hyperlink to the incorporated document on EDGAR. 

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Chairman Clayton Suggests Potential for Shareholder Proposal Rule Reform, Invoking the Quiet Shareholder, as the Chamber of Commerce Makes Specific Recommendations

The Center for Capital Markets Competitiveness, part of the Chamber of Commerce, issued seven recommendations for shareholder proposal reform.  On the same day, SEC Chairman Jay Clayton spoke to the Chamber about a range of issues.  He questioned the viability of continuing to load up on the disclosure system, likening it to a football coach giving the ball to a good running back over and over because he can, and whether increased amounts of disclosure corresponds to useful disclosure.

He spoke about the proxy advisory firms, noting that while he does not have a definitive view at this point, he recognizes that some entities have a “fair amount of influence” on public company governance, and developments that have an impact on the markets are something regulators should examine.  
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Comparing the SEC’s Rulemaking Agendas Indicates Potential for Less Rulemaking, but Significant Disclosure Initiatives Remain

Like other federal agencies, the SEC recently released its regulatory agenda. The agenda is published by the Office of Information and Regulatory Affairs at the Office of Management and Budget within the Executive Office of the President (OMB) and purports to reflect the rulemaking initiatives for the coming year. In the past, the agenda was generally not predictive of the rules the SEC ended up either proposing or adopting, but in light of the new administration’s deregulatory objectives, there is increased focus whether the agenda fulfills that mandate.

Mick Mulvaney, the Director of OMB, personally emphasized the importance of the unified regulatory agenda for all agencies on the day it was released.
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SEC Chairman Clayton on His Agenda

SEC Chairman Jay Clayton gave his first public address yesterday, with some meaningful remarks directed at public company regulations.

The long-term interest of the Main Street Investor (the term is not defined but capitalized in his speech) is the cornerstone of how the SEC will measure whether it is being true to its mission regarding the protection of investors, facilitating capital formation and maintaining markets properly. The Main Street Investor is also characterized as “Mr. and Ms. 401(k)” and it is the SEC’s primary responsibility to ensure that they are informed and have the right opportunities to invest in their future.
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