Capital Markets & Public Companies Quarterly: Changes to SEC Review of Shareholder Proposals, Expansion of Testing-the-Waters, Regulation FD Enforcement Action, Applicability of Proxy Rules to Proxy Advisors and Risks Associated with LIBOR Transition

McDermott Will & Emery

In the third quarter of 2019, the SEC Staff announced major changes to the standard no-action request review and response process relating to shareholder proposals. In addition, the SEC expanded the availability of “testing-the-waters” accommodations to all companies. The SEC also settled an enforcement action for violations of Regulation FD, signaled further scrutiny of the activities of proxy advisory firms, and provided guidance on how market participants should assess and disclose the impact of the anticipated transition away from the LIBOR benchmark.

IN DEPTH


SEC Announces Changes to Shareholder Proposals No Action Letter Process

On September 6, 2019, the Staff of the Division of Corporation Finance of the US Securities and Exchange Commission (SEC) announced two major changes to the Rule 14a-8 no-action process for shareholder proposals for inclusion in the annual proxy statement.

  • The Staff Response May Be Oral, not Written: Starting with the next shareholder proposal season (e., 2019-2020), the Staff’s response to a no-action request relating to the exclusion of a shareholder proposal from a company’s proxy statement may be oral, not in writing. The Staff will only provide a written no-action letter “where it believes doing so will provide value, such as more broadly applicable guidance about complying with Rule 14a-8.”
  • The Staff May Decline to Take a Position: Going forward, in responding to an incoming argument by a company that it is justified in excluding a shareholder proposal, the Staff may respond that it “concurs, disagrees or declines to state a view” with the company’s basis for exclusion of the proposal from the company’s proxy statement. If the Staff declines to take a position on the argument, the Staff advised that parties should not interpret such a decision as an indication that the proposal must be included in the proxy statement and reminded parties that all other remedies remain available as before, including seeking the judgment of a court.

To be clear, the Staff’s new policy does not change the fact that a company seeking to exclude a shareholder proposal must file a no-action request letter with the SEC. The request must state the procedural or substantive basis for the exclusion and must follow the applicable procedural requirements under the federal securities laws.

The practical outcome of the Staff’s announcement on any given proposal or proxy season remains to be seen. In the long term, however, the new policy is expected to result in fewer written no-action letters issued by the Staff, ultimately decreasing the body of published precedent-interpreting rules governing the shareholder proposal process. As uncertainty grows, public companies may need to consider other remedies in addition to or instead of seeking no-action relief for the exclusion of certain proposals. The pressure to “negotiate away” shareholder proposals (i.e., getting the proponent to withdraw the request) will likely increase. Public companies may also choose to face certain shareholder proposals head-on by including them in the company’s proxy materials.

SEC Expands “Test-the-Waters” Communications to All Companies

On September 26, 2019, the SEC adopted a final Rule 163B, as well as related amendments to existing rules, that would allow all companies to engage in “test-the-waters” communications with certain qualified investors. As discussed in our prior On the Subject regarding the proposed rule, “test-the-waters” communications that comply with the new rule would not need to be filed with the SEC and would not need to include cautionary legends. The SEC adopted the proposed rule in its entirety except for clarifying revisions.

“Test-the-waters” communications are oral or written communications that occur either prior to, or following, the filing of a registration statement related to a contemplated offering with investors that are Qualified Institutional Buyers, as defined by Rule 144A, or Institutional Accredited Investors, defined as an institutional investor that is an “accredited investor” under Rule 501 of Regulation D. Prior to the new rule and amendments, “test-the-waters” communications were only permissible for emerging growth companies. The new rule is in line with other administrative and congressional initiatives to liberalize such communications and encourage additional participation in the public markets.

Although the new rule expands use of these accommodations to all companies, companies subject to Regulation FD would need to evaluate if such communications would trigger disclosure obligations. Also, communications made in reliance on the rule would still be considered “offers” subject to Section 12(a)(2) of the Securities Act in addition to the anti-fraud provisions of the federal securities laws.

For our prior commentary on proposed Rule 163B, see our On the Subject.

SEC Brings Enforcement Action for Violations of Regulation FD

On August 20, 2019, the SEC issued a settled enforcement action for violations of Section 13(a) of the Exchange Act and Regulation Fair Disclosure (Regulation FD) thereunder by TherapeuticsMD, Inc., a pharmaceutical company with shares traded on NASDAQ. The action provides details of selective disclosures of material non-public information related to the company’s meeting with the Food and Drug Administration (FDA) concerning the potential approval of a candidate drug. The action states that members of management disclosed the details of the meeting and subsequent interactions with the FDA to research analysts and that such disclosures were either provided to analysts before the company made broader market-wide disclosures or that analysts were provided with details of the interactions that were not disclosed to the broader market. In addition, while not dispositive of the SEC staff’s decision to bring an enforcement action, the Staff noted that at the time of these disclosures TherapeuticsMD did not have policies or employee training relating to compliance with Regulation FD.

As of late, Regulation FD enforcement actions have been infrequent, but the current action acts as a reminder that companies must comply with its disclosure requirements. Companies should control the distribution of any material, non-public information or information that may be construed as such, and only provide such information to those with a “need to know.” For this reason, public companies should maintain policies and procedures to ensure that all public disclosures of such information meet the requirements of Regulation FD and other applicable securities laws.

For additional commentary on the SEC’s Regulation FD enforcement action, see our On the Subject.

SEC Issues Interpretation Regarding Applicability of Proxy Rules to Proxy Advisors

On August 21, 2019, the SEC issued an interpretation and related guidance regarding the applicability of the rules governing proxy solicitation to proxy voting advice. In the guidance, the SEC reiterated guidance provided by the staff of the Divisions of Investment Management and Corporation Finance in Staff Legal Bulletin No. 20 (SLB 20) that proxy voting advice provided by proxy advisory firms is generally considered a “solicitation” under federal proxy rules because the voting recommendations or advice constitute a “communication to security holders under circumstances reasonably calculated to result in the procurement, withholding or revocation of a proxy.” In the guidance, the SEC clarified that such proxy voting advice constitutes a solicitation even if the recommendations provided are based on voting guidelines established by the persons receiving the recommendation, such as an investment advisor.

Most notably, the SEC’s guidance signaled that it may propose amendments to Rule 14a-2(b) of the Exchange Act, which is often relied upon by proxy advisory firms as an exemption from the information and filing requirements of the federal proxy rules. Under the rule, subject to other requirements of the rule, a proxy advisory firm that does not solicit the power to act as proxy for those receiving its recommendations, but instead limits its activities to distributing reports containing such recommendations, is not required to meet other information and filing requirements applicable to proxy solicitations.

In addition, the SEC used the guidance to emphasize that, as solicitations, proxy advisor recommendations remain subject to the anti-fraud provisions under Rule 14a-9, prohibiting solicitations that contain statements that, at the time and in light of the circumstances under which such statement is made, are false or misleading with respect to a material fact. Accordingly, proxy advisory firms must consider whether they need to disclose any underlying facts, assumptions, limitations and other information on which they base their advice or recommendation.

In recent years, institutional investors and investment advisers have increasingly relied on advice and recommendations provided by proxy advisory firms, a practice that has become subject to heightened scrutiny due to its significant influence on proxy voting. The SEC interpretation comes on the heels of last year’s Roundtable on the Proxy Process, at which the SEC solicited comments on the US proxy system, including the role and regulation of proxy advisory firms. As discussed in our prior quarterly update, in the lead up to the Roundtable, the SEC staff of the Division of Investment Management withdrew prior guidance that permitted investment advisers’ to rely on recommendations provided by third-party proxy advisory firms for purposes of adopting “policies and procedures” that are reasonably designed to ensure that client securities are voted in the best interest of the client, as required by Rule 206(4)-6 promulgated under the Investment Advisers Act of 1940. On August 21, 2019, the SEC also issued guidance related to this topic, reiterating the requirement that investment advisors comply with Rule 206(4)-6 and signaled that investment advisors take more control of their voting policies and practices to ensure that they reasonably understands their client’s objectives and make voting determinations in the client’s best interest.

SEC Staff Publishes Statement Regarding Risks Related to Transition Away from LIBOR

On July 12, 2019, the SEC’s Division of Corporation Finance, Division of Investment Management, Division of Trading and Markets, and Office of the Chief Accountant issued a joint statement regarding potential risks to the financial markets and financial market participants resulting from the expected transition away from LIBOR as a standard benchmark for global interest rates. The Staff noted that when current reporting commitments end in 2021, many private banks are expected to cease their reporting contributions to the benchmark and, as a result, LIBOR could cease publication or its quality could degrade such that it is no longer a suitable standard rate.

The joint statement includes guidance from each of the Divisions regarding the most pertinent considerations for market participants regulated by such Division. Guidance provided by the Division of Corporation Finance primarily focused on public disclosures regarding the risks that public companies face as a result of this transition. The Staff reminds public companies to review their periodic reporting and other public disclosures to ensure that they are materially accurate given the expected changes to LIBOR. The Staff specifically called on public companies to consider their disclosures relating to risk factors, management’s discussion and analysis, board risk oversight, and financial statements as those for which the transition will most likely trigger required disclosure. The Staff urged companies to disclose their progress toward risk identification and mitigation as well as any material impact that LIBOR’s expected discontinuation may have on their financial results. In addition, the statement provides market participants with resources for alternative benchmarks and contract language that will endure the pending transition.

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