As we continue to stumble into 2021, initially disappointed that our low expectations for a relatively better year lasted only six days, our editorial staff hews to the clamor for a calming retrospective on legal happenings in the tail end of 2020, for tips on significant changes for 2021, and for updates on the Paycheck Protection Program. We aim to please.
Some public company changes . . .
- The SEC rule changing Regulation S-K Items 101 (description of business), 103 (legal proceedings) and 105 (risk factors) is here and a redline showing the language changes is here. Based on early returns, we don’t expect all that much to change in upcoming annual reports based on the Regulation S-K changes.
- The business description is more clearly principles-based, but we expect most will continue to treat suggested disclosure topics as prescriptive, including the new requirement to disclose information about human capital resources.
- An overview of disclosures about “human capital” by early-filers, including Form 10-K excerpts, is included in the FW Cook report here and the Willis Towers report here; the rule-making petition cited in the rule, which describes potential areas of disclosure focus, is here; at least one perspective on what investors care about is here; and some historical perspective on how we got to the new rule is here.
- The rule changes offer the chance for a fresh look at the business description, but aside from disclosure about human capital and a little tinkering around the edges, we don’t expect radical rewrites. Similarly, we do not expect many to take advantage of the ability to hyperlink to prior disclosures and to just provide only updates in current filings, largely because it’s easier to tweak the whole business description each time rather than to include a cascading series of updates you’ll have to consolidate at some point.
- Written as they are by cautious lawyers, we have never found legal proceeding descriptions particularly interesting, and largely the changes to Item 103 just mean the range of things an issuer need not disclose has broadened slightly, and broadened slightly more if a company discloses its practice of not disclosing government proceedings that are likely to result in sanctions equal to the lesser of $1 million or 1% of current assets.
- Finally, in lieu of trimming risk factors (if only!), we expect issuers with 15+ pages of risk factors will include the summary required by the rule, and that all issuers will reorganize risk factors under “topical headings,” including moving “general” risks to the end. The risk factor summary is supposed to be in “the forepart” of the filing, which isn’t defined. We think it’s adequate to include the risk factor summary in the “forward-looking statement” disclosure, which often immediately follows the cover page and which may already include a bulleted summary of risk factors. Hard to get more “forepart” than that, and there’s obvious flow between the forward-looking statement disclaimer and the risks that could cause those statements to be wrong. There is no requirement to caption the summary, but we’re sympathetic to (and might even agree with) those who prefer to include a separate caption as a guidepost, and expect to see many include successive captions for “Forward-Looking Statements” and “Summary of Risk Factors.”
Lengthier descriptions of the rule changes are here, here, and here.
- The SEC also adopted modifications to Regulation S-K, here, to eliminate selected financial data disclosure, streamline supplementary financial data disclosure, and modify MD&A requirements. A redline showing rule changes is here. The rule is effective February 10, 2021, but compliance is not required until the annual report for the fiscal year ending on or after August 9, 2021. Early compliance is allowed as long as a filer adopts the S-K changes whole-hog. Under revised Item 303 of Regulation S-K, MD&A must now focus on material events and uncertainties likely to affect operations and liquidity,1 making the disclosure more forward-looking and principles-based, and trims prescriptive disclosures significantly, eliminating among other things prescriptive disclosures about off-balance sheet arrangements and contractual obligations. Summaries of the changes are here, here, and here.
- Don’t forget, because it might sneak by you, to make sure you are using the most current Form 10-K cover page, which is here. In addition to the items included on the cover of your recent batch of Form 10-Qs (trading symbol, etc.), the SEC adopted changes that require you to include the following:
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☐
- The SEC also adopted, just shy of 11 years after being required to do so by the Dodd-Frank Act, final rules requiring resource extraction companies to include in an annual report information about payments made to foreign and U.S. governments for commercial development of oil, gas and minerals. The final rule is here.
- In case the first four items of this alert didn’t do it for you, overviews of considerations for upcoming annual reports and proxy statements are here, here, here, here, here, and here.
- SPACs, “special purpose acquisition companies,” have been in the news through much of 2020, although much of the news hasn't been good. (Just as a refresher, SPACs are “blank-check” shell companies that raise money through an IPO based on the strength of their management team, theoretically, and then go on the hunt for a company to acquire—call it “large-scale crowdfunding” of a future idea, or maybe a poor-man’s opportunity to invest in an ersatz equity fund.) According to The Wall Street Journal, SPACs rescued Wall Street last year (see here), but also according to the Journal, here, SPACs seriously underperform the market while sponsors nonetheless come out flush because they skim 20% of the value of the acquired company off the top. The 20% structure might be why the SPAC sponsors of LMF Acquisition Opportunities, Inc. picked their name and stock trading symbol: LMFAO; Nasdaq: LMAO (see here). The heads I win, tails you lose structure, along with the unapologetic unwillingness to break stereotypes, might contribute to the high cost of D&O insurance for SPACs (see here).
- That companies like LMFAO exist as a concept undoubtedly caused many to cheer the multi-billion-dollar losses that some market professionals suffered betting against GameStop, a brick and mortar seller of video games that, based on that description alone, seems a safe “short” bet. Analyses of what the heck happened abound, but here’s our stab: buyers comprising a hodgepodge of believers in GameStop’s business, those who wanted to stick it to hedge funds who had to cover short-sale positions, and those looking to get rich off the mayhem, piled on to drive GameStop’s stock price up higher than makes a lick of sense. Just for fun, here’s a graph of GameStop’s five-year stock price:
More in depth analysis of the GameStop oddity is here, here, and here. Related, but more obscure commentary regarding Robinhood and its call to update the process for settling stock trades, is here. If you are an executive bored with running your company’s business and, inspired by GameStop, want instead to focus on how to take advantage of an unlikely irrational run on your company’s stock, see here; while you scheme, however, keep in mind the SEC’s required disclosures when raising money during a period of stock volatility, embedded in its sample comment letter here. Finally, in case you’re wondering whether there are securities laws or other legal restrictions on a bunch of yahoos who drive up a stock price, simultaneously creating and wiping out fortunes for no rationale reason: “no.”
- It seems inevitable, particularly with the Biden Administration now firmly ensconced, that pressure for the SEC to adopt environmental, governance, and social (ESG) disclosures will increase. In part, pressure may come from corporations and industry groups that desire to stall the ramp of shareholder proposals and to bring some consistency to disclosures. The call for enhanced climate change disclosure, for example, has been around for a decade, and Blackrock continues to push for it (see here). More recently, calls for public disclosure of corporate political spending have grown clamorous, likely spurred by the (let’s face it, temporary) freeze of corporate contributions to (mostly) Republicans (see here). Blackrock recently published its perspective on corporate political activities, here, and a description of increased shareholder interest in finding out exactly what a company hopes to achieve through political contributions is here. (Also interesting, and at least tangentially related to ESG and politics, is recent news that Goya’s board had barred its CEO from talking to the press following his ill-advised remarks to FOX News regarding Presidential election fraud, see here.)
- Related to the “S” in ESG, Nasdaq proposed a rule, here, to impose board diversity standards on Nasdaq-listed companies. Commentary on the Nasdaq rule is here and here. In typical SRO fashion, the listing standard tries to effect change through embarrassing disclosure: essentially, Nasdaq would require that listed companies have two diverse directors within two years of rule adoption or disclose why they do not. The Nasdaq rule would also require a listed company to disclose in its proxy statement or on its website statistical information about each director’s gender, race, and self-identification as LGBTQ+ and to disclose current year and immediately prior year director diversity statistics. Nasdaq’s rule is chicken feed compared to proposed Oregon House Bill 3110, here, which would require each publicly traded company that has its primary office in Oregon to have one woman and one member of an “underrepresented community” on its board (and a single person can’t do double duty). The law would require public companies to file an annual compliance report with the Oregon Secretary of State and would impose significant penalties for violations—$100,000 for failing to file the required annual report and $100,000 for the first violation and $300,000 each for subsequent violation if the board did not have the required directors serving on its board for at least eight months in its prior calendar year. Oregon’s law looks a whole lot like California’s, which its Governor recognized had questionable Constitutional legitimacy and which is, in fact, being challenged. See here. In typical Oregon fashion, its proposed law goes further. Stay tuned.
Some private offering changes . . .
- Effective December 8, 2020, the definitions of “accredited investor” and “qualified institutional buyer” changed to encompass a moderately broader swath of investors. The SEC rule is here and a redline that shows changes to the definitions is here. The rule expands the Regulation D safe harbor for sales to:
- Individuals with SEC-designated professional credentials that suggest they know what they’re doing investment-wise. Out of the gate, the SEC adopted an order, here, identifying holders in good standing of the Series 7, Series 65, and Series 82 licenses as qualifying natural persons.
- A “knowledgeable employee” of an issuing investment company, as defined under the Investment Company Act.
- A “family office” with specified attributes and a “family client,” in each case as defined under the Investment Advisers Act.
The rule also modifies the accredited investor definition to include the concept of “spousal equivalent” whose assets or income can be included in rule thresholds, and clarifies that a limited liability company (in addition to a non-profit, business trust, partnership, and corporation) with assets over $5,000,000 and not formed specifically to invest in securities is accredited (practitioners generally were already comfortable this was the case, but clarity is always helpful).
Generally speaking, changes to the accredited investor definition are not particularly significant and incrementally expand the safe harbor to those in the securities business. In other words, not much help for typical, cash-starved growth companies or for poor investors clamoring to gamble on private company equities. The changes to the definition of a QIB are also limited, and merely add Rural Business Investment Companies and institutional accredited investors defined in Regulation D.
- More significant, the SEC adopted rules to facilitate private offerings, here, that are effective March 15, 2021. The weighty, 388-page rule modifies some existing rules incrementally, including communication and disclosure rules; offering limits under Regulation A, Rule 504, and Regulation Crowdfunding; and eligibility rules under Regulation A and Regulation Crowdfunding. But it also adopts integration rules that try to whack through the existing, fairly incoherent analytical framework. Before getting to that, a summary of the easier item in the rule:
- The rule includes a useful chart of common exemptions, as modified by the rule, starting on page 9.
- Things that aren’t “offers” or are permitted offers:
- New Rule 148 states that “demo days” aren’t offers as long as they are held by an "eligible sponsor" that isn’t hawking securities or profiting from the event. Colleges, government agencies, incubators and defined angel funds are eligible sponsors (and are subject to restrictions to ensure they aren’t making money), but broker, dealers and investment advisers are not. Online, but not in-person, participation must be limited to associates of the sponsor, relevant industry professionals, and those reasonably believed to be accredited investors.
- New Rule 241 allows a generic “solicitations of interest” in an offering as long as the solicitation includes prescribed disclosures and is filed with Regulation A or Crowdfunding filings, or provided to non-accredited investors in a Rule 506(b) offering, if the offer is made within 30 days of the solicitation. We expect this rule will be seldom used, since it may blow up an offering, like a 506(b) offering, that prohibits general solicitation.
- New Rule 206 allows “test the water” communications in a Crowdfunding offering before a Form C is filed, provided that the communication is filed with the Form C.
- To meet the verification requirements under Rule 506(c), issuers may rely on reasonable investigations in the prior five years, plus a questionnaire and good faith belief an investor remains accredited. The rule also states the SEC’s view that a questionnaire alone might suffice if the issuer takes into account prior substantive relationships or other facts that make apparent accredited investor status. (Say, to get comfortable that existing shareholders known to the issuer who are asked to vote on an unregistered stock-for-stock merger are accredited … do you believe us now, Sullivan & Cromwell?)
- The financial statements an issuer must provide to non-accredited investors under Regulation D now match the simpler requirements that apply to Regulation A offerings, including that offerings under $20 million need not be audited, and some Regulation A disclosure requirements are simplified.
- Offering limits under Regulation A are raised to $75 million for Tier 2 offerings (from $50 million), including $22.5 million of secondary sales (from $15 million); limits under Rule 504 are raised to $10 million from $5 million; and limits under Regulation CROWDFUNDING is raised to $5 million from $1.07 million. (It’s still the case that none of these exemptions is going to be terribly useful, but every little bit helps.)
- Allows investment vehicles to participate in Regulation CROWDFUNDING offerings without becoming subject to “investment company” regulation.
- Harmonizes the “bad actor” look-back period for Regulations D, A, and Crowdfunding.
- The SEC’s tinkering with private offering changes is all well and good, but not hugely important in a macro sense. The table on page 203 of the rule (here) tells you that exempt securities offerings are all about Regulation D, so most of the rule changes are “meh.” The revised integration analysis implemented by the rule is a bigger deal.
To take a step back, if two securities offerings are “integrated,” the combined offering must satisfy all the exemption criteria of a single exemption. If they don’t, a string of offerings may suddenly be non-exempt, giving every investor rescission rights, branding the issuer a “bad actor” unable to rely on issuer exemptions for two years, and exposing the issuer and other offering participants to liability under federal and state securities laws. Traditional integration analysis is based on five factors: whether (1) different offerings are part of a single plan of financing; (2) the offerings involve issuance of the same class of security; (3) the offerings are made at or about the same time; (4) the same type of consideration is to be received in each offering; and (5) the offerings are made for the same general purpose. The analysis is wickedly difficult to apply, and determinations are guided heavily by an issuer’s (and counsel’s) tolerance for risk. The SEC has occasionally tinkered with making the analysis easier. On the heels of creating new offering exemptions in 2015, including exempt offerings that for the first time permitted general solicitations, the SEC took some (for it) dramatic steps to clarify its integration analysis. (See here.)
Its latest release provides additional clarity, and gives guideposts to ensure offerings are not integrated and some comfort that if you inadvertently screw up, you may have nonetheless stumbled into a safe harbor or have a good faith argument that offers should not be integrated.
New integration Rule 152 sets forth a general principal for integration analysis and establishes discrete safe harbors. Rule 152 supplements, and does not overturn, the five-factor test or other established integration analysis guideposts. Under the general principle, if a safe harbor does not apply, an issuer may determine offerings are not integrated if it determines each offer meets exemption requirements:
- For exemptions that prohibit general solicitation, the issuer must have a reasonable belief that the purchasers in the exempt offering were not solicited (say, by having any purchaser represent that fact and not knowing otherwise?) or established a substantive relationship with the purchaser before the solicitation.
- For concurrent offers that allow general solicitation, referencing the material terms of the other offering may constitute an offer, which generally means you must include legends, etc. to comply with each exempt offering requirement. The negative inference, perhaps, is that if you don’t discuss the material terms, the offers aren’t integrated. For example, it may be sufficient to say “we’re raising money in another exempt offering, but we’re not going to tell you about it, and will ask you to represent you were not solicited under that offering if you participate in this one.”
Safe harbors to integration abound:
- Offerings at least 30 days apart are not integrated, except that if an offering that doesn’t permit general solicitation follows an offering that does, an issuer still must establish a reasonable belief that the purchaser was not solicited by the earlier offer. (Again, we expect a representation from a purchaser and having no reason to believe the representation is wrong, probably suffices.)
- Offers under Rule 701 (compensation arrangements) or Reg S offerings will not be integrated with other offerings. The Rule 701 exclusion is clear, but the SEC dropped proposed changes to Regulation S, which would have modified the definition of “directed selling efforts.” The upshot of this, read in conjunction with the general integration principles, is likely that if a concurrent U.S. offering does not reference the material terms of a foreign offering, that’s sufficient to ensure you’re not “conditioning the U.S. market” for Regulation S purposes (as intellectually dissatisfying as that conclusion might be).
- Registered offerings will not be integrated with a terminated or completed 506(b) or 506(c) offering, or any offering completed 30 days before the registered offering.
Rule 502 specifies when offers “commence” and when they “terminate” for purposes of integration analysis. It also modifies integration clauses in other rules to reference Rule 152.
More on the PPP . . .
- On December 27, 2020, President Trump2 signed additional COVID-19 relief measures as part of the Consolidated Appropriations Act of 2021, here. Stuffed into the 5,593-page behemoth is the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act, which among other things authorized another $284 billion for Paycheck Protection Program (PPP) loans and another $20 billion for Economic Injury Disaster Loans. Congress continued to tinker with the PPP and, most significantly, authorized “second draw” PPP loans with some additional restrictions. Both first- and second-draw PPP loans are available through March 31, 2021 or until the program runs out of money again.
The SBA and Treasury Department are the best sources for information about PPP loans (see here and here), but a few highlights:
- PPP loans may be used for more uses eligible for forgiveness, including worker protection costs related to COVID-19, uninsured property damage due to looting, and certain supplier costs. SBA interim rules, here, state that a borrower may only receive forgiveness for these new non-payroll costs if the SBA had not yet remitted a forgiveness payment on the borrower’s loan before December 27, 2020. (That doesn’t really seem fair, honestly, but there you go.)
- PPP loans may be made to some new eligible borrowers, notable news organizations which are also exempt from SBA affiliation rules, but also adds to the list of ineligible borrowers, including issuers with securities listed on a national exchange3 and entities in which the President, the Vice President, the head of an executive department, or a member of Congress, or their respective spouses, holds a controlling interest.
- Second draw loans are available for those who used prior PPP loans only for authorized uses, have fewer than 300 employees, and can demonstrate at least a 25% reduction in gross receipts between comparable quarters in 2019 and 2020. Maximum loans are 2.5x average monthly 2019 or 2020 payroll costs (3.5x for Accommodation and Food Service sector), up to $2 million. (The same “affiliation” carve-outs for restaurants and hotels apply here, which is relevant for the 300 employee limit and allows each restaurant held as a wholly owned subsidiary in a restaurant group to apply for a loan up to $2 million; however, a $4 million “corporate group” cap applies to loans.)4
- First draw loans are available, generally with the same strictures as before. Those who chickened out and gave their original PPP loans back may re-apply for a first draw loan. Although borrowers may not generally apply for multiple first draw PPP loans, in circumstances where it qualifies to borrow more, it may increase its existing loan.
- The SBA published a number of new interim rules and guidance:
- Interim final rules on the PPP as modified, here
- Interim rules on second draw PPP loans, here
- Loan forgiveness requirements and loan review procedures, here
- The SBA also published a slew of new forms, including:
- Updated loan forgiveness applications (regular, form EZ, and a new form for loans less than $150,000)
- Updated loan application forms
- A new form that requires 2020 PPP loan recipients to disclose whether Trump, Pence, each head of an executive department, a member of Congress, or their respective spouses, owned at least 20% of the borrower (see here)
- A new “loan eligibility questionnaire,” here and here, that borrowers must complete to help the SBA assess the “necessity” certification that the borrower made when it originally applied for the loan
Potentially, some late-term Trump Administration regulations may be undone, but probably not SEC rules . . .
- Unsurprisingly, the Biden Administration issued a regulatory freeze pending review of late-term regulatory action, here. It’s possible that some regulations will be voided under the Congressional Review Act, similar to what the Trump Administration, in conjunction with a Republican-controlled Congress in 2017, did when it overturned 17 late-term Obama Administration rules, including the prior SEC rule on resource extraction disclosure mandated by the Dodd-Frank Act. Analysis of the potential effect on recent SEC rules is here and the report from the SEC’s Office of the Investor Advocate, here, suggesting revisions or rescissions to 14a-8 rules that make it easier to exclude shareholder proposals, rules that subject proxy advisory firms to more regulation, and rules that make private offerings easier and avoid integration with other offerings. That said, it’s not clear that the White House letter applies to the SEC, an independent agency, and we haven’t heard whether the SEC will voluntarily submit late term regulations for review.
And finally . . .
- As a reward for slogging through the lengthy recap above, or for skipping directly to this item, two bonus hyperlinks:
- The greatest Zoom court hearing to date is here.
- Say what you like about incoming Secretary of the Treasury Janet Yellen’s economic policies, she can pop a collar and rock a power bob, here (turn the volume up, let it wash over you).
1As a plus, fresh-faced law firm associates will no longer have to speculate why an issuer disclosed it has sufficient liquidity for at least the next 12 months, before eventually deciding the disclosure is negative assurance that the company is a going concern under audit standards. Now the 12-month requirement is RIGHT IN THE RULE!
2To be clear, now “former President Trump.”
3The ineligibility of public companies is a clear reaction to public outrage that “public companies” got PPP loans, which we’ve frankly never understood. (Why do people hate dishwashers who work for Ruth’s Chris?) But even this ineligibility criteria isn’t clear since it applies to “an issuer” and not necessarily to a wholly owned subsidiary of an issuer. Congress specifically instructed the SBA to ignore public issuer affiliation for news and broadcast organizations, which could be read as an invitation for the SBA to apply affiliation rules to all other potential borrowers including those who are currently excluded from affiliation rules like restaurant companies. The SBA did not unequivocally do that, and its interim rules are a bit of a mess and state that a borrower is ineligible if:
“viii. Your business is an issuer, the securities of which are listed on an exchange registered as a national securities exchange under section 6 of the Securities Exchange Act of 1934 (15 U.S.C. 78f) 32 (SBA will not consider whether a news organization that is eligible under the conditions described in subsection 1.f. and 1.g.vi. is affiliated with an entity, which includes any entity that owns or controls such news organization, that is an issuer.”
It’s nonsense for “a business” to be “an issuer,” but that sloppy language could be read to apply affiliation rules to everyone except news organizations. That seems a stretch, however, and it’s certainly not clear (a) whether that’s what was intended with respect to any borrower or (b) even if intended, whether that was meant to override the exclusion from affiliation rules that apply to hospitality companies exempted from affiliation rules under the original PPP statute (we think, "not").
4It’s not entirely clear whether the aggregate corporate group cap for first and second draw PPP loans is $24 million or whether the original $20 million corporate group cap applies. The $20 million cap purports to limit “PPP loans in the aggregate” (see the May 2020 interim final rule, here, and the January 2021 interim final rule, here); however, we think the better reading is that the $4 million cap adds to the $20 million cap. That makes aggregate corporate group caps symmetrical to individual borrower caps—$10 million per first draw PPP loan plus $2 million per second draw PPP loan.