During the first quarter of 2016, the Securities and Exchange Commission (SEC) and U.S. stock exchanges issued proposed and final rules that will likely impact disclosure and capital raising efforts. This report provides a brief overview of these developments, and also discusses pending congressional legislation that would affect stockholder activism or potential takeover activity as well as possible further developments affecting public companies and capital markets that can be anticipated in the months to come.
NYSE and Nasdaq Rule Updates
Nasdaq Proposes New Disclosure Requirement Regarding Third-Party Compensation of Directors
On March 17, 2016, the Nasdaq Stock Market resubmitted a proposed rule that would require companies listed on Nasdaq to disclose third-party payment arrangements between a director or director nominee and any third party with respect to such person’s candidacy or service as a director. The proposed rule is intended to capture certain “golden leash” arrangements and would require ongoing disclosure of the terms of such arrangements. Golden leash arrangements involve an activist shareholder compensating board nominees or directors in connection with their service as directors.
The rule as proposed would provide that the disclosure of third‑party compensation could be made either through the company’s website or in the proxy statement for the company’s next annual meeting. The Nasdaq proposal would require disclosure of all such arrangements on an ongoing (i.e., annual) basis. The proposed rule contains several exceptions to avoid duplicative disclosure where such disclosure is made in accordance with an SEC rule. For example, in Footnote 5 of its March 30, 2016 Notice of Filing of Proposed Rule Change, the SEC “notes that various provisions of the federal securities laws already require the disclosure of compensation arrangements between third parties and directors or director nominees. See, e.g., Items 401(a) and 402(a)(2) of Regulation S-K; Item 5(b) of Schedule 14A; and Item 5.02(d) of Form 8-K.” The practical impact of Nasdaq’s proposed rule is that the disclosure of third‑party compensation arrangements would become a listing requirement of the exchange.
To acknowledge the practical reality that companies subject to the proposed rule do not have direct access to the information they will be required to report, the Notice of Filing of Proposed Rule Change states that “a company shall not be deficient with the proposed requirement if it has undertaken reasonable efforts to identify all such agreements and arrangements, including by asking each director or nominee in a manner designed to allow timely disclosure, and upon discovery of a non-disclosed arrangement, promptly makes the required disclosure by filing a Form 8-K or 6-K, where required by Commission rules, or by issuing a press release.” The new proposed rule, if approved by the SEC, will become effective on June 30, 2016.
Perhaps the most interesting potential development with respect to Nasdaq’s proposed rule is mentioned in Footnote 11 to the SEC’s Notice of Filing of Proposed Rule Change. Footnote 11 states that Nasdaq is considering whether to propose additional requirements with respect to golden leash arrangements. Specifically, Nasdaq is considering “whether such directors should be prohibited from being considered independent under Nasdaq rules or prohibited from serving on the board altogether.” Any future developments will come by way of another proposed rule, but the footnote makes it clear that Nasdaq is seriously considering whether a director who is party to such an arrangement should truly be considered independent under Nasdaq’s listing standards.
New NYSE Rules for Foreign Private Issuers (FPIs)
On February 19, 2016, the SEC approved amendments (available here) to the NYSE Listed Company Manual requiring FPIs to submit semi‑annual, unaudited financial information to the SEC on Form 6-K. Currently, FPIs are not subject to a periodic reporting requirement comparable to the requirement that listed domestic issuers submit quarterly reports on Form 10‑Q. As mentioned in the rulemaking notice, the NYSE has now taken the position that the new requirement for FPIs is necessary to protect investors because the annual financial disclosure required on Form 20-F is too “infrequent to enable investors to make informed investment decisions.”
The new Rule 203.03 (Semi-Annual Reporting by Foreign Private Issuers) requires FPIs to submit to the SEC a Form 6-K that includes, at a minimum:
An interim balance sheet as of the end of the issuer’s second fiscal quarter; and
A semi-annual income statement that covers the issuer’s first two fiscal quarters.
The above information needs to be submitted by FPIs listed on the NYSE no later than six months following the end of the issuer’s second fiscal quarter. The information must be presented in English, but is not required to be reconciled to U.S. generally accepted accounting principles (GAAP).
The new requirements are effective with respect to any fiscal year beginning on or after July 1, 2015. This means that for any FPI with a fiscal year ended June 30, 2015, the first required filing under the new rules is due by June 30, 2016 with respect to the six-month period ended December 31, 2015.
SEC Adopts New Rules to Implement Provisions of Fixing America’s Surface Transportation Act (FAST Act)
In January 2016, the SEC adopted interim final rules, now effective, to implement the public offering provisions of the FAST Act. The rules revised the instructions to Forms S-1 and F-1 to allow emerging growth company issuers to omit financial information with respect to certain historical periods in their initial filings with the SEC so long as:
The omitted financial information relates to a historical period that the company reasonably believes will not be required for inclusion in the registration statement at the time of the contemplated offering; and
Prior to the company distributing a preliminary prospectus to investors, the company amends the registration statement to include all financial information required by Regulation S-X at the date of the amendment.
The rules also provide for revisions to Form S-1 and Item 512(a) of Regulation S-K to allow smaller reporting companies to incorporate by reference documents filed after the effective date of a registration statement. Forward incorporation by reference will eliminate the need to file a post‑effective amendment to the registration statement to update information in a filing that has become stale or incomplete.
These changes serve to eliminate the time spent (and fees incurred) preparing and submitting financial statements for historical periods that will not be included in the IPO prospectus and should help streamline the public offering process for smaller issuers.
Brokaw Act and Section 13(d)
The Brokaw Act was introduced in Congress in March and, if adopted, would require significant amendments to the SEC’s Section 13(d) reporting rules. Specifically, the Brokaw Act would:
Shorten the Schedule 13D filing window with respect to an investor’s acquisition of a 5 percent stake in an equity security of a public company from ten days to two business days and require the reporting of certain short positions; and
Attempt to undermine activist investor “wolf packs” by implementing certain reforms to the definition of “person or group” that would limit activists’ ability to avoid the 5 percent filing threshold.
Regulation Crowdfunding Effective Date Approaching
On October 30, 2015, the SEC adopted final rules with respect to Title III of the Jumpstart Our Business Startups Act (JOBS Act). These rules (known as Regulation Crowdfunding) are intended to give small companies access to the capital markets via crowdfunding portals. When the rules take effect on May 16, 2016, this streamlined form of offering will allow companies to access the capital markets without incurring some of the costs associated with a typical registered offering.
Below is a high-level overview of the requirements for an issuer to take advantage of Regulation Crowdfunding:
Who can participate? The rules only permit U.S. domiciled companies to raise capital pursuant to Regulation Crowdfunding. However, Regulation Crowdfunding contains a “bad actor” disqualification that is substantially similar to that found in Rule 506(d) of Regulation D. In addition, Regulation Crowdfunding is not available to: investment companies, reporting companies under the Securities Exchange Act of 1934, companies that are delinquent in filing the ongoing reports required by Regulation Crowdfunding and shell companies.
How much can we raise? Issuers can raise up to $1 million in any twelve-month period under Regulation Crowdfunding.
How will our offering be sold? Offerings conducted pursuant to Regulation Crowdfunding must be conducted through a funding portal or a broker that is registered with the SEC and is a member of a national securities association. An issuer may only conduct such an offering through one broker or funding portal.
How much can an investor buy in our offering? There are significant limitations on the amount any individual investor may purchase. For those with either annual income or net worth below $100,000, the limit is the greater of: a) $2,000 and b) 5 percent of the lesser of their annual income and net worth. For those with both annual income and net worth over $100,000, the limit is generally 10 percent of the lesser of their annual income and net worth.
What do we have to disclose? An issuer engaging in crowdfunding under the new rules will have to submit to the SEC an offering statement on Form C. This will require the issuer to disclose a substantial amount of information with respect to its capital structure, governance, employees, business and financial condition. In addition, an issuer will need to submit financial statements prepared in accordance with GAAP. Depending on the size of the offering, an issuer may have to provide audited financial statements, reviewed financial statements or have its principal executive officer certify the financial statements.
Are there ongoing disclosure requirements? Yes. Once an issuer has conducted a Regulation Crowdfunding offering, it must then file annual reports containing information similar to that included in the initial offering document.
The above bullets set forth a summary of just a few of the rules and requirements with which an issuer will need to comply to conduct a Regulation Crowdfunding offering.
We will continue to provide updates once Regulation Crowdfunding takes effect in May 2016. In the meantime, the SEC and the Financial Industry Regulatory Authority (FINRA) have been busy preparing for the effectiveness of Regulation Crowdfunding. Below is a short recap of what has happened so far in 2016:
On January 28, 2016, the SEC approved FINRA’s proposed Funding Portal Rules and related forms for funding portals that become FINRA members.
On February 16, 2016, the SEC Office of Investor Education and Advocacy released an Investor Bulletin on crowdfunding to educate investors about the rules governing crowdfunding portals and the limitations on investing once Regulation Crowdfunding becomes effective.
On February 29, 2016, the SEC Staff posted a revised version of its Small Entity Compliance Guide with respect to the registration of funding portals under the JOBS Act. The guide provides a concise overview of the registration requirements for funding portals and provides useful links to related materials.