In 2023, the Securities and Exchange Commission (SEC) continued its trend of recent years of robust and significant rulemaking that affects the range of players in the securities industry — public companies, broker-dealers, private fund advisers and major investors, among others. As we prepare to turn our calendars over into 2024, it’s worthwhile to look back at some of the most noteworthy new rules from this year that will help shape the U.S. capital markets in the future.

Cybersecurity

Probably the most important new rule impacting public companies concerned the disclosure of both (i) material cybersecurity incidents and (ii) their risk management, strategy and corporate governance practices relating to general cybersecurity. Specifically, public companies are now required to disclose, by means of a current report on Form 8-K (Item 1.05), when they have experienced a cybersecurity event that they have assessed to be material. While the company itself makes this assessment, and has discretion in the amount of time it needs to arrive at its conclusion, once it determines the incident to have been a material one, it must comply with the standard Form 8-K filing deadline — four business days — in making the disclosure. Further, the instructions to the rule state that the materiality determination must be made without unreasonable delay after discovery of the incident.

(Materiality has never been formally defined in the securities laws, but federal courts have over the years applied their own definition to securities-related cases and controversies, and the SEC has used this definition in its rulemaking and guidance. A fact or event is material if there is a substantial likelihood that a reasonable investor would consider it important in making an investment decision or in deciding how to vote their shares at a meeting, with the disclosure, or the failure to disclose, of this information significantly altering the total mix of information needed for those purposes.)

In addition, public companies must now include in their annual disclosure, made on Form 10-K, information about their processes for evaluating the risk of cybersecurity threats and their effects, when material. They must also describe how the board of directors oversees this risk, including whether a dedicated committee has been delegated this responsibility, and the role of senior management in both assessing it and taking action to deter, mitigate and respond to cybersecurity incidents.

Beneficial Ownership Reporting

Longstanding rules require “beneficial owners”, i.e. a person, a group of persons, or an entity, of more than five percent (5%) of a voting class of a public company’s equity securities, to file either a Schedule 13D or Schedule 13G with the SEC shortly after crossing over the 5% threshold. Schedule 13G is a short-form version of Schedule 13D and is used when (i) the shares were held prior to the company’s having gone public (and the holder limits subsequent purchases to less than 2% of all outstanding shares of the class), i.e. an “exempt investor”; (ii) the holder is a qualifying institutional investor, such as a broker-dealer, bank, insurance company, registered investment company, or registered investment advisor, among others; and (iii) the holder certifies that it is not holding the securities with a view toward obtaining control of the company, or a “passive investor”. All other holders must use Schedule 13D.

Earlier this year, the SEC changed the filing deadlines for these schedules, shortening them significantly, in order to reflect technological changes since the original rules went into effect and provide the market with more timely information about new and significant equity positions in a public issuer. The new deadlines work as follows:

• Schedule 13D filers must now file within five (5) business days after crossing the 5% threshold (the previous deadline was within 10 calendar days). Amendments to Schedule 13D must now be filed within two (2) business days of the material change that prompted the amendment (the earlier requirement was to file “promptly”).
• Schedule 13G filing deadlines vary according to the type of filer, as follows:
  • Exempt investors must now file within 45 days after the end of the calendar quarter in which their beneficial ownership went over 5% (previously, they could wait until 45 days after the end of the calendar year);
  • Qualified institutional investors over 5% must also now file within 45 days after the end of the calendar quarter; but if their ownership goes over 10% then they must file within five (5) business days after the end of that month (it was previously 45 days in the new year and 10 days after end of month, respectively);
  • Passive investors must now file within five (5) business days of crossing the 5% threshold (earlier, it was 10 calendar days).
• Amendments to Schedule 13G also vary according to the filer, as well as the circumstances warranting the amendment. If any material changes in the information filed in the earlier 13G take place, all filers must amend within 45 days after the end of the calendar quarter. If a qualified institutional investor’s ownership exceeds 10% after the filing of the initial 13G, an amendment must be filed within five (5) business days after the end of that month, and thereafter a further amendment must be filed within five (5) business days after the end of the month where ownership either increases or decreases by more than 5%. And, similarly, if a passive investor goes over 10% after an earlier 13G filing, an amendment has to be filed within two (2) business days and a further amendment filed if that investor’s ownership subsequently increases or decreases by over 5%.

Private Fund Advisers

In early 2022, the SEC proposed new rules concerning private fund advisers, some of which are applicable to only those advisers registered with the SEC, while others apply to all such advisers, registered or not. After a quite lengthy comment period, final rules were adopted in late summer of this year. Taken together, these new rules represent a sweeping change in the private funds advisory industry, and while most of the new rules will not become effective until 12-18 months (depending on the size of the adviser) after they are published in the Federal Register, advisers should already begin planning for implementation.

The rules applicable only to SEC-registered investment advisers (RIAs) are as follows:

• Quarterly Statement Rule: All RIAs must provide their investors with a quarterly report detailing the fund’s performance, as well as fees and expenses paid by the fund and amounts paid to the adviser.
• Audit Rule: All RIAs are required to obtain annual audited financial statements, with the audit performed by an independent public accountant registered with the Public Company Accounting Oversight Board.
• Adviser-Led Secondaries Rule: When engaged in a transaction with its investors that will either involve purchasing the investors’ fund shares or converting the shares for those of a related fund, RIAs must obtain a fairness opinion or valuation opinion and provide disclosure to the investors about any recent relationship the RIA has had with the opinion provider.

The rules applicable to all fund advisers, whether or not registered with the SEC, are as follows:

• Restricted Activities Rule: Funds will not be able to do any of the following without either providing satisfactory disclosure to their investors (typically within 45 days after the action taken, although certain acts require advance disclosure), obtaining informed consent from a majority of them in addition to making disclosure, or at all, as follows:
  • Disclosure: charge their investors fees or expenses that relate to regulatory, compliance and examination expenses; offset clawback obligations, i.e. the fund’s commitment to return performance-based compensation to investors, by taxes incurred by the fund; and charging fees or allocating expenses on a non pro rata basis.
  • Informed Consent: charge fees that relate to a governmental investigation of the fund; and borrowing from, or receiving, loans or other credit that are collateralized by, fund assets.
  • Prohibited: assess any fees if a governmental investigation results in sanctions for violations of the Investment Advisers Act of 1940 or its related rules.
• Preferential Treatment Rule: As the title indicates, this new rule prohibits private fund advisors from treating investors differently, at least not without prior disclosure. Specifically, funds may not:
  • Provide preferential redemption rights, i.e. allow certain investors to redeem their interest on terms that the fund reasonably expects to have a material and negative effect on other investors. All investors must have the same redemption ability unless an investor is bound by applicable laws, rules or regulations that mandate a special redemption right. And if a fund has to provide preferential redemption, it must disclose this in advance and ensure that all such terms continue to be disclosed after the initial investment.
  • Give selective information regarding portfolio holdings or exposures; all investors must receive the same information at or around the same time.

Share Repurchase Rule — Almost, but Not Quite

Last spring, the SEC finalized a rule in which public companies must provide enhanced disclosure about their repurchases of their own common stock. Each quarterly report would include daily repurchase activity, more specific information about open market purchases, and state whether repurchased shares are intended to provide issuers with protection against market manipulation liability or an affirmative defense to insider trading liability. Issuers were also to describe the reasons for the repurchases and the process used to determine the number of shares bought, as well as their policy on officers and directors trading in the company’s stock while the repurchase program is in place.

However, the share repurchase rule was challenged by the U.S. Chamber of Commerce and other business groups, which filed a lawsuit against it on multiple grounds, including the SEC’s not having taken into consideration the Chamber’s comments to the rule while it was under consideration. The Chamber had requested that the SEC quantify the costs and benefits of the rule, which the agency declined to do, claiming that such costs and benefits were unquantifiable. The Fifth Circuit Court of Appeals in Texas held in November that the final rule was arbitrary and capricious, and gave the SEC 30 days to correct the perceived defects. In response, the SEC stayed the rule and moved for an extension, but the court denied this motion. The SEC then stated that it was unable to comply with the court’s deadline to fix the rule, and the Chamber has since moved to vacate it altogether. Whether or not the share repurchase rule is revived in some altered form in 2024 is, at this writing, anyone’s guess, but the rule as promulgated earlier this year is not operative.

On the Horizon for 2024 — Climate Change Disclosure

Back in early 2022, the SEC issued a proposed rule requiring public companies with a carbon footprint to make robust quantitative and qualitative disclosures about matters such as their emissions, how their boards and managements oversee climate-related risks, the impact of climate events on financial results, and the companies’ climate targets and goals, if any, among other things.

The proposal has since been subject to heavy comment and pushback from a number of constituencies, with the main substantive concern centering on the belief that certain public companies will be forced to make disclosure about their entire supply chain, including private companies that sell to them, which in effect will result in the indirect regulation of companies typically outside the SEC’s purview. Another, more broad, criticism is that the SEC is overreaching, using its power to pressure American companies and even industries to shift their business models away from practices that may contribute to climate change. These critics claim that imposing the onerous disclosure requirements called for in the rule is a backdoor way of reducing the cost-effectiveness of these business practices, which is outside the SEC’s traditional scope of investor protection and facilitating capital formation.

In mid-December the SEC announced that further consideration of the climate change rule has been rescheduled, after several earlier postponements, to the spring of 2024, a full two years after the initial proposed rule came out. This is one to watch in the upcoming new year.