SEC Developments

SEC Issues New Rules on Naked Short Sales and Plans Further Actions to Combat Market Abuses

Yesterday, the SEC issued new rules to protect investors against "naked" short selling and also announced an intention to take further regulatory and enforcement actions relating to short sales. The new rules, Rule 204T of Regulation SHO, an amendment to Rule 203(b) of Regulation SHO, and Rule 10b-21 under the Securities Exchange Act of 1934, will apply to the securities of all public companies.

SEC Proposes Roadmap for Use of International Financial Reporting Standards by US Domiciled Registrants

The SEC has agreed to publish shortly a roadmap proposing certain milestones which, if achieved, could lead to the mandatory use by US registrants of International Financial Reporting Standards ("IFRS") rather than US GAAP.  The roadmap is expected to contemplate that the largest US registrants would be required to use IFRS beginning in 2014, with smaller registrants required to make the move in 2015 and the smallest registrants allowed to delay until 2016.

Foreign registrants are already allowed to file IFRS financial statements with the SEC without a US GAAP reconciliation.

SEC Adopts Amendments to Cross-Border Rules

The SEC recently adopted significant revisions to its rules relating to cross-border business combinations.  The amendments modify the eligibility tests for determining a company's ability to rely on rule exemptions for cross-border transactions and codify many of the exemptions that the SEC had previously granted only on a case-by-case basis thereby eliminating the need for companies to consult with the SEC on these issues as part of their transaction-planning process.  Also included is interpretive guidance with respect to a number of issues, including the circumstances under which a company may exclude US investors from a cross-border offer and the use of "vendor placements."

The SEC has yet to issue the final rule release providing more detail on these amendments.

SEC Adopts Changes to Foreign Issuer Reporting Requirements and the Rule 12g3-2(b) Exemption for Foreign Private Issuers

The SEC recently adopted, with some modifications, its previously proposed amendments to certain foreign private issuer reporting requirements.  Most significantly, the amendments shorten the filing deadline for annual reports on Form 20-F from six months to four months from the end of the filer's fiscal year after a three-year transition period.  The SEC has yet to issue the final rule release providing more detail on these amendments.

At the same open meeting, the SEC also adopted, with some modifications, its previously proposed amendments to Exchange Act Rule 12g3-2(b).  Rule 12g3-2(b) exempts certain FPIs that have not publicly offered shares within the United States from Exchange Act reporting requirements.

SEC Introduces New Filing System "IDEA"

The SEC has announced that a new system, called IDEA ("Interactive Data Electronic Applications"), will at first supplement and then eventually replace the EDGAR system.  Companies' interactive data filings are expected to be available through IDEA beginning late this year.

ACIFR Final Report

The Advisory Committee on Improvements to Financial Reporting ("ACIFR") issued its final report last month.  The report and its recommendations are primarily focused on improvements to the design of accounting standards and the standard setting process but it also contains recommendations aimed at increasing the usefulness of SEC reports and disclosure in other ways.  For example, the report suggests that:

  • The SEC mandate the inclusion of an executive summary in the forepart of companies' Form 10-K and Form 10-Qs that will provide a roadmap to the fuller discussion in the report and, in the case of Form-Qs, provide material updates to the executive summaries in previously filed annual or quarterly reports. 
  • The SEC encourage the private sector to develop best practices for the use of key performance indicators ("KPIs") in their business reports.  The ACIFR also asks the SEC to reiterate and expand its interpretative guidance regarding the disclosure of KPIs in MD&A and elsewhere.
  • Industry groups such as the National Investor Relations Institute, Financial Executives International and CFA Institute update their best practices for earnings releases to suggest that companies include their condensed financial statements in their earnings releases, locate GAAP reconciliations in close proximity to non-GAAP financial measures and provide more industry- and company-specific key performance indicators in the releases.  The report also requests that the SEC consider reiterating its view that website disclosures regarding GAAP reconciliations for non-GAAP measures presented in connection with earnings calls be available on company sites for at least 12 months.   

The ACIFR also asks the SEC to issue further guidance or rulemaking on materiality to reinforce the concept that materiality is based on the perspective of a reasonable investor within the context of the total mix of information and to address issues of qualitative versus quantitative materiality.

The SEC has already implemented certain of the ACIFR's suggestions, such as the ACIFR's request that the SEC issue guidance related to corporate websites and mandatory XBRL requirements, and is expected to propose further rulemaking related to the ACIFR's other recommendations. 


John White Provides Mid-Year Report

At a recent ABA meeting, John White, Director of the Division of Corporation Finance, provided an update on the Division of Corporation Finance's current rulemaking priorities.  According to Mr. White, we should look for staff action on the following:

  • Inflation Adjustments.  Over the past year, the staff has been looking at the dollar-threshold in all of its rules to determine whether they should be adjusted for inflation and is close to making some recommendations in this area.
  • Regulation D.  Final action on the proposals issued last summer to amend Regulation D, governing privately placed securities, should occur in the near future.
  • Credit Ratings.  The SEC received strong comments on the proposed requirement for rating agencies to disclose information that was provided to the credit rating agency and relied upon by it when formulating a rating.  The Staff is studying the comments closely and will likely act on these proposals by the end of the year.
  • Beneficial Ownership Reporting.  The Division is studying beneficial ownership reporting on Schedules 13D and 13G and considering what, if any, changes to make to these requirements with respect to the use of derivatives. The recent court decision in CSX Corp. v. The Children's Inv. Fund Mgmt. (UK) LLP et. al, Case No. 1:08-CV-02764-LAK (S.D.N.Y. filed June 11, 2008) left some uncertainty in this area but it sounds like the SEC is at the early stages of this project and is unlikely to propose any changes in 2008.
  • E-Proxy.  The staff is studying the feedback received about the first year of e-proxy implementation and considering whether any refinements in the rules are needed (which they would hope to implement this fall or early next year).  Although companies using e-proxy experienced "significant savings" there was also a drop in the retail vote.  Issuers found that the requirement to send a notice of electronic availability 40 days prior to the meeting was tough to meet and shareholders found the notices confusing in some instances.
  • Shareholder proposals.  With respect to no-action requests related to shareholder proposals, the staff would like to remind issuers to:
    • submit requests promptly;
    • send all the correspondence from all the proponents - don't wait for the staff to ask for it;
    • consider whether the Rule 14a-8(b) notice of defect (related to ownership) needs updating - don't assume it is adequate just because it worked in the past;
    • don't "throw in the kitchen sink" when arguing bases for exclusion;
    • let the staff know as soon as possible when a request is withdrawn so the staff can move on to the next proposal sooner.


Nasdaq and NYSE Increase Director Independence Threshold

The Nasdaq and NYSE have increased to $120,000 the amount of compensation that an independent director of a US-listed company can receive from the company while still meeting the definition of "independent" under Nasdaq Rule 4200(a)(15)(B) and Section 303A.02(b)(ii) of the Listed Company Manual ("LCM"), respectively.  The Nasdaq and NYSE rules previously precluded a director of a US-listed company from being considered independent if the director had received more than $100,000 in compensation from the company.  Under both the Nasdaq's and NYSE's rules, the board of directors of a US-listed company is still required to make an overall determination that no relationships exist that interfere with the director's independence.  Foreign private issuers are not subject to these requirements.

The NYSE has also amended the bright-line director independence test applicable to US-listed companies in Section 303A.02(b)(iii) of the LCM, which relates to a director's and his or her immediate family members' relationships with the company's external and internal auditor.  Under the revised test, a director is precluded from being independent if he or she:

  • is a current partner or employee of the company's internal or external auditor;
  • has an immediate family member who:
    • is a current partner of the company's auditor;
    • is a current employee of the company's auditor and personally works on the listed company's audit; or
  • was within the last three years or has an immediate family member who was within the last three years, a partner or employee of the company's auditor and personally worked on the listed company's audit within that time.

SEC Requires Press Release in Four Business Days Upon Notice of Failure to Meet Listing Standards

The NYSE has amended Section 802.02 of the LCM to provide that a US company must disclose receipt of written notification that it has fallen below the NYSE's listing standards by issuing a press release within the amount of time allotted by the SEC for US companies to disclose such an occurrence, but in any event, no later than four business days after receipt of notification from the NYSE (the current period within which US companies must file a Form 8-K under these circumstances).  The NYSE will itself issue a press release on the subject if the company has not acted within this allotted period.

The NYSE has also amended Section 802.03 of the LCM to require a non-US company to issue a press release within 30 days of receiving written notification that it has fallen below the NYSE's listing standard.  Again, the NYSE will itself issue a press release on the subject if the company has not acted within this allotted period.  FPIs are not subject to the Form 8-K requirement imposed on US  issuers.

SEC Approves NYSE Proposal to List Shares Registered on Resale Registration Statements

The SEC has approved a NYSE proposal to amend Section 102.01B and 102.01C of the LCM to allow shares issued in a private placement and subsequently registered with the SEC pursuant to a resale registration statement, without a related underwritten offering, to be listed on the NYSE.  The NYSE had submitted a similar proposal to the SEC in January 2007 but later withdrew it. 

Previously, shares issued in such a scenario, often referred to as a "Rule 144A IPO," could not be listed on the NYSE due to a lack of market valuation of the shares for purposes of the NYSE's market-value listing requirements and difficulty meeting the NYSE's 400 round-lot-holder requirement.  Under the new standard, the NYSE would have the discretion to determine that a company has met the NYSE's market value requirements based on a combination of both a third-party valuation of the company and the most recent trading price for the company's common stock in a private placement trading market.  Further, the NYSE now looks at the number of beneficial round-lot holders, instead of just record holders, in assessing whether the 400 round-lot-holder requirement has been met.


FASB Proposes Changes to EPS

The FASB has issued an exposure draft that would amend FASB Statement No. 128, Earnings per Share, to clarify and simplify the computation of earnings per share ("EPS") and converge the requirements of Statement 128 with those of IAS 33, Earnings per Share.  


SEC Approves PCAOB Auditor Independence Rule Changes Related to Pre-engagement Communications and Tax Services

The SEC has approved changes to the PCAOB's auditor independence rules related to pre-engagement communications and tax services.  The PCAOB approved and published the rule changes last April and submitted them to the SEC at that time. 

The first change is the adoption of a new rule, Rule 3526, pursuant to which a registered public accounting firm will be required, before accepting an initial engagement pursuant to the standards of the PCAOB, to describe in writing to the audit committee all relationships between the firm or any of its affiliates and the issuer or persons in a financial reporting oversight role at the issuer that may reasonably be thought to bear on the firm's independence.  Audit firms will also be required to discuss with the audit committee the potential effects of any such relationships on the firm's independence and make similar communications annually for continuing engagements.  The rule will supersede the PCAOB's comparable interim independence requirement, Independence Standards Board Standard No. 1, Independence Discussions with Audit Committees, and two related interpretations.

The SEC has also approved an amendment to Rule 3523, Tax Services for Persons in Financial Reporting Oversight Roles.  Rule 3523 provides that a registered public accounting firm is not independent of its audit client if the firm, or any affiliate of the firm, during the audit period (i.e., the period covered by the financial statements being audited or reviewed) and professional engagement period (i.e., the period beginning when the company signs the audit engagement letter and ends when the audit firm or company notifies the SEC that it is no longer that firm's audit client) provides tax services to a person in a financial reporting oversight role at the audit client, or an immediate family member of such person, subject to certain enumerated exceptions.   The amendment to PCAOB Rule 3523 provides that the Board will not apply Rule 3523 to tax services that are provided during the portion of the audit period preceding the professional engagement period.


Climate Change Disclosure Update

Disclosure of climate change issues is once again in the news.  Xcel Energy recently announced that it has reached an agreement with Andrew Cuomo, the New York Attorney General, to provide more detailed disclosure to investors in its Form 10-K filing with the SEC on present and probable future climate change regulation and legislation, climate change-related litigation, and the physical impacts of climate change.  The agreement is in response to subpoenas issued by Mr. Cuomo in 2007 pursuant to the Martin Act (New York's securities law) demanding information from Xcel and four other energy companies regarding their analysis and disclosure of climate change risk.  While the SEC has to date declined to issue specific climate change disclosure guidance, environmental groups are pressuring the SEC to mandate, and companies to provide, more detailed climate change disclosure, and investor relations groups such as the ISS are also carefully considering climate change disclosure issues.  Every company (and particularly those with connections to coal-fired power plants) should keep these developments in mind when reviewing their current public disclosure.

Other Davis Polk Memos