SEC Changes Fee Payment Instructions
The SEC has changed its Financial Agent, and hence its fee payment instructions. All SEC fee payments (wires and checks) should be submitted to the SEC’s new Financial Agent, US Bank of St. Louis, Missouri, rather than Mellon Bank.
As of December 31, 2007, the Section 6(b) fee rate applicable to the registration of securities, the Section 13(e) fee rate applicable to the repurchase of securities, and the Section 14(g) fee rate applicable to proxy solicitations and statements in corporate control transactions increased to $39.30 per million dollars.
SEC Issues Final Rule Allowing IFRS Filings by Foreign Private Issuers and Suggests That Early Adoption is Possible
In late December, the SEC issued a final rule release containing amendments that allow foreign private issuers (“FPIs”) to submit financial statements prepared in accordance with International Financial Reporting Standards (“IFRS”) as issued by the International Accounting Standards Board (“IASB”) without a reconciliation to US generally accepted accounting principles (“US GAAP”). The rules will be effective as of March 4, 2008, and apply to all fiscal years ending after November 15, 2007.
The SEC staff has also issued a notice indicating that FPIs that want to take advantage of the final rule but that would like to file their Form 20-F before March 4, 2008, the effective date of the rule, should consult the SEC staff to discuss this option. The staff does not want to discourage companies from filing their 20-F before March 4, 2008 and therefore encourages companies in this situation to call either Craig Olinger, Deputy Chief Accountant (202-551-3547) or Wayne Carnal, Chief Accountant (202-551-3107).
Nazareth Leaves SEC
The SEC is down to three Commissioners, all Republicans, as a result of Commissioner Annette Nazareth's departure at the end of January. The SEC typically has five Commissioners who are appointed by the President of the United States with the advice and consent of the Senate. To ensure that the Commission remains nonpartisan, no more than three Commissioners may belong to the same political party. Roel Campos, the other Democratic Commissioner, left the SEC in mid-2007 and has not yet been replaced.
John White Outlines Goals for 2008 and “Drills Down” on International Securities Matters
In recent speeches before the 35th Annual Securities Regulation Institute and Practising Law Institute's Seventh Annual Institute on Securities Regulation in Europe, John White, Director of the Division of Corporation Finance, discussed the Division's agenda for 2008.
Financial Reporting and Materiality. Mr. White said that the Division's biggest focus will be on financial reporting, including review of the interim proposals scheduled to be voted on soon by the SEC Advisory Committee on Improvements to Financial Reporting (the “Committee”). Specifically, Mr. White intends to focus on the Committee's anticipated proposal discussing whether and when a quantitatively material error can be immaterial based on qualitative factors as well as its proposal related to the correction of prior period errors. While these proposals are pending, Mr. White encouraged companies that are currently dealing with these issues to contact the SEC staff before presuming that the SEC staff would require a restatement for a quantitatively large error that might be qualitatively immaterial.
Form 8-Ks Related to Restatements. The SEC staff plans to conduct rule making this year to address whether or not a company must file a Form 8-K to announce a restatement. According to Mr. White, the SEC staff believes that Question 1 of the Current Report on Form 8-K Frequently Asked Questions, issued November 23, 2004 makes it clear that a separate Form 8-K filing is required, but companies continue to announce restatements in periodic reports rather than by filing a Form 8-K. Mr. White hopes that the SEC will issue a rule this year to directly address this issue.
Corporate Websites. The SEC staff is also looking to update the interpretative guidance the SEC issued in 2000 regarding the use of corporate websites for the disclosure of information.
Revisions to Regulation D. The revisions to Regulation D the SEC proposed this past summer are on Mr. White's “short list,” and he hopes that the SEC will be in a position to issue final rules soon.
Voluntary Filers. The SEC staff continues to “think about how [its] rules apply to so-called voluntary filers and whether rule making or guidance in this area might be advisable.”
PIPEs. Mr. White mentioned two recent court cases, SEC v. John F. Mangan, Jr., et al., 3:06CV531 (W.D.N.C. October 24, 2007) and SEC v. Edwin Buchanan Lyon, IV, et al., 06 Civ. 14338 (S.D.N.Y. January 2, 2008). In these cases, the court dismissed Section 5 claims brought by the SEC against Private Investment in Public Equity (“PIPE”) investors that allegedly used shares that they had purchased in the PIPEs transaction to cover short positions that they created prior to the effective date of the resale registration statement covering such PIPEs shares.
In discussing these cases, Mr. White noted, “Although I cannot comment directly on the cases, I will take this opportunity to restate the Division's position concerning short sales and Section 5 generally. With respect to short sales, the time of the sale is when the seller of the securities establishes its short position. The staff has made a similar point as far back as at least the early '70s and nothing has changed on our end. So, applying this to a PIPEs offering, if the investor takes the shares it is selling off the resale registration statement to settle the short (or to return shares to the lender when borrowed shares were used to settle the short sale), that violates Section 5 because the short sale was completed before the registration statement for those shares was effective.”
Mr. White went on to say, “As you can imagine, we are watching closely the developments in this area and assessing what, if any, response may be appropriate - obviously our priority here is to make sure that investors remain protected.”
E-proxy. As he has said previously, Mr. White commented that the SEC is monitoring the implementation of the e-proxy model and will consider follow-up rule-making to smooth its use in the future, if needed.
International Initiatives. Mr. White made a point of highlighting the SEC's international initiatives generally in his recent speeches. He specifically stressed the following:
- IFRS: The SEC staff is “deeply committed” to the goal of achieving a single set of high-quality, globally accepted accounting standards and is seriously considering how to best achieve this goal. According to Mr. White, commenters have suggested that the SEC consider one or more of the following approaches with respect to the transition to IFRS for US issuers:
- Laying out a “road map” of steps forward.
- Allowing the voluntary use of IFRS for an indeterminate period.
- Setting a fixed date in the future for the mandatory use of IFRS.
- Adopting a “wait and see” approach for the time being in order to allow convergence, investor understanding and the infrastructure for IFRS to further develop over the next few years.
Possible Revision to Section 12(g) Rules: Mr. White said that he thinks that the SEC should consider revisions to the entrance rules contained in Section 12(g) of the Securities Exchange Act of 1934 (“the Exchange Act”) in order to allow FPIs to avoid Exchange Act registration if they provide certain information to investors via the Internet. Under the current rules, a FPI that has not conducted a US- registered offering and does not have securities listed on a US exchange may still be required to register under Section 12(g) of the Exchange Act and file periodic reports with the SEC if it has over 300 shareholders resident in the United States. An exemption in Rule 12g3-2 of the Exchange Act allows such FPIs to avoid Exchange Act registration and the related periodic report filing requirements but requires the FPI to provide the SEC copies of certain information released publicly in the FPI's home country. The SEC currently makes this information, which is less comprehensive than the information that would be required to be filed under the Exchange Act reporting requirements, available to investors via its Public Reference Room.
Use of Automatic Shelf Registration Statements by FPIs: Mr. White acknowledged that FPIs that are also well-known seasoned issuers (“WKSIs”) may be reluctant to utilize automatic shelf registration statements because the annual financial statements contained in the Form 20-F will become stale at a certain point during the year. In order to update a shelf registration statement that has become stale during the year, an FPI is required to file interim financial statements and reconcile them with US GAAP, a requirement not otherwise applicable to foreign issuers. This is not an issue for US issuers, which are already required under the Exchange Act to file quarterly US GAAP financial statements that are incorporated by reference into their automatic shelf registration statement.
Although Mr. White recognizes that this issue is mitigated for FPIs that will now file IFRS financial statements without a US GAAP reconciliation in accordance with the SEC's recent rule change, he also believes that this issue could be further addressed “in a way that would be beneficial to foreign private issuers and investors.”
Possible Shortening of Form 20-F Deadlines: Echoing the comments of other SEC staffers in recent months, Mr. White reminded issuers that the SEC has solicited comment in the past on whether to shorten the Form 20-F filing deadline. Mr. White went on to note, however, that he believes that the accelerated filing deadlines might be phased in gradually as they were for US issuers.
Definition of FPI: Mr. White believes that the current definition of FPI (which looks at the residency of a company's shareholders, officers and directors and assets and where the issuer's business is principally administered) seems to be working but that the measure dates may need to be reexamined so that companies “don't find themselves suddenly in a world they didn't create, such as when their US shareholder base rises above 50%.”
Cross-Border Tender Offer Rules. SEC staff members have mentioned on more than one occasion in the past few years that the Division intends to propose revisions to the cross-border tender offer rules. Mr. White suggested that these anticipated revisions might actually come to fruition in 2008, noting that “revisions to these rules are currently the number one priority” in the Office of Mergers and Acquisitions.
Corporation Finance Staff Members Address Various Topics at AICPA Conference
In January, the SEC published speeches made by various staff members at an American Institute of Certified Public Accountants conference in December 2007. The SEC staff members discussed a variety of topics of interest to corporate issuers including the following:
Consent Requirement. Stephanie Hunsaker, Associate Chief Accountant, Division of Corporation Finance, noted that the SEC staff has seen an increase in the number of companies that have chosen to reference the use of an independent valuation firm or other expert in their SEC filings. Accordingly, she provided the following reminders of when the consent of an independent expert is required to be filed and how an issuer should disclose the use of an expert in its filings.
- Rule 436 of Regulation C requires a filing made pursuant to the Securities Act of 1993 (the “Securities Act”) that quotes or summarizes a report or opinion of an expert to contain the expert's written consent to the inclusion of the quotation or summarization in the registration statement.
- While there is no requirement to obtain a consent from an expert cited in an Exchange Act filing, if the Exchange Act filing will be incorporated by reference into a registration statement, a consent must also be filed with respect to such citation.
- If a registrant makes reference to an expert or valuation firm in an Exchange Act filing, the SEC staff expects that expert to be named, even if no consent is required in the Exchange Act filing. If the issuer does not wish to explicitly name the expert, it could simply chose to not make reference to the expert at all, thereby taking full responsibility for the valuation. A reference to an expert's valuation does not need to be contained within a specific “Experts” section (which is not required by the SEC's forms) in order to trigger the consent requirement.
- The SEC staff interprets the consent requirement broadly, such that any reference to the expert, whether as a single basis for the measurement determination, or as one of several things that was considered in arriving at the measurement determination, would require a consent.
- There is no requirement to reference an expert in the discussion of a valuation just because the expert contributed to the registrant's analysis. Once the expert is referenced, however, the expert's consent must be filed.
- The expert providing the consent may state that it does not admit to being an expert but it may not deny that it is an expert.
The expert may not attempt to limit its liability under Sections 7 and 11 of the Securities Act or include language that attempts to state a legal conclusion as to which party is responsible for which item of disclosure. For example, an expert cannot say that the responsibility of the valuation rests solely with the registrant.
Off-Balance Sheet Disclosure. Ms. Hunsaker commented that the SEC staff has been reviewing disclosures of registrants that are significantly impacted by the current credit environment. According to Ms. Hunsaker, while the staff has “noted some improvement from these registrants' prior disclosures,” registrants may also want to consider additional MD&A disclosures that would provide insight into the quality of the off-balance sheet assets held and the liquidity risk of those assets. Ms. Hunsaker provides a detailed discussion on the types of disclosures the SEC is looking for in the section of her speech entitled, “MD&A Disclosures in Current Credit Environment.”
SOX 404 Transition Relief. Steven Jacobs, Associate Chief Accountant, Division of Corporation Finance, said that since passing a rule in December 2006 that allows newly public companies a one-year transition period before being subject to the internal control requirements of Section 404 of the Sarbanes-Oxley Act (“SOX 404”), the SEC has received many requests to extend this relief to similar situations. Companies have also asked whether the third question of the SEC's “Frequently Asked Questions on Management's Report on Internal Control Over Financial Reporting and Certification of Disclosure in Exchange Act Periodic Reports” (updated September 2007) (“FAQ #3”) may be applied to reverse mergers and Special Purpose Acquisition Companies (“SPACs”). FAQ #3 permits the exclusion of internal controls related to acquired businesses from the scope of management's assessment in the first Form 10-K following a material business combination. In his speech, Mr. Jacobs indicated that the SEC staff may apply such relief in certain limited circumstances and suggested that companies seeking such relief discuss their circumstances with the Division staff.
Disclosure of Material Weaknesses. Josh Jones, Professional Accounting Fellow, Office of the Chief Accountant, discussed the SOX 404 guidance issued by the SEC in 2007. He noted that companies' disclosures of material weaknesses in management's SOX 404 reports are often deficient because they do not provide the information needed for investors to understand the impact of the material weakness on such companies' financial reporting. Mr. Jones urged companies to look to the SOX 404 guidance in crafting this disclosure because the guidance includes a number of considerations that should be taken into account.
Auditor Independence. Vassilios Karapanos, Associate Chief Accountant, Office of the Chief Accountant, confirmed that the SEC staff is frequently asked, “How much advice can an auditor provide to an audit client with regard to an accounting issue or standard without impairing its independence?” Mr. Karapanos acknowledged that while the question of whether an auditor's independence is impaired depends upon the facts and circumstances, the following types of services would typically not create such an impairment:
- Discussions regarding the requirements and the related concepts, terminology and implementation issues related to an accounting application
- Provision of sample journal entries that help management understand the accounting application
- Discussions of the factors to be considered in making judgments that may become critical in the accounting process
- Discussions of the nature of relevant model inputs and related market sources of information
In summary, Mr. Karapanos stated that, “In general, the staff believes that the auditor may provide advice to the audit client on the proper application of accounting and assist him or her in gaining an understanding of the methods, models, assumptions and inputs used by such accounting application or standard.”
Mr. Karapanos also noted that the staff is often asked whether a predecessor auditor has to be independent in order to issue a consent for a previously issued audit report. According to Mr. Karapanos, “An auditor has to be independent during the audit and professional engagement period. Once the audit and professional engagement period has ended, he or she does not have to be independent. Issuing a consent for a previously issued opinion does not constitute a new 'audit and professional engagement period' for which the auditor needs to be independent. However, if there is going to be a restatement of previously issued financial statements (whether it be for error correction, retrospective adoption of an accounting principle, for a discontinued operation, etc.) and the auditor is required to dual date their opinion on restated financial statements, the auditor has to be independent.”
Materiality of Large Errors. Todd Hardiman, Associate Chief Accountant, said that he believes that a large error can be immaterial. In order to conclude this, however, a company has to go back to the established US Supreme Court test for materiality-i.e. “is there a substantial likelihood that the . . . fact would have been viewed by a reasonable investor as having significantly altered the ‘total mix’ of information made available.” Mr. Hardiman urged companies that have done this analysis and concluded that a large error is not material to come talk to the SEC staff before concluding that the staff will not agree with them.
Direct Registration Deadline Extended, Listed Companies Have Until March 31, 2008 to Be Able to Issue Uncertificated Shares
Citing confusion over the steps that listed companies need to complete to become compliant with the NYSE and Nasdaq Direct Registration System (“DRS”) requirements, the SEC has approved the NYSE and Nasdaq's extension of the compliance deadline by which listed issuers must be DRS eligible to March 31, 2008. Under the NYSE's and the Nasdaq's DRS rules, issuers are not required to actually participate in DRS but must be eligible to participate in the system (i.e., they must be able to issue uncertificated securities, have a transfer agent that is DRS eligible and be registered as eligible with DTC). Companies should make sure that their bylaws do not prohibit them from issuing uncertificated shares and that their transfer agent has taken the proper steps to make them DRS eligible. Companies should also determine whether the laws of their state of incorporation require them to do anything else in order to be eligible to issue uncertificated shares. For example, Section 158 of the Delaware General Corporation Law requires Delaware corporations to pass a board resolution authorizing the issuance of uncertificated shares.
FASB Publishes Codification of US GAAP
The FASB has published its proposed codification of US GAAP and is seeking comments on the project throughout the year. The codification reorganizes thousands of authoritative US accounting pronouncements issued by multiple standard-setters, including those of the FASB, the AICPA and the Emerging Issues Task Force (“EITF”) into a single source with a consistent structure. Also to be included is relevant SEC guidance. Once approved by the FASB, the codification will become the single source of authoritative US GAAP and will supersede existing FASB, AICPA, EITF, and related literature.
The FASB encourages constituents to use the FASB's online Codification Research System free of charge during the one-year comment period to research accounting issues and provide feedback on whether the codification content accurately reflects existing US GAAP. The FASB warns users, however, that the codification content is not yet approved as authoritative and, therefore, they must verify research results using their existing resources for the currently effective literature.
Other Developments and DP&W Memos
IRS Ruling Reflects Changed Position on Application of $1M Deduction Limit on Annual Compensation to Top Executives Under Internal Revenue Code Section 162(m)
A recently released private letter ruling (200804004) appears to reverse a position taken by the IRS in several prior rulings. At issue was whether compensation meets the performance-based requirement of Section 162(m) for an executive whose employment agreement provides that, in the event his employment is terminated by the employer without cause or by him with good reason, the executive is entitled to receive an amount based on the target performance level without regard to the actual performance results. In this circumstance, the ruling holds that any compensation paid to the executive under an award covered by the special payment provision will not qualify as performance-based, including compensation paid under any such award in years in which the executive did not terminate employment and the performance targets were achieved.
US Supreme Court Issues Decision in Stoneridge Investment Partners LLC v. Scientific-Atlanta
On January 15, 2008, the US Supreme Court issued its decision in Stoneridge Investment Partners LLC v. Scientific-Atlanta [“Stoneridge”], No. 06-43, resolving whether there can be private civil liability under Section 10(b) of the Exchange Act, 15 USC. § 78j(b), for actors who do not make misstatements or omissions or engage in manipulative securities transactions, but instead are alleged to have participated in a “scheme” to defraud in which another actor has made misleading statements to investors. In a 5-3 decision (with Justice Breyer recusing himself), the Supreme Court answered this question in the negative, holding that there is no private civil liability for a secondary actor who did not speak to the market, and whose allegedly deceptive conduct is not disclosed to the market, because the reliance element of a Section 10(b) claim cannot be satisfied.
Delaware Judge Blesses Accommodation with Dissident Shareholder, but Emphasizes Need for Disclosure
In light of surging shareholder activism, boards and issuers may be interested in a decision handed down by the Delaware Chancery Court on January 15, 2008. In Portnoy v. Cryo-Cell International, Inc. C.A. No 3142-VCS (Del. Ch. January 15, 2008), Vice Chancellor Strine blessed an agreement by management to accommodate a dissident shareholder by including him on the management slate in exchange for his agreement to vote for the incumbent board. Drawing a distinction between this type of accommodation and a traditional case of vote-buying, Vice Chancellor Strine refused to apply the heightened standard of review applicable under some Delaware cases to a compromise among candidates about the shape of a board slate. Even though the Vice Chancellor ultimately decided the case for plaintiffs (ordering a re-vote due in part to a lack of disclosure regarding a second voting arrangement), the opinion makes clear that a voting arrangement to accommodate board service that is subject to an informed shareholder vote will not be presumed to be unfair, but rather is subject to a determination that the parties’ subjective motives were fair.