Category SEC

Earlier this month, the SEC issued a press release announcing that it was soliciting comments on earnings releases and quarterly reports. Specifically, the SEC is seeking comments on how the existing periodic reporting system, alone or in combination with other factors, may foster an overly short-term focus by managers and other market participants.

The request for comments addresses the following:

• The nature and timing of disclosures that reporting companies must provide in their quarterly Form 10-Q reports, including when the Form 10-Q disclosure requirements overlap with the disclosures companies voluntarily provide to the public in earnings releases furnished on Form 8-K.
• How the SEC can promote efficiency in periodic reporting by reducing unnecessary duplication in the information that reporting companies disclose and how any such changes could affect capital formation, while enhancing, or at a minimum maintaining, appropriate investor protection.
• Whether SEC rules should allow reporting companies, or certain classes of reporting companies, flexibility as to the frequency of their periodic reporting.
• How the existing periodic reporting system, earnings releases, and earnings guidance (either standing alone or in combination with other factors) may affect corporate decision making and strategic thinking, including whether these factors foster an inefficient outlook among reporting companies and market participants by focusing on short-term results.

The SEC will accept comments through March 21, 2019.

The SEC Press Release can be found at, https://www.sec.gov/news/press-release/2018-287, and the version of the request published in the Federal Register can be found at, https://www.sec.gov/rules/other/2018/33-10588.pdf.

On December 18, 2018, the SEC announced that it had finalized the hedging rules required by the Dodd-Frank Act (see https://www.sec.gov/news/press-release/2018-291). The SEC then made the Final Rule release (Release No. 33-10593; File No. S7-01-15) available on its website at: https://www.sec.gov/rules/final/2018/33-10593.pdf).

Final Rule Requirements

• New Item 407(i) of Regulation S-K requires a company to describe any practices or policies it has adopted regarding the ability of its employees (including officers) or directors to purchase securities or other financial instruments, or otherwise engage in transactions, that hedge or offset, or are designed to hedge or offset, any decrease in the market value of equity securities granted as compensation, or held directly or indirectly by the employee or director.
• Companies can satisfy this requirement by providing a summary of the practices or policies that apply, including the categories of persons they affect and any categories of hedging transactions that are specifically permitted or specifically disallowed, or by disclosing the practices or policies in full.
• If the company does not have any such practices or policies, the company must disclose that fact or state that hedging transactions are generally permitted.
• Equity securities for which this disclosure requirement applies are equity securities of the company, any parent, or any subsidiary of the company or any parent.

Timing of Application of Final Rules

Companies must generally comply with these new disclosure rules in proxy and information statements for the election of directors during fiscal years beginning on or after:

• July 1, 2020 for smaller reporting companies and emerging growth companies; and
• July 1, 2019 for public companies
• But note that the rules will not apply to closed-end funds and foreign private issuers.

On October 23, 2018, the SEC issued Staff Legal Bulletin No. 14J (CF) [SLB 14J] regarding Rule 14a-8. Specifically, SLB 14J takes a look at the economic relevance and ordinary business exclusions for shareholder proposals. The SEC Staff last addressed these concepts in SLB 14I.

SLB 14J offers additional guidance on proposals that address senior executive and/or director compensation and ordinary business matters. The SLB states that in evaluating proposals that raise both ordinary business and senior executive and/or director compensation matters, the SEC staff examines whether the focus of the proposal is an ordinary business matter or aspects of senior executive and/or director compensation. Where the focus appears to the SEC staff to be on an ordinary business matter, the proposal might be excludable under Rule 14a-8(i)(7).

Furthermore, the SEC Staff indicated that it believes a proposal that addresses senior executive and/or director compensation may be excludable under Rule 14a-8(i)(7) if a primary aspect of the targeted compensation is broadly available or applicable to a company’s general workforce and the company demonstrates that the executives’ or directors’ eligibility to receive the compensation does not implicate significant compensation matters.

The SEC also announced a bit of a change in how it will approach the exclusion of proposals addressing senior executive and/or director compensation on the basis of micromanagement. Historically, the SEC has not agreed with such exclusions. However, the SEC rethought its position and may support such exclusions in cases where the proposal seeks intricate details or seeks to impose specific timeframes or methods for implementing complex policies.

SLB 14J also details the form of analysis that would be most helpful to the SEC Staff as it considers the no-action request to exclude a shareholder proposal. The SLB lays out the factors that the SEC Staff believes the board may need to address depending on the facts and circumstances in determining whether the shareholder proposal involves a policy issue that is otherwise significantly related to the company’s business or is sufficiently significant in relation to the company’s business. The SLB indicates that a well-developed discussion will describe in sufficient detail the specific substantive factors the board considered in arriving at its conclusion that an issue is not otherwise significantly related to its business or is not sufficiently significant in relation to the company.

SEC Staff Legal Bulletin

Available at: https://www.sec.gov/corpfin/staff-legal-bulletin-14j-shareholder-proposals#

This week, the new Democrat SEC Commissioner, Robert J. Jackson, Jr., gave a speech in which he presented the findings of his staff’s research into how “buybacks  affect how much skin executives keep in the game.” Commissioner Jackson was a law professor who liked to conduct research before joining the SEC. Commissioner Jackson said that he often asked his students two questions when thinking about how to give corporate managers incentives to create sustainable long-term value:

• Are we making sure that executive pay gives managers reason to invest in the long-term development of their workforce and their communities?
• Or are we paying executives to pursue short-term stock-price spikes rather than long-term growth?

Commissioner Jackson noted that the theory behind paying executives in stock is to give them incentives to create long-term sustainable value. But, as he also pointed out, that only works when executives are required to hold the stock over the long term.

So when the Tax Cuts and Job Act was signed into law, Commissioner Jackson worried that we would see a repeat of what corporations did when the last corporate tax holiday was enacted in 2004–use the cash influx for stock buybacks and not necessarily  invest in long-term value creation. The first quarter of 2018 saw corporations buyback $178 billion in stock. So Commissioner Jackson and his staff studied 385 buybacks over the last 15 months and matched them to information on executive stock sales. They found:

• A buyback announcement leads to a big jump in stock price–typically more than 2.5% during the 30-days after the announcement;
• In half the buybacks studied, at least one executive sold shares in the month following the buyback announcement.
• In the days before a buyback announcement, executives trade in relatively small amounts (less than $100,000 worth daily), but during the 8 days following a buyback announcement, executives on average sell more than $500,000 worth of stock each day.

Commissioner Jackson did acknowledge that this stock trading by executives is not necessarily illegal. However, he finds it troubling as he see it as more evidence that executives are spending more time on short-term stock trading than long-term value creation.

Commissioner Jackson pointed out that, “Executives often claim that a buyback is the right long-term strategy for the company, and they’re not always wrong. But if that’s the case, they should want to hold the stock over the long run, not cash out once a buyback is announced. If corporate managers believe that buybacks are best for the company, its workers, and its community, they should put their money where their mouth is.”

Commissioner Jackson then called for the SEC to update its rules to limit executives from using stock buybacks to cash out from America’s companies. He also called for an open comment period to reexamine the SEC’s rules in this area to make sure they protect employees, investors, and communities given today’s unprecedented volume of buybacks.

Implications

At the very least, any company that has undertaken a stock buyback during the past 1 to 2 years, should know how their executives traded stock shortly after the announcement of their buyback. Companies should know which executives made these stock sales and the rationale for the sales. Companies should be prepared to answer questions about such transactions from their investors and the media. It also might be a good idea to review whether peers undertook stock buybacks during the past 1-2 years and how much stock was sold by their executives shortly after their buybacks were announced. Companies should review this data and know how they compare to their peers, and, if relevant, larger market players. Companies contemplating adopting a stock buyback should consider this emerging view as an additional point in their deliberations.

Executives should ensure that they are utilizing a Rule 10b5-1 stock trading plan, and have established such a plan when they do not have any material non-public information (such as the fact that the company is considering adopting a stock buyback plan). While a Rule 10b5-1 plan does not offer full protection to executives, it is the best currently available to protect them from allegations of illegal stock trading, assuming the plan is set up as required by the rule. If stock sales were made after a buyback announcement that did not utilize a Rule 10b5-1 plan, executives should ensure that all preclearance procedures were followed. To the extent that stock sales increased after a buyback announcement, executives should review the reason for such action and be prepared to discuss with their Boards or internal compliance officer.

Link to SEC Commissioner Jackson’s Speech

https://www.sec.gov/news/speech/speech-jackson-061118