Last week, in Gibbons v. Malone, the Second Circuit affirmed the lower court’s dismissal of a shareholder suit brought under Section 16(b) of the Securities and Exchange Act of 1934 against a former director of Discovery Communications, Inc. Also known as the short swing profit rule, Section 16(b) provides for the disgorgement of any profits earned from the purchase and sale, or sale and purchase, by a corporate insider, of any equity security within a six-month period. In Gibbons, the corporate insider sold Series C common stock, which had no voting rights, and purchased Series A common stock which had voting rights, within a six-month period. The three-judge panel held that absent SEC guidance, the purchase and sale of different types of stock in the same company, where those securities are separately traded, nonconvertible, and come with different voting rights cannot be matched, and therefore do not trigger the short swing profit rule.
Securities Regulation
SEC Approves PCAOB Auditing Standard No. 16 – Communications with Audit Committees
Yesterday, the SEC issued an order approving new Auditing Standard No. 16, Communications with Audit Committees (“AS 16”). AS 16 was previously approved by the Public Company Accounting Oversight Board (“PCAOB”) at an open meeting held on August 15, 2012. As we noted in our August client alert reporting on this new standard (available here), AS 16 retains most of the preexisting communication requirements, but also adds a number of new topics that the auditor must discuss with the audit committee and requires that the auditor seek specific responses from the audit committee when discussing certain topics. In response to comments, the SEC also clarified that the new standard will apply to audits of foreign private issuers. Significantly, the SEC concurred with the PCAOB that AS 16 will apply to emerging growth companies (“ECGs”) and will be effective for fiscal periods beginning on and after December 15, 2012.
Corp Fin Allows Company To Cease Reporting Stating Company’s Stock Is Not a Security
The SEC’s Division of Corporation Finance recently granted no-action relief that allows an SEC reporting company, Minn-Dak Farmers Cooperative, to cease reporting on the basis that the company’s common and preferred stock are not “securities” under the federal securities laws.
Departure of SEC Chairman Schapiro Creates Uncertainty Regarding Rules to Remove the General Solicitation Ban in Certain Private Offerings
On November 26, 2012, SEC Chairman Mary Schapiro announced that she will leave the Commission on Friday, December 14. Commissioner Elisse Walter will take over as Chairman.
On August 29, 2012, the SEC proposed rules to implement Section 201(a) of the JOBS Act, which requires the SEC to eliminate the prohibition against general solicitation and general advertising (together, “general solicitation”) in securities offerings conducted pursuant to Rule 506 of Regulation D under the Securities Act of 1933 (the “Securities Act”) and Rule 144A under the Securities Act. The Commission voted 4-1 to propose the rules, with Democratic Commissioner Aguilar as the lone dissent, but Commissioner Walter, also a Democrat, expressed reservations about the proposal in her opening statement at the Commission’s meeting. Republican Commissioners Gallagher and Paredes strongly supported the proposed rules.
New Process for Submitting Draft Registration Statements and Amendments
Draft Registration Statements to Be Submitted and Filed on EDGAR
On September 26, 2012, the SEC’s Division of Corporation Finance announced that, beginning on Monday, October 1, 2012, Emerging Growth Companies and foreign private issuers may voluntarily submit their draft registration statements and amendments for confidential, non-public staff review using either the current secure email system or through a new EDGAR-based submission process.
SEC Raises ’33 Act Registration Fees
The SEC recently announced that Securities Act registration fees that companies are required to pay in connection with registered securities offerings will increase significantly. Effective October 1st, the current fee of $114.60 per million dollars of securities offered will increase to $136.40 per million dollars, representing an increase of more than 19 percent.
SEC Proposes Amendments Required by JOBS Act to Permit General Solicitation and General Advertising in Rule 506 and Rule 144A Offerings
ON August 29, the Securities and Exchange Commission (the “SEC” or the “Commission”) proposed rules to implement Section 201 of the Jumpstart Our Business Startups (JOBS) Act, which requires the SEC to eliminate the prohibition against general solicitation and general advertising (together, “general solicitation”) in securities offerings conducted pursuant to Rule 506 of Regulation D under the Securities Act of 1933 (the “Securities Act”) and Rule 144A under the Securities Act. The comment period for the proposed rules will expire 30 days after the proposed rules are published in the Federal Register; that is, likely around the end of September. Notably, the JOBS Act directed the Commission to issue final rules within 90 days of enactment of the JOBS Act, or by July 4, 2012, and Chairman Schapiro and Commissioners Paredes and Gallagher all expressed a desire to move expeditiously to a final rule. As a result, commenters should submit their comments on the proposal promptly in order to ensure that the Staff and Commission have ample time to consider them before issuing a final rule.Highlights of the ProposalThe following summary of the key terms of the proposal is based upon attendance at the open meeting of the Commission, information provided in a Fact Sheet on the SEC’s website (available here) and a preliminary review of the proposing release (available at here).• Rule 506 would be amended by adding a new paragraph (c), which would allow general solicitation where the issuer takes reasonable steps to verify, and reasonably believes, that each purchaser in the offering is an accredited investor. There are no changes to the definition of “accredited investor.” Thus, the issuer must take reasonable steps to verify that the purchaser satisfies one of the categories of persons defined as an “accredited investor” under Rule 501(a)(1)-(8) at the time of the sale of the securities to that person. • This means that the issuer would not lose the benefit of Rule 506(c) so long as it has taken reasonable steps to verify, and reasonably believes, that the purchaser is an accredited investor, even if a purchaser circumvents the issuer’s verification measures.• The proposed rules would not specify the methods by which an issuer must satisfy its obligation to “take reasonable steps to verify” that a purchaser is an accredited investor. Instead, in light of the wide range of types of investors that may invest in an offering conducted pursuant to Rule 506(c), the steps that an issuer takes would be required to be reasonable under the facts and circumstances. • The revised rules would include a non-exclusive list of factors that an issuer would consider when taking reasonable steps to verify that a purchaser is an accredited investor, including (i) the nature of the purchaser and the category of accredited investor that the purchaser claims to satisfy, (ii) the amount and type of information that is available to the issuer about the purchaser, and (iii) the nature of the offering, including the manner in which investors were solicited, and the terms of the investment, such as the minimum investment amount.• The existing exemption for offerings conducted pursuant to Rule 506 without engaging in general solicitation would remain unchanged.• Form D would be amended to include a checkbox indicating that an offering was conducted using general solicitation. Issuers are currently required to file Form D with the SEC upon selling securities pursuant to Regulation D, although the failure to file a Form D does not result in the loss of the exemption provided by Regulation D. Contrary to the request of some commenters, the proposed rules would not require that the issuer file the content of any solicitation or advertising with the Form D, and would not condition the availability of any exemption under Regulation D on filing the Form D. The checkbox provision is intended to allow the Commission to monitor the use of general solicitation and to assess the impact of the changes on the market, including the effectiveness of various verification practices used by issuers.• Rule 144A would be amended to permit “offers” to persons who are not QIBs, and thus to permit general solicitation in offerings conducted pursuant to Rule 144A. Subparagraph (d)(1) would continue to condition the exemption on the securities being sold only to QIBs or to purchasers that the seller and any person acting on its behalf reasonably believe is a QIB. The proposed amendments would not add any additional standards for whether a seller reasonably believes a purchaser to be a QIB or otherwise (note however that, unlike Rule 506, Rule 144A currently provides non-exclusive methods by which a seller may establish that an investor is a QIB).• The proposal clarified the Commission’s view that the use of general solicitation in connection with a Rule 506 or Rule 144A offering would not be a barrier to a concurrent offering by the issuer in an offshore transaction in reliance on Regulation S.We expect to issue a Client Alert on these proposed rules within a few days, following a more detailed review of the proposing release.
SEC Adopts Conflict Minerals Rules
The SEC today adopted final rules regarding disclosure and reporting requirements with respect to the use of “conflict minerals” to implement Section 1502 of the Dodd-Frank Act. The final rules were adopted by a vote of 3 to 2, with Commissioners Paredes and Gallagher dissenting. The 356 page adopting release containing the final rules is available here. Gibson Dunn will issue a client alert with a more detailed discussion of the rules in the near future. However, from the discussion at the Commission meeting and a Commission briefing paper, we note a few significant points:• The final rules apply to any issuer that files reports with the SEC under Section 13(a) or 15(d) of the Securities Exchange Act of 1934. There is no exception for foreign private issuers, emerging growth issuers or smaller reporting issuers. The rules will apply to all issuers on a calendar year basis, regardless of an issuer’s fiscal year. Thus, the rules will apply to all covered issuers commencing on January 1, 2013. • The final rules adopt the same three-step analytical process contemplated in the proposed rules, but include significantly modified mechanisms for carrying out certain steps of the process. Those three steps involve: (1) determining whether conflict minerals are necessary to the functionality or production of a product manufactured or contracted to be manufactured by the issuer; (2) if so, conducting a reasonable country of origin inquiry to determine if the issuer knows or has reason to believe that such minerals may have originated from the Democratic Republic of the Congo (DRC) or an adjoining country (the “covered countries”) and are not from scrap or recycled sources; and (3) if so, conducting supply chain due diligence and issuing a Conflict Minerals Report.• The final rules, like the proposed rules, apply to products an issuer “manufactures” or “contracts to manufacture” if a conflict mineral (generally, gold, tin, tungsten or tantalum) is “necessary to the functionality or production” of the products. The final rules do not define any of these quoted terms, but the adopting release provides interpretive guidance on them. In determining whether an issuer “contracts to manufacture” a product, the standard will focus on the degree of influence the issuer exercises over the product’s manufacturing. An issuer would not be deemed to have influence over manufacturing if it merely: (1) affixes its brand, marks, logo, or label to a generic product manufactured by a third party; (2) specifies or negotiates contractual terms with a manufacturer that do not directly relate to the manufacturing of the product; or (3) services, maintains, or repairs a product manufactured by a third party. • The final rules, unlike the proposed rules, do not apply to issuers that mine conflict minerals or to issuers that contract to mine conflict minerals.• In contrast to the proposed rules, disclosures under the conflict minerals rules will not be included in or as an exhibit to an issuer’s annual report on Form 10-K, but will be made on a new, specialized Form SD. All issuers that manufacture or contract to manufacture a product for which a conflict mineral is necessary to the functionality or production of the product will be required to file the Form SD on May 31 with respect to their conflict minerals use in the prior calendar year. Thus, all issuers will file their first disclosure report on May 31, 2014 for the 2013 calendar year.• Also unlike the proposed rules, the final rules provide that the disclosure report on Form SD is to be filed, rather than furnished. This means that issuers will be subject to liability under Section 18 of the Exchange Act for any “false or misleading” statements in their Form SD, subject to a defense if the issuer acted in good faith and did not have knowledge that the report was false and misleading. The Form SD is not required to be accompanied by the officer certifications that apply to Forms 10-K and 10-Q, and is not incorporated into an issuer’s registration statements under the Securities Act of 1933, unless the issuer so specifies.• If, after conducting its reasonable country of origin inquiry, an issuer knows that the conflict minerals in its products did not originate from a covered country, or has no reason to believe that they may have originated in a covered country, then the issuer’s Form SD only has to disclose its determination and provide a brief description of the inquiry it undertook. These same disclosures are required on Form SD if an issuer determines that the conflict minerals in its products are from scrap or recycled sources, or has no reason to believe that they are not from scrap or recycled sources. • If, after conducting its reasonable country of origin inquiry, an issuer cannot reach one of the foregoing conclusions, then it must conduct due diligence on the source and chain of custody of its conflict minerals, and its Form SD must include a Conflict Minerals Report. The Conflict Minerals Report will reflect the issuer’s conclusion, based on its due diligence, on whether the issuer’s products are “DRC Conflict Free” or “Not DRC Conflict Free” and the report must be audited under a standard set forth in the final rules. However, in a departure from the proposal, the final rules include a temporary (two years, or four years for smaller issuers) reporting category for issuers who are unable to determine whether the minerals in their products originated in a covered country or financed or benefitted armed groups in the covered countries. The products of issuers falling into this category will be deemed “DRC Conflict Undeterminable.” The Conflict Minerals Report for products that are DRC Conflict Undeterminable will be required to address much of the same information required when products are Not DRC Conflict Free, except that (1) it need not be audited, and (2) it must describe steps the issuer has taken or intends to take to reduce the risk that the conflict minerals contained in its products are benefiting armed groups in the covered countries. • As noted above, the Conflict Minerals Report, where required, generally must include an independent private sector audit. There are two exceptions to the audit requirement: (1) when the Conflict Minerals Report relates to products that are “DRC Conflict Undeterminable” during the temporary period described above; and (2) when the Conflict Minerals Report relates to certain recycled or scrap materials, as described in the next bullet. The proposed rules were unclear on the scope of the required audit; for example, whether the audit concerns an issuer’s due diligence process or the conclusions reached in the Conflict Minerals Report. The final rules specify a two-fold “audit objective.” First, the audit must express an opinion regarding whether the issuer’s due diligence measures conform with a nationally or internationally-recognized due diligence framework. The only such framework currently available is the due diligence guidance adopted by the Organization for Economic Co-Operation and Development (“OECD Due Diligence Guidance”). Second, the required audit must express an opinion regarding whether the issuer, in fact, engaged in the due diligence according to the framework it adopted. • The final rules revise the SEC’s proposed treatment of recycled and scrap materials and provide that products containing conflict minerals originating from recycled or scrap sources do not automatically trigger an obligation to file a Conflict Minerals Report. Rather, products containing such materials are considered “DRC Conflict Free.” There are, however, additional requirements for products that contain gold. In addition, in cases when an issuer must prepare a Conflict Minerals Report relating to tantalum, tin, and tungsten from recycled or scrap sources, a private sector audit is not required.The SEC today also adopted final rules to implement Section 1504 of the Dodd-Frank Act. These rules, applying to approximately 1,100 issuers that are involved in exploration, extraction, processing or export of oil, natural gas or minerals, or acquiring licenses to conduct any of the foregoing activities, will require detailed disclosure of payments to governments by such issuers on a project by project basis. The disclosures likewise will be made on the new Form SD, and for calendar year issuers will first cover the period from October 1, 2013 through December 31, 2013.
FASB Votes Against Continuing Loss Contingency Disclosure Reform Project
At a July 9, 2012 meeting, the Financial Accounting Standards Board (“FASB”) voted against moving forward with its outstanding exposure draft to modify the accounting and disclosure requirements for loss contingencies. The FASB considered two alternatives at the meeting: (1) remove the loss contingency project from its agenda; or (2) continue to explore moderate changes to the loss contingency requirements. The FASB Staff recommended that the Board remove the project from its agenda. Chairwoman Seidman and Board members Buck, Golden, Schroeder and Smith voted to remove the project from the Board’s agenda. The majority agreed that the current requirements under Accounting Standards Codification Topic 450 are sufficient and that addressing any concerns with the adequacy of loss contingency disclosures is an issue of compliance and enforcement rather than standard-setting. Board members Linsmeier and Siegel dissented, with each noting that the project should continue with a focus on providing additional guidance on qualitative disclosures about loss contingencies.
UK Government to Require Mandatory Greenhouse Gas Emissions Reporting
On June 20, 2012, British Deputy Prime Minister Nick Clegg announced at the United Nations Rio+20 Summit that the UK will become the first country to require emissions data disclosure in companies’ annual directors’ reports. Pursuant to regulations to be made under the UK’s Climate Change Act 2008, which must come into force by April 2013, all UK “quoted companies” will be required to report their greenhouse gas emissions. (Quoted companies generally are UK companies whose equity share capital is included in the Official List, officially listed in an European Economic Area (EEA), or admitted to dealing on either the NYSE or NASDAQ.) In 2016, the British government will determine whether to extend this requirement to all large UK companies, including private companies.