Category Archives: General

SEC Adopts Amendments to Financial Reporting Requirements in Acquisitions and Dispositions of Businesses

Yesterday, May 21, 2020, the Securities and Exchange Commission announced that it approved amendments to its rules and forms “to improve for investors the financial information about acquired or disposed businesses, facilitate more timely access to capital, and reduce the complexity and costs to prepare the disclosure.”  The 267-page final rule release is available by clicking here.

The amendments update SEC rules which have not been comprehensively addressed since their adoption, some over 30 years ago.  Jay Clayton, the SEC’s Chairman, said that amendments are “designed to enhance the quality of information that investors receive while eliminating unnecessary costs and burdens [and] will benefit investors, registrants and the market more generally.”

Among other things, the amendments:

  • update the significance tests (i.e., to determine when financial statements regarding an acquisition or disposition must be included) in Rule 1-02(w) and elsewhere by revising the investment test to compare the registrant’s investments in and advances to the acquired or disposed business to the registrant’s aggregate worldwide market value if available; revising the income test by adding a revenue component; expanding the use of pro forma financial information in measuring significance; and conforming, to the extent applicable, the significance threshold and tests for disposed businesses to those used for acquired businesses;
  • modify and enhance the required disclosure for the aggregate effect of acquisitions for which financial statements are not required or are not yet required by eliminating historical financial statements for insignificant businesses and expanding the pro forma financial information to depict the aggregate effect in all material respects;
  • require the financial statements of the acquired business to cover no more than the two most recent fiscal years;
  • permit disclosure of financial statements that omit certain expenses for certain acquisitions of a component of an entity;
  • permit the use of, or reconciliation to, International Financial Reporting Standards as issued by the International Accounting Standards Board in certain circumstances;
  • no longer require separate acquired business financial statements once the business has been included in the registrant’s post-acquisition financial statements for nine months or a complete fiscal year, depending on significance; and
  • make corresponding changes to the smaller reporting company requirements in Article 8 of Regulation S-X, which will also apply to issuers relying on Regulation A.

The amendments will be effective on Jan. 1, 2021, but voluntary compliance will be permitted in advance of the effective date.

 

 

SEC Amendments to Accelerated and Large Accelerated Filer Definitions Become Effective

Today, final amendments to the definitions of “accelerated filer” and “large accelerated filer” under Rule 12b-2 of the Securities Exchange Act of 1934 became effective. The SEC adopted the final rule implementing the amendments on March 12, 2020.

The amendments are designed to reduce the number of issuers that qualify as accelerated and large accelerated filers, thereby promoting capital formation for certain smaller reporting companies by reducing compliance costs while still maintaining investor protections.

For additional information regarding the amendments, please visit the firm website.

California Mandates Gender Diversity on Public Company Boards

California has become the first state in the nation to require public companies to put female directors on their boards. On September 30, 2018, Governor Jerry Brown signed a bill mandating that by the end of 2019 certain publicly traded companies with headquarters in the state appoint at least one woman to their boards. Further, by 2021, companies subject to the law with at least five directors will need to appoint at least two female directors to their boards, and those with at least six directors will need to appoint at least three female directors to their boards. Companies subject to the law that do not comply with the mandates will face financial penalties.

Whether the law is constitutional is questionable. Governor Brown acknowledged as much after he signed the bill, stating, “I don’t minimize the potential flaws that may indeed prove fatal to its ultimate implementation,” but he justified the law, stating that “recent events in Washington, D.C.—and beyond—make it crystal clear that many aren’t getting the message.” Opponents argue that the mandate violates both the California and U.S. Constitutions because it imposes impermissible gender quotas and requires companies to reject or replace men seeking to serve on boards. In addition, opponents claim that the law violates constitutional principles because it applies to companies headquartered in California even if they are incorporated in another state, creating an inherent conflict between California law and the corporate law of every other state.

Regardless of whether the California law is ultimately enforceable, there is no question that proxy advisory firms and some institutional investors like BlackRock remain focused on board diversity, including gender diversity, and there will continue to be pressure on public company boards to increase their diversity. Action by shareholders seeking to increase board diversity, rather than state governments mandating quotas, is likely to be more enduring and ultimately more successful.

U.S. Supreme Court Holds Whistleblowers Must Report to SEC to be Afforded Protection Under Dodd-Frank Act

On Wednesday, February 21, 2018, the United States Supreme Court held, 9-0, in the case of Digital Realty Trust, Inc. v. Somers that the term “whistleblower” under the Dodd-Frank Wall Street Reform and Consumer Protection Act does not include individuals who report violations of securities laws internally to their companies but not to the United States Securities and Exchange Commission.

In Digital Realty Trust, Paul Somers sued his former employer, Digital Realty Trust, alleging that his employment was terminated because he reported certain suspected securities laws violations to Digital Realty Trust’s senior management and that such termination constituted an unlawful retaliation against a whistleblower under the Dodd-Frank Act. The Court held in favor of Digital Realty Trust, stating that the whistleblower anti-retaliation provision under the Dodd-Frank Act does not protect individuals who have reported alleged misconduct internally to their employer, but not to the SEC.

In reaching its conclusion, the Court focused on the actual text of the anti-retaliation provision of the Dodd-Frank Act as well as the Dodd-Frank Act’s purpose. The Court noted that the Dodd-Frank Act defines a “whistleblower” as “any individual who provides…information relating to a violation of the securities laws to the Commission, in a manner established, by rule or regulation, by the Commission.” Further, the Court stated that the purpose of the Dodd-Frank Act was to aid the SEC’s enforcement efforts by motivating people who know of securities law violations to tell the SEC.

The Court’s ruling overturned the Ninth Circuit’s March 2017 ruling and resolved a split between the Ninth and Fifth Circuits.  In March 2017, the Ninth Circuit found that Mr. Somers was entitled to protection under Dodd-Frank Act.  In July 2013, the Fifth Circuit ruled in the case of Asadi v. G.E. Energy that whistleblowers must take their complaints to the SEC to be eligible for protection under the Dodd-Frank Act.

First SEC Staff Comments on Recent Non-GAAP CDIs

As many of us have noticed, the first comment letters from the staff in the SEC’s Division of Corporation Finance, following Corp Fin’s recent issuance of new CDI guidance on the presentation of non-GAAP financial measures, have become available publicly.  The comment letters shed additional useful light on Corp Fin’s views concerning non-GAAP presentations.

One of the comment letters sent to Alexandria Real Estate Equities, Inc. on June 20, 2016, provides a particularly helpful glimpse into Corp Fin’s views about the use of non-GAAP information in the executive summary of MD&A.  The staff’s letter includes the following comment in reference to MD&A in the registrant’s 2015 Form 10-K:

We note that in your executive summary you focus on key non-GAAP financial measures and not GAAP financial measures which may be inconsistent with the updated Compliance and Disclosure Interpretations issued on May 17, 2016 (specifically Question 102.10). We also note issues related to prominence within your earnings release filed on February 1, 2016. Please review this guidance when preparing your next earnings release.

Indeed, the executive summary portion of the MD&A – when initially conceptualized in the SEC’s 2003 release providing interpretive guidance in the preparation of MD&A – was supposed to include an overview to facilitate investor understanding.  The overview was intended to reflect the most important matters on which management focuses in evaluating operating performance and financial condition.  In particular, the overview was not supposed to be duplicative, but rather more of a “dashboard” providing investors insight in management’s operation and management of the business.

Looking back at the release to write this blog entry, I note references, with regard to Commission guidance on preparation of the MD&A overview, explaining that the presentation should inform investors about how the company earns revenues and income and generates cash, among other matters, but should not include boilerplate disclaimers and other generic language.  The Commission even acknowledged that the overview “cannot disclose everything and should not be considered by itself in determining whether a company has made full disclosure.”

Many companies have presented in their MD&A overview those non-GAAP measures used by management to operate the business and otherwise manage the company.  Where appropriate, references typically are made to the information appearing elsewhere in the document, presented to enable compliance with applicable rules and guidance for non-GAAP presentations.  Interestingly, the staff, in its comment, questions the “prominence” of the non-GAAP presentation in the context of the earnings release (noting that the staff provides less specificity in the portion of its comment relating to the MD&A overview).  This focus on prominence – to the extent the staff’s concerns relate to the MD&A overview – is worth further consideration in preparing MD&A disclosure.   In this connection, query whether the staff – in questioning prominence – could be expressing a view that when management analyzes for investors the measures on which it focuses in managing the business, if management relies on non-GAAP measures, it necessarily must focus on (and explain) – with no less prominence – the corresponding GAAP measures.