SEC and NYSE/Nasdaq Developments SEC Proposes Changes to Accredited Investor Definition to Broaden Access to Investments In December 2019, the Securities and Exchange Commission (SEC) proposed updates to its rules regulating participation by investors in private placements. The proposal seeks to update and improve the definition of “accredited investor” to more effectively identify institutional and individual investors that have the knowledge and expertise to participate in securities offerings made other than by way of an SEC-registered public offering. Accredited investors are eligible to participate in private placements structured under the Regulation D safe harbor, which provides an exemption from SEC registration. Under the SEC’s rule proposal, the accredited investor definition would be expanded to include the following categories of natural persons and entities: natural persons who have certain professional certifications and designations, such as a Series 7, 65 or 82 license, or other credentials issued by an accredited educational institution; with respect to investments in a private fund, “knowledgeable employees” of the fund; limited liability companies (LLCs) that meet certain conditions, registered investment advisers and rural business investment companies (RBICs); any entity, including Indian tribes, owning “investments”, as defined in Rule 2a51-1(b) under the Investment Company Act, in excess of $5 million and that was not formed for the specific purpose of investing in the securities offered; and “family offices” with at least $5 million in assets under management and their “family clients”, as each term is defined under the Investment Advisers Act. The rule changes would also add the term “spousal equivalent” to the accredited investor definition, so that spousal equivalents may pool their finances for the purpose of qualifying as accredited investors. The SEC is also proposing to update the definition of “qualified institutional buyer” (or QIB) for purposes of the Rule 144A safe harbor, which allows large institutional investors with an investment portfolio of at least $100 million to participate in private offerings. The rule change would add LLCs and RBICs to the types of entities eligible to qualify as QIBs, as well as a catch-all for other institutional accredited investors that meet the $100 million investment threshold. The 60-day public comment period on the proposed rule is now open. Changes to the SEC’s rules will not take effect until the SEC publishes a final rule. View our related client publication here. SEC Staff Provides Guidance on Role of Audit Committees On December 30, 2019, the SEC’s Chairman, Chief Accountant and Director of the Division of Corporation Finance issued a public statement on the role of audit committees in financial reporting and key reminders regarding their oversight responsibilities. The general observations discussed in the statement include, among others: Tone at the top—Audit committees are encouraged to focus on the “tone at the top” with the objective of creating and maintaining an environment that supports the integrity of the financial reporting process and the independence of the audit. In this regard, it is important for the audit committee to set an expectation for clear and 4 SHEARMAN GOVERNANCE & SECURITIES LAW FOCUS | FEBRUARY 2020/LATIN AMERICA candid communications to and from the auditor, and likewise to set an expectation with both management and the auditor that the audit committee will engage as reporting and control issues arise. It is similarly important for audit committees to proactively communicate with the independent auditor to understand the audit strategy and status, and ask questions regarding issues identified by the auditor and understand their ultimate resolution. Auditor independence—Audit committees are encouraged to maintain appropriate oversight over the company’s and the auditor’s processes for monitoring factors that may affect the auditor’s independence. Among other items, these processes should address corporate changes or other events that could affect auditor independence (e.g. changes or events that may result in new affiliates or business relationships) and facilitate the timely communication of these events and changes to the audit firm. Generally accepted accounting principles (GAAP)—With regard to the implementation of new accounting standards, audit committees are encouraged to engage proactively with management and the auditors in the implementation process to understand management’s implementation plan, including whether the plan provides sufficient time and resources to develop well-reasoned judgments and accounting policies. It is also important for an audit committee to understand management’s processes to establish and monitor controls and procedures over adoption and transition. Internal control over financial reporting (ICFR)—Audit committees should have a detailed understanding of identified ICFR issues and engage proactively to aid in their resolution. If material weaknesses exist, it is important for audit committees to understand and monitor management’s remediation plans and set an appropriate tone that prompt, effective remediation is a high priority. The statement also reminds audit committees of their oversight responsibilities in respect of: Non-GAAP financial measures—Audit committees should ensure they understand how management uses such measures to evaluate performance, whether they are consistently prepared and presented from period to period and the company’s related policies and disclosure controls and procedures. LIBOR transition—Audit committees are encouraged to understand management’s plan to identify and address the risks associated with reference rate reform, and specifically, the impact on accounting and financial reporting and any related issues associated with financial products and contracts that reference LIBOR. Critical audit matters (CAMs)—Starting in 2019, the auditors of certain public companies will be required to include CAMs in the auditor’s report. Audit committees are reminded that the discussion of the CAM in the auditor’s report should capture and be consistent with the auditor-audit committee dialogue regarding the relevant matter. SEC Tries Once Again to Implement Government Payments Disclosure Rule In December 2019, the SEC issued a proposed rulemaking to implement Section 1504 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”). Enacted nearly a decade ago as Section 13(q) of the Securities Exchange Act of 1934, Section 1504 directs the SEC to make rules to mandate transparency by SEC-reporting companies in the resource extraction sector (oil and gas and mining) of the payments they make to governments. The SEC has tried to implement rules under Section 13(q) twice in the past: the first rulemaking was vacated by federal courts, and the second time the SEC’s rules were overturned by Congress shortly after the start of the Trump Administration. Given this rocky history, doubts remain whether the third time really will prove the charm. In the meantime, Canada and the EU have adopted government payments transparency rules substantially similar to what the SEC had originally proposed. The proposed rules would require “resource extraction issuers”, meaning issuers that are required to file annual reports on Forms 10-K, 20-F or 40-F with the SEC and that engage in the commercial development of 5 SHEARMAN GOVERNANCE & SECURITIES LAW FOCUS | FEBRUARY 2020/LATIN AMERICA oil, natural gas or minerals, to file a Form SD on an annual basis that includes information about payments related to the commercial development of oil, natural gas or minerals that are made to a foreign government or the U.S. federal government. The SEC is proposing to exempt the following companies from the disclosure requirements: newly public companies until the fiscal year immediately following the year their IPO registration statement became effective; emerging growth companies; and smaller reporting companies. The proposed new rules include several significant changes compared to the SEC’s prior rulemaking attempt (see our client publication summarizing the 2016 rule), intended to ease the compliance burden on companies and address concerns that companies would be compelled to disclose potentially competitively sensitive information. For example, the proposed rules would: revise the definition of the term “project” to require aggregated disclosure at the national and subnational (e.g., state or provincial) level, as opposed to for each contract; revise the “de minimis” threshold below which disclosure is not required to include both a project threshold and an individual payment threshold; add two new conditional exemptions for situations in which a foreign law or a contract in place prior to the new rule’s effective date prohibits the required disclosure; add an exemption for smaller reporting companies and emerging growth companies; revise the definition of “control” to exclude entities or operations in which an issuer has a proportionate interest; limit the liability for the required disclosure by deeming the payment information to be furnished to, but not filed with, the SEC; add an instruction in Form SD that would permit an issuer to aggregate payments by payment type made at a level below the major subnational government level; add relief for issuers that have recently completed their U.S. initial public offerings; and extend the deadline for furnishing the payment disclosures—companies with a December 31 fiscal year-end would have until March 31 in the second calendar year following their most recent fiscal year to file their reports under Form SD. The SEC is also proposing to recognize the equivalence of similar transparency regimes adopted by other jurisdictions. If, for example, the SEC were to determine that the Canadian or EU extractive industry payments disclosure rules satisfy the transparency objectives of Section 13(q), companies subject to those rules would be able to file the reports they prepare under the alternative disclosure regime in satisfaction of their obligations under the SEC rules. Extractive industry companies subject to the new rules would be required to submit government payments reports starting with the first fiscal year ending no earlier than two years after the new rule’s effective date. The 60-day public comment period on the proposed rule is currently underway. The new rules will not take effect until after the SEC publishes a final rule. 6 SHEARMAN GOVERNANCE & SECURITIES LAW FOCUS | FEBRUARY 2020/LATIN AMERICA US Chamber of Commerce Publishes Best Practices for Voluntary ESG Reporting The U.S. Chamber of Commerce’s Project for Growth and Opportunity, or Project GO, has published best practices for voluntary reporting of environmental, social and governance (ESG) information. The report suggests that ESG reporting can be best advanced through disclosure on a voluntary basis, rather than through additional regulation and mandatory “one-size-fits-all” disclosure regimes. The best practices are intended to incorporate flexibility in the approach to ESG disclosure, recognizing that the relevance of certain ESG factors differs across companies and across industries. The report identifies the following best practices, among others: ESG disclosures should focus on a company’s risks and opportunities with sufficient potential to impact the company’s long-term operational and financial performance in light of its business and should discuss the company’s approach to risk management, making the connection, to the best of their ability, between the ESG topics on which they report and the company’s long-term value creation strategy. Companies should consider the intended audience for the ESG disclosure and tailor reporting to include the most useful information for that audience. Companies should clearly define in plain English technical terms that do not have a universally accepted definition. Companies should explain why they selected the metrics and topics they ultimately disclose in ESG reports, including why management believes those metrics and topics are important to the company. Companies should consider including in voluntary ESG reports a description of internal review and audit processes or any external verification of the information that the company received. SEC Updates Guidance on Confidential Treatment Applications On December 19, 2019, the SEC’s Division of Corporation Finance published an update to its guidance with respect to the SEC’s procedures for confidential treatment applications. In April 2019, the SEC adopted new rules amending Regulation S-K to allow filers to redact confidential information from most exhibits to their filings without submitting a request for confidential treatment, provided that the redacted information is not material and that public disclosure would likely cause competitive harm. Although most filers now rely on those new provisions, the Division of Corporation Finance has updated its guidance regarding the “classic” procedure involving confidential treatment applications. Indeed, for certain filings, such as Schedule 13D or filings whose exhibit requirements are set out in Item 1016 of Regulation M-A, the confidential treatment application remains the only available method to protect private information in filed exhibits. Under the updated guidance, companies must file the required exhibit and omit confidential information, and then separately provide the SEC with an unredacted copy of the document identifying the confidential information. They must also identify the Freedom of Information Act (FOIA) exemption on which they are relying to object to public disclosure of the redacted information, explain why the information is not necessary to protect investors and justify the time period of the confidential treatment. According to the guidance, the SEC staff may request an amendment with more circumscribed omissions and an amended application if the applicant omits information beyond what it customarily and actually treats as private or confidential, and may also request additional information, in particular to assess the impact of the proposed omissions. 7 SHEARMAN GOVERNANCE & SECURITIES LAW FOCUS | FEBRUARY 2020/LATIN AMERICA The guidance specifically refers to the U.S. Supreme Court’s recent decision in Food Marketing Institute v Argus Leader Media, which addresses the definition of “confidential” in the context of the FOIA exemption for “commercial or financial information obtained from a person and privileged or confidential.” SEC Proposes Updates to Auditor Independence Rules On December 30, 2019, the SEC issued a rulemaking proposal to codify positions taken by the SEC staff in consultations and modernize certain aspects of the SEC’s auditor independence rules, which are set out in Rule 2-01 of Regulation S-X. The rule change principally addresses the situation of “sister” companies within private equity funds and investment companies that have investments in large numbers of portfolio companies. In this context, auditor independence issues frequently arise under the current rules in respect of an auditor of one portfolio company because such audit firm or its affiliates may also be providing non-audit services to other, non-material portfolio companies within the fund family that do not practically risk impacting the objectivity and impartiality of the auditor in conducting the audit. The 60-day public comment period on the proposed rule is now open. Changes to the SEC’s rules will not take effect until the SEC publishes a final rule. IASB Proposes Changes to Presentation and Disclosure of IFRS Financial Statements In December, the International Accounting Standards Board (IASB) published an exposure draft proposing changes to the rules governing the presentation of financial statements prepared in accordance with International Financial Reporting Standards (IFRS). The three main changes proposed are: New subtotals in the statement of profit or loss—The proposed rule change would require three new profit subtotals to be included in the statement of profit or loss, including “operating profit”. Given that many companies already report operating profit, this change is intended to enhance comparability between companies. “Non-GAAP” transparency—Companies would be required to disclose management performance measures— subtotals of income and expenses that are not specified in IFRS standards—in a single note to the financial statements. In this note, companies would be required to explain why the measures provide useful information, how they are calculated and to provide a reconciliation to the most comparable profit subtotal specified under IFRS. These proposed requirements are similar to the existing rules regarding disclosure of non-GAAP measures to which SEC-reporting companies are already subject. However, by requiring such measures to be disclosed in a note to the financial statements, they would technically not be “non-GAAP” measures for purposes of (and thus not subject to) the SEC’s non-GAAP rules. Improved disaggregation of information—The proposed rule change includes new guidance to help companies disaggregate information in the most useful way for investors. Companies would also be required to provide better analysis of their operating expenses and to identify and explain in the financial statement notes any unusual income or expenses. SEC Proposes to Modernize Filing Fee Disclosure On October 24, 2019, the SEC proposed changes that would modernize filing fee disclosure and payment methods, by amending the fee-bearing forms, schedules, statements and related rules, including registration statements for making public securities offerings. The current methods by which filers and the SEC staff process and validate EDGAR filing fee information within filings are highly manual, labor-intensive and, further, are not machine readable. Under existing rules, the calculation of filing fees can be difficult, particularly in complex transactions or situations in which a company is engaged in several transactions. 8 SHEARMAN GOVERNANCE & SECURITIES LAW FOCUS | FEBRUARY 2020/LATIN AMERICA The amendments would require the fee table on the cover page of a filing and all related explanatory notes to (i) include all required information for the applicable fee calculations and (ii) be presented in an Inline eXtensible Business Reporting Language (Inline XBRL) format. The Inline XBRL format would eliminate the need to include fee data in several places within a filing and the related EDGAR submission header, thereby reducing data input error risks and enabling more efficient automated processing of fee calculation information by the SEC. The proposal would add to the fee table: a “Reliance on Rule(s)” column to show (with checkboxes) whether the filer is planning to carry forward or include an equivalent amount of unsold securities, use a combined prospectus, offset a fee paid in connection with the same or a prior transaction or is calculating a fee based on maximum aggregate offering price; a requirement for basic fee calculation information (for certain forms); a “fee rate” column (for certain forms, mainly for business combinations); and various clarifying instructions regarding fee table presentation, calculations and related disclosure content and presentation. The proposed rule would allow the payment of filing fees via Automated Clearing House and discontinue the option to pay fees by paper cheques and money orders. SEC Rejects NYSE Proposal to Allow Companies to Raise Capital in Direct Listings In November 2019, the New York Stock Exchange (NYSE) filed a proposed rule change seeking to modify its listing rules to allow companies to use direct listings to raise capital and issue new securities. In a direct listing, a company’s existing shares are publicly listed on a stock exchange without an underwritten initial public offering. This option has received attention recently due to the high profile direct listings of companies such as Spotify, although the number of direct listings has remained limited. The NYSE sought to make direct listings available to companies wishing to raise capital in a primary offering, in addition to resales by existing shareholders in the secondary market. The NYSE rule change would also have eased compliance with the initial listing distribution requirement to have at least 400 round lot holders by giving companies meeting certain market capitalization thresholds a 90-day grace period to meet the distribution criteria. However, in December, the SEC rejected the proposed rule change. The NYSE plans to revise its rule change proposal and resubmit it to the SEC. It is reported that Nasdaq is considering a similar change to its listing rules. Noteworthy US Securities Litigation and Enforcement Second Circuit Affirms Dismissal of Putative Class Action for Failure to Allege With Particularity Illegal Acts Underlying Alleged Mispresentations On December 10, 2019, the U.S. Court of Appeals for the Second Circuit affirmed the dismissal of a putative class action asserting claims under Section 10(b) of the Securities Exchange Act of 1934 against a chicken producing company and certain of its executives. The decision is significant because it confirms that securities fraud plaintiffs within the Second Circuit (which hears appeals from Connecticut, New York and Vermont) are required to allege with particularity the elements of the alleged illegal conduct supposedly giving rise to a securities violation, and is likely to serve as persuasive authority outside of the Circuit. 9 SHEARMAN GOVERNANCE & SECURITIES LAW FOCUS | FEBRUARY 2020/LATIN AMERICA In Gamm v. Sanderson Farms, Inc., the plaintiffs had alleged that defendants’ SEC filings contained misrepresentations because they failed to disclose an illegal antitrust conspiracy to drive up chicken prices by reducing supply and to manipulate a chicken price index. The court held that the complaint was properly dismissed because the plaintiffs failed to plead with sufficient particularity facts supporting the alleged antitrust conspiracy, explaining that “when a securities fraud complaint claims that statements were rendered false or misleading through the nondisclosure of illegal activity, the facts of the underlying illegal acts must be pleaded with particularity in accordance with the requirements of Rule 9” of the Federal Rules of Civil Procedure and the Private Securities Litigation Reform Act (PSLRA). The plaintiffs acknowledged that their allegations of misstatements and omissions had to be pleaded with particularity under the PSLRA and Rule 9(b), but they argued that facts of the underlying antitrust conspiracy only needed to meet the plausibility standard of Rule 8 of the Federal Rules of Civil Procedure. The court rejected that argument, holding that, because the plaintiffs’ nondisclosure and material omission claims were entirely dependent upon the predicate allegation that the defendants participated in a collusive antitrust conspiracy, the plaintiffs’ allegations “must also provide particularized facts about the underlying conspiracy” in order to properly allege with the requisite particularity “all facts” upon which their securities fraud claim was based. The court reasoned that “[u]ntil and unless they have done so, [the] appellants’ complaint had not met the burden of explaining what rendered the statements materially false or misleading.” Next, the Second Circuit assessed whether the plaintiffs had alleged the basic elements of an antitrust conspiracy. With respect to the alleged collusive activities to reduce supply, the court determined that “[a]lthough appellants do allege that [the defendants] engaged in ‘anticompetitive’ conduct, there is virtually no explanation as to how that collusive conduct occurred, and whether and how it affected trade.” It further noted that the plaintiffs failed to allege that the defendants or any other chicken producers were successful in reducing the supply of chicken, or that any reduction in supply resulted from an anticompetitive agreement. Moreover, the court emphasized that the plaintiffs failed to allege “when [the company] decided on its course of supply reduction, which industry peers were a part of that decision, how specific supply reductions were performed by each of the different poultry producers, what information [the company] knew about its peers’ supply reductions, if any, and — perhaps most basic of all — whether [the company] actually reduced chicken supply, and if so, by what volume.” With respect to the alleged conspiracy to manipulate the chicken price index, the plaintiffs alleged that the company and other chicken producers submitted artificially high prices to the government agency that maintained the index, and coordinated these activities by learning about the prices other producers were submitting through a service that collected such information for the industry. The court held, however, that the plaintiffs’ allegations failed to show “when and how” the company used this service, or to allege what communications the company had with the government agency that maintained the index, when that information was provided, and whether it was false. Finally, the court concluded that “[t]he complaint is entirely silent” as to whether the alleged manipulative conduct “unreasonably restrained trade, and whether that restraint affected interstate commerce.” Assistant Attorney General Reviews FCPA Enforcement in 2019 On December 4, 2019, Assistant Attorney General Brian A. Benczkowski provided a synopsis of Foreign Corrupt Practices Act (FCPA) enforcement in 2019 generally and emphasized two key points—an increased focus on charging individuals, and the Department of Justice’s (DOJ) interpretation of agency theory under the FCPA.