What should we expect from the U.S. Securities and Exchange Commission regarding the status of new and existing initiatives by Congress and SEC policy, and how will it affect disclosure, governance and capital formation?

In this recap of our September presentation, which includes video and an accompanying transcript, three panelists – Keith Higgins, chair of Ropes & Gray’s securities and governance practice and former director of corporation finance at the SEC, and securities & public companies partners Patrick O’Brien and Christopher Comeau – address topics such as:

Why are there fewer IPOs, and what can the SEC do about it?

  • Practical tips on interactions with SEC staff and resolving SEC comments
  • Developments in private financings, including Regulation A
  • Prospects for changes to shareholder proposals and proxy advisory firms
  • Status of disclosure effectiveness

This presentation is part of Life Sciences Quarterly, a quarterly seminar series that delivers insights from Ropes & Gray attorneys, speakers from government and industry and other professionals as they examine key developments, issues and trends affecting the life sciences sector.

Click here to view the video.

Transcript:

Chris Comeau: So we're gonna talk a little bit about the securities laws today. We've got two terrific, knowledgeable panelists and me, who's gonna play the role of everyman because I am everyman and I'm only here to ask questions if you don't ask questions to keep the discussion going. So we've got a couple topics planned that we thought we would cover, but really, I encourage you to-- if you've got questions, shout 'em out, raise your hand, or whatever, 'cause we'd like to talk about what you wanna talk about. And we've got people here that can do it. So to my immediate left is Pat O'Brien. Pat is a partner in our Securities & Public Companies group. Has been with Ropes & Gray ten years longer than me, which is now about 17 years. So that's 28 years or so?

Pat O’Brien: Wow. Yeah. Good math.

Chris Comeau: So Pat does a lot of life science offerings. I was gonna-- as I was thinking about I'd describe it, I was gonna say that is the focus of Pat's practice, but Pat has a broader practice than that. And so I will use the securities language and say it is a leading facet of Pat's practice. But really, he's terrific. And if there's a securities disclosure that comes up, he's just seen it all. So he's my port of call. And then to his left is Keith Higgins. Keith probably has ten years on Pat----in terms of experience. And so Keith had practiced at Ropes & Gray forever. I worked on my first deal with Keith. It was a IPO of a company called Entrust Technologies. I was a summer associate at the time. But Keith did spend a career at Ropes & Gray practicing and then had a three or four-year hiatus to the SEC to serve as the director of corporate finance. And so really had an opportunity to influence the recent legal developments down there and see how the SEC works from the inside. So we thought it'd be useful to have Keith here to talk about any questions that people have about the SEC from the inside and share his perspectives about what's going on down there. And so maybe we start with that, Keith. Why don't you start by just sort of sharing an update about the new SEC, as constituted by our dear leader? And, you know, any reflections on where you think they're going and what we can tell from who's been appointed?

Keith Higgins: Sure. Well, thanks. The nice thing about-- I was talking now, is I don't have to give the disclaimer that the views I express my own and don't reflect the views of the commissioner or any of the commissioners. So in any event, thanks for coming. It's good to be here. So the new SEC. About last April, the president appointed a new chair of the SEC. And he began serving. Jay Clayton is his name. Jay is a-- I would say young. Early 50s. Was a partner at Sullivan & Cromwell. Was a deal lawyer. Securities lawyer. Did securities offerings. Did M&A. Did the kinds of things that Pat does, that I did when I was practicing back before I went to the SEC. So somebody who knows what it is. What it takes to get a deal done. And by all accounts, he doesn't really have any discernible political or policy bent. He's a independent and I think it's a good appointment. So far he seems to be saying the right things, expressing the right views. He's joined on the commission currently by the two holdover-- the two commissioners who had been there who'd been holding the fort until he was appointed. Mike Piwowar, who's a Republican, and Kara Stein, who's a Democrat. Both of them come from the Senate. They were Senate staffers on the Senate Banking Committee. And one of the things that you learn about the SEC is that, probably for about the last 15 years, the practice has been the president will appoint the chair of the SEC, and we'll leave it to the Senate to choose the commissioners. By law, the SEC has to-- no more than three commissioners can come from any one political party. So it had to be quote “balanced” between Republicans and Democrats, which is sort of an odd thing, written into the '34 Act that it's-- it doesn't say Republicans, Democrats, it doesn't-- says one political party. I guess the Green-- you could have more than three Green Party people or the like.

Keith Higgins: But in any event, Mike and Kara are sort of like oil and water as far as policy goes. Mike is sort of a real free-market Republican who thinks it's a shame that investments aren't available to anybody. He would throw out the accredited investor definition and just say anybody can buy anybody. Because he thinks by limiting investments to accredited investors, you're actually depriving mom and pop from being able to balance their portfolios and take advantage of high-yielding investments, which, in fact, may be true. But it would certainly go against about 80 years of jurisprudence in the securities laws. Kara Stein, on her part, is a pretty regulatory person. She was described, not by me, but by the Wall Street Journal editorial page as, “Elizabeth Warren's mini-me” and that was not a compliment, although I think she might have taken it as one. In any event, so you have Mike and Kara. And then recently, there'd been two nominations that have been made by the president. One is a woman named Hester Peirce. Hester is a lawyer who's currently associated with the Mercatus Center, which is kind of a think tank connected to George Mason University, which is, of course, home of the Antonin Scalia Law School. It's like the conservative think tank to other liberal think tanks. Hester was also a Senate staffer. Worked for Senator Shelby on the Senate Banking Committee. You'll notice a pattern here. And she is known for her fierce opposition to Dodd-Frank. She's written a book about how Dodd-Frank is what's wrong with current financial regulation. So that's one point of view. The other person, that Democrat seat, is-- Professor Robert Jackson was nominated by the president. Professor Jackson's a professor at Columbia Law School. He's probably best known for his co-authorship, along with Lucian Bebchuk here at Harvard Law School, of the rulemaking petition and the campaign to require public companies to disclose their political spending. He's very, very keen on that. He appears to be a pretty fiercely partisan on the left-hand side of the aisle. So it looks as if the way things will line up, you'll have Jay Clayton kind of in the middle, and you'll have people with relatively partisan ideologies on either side, which will just really put upon him-- on Jay the requirement of figuring it out what it is to-- how best to bring a consensus so that the SEC can drive its agenda further. In the three and a half years that I spent at the SEC, we spent a lot of our time rule making, working off of the backlog of congressional mandates that had been placed upon the SEC by Congress. And, of course, Congress is the legislative body of the land. And they have their role. But boy, they've really dumped a lot of rulemaking on the SEC over the last ten years.

Keith Higgins: And so we're working off that backlog, some of which, when it's partisan-related, like the Dodd-Frank Act was, really you know, it was a little bit naive to think that you could have partisan fight in Congress and then push the rulemaking down to the SEC and not have the same partisanship affect the SEC. And, of course, it did. My hope for the new SEC is that Congress, which has shown itself to be amazingly gridlocked of late-- that they'll stay gridlocked and will leave the SAC alone for some period of time to fashion its own agenda. While I think it could be tough bringing all-- everybody together to move an agenda, I think that the opportunity for them to move forward will be better if they're able to set their own agenda, rather than having Congress set it for them. I will say as far as-- so far, the appoints that Clayton has made-- 'cause, at the SEC, you've got five commissioners. The chair's appointed by the president. The chair sets the agenda for the commission and the staff reports to the chair. The chair really hires all the staff. And even though each commissioner only has one vote, the chair has a lot of power through the power to set the agenda and the power to hire staff. So far, the staff people that Clayton has hired have been good. The new director of corporation finance, a corporate lawyer who'd been at Simpson Thacher out in the Silicon Valley area. Very skilled capital markets lawyer and a good, sensible person. He brought in as a deputy somebody who'd been at Shearman & Sterling and did capital markets work at Shearman & Sterling. So the same kind of people who have populated those seats recently. The new head of enforcement came from Sullivan & Cromwell and the new head of investor management came from Ropes & Gray's Washington office. So the people that Clayton is bringing in, I think, are high-quality people who, if left to their own devices, will be able to help him figure out a solid agenda. So far, it looks like the agenda is gonna be capital formation. Clayton talked a lot in his confirmation testimony, as well as since then, about the decline in IPOs, which Pat will talk about a little bit. And what the SEC can do to help make that better. He'll focus on enforcement. Recently, he had a speech in which he talked about the enforcement agenda. It'll likely be similar to what the agenda has been so far. I wouldn't expect a radical change. I think you'll see a lot of-- and you see 'em every day-- cases are brought every day. Ponzi scheme, fraud against elders, you know, affinity schemes. All-- you know, pump and dump kind of arrangements…Anything related to fraud, I think, you can expect to see a lot enforcement against. I think you can expect to see, you know, financial accounting cases brought. FCPA probably, although Clayton has written in the past that he's a little bit concerned about how FCPA enforcement may be making American businesses a little less competitive. Although, with everything that's going on in that area, it's probably a little less dramatic. I think that you'll probably see a little less on the broken windows type of enforcement. The enforcement of technical violations of the law, et cetera, just to sort of clean up certain practices. I also think that it'll be interesting to see where the focus is on corporate penalties. One of the controversies around-- that certainly the Republicans had while I was there, was they were not sure that corporate penalties against companies-- you know, companies where people would've done bad things within the corporation. The corporation would settle with the SEC, and they'd pay a huge fine. Well, who pays that fine? It's the existing shareholders of the company who paid the fine. And there's some question of whether that's really a fair way to do it. And so I can-- I suspect there'll be a little of debate there. But I'm optimistic that if Congress leaves the SEC alone, that the new SEC will be able to chart a course and probably head in a sensible direction. So--

Chris Comeau: How much does the commission influence the day-to-day administration of the securities laws that we tend to deal with talking with the staff about offerings and comments, and stuff like that? Is there--

Keith Higgins: Yeah, so at the--

Chris Comeau: trickles down through? Or is it-- are they really just executing it--

Keith Higgins: They're sort of rule-making and policy-making. The commission spends an awful lot of its time on the enforcement calendar. And-- but as far as “Come and listen,” I don't think I ever had an inquiry in the three and a half years I was there from a commissioner about a particular review that was going on, or-- I mean, it just didn't happen like that. The staff at Corp-Fin is very professional. You know, as Pat knows, people get to know the staffers pretty well. You can talk to them. You know? Look, there's 500 people in the Division of Corporation Finance. Three hundred and eighty-five of them are reviewing filings. I can't tell you that all 385 people are kind of reasonable, nice people, easy to deal with. But an awful, awful lot of them are and, in particular, working on IPOs, I always tell people-- I mean, these people like to work on IPOs. I mean, and think about it. If you spent your day reviewing 10Ks and 10Qs, you'd love to get a deal. You know? You-- the-- 'cause you actually-- these people actually-- they identify with the deal. And they-- they're proud about it. They've got a team that's working on it. So I think that you don't really have-- you don't see commissioners getting mixed up in the day-to-day activities of...

Chris Comeau: Maybe that's a good transition to working with the SEC and what techniques, you know, have been effective. And what you should and shouldn't do and it'd be interesting to hear both of your perspectives on that. One from the inside, one from the outside.

Pat O’Brien: Why don't I start on that? 'Cause I think what Keith just said is right. I mean, I noticed it probably about ten years ago and I think it accelerated through Keith's administration, that the SEC staff, by and large, wants to help. And, you know, particularly in the IPO context or the offering context where, you know, if an issue or you're trying to get a deal done, the SEC is, you know, wants to work with you. Wants to, you know, respond in a way that allows you to keep your schedule. So on that note, I think one tip is to, you know, talk to the SEC. Tell 'em what you're thinkin'. Tell 'em what your timing's gonna be. Tell 'em what you need them to do. And we have found them to be, you know, pretty darn responsive in that respect.

Keith Higgins: And the new director, Bill Hinman, has made it clear that-- you know, actually, when I hear this, as the most recent incumbent, I sort of feel like, “Well, what am I, chopped liver?” I mean, you know, he says, “Well, this is the new friendly SEC. We wanna help you--” and I--

Chris Comeau: There's no non-disparagement on the way out the door?

Keith Higgins: I can't help but feel a little bit bad about it. But I'm sure it wasn't directed at me. But he's really made it clear that, you know, they wanna be collaborative. They wanna be cooperative. They recognize that capital formation is important and they wanna help companies get their deals done. So if you're having difficulties, he-- you know, let them know about it. And let 'em know their schedule. You know, I will say on one thing. You get a comment letter from the SEC. And, you know, certainly IPOs, all of them get reviewed. But, on a regular course, the SEC has to review your filings at least once every three years. And so you'll typically get a comment letter. Sometimes you won't. And sometimes they'll review your filings and won't have any comments to make and so you won't get a comment. But you might get, you know, five or six comments. Most of them will be accounting related, because that's where the staff spends most of their time. My advice would be-- you know, you get these comments. Don't think that you can smoke one by them. You know? I mean, if they ask you a questions—

Chris Comeau: What if they're wrong? What if they're wrong?

Keith Higgins: If they're wrong, address how they're wrong. You know, it-- point out how they're wrong. Don't disregard it, thinking, ”Well, if we don't say anything, maybe they'll be too busy and they won't recognize it.” They'll come back to you on it. And they can be wrong. I will say-- the other tip is if they're wrong, don't call 'em up and try to talk 'em out of the comment.

Chris Comeau: To withdraw it?

Keith Higgins: They're not gonna withdraw the comment. They wanna hear from you. They’ll say--And even if they're wrong, they'll say, “Just send it to us in letter.” And, quite frankly, remember that often times, the comment is asked not because the SEC thinks, or the staff person thinks, that you should change your disclosure. Often times it's just they may not understand exactly what you're getting at and they wanna understand it better. They don't necessarily have a preconceived notion about what you oughta be putting in. They may have some hypotheses, but they really wanna understand it better. And, I think, you're most effective when you help them to understand it better.

Pat O’Brien: And I agree with that, although, in terms of-- I think I would rec-- you know, I-- you definitely need to respond to the SEC, although I think-- respond to the comment, rather. But I think sort of giving them a little bit-- and less so in the accounting, but certainly in the legal space-- on the legal comments. If you can, you know, sort of genuflect in their direction. Give them some disclosure that sort of, you know, mostly gets at what they're looking for, rather than-- and then say, “Oh,” you know, “We've addressed your comment by adding 'disclosure' on page, you know, 34 of our 10K,” we found that, you know, by and large, those comments go away. Occasionally, they'll come back, but--

Chris Comeau: Yeah, and what stinks…is that when you go down that road, you propose this and they say, “No, that doesn't work.” And then, all of a sudden, you're out there having done that, and now you've got to do more.

Keith Higgins: I actually have a slightly different view than Pat. It's still a holdover from, maybe, my regulator status. One of the things that's not a good result is if you get a comment and you think, “Okay, I don't really think this is material disclosure. I don't think investors really need to know this. But we'll just throw some disclosure in to make the comment go away.” That's not a good result. That's not a good result for the SEC…

Chris Comeau: I can attest in person from doing that, that that doesn't actually work.

Keith Higgins: Well, no, it-- it's not a good result from your investor standpoint, because you're sort of giving a more-- you know, it's kind of the information overload problem. It's not good from the SEC's standpoint. I don't think it really helps anybody. And it just makes documents longer. If you don't think the disclosure is appropriate, make the case. Now, I recognize that most people have management to report to. And the last thing in the world you wanna do is to spend all your time-- you know, it's much easier-- it might be, at the margins, more cost-effective just to give them the disclosure, but it would be wrong. Right? You know, it's better, you know, I think, to get it right than it is to get it done, recognizing that everybody does-- you know, you have to get deals completed and you have to-- you know, you don't wanna spend all your time going back and forth with the SEC staff. At the end of the day, I will say my experience-- if the company makes a judgment, “This is not material information” and makes that argument to the SEC, it's pretty hard for the staff to dispute that. I mean, you all are in a better position to assess the materiality of your information than the SEC staff is. And so, you know, that's the ultimate line in the sand that, I think that, you can draw--

Chris Comeau: The challenge with that is the staff gets to decide. Right? That’s the hardest thing I’ve been in--is there's a disclosure requirement. It says you need to provide a breakdown of some way that's not entirely clear. The client doesn't wanna provide the most clear breakdown because they don't wanna make the information public. And then you're sort of stuck arguing to the staff that, “We don't think investors care about that.” And they say, “Well, we think that they probably will,” and that it's required. And then that's when you're sort of stuck trying to come up with a solution to make the client believe that we're working hard to, you know, solve their problem by proposing, you know, something that's acceptable. And then you just sort of go down this path where you're disclosing stuff that's not responsive. And then you're stuck with stuff that you've already proposed to disclose, which, in fact, doesn't solve the problem.

Pat O’Brien: I think they're two different-- the problem with the situation--

Chris Comeau: And I don't know what the answer is to the problem.

Pat O’Brien: Well, the situation you had in the IPO context, where you're trying to get a deal done on a schedule, you know, every time you make sort of incremental disclosure-- or, you know, my advice of, you know, sort of givin' them a little bit, is right now you're a week or two weeks delayed in trying to-- you know, while the SEC cogitates and gets their necks around the comments. I think in the context of a review of a 10K or a 10Q, or, you know, periodic filings, you have a little more time to go back and forth with the SEC. A little more time to convince them that your point of view is the right one. The--

Keith Higgins: Absolutely. I mean, that's an important point. If it's just a review of your periodic reports, they wanna clear that and I think, at the end of the day, they'll accept your view that something's not material. And if you view it as not material, you know, there's no downside to you continuing to dribble the ball, except that you wanna get it cleared out. But they probably want to get it actually cleared out more than you do. And-- although there is a disclosure requirement that, if you have unmaterial, unresolved staff comments, you've gotta disclose those in your 10K, if you've concluded they're not material, they don't need to be disclosed. So they don't really have that much to hammer over you. Pat's right. On an IPO, it's different. They've gotta declare you effective. But at the end of the day, and, you know, Hinman's been talking the talk, they do seem to be keen on helping people get effective. So I think it's a doable thing.

Pat O’Brien: I think on the one-- in terms of sort of dealing with them, I think if you've gone around, or maybe to, either in the IPO context or the ongoing-- review, if you're still not getting it, right? If, you know, you think... then I think it's time to pick up the phone. You know, call your examiner. And set somethin' up. Back to the earlier comments we were makin', I think, you know, they're amenable to that. And I don't think-- you know, you're not gonna get-- be met with sort of a prosecutorial demeanor, at least for the most part. And I think, as Keith said, you know, they wanna understand. And I think there's an opportunity to do that. I think, you know, I don't think you wanna jump over their head immediately, but, you know, at some point, it's appropriate to get, you know, the-- whatever it is. They're not branch chief anymore. Assistant director, or the-- typically shows up on your comment letter as, you know, “If you have any questions, call this person or that person.” And, you know, those-- I think that's getting the right people on the phone and talkin' it through, understanding what's behind their comment. Helping them understand sort of your business a little bit better is-- you know, I would encourage you to go down that path.

Keith Higgins: Right. And don't be embarrassed at all. Or feel reluctant to ask the examiner, you'd like to get, you know, his or her supervisor and/or their supervisor involved. That happens all the time. Staff's used to doing it. They're more than happy to do it. You don't need to pick up the phone and call the director immediately and say, “Those people are giving me--” the process will work. I will say, also, on accounting matters, if you have a GAAP issue that you're going back and forth with the staff on, make sure that you've vetted it with your auditors and that, actually, your local team has checked with the national office to make sure that the national office is on board with how you wanna do it. Because sometimes the local team and the national office don't always speak to one another. And it's gonna be important in clearing the comment to be able to say that your auditor's behind it.

Pat O’Brien: And, you know, they have relationships, too, right? So they have relationships at-- you know, institutionally with folks on the accounting side. And, you know, you definitely wanna make sure you're not out in front of your accountants on, you know, some nuance that they or … either your audit team or the national office field, because, you know, they may get a call from the accounting… “Really? Is that what you think?”

Keith Higgins: One other thing that actually has been very prominent since the new administration took over is they're really welcoming people to make requests for waivers of financial statement requirements under 3-13 of Regulation S-X. 3-13 of Regulation S-X says, effectively, that the commission and the Division of Corporation Finance has delegated authority to do this-- can waive the requirements of any financial statements that are required. And they can require substitute or supplemental or other disclosures. It's-- for example, a situation where-- best example I can think of is in the acquisition situation, where you're acquiring a company and, under the rules, you would be required to have three years of financial statements of that acquired entity. And let's say the third-- the earliest year, that's just not available. It was never audited. You don't have it. You wouldn't be able to do it without unreasonable expense. That's a situation where-- and let's say you-- the reason you have three years is because you're at a break-even level and the significance test work in a funny way. That's tailor-made for goin' to the staff and asking for a waiver request, thinking through what you might be able to provide supplementally, or just say that, “Look, the two years should be enough.” The staff has said-- and I just heard Bill Hinman, the director of Corp-Fin, talk about it just last Friday-- said that they are prepared to move on them quickly. You don't need to go to them with some perfectly fleshed-out white paper, although I do think you need to have at least some talking points that lay out what your argument is as to why the information shouldn't be required. And he said they're prepared to move on it as quickly as five days. So I think that we should take him on his offer and, if you have situations, don't think that they -- don't think all hope is lost. That there is the opportunity for waivers, so... And not only has the Division Director said that, but even the Chair said it in a speech that he made to the Economic Club of New York, so they seem to be pretty serious about being friendly to companies trying to get their deals done.

Chris Comeau: Any questions on that topic? Or others? While we--

Keith Higgins: Workin' with the SEC?

Chris Comeau: Yeah. Well, I'm glad to hear that, because I had that exact circumstance in, like, 2004, and got a clear “no” about the--

Keith Higgins: Oh, is that right?

Chris Comeau: Yeah.

Keith Higgins: Yeah, well sometimes the-- I mean--

Chris Comeau: A clear “no.”

Keith Higgins: Sometimes you'll get a “no,” but they do seem to be willing to work with you.

Female Audience Member: So what is the pattern for, you know, the period filings when you are putting everything in a response letter, and, you know, not proposing new disclosures-- sort of take more of an educational approach: here is the background, here's why it doesn't apply. In some cases, you know, you can request for confidential treatment--

Keith Higgins: Correct.

Female Audience Member: --parts of that disclosure. In your experience, how often are those granted during-- in that context? Or...

Keith Higgins: In those situations, it's not a question of granting. You can seek confidential treatment for portions of the letter, or the entire letter. And it is confidential until someone makes a FOIA request for. It's not like when you file an exhibit to a period filing and you seek confidential treatment for portions of it under 24 B-2, or whatever the rule is. There, the staff has to go through it and decide whether they think it's appropriate. When you're submitting a comment letter, that's totally different. You can-- you're entitled to have that, under Rule 83, confidential. And there's a procedure you go through for. And then it's confidential. And the only time it would be unconfidential is if someone makes a FOIA request and then you have the opportunity, at that time, to argue why it should be confidential. And many people-- and on these waivers, it's a perfect example. Many people go in because often times, they're going in on an unannounced deal, you know, where they wouldn't want that to become public. So, yeah. So you don't have to-- it doesn't have to be granted. It's automatic under Rule 83.

Chris Comeau: What about CEO pay ratio disclosure? Which is a hot topic these days.

Keith Higgins: It is a hot topic. And as-- in case you've been hibernating or living under a rock, or maybe in denial, as of next proxy season, companies will have to disclose the ratio of their total annual CEO compensation to the annual compensation of their median employee. So they'll have to have those two numbers and the ratio of those two numbers. It was a very controversial rulemaking that come out of the Dodd-Frank legislation. And just recently, there's been some hope-- the Financial Choice Act, which passed the House, but hasn't yet passed the Senate, and probably isn't going to pass the Senate, would call for a repeal of the CEO pay ratio statute and, therefore, the rule wouldn't-- and it would also actually repeal the rule. That's probably not going anywhere. And, just last Friday, Bill Hinman, in talking to an ABA group, said that the commission expected the CEO pay ratio to be in effect as of next proxy season. And my guess is that Hinman would not have said that unless he had spoken with Clayton and that-- in other words, don't expect a reprieve from the governor on pay ratio. I think that it's gonna happen. So what does that mean? I mean, if you haven't gotten started on it already, you're probably a little bit behind the eight ball. It's-- all hope is not lost, depending on how big your company is. But, you know, the first thing you have to do is to find your median employee. And the rules give you a lot of flexibility in how you find the median employee. You know, obviously one way to do it-- let's say you had 100 employees. You could put their compensation into a spreadsheet and then hit the “Find the median” button and that would do it. And that would be pretty simple. Unfortunately, many companies don't have quite that simple a situation. Many-- the rule requires that you find the median employee from among all your employees, which is full-time, part-time, seasonal, and temporary employees. It does not include independent contractors. But there's something in the rule that says so long as the independent contractor's compensation is set by an unaffiliated third party-- and people might scratch their head and think, “What does that mean?”

And I think what it was really meant to get at it, is one of the commissioners was concerned that, with independent contractors, some company would set up an affiliate where it would have all its employees, and then have those employees leased to the company and-- as a way of getting around the pay ratio. And so that's the genesis behind that language. The question is, “If I'm a software developer and I go to work at a company-- and a company needs a software developer to do a six-month gig, and I go and I say, 'Yeah, my rate is $150/hour,' or whatever it happens to be, and the company says, 'Yeah, no, I'll pay you $120/hour.' You go, 'Oh, okay. How about $130?' And then--” that's fine. You are-- that unaffiliated third party, i.e. the software developer, is setting his own compensation. And it's not-- that's fine. It--the one situation where I think it would actually be a little bit difficulty, and, fortunately, they don't have to deal with yet, is, I don't know what Uber would do with their Uber drivers. The question there would be, “Are the Uber drivers really setting their own compensation?” Probably not. I mean, it's probably, “Here's the deal. If you're an Uber driver, this is what you get out of that.” My guess, if I were advising them, and I'm not, would be that they would have to consider those people in the pay ratio. And you might say, “Boy, does that make any sense? You've got full-time, part-time, seasonal, what have you,” well, that's just what the rule is.

Keith Higgins: It-- the SEC made a decision that “all employees” meant all employees. And trying to carve out any groups wasn't really consistent with the spirit of the statute. So finding the median employee. You can do it by using any consistently-applied compensation measure. You know, for U.S. employees, you'd take something like W-2 compensation. From your payroll records. You could do cash compensation. So long as that consistently-applied compensation measure reasonably reflects what the annual compensation would be. So, for example, you know-- if there were some measure that was widely variable among employees and really didn't reflect what your annual comp would be, you shouldn't use that. I do think most people will be using something like W-2 or something like cash compensation paid-- some questions came up about, “Well, what about if equity gets paid?” And there was some guidance that the staff put out while I was there that said that would be fine. You know, that the fact that equity was paid doesn't mean you can't use cash compensation, unless equity is widely distributed across the organization. And a lot of people said, “Oh, well gee, what does that mean? Well, does that mean if everybody gets stock options, we have to buld that in?” I think what it really meant is that where equity spread across the organization would skew the pay ratio-- if the equity that's spread across the organization is basically given in the same proportion to what the cash compensation is, then it's really not gonna affect what the median compensation is, and you should-- you can use cash compensation as the basis for your median employee compensation. So you need to pick a date within three months of the end of the fiscal year. You can pick at the end of the fiscal year, but you can choose any date within three months. And look at your workforce on that date and find the median employee among that population. So, for example, if-- and I know this probably isn't gonna apply in the life sciences industry very much, but it does apply in retail. If you're a retailer that hires a lot of people temporary at Christmastime, you're probably not gonna choose, you know, December the 28th-- or December the 23rd, or the 20th. You're probably gonna choose October the 1st in deciding. Because your temporary people won't be on there. And that's perfectly fine. For part-time people, you can't make a full-time equivalent. And I know that doesn't make sense and people argued to us, “Wait a minute. The CEO is a full-time employee. How do you compare the pay ratio--” well, always said, “Look, it's not supposed to make sense. It says 'all employees.' You know, what do you want us to-- what--So that's how it came out. Sorry. Foreign employees. You can exclude up to 5% of your workforce in foreign jurisdictions provided that, if you exclude any employee in a foreign jurisdiction, you have to exclude everybody from that jurisdiction. I think some people will use foreign jurisdiction. You can also exclude any employee in a jurisdiction where the privacy laws prevent you from accessing the information that's necessary to calculate the median compensation. That was really in response to a lot of comments that the SEC got about, “Oh, there's these foreign laws.” It's a little like when you were doing a deal and somebody says, “Oh, there's a '40 Act problem here,” and everybody goes, “Oh, your '40 Act problem.” Of course, nobody knew quite what it was, but, in any event, it was just, I think, a little bit of a scare tactic from people who were rightly concerned about the expense and, you know, about the non-materiality of this number and the like. But raising the foreign privacy issue was always sort of a Boogieman. So the SEC said, “Fine, if foreign laws prevent you from providing the information, you can exclude those people, provided you give us-- tell us exactly what the statute is that prevents you from doing it.&lrdquo; Requires you take reasonable efforts to have the statute changed. Yeah.

Keith Higgins: And requires a legal opinion from foreign counsel that says you're prohibited from doing it. I have not yet talked to a company who thinks they're gonna use the foreign exclusion. I just think-- I would be shocked if anybody tried to use it. You know, another thing the SEC threw in for foreigners is, they said, “Okay, you can COLA adjust foreign workers if you'd like in calculating your median employee.” 'Cause people said, “Hey, wait a minute.” You know, “If somebody who's making $10,000 in the Philippines-- you could, that could be the equivalent of $45,000 in the U.S.” And the SEC said, “Fine. If you wanna COLA adjust your people, feel free to COLA-- you know, if-- for people who don't live in the jurisdiction in which the CEO resides, you can COLA adjust it.” Companies that I've talked to-- it's just more work. I mean, it just requires more work to do it. You've gotta do it for everybody that's in the sample that you used to figure out the median employee. And, at the end of the day, is it really gonna be worth it? So you've done this calculation. You find your median employee. You compare it to the total annual compensation of the CEO. And that is just right out of the summary compensation table. The number that's on the far right-hand side. Just pick that out. And if you want to, you can add to the employees compensation things like-- because it's one thing to figure out who the median employee is. Then you have to calculate that median employee's compensation as you would your CEO's compensation for purposes of the SEC rules. So, you know, you use salary and then equity, and bonus, et cetera. And it would include perquisites, unless they qualified for the $10,000 de minimis exclusion. Now, for a lot of-- for your median employee, they may get excluded. The SEC says, “Fine. If you wanna add that into your median employee's compensation, that's fine, as long as you do a comparable thing to the CEO's compensation.” So you could do that. I wonder, again, whether it'd be worth it. But it does point up an interesting-- sort of one of the laws of unintended consequences aspect of the CEO pay ratio is-- you know, it's one thing to-- you put the pay ratio out, the CEO makes a hundred times more than the median employer. Two hundred and fifty times, or 30 times, or, I guess at Ben & Jerry's, it'd be three times. But that's one thing. The other aspect of it, though, is, all of a sudden, you're gonna have a number out there that 50% of your workforce is gonna know they're in the bottom half of the class and the employee communications around that disclosure is probably at least as important as the communications around the CEO pay ratio number. And I heard, also, people talking about, “Gee, do you want the number--” on the one hand, you probably want the median compensation of the employee high, to have a better pay ratio. But, is that kind of how you want it? Some people say, “Well, gee, if it's high, then the people in the bottom half 'Gee, they're-- people are making a lot more.'” The other thing about the pay ratio is people are worried that, “Okay--” that competitors will be looking at your median employee compensation and be saying, “Oh, look,” you know, “At Bioverativ, their median compensation is 'x.' At my company, it's 'x' plus something. We're a better company.” You know, so it'll be a little bit of a…So maybe you do want that number to be higher. So I don't know. I do think that it will be interesting. The rule requires that the company describe briefly the methodology that it use to calculate the pay ratio. And the real-- the intent really is for a brief discussion. I think, here, our advice is that less is more. That, if you are having to say more than four or five sentences, you're probably talking too much.

Keith Higgins: I think, you know, you just-- kind of-- if you did statistical sampling to get your median employee, I think you just say, you know, “We used a statistical sample of, you know, 600 people out of our workforce of 4,000, and we calculated the median using W-2 income, and, basically, that's how we did it.” I think trying to explain here-- the numbers are gonna be so wildly different across companies. And it's gonna depend on how they get their work done. Whether they contract things out. Whether they have, you know, people do it in-house. Whether they have big foreign operations. Whether they're all domestic. Where those operations are. I think-- the SEC recognized that it would be silly to try to make this number comparable across companies, because that would simply unachievable because of the way that people get their work done. And so it's-- I don't think that comparing your company's CEO pay ratio to another company's, to another company, is really gonna be that meaningful a number. And I don't think I'd spend a lot of ink in the proxy statement trying to explain that. First of all, when you're writing it, you probably won't know what everybody else's is, unless you've sort of talked among your colleagues to figure out what-- how bad it's gonna look. But anyway, it's a brave new world. I do think it'll be repealed someday, if the-- no, I do. I mean, I think--

Pat O’Brien: Like, by next year.

Keith Higgins: I don't think by next year, though--

Chris Comeau: That'd be fun.

Keith Higgins: I don't think they'll get it done by next year. But I do think-- you know, I think that it's in the Financial Choice Act. I think that something will pass the House. But I think that it's-- their-- I think, from the SEC's standpoint, they could have deferred it. I think they probably made the sensible conclusion that, to defer it, would've just brought a lot of controversy to something and caused a lot of focus on-- because, you know, the labor unions and the supporters of this are really-- they-- I mean, who-- look, they could've sued just like many things have been sued in the current Trump administration. And maybe they could've been enjoined. So it just-- I don't think was worth dragging the agency through that fight.

Chris Comeau: And who's gonna be the police on the calculations? Is the SEC gonna--

Keith Higgins: That's a very good--

Chris Comeau: pass comments or is it the auditors? Are the auditors…gettin' involved? The underwriters gonna require, like...

Keith Higgins: No way. I would be shocked if anyone ever got a comment on CEO pay ratio. I just don't think that's gonna happen. I don't-- I don't think the people in Corp-Fin-- unless you don't put it in. I mean, if you didn't put it in your file, like, you might get a comment to that effect. But the SEC staff is not going to look through your methodology and say, “Huh. I see that you--” it's just not-- you know. I could be wrong. And who knows? At least under the current administration and the current way the SEC does business, I would be shocked if that happened. I just don't think-- I mean, look, you already had the division putting out guidance saying that, if you didn't file your Conflict Minerals Report that you were required to file, they wouldn't recommend enforcement action. This is not a division that's gonna be trying to flyspeck your CEO pay ratio. So don't worry about the SEC. And, you know, whether the labor unions or the NGOs-- I wouldn't worry too much about that. As I say, just do the number. It doesn't-- I don't think it has to be perfect, because, you know, whether the number's 103 to one, or 98 to one, or 112 to one, does it really-- it-- I don't think it really matters that much. Try to do as good a job as you can. Recognize that it's not gonna be perfect. Briefly describe it and get out. So that's my riff on pay ratio--

Chris Comeau: Yeah, it really stops the have meaning once you get over, like, 20 or 25, or something like that. Like, what's the difference between 37 and 46? Like, it just doesn't matter--

Keith Higgins: Right. It-- right. And when you look at organizations like Goldman Sachs, where the CEO, you know, makes a lot of money-- but their average compensation, and that's not the same as median, but average compensation's, like, $500,000. So, you know, that's gonna-- they're probably gonna look better than a lot of companies, where CEOs are paid far more modestly. So... and, you know, who knows? Questions on pay ratio?

Pat O’Brien: You should think about this a little bit when you have some time. You know? It doesn't sound like you...

Chris Comeau: Another topic that's been in the news is IPO numbers, whether they've been trending downward as opposed to historical norms. Any thoughts on that?

Pat O’Brien: It has gotten a lot of press. And, you know, I think the SEC chair has indicated that that's something that he wants to work on. The-- you know, from a historical perspective, IPOs are down. But from-- we just looked up a couple of stats before this thing, and between 1986 and sort of 2000, there was, like, 311 IPOs a year. And since 2000, about 150. You know, it's a pretty dramatic falloff. Two thousand seventeen's been a nice rebound from last year. Although I'm not sure we'll get back to the 150 mark this year. It'll be close. There's been about 22 IPOs in our little corner of the world this year in the biotech space, which, again, I think was a-- and I think we'll see, you know, a fair amount of activity between now and year end. And based on sort of what we're working on, I think the first quarter of next year as well. But, you know, the numbers overall are down. You know, a lot of handwringing around sort of overregulation as the reason for that. You know, I'm not so sure. And there's-- you know, some academics, I think, are not so sure. But certainly, the-- you know, people are-- point the finger at the 404, the Audit of Internal Controls, and, you know, as we were talking about before, just the sort of regulatory creep, right? The pay ratio in and of itself. You know, not the-- you know, and executive comp. And then, you know, even when you scale it back. But sort of all these things add up. The GAAP disclosure rules have gotten more burdensome. So maybe there something to that that's sort of-- the overall creep of the burden, either regulatory or accounting, is to explain some of this. But, you know, clearly, I think, certainly in recent-- in the last few years, you know, the abundance of private capital is certainly one thing that's-- you know, there's the sort of unicorns of the world. You know, there's an unlimited amount of money. You know, here in Cambridge, there's, you know, some of the companies that-- you know, like a Moderna, that, you know, you would've normally expected to go public, has been able to keep private. Just because there's, you know, a ton of private capital from a ton of different sources. The SEC commissioner-- or chair, Clayton, has indicated that he wants this to be a-- you know, on top of his agenda. And that he wants to-- sort of the mainstream, mom-and-pop investor, to be able to benefit from sort of this hypergrowth stage of companies, so that companies are going earlier in the process. You know, it's not-- again, you know, I'm probably a little biased given my work in the life science space. I'm not sure it's clear that we want, you know, a lot of mom-and-pop investors investing in early-stage biotech, but--

Keith Higgins: Well, the old adage is-- right? If someone tells you, “Hey, I've got an IPO that you can invest in,” it's probably one you want to stay away from. Because if it's getting to you, it's probably the smart money has passed. Although I will say-- I mean, Clayton's argument seems to be that, you know, it's-- what's happening now is companies staying private longer. And when they go public, it's not to fund their growth. Their growth has already happened while they were private. And it's really to cash in, so that the people who own can cash in. And it's when the growth has sort of tapered off and flattened out a little bit. And he thinks that that's, you know, too bad. That much better-- and I think, Pat obviously investing in individual stocks can be risky. Investing in anything can be risky. But if active managers of mutual funds are able to buy IPOs at an earlier stage and fund the company's growth, I think that's what, you know, he's. And, you know, if you had bought Amazon when it went public, you'd be-- we wouldn't be talking about the SEC, you know--

Chris Comeau: It's funny, though, 'cause that swung, right? So, like, three or four years ago, all you needed was a research project in the biotech world and you were an IPO candidate. And, you know, then it sort of-- the window sort of closed and then it sort of hasn't-- and then nothing has changed in the regulations that affected that. That's just sort of the way the ebbs and flows are going.

Keith Higgins: Well, and that's the real question is, “Is it regulation that's causing companies to not want to be public?” And at some level, that's gotta be right. At some level, the hassle of being a public company, the hassle of having shareholders vote on your pay every year, having to deal with shareholders who, you know, are activists and wanna tell you how to run your company, having to, you know, put a lot of disclosure in the book that you-- you know, in your filings that you really don't think is meaningful, that you wouldn't otherwise be preparing for your investors, if you had private investors, all of that. Dealing with the-- I mean, the accounting profession-- the change in the accounting professions. Some of my best friends are accountants. But since Sarbanes-Oxley and since the PCAOB-- I mean, the accounting profession has changed dramatically. And, you know, it used to be, back in the day, you felt like you were working with your-- your accountant was a partner on your team. And now, it's like they work for the government. Or, you know, they work for the PCAOB. Because-- and I'm sympathetic to these people. Because the PCAOB is looking over their shoulder, questioning all of their judgments. And, you know, management feels like it can't ask its accountants any questions anymore, because they-- that might be indicative of some material weakness that they have, you know, in their control environment. It's problem-- you know, all of that stuff is a tenet to being a public company, that you don't have that when you're a private company. So there's no question about it. But, you know, when you talk about-- on the accounting front, you know, when they talk about stripping out 404-B and not requiring audit of internal controls. And lot of people are arguing for that. The counterarguments are gonna be, “Look. Take a look at accounting restatements right after Sarbanes-Oxley. And they've just gone down, down, and down, down every year.” And again, you know, it's not necessarily a causative relationship. But certainly they're gonna point to it as being evidence that this stuff is really working and why would we want to mess with it? But...

Pat O’Brien: By the way, your accountants back in the day were your best friends, 'cause their non-audit fees were through the roof and they were all making a ton of money. But that's-- we solved that problem. So real quick, we gotta wrap up here and let everyone get goin'. The two substantive things that the SEC has done, which, I think, everyone agrees was sort of low-hanging fruit, and-- but I think will make a big difference. One is expanding the ability, to non-emerging growth companies, to file confidentially in their IPO and in their follow-on offerings for the first year that they're public. So once the company does the IPO, they can file their S-1 before they're S-3 eligible. Confidentially figure out whether you're gonna get a review or no review. And, if you get a review, to sort of work through the comments. And then file publicly, in the case of an IPO, 15 days before, just like it is for emerging growth companies. And in the case of follow-on offering, 48 hours before you're ready to go. So that's sort of just startin'. We haven't-- I haven't worked on one of those yet, but we'll sort of see how that works out as a practical matter. But that will certainly, you know, at the margin, sort of facilitate some financing in the first year of a company being public. The other thing, which is a-- which, I think, does reduce some of the burdens and costs of going-- of an IPO is extending the-- is now, if you have financial statement-- you don't have to include financial statements in your initial filings that you don't think will be in your prospectus-- you don't reasonably believe will be in your prospectus at the time you go effective. So if you start working on an IPO today, your plan is to go out, you know, with audited financials for 2017, you know, in mid-February or something. You could file your S-1 right now with just-- if you were an emerging growth company, with just 2016 financial statements. The audited financial statements. No interim financial statements. And then drop in your audit for 2017 and go public. So that, I think, will facilitate things. I think, in general, we think people, you know, will now file with just-- if you're an EGC, you know, one year of audited financial statements, depending on when in the calendar you think you're gonna go, you'll sort of not put in any interim financial statements. Because it's almost always true that, from the time you, you know, make your initial filing, till the time you actually go effective and do the IPO, more than one quarter will have passed. Or at least a quarter will have passed. The one thing I would caution on that is, you know, the SEC still has-- you still have to get through the SEC review process. And if you're just filing your financial statements and looking to sort of immediately do your IPO, you know, the SEC review may hold you up. Particularly if there's sort of novel issues in your financial statements.

Keith Higgins: Well, in the year-over-year analysis. The problem with only filing one year is what the staff is gonna be looking for in your review of your MD&A, is, “What were the changes year over year?” and “What drove those changes?” And “What were the components of the change?” And if you're only showing one year, they won't have had an opportunity to look at that. And so when you drop your 2017 financials in as Pat said, and wanna hit the road, at that time you will be disclosing your year-- having description of your year-over-year results. And so you'll wanna be in a position-- your-- the staff will look at that, and they may have comments. So I think you need to at least be mindful that it could take a little bit longer on the backend if they haven't had a chance to sort of see what your thinking is on things that, year over year, or period over period, are driving the business.

Pat O’Brien: We have some deals now in the biotech space where, you know, the company's done, you know, a sort of complicated collaboration. And, notwithstanding that we could avoid filing June 30 numbers in the initial submission with the IPO, we're gonna go ahead and put 'em in, because we wanna get through-- you know, as you guys know, there could often be naughty comments around how various derivatives, or other issues in the collaboration are accounted for. So we're gonna go ahead and represent the underwriters. So we had some interest in just sort of getting it going. But, you know, we're gonna go ahead and get the June 30 financial statements in there so we can get through the SEC review process somewhat more expeditiously, so we're ready to go next year.

Chris Comeau: So it's funny. Stuff like that-- you say that as I'm thinking about it-- it's not gonna change people-- make more people more likely to do an IPO, but I think as you tack those things onto each other over time, the process gets easier. And maybe then, people's perspective starts to change about the process.

Keith Higgins: Question?

Female Audience Member #2: Just a reflection. I mean, I think if there's a feeling around, you know, micro-cap and small-cap is that you're actually better off remaining private longer. And so, if that, you know, a sort of feeling spreads, et cetera, you know, I'm not surprised that IPOs have dropped off, and there's kind of nothing you can do that's a market dynamic, rather than regulatory …. But no one seems to talk about that.

Keith Higgins:Oh, sure.

Pat O’Brien: There-- I was just-- again, sort of preparing for today, you know, there is some academic research out there that says exactly that, right? That the smaller micro-cap IPOs have not done well, have not gotten good returns. And that, you know, it's both investors sort of saying, “That's not where we wanna put our money,” and, I think, companies saying, “We can-- you know, we don't need to do it. We have access to capital. We can progress longer and, sort of, we'll be rewarded for that in the long run.”

Keith Higgins: And there's the Comeau theory of fewer active managers of money. A lot of index funds are buying, but they're not buying an IPOs. The fewer active managers you have, the fewer buyers that you have for IPOs. And nobody, no active manager, wants to buy into a stock that doesn't have at least $75 to $100 million of public float, when it's a public-- and for some micro-cap companies, it's-- that's way too much. Anyway.

Chris Comeau: Good. Well, with that, we'll wrap up. Give everybody the rest of their morning back. Thanks for coming. Thanks for the good questions.