Conflict Minerals…the Legal Saga Continues…

Yesterday, the United States Court of Appeals for the District of Columbia issued its opinion on the conflict minerals legal challenge. (See our earlier blogs regarding the conflict minerals rules and the legal challenge thereto). The ruling rejected a number of the petitioner’s arguments, but agreed with the petitioner’s first amendment challenge. Specifically, the court held that the conflict minerals rules “violate the First Amendment to the extent the statute and rule require regulated entities to report to the Commission and to state on their website that any of their products have ‘not been found to be DRC conflict free.’” Accordingly, the three-judge panel affirmed the district court’s judgment in part and reversed in part and remanded the case back to the district court for further proceedings.

It is not crystal clear what practical effect the Court of Appeal’s decision will have on the conflict minerals rules or what actions the SEC may take in response to such decision. Despite yesterday’s ruling, companies should “keep the course” and continue preparing their initial Form SD which, as of now, is still due on June 2, 2014.

New Conflict Minerals FAQs

I know that many companies are working through their conflict minerals analysis and have begun preparing their initial Form SD which is due June 2nd.  I wanted to make companies aware that the SEC issued new FAQs today clarifying various issues related to conflict minerals due diligence and the conflict minerals report.  Please see the link below:

Have you been a “Bad Actor”? Maybe You Should Just Beg for Forgiveness.

Rule 506 under the Securities Act of 1933 is the most widely used exemption from the registration requirements of the Securities Act. The exemption is used by a wide range of issuers from small, start-up companies to the largest investment and hedge funds. Rule 506 generally permits issuers to sell an unlimited amount of securities to an unlimited number of accredited investors. However, pursuant to Section 926 of the Dodd-Frank Act, the SEC adopted Rule 506(d) disqualifying securities offerings involving certain felons and other “bad actors” from reliance on the Rule 506 exemption. Rule 506(d) became effective on September 23, 2013.  

Rule 506(d)(2)(ii) provides that the disqualification shall not apply “upon a showing of good cause . . . if the Commission determines that it is not necessary under the circumstances that an exemption be denied.” Similar disqualification provisions are applicable to offerings exempt from registration pursuant to Regulation A and Rule 505(b). However, neither Regulation A nor Rule 505 is relied upon nearly as often as Rule 506 because of the inherent limitations of those rules. Therefore, the impact of the bad actor disqualifications under Regulation A and Rule 505 has been somewhat limited. However, given the wide use of the Rule 506 exemption, we can expect many more issuers and others involved in securities offerings to request waivers.    

Since Rule 506(d) became effective, the SEC has granted exemptions to five issuers, four of which are financial institutions. In each case, the “bad act” which led to possible disqualification (I say possible because none of the entities requesting exemption actually admitted to disqualification) was an order or judgment entered with the consent or acquiescence of the financial institution.

Generally, each of the requests for exemption cited the following facts: the bad conduct did not involve the offer or sale of securities pursuant to Regulation A or Regulation D; steps have been taken to address the underlying conduct; and disqualification would have an adverse impact on third parties. In addition, each company requesting the exemption also committed to furnishing to each purchaser in certain exempt offerings disclosure of the “bad acts.”

In each case, the order or judgment giving rise to the disqualification, the letter from the financial institution requesting an exemption from Rule 506(d)’s disqualification provision and the letter from the SEC staff confirming that the exemption had been granted, all bear the same date. Most likely the granting of the exemption was part of the overall settlement of the matters that were the subject of the various orders. The four letters can be found here, here, here and here.

NASDAQ Proposal to Amend its Independence Standards for Compensation Committee Members Is Effective

Last week we blogged that NASDAQ proposed to amend its independence standards for compensation committee members, which amendments would align NASDAQ’s approach to compensation committee independence with that employed by the NYSE.   On December 11th, the SEC published a notice of filing and immediate effectiveness of the proposed rule change. Companies are required to comply with the compensation committee independence rules by the earlier of the date of their first annual meeting after January 15, 2014, or October 31, 2014.

NASDAQ Proposes to Align its Independence Standards for Compensation Committee Members with the NYSE’s Approach to Such Standards

On November 26, 2013, The NASDAQ Stock Market LLC proposed to amend its listing rules on compensation committee composition (Rule 5605(d)(2)(A) and IM-5605-6) to replace the prohibition on the receipt of compensatory fees by compensation committee members with a requirement that a board of directors instead consider the receipt of such fees when determining eligibility for compensation committee membership.  NASDAQ cited the feedback that it had received from listed companies as the reason for these changes.  The proposed rules are almost identical to the NYSE’s rules related to compensation committee independence and, if adopted, would remove the anomaly of NASDAQ listing rules being more stringent than NYSE rules.

The proposed Rule 5605(d)(2)(A) states that in affirmatively determining the independence of any compensation committee member, the board must consider all factors specifically relevant to determining whether a director has a relationship to the company which is material to that director’s ability to be independent from management in connection with the duties of a compensation committee member, including, but not limited to:

  • the source of compensation of such director, including any consulting, advisory or other compensatory fee paid by the company to such director; and
  • whether such director is affiliated with the company, a subsidiary of the company or an affiliate of a subsidiary of the company.

In IM-5605-6, NASDAQ proposes to clarify that when considering the sources of a director’s compensation in determining compensation committee member independence, the board should consider whether the director receives compensation from any person or entity that would impair the director’s ability to make independent judgments about the company’s executive compensation, including compensation for board or board committee services. 

The approach to the affiliation prong of the independence analysis is not significantly changed in the proposed rules.  However, NASDAQ proposes to revise IM-5605-6 to explain that the board should consider whether the affiliate relationship places the director under the direct or indirect control of the company or its senior management, or creates a direct relationship between the director and members of senior management, in each case of a nature that would impair the director’s ability to make independent judgments about the company’s executive compensation.

Companies are required to comply with the compensation committee composition aspects of the NASDAQ rules by the earlier of their first annual meeting after January 15, 2014, or October 31, 2014.  NASDAQ intends to implement the proposed changes before companies suggest changes to board and committee composition in connection with their 2014 annual meetings.

Should Pay Ratio Disclosure Be “Furnished” or “Filed”?

In the recently proposed pay ratio rules, the SEC acknowledged that some commenters had suggested that pay ratio information should be deemed “furnished” and not “filed” for purposes of the Securities Act of 1933 and Securities Exchange Act of 1934, and no commenters had asserted that pay ratio disclosure should be “filed.”[1]  However, the SEC rejected these suggestions based on an extremely literal reading of Section 953(b) of the Dodd-Frank Act, which mandates the SEC to amend Item 402 of Regulation S-K to require disclosure of the pay ratio in any filing of the issuer described in Item 10(a) of Regulation S-K.  The SEC concluded that “the use of the word ‘filing’ in Section 953(b) is consistent with the disclosure being filed and not furnished” and proposed that “the pay ratio disclosure would be considered “filed” for purposes of the Securities Act and Exchange Act and, accordingly, would be subject to potential liabilities under such acts.”[2]  For additional information about the proposed pay ratio rules, see our September blog post.

 Information Disclosed in a Filing Does not Have to be Filed with the SEC

 I believe the SEC gave disproportionate weight to the use of the word “filing” in Section 953(b).  “Filings” described in Item 10(a) of Regulation S-K include, without limitation, registration statements under the Securities Act and Exchange Act, annual and other reports under Sections 13 and 15(d) of the Exchange Act, and proxy and information statements under Section 14 of the Exchange Act.  However, some of these filings include disclosures that are considered “furnished” and “not filed”.   For example, a current report on Form 8-K is considered a “filing” described in Item 10(a) of Regulation S-K.  However, information included in a Form 8-K pursuant to Item 2.02 (Results of Operations and Financial Condition) or Item 7.01 (Regulation FD Disclosure) is not “deemed to be ‘filed’ for purposes of Section 18 of the Exchange Act or otherwise subject to the liabilities of that section, unless the registrant specifically states that the information is to be considered “filed” under the Exchange Act or incorporates it by reference into a filing under the Securities Act or the Exchange Act.”[3]  Therefore, it seems that the legislative mandate to disclose the pay ratio in any filing described in Item 10(a) of Regulation S-K does not mean that such disclosure cannot be afforded the furnished status.  I believe, Section 953(b) of the Dodd-Frank Act only prescribes the type of documents in which pay ratio disclosure should appear and does not dictate whether such disclosure should be furnished or filed.  

 The Proper Response is the Ballot, not Litigation Challenging the Disclosure

 The proposed pay ratio rules are very flexible and allow a registrant to use (i) a methodology that uses reasonable estimates to identify the median and (ii) reasonable estimates to calculate the annual total compensation or any elements of total compensation for employees other than the PEO. Moreover, in determining the employees from which the median is identified, the registrant may use not only its total employee population, but also statistical sampling or other reasonable methods.  The ability to use various estimates and statistical sampling for a complex analysis required by the proposed pay ratio rules leads to potentially subjective disclosure that may be difficult to verify and that should not serve as potential grounds for shareholder litigation.    

 In contrast, the SEC views the flexibility of identifying the median and the ability to use reasonable estimates as arguments against the pay ratio disclosure being furnished.  The SEC believes that the proposed transition periods, flexibility of identifying the median and the ability to use estimates should mitigate registrants concerns about compiling and verifying the pay ratio disclosure.”[4]  Such argument contradicts the SEC’s original rationale for granting other compensation-related information “not filed” status. In1992, the SEC issued Release No. 33-6962, Executive Compensation Disclosure, which adopted amendments to the executive officer and director compensation disclosure requirements (the “1992 Release”).  The 1992 Release recognized that the newly adopted Compensation Committee Report on Executive Compensation and Performance Graph raised significant concerns about the potential for litigation and increased an issuer’s exposure to liability with respect to these disclosures.  To accommodate these concerns, the SEC stated that the information required by the Compensation Committee Report on Executive Compensation and Performance Graph “shall not be deemed to be ’soliciting material’ or to be ’filed’ with the Commission or subject to Regulations 14A or 14C …, or to the liabilities of Section 18 of the Exchange Act …, except to the extent that the registrant specifically requests that such information be treated as soliciting material or specifically incorporates it by reference into a filing under the Securities Act or the Exchange Act.”[5] 

 The SEC’s reasoning in connection with the “not filed” status of the Compensation Committee Report was that “[i]f shareholders are not satisfied with the decisions reflected in the report, the proper response is the ballot, not resort to the courts to challenge the disclosure.”[6]  This same reasoning should apply to pay ratio disclosures.  Instead of treating the disclosure that most companies will base on subjective estimates and statistical sampling as “filed” and thus subject it to the liability provisions of the Exchange Act and Securities Act, this disclosure should be afforded the “furnished” status and shareholders should use voting as the venue for objecting to a specific ratio.  

 It will be interesting to see whether after the comment process the final SEC release would still support the “filed” status of pay ratio disclosure.  



[1] See Release No. 33-9452, p. 75 and Note 138.

[2] See id at p. 75.

[3] See Form 8-K, General Instruction B.2.

[4] See Release No. 33-9452, pp 75-76.

[5] See 1992 Release, Item 402(a)(9).  Both the Compensation Committee Report and Performance Graph have retained this “not filed” status in SEC Regulation S-K. See Item 402(e)(5), Instructions to Item 407(e)(5) and Item 201(e), Instruction 8 of Regulation S-K.

[6] See id.

Is Less More? SEC Chair White Speaks on the Future of Disclosure Reform

SEC Chair Mary Jo White spoke about the future of securities disclosure reform in a speech yesterday before the National Association of Corporate Directors.

Ms. White noted that a common problem today is “information overload” –  when investors are provided “too much” information –  “a phenomenon in which ever-increasing amounts of disclosure make it difficult for an investor to wade through the volume of information she receives to ferret out the information that is most relevant.” The reasons for the increase are several: new rules issued by the Staff, legislative changes such as the Private Securities Litigation Reform Act, which led to a proliferation of risk factors, and the “say-on-pay” vote mandated by the Dodd-Frank Act, which led to 40+ pages of executive compensation disclosures, and a company’s decision (typically prompted by their counsel) to provide more information in an effort to reduce the risk of litigation.  

As required by the JOBS Act, the SEC Staff is reviewing current disclosure requirements to determine how to modernize and simplify the requirements, and to reduce the costs and other burdens of the disclosure requirements for emerging growth companies. Chair White said that the SEC expects to issue this report “very soon.”

The areas of disclosure reform for future consideration noted by Chair White include:

  • Use of a “core document” or “company profile” containing base information that would be updated as required with information about offering, financial statements and significant events.
  • Elimination of repetitive disclosures in filings, such as “legal proceedings” for which the identical information can appear in a Form 10-K four or more times.
  • Revision of the Industry Guides, which, except for oil and gas, have not been updated in decades.  
  • Consideration of whether the applicable disclosure timeframes should be shortened in light of the increased use and speed of technology, including social media and smart phones.
  • Whether there are required disclosures that are not necessary for investors or that investors do not want, such as share prices, dilution disclosures and earnings to fixed charges ratios.

Hopefully, the SEC can quickly complete the remaining rules it is required to write under the Dodd-Frank Act and turns its attention to writing rules designed to streamline the disclosure process.

Proposed Pay Ratio Disclosure – Delicate Balancing Act Between Congressional Mandate and Practical Implementation

On September 18, 2013, the SEC proposed the long-awaited and feared pay ratio rules.  The proposed rules embodied in the new Item 402(u) of Regulation S-K implement the mandate of Section 953(b) of the Dodd-Frank Act to disclose the ratio of the median of annual total compensation of all employees (excluding the CEO) to the annual total compensation of the CEO. 

In the proposed rules, the SEC provided registrants with a lot of flexibility in terms of various calculations that should be performed.   However, the SEC conceded that permitting registrants to select a methodology for identifying the median, rather than prescribing a specific methodology, could enable a registrant to “alter the reported ratio to achieve a particular objective with the ratio disclosure, thereby potentially reducing the usefulness of the information.”

Continue reading “Proposed Pay Ratio Disclosure – Delicate Balancing Act Between Congressional Mandate and Practical Implementation”

Pay Ratio Rules to be Proposed this Week

On Wednesday, September 18, 2013 at 10:00 a.m. the SEC will hold an open meeting to consider whether to propose rules to require companies to disclose the median annual total compensation of all employees and the ratio of that median to the annual total compensation of the company’s chief executive officer as mandated by Section 953(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Update- The Conflict Minerals Legal Challenge Continues

In July, the United States District Court for the District of Columbia rejected a summary judgment motion challenging the SEC’s conflict minerals rules. Accordingly, the conflict minerals rules remain in effect as adopted. 

However, the legal challenge continues as the National Association of Manufacturers and other business interests recently filed a notice of intent to appeal this district court ruling.  Initial documents related to the appeal are due on September 12th.