On Friday, June 20, 2014, the Securities and Exchange Commission filed an action against the Committee on Ways and Means of the U.S. House of Representatives and congressional staffer Brian Sutter seeking enforcement of subpoenas the SEC issued. The SEC is investigating whether laws against insider trading, specifically applicable to members and employees of Congress via the Stop Trading on Congressional Knowledge Act of 2012 (the “STOCK Act”), were violated by the disclosure of non-public information about Medicare reimbursement rates. This is pretty exciting stuff for securities lawyers. It isn’t everyday that one branch of the federal government sues another. (Generally, the facts set forth below are derived from the SEC’s court filing and have not yet been established as true in court.)

About a year after the STOCK Act became law, the SEC launched an investigation into whether information regarding the April 1, 2013 announcement by the U.S. Centers for Medicare and Medicaid Services (“CMS”) on the 2014 reimbursement rates for the Medicare Advantage program was leaked improperly prior to the official public announcement. In its brief filed with the United States District Court for the Southern District of New York, the SEC details the opening of a formal investigation to determine, among other things, the source(s) of information in an email sent from a lobbyist to a broker-dealer that issued a “flash report” indicating that certain Medicare reimbursement rates would actually increase, rather than decrease as had been expected. The flash report was issued approximately 40 minutes before the official CMS announcement regarding the reimbursement rates and was followed promptly by a dramatic increase in the price and trading volume of certain health care stocks.

On May 6, 2014 the SEC staff issued subpoenas to the House Committee on Ways and Means and Brian Sutter. Mr. Sutter is the Staff Director of the House Ways and Means Committee’s Healthcare Committee. Before becoming Staff Director, Mr. Sutter was a staff member to the Subcommittee. Both the Committee and Mr. Sutter have refused to comply with the subpoenas, citing a number of legal objections, including that the documents demanded are protected by the Constitution’s Speech or Debate Clause. The SEC is having none of that and, on June 20, 2014, the SEC filed an action to enforce subpoenas it issued in connection with its investigation, potentially setting up a Constitutional showdown.    

From my perspective, there are at least two interesting points here. First, the SEC appears to be aggressively enforcing the STOCK Act. Hopefully, the courts will find a way to support the SEC in its efforts to conduct the investigation. If the SEC cannot investigate, the STOCK Act may have little, if any, bite. (If you would like to read more about the STOCK Act, please see our summary in the April 2012 issue of Up to Date.) Second, it will be very interesting to watch the matter unfold from a Constitutional perspective.

Companies Listing on the NYSE Can Appoint an Internal Auditor Within a Year after an IPO

On August 22, 2013, the SEC approved the NYSE’s proposal that permits a company listing in conjunction with an IPO to comply with the internal audit function requirement of Section 303A.07(c) of the NYSE Listed Company Manual within one year of the listing date.  NYSE rules now require such company to have an internal audit function in place no later than the first anniversary of its listing date[1].  Previously, NYSE rules only required each listed company to have an internal audit function but did not provide any transition period for companies listing in connection with an IPO.  

The new one-year transition period for compliance with an internal audit function requirement expanded NYSE corporate governance provisions, to which a transition period applies in connection with an IPO.  Such provisions relate to the composition of the board of directors as well as the composition of the nominating, compensation and audit committees (see Section 303A.00). 

The NYSE believes that a transition period for establishing an internal audit function will make the company’s process of implementation of such function more effective and will reduce the costs it faces in its first year as a public company.  The NYSE also expects that this transition period would enable the company’s audit committee to play a significant role in the design and implementation of the company’s internal audit function. 

In case of a company availing itself of a one-year transition period with respect to its internal audit function, the audit committee must:

  • assist board oversight of the design and implementation of the internal audit function; and
  • meet periodically with the company personnel primarily responsible for the design and implementation of the internal audit function.

Once the company establishes its internal audit function, the audit committee must (i) assist board oversight of the performance of the company’s internal audit function, and (ii) meet periodically with internal auditors or other personnel responsible for the internal audit function.

In addition, if the listed company does not yet have an internal audit function because it is using the internal audit function transition period, the audit committee’s review with the independent auditor of any audit problems should include a discussion of management’s plans with respect to the responsibilities, budget and staffing of the internal audit function and its plans for the implementation of the internal audit function.  Once the transition period is over, the audit committee’s review with the auditors should include a discussion of the responsibilities, budget and staffing of the company’s internal audit function.

The audit committee should also discuss with the board management’s activities with respect to the design and implementation of the internal audit function during the transition period, and after the transition period, the audit committee should review with the full board any issues that arise with respect to the performance of the internal audit function.

 Generally, a listed company must maintain an internal audit function to provide management and the audit committee with ongoing assessments of the company’s risk management processes and system of internal control, and the company can outsource an internal audit function to a third party service provider (other than the company’s independent auditor).   




[1] It is interesting to note that The NASDAQ Stock Market LLC (NASDAQ) does not have an internal audit function requirement.  Earlier this year, NASDAQ proposed, and later withdrew, an amendment to its listing requirements that each listed company establish and maintain an internal audit function to provide management and the audit committee with ongoing assessments of the company’s risk management processes and system of internal control.  The SEC received 42 comment letters on the proposal, and NASDAQ stated in its withdrawal that it was withdrawing the proposal to fully consider such comments and that it intends to file a revised proposal (see SEC Release No. 34-69792).

Burn, Baby, Burn – Reg D Inferno*

A recent report issued by SEC’s Division of Economic and Risk Analysis shows that Regulation D remained “hot” as a means to raise capital – even before the recent amendments to that rule take effect. The report updates a 2012 SEC report that analyzed Form D filings from the beginning of 2009 through the first quarter of 2011. The updated report contains information through the end of 2012 and provides additional analysis.

Among the highlights of the report:

• Capital raised through Regulation D offerings continues to be sizeable – $863 billion reported in 2011 and $903 billion in 2012. By contrast, public equity offerings raised less than $250 billion in each of those years.

• Since 2009, hedge funds reported raising $1.3 trillion through Regulation D offerings. Private equity funds reported $489 billion; non‐financial issuers reported $354 billion. Foreign issuers account for 19% of the total amount sold.

• Since 1993, the number of Regulation D offerings fluctuates directly with the S&P 500, suggesting that the health of the private market is closely tied to the health of the public market (and thereby contradicting the view that the private capital markets step in during times of public market stress).

• Rule 506 accounts for 99% of amounts sold through Regulation D. More than two‐thirds of non‐fund issuers could have claimed a Rule 504 or 505 exemption based on offering size, indicating that issuers value the Blue Sky law preemption allowed under Rule 506.

• More capital was raised in Regulation D offerings in 2012 than in public equity offerings or Rule 144A offerings; public debt offerings raised slightly more capital than Regulation D, but, as the authors noted, public debt offerings include many refinancings of existing debt, while approximately two-thirds of Regulation D offerings represent new equity capital.

• There have been more than 40,000 Regulation D offerings by non‐financial issuers since 2009 with a median offer size of less than $2 million.

• Form D filings report that more than 234,000 investors participated in Regulation D offerings in 2012, of which 91,000 participated in offerings by non‐financial issuers, more than double the number of investors participating in hedge fund offerings.

• Nonaccredited investors were present in only 10% of Regulation D offerings (suggesting that the recent amendments permitting general solicitations, provided that there are no sales to nonaccredited investors, should have little adverse effect).

• Only 13% of Regulation D offerings since 2009 reported using a broker‐dealer or finder, which usage may decline after general solicitation becomes permissible.

• Nearly 10% of all SEC reporting companies raised capital through Regulation D offerings during the period 2009-1011, and about 6% in 2012.

The authors noted that the actual amount of capital raised through Regulation D offerings may be higher than reported because there is no requirement to file a final From D showing the total raised and, further, some issuers do not file a Form D at all.

The bottom line is that the recent Regulation D amendments permitting general solicitation will likely add additional fuel to this already hot market.

* With humble apologies to The Trammps and their 1976 hit, “Disco Inferno.”

You Can’t Shoot Zombie Directors!

Recently, investor advocacy groups have focused on so-called “zombie directors” – directors of public companies who are elected despite failing to garner a majority of stockholders’ votes in uncontested elections.  CalPERS recently identified 52 directors who failed to win shareholder votes but either stayed in place or subsequently were reinstated. 

Corporate laws across most states, including Delaware, generally adhere to “plurality voting,” which provides that a director receiving the most “for” votes will be elected as a director.  As a result, in an uncontested election, a director receiving just one vote would be elected even though the balance of the votes was withheld.

In recent years, various corporate governance and stockholder advocacy groups have pushed for “majority voting” for directors to make boards accountable to investors.  Majority voting generally provides that, in uncontested elections, a director nominee must receive more “for” votes than “withhold” votes (or if permitted, “against” votes) to be elected. 

The Council of Institutional Investors’ corporate governance policies state that in uncontested elections, directors should be elected by majority vote; directors who fail to receive majority support should step down from the board and not be reappointed.  According to the Council, while more than 70 percent of companies in the Standard & Poor’s 500 Index use the majority vote standard for uncontested board elections, thousands of U.S. companies still use plurality voting.  Further, the Council has noted that some companies that have embraced majority voting for directors give their boards discretion to overrule stockholders and reappoint incumbent directors who fall short of majority support in uncontested elections.

If your company has a majority voting requirement, one way to ensure that you do not have zombie directors is to institute a board policy to the effect that board nominees must submit an irrevocable resignation in advance that will become effective upon the failure of that nominee to receive a majority of votes in an uncontested election.  Such a resignation is now expressly permitted under Delaware corporate law.

But be careful of what you wish for – one unintended consequence of a majority voting requirement coupled with an advance resignation provision is that you may be left with an understaffed board.  For example, a company with a majority voting requirement runs a risk that, in an uncontested election, it may not have a sufficient number of independent directors if either a proxy advisory firm, such as ISS, or a group of dissident stockholders, wages a successful “withhold” vote campaign against some or all of the incumbent board (perhaps due to dissatisfaction with the company’s executive compensation policies).  As a result, a company may be left without a sufficient number of independent directors to satisfy stock exchange listing requirements. 

At the end of the day, in some cases, a zombie director may be better than no director!

NYSE Proposes to Move to Only Website Disclosure of Listing Application Materials and to Otherwise Streamline its Listing Application Process

It has been a long-standing practice of the NYSE to post on its website the forms of the documents required to be submitted in connection with the NYSE listing applications. On April 30, 2013, the NYSE filed proposed rule changes to its Listed Company Manual (Manual), which, if adopted, will result in the Manual sections containing the listing application materials being deleted, and updated listing application materials will be posted only on the NYSE’s website. 

Although the NYSE amends its Manual from time to time, forms of listing agreements contained in the Manual have not always been amended to reflect changes made to the NYSE listing documents.  Some provisions in the listing agreements contained in the Manual are obsolete. The NYSE proposes to remove from the Manual (i) each of the agreements set forth in Sections 901.01 through 901.05, (ii) the form of original listing application contained in Section 903.01, and (iii) the form of supplemental listing application contained in Section 903.02. 

In the event that in the future the NYSE makes any substantive changes to those documents that are being removed from the Manual, it will submit a rule filing to the SEC to obtain approval of such changes, except for typographical or stylistic changes. The NYSE also plans to maintain all historical versions of those documents on its website after changes have been made, so that it will be possible to review how each document has changed over time. 

In addition, the NYSE proposes to state certain requirements, which it has been imposing as a matter of practice, in the Manual to add transparency to the listing process.  For example, the NYSE proposes to include in the Manual a new Section 107.00, Financial Disclosure and Other Information Requirements, which will contain the following requirements, among others:

  • Section 107.03 (SEC Compliance): No security shall be approved for listing if the issuer has not for the 12 months immediately preceding the date of listing filed on a timely basis all periodic reports required to be filed with the SEC or Other Regulatory Authority or the security is suspended from trading by the SEC pursuant to Section 12(k) of the Exchange Act.
  •  Section 107.04 (Exchange Information Requests): The NYSE may request any information or documentation, public or non-public, deemed necessary to make a determination regarding a security’s initial listing, including, but not limited to, any material provided to or received from the SEC or Other Regulatory Authority. A company’s security may be denied listing if the company fails to provide such information within a reasonable period of time or if any communication to the NYSE contains a material misrepresentation or omits material information necessary to make the communication to the NYSE not misleading. 

The NYSE also proposes to no longer require the following supporting documents in connection with an original listing application (see Section 702.04):

  •  Stock Distribution Schedule (the stock distribution schedule requirement is obsolete because the NYSE obtains the distribution information it needs from the applicant’s public filings and from its transfer agent). 
  • Certificate of Transfer Agent/Certificate of Registrar (the information that the NYSE needs about the applicant’s outstanding shares is available in its prospectus or periodic SEC reports, as well as the report of the applicant’s outstanding shares that will be required to be delivered to the Exchange once a quarter after listing). 
  • Notice of Availability of Stock Certificates (all transactions in listed securities in the national market system are conducted electronically through DTCC). 
  • Prospectus (final prospectuses are publicly available on the SEC’s website). 
  • Financial Statements (financial statements are included in the applicant’s SEC filings which are publicly available on the SEC’s website).


Update to Nasdaq Proposed Rule Relating to Internal Audit Function

As we discussed previously in our recent Up to Date  issue, the Nasdaq Stock Market recently proposed a rule that would require Nasdaq listed companies to establish and maintain an internal audit function. The proposal provides that each company listed on Nasdaq on or before June 30, 2013 establish an internal audit function by no later than December 31, 2013. Companies listed after June 30, 2013 would be required to estab­lish an internal audit function prior to listing. The SEC was scheduled to approve or disapprove such proposed rule on or before April 22, 2013. However, on April 18, 2013, the SEC designated June 6, 2013, as the date by which the SEC should either approve or disapprove or institute proceedings to determine whether to disapprove the proposed rule change.

Upcoming SEC Roundtables

Recently, the SEC announced two roundtables – the Credit Ratings Roundtable  and the Fixed Income Roundtable.  

The Credit Ratings Roundtable will be held on May 14, 2013 in response to the SEC Staff report on Assigned Credit Ratings.  The SEC staff issued the credit ratings report in response to Section 939F of the Dodd-Frank Act.  Section 939F requires the SEC to study various issues relating to credit rating process and report its findings to Congress.  The credit rating process report focuses on conflicts of interest in the credit rating process for structured finance products, the feasibility of alternative credit rating systems, metrics that could be used to judge the accuracy of credit ratings for structured finance products and alternative compensation structures that would provide incentives for accurate credit ratings. 

The Fixed Income Roundtable will be held on April 16, 2013 and focus on the corporate bond market and the municipal securities market.  The municipal securities market was the subject the SEC’s July 2012 Report on the Municipal Securities Market.    The 2012 report makes a host of recommendations regarding the municipal securities market, including recommendations to improve price transparency, strengthen brokers’ existing obligations to provide investors with the best execution and fair pricing, and enhance disclosure, as well as increases in the SEC authority to regulate the municipal securities markets. 

Both roundtables will be held at the SEC’s headquarters in Washington, D.C., open to the public and webcast live.

SEC Announces Small and Emerging Companies Advisory Committee Agenda

The SEC has announced the agenda for a meeting of its Advisory Committee on Small and Emerging Companies being held this Friday, February 1st.
The Committee will consider recommendations about:
• trading spreads for smaller exchange-listed companies,
• creation of a separate U.S. equity market limited to sophisticated investors for small and emerging companies, and
• disclosure rules for smaller reporting companies.
The meeting will begin at 9:30 a.m. in the multi-purpose room at the SEC’s Washington D.C. headquarters. Public seating will be on a first-come, first-served basis. The event will be webcast live on the SEC website and will be archived for later viewing.
For information about providing written comments, see the SEC’s press release available at

When Do You Need to Start Complying With New NASDAQ and NYSE Compensation Committee Rules?

On January 11, 2013, the SEC approved proposed changes to the listing standards of the New York Stock Exchange LLC and NASDAQ Stock Market LLC related to compensation committees. Both exchanges created transition periods to comply with the new rules.

As of July 1, 2013, NASDAQ and NYSE listed companies will be required to comply with the new rules relating to the authority of a compensation committee to retain compensation consultants, legal counsel, and other compensation advisers; the authority to fund such advisers; and the responsibility of the committee to consider independence factors before selecting such advisers. The requirement that such authority and responsibilities of the compensation committee be included in the compensation committee’s written charter does not apply until a later date (see below) for NASDAQ listed companies and such companies should consider under state corporate law whether to grant such specific responsibilities and authority through a charter, resolution or other board action. In contrast, NYSE listed companies will have to amend their existing charters as of July 1, 2013 to address these additional rights and responsibilities of the compensation committee related to compensation consultants, legal counsel, and other compensation advisers. To the extent a NASDAQ listed company does not have a compensation committee by July 1, 2013, these requirements will apply to the independent directors who determine, or recommend for the board’s determination, the compensation of the CEO and other executive officers of the company.

The remaining new rules, for example, compensation committee charter and independence standards for compensation committee members, will not have to be complied with by NASDAQ listed companies until the earlier of their first annual meeting after January 15, 2014, or October 31, 2014.

NYSE listed companies will have until the earlier of their first annual meeting after January 15, 2014, or October 31, 2014, to comply with the new standards for compensation committee director independence.

Time Period for SEC Action on Exchanges’ Proposed Compensation Committee Rules Was Extended until January 13, 2013

On September 25, 2012, each of The NASDAQ Stock Market LLC and New York Stock Exchange filed with the SEC proposed rules amending their listing standards for compensation committees.  Generally, under the Securities Exchange Act of 1934, the SEC should decide whether to approve or disapprove proposed rule changes within 45 days of the publication of notice of the filing of a proposed rule change or within such longer period (up to 90 days) as the SEC may designate.  The 45th day from the publication of notice of filing of the compensation committee proposed rule changes by the exchanges was November 29, 2012. The SEC extended the 45-day time period for SEC action on these proposed rule changes and designated January 13, 2013, as the date by which the SEC should either approve or disapprove these changes.