On June 1, 2017, the Public Company Accounting Oversight Board (“PCAOB”) announced the adoption of a new auditor reporting standard, subject to SEC approval. Although the standard maintains the current pass/fail opinion in auditor reports it does make substantial changes to the report. Most significantly, the new standard requires the auditor to communicate any critical audit matters that arose during the audit.
On March 22, 2017, the U.S. Securities and Exchange Commission (SEC) announced the unanimous passage of an amendment to Rule 15c6-1(a), shortening the standard settlement cycle for most broker-dealer securities transactions from three business days (T+3) to two business days (T+2). The new T+2 settlement cycle will apply to the same securities transactions covered by T+3, including transactions for stocks, bonds, municipal securities, exchange-traded funds, certain mutual funds traded through a broker, and limited partnerships that are not listed on an exchange; provided, however, parties still retain the right to expressly agree to a longer settlement cycle pursuant to the “override provision” of Rule 15c6-1(a). Sales of securities exempt from the T+2 settlement cycle are exempted securities, government securities, municipal securities, commercial paper, banker’s acceptances and commercial bills.
The amendment also does not apply to contracts for the sale of securities for cash that are priced after 4:30 p.m. Eastern time on the date of pricing of the securities that are either (i) sold pursuant to a firm commitment underwritten offerings registered under the Securities Act of 1933 by the issuer to an underwriter or (ii) sold to an initial purchaser by a broker-dealer participating in such offering. Such firm commitment offerings remain outside of the settlement cycle pursuant to Rule 15c6-1(c) and (d) as long as the alternative settlement date is expressly agreed to by the managing underwriter and issuer for all securities sold in the offering at the time of the transaction.
The SEC states that this amendment aligns with the SEC’s desire that regulations reflect the technology of modern times. Shortening the settlement cycle is aimed to increase efficiency and reduce risk for market participants, including the risk of a counterparty defaulting.
Compliance by broker-dealers with the T+2 amendment is not required until September 5, 2017, consistent with the Industry Steering Committee’s target implementation date. In order to assist compliance preparation, inquiries regarding the amendment may be submitted to the SEC staff at T2settlement@sec.gov.
The SEC press release announcing the amendment and the release adopting the change to Rule 15c6-1(a) are available at https://www.sec.gov/news/press-release/2017-68-0 and https://www.sec.gov/rules/final/2017/34-80295.pdf, respectively.
Since the inception of the Consumer Financial Protection Bureau in July 2011 as part of the Dodd-Frank Act, the financial services industry has watched as the Bureau has proposed a large number of regulations and created law by entering into consent decrees with financial institutions and a host of other creditors. There is no argument that the CFPB has radically changed the manner in which the financial services industry is regulated with its preferred method of legislating through consent decrees. Recently, however, it has been under scrutiny by each branch of the government because of what many see as its potential overreach in power. Recent case law, new bills and presidential executive orders are aimed at reining in the CFPB and its aggressive director, Richard Cordray.
Husch Blackwell’s Financial Services & Capital Markets team is watching these developments and advising clients on the effects of the potential changes. This particular alert addresses the recent executive order by President Trump to “dismantle” the Dodd-Frank Act and how the administration’s “Core Principles for Regulating the United States Financial System” are likely to pertain to providers of consumer financial services.
On August 5, 2015, the Securities and Exchange Commission (“SEC”) adopted rule amendments to implement Section 953(b) of the Dodd-Frank Act, requiring that public companies disclose the “pay ratio” between its CEO’s annual total compensation and the median annual total compensation of all other employees of the company. The new rule, located in Item 402(u) of Regulation S-K, is effective in the first full fiscal year commencing on or after January 1, 2017, and the initial pay ratio disclosure will be required in the company’s first annual meeting proxy statement following the conclusion of such year.
Below is a short guide that will assist companies in preparing for pay ratio disclosure.
Does pay ratio apply to my company?
Pay ratio applies to all companies required to provide summary compensation table disclosure pursuant to Item 402(c) of Regulation S-K. Smaller reporting companies, emerging growth companies, foreign private issuers, multijurisdictional disclosure system filers and registered investment companies are exempt.
What is the required disclosure?
Companies must disclose (1) the annual total compensation, but not the identity, of the employee whose compensation falls at the mathematical median of compensation for all employees of the company (except the CEO), (2) the annual total compensation of the CEO and (3) the ratio of (1) to (2) (the “pay ratio”). The total compensation may be calculated consistent with Item 402(c)(2)(x) of Regulation S-K or the company can use its own methodology provided the disclosure contains the material assumptions, estimates, adjustments and exclusions (including relating to cost-of-living, non-U.S. employees, business combinations and acquisitions) used in the identification of the median employee and the calculation of that employee’s annual total compensation.
How is the ratio presented?
The Ratio must be presented as either:
- a ratio in which the median compensation equals one; or
- a narrative in terms of the multiple that the CEO compensation bears to the median compensation.
For example, if the Median Compensation is $100 and the CEO compensation is $1,000, the ratio can be presented as: (1) 10 to 1, (2) 10:1 or (3) “The CEO compensation is ten times the median compensation.”
How do I determine who the median employee is?
The median employee may be identified:
- using the company’s entire employee population or by means of statistical sampling and/or other reasonable methods;
- once every three years, assuming no significant changes in either (a) the median employee’s circumstances or (b) the company’s compensation levels or employee composition;
- using any date within the last three months of the last completed fiscal year;
- using annual total compensation or any consistently applied compensation measure;
- by making cost-of-living adjustments for employees in jurisdictions other than the jurisdiction in which the CEO resides.
In determining who the median employee is, companies must include all full-time, part-time, seasonal, temporary and non-U.S. employees of the company and its consolidated subsidiaries. Independent contractors and “leased” workers providing services to the company are excluded from the definition as long as they are employed by an unaffiliated third party and their compensation is determined by such party. Companies may exclude:
- employees employed in a foreign jurisdiction in which the laws or regulations governing data privacy are such that, despite reasonable efforts to obtain or process the necessary information, the company is unable to do so without violating such data privacy laws or regulations
- a de minimis number of non-U.S. employees (up to five percent of the company’s global workforce, including any employees excluded under the foreign data privacy law exemption)
What reports require the pay ratio disclosure?
Companies must include disclosure in any annual report on Form 10-K, proxy or information statement or registration statement that requires executive compensation disclosure pursuant to Item 402 of Regulation S-K.
What pay ratio disclosure is required if my company files a registration statement before filing its proxy?
A company does not need to update its pay ratio disclosure until it files its annual report on Form 10-K or, if later, its proxy statement or information statement for its next annual meeting of shareholders.
How does my company comply with the rule if it transitions from being a smaller reporting company or an emerging growth company after January 1, 2017?
Companies that cease to be smaller reporting companies or emerging growth companies are not required to provide the pay ratio disclosure until they file a report for the first fiscal year after they cease to be a smaller reporting company or emerging growth company.
How does my company comply with the rule if it acquires new employees through a business combination during any part of the fiscal year?
The rule permits companies that engage in a business combination or acquisition to omit the employees of a newly-acquired entity from their pay ratio calculation for the first fiscal year in which their business combination or acquisition occurs.
Should my company begin providing pay ratio disclosures before the first reporting period in which such disclosures are required?
You may if you choose to do so. A number of companies began voluntarily providing pay ration disclosures in their 2016 proxy statements. By going through the disclosure process before the pay ratio reporting period begins, companies are able to address a number of key issues that require management consideration well in advance of the reporting period. Additionally, companies that voluntarily report ahead of the reporting period get the benefit of SEC Staff review of their pay ratio disclosures before the disclosures are mandated. At the very least, companies should start thinking about issues that will go into developing the pay ratio disclosures. First, what method will the company adopt in determining the median employee? Second, how will annual compensation be determined? If the company will not follow Item 402 of Regulation S-K in determining annual compensation, what methodology will the company use and what material assumptions, estimates, or adjustments are required? What accompanying disclosures are needed in the pay ratio disclosure to provide the appropriate context needed to make the disclosure helpful to investors? We believe it is prudent for all companies to begin implementing and testing their procedures to support these disclosures now, if they have not already done so, regardless of whether the company plans to elect early compliance. This will allow any unforeseen difficulties that arise in the company’s implementation process to be addressed in a deliberate manner, without the pressure of looming disclosure deadlines.
The Securities and Exchange Commission’s (“SEC”) Advisory Committee on Small and Emerging Companies (the “Committee”) met on Wednesday, May 18, 2016, to discuss two main topics (1) the definition of “accredited investor” and (2) Regulation D. The discussion on the definition of accredited investor was necessitated by the SEC’s recent publication of its report analyzing such definition. As background, the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) directed the SEC to review the definition of accredited investor every four years in order to determine whether or not the definition should be modified. The SEC published its first report under such Dodd-Frank requirement on December 18, 2015, entitled “Report on the Review of the Definition of ‘Accredited Investor’” (the “2015 Report”), which served as the basis for the discussion by the Committee. Continue Reading Committee on Small and Emerging Companies Met to Discuss the Definition of Accredited Investor and Issues under Section 506 of Regulation D
On May 3, 2016, the Securities and Exchange Commission (SEC) approved rule amendments to implement changes liberalizing certain rules related to registration thresholds, termination of registration, and suspension of periodic reporting obligations under Section 12(g) and Section 15(d) of the Securities Exchange Act of 1934 (Exchange Act), as mandated by the Jumpstart Our Business Startup Act (JOBS Act) and the Fixing America’s Surface Transportation Act (FAST Act). The following highlights the three major revisions implemented by the amendments. Continue Reading SEC Adopts Rule Amendments Related to Reporting Thresholds
In March, the U.S. Securities and Exchange Commission (SEC) issued a no-action letter regarding satisfaction of the required holding period under its Rule 144 safe harbor for certain resales of “restricted securities” without registration under the Securities Act of 1933 (the “Securities Act”), in the context of sales of common stock of a public real estate investment trust (REIT) acquired in exchange for the same REIT’s operating partnership (OP) units. In contrast to the SEC staff’s general position that a holder exchanging a security of one issuer for a security issued by a different (albeit related) entity may not satisfy the safe harbor’s requirements by “tacking” its holding period for the two securities, this letter affirmed that when REIT common stock is received by holders in exchange for OP units in a customary umbrella partnership real estate investment trust (UPREIT) structure, notwithstanding that the REIT and its OP are not the “same issuer,” such holders generally may count their holding period for the OP units, plus their holding period for the REIT common stock following such exchange, in determining whether they meet Rule 144’s holding period requirement.
Generally, securities issued without registration – which is normally the case for OP units issued in exchange for real property as well as common stock that may be issued in exchange for OP units in a typical UPREIT structure – are classified as “restricted securities” under the Securities Act. In order to avoid Securities Act registration for the resale of restricted securities by not being classified as “underwriters” pursuant to the Rule 144 safe harbor, a holder must satisfy a number of requirements, including a requirement under Rule 144(d) that such securities have been held for a period of at least six months before they are transferred or sold.
UPREIT partnership agreements typically require that OP units issued in exchange for a contribution of real property assets must be held for a specified period (usually one year) before they may be exchanged for REIT common stock, which represents an economic interest in the underlying portfolio of real estate assets substantially identical to that of the OP units. Notwithstanding this fact, prior to this no action letter informal SEC guidance under Rule 144 indicated the SEC would not allow holders to “tack” the holding periods of the two securities. Thus, the REIT common stock had to separately satisfy the Rule 144(d) holding period before it could be sold without registration under Rule 144. Under this new guidance, the holding period generally will begin to run as soon as the OP units are acquired.
The guidance issued will be applicable to transactions that conform to the facts and circumstances addressed in the underlying no-action request submitted on behalf of Bank of America, N.A, Merrill Lynch, Pierce, Fenner & Smith Incorporated (“BAML”). Because that request did not address a particular REIT or transaction, however, it should be applicable for all exchanges of UPREIT OP units that conform to the four factors cited by the SEC as the basis for its grant of the required “no action” relief:
- Unit holders must pay the full purchase price for the OP units at the time they were acquired from the OP;
- An OP unit must be the economic equivalent of a share of REIT common stock, representing the same right to the same proportional interest in the same underlying pool of assets;
- The exchange of REIT common stock for OP units must be at the discretion of the REIT; and
- No additional consideration is required to be paid by the OP unit holders for issuance of the shares of REIT common stock in exchange for the OP units.
The SEC noted that absence of any of these factors could result in a different conclusion concerning the application of the Rule 144(d)(1) holding period to the exchanged shares.
What This Means to You
This guidance should benefit both REITs and the holders of their OP units by eliminating the need, in most cases, for a “selling stockholder” registration statement or prospectus to be filed under the Securities Act before the REIT common stock issued in exchange for OP units may be sold into the public market by the exchanging holder. Where exchanging holders of OP units have been granted the right to have the REIT register their securities for public resale under the Securities Act, such agreements typically provide that no registration statement need be filed, or that an existing resale registration may be discontinued, if the selling holders are able to utilize the Rule 144 safe harbor for their transactions. The elimination or significant reduction of such resale registration statement filings will save REITs both time and money, and may also avoid potential conflicts with primary offerings by the REIT, under a shelf registration statement or otherwise, in other capital raising transactions.
OP unit holders also benefit from this guidance, which provides additional flexibility and certainty concerning their ability to freely transfer REIT common stock acquired upon the exercise of OP unit exchange rights without the delays previously associated with waiting for a resale registration to be completed or for the full Rule 144 holding period to run after acquiring their stock.
 The six month holding period applies to securities of issuers that are SEC reporting companies and are current in their Exchange Act reporting requirements. For non-reporting companies, or for any reporting company that is not current in its Exchange Act filings, the required holding period is one year.
 Based on the assumptions set forth in BAML’s request and the SEC’s response, it seems clear that this includes issuances in exchange for real property contributed to an UPREIT’s operating partnership.
Overview. Last week, the Securities and Exchange Commission (SEC) adopted new rules permitting “crowdfunding,” a method for growing businesses to raise capital over the Internet by soliciting small investments from a large number of individuals. The new rules are the final significant rulemaking procedure required by the Jumpstart of Business Startups (JOBS) Act of 2012 and aim to increase access to capital for new companies nationwide.
For Companies Seeking to Raise Capital. The crowdfunding rules permit issuers to raise up to $1 million in a 12-month period through a funding portal registered with the SEC or through specific online broker-dealer platforms. Only one offering through one intermediary platform is allowed at any time, and advertisements of the offering outside of the platform are limited to information similar to traditional “tombstone” ads. To protect investors from the inherent risks associated with crowdfunding offerings, the SEC requires each issuer to provide certain detailed information on a new Form C, including among other things: a detailed description of the business; the target offering amount; the price of the securities offered; the company’s financial statements (subject to scaled requirements based on the targeted offering size); the intended use of the proceeds; all related-party transactions; and the identities of all significant stakeholders, as well as updates when certain milestones are reached in the offering on a prescribed Form C-U. Issuers will also be required to file annual reports with the SEC on a new Form C-AR and provide the same to investors.
Certain companies are not be eligible to be issuers, such as non-U.S. companies, Exchange Act reporting companies, certain investment companies, companies subject to prior disqualification, and companies with no business plan other than to execute a merger or acquisition.
For Individuals Seeking to Invest. Under the new rules, the SEC established limits on the amounts that an individual can invest in crowdfunding offerings, based on the individual’s income level. Investors with an annual income or net worth greater than $100,000 may invest up to ten percent of their income or net worth every 12 months (in total, across all crowdfunding platforms). For investors with an annual income or net worth below $100,000, the aggregate investment limit is equal to the greater of (i) $2,000 or (2) five percent of their net worth. Regardless of income level, the amount of securities sold to an investor may not exceed $100,000 in a 12-month period.
For Crowdfunding Platforms. Each crowdfunding intermediary is required to register with the SEC and become a member of FINRA. To reduce the risk of fraud, the new rules establish additional operating and process requirements for intermediaries, such as: providing investors with educational materials (on both the issuer and the investment process); reviewing and timely disseminating all issuer disclosures; providing clear channels for prescribed communications; and reasonably policing monetary exchanges. The rules also prohibit certain intermediary activities, including: offering investment advice; having a financial interest in an issuer (unless received as compensation for its intermediary service, subject to restrictions); compensating promoters; and providing platform access to fraudulent companies.
What’s Next? The new crowdfunding rules and forms will be effective 180 days after they are published in the Federal Register. The forms enabling intermediaries to register with the SEC will be effective on January 29, 2016.
The Securities and Exchange Commission (“SEC”) released a proposed rule on July 14, 2015 that will require publicly traded companies to create and enforce a clawback policy (called a “recovery policy” by the SEC) to recover incentive-based compensation (“IBC”) paid to executives for specific metrics for which the company has to issue revised financial statements because those metrics were overstated. While the rule is discussed in more length in a previous post, this blog post discusses two tax issues that companies and executives should be aware of when creating a clawback policy. The first issue arises if a company’s recovery policy were to provide for clawback from nonqualified deferred compensation before it becomes payable, which could result in a significant tax penalty on an affected executive under Section 409A of the Internal Revenue Code. The second issue arises when an executive has already paid taxes on the IBC, as the rule requires the clawback be equal to the bonus amount pre-tax, not the amount that the executive netted from the bonus.
Section 409A generally does not allow the payment of deferred compensation at times other than upon certain events specified in the statute (separation from service, disability, or death) or on a fixed date. Acceleration of payment is generally prohibited. Under the existing Section 409A guidance, the ability of a company to clawback IBC from deferred compensation that is not yet payable generally would violate the anti-acceleration rule of Section 409A, potentially triggering severe tax consequences for affected executives. Companies should draft their recovery policies so that clawback will come from sources other than deferred compensation subject to the anti-acceleration rule of Section 409A.
The second issue arises when the executive has already paid taxes on IBC, but the amount to be recovered is on a pre-tax basis. The executive generally should be able to claim the clawback repayment as a miscellaneous itemized deduction in the year of the repayment. However, there will be instances where the tax benefit from this deduction will not completely offset the amount of additional taxes incurred in the year the IBC was received (e.g., when the executive’s tax rate is different in the year of receipt of the IBC than the year the clawback takes place and due to limitations on miscellaneous itemized deductions). While Section 1341 generally provides relief in the situation where the deduction in the year of repayment does not fully compensate a taxpayer for the additional taxes previously paid on such repaid amount, tax practitioners are skeptical that Section 1341 will always be available to executives in these situations. This issue likely will not affect how companies draft their policies; rather, it will inform how executives make financial and tax decisions, particularly given that executives will generally have to make the clawback repayment of (and therefore will generally be “out of pocket” for) the full pre-tax amount of the bonus before realizing any tax benefits from the repayment.
On July 1, 2015, the Securities and Exchange Commission published a Concept Release on Possible Revisions to Audit Committee Disclosures. This comes on the heels of a PCAOB request for comments regarding whether public accounting firms are required to release the name of audit engagement partners and certain participants in audits. While not strictly related, these new possible rules highlight regulators’ renewed concern for audit disclosures. At this time, the SEC is seeking comments regarding (1) the idea of revisions to the existing requirements in general, and (2) specific areas of possible disclosure. The SEC cites some shareholders expressing the view that the existing “rules do not provide investors with sufficient useful information regarding the role and responsibilities carried out by the audit committee in public companies.” The SEC is particularly careful to point out that many companies “voluntarily provide information beyond the disclosures required by [the SEC’s] current rules.” The areas of possible disclosure seem to cover a wide array of issues, indicating that the SEC may be strongly influenced by the input from comments.
Below are some of the areas that the SEC is considering for additional disclosures:
- the audit committee’s oversight of the auditor, including: communications between the committee and auditor (which would provide information about actions taken in the most recent fiscal year); meetings between the auditor and audit committee; committee review of the auditing firm’s internal controls; and how the committee reviews the auditor’s objectivity and professional skepticism;
- the audit committee’s process for appointing and retaining the auditor, including assessments, proposals, and shareholder input;
- qualifications of the audit firm, such as the engagement team and number of years the firm has audited the company;
- whether the audit committee disclosures should be included in IPO and other registration statements; and
- requirements for smaller and emerging growth companies.
While some of these disclosures appear to be less difficult than others, such as how long an auditor has audited a company, others appear to be more in depth, such as requiring disclosure of the committee’s review of the auditor’s internal controls, or others that could be hard to explain, such as why ABC Co. chose KPMG over PWC. It is unclear from the SEC’s release how these disclosures will help the average investor make wise investment decisions. Arguably the process would be more transparent, but the flip-side is that it becomes more burdensome on companies to disclose more and more, and may overload investors with information. However, the SEC is seeking comment, and issuers may be able to influence the direction and scope of the rules by submitting comments.
It is clear from the SEC’s broad request for comments that the necessity, demand, and scope of the rules is not yet clear, which is good reason for reporting companies to take advantage of the request for comments. Companies should consider the effect this may have on small versus large companies, as well as the possible disclosures regarding justification – and what burden that might entail. Additionally, there are also forthcoming PCAOB regulations requiring public disclosures that might make some of these rules redundant, and perhaps the SEC rules would be better created after the scope of the PCAOB regulations is determined. If companies wish to submit comments to the SEC, Husch Blackwell LLP is here to help.
Alex Gross, a summer associate at the firm, assisted in the preparation of this post.