Securities Law

Archive for April 2017

Posted on Wednesday, April 26 2017 at 2:36 pm by

Your SEC Filing Cover Page is (Probably) Wrong!

By: David M. Eaton

If you blinked, you may have missed this one—in a release deceptively titled “Inflation Adjustments and Other Technical Amendments Under Titles I and III of the JOBS Act,” the SEC amended the cover pages of a slew of its forms, including Securities Exchange Act Forms 10-K, 10-Q and 8-K, and Securities Act Forms S-1, S-3 and S-8.  These amendments were effective April 12, 2017, so most forms public companies would have filed since then should have had a slightly different cover page than comparable forms filed before that date.

The amendments facilitate an SEC registrant identifying itself as an “emerging growth company” (a new-ish category of recently public registrants established by the 2012 JOBS Act that are eligible for various disclosure/reporting and corporate governance breaks). An emerging growth company (“EGC”) must also indicate by check box whether or not it is relying on a particular benefit extended to EGCs—delaying complying with new or revised accounting standards until the time non-public companies are required to adopt them.  See our prior legal alert on the JOBS Act for more on EGCs.

Even though the changes are currently effective, the SEC may not have updated all of the affected forms on its forms list by the time you read this (look at the “Last Updated” column for a date of April 2017 or later to confirm). In light of this, please confer with us if you want to make sure your cover page is compliant.

Posted on Tuesday, April 25 2017 at 12:54 pm by

Disclosing Election of a New Director: Remember Item 5.02(d) of Form 8-K When Doing a Merger

By: W. Randy Eaddy and David A. Stockton

All competent securities lawyers know that Item 5.02(d) of Form 8‑K requires a filing, on Form 8‑K, whenever a public company elects a new director other than pursuant to a shareholder vote at an annual meeting or a special meeting that was convened for that purpose. That requirement typically does not present any compliance problems. The information required to be disclosed is fairly straight forward, and most companies usually obtain and prepare the relevant information for purposes of a press release or other public disclosure as part of the transaction or other corporate event leading to the election of the new director.

So, no big deal, unless one forgets that no such press release or other public disclosure ─ including, for example, a merger proxy statement ─ satisfies the Item 5.02(d) filing requirement. And, there is at least one significant adverse consequence of a missed Form 8‑K ─ i.e., Form S‑3 eligibility.

For most companies with even a modestly sophisticated capital structure, eligibility to use Form S‑3 to register securities is an important element of its ongoing securities issuance compliance regime. And, a baseline eligibility requirement for use of Form S‑3 is that a company be current with all filings under the Securities Exchange Act of 1934, as amended, for the past 12 months. Missing even a seemingly innocuous Form 8‑K filing will fail that test.

A disarming context that has led to more than a few instances of unwitting Item 5.02(d) non‑compliance is where a public company acquires a privately held business and elects as a new director a person who was involved with the privately held acquisition target. In that context, the company typically files a Form S‑4 registration statement that includes a proxy statement (if the acquisition consideration includes issuing stock to the target’s owners), or a proxy statement otherwise if the acquiror’s shareholders must approve the acquisition transaction.  (For convenience, we assume the acquisition is structured as a merger, and we refer to the transaction‑related disclosure document as a “merger proxy statement”.  The same issues discussed here are present regardless of that deal structure.)

Good and customary disclosure by the company in its merger proxy statement will include that the person associated with the target is being elected as a new director as part of consummating the merger, and that person’s background information will be included in the merger proxy statement. Also, as a part of typical corporate governance and disclosure hygiene, the planned election of such a new director will likely be included as part of the company’s press release to announce the upcoming merger and/or the meeting being held to approve it. In any case, the information provided to the public about the new director is likely to cover everything required, as a matter of substance, by Item 5.02(d).

Even more disarming is where a Form 8‑K is required and has been filed, pursuant to Item 1.01, to disclose the anticipated merger, with information about the planned election of the new director expressly included as part of that disclosure.  And, the merger is thereafter approved and consummated as so disclosed.

Ah, but there’s the rub. Unless a Form 8‑K is timely filed after consummation of the merger, and the election of the new director is disclosed in that Form 8‑K, the Item 5.02(d) requirement has not been met. Not even a Form 8‑K filing pursuant to Item 2.01 (to disclose completion of the merger) will be sufficient for Item 5.02(d) compliance purposes, if the loop is not closed by referring expressly to the new director’s actual election as previously anticipated.  After all, there can be last minute changes in the deal.

In that context, compliance with the Item 5.02(d) requirement is ripe for being overlooked. After all, the public has been informed, conspicuously and, probably, on multiple occasions, that the subject person would be elected as a new director of the company if and when the merger is completed, and the public has been informed by the Item 2.01 filing that the merger is effective. What could possibly have been missed? Well, the prescribed Item 5.02(d) filing, that’s what.

We have no empirical data, but we have great confidence, that there are many missed Form 8‑K filings in such an acquisition context.  We believe that many go unrecognized, and that they won’t be recognized, unless there is a later, specific occasion – such as the due diligence process for a future, unrelated transaction – to test for Form S‑3 eligibility. That is not a good time to make the discovery. So, make sure the Item 5.02(d) filing is a specific, post‑consummation item on the comprehensive checklist for managing the transaction.

That said, in a pinch, it might be possible to obtain a de facto waiver from the Staff of the SEC. We are aware that the Staff of the Division of Corporation Finance has taken a verbal “no objection” position with respect to a company’s use of Form S‑3 notwithstanding a missed Item 5.02(d) filing in a situation analogous to that described above. We believe the Staff’s position was based on a compelling demonstration by the company of “no harm, no foul” because the company had otherwise provided a conspicuous, substantially equivalent, timely disclosure of the same information.  But, don’t plan on such an outcome; remember the Item 5.02(d) filing.

Posted on , April 25 2017 at 12:51 pm by

Supreme Court to Consider Fundamental Issues in Omissions-Based Fraud Cases

By: David A. Stockton and W. Randy Eaddy

The Supreme Court recently agreed to review a case which has split the circuit courts and has potentially huge implications for disclosure liabilities of public companies. The case, Leidos Inc. v Indiana Retirement System, centers on the failure to disclose in SEC periodic reports the existence of a governmental investigation, which ultimately proved to be a very material development. The issue in the case is whether such failure to comply with a Regulation S‑K line item disclosure is actionable only by the SEC or raises a private cause of action for investors in the company’s stock under Rule 10b‑5. The particular line item at issue is Regulation S‑K Item 303, which requires disclosure of known trends or uncertainties reasonably likely to have a material impact.

Historically, the failure to address line item disclosures required by Form 10‑K and 10‑Q under the Exchange Act of 1934 does not, standing alone, provide investors with a private cause of action to sue. Instead, the SEC has the right to remedy such omissions through comment letters submitted directly to the issuer and, in more egregious circumstances, enforcement actions against the company. The primary tool for aggrieved investors to recover losses directly from an issuer has been Rule 10b‑5. However, by its express terms, a Rule 10b‑5 action based on an issuer’s failure to disclose can only be maintained if such omission causes affirmative statements made by the issuer to be misleading. So, while not disclosing a big, problematic governmental investigation may violate the Regulation S‑K line item disclosure, it is not a violation of Rule 10b‑5 if the issuer had never made any affirmative statement suggesting the absence of such an investigation. This is because there must be an underlying affirmative statement that is rendered false or misleading by the later omission.

The Supreme Court affirmed this fundamental principle in the seminal case of Basic v. Levinson, stating “silence, absent a duty to disclose, is not misleading under Rule 10b-5.”  Periodic disclosure requirements have not been considered by courts or practitioners to raise such a duty to disclose under 10b‑5, until now, when the Second Circuit Court of Appeals took a different view in the Leidos case. The Second Circuit held that the failure to make a disclosure required by Regulation S‑K can form the basis for a 10b‑5 omission claim by investors, even if the omitted material facts do not render an affirmative statement misleading. This is contrary to holdings by the Ninth Circuit that a duty of an issuer to disclose information under SEC regulations does not necessarily create a duty for purposes of a 10b‑5 claim. This split in the circuits caused the Supreme Court to grant certiorari to resolve the split.

Both sides of this debate – issuers and investors – see great significance in the outcome of the Leidos case. The investor community contends that investors expect to see disclosure of information that the SEC requires by regulation and, if a public company fails to comply with those regulations, it is only fair that investors harmed by such failure be able to bring an action directly against the company.

Public companies facing lawsuits from investors view the Second Circuit’s ruling as threatening to open the floodgates of vexatious 10b‑5 litigation. They are particularly alarmed because the Regulation S‑K Item 303 mandatory disclosure involved in the Leidos case is one of the most difficult disclosure requirements found in Regulation S‑K, as it calls for a subjective determination as to what constitutes a “known trend or uncertainty” and then a prediction as to whether the uncertainty is likely to have a “material impact” in the future.

The issue is joined on a recurring, quarterly basis in drafting a company’s MD&A. Issuers often conclude that the best course is to be silent about a particular circumstance because it is not clear that the circumstance is likely to have a material impact, and drafting full and fair disclosure can be problematic in a fluid situation where the facts have not yet fully played out. Issuers contend that the appropriate forum within which to regulate those difficult disclosures is before the SEC Staff who have expertise in such matters, as opposed to in expensive and disruptive shareholder litigation. But, the Second Circuit’s position in Leidos would make a non-disclosure decision the basis for shareholder class actions anytime the omitted speculative matter later turns out to have been materially adverse, as was the case in Leidos.

The Leidos approach would substantially increase the exposure of public companies to shareholder lawsuits under Rule 10b‑5. Further, potential liability to investors would not necessarily be limited to the required Regulation S-K disclosures that are at issue in the Leidos case. The Second Circuit theory that a 10b‑5 claim may be based on a duty to disclose mandated by federal regulations could also be held to apply to any other statutes or regulations containing specific disclosure requirements.

Handicapping the outcome of a Supreme Court case is always difficult, but we read the tea leaves as pointing toward the court agreeing with the issuer that the basis of a private Rule 10b‑5 claim should not be expanded to include omissions of required Regulation S‑K disclosures. This view is based largely on the Supreme Court recent trend to limit private rights of action under Rule 10b‑5.

That trend may be advanced by the recent addition of Justice Neil Gorsuch to the Court. Justice Gorsuch published an article some years ago that suggested he would take a hardline on shareholder litigation, noting that securities class actions have “brought with them vast social costs.” Public company issuers and those responsible for drafting  their periodic disclosure documents, particularly those charged with addressing the requirement to discuss the future impact of known trends and uncertainties, will be anxiously awaiting the result.

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