Securities Snapshot: 2nd Quarter 2021

Turning up the Heat on Executive Trading Plans

Since the Senate confirmed his nomination to lead the U.S. Securities and Exchange Commission on April 14, 2021, Commission Chief Gary Gensler has wasted little time calling for the review of and changes in several areas of federal securities regulation. During the second quarter of 2021, Gensler established an aggressive rulemaking agenda calling for new restrictions on executive trading plans and additional regulation for climate change disclosure, human capital management disclosure, enhanced cybersecurity risk governance disclosure, SPACs, and proxy voting advice. Gensler also called for a review of current equity market rules and adopted a transition period for the 2020 Rule 14a-8 shareholder proposal rule amendments. The Commission also approved Nasdaq’s direct listing rules, extended its review period for Nasdaq’s board diversity proposal and announced an enforcement action against a firm for alleged cyber disclosure failures. Additionally, in a link below as an appendix are summaries of recent Commission technical form updates to Form 8-K and Form 10-K.

SEC Chief Calls for New Restrictions on Executive Trading Plans

Expressing concerns about potential abuses of executive trading plans established under Securities Exchange Act Rule 10b5-1, on June 7, 2021, Chief Gensler announced that he expects to revise the rule. Rule 10b5-1 provides an affirmative defense from insider trading for corporate insiders and companies to buy and sell company stock as long as they adopt their trading plans in good faith and while not in possession of material nonpublic information. The Commission’s updated regulatory agenda suggests that proposed new rules may come before the end of the year. Gensler described five areas he has asked Commission staff to consider for potential reforms:

• Cooling off Period: Gensler recommended a cooling off period when insiders or companies adopt 10b5-1 plans before they can make an initial trade. He noted, with approval, that proposals of four to six months have received support from former Chair Clayton and current Commissioners Caroline Crenshaw and Allison Herren Lee. While cooling off periods are in our experience common, they are typically shorter than four to six months.
• Limitations on Cancellation of 10b5-1 Plans: Gensler has asked the Staff to consider limitations on when and how plans can be cancelled, because currently there is no regulatory prohibition on canceling a 10b5-1 plan when in possession of material nonpublic information.
• Mandatory Disclosure Requirements: There are no disclosure requirements for 10b5-1 plans, and Gensler recommends disclosure for the adoption, modification, and terms of 10b5-1 plans.
• Absence of Limits on Number of 10b5-1 Plans: Insiders can currently enter into multiple plans, permitting insiders to cancel, amend, or choose the most favorable plan to rely on for sales.
• Share Buybacks: Gensler asked the Staff to consider reforms that address the relationship between 10b5-1 plans and corporate share buybacks.

Regulatory Flex Agenda: Climate Change; Human Capital Management; Cyber Risk Governance; SPACs

As part of a federal agency-wide review of the new Administration’s plans for rulemaking, the Commission updated its Regulatory Flex Agenda (Agency Rule List - Spring 2021 (reginfo.gov)). Among other items, included in the agenda’s proposed rulemaking stage are:

• Rule 10b5-1 – October 2021
• Climate change disclosure (climate-related risks & opportunities) – October 2021
• Human Capital Management disclosure – October 2021
• Enhanced cybersecurity risk governance disclosure – October 2021
• Corporate Board Diversity – October 2021
• SPACs – April 2022
• Proxy Voting Advice – April 2022
• Exempt Offering Framework – April 2022

While the Commission’s regulatory agenda is non-binding, it is of interest in that it identifies its rulemaking priorities.

Commission Launches Review of Equity Market Rules

On June 9, 2021, Gensler directed Commission staff to review equity markets rules to ensure investors are getting the best prices on trades and are not being slipped hidden costs by more sophisticated market players. Gensler appears to be focusing on the rise of compensation systems known as "payment for order flow" — used by trading apps like Robinhood Markets where brokers charge customers zero commissions while directing their orders to intermediaries willing to pay for data gained by viewing such order flow. Critics of PFOF, as it is called, worry that brokers are profiting by steering business to market intermediaries that do not assure customers the best prices.

Nevermind Those Rules on Proxy Voting Advice

Gensler announced on June 1, 2021 that the Commission will not enforce 2020 rules that restrict the practices of proxy advisory firms. The rules require that proxy advisory firms share their voting recommendations with the public companies that are the subject of those votes before sending them to clients or at the same time. The rule also requires those firms to inform clients about the companies’ response to their recommendation and to disclose any conflict of interest in their voting advice.

Gensler is directing the Staff “to consider whether to recommend further regulatory action regarding proxy voting advice.” In light of that directive, the agency’s Division of Corporation Finance said it “will not enforce the rule … while it considers further regulatory action.”

The rules took effect on November 2, 2020, but compliance is not required until December 1, 2021. If there is no new regulatory action before December 1, 2021, the Division of Corporation Finance said it will not recommend any enforcement action “for a reasonable time after any resumption” of a lawsuit by Institutional Shareholder Services challenging the rule.

ISS had sued the agency in 2019 over guidance that advice provided by firms like ISS constitutes a solicitation under federal proxy rules under the Exchange Act, which “authorizes the Commission to establish rules and regulations governing such solicitations as necessary or appropriate in the public interest or for the protection of investors.” It paused the suit while the Commission was working on finalizing new proxy rules, then reactivated it after the new rules were finalized.

Commission Approves Nasdaq’s Direct Listing Rule

On May 19, 2021, the Commission approved proposed rule changes submitted by The Nasdaq Stock Market LLC that allow companies to list in connection with a concurrent primary offering. The approved rule allows a company that has not previously had its equity securities registered under the Securities Exchange Act of 1934, as amended, to list its equity securities on the Nasdaq Global Select Market at the time of effectiveness of a registration statement pursuant to which the company will sell its shares in the opening auction on the first day of trading.

In determining whether the market value requirement for an initial listing is satisfied, Nasdaq will deem the requirement to be met if the amount of the company’s unrestricted publicly-held shares before the offering, along with the market value of the shares to be sold by the company in its opening auction, is at least $110 million (or $100 million, if the company has stockholders’ equity of at least $110 million). For comparison, a company may list in connection with a traditional underwritten initial public offering with a minimum $45 million market value. Nasdaq will calculate the market value using a price per share equal to the lowest price of the price range disclosed by the company in its registration statement (shares held by officers, directors or owners of more than 10% of the company’s common stock are excluded from the calculation).

The rule changes also amend Nasdaq Rule 4702 in order to add a new order type, the “CDL Order,” which must be submitted by the company in the opening auction for the full quantity of offered shares and must be executed in full. The price of the CDL Order must be set at or above the lowest price and at or below the highest price of the price range established by the company in its registration statement. The CDL Order cannot be modified or cancelled by the company once entered. The Commission previously approved a similar rule amendment by the New York Stock Exchange to allow a direct listing with a primary offering.

A link to the Commission’s approval of the Nasdaq proposal can be found here: Order Approving a Proposed Rule Change, as Modified by Amendment No. 2, to Allow Companies to List in Connection with a Direct Listing with a Primary Offering In Which the Company Will Sell Shares Itself In the Opening Auction on the First Day of Trading on Nasdaq and to Explain How the Opening Transaction for Such a Listing Will be Effected (sec.gov)

Commission Extends Consideration Period for Nasdaq Board Diversity Rules

On June 7, 2021, the Commission issued a notice stating that it designated a longer period to consider Nasdaq’s proposed rule change related to board diversity. August 8, 2021 is the new date by which the Commission shall either approve or disapprove Nasdaq’s proposed rule change. It is worth noting that corporate board diversity is among items listed in the proposed rulemaking stage on the Commission’s Flex Agenda, which includes an October 2021 target date.

Commission Charges Firm for Cybersecurity Disclosure Controls

On June 15, 2021, the Commission announced that that it had settled charges that a title insurance company’s cybersecurity disclosure controls and procedures violated reporting requirements. The title insurance company, First American Financial Corp., which neither admitted nor denied the charges, agreed to a cease-and-desist order and to pay a $487,616 penalty. The Commission’s press release about the charges can be found here. The cease-and-desist order can be found here. The company’s June 15, 2021 filing on Form 8-K about the charges and their resolution can be found here.

According to the Commission, a cybersecurity journalist contacted First American in May 2019 to notify the company that its system had a vulnerability exposing over 800 million title and escrow documents. In response, First American promptly issued a statement concerning the breach and reported it in a filing on Form 8-K.

Unknown to the company executives responsible for the press release and filing, the vulnerability had first been identified by First American information security personnel in January 2019. The vulnerability was described in a January 2019 report that was provided to security and IT managers at the time, but not to senior company management. Though the vulnerability had been identified internally in January 2019, it had not yet been remediated by the time of the May 2019 contact from the journalist.

The order charges that the company “did not maintain disclosure controls and procedures designed to ensure that senior management had this relevant information about the January 2019 [vulnerability report] prior to issuing the company’s disclosures about the vulnerability.” The order charged further that as of May 24, 2019, First American “did not have any disclosure controls and procedures related to cybersecurity, including incidents involving potential breaches.”

This company did not have a mechanism to ensure that cybersecurity incidents and vulnerabilities were reported up to senior management responsible for the company’s reporting and disclosures. So, at a minimum, a company interested in putting cybersecurity disclosure controls and procedures in place in order to try to ensure compliance with the Commission’s requirements will want to ensure that the company has a mechanism in place to ensure that management personnel responsible for reporting and disclosures are apprised of cybersecurity incidents and vulnerabilities.

Reminder: How Will You Implement MD&A and Financial Disclosure Changes?

As described in our 2020 Fourth Quarter publication [Securities Snapshot: 4th Quarter 2020: Keating Muething & Klekamp PLL (kmklaw.com)], on November 19, 2020, the Commission amended certain financial disclosure requirements under Regulation S-K. The amendments eliminate the Item 301 requirement to provide selected financial data, replace the Item 302 requirement for tabular supplementary financial information with a principles-based disclosure requirement regarding material retrospective changes, and make significant changes to Item 303’s Management’s Discussion and Analysis. Recall that the transition for the new rules provides that companies may voluntarily adopt the changes on an S-K item-by-item basis after the February 10, 2021 effective date. If a company does not early implement the new rule, the mandatory transition date is August 9, 2021. For calendar year-end companies, the new rules must be implemented for the year ended December 31, 2021. For more information, please see our link here: More Disclosure Modernization: SEC Adopts Significant Amendments to Financial Disclosure Rules: Keating Muething & Klekamp PLL (kmklaw.com)

APPENDIX: Technical Form Updates to Form 8-K and Form 10-K

Should you have any questions or need assistance, please contact us.

James C. Kennedy
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F. Mark Reuter
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Allison A. Westfall
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Christopher S. Brinkman
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Michael W. Goldman
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