Tag: SEC

“We are not going to be moving slowly” SEC Director on ESG Disclosure Requirements

The Securities and Exchange Commission (SEC) requests public comments to be made ahead of their decision to possibly strengthen Environmental, Social, and Corporate Governance (ESG) disclosures for corporations. Specifically, this action would hold companies more accountable for their possible contributions to global climate decline. While the comment period is open until June 13th, SEC Director of the Division of Corporation Finance John Coates urges submissions sooner rather than later.

“We’re not going to be moving slowly,” Coates said in a round table discussion of the SEC action hosted by New York University Vincent C. Ross Institute of Accounting Research on April 30th. “We’re going to be moving relatively promptly on this front, and if you really want your contributions read, I would send them in earlier than June 13th.”

Coates assured that more detailed attention will go into the submissions received ahead of the deadline.

“If you get them in earlier… we will be able to spend more time carefully reading them right away. We will eventually process all of them, just to be clear, but it may take more time for the ideas of them to get into our head so sooner rather than later, would be great.”

Among the comments already submitted, there is a wide range of opinions on whether the SEC is overstepping its responsibilities in taking on climate issues by requiring more transparency from companies. While some commenters tell the SEC to leave any climate policy to elected officials, others are enthusiastic about more uniform and structured approaches to accountability.

Some opinions fall in the middle, where commenters want to see the SEC simply enforce existing guidelines, set by organizations such as the Task Force on Climate-Related Financial Disclosure (TCFD) and the Sustainability Accounting Standards Board (SASB), instead of creating new and possibly confusing procedures. This is in response to arguments that the current course of action in climate reporting is insufficient, and corporations have found ways to escape sharing climate impact with their shareholders in the past.

Kelsey Condon, a whistleblower attorney at Kohn, Kohn and Colapinto, published an article on this issue stating, “This policy change is important for whistleblowers to be aware of because a corporation’s misleading statements on these subjects are now likely to be treated as material by the SEC and may actually be prosecuted. Corporate insiders, i.e., whistleblowers, are well-positioned to report to the SEC when they know that a company’s statements about climate and ESG are false or designed to be misleading.”

And that, “Whistleblowers are a crucial source of information and evidence, providing a window into the opaque and sophisticated worlds of corporate inner workings and criminal networks, which law enforcement would otherwise not have. In this way, whistleblowers are our best hope for holding corporations to their environmental promises through such reporting. Now, the SEC may actually take action on such reports, and whistleblowers will enjoy the safeguards that come with reporting to the SEC, such as anti-retaliation protection, anonymity, and awards.”

With stricter regulations would come a greater need for those ready to blow the whistle on companies still failing to accurately communicate their environmental impact.

To read previously submitted comments, or submit your own, click here.

Copyright Kohn, Kohn & Colapinto, LLP 2021. All Rights Reserved.

ARTICLE BY Grace Schepis of Kohn, Kohn & Colapinto

For more articles on the SEC, visit the NLR Securities & SEC section.

How a CEO Can Be Liable for a Noncompliant Business

Your company is being targeted in a civil lawsuit. A whistleblower has filed a complaint with the U.S. Securities and Exchange Commission (SEC). The Internal Revenue Service’s Criminal Investigations Division (IRS-CI) is investigating your company for tax fraud. As the company’s chief executive, are you at risk for personal liability exposure?

Maybe. While most corporate liabilities reside exclusively at the corporate level, there are circumstances in which CEOs can be held liable for their companies’ noncompliance. In certain circumstances, CEOs can face personal civil, or criminal liability for acts taken by, or on behalf of, their companies. Litigation and investigations targeting businesses’ noncompliance can also lead to the discovery of wrongs committed by CEOs in their individual capacities, and these discoveries can lead to personal liability as well.

“CEOs can potentially face personal liability in a broad range of circumstances. As a result, CEOs need to take adequate steps to mitigate their risk, and they must be prepared to defend themselves during (and in some cases after) corporate investigations, litigation, and enforcement proceedings. ” – Dr. Nick Oberheiden, Founding Attorney of Oberheiden P.C. 

3 Types of Scenarios in Which CEOs Can Face Personal Liability Arising Out of Corporate Noncompliance

There are three main types of scenarios in which CEOs can face personal liability arising out of corporate noncompliance. However, within each of these three broad areas, there are numerous possible examples; and, as discussed below, CEOs need to implement appropriate measures to mitigate their personal risk. The three main types of scenarios in which CEOs can face personal liability are:

  • Piercing the corporate veil
  • Acts and omissions in the CEO’s corporate capacity
  • Acts and omissions in the CEO’s personal capacity

1. Piercing the Corporate Veil

Even outside of the legal and corporate environments, it seems that most people are familiar with the phrase, “piercing the corporate veil.” However, few people (including people in the legal and corporate environments) have a clear understanding of what this phrase actually means.

Piercing the corporate veil refers to the act of holding a company’s owners and executives liable for the company’s debts. This can include either debts owed to commercial creditors, debts owed to judgment creditors, or both.

Corporations, limited liability companies (LLCs), and certain other types of business entities insulate owners and executives from personal financial responsibility for corporate debts. Owners and executives enjoy “limited liability” based on the existence of the business entity, which itself is classified as a “person” for most legal purposes. If the company gets sued, the limited liability protection afforded to its owners and executives means that they are not at risk for facing judgments in their personal capacities—in most cases.

But, there are various circumstances in which the veil of limited liability can be pierced (or, in plain English, in which a CEO can be held financially responsible for a company’s debts). Three of the most common circumstances that allow for piercing are:

  • Commingling – If a CEO commingles his or her personal assets with the assets of the business, a court may find that there is an insufficient distinction between the two. For example, if a small business owner/CEO deposits payments for accounts receivable into his or her personal account, a judge might determine that since the business owner/CEO is not respecting the company’s existence, the court should not respect it, either.
  • Failure to Observe Corporate Formalities – In addition to commingling, failure to observe other corporate formalities can lead to piercing as well. This includes failure to observe formalities such as preparing meeting minutes and resolutions, making annual filings, and separately purchasing assets for personal and business use.
  • Insufficient Corporate Assets – Judges have also allowed piercing in circumstances in which companies are grossly undercapitalized. Essentially, if a company is undercapitalized and takes on more debt or risk than it can reasonably handle, then a judge might hold the company’s owner and/or CEO personally liable as a result of failing to endow the company with the funds it needed to operate in good faith.

In piecing cases, CEOs can face full liability for debts incurred at the corporate level. Theoretically, this is true even if the CEO did not personally participate in the conduct that gave rise to the liability. The CEO’s personal liability attaches not as a result of the underlying wrong, but as a result of the CEO’s failure to observe and respect the requirements for securing limited liability protection.

2. Personal Liability for Acts and Omissions Committed in the CEO’s Corporate Capacity

Even when piercing is not warranted, CEOs can still face personal liability if they commit certain wrongful acts in their corporate capacity. CEOs can also face criminal culpability for crimes committed in their corporate capacity (including crimes purportedly committed for or in the name of the company).

For example, this has come up multiple times recently in federal Paycheck Protection Program (PPP) loan fraud investigations. In these investigations, companies are facing penalties for fraudulently obtaining (or even just applying for) PPP loans during the pandemic. But, in many cases their CEOs are facing personal liability as well. Typically, this liability is the result of either (i) the CEO submitting a fraudulent PPP loan on the company’s behalf, or (ii) simply being at the helm of an organization that fraudulently applied for and/or obtained federally-backed funds from a financial institution.

In most cases, in order for a CEO to be held liable for an act or omission committed in the CEO’s corporate capacity, the act or omission must either:

  • Have been committed intentionally;
  • Constitute gross negligence;
  • Constitute a criminal act; or
  • Fall outside of the CEO’s actual or apparent authority.

In addition to federal law enforcement investigations, this type of liability exposure frequently arises in civil litigation (where plaintiffs will often pursue claims against multiple related parties and individuals) and in shareholder derivative cases. If a plaintiff or group of shareholders believe that a CEO is directly responsible for the company’s conduct or performance, then the CEO will need to engage his or her own defense counsel for the litigation.

3. Investigations and Litigation Targeting CEOs in Their Personal Capacity

The third main type of scenario in which CEOs will face personal liability for business noncompliance is when litigation or an investigation at the corporate level leads to scrutiny of the CEO’s conduct in his or her personal capacity. For example, if IRS-CI investigates a company for tax fraud and there is evidence to suggest that the CEO may have been embezzling funds or withholding income from his or her own returns, then the CEO could face an investigation as well.

What Can CEOs Do to Protect Themselves from Personal Liability?

Given the risk of facing personal liability, what can – and should – CEOs do to protect themselves? Just as CEOs need to manage their companies’ risk effectively, they need to manage their own risk as well. Similar to corporate risk mitigation strategies, CEOs’ risk mitigation strategies should focus on (i) understanding their risks, (ii) understanding what it takes to maintain compliance, (iii) purchasing adequate insurance coverage, and (iv) knowing what to do in the event that a liability risk arises.

  • Understanding CEOs’ Risks – Mitigating risk starts with understanding the risks that need to be mitigated. For CEOs, while some of these risks mirror those that exist at the corporate level, others do not. While CEOs don’t necessarily need to implement risk mitigation practices that are on par with those of their companies, they do need to ensure that they have a clear understanding of the acts and omissions that have the potential to lead to trouble.
  • Understanding and Maintaining Compliance – CEOs need to have a clear understanding of what it takes to maintain compliance in both their corporate and individual capacities. At the corporate level, this ensures that CEOs don’t make mistakes that have the potential to be classified as criminal, intentional, or grossly negligent conduct. At the individual level, this helps mitigate against the risk of facing personal liability as a follow-on to a corporate-level lawsuit or investigation.
  • Purchasing Insurance Coverage – CEOs can purchase directors and officers (D&O) liability insurance coverage to mitigate against the risk of facing personal financial responsibility for noncompliance. However, CEOs also need to understand the limitations of D&O coverage. Policies often exclude claims based on gross negligence or failure to exercise the duties of a CEO’s office in good faith—and this means that lawsuits often target allegations based on gross negligence and bad-faith conduct so that plaintiffs can seek damages beyond CEOs’ D&O policy limits.
  • Knowing How to Respond to Liability Risks – Finally, CEOs need to know how to respond to liability risks. Just as companies should have policies and procedures for responding to lawsuits and investigations, CEOs should have discussions with their personal legal counsel so that they know what to do when a claim or inquiry arises. While there is certainly the possibility that a reactive response could be too little too late, when coupled with the other mitigation strategies discussed above, acting quickly in response to a threat can help reduce the likelihood of facing a civil judgment and/or criminal charges.

Oberheiden P.C. © 2021

ARTICLE BY Dr. Nick Oberheiden of Oberheiden P.C.
For more articles on compliance, visit the NLR Corporate & Business Organizations Section.

“I Robot:” The SEC Evaluates the First Law of Robotics

One of the priorities announced in the 2021 Examination Priorities Report of the U.S. Securities and Exchange Commission’s Division of Examinations (“EXAMS”) is a review of robo-advisory firms that build client portfolios with exchange-traded funds (“ETF’s”) and mutual funds. EXAMS notes that these clients are almost entirely retail investors without investments large enough to support the costs of regular human investment advisers. EXAMS sees that the risks involved in these robo-advisor accounts pose particular issues, that retail clients may well not recognize.

Law of Robotics

Accordingly, it may help to reflect on the Laws of Robotics invented by that science fiction author Isaac Asimov (for “I Robot,” a short story in his 1950 collection), particularly the First Law:

A robot may not injure a human being or, through inaction, allow a human being to come to harm.

This “policy” undergirds the 2021 Examination Priorities Report’s focus on robo-advisors. EXAMS notes the following as matters of particular concern:

Investors may not understand the risks associated with specific investments; the risk profiles of mutual funds and of ETF’s vary widely, from diversified to concentrated, from simple to complex strategies. Robo-advisors have a fiduciary duty to provide adequate disclosure to investors and to insure that the information is understood.

Funds used in client accounts may not be suitable for the investor, again the robo-advisor has a fiduciary duty to know a client’s particular financial situation and investment goals. EXAMS notes that it will be checking on the bases for selecting investments, especially when niche or leveraged/inverse ETF’s are involved.

Full disclosure of any conflicts of interest are mandatory, noting the continuing enforcement actions for abuses in mutual fund investments involving higher cost fund shares.

The SEC Evaluates

Now is the time for compliance personnel to review all of the account opening documentation to ensure that relevant information about a client’s financial condition, investment objective, and time horizons are captured. Further, the firm brochure and websites should be carefully scrutinized to ensure that disclosures are written in plain English AND are robust. Then compliance personnel should review the process by which investments are recommended to ensure it adequately takes into account the client’s risk tolerance and investment objectives, and to be able to confirm that a recommended investment aligns with those factors, all of which should be documented.

The 2021 Examination Priorities Report makes clear that the Law invented by Isaac Asimov some 70 years ago equally applies to robo-advisory firms.

©2021 Norris McLaughlin P.A., All Rights Reserved
ARTICLE BY Peter D. Hutcheon of Norris McLaughlin P.A.
For more articles on the SEC, visit the NLR Securities & SEC section.

Oops: NASDAQ Seeks to Correct a 2009 Error Re: ADR Listing Requirements

On Wednesday, April 7, 2021, the U.S. Securities and Exchange Commission (“SEC”) issued Release No. 34-91492 publishing a Proposed Rule Change by NASDAQ to amend the requirements for listing ADRs on each of NASDAQ’s Global Select AND Global Markets.

American Depository Receipts

“ADRs” are American Depository Receipts. They have a long history in the U.S. capital markets, having been invented by J.P. Morgan in 1927 to facilitate access to the American stock market by Selfridges, an iconic British department store organized and managed by an American expatriate as the second-largest (after Harrod’s) department store in the UK in 1909 (and featured in a BBC TV series of that name about both the store and Mr. Selfridge). ADRs are depository receipts issued by an American bank when the underlying securities are deposited in a foreign depository bank. There are some interesting complexities about ADR’s depending on whether the ADR is a Level 1 ADR, or whether it is a Level 2 Sponsored ADR, which requires filing a separate registration statement with the SEC. And then there are Level 3 ADRs that require the foreign company to not only file a Form F-1 with the SEC but to adhere either to U.S. GAAP accounting standards OR IFRS as published in the IASB. The April 7 NASDAQ Proposal does not directly impact any of these ADR complexities.

Listing requirements are just that: the conditions a company must meet in order to have its securities traded on NASDAQ. NASDAQ has three market tiers: the Global Select Market, the Global Market, and the Capital Market. The Capital Market is the trading tier with the least stringent requirements for listing. The NASDAQ Global Market requires that the companies seeking to list on it must have some international attributes and substantially higher financial and governance features. The NASDAQ has the most rigorous listing requirements and is the tier for leading international companies.

NASDAQ Listing Requirements

Until 2009, NASDAQ required that at least 400,000 ADRs be issued in order to be listed on any of the three NASDAQ tiers, insure that there would be sufficient liquidity and “depth in the market” to support public trading. Then in 2009, as part of a “housekeeping,” NASDAQ moved the listing requirements for ADRs on the Global Market AND the Global Select Market to a new section of NASDAQ listing requirements that had NO minimum number of ADRs in order to be listed on those tiers. Ironically, the least restricted trading tier RETAINED the 400,000 ADR requirement. Recently, someone at NASDAQ noticed the disparity. Fortunately, NO issue with fewer than 400,000 ADRs has been listed on either the Global Select or Global Market tiers in the 12 years since 2009. Now, NASDAQ seeks to reimpose the 400,000 minimum ADR requirement for ALL NASDAQ tiers. As this proposed change to the listing requirements is a simple reinstatement of a condition accidentally omitted in the 2009 “housekeeping,” and as no present listing will be adversely affected, NASDAQ requested, and the SEC granted, a waiver of the normal 30-day period before a change might take effect.

While, as Alexander Pope wrote: “To err is human, to forgive, divine;” to correct may even be better.

©2021 Norris McLaughlin P.A., All Rights Reserved

ARTICLE BY Peter D. Hutcheon of Norris McLaughlin P.A.
For more articles on the SEC, visit the NLR Securities & SEC section.

SEC Ventures Into The Dark Web, But Can It Establish A Connection?

In March, the Securities and Exchange Commission announced its first securities enforcement action involving the “dark web”.  The SEC’s complaint describes the “dark web” as referring to “a subset of the deep web that is intentionally hidden, requiring specific software to access content”.   The SEC states that the “deep web” refers to “anything on the internet that is not indexed by, or accessible via, a search engine like Google”.

The SEC’s complaint alleges that the defendant “offered and sold on one of the dark web marketplaces various purported
‘insider tips’ that he falsely described as material, nonpublic information from the insider trading forum or corporate insiders”.  I found this interesting because the SEC wasn’t charging the defendant with insider trading but with selling false insider tips.  This may be fraudulent, but is it it a securities law violation?  Stock tips, whether false or true, are not themselves securities.  How does the SEC bring the defendant’s allegedly fraudulent conduct under the securities laws?

To establish a violation of Rule 10b-5, the SEC must prove that the defendant’s activities were “in connection with” the purchase or sale of a security.  Here, the defendant’s deception did not relate to securities that he sold to investors.  The SEC’s complaint attempts to connect the defendant’s activities to securities transactions by alleging  that traders paid for the tips using Bitcoin, and used the fake insider information to purchase and sell stock of various publicly traded companies.  In SEC v. Zandford, 535 U.S. 813 (2002), the U.S. Supreme Court found that the person deceived do not have to be counterparties to the person committing the fraud.  However, the defendant in this case might argue that his fraud was complete when he sold the false tips and therefore the SEC cannot establish the requisite connection.  I will be interested to learn whether this becomes a contested issue at trial.

© 2010-2020 Allen Matkins Leck Gamble Mallory & Natsis LLP

ARTICLE BY Keith Paul Bishop of Allen Matkins Leck Gamble Mallory & Natsis LLP
For more articles on the SEC, visit the NLR Securities & SEC section.

SEC Adopts Final Rules to Modernize Financial Disclosure Requirements

On November 19, 2020, the Securities and Exchange Commission (SEC) adopted final rules to update the core financial disclosure requirements of Regulation S-K – relating to Selected Financial Data, Supplementary Financial Information and Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) – to efficiently provide investors with material financial information and ease the compliance burden for registrants.1 As noted in our client alert on the proposed rules earlier this year, these final rules are part of the broader initiative by the SEC to modernize and simplify disclosure requirements.

Highlights of the rules include the following:

Eliminate Item 301 (Selected Financial Data)

  • Registrants will no longer be required to provide five years of selected financial data.

Simplify Item 302(a) (Supplementary Financial Information)

  • Replace the current requirement in Item 302(a) to provide two years of tabular selected quarterly financial data with a principles-based requirement for material retrospective changes.
  • Specifically, disclosure will only be required under Item 302(a) when there are one or more retrospective changes to the statements of comprehensive income for any of the quarters within the two most recent fiscal years or any subsequent interim periods for which financial statements are included or required to be included that are, individually or in the aggregate, material.

Restructure and Streamline Item 303 (MD&A) 

  • Add a new Item 303(a) to clarify the objective of MD&A and streamline the instructions.
    • The objective clarifies that the disclosure is to provide material information relevant to an assessment of the financial condition and results of operations of the registrant, including an evaluation of the amounts and certainty of cash flows from operations and from outside sources. The disclosure is expected to better allow investors to view the registrant from management’s perspective.
  • Amend current Item 303(a)(1) and (2) (amended Item 303(b)(1)) to enhance disclosure requirements for liquidity and capital resources.
    • The amended rules elicit enhanced analysis, by encouraging registrants to provide a more meaningful discussion of the reasons underlying material changes in line items (and discouraging registrants from simply reciting amounts of changes).
    • Registrants will need to provide material cash requirements, including commitments for capital expenditures, as of the latest fiscal period, the anticipated source of funds needed to satisfy such cash requirements, and the general purpose of such requirements.
  • Amend current Item 303(a)(3) (amended Item 303(b)(2)) to simplify disclosure requirements for results of operations.
    • Registrants will need to disclose known events that are reasonably likely to cause a material change in the relationship between costs and revenues, such as known or reasonably likely future increases in costs of labor or materials or price increases or inventory adjustments.
    • Registrants will also need to discuss material changes in net sales or revenue (as opposed to just material increases).
    • Although the specific disclosure requirement with respect to the impact of inflation and price changes (Item 303(a)(3)(iv)) will be eliminated, registrants will still be required to discuss these topics if they are part of a known trend or uncertainty that had, or is reasonably likely to have, a material impact on net sales, revenue, or income from continuing operations.
  • Add a new Item 303(b)(3) to clarify and codify SEC guidance on critical accounting estimates.
    • Registrants will also be required to disclose, to the extent that the information is material and reasonably available, how much an estimate and/or assumption has changed over a relevant period, and the sensitivity of the reported amount to the methods, assumptions and estimates underlying its calculation.
  • Replace current Item 303(a)(4) regarding off-balance sheet arrangements with an instruction to discuss such obligations in the broader context of MD&A.
    • Registrants will be required to discuss commitments or obligations, including contingent obligations, arising from arrangements with unconsolidated entities or persons that have, or are reasonably likely to have, a material current or future effect on the registrant’s financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, cash requirements, or capital resources even when the arrangement results in no obligation being reported in the registrant’s consolidated balance sheets.
  • Eliminate current Item 303(a)(5) regarding tabular disclosure of contractual obligations.
    • Registrants must still disclose material contractual obligations as part of an enhanced principles-based liquidity and capital resources requirement focused on material short- and long-term cash requirements from known contractual and other obligations.
  • Amend Instruction 4 to Item 303(a) (amended Item 303(b)) to clarify disclosure of material changes in line items.
    • Where there are material changes in a line item, including where material changes within a line item offset one another, registrants must disclose the underlying reasons for these material changes in quantitative and qualitative terms.
  • Amend current Item 303(b) (amended Item 303(c)) to allow for flexibility in the comparison of interim periods.
    • Registrants will be permitted to compare their most recently completed quarter to either the corresponding quarter of the prior year or to the immediately preceding quarter to provide a more tailored and meaningful analysis that is relevant to their specific business cycles.

What’s Next?

The final rules will become effective 30 days after they are published in the Federal Register, and registrants will be required to comply with the rules beginning with the first fiscal year ending on or after the date that is 210 days after such publication date. Following the effective date, however, registrants may provide disclosure consistent with the final amendments, as long as registrants provide disclosure responsive to an amended item in its entirety. For example, following the effective date, a registrant with a calendar year-end may omit disclosure to comply with Item 301 in its Annual Report on Form 10-K to be filed in early 2021, and may provide disclosure to comply with amended Item 303 in such report, if the registrant provides disclosure pursuant to each provision of amended Item 303 in its entirety in such report.

1 See “Management’s Discussion and Analysis, Selected Financial Data, and Supplementary Financial Information,” SEC Release No. 33-10890 (Nov. 19, 2020), available here.

Copyright © 2020 Womble Bond Dickinson (US) LLP All Rights Reserved.

SEC Proposes to Modernize Fund Shareholder Reports and Disclosures

The SEC has proposed modifications to the disclosure framework for mutual funds and exchange-traded funds (ETFs). The proposal sets forth a layered disclosure approach to highlight key information for retail investors. If adopted, the proposed modifications would:

  • require streamlined shareholder reports that would include fund expenses, performance, illustrations of holdings and material fund changes;
  • encourage the use of graphics or text features to promote effective communications; and
  • promote a layered and comprehensive disclosure framework by continuing to make available online certain information that is currently required in shareholder reports but may be less relevant to retail shareholders. Highlights from the proposal include the following: Tailored Shareholder Reports. Under proposed Rule 498B, new investors would receive a fund prospectus in connection with their initial investment, as they currently do, but funds would not deliver annual prospectus updates to shareholders thereafter.

Instead, funds would keep existing shareholders informed through streamlined annual and semi-annual reports, as well as timely notifications of material fund changes as they occur. Certain changes to a registration statement, such as updates to existing risk disclosures, may be deemed not to be material and therefore not subject to the timely notification requirements under proposed Rule 498B. Proposed Rule 498B would not prohibit a fund from continuing to satisfy its prospectus delivery obligations by delivering a copy of the summary prospectus and any supplements to the summary prospectus to existing shareholders. Current versions of the prospectus, which must include any material fund changes, would remain available online and would be delivered upon request in paper or electronically, consistent with the shareholder’s delivery preference. Funds would continue to be subject to the same prospectus and registration statement liability and anti-fraud provisions for fund documents required to be made available online but not required to be delivered to existing shareholders (the summary and statutory prospectus and information required to be incorporated into those documents). The proposal would require a fund company to prepare separate reports for each of its series but not for each class of a multi-class fund. The proposal also would provide additional flexibility for funds to add tools and features to annual reports that appear on their websites or are otherwise provided electronically. This could include video or audio messages, mouse-over windows, pop-up definitions, chat functionality and expense calculators. A link to a hypothetical streamlined shareholder report issued by the SEC in connection with the proposal is available here.

Availability of Information on Form N-CSR and Online. Information currently required in shareholder reports that is not included in the streamlined shareholder report would be available online, delivered free of charge upon request, and filed on a semi-annual basis with the SEC on Form N-CSR. Such information includes the schedule of investments and other financial statements, while a graphical representation of a fund’s holdings would be retained in the streamlined shareholder reports.

Exclusion of Open-End Funds from Scope of Rule 30e-3. The proposal would also amend the scope of Rule 30e3, the optional internet availability of shareholder reports, to exclude open-end funds. The proposal would not affect the availability of Rule 30e-3 for closed-end funds. The SEC’s rationale for narrowing the scope of this rule is based on its preliminary belief that the direct transmission of tailored reports represents a more effective means of improving investors’ access to and use of fund information, and reducing funds’ printing and mailing expenses, than allowing open-end funds to rely on Rule 30e-3.

Amended Prospectus Disclosure of Fund Fees and Risks. The proposal would amend prospectus disclosure requirements and related instructions to provide greater clarity and more consistent information regarding fees, expenses, and principal risks. The proposed amendments would: (1) replace the existing fee table in the summary section of the statutory prospectus with a simplified fee summary, (2) move the existing fee table to the statutory prospectus, and (3) replace certain terms in the current fee table with terms intended to be clearer to investors. The proposed amendments would also permit funds that make limited investments (up to 10% of net assets) in other funds to disclose acquired fund fees and expenses (AFFE) in a footnote to the fee table and summary instead of requiring AFFE to be presented as a line item in the table. The amendments would preclude a fund from disclosing non-principal risks in the prospectus. An additional new instruction would require that funds describe principal risks in order of importance, with the most significant risks appearing first, and tailor risk disclosure to how the fund operates rather than rely on generic, standard risk disclosures. Proposed instructions would also prohibit the presentation of principal risks in alphabetical order.

Fee and Expense Information in Investment Company Advertisements. The proposed amendments would require that presentations of investment company fees and expenses in advertisements and sales literature be consistent with relevant prospectus fee table presentations and reasonably current. The proposed amendments to the advertising rules would affect all registered investment companies and business development companies. The amendments would require fees and expenses in advertisements to include timely and prominent information about a fund’s maximum sales load (or any other non-recurring fee) and gross total annual expenses. Next Steps. The SEC has proposed an 18-month transition period. Accordingly, if adopted, the compliance date would be 18 months after the amendments’ effective date. Comments on the SEC’s proposal are due within 60 days after publication in the Federal Register.

Copyright © 2020 Godfrey & Kahn S.C.
For more artices on the SEC, visit the National Law Review Securities & SEC section.

SEC Publishes New Whistleblower Rules; Deadlines Impact Thousands of Cases

The Federal Register published the Whistleblower Program Rule changes approved by the U.S. Securities and Exchange Commission (“SEC” or “Commission”) on September 23, 2020. The changes published today not only impact the requirements governing the whistleblower program, but they establish new deadlines relevant to thousands of current or future cases.

While the effective date of the rules changes is listed as December 7, 2020, each rule’s applicability date should be examined as many are retroactive.

In Section III of the published rules, the SEC carefully explains the applicability of each provision. Highlighted below are rules that can impact pending cases.

Among the new deadlines established by the SEC are:

  • Rule 21F-4(e) defining “monetary sanctions.” This rule change will be applied retroactively and has a significant impact on the amount of an award a whistleblower may be entitled to under pending cases and in cases related to non-prosecution agreements. The rule applies “calculating any outstanding payments to be made to meritorious whistleblowers.” This means the rule covers all pending cases. It also covers sanctions obtained in cases resolved by non-prosecution agreements where the SEC never published a Notice of Covered Action.
  • Rule 21F-6 concerns the SEC’s discretion in small cases where sanctions obtained by the SEC are $5 million or less that rewards should be paid at the highest amount (i.e., 30% of sanctions obtained), barring the existence of negative factors that would justify a reduction. This rule applies to “all award claims still pending” on December 7, 2020. Thus, the applicability of this rule is retroactive.
  • Rule 21F-9 requires whistleblowers to file complaints using the TCR form to qualify for a reward. Whistleblowers have 30-days from an initial contact with the SEC to file the TCR. The 30-day requirement is tolled until a whistleblower obtains actual or constructive knowledge of the TCR filing requirement. However, the thirty day requirement can be triggered when a whistleblower hires an attorney to file a reward claim. This provision applies “to all award claims still pending” as of December 7, 2020, and all future filings. All persons contacting the SEC with information on potential violations need to be aware of this 30-day filing deadline, along with all attorneys who represent whistleblowers in SEC proceedings.
  • Rule 21F-13 relates to the administrative record on appeal of Whistleblower Award Applications. Under this rule, any WB-APP award application filed with the SEC after December 7, 2020, may not be supplemented. Therefore, whistleblowers must be careful to include the entire basis for an award claim in their WB-APP application. This rule applies “only to covered-action and related-action award applications that are connected to a Notice of Covered Action” posted on or after December 7, 2020.
  • Rule 21F-18 established a new summary disposition process. This rule applies to “any whistleblower award application for which the Commission has not yet issued a Preliminary Determination” as of December 7, 2020, as well as to any future award applications that might be filed. Therefore, this rule impacts pending reward claims.
  • Interpretive guidance on the meaning and application of the term “independent analysis” in Rule 21F-4. The SEC intends to rely on the principles articulated in the guidance for “any whistleblower claims that are still pending at any stage.” Thus, any person who has already filed a TCR complaint or a WB-APP application based on the “independent analysis” rules should examine this new guidance and determine whether they need to amend or supplement their filings.

The SEC whistleblower program has been extremely successful. As of today, the Commission has collected over $2 billion in sanctions from whistleblower cases, paid to harmed investors well over $750 million, and paid 112 whistleblowers over $719 million in rewards.

Copyright Kohn, Kohn & Colapinto, LLP 2020. All Rights Reserved.
For more articles on whistleblowers, visit the National Law Review Securities & SEC section.

SEC Adopts Final Rules Amending Its Whistleblower Program

On September 23, 2020, the U.S. Securities and Exchange Commission (SEC) voted 3-2 to pass the final rules amending its whistleblower program. The five following changes will have the most impact on SEC whistleblowers who report potential violations of securities law:

  1. Creation of a presumption in favor of awarding the maximum statutory award to whistleblowers who face a maximum potential award of $5 million or less;
  2. Providing for the SEC’s broad discretion in evaluating and applying award criteria, including explicitly the SEC’s consideration of dollar amounts of awards;
  3. Expanding the definition of successful enforcement actions to include deferred prosecution and non-prosecution agreements, as well as any settlement agreements that the SEC enters into outside of a formal proceeding;
  4. Limiting recovery from the program where a whistleblower may be able to recover from another program; and
  5. Revising the definition of whistleblower in light of Digital Realty Trust, Inc. v. Somers, 138 S. Ct. 767 (2018).

The details of these changes and their potential impact on whistleblowers are discussed in more detail below. In passing the rules, the SEC emphasized its intention “to provide greater transparency, efficiency and clarity to whistleblowers.”  Final Rules at 2. In implementing the final rules, some of which require greater clarity, the SEC should keep in mind these goals.

Background on the SEC Whistleblower Program

First established in 2010 under the Dodd-Frank Act, the SEC whistleblower program allows the Commission to award individuals who have provided the SEC original information about fraud and securities violations between 10% and 30% of the monetary sanctions recovered from a successful SEC enforcement action. The program has been very successful thus far. Since its inception, the SEC has obtained more than $2.5 billion in monetary sanctions as a result of whistleblower tips and has awarded approximately $521 million to 96 whistleblowers. In July 2018, the SEC voted 3-2 to propose amendments to the whistleblower program. Over two years later, the SEC passed the final rules, which largely adopt the proposed amendments with some important modifications. The new rules will take effect 30 days after publication in the Federal Register.

Changes to Whistleblower Award Payouts

The regulations implementing the SEC whistleblower program set criteria for determining the appropriate amount of an award under Rule 21F-6.[1]  These include factors that may increase the whistleblower’s award, such as the significance of the information provided by the whistleblower, the whistleblower’s level of assistance to the SEC and his or her participation in internal compliance systems,[2] and the extent to which the whistleblower’s information advanced law enforcement goals of the Commission. The regulations also allow the SEC to decrease an award based on various factors, such as the whistleblower’s level of culpability regarding the securities violations, whether the whistleblower unreasonably delayed reporting, and whether the whistleblower interfered in internal compliance systems.

In the final rules, the SEC voted not to pass one of the more controversial proposed amendments, which would have allowed the SEC to cap a total payout for any whistleblower award at $30 million based solely on the size of the award. Id. at 61-62. The proposal received numerous comments in opposition that argued that the rule would discourage whistleblowers from coming forward and that it would arbitrarily penalize whistleblowers. See id. at 60-61 (summarizing comments in opposition to the proposed amendment). Instead of adopting a bright line rule as initially proposed, the SEC instead modified language of Rule 21F-6. Id. at 48. The modified provision explicitly folds in consideration of the potential dollar amount of an award into the SEC’s analysis of award criteria. Id. at 48-49. The SEC framed this provision as a clarification of its broad discretion; however, whistleblowers and their advocates are left with little clarity. While not explicitly adopting the rule as proposed, the SEC instead has adopted a more expansive rule that would allow for discretionary downward adjustments of any award amount.

One significant positive change for whistleblowers was the SEC’s adoption of a presumption in favor of awarding the maximum statutory award of 30% of recovered proceeds to whistleblowers who are eligible to receive a maximum award of $5 million or less. The final rule benefits more whistleblowers than the proposed amendment, which would have allowed such a presumption for cases involving maximum awards of $2 million or less. The majority of whistleblowers, 75% according to the SEC’s data, will benefit from this new rule. Once the SEC determines that no negative factors exist, such as engaging in culpable conduct with regards to an internal compliance program or securities law, the presumption applies, and the whistleblower should receive the maximum award of 30%. Id. at 52-53. The new rule helps to streamline the awards process. It also represents a positive step towards encouraging more whistleblowers, especially those who may be concerned about jeopardizing their careers for relatively low potential awards, to come forward.

Final Rule Expanding “Successful Enforcement”

Another rule beneficial to whistleblowers is the expansion of the meaning of “successful enforcement.” Because whistleblowers cannot control the law enforcement mechanism chosen by the Department of Justice (DOJ) or the SEC, this new rule allows whistleblowers to collect awards should the DOJ or SEC choose to pursue specific types of enforcement actions; however, the final rule is narrower than the one initially proposed. Under the new final rule, “successful enforcement” includes deferred prosecution and non-prosecution agreements entered into by the DOJ in a criminal case and settlement agreements entered into by the SEC in actions outside of a judicial or administrative proceeding that involve violations of securities laws. Id. at 13-14, 17. Such actions would be deemed “administrative actions,” and any money recovered would be considered a “monetary sanction,” which would allow the whistleblower to recover a percentage of that monetary sanction. Id. The final rule eliminated the extension of “successful enforcement” to include deferred prosecution and non-prosecution agreements entered into by state attorneys general. Id. at 17. One commenter argued persuasively to the SEC that securities violations under state law may differ considerably from those under federal law and warned of inconsistency in determining whistleblowers’ eligibility across states. Id. at 20-21. While not as expansive as initially proposed, the rule nonetheless benefits whistleblowers who provide information that results in these specific forms of law enforcement action.

New Definition of “Related Action” and Its Limitations on Recovery

The final rule amends the definition of “related action,” which effectively limits recovery under the SEC program where the whistleblower is eligible to recover under a different whistleblower program in addition to the SEC’s. Prior to this rule, where another enforcement agency in addition to the SEC brings an action based on the information the whistleblower provided—a “related action” under the whistleblower program rules—the individual can also receive from the SEC whistleblower award fund a percentage of the other agency’s recovery. The new rule does not provide a bright line; rather, the SEC will evaluate the facts and circumstances of the action to determine whether the SEC whistleblower program has the “more direct or relevant connection to the action.” Id. at 43-44. The SEC was not persuaded by commenters who opposed the proposed amendment, including some who argued that the rule would undermine the program’s goal of encouraging whistleblowers to come forward. Id. at 41-43.

Changes to Definition of “Whistleblower Status” and Anti-Retaliation Provisions

The SEC adopted the new definition of “whistleblower” as proposed. The new definition, articulated in the Supreme Court case, Digital Realty Trust, Inc. v. Somers, 138 S. Ct. 767 (2018), confers “whistleblower status” to “(i) an individual (ii) who provides the Commission with information ‘in writing’ and only if (iii) the information relates to a possible violation of the federal securities law (including any law, rule, or regulation subject to the jurisdiction of the Commission) that has occurred, is ongoing, or is about to occur.” Id. at 65-66.

Under the new rule, anti-retaliation protections under the Dodd-Frank Act are available only if the individual first qualifies for “whistleblower status” by having reported the information to the SEC. This was the holding of Digital Realty. In its definition, the SEC goes farther than the Supreme Court, specifying that the information be presented to the Commission “in writing.”  The SEC justified the “in writing” requirement by noting it imposes “a minimal burden to individuals who want to report potential securities violations” and provides greater “efficiency and reliability” to the Commission in processing both internal and external reports of possible violations. Id. at 75-76. The SEC assured commenters who expressed concerns that this new definition would generate uncertainty for whistleblowers by noting that the “in writing” requirement “will be applied in a flexible manner to accommodate whistleblowers who make a good-faith effort to comply with our rules in seeking retaliation protection.” Id. at 79-80. Individuals who report securities violations only within their companies have no protection under Dodd-Frank. If an individual reports internally and then reports to the Commission in writing, then that individual is protected only for retaliation experienced after, but not before, the SEC report. Id. at 78.

Change to Reporting Requirements

The final rule concerning reporting requirements for award eligibility was modified in order to address commenters’ concerns that, in practice, an individual’s initial communication with the SEC does not typically meet those requirements. Id. at 94-97. The final rule requires that whistleblowers submit either a tip through the SEC’s online portal or a specific form, a Form TCR, by mail or fax to the SEC; however, recognizing that many individuals initially contact SEC officials informally prior to submitting a form, the SEC clarified that “an individual need not in the first instance provide original information to the Commission” through filing a specific form, though that individual must comply with the form reporting requirements within 30 days of first providing information to the SEC. Id. at 97. Consequently, an individual’s first contact with the SEC need not meet the form requirements, as long as the individual follows those requirements within 30 days. This modification relieves some fears generated by the initial proposal that whistleblowers would have been penalized for filing with the incorrect agency or making a procedural error in the initial report, or by contacting SEC enforcement staff before the Office of the Whistleblower.

While the final rules will not substantially hinder the progress of the program, some of the rules create additional hurdles for whistleblowers and leave some lingering questions about implementation in practice. The SEC should implement the rules consistently with the agency’s intentions in the rules’ passage, specifically to improve transparency, efficiency and clarity for whistleblowers. The SEC must keep the program’s ultimate goals in mind—to award whistleblowers who present meritorious claims because they provided information that led to enforcement actions, and to encourage future whistleblowers to come forward.

[1] See 17 C.F.R. § 240.21F-6.

[2] Notably, the final rules maintain that a whistleblower’s participation in internal compliance systems is one factor that the SEC considers in awarding an upward adjustment. Id. at 81.

Katz, Marshall & Banks, LLP
For more articles on the SEC,  visit the National Law Review Securities & SEC section.

SEC Adopts Expansion of “Accredited Investor” Definition

On August 26, 2020, the U.S. Securities & Exchange Commission (SEC) adopted amendments to Rule 501, Rule 144A and other related rules (the Amendments) to expand the definition of “accredited investor” under the Securities Act of 1933 (the Securities Act). The amendments were adopted largely as proposed and broaden the scope of natural persons and entities that may qualify to participate in private offerings of securities that are exempt from registration under the Securities Act.

In particular, the “accredited investor” designation will now include the following:

  • Natural persons holding certain professional certification and designations. The SEC will periodically issue orders designating those professional certificates, designations or credentials that, when held by a natural person, would qualify such person as an accredited investor. Contemporaneously with the Amendments, the SEC designated holders in good standing of the Series 7, Series 65 and Series 82 licenses as qualifying for accredited investor status. In evaluating additional professional designations for qualifying status, the SEC will consider a non-exhaustive list of attributes established by the Amendments.
  • “Knowledgeable Employees” of private funds as defined under the Investment Company Act, but only with respect to investment in such private fund. A Knowledgeable Employee’s spouse will also be considered an accredited investor with respect to joint investments in the private fund.
  • Certain enumerated entities, including:
    • federal- or state-registered investment advisers and exempt reporting advisers, regardless of the level of assets under management;
    • rural business investment companies (RBICs), as defined in Section 384A of the Consolidated Farm and Rural Development Act;
    • limited liability companies that have total assets in excess of $5 million and were not formed for the purpose of acquiring the securities offered1 ; and
    • any entity with at least $5 million in investments (as defined under the Investment Company Act of 1940) that has not been formed for the purpose of investing in the securities offered, in order to encompass entities such as Indian tribes, foreign entities and local government bodies that were not previously covered by Rule 501.
  • “Family offices” and their “family clients,” each as defined under the Advisers Act, provided the family office has at least $5 million in assets under management, was not formed for the purpose of acquiring the securities offered and was directed to make the investment by a person who has such knowledge and experience in financial and business matters such that the family office is capable of evaluating the merits and risks of the investments.

The Amendments would also clarify that spousal equivalents can pool finances when determining qualification as an accredited investor and update the definition of “qualified institutional buyer” under the Securities Act to conform with the new accredited investor definition.

The expansion of the accredited investor definition has many implications for asset managers, including updates to offering and subscription documents and questionnaires, consideration of expanded options for funding GP commitments via the expanded pool of knowledgeable employees and affiliated professionals and evaluation of fund-raising opportunities. Commissioners adopted the amendments on a 3-2 vote, with commenters disagreeing with the SEC’s decision not to index the wealth thresholds, which were initially adopted in 1982, for inflation.

The Amendments will go effective 60 days after publication in the Federal Register.

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1 While Rule 501 did not explicitly include LLCs meeting these requirements prior to the Amendments, the SEC historically has taken the position that such LLCs qualify as accredited investors.

© 2020 Vedder Price
ARTICLE BY Robert M. Crea, Joseph M. Mannon, and Adam S. Goldman of Vedder Price.
For more SEC news, visit the National Law Review Securities, SEC, & Financial Institution Law News section.