September One-Minute Reads
California climate bills to be signed into law
This month, The Associated Press reported that California Gov. Gavin Newsom plans to sign into law a pair of far-reaching climate disclosure bills that will impact many large US companies, regardless of where they are based.
The first bill – SB 253 – will require public and private companies that have more than $1 billion in annual revenues and qualify as "doing business" in California to publicly disclose their greenhouse gas (GHG) emissions beginning in 2026. Businesses would have to report their own emissions from operations and energy use (Scopes 1 and 2) beginning in 2026, and their indirect emissions from supply chains, contractors and consumer use of their products (Scope 3) beginning in 2027. Importantly, because Scope 3 reporting will be required, many companies with revenues well below $1 billion that are not directly subject to the reporting obligations should expect to come under additional pressure from their customers and vendors to calculate and produce GHG emissions data. Under the final bill, Scopes 1 and 2 emissions disclosures will require independent third-party assurance, while more limited third-party assurance for Scope 3 emissions will be required in 2030.
The second bill – SB 261 – will require public and private companies that have more than $500 million in annual revenues and qualify as "doing business" in California to prepare reports disclosing their climate-related financial risk in accordance with the Task Force on Climate-Related Financial Disclosures (TCFD) framework and describe their measures adopted to reduce and adapt to that risk. This requirement will begin on January 1, 2026, and will continue biennially thereafter.
Notably, while these bills are poised to be adopted as the Securities and Exchange Commission (SEC) is still preparing the final version of its own climate disclosure rules, it is likely that once the initial SEC disclosures are adopted, they will apply to large accelerated filers for fiscal year 2024. As a result, for those companies, SEC disclosures may be due in 2025, a year in advance of California’s reporting obligations. For more information, including on differences between the California bills and the SEC’s proposed rules, see this September 2023 client alert and this September 2023 PubCo post.
Corp Fin issues new C&DIs on Rule 10b5-1 plans
On August 25, 2023, the SEC Division of Corporation Finance (Corp Fin) posted several new Compliance and Disclosure Interpretations (C&DIs) related to the final rules regarding Rule 10b5-1 plans that were adopted by the SEC in December 2022. The final rules impose new conditions on the availability of the Rule 10b5-1 affirmative defense and require enhanced disclosures regarding Rule 10b5-1 plans, option grants and insider trading policies, while also adding a checkbox to Forms 4 and 5 to indicate whether a transaction is made pursuant to a plan that is “intended to satisfy the affirmative defense conditions” of Rule 10b5-1(c). For more information on the final rules, refer to this December 2022 client alert and this January 2023 PubCo post.
The new C&DIs address the calculation of the mandated cooling-off period triggered by entering into or materially modifying a plan, overlapping plans involving 401(k) plans, the new Form 4 checkbox, and disclosures about adoption and termination of trading arrangements under Item 408(a) of Reg S-K. In brief:
- Question 120.29 clarifies that for purposes of the “later of” cooling-off period applicable to directors and Section 16 officers, the date of disclosure of the issuer’s financial results is the filing date of the relevant Form 10-Q or Form 10-K, and the first business day would be the next business day that follows the filing date.
- Question 120.30 addresses a scenario where an administrator of a 401(k) plan uses issuer cash advances to purchase stock in the open market to make matching grants to plan participants, clarifying that a participant that relies on Rule 10b5-1 to participate in the 401(k) plan also can rely on Rule 10b5-1 for a concurrent plan for purchases or sales on the open market without running afoul of the restriction on overlapping plans.
- Question 120.31 explicitly states that the Rule 10b5-1(c) checkbox in Form 4 should not be checked for trades pursuant to 10b5-1 plans adopted prior to the final rules.
- Question 133A.01 clarifies that Item 408(a)(1) does not require disclosure of the termination of a plan that ends by its own terms due to its expiration or completion.
- Question 133A.02 confirms that Item 408(a) picks up any 10b5-1 trading arrangement or non-10b5-1 trading arrangement in which an officer or director has a direct or indirect pecuniary interest that is reportable under Section 16, provided that the officer or director made the decision to adopt or terminate the arrangement.
For additional information, refer to this August 2023 PubCo post.
SEC finds Form 12b-25 disclosures inadequate
On August 22, 2023, the SEC announced settled charges against five companies for failing to disclose in their Form 12b-25 filings that their request to delay quarterly or annual reporting was caused by an anticipated restatement or correction to prior financial reporting. Filing a Form12b-25 “Notification of Late Filing” is required of public companies when they are unable to file a periodic report within the prescribed time period without unreasonable effort or expense and are seeking additional time to file the applicable report in order for such report to be considered “timely.” When filing this form, companies are required to disclose why their quarterly or annual report could not be filed on time, in addition to revealing any anticipated significant changes in results of operations from the corresponding period of the prior fiscal year.
The SEC orders found that each of the five companies announced restatements or corrections to their financial reporting shortly after the Form 12b-25 filing, within a range of three days to three weeks, despite failing to disclose that anticipated restatements or corrections were among the principal reasons for their late filings. The orders also found that the companies failed to disclose that management anticipated significant changes in results of operations from the prior fiscal year. These actions serve as a reminder that companies filing a Form 12b-25 should take special care to ensure their disclosures in the form address these requirements. For more information, refer to this August 2023 PubCo post.
Massachusetts case cautions careful preparation of disclosures regarding pending litigation
A recent case from the US District Court for the District of Massachusetts serves as a cautionary tale to companies making public statements about the merits or prospects of pending litigation. In this example, a securities fraud class action case was brought against Pegasystems based on statements made by the company regarding pending litigation against it. In the prior litigation, a competitor filed a complaint against Pega for $3 billion, after which the company described the litigation in its Form 10-K, stating that the claims were “without merit,” the company had “strong defenses to these claims” and “any alleged damages claimed by [the competitor] are not supported by the necessary legal standard.”
Pega subsequently lost the case and was ordered to pay $2 billion in damages, leading to a claim of fraud against the company for the Form 10-K disclosure. The court highlighted in the finding for the plaintiffs the difference between stating that a claim is “without merit” and “a mere statement that Pega had legal defenses against those claims.” The court continued to say that “this does not mean that Pega was under the obligation to ‘confess to the wrongdoing’” in its disclosure, as an “issuer may legitimately oppose a claim against it, even when it possesses subjective knowledge that the facts underlying the claims against it are true,” but continued to state that issuers “must do so with exceptional care, so as not to mislead investors.” For more information, see this August 2023 PubCo post.
SEC enforcement focuses on related party transaction disclosure
The SEC recently settled two enforcement actions that indicate the staff is closely analyzing disclosures regarding related party transactions. In the first action, the SEC announced charges against Maximus for failing to disclose that it employed two siblings of one of its executive officers, for which the company agreed to pay a $500,000 penalty.
In the second action, the SEC announced charges against Lyft for failing to disclose a director’s role in a shareholder’s sale of approximately $424 million in private shares of Lyft’s stock before the company’s initial public offering. According to the SEC’s press release, before Lyft’s IPO in March 2019, “a Lyft board director arranged for a shareholder to sell [their] shares to a [SPV] set up by an investment adviser affiliated with the same director.” According to the SEC, that same director then “contacted an investor interested in purchasing the shares through the SPV,” and Lyft was a “participant in the transaction” by virtue of approving the sale and securing several terms in the contract. The director also “received millions of dollars in compensation from the investment advisory for his role in structuring and negotiating the deal,” which Lyft failed to disclose in its Form 10-K in 2019. To settle these charges, Lyft agreed to pay a $10 million penalty. Given the enhanced scrutiny around these types of disclosures, companies should carefully consider all potential related party transactions to ensure compliance with Item 404 of Regulation S-K. For more information, refer to this September 2023 PubCo post.
SEC brings another enforcement action for discouraging whistleblowing
On September 21, 2023, the SEC charged CBRE for violating an SEC whistleblower protection rule. According to the SEC, CBRE was using an employee release form that allegedly violated the rule, as “CBRE took action to impede potential whistleblowers from reporting complaints to the Commission” by “conditioning separation pay on employees’ signing the release” form. This case should remind companies to precisely draft relevant provisions in their separation agreements to ensure they do not run afoul of the SEC’s whistleblower rules. See this September 2023 PubCo post for more information.
FASB approves expanded tax disclosure requirements and adopts crypto accounting and disclosure rule
On August 30, 2023, The Wall Street Journal reported that the Financial Accounting Standards Board (FASB) had approved new standards to require companies to disclose more details about the income taxes they pay to government authorities. Under the new standard, both public and private companies will be required to break out income taxes that were paid to authorities at the federal, state and foreign levels for the full year in annual financial reports. If a jurisdiction represents more than 5% of the taxes for the year, businesses will need to identify that jurisdiction and specify the amount in their annual reports. Public companies also will be required to:
- Disclose detail on how they reconcile their domestic statutory rate with the rate they actually paid.
- Present a standardized table showing how categories such as state and local income taxes, foreign taxes, tax credits and the enactment of new tax laws contribute to the difference between the two rates by providing the percentages and dollar amounts.
The requirements are set to go into effect for public companies beginning with their 2025 annual reports and for private companies one year later. The FASB expects to formally issue the new standard by the end of 2023.
On September 6, 2023, the WSJ also reported that the FASB adopted the first crypto accounting and disclosure rule for companies. Under this new standard, companies will be required to use fair-value accounting for bitcoin and certain other crypto assets. This is a change companies were calling for, as it will allow them to recognize losses and gains immediately and treat digital assets like some financial assets. Public company financial statements will have to disclose crypto assets on a quarterly and annual basis, while private companies must do the same in whichever financial reports they compile. Gains and losses on crypto assets also will now have to be included by companies in their net income. The rule is set to go into effect for 2025 annual reports for calendar-year public and private companies. The FASB expects to formally issue the new rule by the end of 2023.
Foreign private issuers to potentially become subject to Section 16
Section 6081 of the new National Defense Authorization Act for Fiscal Year 2024 would amend Section 16(a)(1) of the Exchange Act to make insiders of foreign private issuers (FPIs) subject to Section 16. In effect, the amendment would eliminate the longstanding exemption from Section 16 set forth in Exchange Act Rule 3a12-3 applicable to securities registered by FPIs and would subject insiders (i.e., directors, executive officers and greater than 10% shareholders) of FPIs to report their ownership and transactions in the securities of the FPI, in addition to insiders becoming subject to the short-swing profit provisions of Section 16 of the Exchange Act. In July 2023, the bill passed the House (H.R. 2670) and then passed the Senate with amendments (S. 2226). The provision that would repeal the Section 16 exemption for FPIs is not yet law, and both the House and Senate will have to resolve their differences before the bill reaches the president for signature. If enacted, the SEC will have to first propose, then adopt, rules to repeal the Section 16 exemption granted to FPIs within 90 days of enactment.
Another sweep? SEC charges multiple companies and insiders with untimely reporting under Sections 16 and 13(d)
On September 27, 2023, the SEC announced charges against six officers, directors and major shareholders of public companies for failing to timely report information about their holdings and transactions in company stock on Form 4 and Schedules 13D and 13G. Five publicly traded companies also were charged for contributing to the filing failures by insiders or for failing to report their insiders’ filing delinquencies. Using data analytics, SEC staff identified the insiders charged as “repeatedly filing these reports late.” Those charged were assessed penalties ranging from $66,000 to $200,000. In commenting on these cases, SEC Director of Enforcement Gurbir Grewal said, “These enforcement actions also make clear that we will not hesitate to charge companies for causing their insiders’ disclosure violations where the companies took on the responsibility for making relevant filings for their insiders, and then acted negligently.” According to the deputy enforcement director, “Several years ago, we undertook a similar initiative to root out repeated late filers. Today’s enforcement action should serve to remind SEC filers that reporting obligations under the securities laws are not optional, and there are consequences for failing to file required forms in a timely manner.” The SEC’s announcement referenced an ongoing investigation of potential beneficial ownership violations.
Potential government shutdown looms
On September 27, 2023, the SEC’s Corp Fin posted an announcement regarding its plans in the event of a federal government shutdown, which indicates that its activities would be “extremely limited.” According to the announcement, although the Electronic Data Gathering, Analysis, and Retrieval (EDGAR) system would continue to operate and accept filings, Corp Fin “will not be able to accelerate the effectiveness of registration statements.” In light of the uncertainty, Corp Fin suggests that “registrants with pending registration or offering statements that are substantially complete, and that have met all statutory requirements to request acceleration of the effective date (including the dissemination of any draft registration statement for the required periods under Securities Act Section 6(e) or the related Division accommodations) or qualification, may want to consider requesting effectiveness or qualification while the Division continues its normal operations.”
Corp Fin has posted a series of FAQs primarily addressing companies in the registration process (or contemplating offerings) but potentially caught in the shutdown, in addition to FAQs about shareholder proposals and guidance. Corp Fin plans to post updates on operating status on the SEC’s website.