Federal Securities Lawyer & Attorney : Porter Wright Law Firm : Securities Exchange Law : Serving Ohio, Washington DC, Florida

SEC Commissioners will meet on Monday to consider implementation of a plan to require companies to file financial statement information in an interactive format known as XBRL (extensible business reporting language).

XBRL or data tagging is the process of identifying accounting principals with unique data tags that allow financial statements to be easily downloaded into various applications for quick comparisons over time and across industries. Currently more than 70 companies voluntarily disclose financial information using XBRL in an SEC pilot program, and at least 20 mutual funds voluntarily submit risk/return summaries from their prospectuses in XBRL.

Mandatory XBRL reporting is predicted to take several years to implement while the SEC deals with the following questions/concerns:

• XBRL is predicted to increase transparency and usability of financial information, but what will it cost companies to comply?
  
• What liability should result if financial information is improperly “tagged” and therefore mistakenly misleading? Should XBRL documents be considered “furnished” rather than “filed” during a phase-in period?
  
• How much time will auditing and finance professionals need to learn the new system? The SEC’s Advisory Committee on Improvements to Financial Reporting has suggested the SEC wait three years.
  

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Earlier this week the US Department of Treasury released its self-commissioned study, the “Blueprint for a Modernized Financial Regulatory Structure.” In part in response to the current financial crises of lenders and investment banks, the Department of Treasury has proposed an overhaul of the way the federal government regulates securities, banks, investment banks, and the various services they offer.

One theme of the Blueprint is to give more power to the Federal Reserve, especially in the context of regulating banks and investment banks. Some commentators are predicting that investment banks will eventually have to fully report all direct and indirect holdings of securities, including the amount and the basic characteristics.

The Blueprint is unclear on whether increased power for the Federal Reserve means decreased power for the SEC, but some are predicting as much. What is clear is that the Blueprint calls for some significant changes to how the SEC operates, including the following:

• Create “core principles” to apply to securities clearing agencies and exchanges;
• Make it easier for securities products to be approved;
• Expand registration of investment companies, including registration of new “global” investment companies; and,
• the most significant: merge with the Commodity Futures Trading Commission

Most politicians predict the Blueprint will not become law and even Treasury Secretary Henry Paulson has called it “aspirational.”

Interestingly, the Blueprint calls for increased regulation across the board—presumably because market participants have failed to regulate themselves in the form of how they value their assets and liabilities—and at the same time calls for streamlining the rule-making process of self-regulatory organizations to allow US markets to remain competitive worldwide.

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Effective February 4, 2008, smaller reporting companies may begin preparing their SEC reports and registration statements using the same forms as other SEC reporting companies but with scaled disclosure requirements. Eventually, there will be no special “small business” forms such as Forms 10-KSB and SB-2.

Companies qualify as a smaller reporting company if they:

1. have a common equity public float of less than $75 million or
2. are unable to calculate their public float and have annual revenue of $50 million or less.

Public float is calculated as of the last business day of the second fiscal quarter.

Companies with a public float between $25 million and $75 million would not have qualified as “small businesses” under the old rules, but can now choose to alternate between the disclosure requirements of smaller reporting companies and other companies, with some limitations.

Note the following key differences in disclosure obligations:

• Smaller reporting companies do not have to disclose risk factors;
• Smaller reporting companies need only provide two years of analysis and financial statements, as opposed to three years, in their Management Discussion & Analysis; and
• Smaller reporting companies need only provide 3 of the 7 compensation tables in their proxy statement.
  

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In an effort stop identity theft and intrusions into online brokerage accounts, the SEC has proposed amendments to Regulation S-P to provide more specific requirements for protecting personal information. Regulation S-P requires certain institutions to safeguard customer records and information. It was adopted in 2000 in direct response to the Gramm-Leach-Bliley Act, which requires every financial institution to inform its customers about its privacy policies and imposes limits on the disclosure of personal customer information to third parties.

The proposed amendments to Regulation S-P create more specific requirements for protecting information and responding to security breaches, including requiring financial institutions to designate which employees coordinate information security programs. The amendments also broaden the scope of the disposal of customer records and information and the requirements for such disposal. The SEC has specifically requested comment on what should be considered “personal information.”

Finally, the amendments permit some transfer of information to third parties without notice to the investor when the investor follows a representative who moves from one brokerage or advisory firm to another. The proposed exemption would allow firms with departing representatives to share limited customer information with the new firm for use in contacting the investor and offering a choice about whether to follow the representative to the new firm. The proposal is presented as a way of maximizing choice for the investor.

The SEC is accepting comments for 60 days from publication. Presumably some comments will address what the new rules mean in terms of the costs of compliance.

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The Securities and Exchange Commission (“SEC”) recently adopted certain rule amendments mandating that the information required to be filed on Form D under the Securities Act of 1933 (“Form D”) be filed electronically through the internet.  The information required by Form D will be filed electronically with the SEC through a new online filing system that will be accessible from any computer with Internet access and the data filed will be available on the SEC’s web site.  In addition, the amendments revised Regulation D promulgated under the Securities Act of 1933 and Form D to simplify and restructure Form D and update the information required by Form D.

View Final Rule

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The SEC has recently released a Small Entity Compliance Guide to assist "small businesses" with the transition to reporting as "smaller reporting companies." As previously discussed, the S-B disclosure rules will be eliminated, as well as the small business forms, and small businesses will be required to comply with specific requirements for "smaller reporting companies" in Regulation S-K.  A copy of the Guide is attached.

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As the 2008 proxy season gets started, many companies are choosing whether to take advantage of the SEC's new e-proxy rules, which allow for the electronic delivery of proxy materials. As the attached Porter Wright Law Alert explains, the new rules are not without their disadvantages.

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Last week the SEC released its final rules for the registration of securities on Form S-3 and F-3 registration statements. The amendments will allow a larger number of public companies to take advantage of the flexible requirements of Form S-3 and F-3 when registering securities for sale.

Form S-3 is the “short form” used to register securities offerings under the Securities Act of 1933, and Form F-3 is the equivalent form used by foreign private issuers. Perhaps the greatest benefit of Form S-3 is that it allows companies to rely on filings under the Securities Act of 1934 to satisfy the form's disclosure requirements. Previously, a company could not take advantage of Form S-3 unless its public float (non-affiliate equity market capitalization) was at least $75 million; however, the amendments eliminate the public float requirement if other requirements are met, including having a class of securities listed on a national exchange and not selling more than the equivalent of one-third of the company’s public float in any 12-month period.

Like almost all SEC rules, the goal of Forms S-3 and F-3 is to strike a balance between investor protection and the ease with which issuers can bring their securities to market. In relaxing the requirements of Form S-3 and F-3, the SEC has evidently decided that the benefits of Form S-3 and F-3 can be expanded to a larger number of public companies without sacrificing investor protection.

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The SEC has promised to react faster and more efficiently to information provided by self-regulating organizations concerning insider trading. The promise follows a critical report of the SEC conducted by the Government Accountability Office, the investigative arm of Congress.

For over 70 years the SEC has shared its investigative powers regarding securities trading irregularities with self-regulating organizations such as FINRA (formerly NASD) and NYSE Regulation). These SROs enforce their own rules against market participants and tip off the SEC when they believe federal law has been violated. According to the GAO, however, the SEC has been slow to react to such tips. The biggest criticism in the GAO report is that the SEC does not have electronic access to the referrals from the SROs and therefore cannot electronically search referral information.

The SEC promises improvements for 2008.

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The SEC has released the final language for certain amendments to Rule 144. Rule 144 is the SEC rule that allows a seller of securities to determine if it is an underwriter. This determination is important because anyone deemed not to be an issuer, underwriter, or dealer has an exemption from the federal law requirement that the sale of securities must be registered.

The new Rule 144 shortens the holding period requirement for the sale of restricted securities, reduces the restrictions applicable to the resale of securities by non-affiliates, and increases certain ownership thresholds that affect how many restricted securities can be sold.

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The commissioners of the SEC have decided by a vote of 3-1 to restate the Commission’s view that companies can exclude proposals to allow shareholder director nominees on the company’s proxy statement.

As previously discussed here under the heading, SEC shareholder Access Proposals, the SEC was considering two conflicting proposals on the matter. Proposal 1 was to strengthen the language of the relevant rule (Rule 14a-8(i)(8)) because of a Second Circuit decision that said the language did not mean what the SEC said it meant. Proposal 2 was to scrap the former rules and allow for shareholder director nominees to appear on the company’s proxy statement.

By way of background, shareholders have a state law right to nominate and elect directors; they just can’t use the company’s proxy statement to solicit votes for their candidates. The SEC believes the philosophy of the proxy statement is in conflict if two competing parties (the company and a rogue shareholder) can use the same document (the company’s proxy statement) to solicit proxies for competing nominees for director.

The SEC, after receiving 34,000 comment letters, has decided to proceed toward Proposal 1. Several investor groups have disapproved, including the influential RiskMetrics (ISS).

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The SEC has unanimously approved several new rules that will have a direct effect on the disclosure obligations of small businesses and their ability to raise capital. As previously discussed, the new rules do the following:

• Replace the current “small business issuer” category with a new “smaller reporting companies” category (defined as having less than $75 million in public equity float or revenues less than $50 million if public equity float is not calculable) and continue to require less disclosure and reporting requirements for small businesses;
• Move certain disclosure items into Regulation S-K and allow “smaller reporting companies” to elect to comply with the scaled down version of each item on an item-by-item basis;
• Eliminate all “SB” forms, but allow a phase-out period;
• Permit all foreign companies to qualify as “smaller reporting companies” if they choose to file on domestic company forms and provide financial statements prepared in accordance with GAAP;
• Shorten the holding period for restricted securities of reporting companies to six months;
• Simplify Rule 144 compliance by allowing non-affiliates of reporting companies to resell restricted securities after 6 months and allowing non-affiliates of non-reporting companies to resell after 12 months;
• Raise the thresholds that trigger Form 144 filing requirements; and
• Eliminate the presumptive underwriter provision of Rule 145, except with respect to transactions involving blank check or shell companies.
  

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The SEC announced today that Japan, China, Korea, Canada, Israel, and Australia are all on board with implementing interactive data requirements for financial reporting. SEC Chairman Christopher Cox recently met with representatives from the countries to discuss data tagging of financial reports using XBRL (Extensible Business Reporting Language).

Data tagging of financial materials is the process of identifying accounting principals with unique data tags that allow financial statements to be easily downloaded into various applications for quick comparisons over time and across industries.

Japan is requiring public companies to use XBRL data tags for financials beginning the second quarter of 2008. China and Korea already require XBRL reporting in some contexts. Australia, Canada, and Israel have plans for interactive data by 2010. No word yet on when the SEC will require data tags, but the Commission has allowed voluntary interactive financial data for over two years.

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The SEC announced last week that the development of “data tags” for U.S. generally accepted accounting principals will soon allow investors and analysts to download financial reports filed with the SEC directly into spreadsheets in Excel. This will allow for instant financial comparisons across entire industries.

Financial reports of public companies are housed in a publicly-accessible SEC database called EDGAR (Electronic Data Gathering, Analysis, and Retrieval system), but the data is not interactive. The newly created data tags correspond to each unique accounting concept. Now that each accounting concept has been tagged, companies can more easily tag their financials and use the tagged information.

The SEC has allowed for the filing of financial reports in interactive data format for over two years. It seems likely that some day such interactive filings will be required to allow for investors and analysts to make sophisticated comparisons.

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Several news outlets are reporting the release of over 300 letters from the SEC to U.S. companies requesting more information on executive compensation. There have been murmurs from the SEC for months that these requests would be coming, along with a report due out this Fall that will detail lackluster executive compensation disclosure from the most recent proxy season. The following represents a composite of some of the SEC’s requests:

• Why was the chief executive’s pay “significantly higher” than the rest of the company’s highest-paid executives?
• How does the company target each element of compensation against other companies used to benchmark executive pay?
• Provide analysis about how you determine the amount and formula for each element of pay.
• Provide analysis of why you paid each level and form of compensation.

Some commentators are suggesting the SEC’s waive of comment letters is not over and is a response to overly-conservative interpretations of new disclosure requirements. Generally, letters are made public 45 days after correspondence with a company is closed.

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Our latest Securities Law Alert provides an update on why issuers and executives need to carefully review insider trading compliance programs and Rule 10b5-1 trading plans.

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On July 17, 2007, the Securities and Exchange Commission created the Advisory Committee on Improvements to Financial Reporting. The overall purpose of the Advisory Committee is to review and analyze the U.S. financial reporting system to provide recommendations regarding reducing needless complexity and how the system could become more useful to investors. 

Now, the Advisory Committee is seeking comments on its discussion paper, which outlines various issues that it proposes to consider. The outline includes the following five key areas of consideration: 

1. The causes and effect of complexity on financial accounting and reporting standards;
2. The standard setting process, which includes GAAP, the characteristics of the Financial Accounting Standards Board and the Board selection process, interpretive guidance by the Emerging Issues Task Force, the SEC and others, and possible changes to the cost-benefit analysis practices of various organizations;
3. The existing process of regulating accounting and reporting standards compliance and other factors that result in needless complexity;
4. The vehicles that companies use to convey financial information to investors and the systems available to investors for accessing such information; and
5. The various international accounting standards and whether such standards should be integrated into the U.S. financial reporting system.

Comments should be submitted within 30 days after publication in the Federal Register. Click here for information on how and where comments may be submitted.

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The SEC believes that the global capital markets and investors could benefit from globally accepted accounting standards, and is therefore considering permitting U.S. issuers to prepare financial statements in accordance with International Financial Reporting Standards, as opposed to generally accepted accounting principles as used in the United States.

In its concept release, the SEC explains its long-standing desire to minimize disparity between the U.S. accounting and disclosure methods and those of other countries. Minimizing such disparity may encourage and facilitate expansion of capital markets across borders while simultaneously affording sufficient disclosure to protect investors.

Currently, the Financial Accounting Standards Board and the International Accounting Standards Board are working together toward converging U.S. and international accounting standards. The SEC acknowledges the risk that each Board may slow convergence efforts if U.S. issuers are permitted to use International Financial Reporting Standards to prepare financial statements. This is just one of the many considerations the SEC is seeking comment on in its concept release.

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The SEC has released two conflicting proposals regarding shareholder access to proxy statements. The SEC has been considering different versions of increased shareholder access to proxy statements for several years, but it was last year’s Second Circuit decision in American Federation of State, County, and Municipal Employees, Employees Pension Plan v. American International Group, Inc. (462 F. 3d 121) that has driven the recent wave of activity.

By way of background, shareholders have a state law right to nominate and elect directors; they just can’t use the company’s proxy statement to solicit votes for their candidates. The SEC believes the philosophy of the proxy statement is in conflict if two competing parties (the company and a rogue shareholder) can use the same document (the company’s proxy statement) to solicit proxies for competing nominees for director.

Instead, the proxy rules contemplate a separate proxy statement for shareholders who want to nominate directors. And, just to make sure these shareholders don’t get onto the company’s proxy through a backdoor, there is a specific rule (14a-8(i)(8)) that allows the company to exclude shareholder proposals that relate to the election of the board.

The Second Circuit disrupted this system in the AIG case when it ruled that AIG could not rely on Rule 14a-8(i)(8) to exclude a shareholder proposal aimed at direct election of directors. The shareholder proposal was for an amendment to the AIG bylaws that would allow for a procedure under which AIG would be required to include shareholder nominated directors in its proxy materials.

The SEC is worried that this ruling allows a shareholder to get nominees on the company proxy without having to disclose all the information that would be required if the shareholder would have to produce its own proxy statement. Hence the two proposed changes to the proxy rules:

Proposal (1) is an affront to the AIG decision. It would amend Rule 14a-8(i)(8) in hopes of allowing it to exist essentially the way it did before the AIG decision. Of course, a court could always disagree that the amendment has this effect.

Proposal (2) embraces the AIG decision, in that it would allow for shareholder director nominees to appear on the company’s proxy statement; however, there are significant caveats. For example, only shareholders who have been 5% holders for the previous year would be permitted to propose bylaw amendments in the company’s proxy, and they would first need to file a more-detailed Schedule 13G disclosing their background and interactions with the company. And, a shareholder that nominates a director must also disclose the same type of information that would currently be required in a separate proxy, such as basic information about the nominating shareholder and the nominee. Nominating shareholders will have the burden of providing this information to the company and will be liable for any fraud that goes along with this information.

Proposal (1) is an attempt to preserve the status quo despite the Second Circuit’s ruling in the AIG case. Proposal (2) is a whole new system. Both proposals are sure to produce significant comments and discussion. 

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The SEC has released the language of amendments to the proxy rules that will require issuers and other soliciting persons to post proxy materials online. As posted earlier here, under the new rules, issuers have two options for making proxy materials available to shareholders:

(1) Post proxy materials on an Internet Web site and send a notice to shareholders that materials are online at least 40 days before the shareholders’ meeting. Shareholders can still request hard copies, including a permanent request for paper or e-mail copies for all meetings.

(2) Post proxy materials on an Internet Web site, send a notice to shareholders that materials are online, and still deliver a hard copy of materials to each shareholder.

Neither option is exclusive. After posting the materials online, the issuer may submit just the notice to some shareholders and the notice plus the hard copy to other shareholders.

Finally, the issuer must provide shareholders with a method to execute proxies as of the time the notice is first sent to shareholders. Some had worried this would mean issuers have to establish an Internet voting platform. The SEC has assured issuers that this requirement can be satisfied through a variety of methods, including an Internet voting platform, a toll-free telephone number for voting, or a printable or downloadable proxy card on the Web site. Interestingly, a toll-free telephone number for voting may appear on the Web site, but not the notice, because it would allow a shareholder to vote a proxy without having access to the proxy statement.

The new rules are effective for Large Accelerated Filers on January 1, 2008, and other filers and persons soliciting proxy materials on January 1, 2009.

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Yesterday, the Securities and Exchange Commission approved PCAOB Auditing Standard No. 5, which, together with the SEC’s new guidance on internal control over financial reporting, will allow Section 404 audits to be scaled appropriately in light of a particular company’s size and complexity.

Auditing Standard No. 5 replaces Auditing Standard No. 2, An Audit of Internal Control Over Financial Reporting Performed in Conjunction with an Audit of Financial Statements. 

In addition to its scalability, Auditing Standard No. 5 includes various improvements, including the following:

• There exists fewer mandatory requirements, which will allow auditors to use their best judgment to determine when certain tests should be performed;
• It narrows auditors’ focus on high-risk areas, and thus, allows auditors to closely examine deficiencies that my constitute a “material weakness”; and
• It emphasizes a principles-based approach, which will allow auditors to use their best judgment in determining the extent to which they can rely on another person’s work.

Audits conducted for fiscal year ending on or after November 15, 2007 will be required to utilize Auditing Standard No. 5.

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As reported here, Whole Foods founder and CEO John Mackey admitted yesterday to anonymously posting messages about Whole Foods and its rival, Wild Oats, on Yahoo’s stock forum. This revelation comes following a Federal Trade Commission suit to stop a pending merger between Whole Foods and Wild Oats over antitrust concerns.

Several reports have indicated the SEC is conducting its own investigation into whether Mackey violated securities laws with the postings. The mere use of a pseudonym on a website by a company’s CEO is not a violation of securities laws; however, the securities laws are implicated if the postings are used to selectively disclose material non-public information in violation of Regulation FD or to commit fraud. Professor J. Robert Brown of the University of Denver Sturm College of Law offers further explanation here regarding potential violations by Mackey.

Brown concludes that any Reg. FD violation will depend on (a) whether the information disclosed was material, (b) whether Whole Foods knew about it and failed to disclose the information to the entire market, and (c) whether posting on a forum accessible by the entire market is selective disclosure. It will be difficult to prove a Reg. FD violation on these facts.

And, Brown asserts any allegation of fraud will depend on showing Mackey made materially false or incomplete statements. This will be difficult to show because statements made by an unidentified contributor to a message board are likely not considered material by a reasonable investor.

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Several news outlets have recently reported that the SEC is circulating a plan to allow 5% shareholders to propose bylaw amendments aimed at nominating directors on the company’s proxy ballot. The goal is direct proxy-ballot access by shareholders. How such a proposal would work is unclear. Presumably, a 5% holder would propose a bylaw amendment that would allow shareholders of an unknown percentage to nominate candidates on the company’s proxy ballot. If the bylaw amendment were approved by a majority of shareholders, direct shareholder access to the company’s ballot would be achieved.

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Issuers that are not required to file periodic reports under the Exchange Act may soon be able to exempt compensatory employee stock options from registration. The SEC has proposed amendments to Exchange Act Rule 12h-1 that would allow private, non-reporting issuers to take advantage of an exemption for compensatory employee stock options issued under employee stock option plans.

Private, non-reporting issuers use compensatory employee stock options to attract and reward employees of all levels. But, if an issuer has more than 500 holders of record of a class of equity securities, such as stock options, and assets in excess of $10 million, it must register the class or qualify for an exemption. The new rules provide an exemption for compensatory employee stock options. 

Comments to the proposed amendments must be received by the SEC by September 10, 2007.

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Today is the first day that companies are permitted to send a Notice of Internet Availability of Proxy Materials to its shareholders. Earlier this year, the SEC amended the proxy rules to provide for a “notice and access” model, which permits publicly traded companies to send a notice to shareholders indicating the Internet website where the companies’ proxy materials are available in lieu of sending hard copies of the proxy materials to every shareholder. 

As we reported on June 23, 2007, the SEC has adopted mandatory e-proxy rules, which will soon require companies to make their proxy materials available to shareholders on an Internet website. Large accelerated filers (excluding registered investment companies) must comply with the amendments starting January 1, 2008 and registered investment companies, soliciting persons other than issuers, and issuers that are not large accelerated filers must comply with the amendments starting January 1, 2009.

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In a move that is expected to ease filing burdens for small businesses in particular, the SEC announced today proposed amendments to Regulation D and Form D. The most significant is that Form D—the form used by issuers to report offerings of securities without registration under the Securities Act—must be filed electronically, and paper submissions will no longer be accepted.

The SEC has officially been considering electronic filing of Form D since 1998, but the inquiry into electronic filing stalled over concerns that it might be burdensome to force small businesses to file Form D using the SEC’s EDGAR filing system. The SEC’s description of the proposed amendments, however, states that Form D will be filed through a new filing system accessible by any computer with internet access. Issuers will file by providing information in electronic data fields in response to a series of questions. The SEC promises clearer and simpler questions, streamlined informational requirements, and an electronic database of Form D information available to regulators and the public. 

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The SEC recently announced that it has adopted amendments to the proxy rules, which will require companies to make their proxy materials available to shareholders on an Internet website. Large accelerated filers (excluding registered investment companies) must comply with the amendments starting January 1, 2008 and registered investment companies, soliciting persons other than issuers, and issuers that are not large accelerated filers must comply with the amendments starting January 1, 2009.

Companies and other soliciting persons may choose one of two options in order to provide shareholders with proxy materials: (1) the “notice only option”; or (2) the “full set delivery option.”

The “notice only option” requires companies to send a Notice of Internet Availability of Proxy Materials to its shareholders 40 calendar days or more in advance of a meeting. Notably, no other materials (including a proxy card) may be sent with the Notice, except for the notice of a shareholder meeting required by state corporation law. The “notice only option” also requires all proxy materials to be posted on a specified Internet website (other than EDGAR) by the time the company sends the Notice to shareholders. Under this option, companies are required, upon request from a shareholder, to deliver a hard copy of all proxy materials, at no charge to the requesting shareholder.

Under the “full set delivery option,” a company may continue to deliver its proxy materials to shareholders the traditional way - by sending them a hard copy of the materials. Two requirements, however, have been added to this option: (1) the company must provide the same information required in a Notice of Internet Availability of Proxy Materials with the proxy materials or in a separate notice; and (2) the company must post the proxy materials on a specified Internet website (other than EDGAR).

The amendments to the proxy rules do not apply to business combination transactions.

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The SEC voted Wednesday to strengthen Rule 105 of Regulation M in an effort to prevent manipulation of the offering prices of securities. The SEC press release is available here. Specifically, the SEC wants to combat traders who sell short prior to the pricing of an offering and then cover the short position with shares bought at a reduced offering price.

Selling short is a bet that the price of a particular security will decrease. A trader sells short by borrowing a specific security and selling it. If the price then goes down, the trader buys the amount of securities it initially borrowed and profits off the difference between the price on the date of sale and the price on the date of purchase.

The old Rule 105 prohibited using shares obtained in an offering to cover a short position taken in the restricted period before the pricing of the offering. The new rule prohibits purchasing an offered security if the trader took a short position in the restricted period prior to pricing the offering. In the words of the SEC, “the amended rule changes the prohibited activity from covering to purchasing the offered security.”

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Yesterday, the SEC released its guidance regarding management’s report on internal control over financial reporting, and made clear that an evaluation in compliance with the guidance is one way to satisfy the Exchange Act Rules 13a-15 and 15d-15 evaluation requirements. As we reported on May 24, 2007, the guidance is meant to provide a principles-based framework to help public companies strengthen internal control over financial reporting without needless costs, which will particularly benefit small companies.

If you are interested in reviewing the actual text of the rule amendments, the SEC has also posted its adopting release. In addition to providing that a company which complies with the interpretive guidance in evaluating its internal control over financial reporting satisfies the Exchange Act Rules 13a-15 and 15d-15 evaluation requirements, the amendments provide for the following:

• a definition for the term “material weakness”;
• the elimination of the requirement that auditors attest to management’s evaluation process; and
• the requirement for an auditor’s single opinion on the effectiveness of internal control over financial reporting in its attestation report.

With one exception, the effective date of the rule amendments is August 27, 2007.

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The SEC has proposed several new measures to allow small businesses greater access to new capital and to ensure less-burdensome reporting requirements. These new measures include:

1. A new, simpler disclosure regime for what will be known as “smaller reporting companies.” This new regime will apply to companies with up to a $75 million public float and will replace the rules that currently apply to “Small Businesses” and require SB Forms. Smaller reporting companies will instead comply with applicable provisions of Regulation S-K.
2. Shelf registration for companies with a public float below $75 million. This new rule would allow smaller public companies that timely file their SEC reports but otherwise don’t meet current public float requirements to have the flexibility of shelf registration.
3. A new category of securities purchasers who are exempt from registration. This amendment establishes a new Rule 507 of Regulation D which allows no registration and limited advertising for sales of securities to “qualified purchasers.” Also built into the rule are inflation adjustments for investors who currently qualify as “accredited.”
4. Shortened holding periods under Rule 144. These shortened periods allow for faster resale of restricted securities for a more efficient use of capital. There is also a proposal to allow insiders to satisfy their Form 144 requirements by filing a Form 4.
5. New exemptions from registration of compensatory employee stock options. This would ensure that registration requirements are not triggered by option granting practices alone.
6. Finally, electronic filing of Form D, the form by which companies disclose securities transactions that are exempt from registration. Electronic filing would presumably allow for simpler reporting and review of exempt securities transactions.

Comments on the proposed amendments are due within 60 days of publication in the Federal Register.

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The SEC recently released new telephone interpretations on Section 16 of the Securities Exchange Act and related rules and forms. The new guidance replaces the Section 16 interpretations in the July 1997 Manual of Publicly Available Telephone Interpretations, the March 1999 Supplement to the Manual, the Section 16 Electronic Reporting Frequently Asked Questions, and the November 2002 Sarbanes-Oxley Act Frequently Asked Questions.

Two issues that arise fairly frequently are highlighted in questions 102.02 and 133.08 of the Guidance. Question 102.02 highlights the fact that when filing a Form 4 or Form 5, the insider need only report ownership for all classes of equity securities for which there was a transaction. The issue arises because Section 16(a)(3)(B) of the Exchange Act states that Forms 4 and 5 “shall indicate ownership by the filing person at the date of filing.” This language led some to wonder whether ownership of all classes of securities must be reported with every filing, regardless of whether there was a transaction for every class. The SEC says “no.” 

Question 133.08 highlights an important issue for brokers reporting their clients’ sales to the securities lawyers. When a sale is executed in increments at different prices on the same day, the number of securities sold at each price must be reported. The SEC states, “It is not acceptable to report the aggregate number of securities and a weighted average price.”

Several other specific situations and questions are detailed in the Guidance.

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As we reported on May 2, 2007, the SEC has been analyzing Section 404 of the Sarbanes-Oxley Act and rules promulgated thereunder in connection with developing interpretive guidance to assist management in creating a process for evaluating internal controls over financial reporting. The SEC was particularly interested in providing guidance that would enable public companies of all sizes to tailor their internal control procedures appropriately, in an effort to reduce needless costs, especially for smaller companies.

Yesterday, the SEC approved such guidance, which provides a principles-based framework to help public companies strengthen internal control over financial reporting without needless costs. Smaller companies in particular should benefit from the scalability of the guidance. 

The SEC also amended its rules to provide for the following:

• a company that complies with the interpretive guidance in evaluating its internal controls satisfies the annual evaluation required by Rules 13a-15 and 15d-15 of the Securities Exchange Act of 1934;
• a definition for the term “material weakness”;
• the elimination of the requirement that auditors attest to management’s evaluation process; and
• the requirement for an auditor’s single opinion on the effectiveness of internal control over financial reporting in its attestation report.

The guidance and rule amendments will be effective 30 days from their publication in the Federal Registrar.

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You may review the agenda here and view the webcast here. Also, if you are interested in the SEC’s briefing paper on the roundtable, click here.

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The SEC is holding its Roundtable on the Federal Proxy Rules and State Corporation Law today. Topics include:

1. the federal role in upholding shareholders' state law rights;
2. the purpose and effect of the federal proxy rules;
3. non-binding proposals under the proxy rules; and
4. binding proposals under the proxy rules.

Panelists include:

• Stephen Bainbridge (UCLA School of Law)
• R. Franklin Balotti (Richards, Layton & Finger, P.A.)
• John C. Coffee (Columbia Law School)
• Richard J. Daly (BroadRidge Financial Solutions, Inc.)
• Jill E. Fisch (Fordham University School of Law)
• Amy L. Goodman (Gibson, Dunn & Crutcher LLP)
• Joseph A. Grundfest (Stanford Law School)
• James J. Hanks, Jr. (Venable LLP)
• Stanley Keller (Edwards Angell Palmer & Dodge LLP)
• Cary Klafter (Intel Corporation)
• Stephen P. Lamb (Court of Chancery of the State of Delaware)
• Donald C. Langevoort (Georgetown University Law Center)
• Paul M. Neuhauser (University of Iowa College of Law)
• Larry E. Ribstein (University of Illinois College of Law)
• Roberta Romano (Yale Law School)
• Leo E. Strine, Jr. (Court of Chancery of the State of Delaware)
• William Underhill (Slaughter and May)
• Ted White (Knight Vinke Asset Management)
• John C. Wilcox (TIAA-CREF)
• Ann Yerger (Council of Institutional Investors)

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According to testimony given by SEC Chairman Christopher Cox before the Senate Committee on Small Business & Entrepreneurship on April 18, 2006, the SEC is currently in the midst of a “critical time for small businesses” as it finalizes its analysis of Section 404 of the Sarbanes-Oxley Act of 2002 in the coming weeks.

Section 404 of SOX requires the SEC to prescribe rules mandating that:

• Management of a publicly-traded company must disclose their own conclusions about the effectiveness of their internal control structure and procedures for financial reporting; and
• A publicly-traded company’s independent registered public accounting firm must attest to, and report on, management’s assessment.

The SEC complied with this rule-making requirement by creating rules that applied to all issuers, including small businesses; however, implementation for small businesses was delayed due to concerns over the cost of developing procedures to identify, test, and analyze the effectiveness of controls. In the past year the SEC has continued to analyze potential reforms of Section 404 implementation, specifically with regard to small businesses.

Proposed interpretative guidance to assist management in developing a process for evaluating internal controls is no longer open to public comment, and according to Commissioner Cox, the SEC is currently working to provide guidance in time for companies and auditors to use in connection with annual reports to be filed in 2008. Commentators have expressed concerns that the current principles-based SEC guidance is not in line with restrictive auditing standards proposed by the PCAOB. Both organizations are attempting to reconcile the discrepancies.

The SEC rule adopted in December 2006 continues to permit companies with a public float of $75 million or less to postpone their first 404 audit until March 2009 (for calendar year end companies).  

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As recently reported in our firm’s Securities Law Alert, safe harbor Rule 10b5-1 trading plans for executives may no longer be safe. Linda Chatman Thomsen, Director of the SEC’s Division of Enforcement, recently warned that the SEC is “looking at” trading conducted under Rule 10b5-1 plans by company executives, and looking at those trades “hard.” Ms. Thomsen further declared that “[w]e want to make sure that people are not doing here what they were doing with stock options. If executives are in fact trading on inside information and using a plan for cover, they should expect the ‘safe harbor’ to provide no defense.” 

In light of the SEC’s recent focus on Rule 10b5-1 plans, it would be prudent for companies and executives to examine such plans and any trades made thereunder to preserve executives’ affirmative defense to insider trading charges.

Click here for the full text of the Securities Law Alert.

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The SEC has amended Rule 146 under Section 18 of the Securities Act of 1933 to include securities listed on the Nasdaq Capital Market or NCM (previously known as the Nasdaq SmallCap Market) in the category of “covered securities.” Covered Securities are only subject to federal registration requirements and are therefore exempt from state blue sky registration requirements.

The inclusion of securities on the NCM as covered securities is expected to make it easier for Nasdaq to compete for listings with other markets whose securities are exempt from state registration. The recent amendments should also reduce registration costs for issuers listing on the NCM.

Covered Securities are defined in Section 18 to include securities listed on the New York Stock Exchange, the American Stock Exchange, the National Market System of the Nasdaq Stock Market (now known as the Nasdaq Global Market), and any other national securities exchange with similar listing standards as determined by the SEC.

With these most recent amendments to Rule 146, the SEC has determined that national exchanges with similar listing standards include (i) Tier I of the NYSE Arca, Inc.; (ii) Tier I of the Philadelphia Stock Exchange, Inc.; (iii) the Chicago Board Options Exchange, Incorporated; (iv) options listed on the International Securities Exchange, LLC; and (v) the NCM. The amendments are effective May 24, 2007.

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