Monthly Archives: April 2022

Statement by Commissioner Peirce on In the Matter of Lloyd D. Reed

Hester M. Peirce is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on her recent public statement. The views expressed in this post are those of Ms. Peirce and do not necessarily reflect those of the Securities and Exchange Commission or its staff.

The Commission’s Order finds that Lloyd D. Reed violated Exchange Act Section 10(b) and its accompanying Rule 10b-5 “by trading on material, non-public information [of Torotel, Inc.] in breach of his duty of trust and confidence owed to his business partner (“Business Partner”), who was also a Torotel director and family member.” [1] In other words, the case is based on the misappropriation theory of insider trading: Reed’s Business Partner shared with him material, non-public information about Torotel with the expectation that Reed would keep that information confidential, and Reed misappropriated that information by trading on it in breach of his duty to his Business Partner to keep the information confidential. The Order’s next line, however, states: “Reed purchased Torotel stock in July and August 2019 based on information Business Partner gave him about Torotel’s plans to seek a business combination and after observing Business Partner’s increased activities with Torotel.” (emphasis added). Undoubtedly, that a company is considering a business combination generally would constitute material, non-public information about that company. But when and how one’s observations of what someone else is doing for a company constitute material, non-public information about the company is considerably less clear.

The Order explicitly identifies two instances when Reed’s Business Partner passed Torotel’s material, non-public information to him. First, in February 2015, his Business Partner, who at that time had been hired by Torotel to analyze its business, gave Reed a copy of the resulting thirteen-page report and recommendations. In the Order’s telling, the 2015 Report included an “analysis . . . [of] additional investments to prepare the company for sale in the future” and “recommendations about preparation for a possible sale of Torotel.” Second, “on August 5, 2019, Business Partner sent Reed an email . . . about a potential Torotel merger [which] referenced the internal pseudonym for Torotel’s search for bidders and identified a document summarizing the bids Torotel had received.” A gap of four years and six months separated the date his Business Partner shared a report that recommended, among a number of other options, the possibility of a merger from the date his Business Partner sent him an e-mail that indicated Torotel was in fact pursuing a merger.


The SEC’s Proposed Climate-Related Disclosure Rules: Thoughts for Audit Committees

David M. Silk is partner, Carmen X. W. Lu is counsel, and Ram Sachs is an associate at Wachtell, Lipton, Rosen & Katz. This post is based on their Wachtell memorandum.

Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance by Lucian A. Bebchuk and Roberto Tallarita (discussed on the Forum here); For Whom Corporate Leaders Bargain by Lucian A. Bebchuk, Kobi Kastiel, and Roberto Tallarita (discussed on the Forum here); Restoration: The Role Stakeholder Governance Must Play in Recreating a Fair and Sustainable American Economy—A Reply to Professor Rock by Leo E. Strine, Jr. (discussed on the Forum here); Stakeholder Capitalism in the Time of COVID, by Lucian Bebchuk, Kobi Kastiel, and Roberto Tallarita (discussed on the Forum here); and Corporate Purpose and Corporate Competition (discussed on the Forum here) by Mark J. Roe.

The SEC’s proposed amendments to Regulations S‑K and S‑X to require new climate-related disclosures will, if adopted, require an expansion in the scope and responsibilities of audit committees. As described in our prior memo, the rules contemplate domestic and foreign issuers disclosing, in registration statements, annual reports and audited financial statements, information on board and management climate-related risk oversight and governance, material climate-related risks and opportunities over the short-, medium- and long-term, Scopes 1 and 2 greenhouse gas (GHG) emissions, impact of climate-related events on line items of audited financial statements, and climate-related targets, goals and transition plans (if any). Accelerated and large accelerated issuers will also be required to provide third-party attestation on their Scopes 1 and 2, and in certain cases Scope 3, emissions over time.

While the SEC’s proposed rules are drawn from the recommendations of the Task Force on Climate-Related Financial Disclosures (TCFD) and the Greenhouse Gas Protocol, elements of the proposed rules are more prescriptive and expansive in nature and will require expanded oversight by audit committees. In particular, the requirement for climate-related line items in audited financial statements will come within the scope of a registrant’s internal control over financial reporting (ICFR). Climate-related disclosures within registration statements, including information filed in annual reports and incorporated by reference, will also be subject to liability provisions under the Securities Act of 1933 and will not be afforded protections under the forward-looking safe harbors pursuant to the Private Securities Litigation Reform Act. Additionally, all public climate-related disclosures are subject to the liability provisions of Section 10(b) and Rule 10b-5 of the Securities and Exchange Act of 1934. The fact that climate disclosures will need to be prepared within the 10‑K filing window may also warrant additional forward-planning, including drawing upon and enhancing existing internal processes used for financial and ESG-related reporting.


SEC Proposes Short Sale Disclosure Rules

Brian Breheny and Raquel Fox are partners and James Rapp is counsel at Skadden, Arps, Slate, Meagher & Flom LLP. This post is based on their Skadden memorandum.

On February 25, 2022, the U.S. Securities and Exchange Commission (SEC) announced that it unanimously voted to approve proposed changes requiring certain institutional investment managers [1] (managers) to report short sale-related information to the SEC.

Proposed Rule 13f-2 under the Securities Exchange Act of 1934 (Exchange Act) would require managers exercising investment discretion over short positions exceeding certain thresholds to file with the SEC, on a nonpublic basis, new Form SHO to report certain information relating to month-end short positions and certain related daily activity. The SEC would then take the details provided in Form SHO and publish aggregate information on large short positions related to individual equity securities and net activity during the applicable month. This information is intended to supplement the current short sale transaction information provided by major U.S. stock exchanges and the Financial Industry Regulatory Agency (FINRA).

Ultimately, Proposed Rule 13f-2 seeks to address Congress’ directive under Section 929X of the Dodd-Frank Act to provide more transparency of short selling. SEC Chairman Gary Gensler stated that Proposed Rule 13f-2 “would strengthen transparency of an important area of our markets that would benefit from greater visibility and oversight.” If adopted, this new rule will make significant changes to short selling disclosure obligations for managers in the SEC’s effort to provide more insight on large short sellers’ behavior and mitigate stock price manipulation during times of irregular market volatility. Key aspects of the proposed changes are described in further detail below.


Post-Doctoral Corporate Governance Fellowships For Finance, Economics, and Accounting Researchers

The Program on Corporate Governance at Harvard Law School (HLS) is seeking applications for Corporate Governance Fellowships from highly qualified candidates with graduate training in finance, economics, or accounting.

Applications are considered on a rolling basis, and the start date is flexible. Appointments are for one year but the appointment period can be extended for additional one-year period/s (contingent on business needs and funding as are other Program positions).

Candidates should have completed a Ph.D., or a substantial part of their work towards it, in finance, economics, or accounting, have significant experience in empirical research, and have an interest in corporate governance.

During the term of their appointment, Fellows will be in residence at HLS. They will be required to devote part of their time to work on research projects of the Program, depending on their skills, interests, and Program needs. Fellows will also be able to spend significant time on their own projects. The position will provide a competitive fellowship salary and Harvard University benefits.

Interested candidates should submit a CV, graduate program transcripts, any research papers they have written, and a cover letter to the coordinator of the Program, Ms. Marzieh Noori, at [email protected]. The cover letter should describe the candidate’s experience, reasons for seeking the position, career plans, and the period during which they would like to work with the Program.

Five Questions Boards Should Ask About the War in Ukraine

Matteo Tonello is Managing Director of ESG Research at The Conference Board, Inc. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance (discussed on the Forum here) and Will Corporations Deliver Value to All Stakeholders?, both by Lucian A. Bebchuk and Roberto Tallarita; and For Whom Corporate Leaders Bargain (discussed on the Forum here) and Stakeholder Capitalism in the Time of COVID, both by Lucian Bebchuk, Kobi Kastiel, and Roberto Tallarita (discussed on the Forum here).

While still recovering from the disruptions of the global pandemic, many companies find themselves grappling with a new and, for the most part, unanticipated emergency. Russia’s invasion of Ukraine requires business leaders to remain in crisis-management mode. Many commentators suggest that what we are witnessing is only the beginning of a new, precarious period of reconfiguration of the world order, with unclear economic and political implications. Whether or not it is true, at this stage of the crisis the main role of the board is to exercise oversight by asking probing questions to ensure the company is planning for multiple scenarios, reducing uncertainty, and adapting its business strategy.

The following are five key probing questions board members should consider posing.

1) What is the business impact of the war?

Directors should ask for management’s view of the immediate business impact of the invasion, including macro concerns such as rising inflation and impaired economic growth, as well as more specific issues pertaining to the safety of employees in the region, the resilience of supply chains, and legal or compliance issues regarding terminated or defaulted contracts with customers or suppliers in Russia or Ukraine. Special attention must be paid to the impact of measures swiftly introduced by many governments, including the US, to sanction Russian banks, state-owned enterprises, and oligarchs and to control exports from Russia. These measures are meant to impair the country’s economic growth by “isolating it from the global financial system” and by curtailing “its access to cutting-edge technology.” [1]

In an interconnected global economy, however, sanctions also have unintended consequences on US businesses operating in Russia or relying on Russian suppliers. In fact, either because of the sanctions or because they have decided to avoid the reputation risks of their continued presence in the country, hundreds of public companies—from the financial services to the consumer discretionary sectors—have announced their decision to suspend business operations in Russia or halt relationships with Russian suppliers. [2] For many Western firms, what was an enticing emerging market at the end of the Cold War may have suddenly become a major balance sheet liability. The boards of companies with an exposure to Russia should request periodic reports from management on the magnitude of this situation and work with the senior leadership on the appropriate mitigation strategy.


SEC Proposes Rules Enhancing Cybersecurity Disclosures

Zachary L. Cochran, Zachary J. Davis and Elizabeth Morgan are partners at King & Spalding LLP. This post is based on a King & Spalding memorandum by Mr. Cochran, Mr. Davis, Ms. Morgan, and William Johnson.

On March 9, 2022, the Securities and Exchange Commission (SEC) proposed rules intended to enhance and standardize public company disclosures regarding cybersecurity risk management, strategy, governance, and incident reporting. [1] The proposed rules accomplish these objectives through specific, mandated disclosure requirements applicable to all companies in a manner designed to enhance comparability across issuers and industries. If adopted, the proposed rules would supplement existing SEC guidance on cybersecurity disclosure requirements for public companies. [2] Comments on the proposed rules are due by the later of May 9, 2022 and the date 30 days after publication of the proposed rules in the Federal Register.

Disclosure Concerning Cybersecurity Incidents

Form 8-K Disclosure of Material Cybersecurity Incidents

In its proposing release, the SEC stated that cybersecurity incident disclosure was inconsistent notwithstanding the SEC’s existing guidance. In particular, the SEC noted that some incidents were reported in the media but were not disclosed by the affected companies in their periodic filings and that the nature of disclosures, when made, varied widely. [3]


EU Taxonomy and the Future of Reporting

Holly Pettingale is Director and Stéphane de Maupeou and Peter Reilly are Senior Directors at FTI Consulting. This post is based on an FTI Consulting memorandum by Ms. Pettingale, Mr. de Maupeou, Mr. Reilly, and Joel Kuenzer. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance (discussed on the Forum here) and Will Corporations Deliver Value to All Stakeholders?, both by Lucian A. Bebchuk and Roberto Tallarita; and For Whom Corporate Leaders Bargain (discussed on the Forum here) and Stakeholder Capitalism in the Time of COVID, both by Lucian Bebchuk, Kobi Kastiel, and Roberto Tallarita (discussed on the Forum here).

While the period up to 2018 was marked by an absence of ESG and sustainability focused regulatory pressure, in the period since, there have been efforts across the globe to ensure investors, financiers and companies pursue more sustainable business practices. At the forefront of those efforts has been the EU, which is seeking to become the ‘first climate-neutral continent’. [1] A core component of those efforts is the EU Taxonomy (the ‘Taxonomy’) [2], which is part of a suite of wider regulation of market participants, including the Sustainable Finance Disclosure Regulation (SFDR) [3] and the Corporate Sustainability Reporting Directive (CSRD). [4]

Corporates have, over the past two years in particular, made significant strides to respond to investor and regulatory pressure on ESG reporting. From 2022, however, that pressure is likely to ramp up further, with a number of regulations being adopted or coming into effect. Among them, the Taxonomy will attempt to, for the first time, determine what is and what is not ‘green’. While some companies will remain outside of those designations over the short-term, the Taxonomy is the starting point for the development of the regulatory labelling of businesses—and their activities—as ‘green friendly’ or ‘green hostile’. In the face of what is likely to be an ever-more regulated aspect of corporate reporting, all companies should be looking at these latest steps to evaluate business activities and be prepared to report against more demanding regulations in the period ahead.

As a starting point, we attempt to set out a path for all companies, with activities within or outside of the Taxonomy’s current scope.


The Promise and Perils of Open Finance

Joshua Macey is an Assistant Professor of Law at the University of Chicago Law School. Dan Awrey is a Professor of Law at Cornell Law School. This post is based on their recent paper, forthcoming in the Yale Journal on Regulation.

Open Finance seeks to harness the potential of new platform technology to enhance customer data access, sharing, portability, and interoperability—thereby leveling the informational playing field and fostering greater competition between incumbent financial institutions and a new breed of fintech disruptors. In the eyes of its proponents, this competition will yield a radical restructuring of the financial services industry: offering more and better choices for consumers looking to make fast payments, borrow money, invest their savings, manage household budgets, and compare financial products and services.

The promise of Open Finance is very real. Yet the shift toward Open Finance will force financial institutions and policymakers to confront a host of thorny technical challenges. Paramount amongst these challenges is ensuring that consumers give informed consent to the collection, transfer, and use of their personal information. Once this consent has been obtained, it is also imperative that consumers are adequately protected against the risk of data breaches, identity theft, and cyber-fraud. By the same token, for all the potential benefits of using new technology to promote greater competition, there exists the corresponding threat that expanding access to large volumes of potentially sensitive personal and transactional information will open the door to algorithmic discrimination and the exploitation of consumer behavioral biases. Without question, successfully addressing these—already well understood—challenges will be key to building trust in this new financial ecosystem.


Materiality in Recent SEC Comments on Climate Disclosure

Cydney S. Posner is special counsel at Cooley LLP. This post is based on her Cooley memorandum.

In September last year, Corp Fin posted a sample letter to companies containing illustrative comments regarding climate change disclosures, presumably designed to help companies think about and craft their climate-related disclosure. (See this PubCo post.) Corp Fin began by noting that, under its 2010 guidance (see this PubCo post), depending on the facts and circumstances, climate change disclosure could be elicited in a company’s SEC filings in connection with the description of business, legal proceedings, risk factors and MD&A. Still, right now, there is little in the way of prescriptive climate disclosure requirements, although a proposal for climate disclosure regulation is high on the SEC’s agenda. (See this PubCo post.) Instead, companies have instead looked largely to standards of materiality to determine whether climate disclosure is required in their SEC filings. However, many companies provide climate disclosure in corporate social responsibility reports that are not filed with the SEC, but instead typically posted on company websites. As reported in a recent analysis by Audit Analytics, in the SEC’s most recent round of comment letters about climate last month, the climate disclosure on which the SEC is commenting is primarily contained in these CSR reports. And the SEC wants companies to justify—in some detail—why that disclosure isn’t also in companies’ SEC filings.

According to the analysis from Audit Analytics, recent SEC climate-related comments were sent to nine large companies, with market caps between $3 billion and $240 billion and revenues between $3 billion and $50 billion. The recipients operated in a variety of industries.


SEC Proposes Unprecedented Cybersecurity Rules and Reporting Requirements

Adam FeeAntonia M. Apps, and George S. Canellos are partners at Milbank LLP. This post is based on their Milbank memorandum.

On March 9, 2022, the SEC voted to propose rules mandating sweeping cybersecurity measures for public companies and foreign private issuers. [1] Most notably, the rules would impose a 4-day reporting requirement for domestic issuers who have experienced a “material cybersecurity incident.” The rules would also require foreign issuers to disclose information about material cybersecurity incidents on Forms 6-K and 20-F.

The proposed rules broadly define a “cybersecurity incident” to cover effectively any intrusion of a company’s systems: “an unauthorized occurrence on or conducted through a registrant’s information systems that jeopardizes the confidentiality, integrity, or availability of a registrant’s information systems or any information residing therein.”  Within four days of determining that such an incident is material—with no extension of time for an “ongoing investigation”—the issuer would have to disclose on an amended Form 8-K:

  • when the incident was discovered;
  • whether it was ongoing;
  • a brief description of its nature and scope;
  • whether any data was stolen, altered, accessed, or used for any other unauthorized purpose;
  • the effect of the incident on operations; and
  • whether the company “has remediated or is currently remediating the incident.”

The proposed rules do not offer any further color on what may render a cybersecurity incident “material” but reiterate the conventional standard: “information is material if ‘there is a substantial likelihood that a reasonable shareholder would consider it important.’”


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