Worldwide: Governance & Securities Law Focus: Asia Edition, July 2018

US DEVELOPMENTS

SEC and NYSE/Nasdaq Developments

SEC Publishes New Guidance on Non-GAAP Financial Measures

On 4 April 2018, the staff of the Division of Corporation Finance of the U.S. Securities and Exchange Commission (SEC) updated its compliance and disclosure interpretations (C&DIs) regarding disclosure of non-GAAP financial measures in the context of business combination transactions. The new C&DI expands on prior guidance that financial measures included in forecasts provided to a financial advisor and used in connection with a business combination transaction are not considered non-GAAP financial measures if two conditions are met:

  • The financial measures are included in forecasts provided to the financial advisor for the purpose of rendering an
  • opinion that is materially related to the business combination transaction;
  • The forecasts are being disclosed in order to comply with Item 1015 of Regulation M-A or requirements under state or foreign law, including case law, regarding disclosure of the financial advisor's analyses or substantive work;
  • The new C&DI states that a registrant can rely on this guidance if the same forecasts provided to its financial advisor are provided to its board of director or board committee; and
  • In another new C&DI, the staff provided its view that when a registrant provides material forecasts to bidders in a business combination transaction and the disclosure of such forecasts is required to comply with the anti-fraud and other liability provisions of the federal securities laws, the financial measures included in such forecasts would be excluded from the definition of non-GAAP financial measures and therefore not subject to Item 10(e) of Regulation S-K and Regulation G.

The SEC's C&DI's are available at:

Center for Audit Quality Publishes Roadmap of Non-GAAP Financial Measures for Audit Committees

On 16 March 2018, the Center for Audit Quality (CAQ) published Non-GAAP Measures: A Roadmap for Audit Committees (Roadmap) to serve as a guide to audit committees on advancing their oversight and involvement with non-GAAP financial measures. The Roadmap presents themes that emerged at a series of 2017 roundtable discussions held by the CAQ and attended by a variety of stakeholders, including audit committee members, management, investors, securities lawyers and public company auditors. The Roadmap suggests that audit

committees should:

  • Put themselves in the investors' shoes when evaluating if the presented non-GAAP measures and related disclosures align with the company's overall strategy and performance;
  • Engage with investors directly or through investor relations to ensure that the presented non-GAAP measures aid investors' understanding of the company's performance;
  • Ask management whether it has an internal policy that provides guidelines for determining how non-GAAP measures are generated, calculated and presented, including the rationale for the measures and adjustments that it presents and excludes. If there is no policy, encourage management to create one;
  • Discuss with management how the company makes changes to non-GAAP measures it presents, and the rationale for why it would or would not make changes;
  • Seek the perspective of counsel on non-GAAP measures;
  • Ask the company to compare or to benchmark its non-GAAP measures to those of its peers;
  • Find out what disclosure controls and procedures are in place as they relate to the information that is presented and disclosed; and
  • Ask the external auditors what their responsibilities are for non-GAAP measures, including whether the measures are consistent with the auditors' understanding and knowledge of the company's performance.

In addition, the Roadmap identified the following as some of the leading and recommended practices that companies have instituted to support their presentation of appropriate non-GAAP financial measures:

  • Disclosure controls: Companies should strive to establish robust disclosure controls specific to non-GAAP financial measures as this will help mitigate risks and support sound decision-making about the reporting of non-GAAP measures. The disclosure controls should be documented and should facilitate their testing;
  • Non-GAAP policies: Management should have policies and guidelines in place to guide the preparation and presentation of non-GAAP financial measures with a view to promoting consistency in how the measures are presented and calculated; and
  • Audit committee disclosure: Companies may benefit from their audit committee making disclosure regarding the existence of non-GAAP policies (even if the policies themselves are not disclosed) as this could serve as helpful evidence for investors that the company has adequate policies to ensure the non-GAAP financial measures are used consistently, transparently and comparably.

The Roadmap is available at:

SEC Considering Allowing All Companies to Use 'Testing the Waters'

The JumpStart Our Business Startups Act of 2012, commonly known as the JOBS Act, sought to make it easier for smaller companies to access the public capital markets by relaxing restrictions on pre-IPO communications and allowing "emerging growth companies" (companies with less than $1 billion in annual turnover) to pursue limited private discussions with institutional or accredited investors to gauge their interests in a potential IPO, known as "testing the waters." The provision was intended to allow companies to gain a better sense of whether to pursue an offering without violating pre-IPO communications restrictions.

The SEC has announced it is considering giving all companies access to "testing the waters" benefits. Bill Hinman, SEC Division of Corporation Finance, stated that there is no specific timeline to put such plans into effect for all companies but that the agency does not expect implementation to take an "inordinate time."

SEC Launches Probe Into Whether Issuers May Have Improperly Rounded Up Their Earnings

On 22 June 2018, the Wall Street Journal, relying on a source familiar with the matter, reported that the SEC has launched a probe into whether certain issuers may have improperly rounded up their earnings per share to the next highest cent in quarterly reports. The article stated that the investigation was incited by the release of an academic research paper which found the number "4" appeared at an abnormally low rate in the first decimal place of companies' earnings per share, expressed in cents. Companies whose earnings per share come out to 5 or higher in the first decimal place should round up to the next higher cent (e.g., 55.5 cents would be rounded up to 56 cents), while if the first decimal place is a 4 or lower, it should be rounded down to the next lower full cent (e.g., 55.4 cents would be rounded down to 55 cents).

Although the SEC's investigation into the matter has not been officially confirmed, the Journal reports that the SEC has sent inquiries to at least ten companies requesting information about such adjustments that could have inflated reported earnings.

The Wall Street Journal article is available at:

SIFMA Issues Recommendations to Help More Companies Go and Stay Public

On 27 April 2018, the Securities Industry and Financial Markets Association (SIFMA) along with other organisations, notably the U.S. Chamber of Commerce and Nasdaq, published a report entitled Expanding the On-Ramp:

Recommendations to Help More Companies Go and Stay Public (SIFMA Report). The SIFMA Report sets forth several recommendations, including the following:

  • Enhancement of several provisions of the JOBS Act

    The JOBS Act entered into force six years ago and has demonstrated that laws and regulations dealing with capital raising can be relaxed without compromising investor protections. The SIFMA Report recommends amending several provisions of the JOBS Act, notably:

    • Extend certain JOBS Act "on-ramp" provisions from five years to ten years following an IPO in favour of issuers that continue to meet the definition of an EGC. These benefits include streamlined financial disclosure, allowance for confidential reviews of registration statements by the SEC and simplified executive compensation disclosure or exemption from certain executive compensation requirements under the Dodd- Frank Wall Street Reform and Consumer Protection Act.
    • Allow all issuers, not only EGCs, to use "testing the waters" by amending Section 5(d) of the Securities Act of 1933 (Securities Act). See "SEC Considering Allowing All Companies to Use 'Testing the Waters'" above.
    • Extend the five-year exemption from the requirement in Section 404(b) of the Sarbanes-Oxley Act of 2002 to report on the adequacy of internal control over financial reporting to ten years for EGCs that have less than $50 million in annual revenue and less than $700 million in public float.
  • Encourage more research of emerging EGCs and other small public companies
    In response to the lack of research coverage with regard to a majority of listed companies, which may reduce interest from investors and impact the liquidity for such companies' stock, the SIFMA Report recommends:

    • Amend the Rule 139 research safe harbour to provide that continuing coverage by research analysts of any issuer (including those that do not qualify for Form S-3 or F-3) would not constitute an offer or sale of a security of such issuer before, during or after an offering by such issuer.
    • Allow investment banking and research analysts to jointly attend "pitch" meetings in order to have an open and direct dialogue with EGCs. Currently, Section 105(b) of the JOBS Act prohibits analysts from engaging in efforts to solicit investment banking business.
  • Improvement to certain corporate governance, disclosure and other regulatory requirements

Companies often view the significant compliance costs of being a public company as a disincentive to going and staying public. In order to address this, the SIFMA Report recommends the following:

  • Institute reasonable and effective SEC oversight of proxy advisory firms, such as Institutional Shareholder Services (ISS) and Glass Lewis which have growing influence over public companies and have become the standard setters for corporate governance.
  • Reform shareholder proposal rules under Rule 14a-8 under the Securities Exchange Act of 1934 (Exchange Act) by increasing the "resubmission thresholds" that determine when a proponent is permitted to resubmit a proposal that has previously garnered low support. Currently, the level of support that a proposal must receive before resubmission is:

    • if voted on once in the past five years, 3% of shareholders the last time it was voted on;
    • if voted on twice in the past five years, 6% of shareholders the last time it was voted on; or
    • if voted on three or more times in the past five years, 10% of shareholders the last time it was voted on.

    The SIFMA Report recommends raising these thresholds to 6%, 15% and 30%, respectively.

    • Simplify quarterly reporting requirements and grant EGCs the option to issue a press release that includes quarterly earnings results in lieu of a full Form 10-Q.
  • Recommendations related to financial reporting

    The SEC guidance, the SIFMA Report, recommends the following:

    • Modernize the Public Company Accounting Oversight Board (PCAOB) inspection process related to internal control over financial reporting (ICFR), by updating SEC guidance issued in 2007. The recommendation is intended to ensure that the existing SEC guidance, which aimed to allow companies to prioritize and focus on "what matters most" in assessing ICFR, works as intended.
    • It also suggests that the PCAOB should consider forming an ICFR task force that could address issues that arise for companies as a result of the PCAOB inspection process and its consequences for audit firms and auditors.
    • Lastly, the SIFMA Report recommends pre- and post-implementation reviews to improve audit standards setting, prevent harmful impacts and address unintended consequences that occur in the process of implementing PCAOB auditing standards.

The SIFMA Report is available at:

SEC May Consider Amending Rules on Oil and Gas Reserve Reporting

On 21 June 2018, during the oversight hearing held by the House Financial Services Committee, SEC Chairman Jay Clayton stated that the agency was considering amendments to the SEC oil and gas reserves reporting rules, notably given the increasing significance of the shale formations in U.S. energy supply.

Under current SEC rules, companies may generally only report estimates of oil and gas quantities as "proved undeveloped reserves" for up to five years without being developed, unless the specific circumstances justify a longer time. The SEC has provided guidance that no particular type of project per se justifies a longer time period, and any extension beyond five years should be the exception, and not the rule. A relaxation of this five-year rule could potentially allow companies to include reserves as proved undeveloped reserves that take more than five years to develop, such as shale projects.

Answering a question from Representative Frank Lucas highlighting both changes in domestic energy production and the fact that "the five-year rule might not reflect the realities of the new American energy landscape," Chairman Jay Clayton stated: "I'm concerned in this space that the way our rules require disclosure is inconsistent with the way investors value these companies. So they are looking for additional disclosures, and we should make sure that our rules line up with what investors think is the material information."

Virtual Currency Regulatory Developments

In recent months, several virtual currency regulatory developments have taken place in the United States:

  • SEC Corporation Finance Director provides analysis in assessing whether digital assets constitute securities

    • On 14 June 2018, the Director of the SEC's Division of Corporation Finance, William Hinman, discussed the analysis applied by the SEC Staff in assessing whether a digital asset constitutes a security. The assessment of the status of a given asset as a security will rely on two sets of non-exhaustive factors. Hinman stated that the primary issue is "whether a third party . . . drives the expectation of a return," and then, whether the digital asset functions "more like a consumer item and less like a security."
    • The list of factors to consider in assessing whether a digital asset is offered as an investment contract and is thus a security includes:

      • Is there a person or group that has sponsored or promoted the creation and sale of the digital asset, the efforts of whom play a significant role in the development and maintenance of the asset and its potential increase in value?
      • Has this person or group retained a stake or other interest in the digital asset such that it would be motivated to expend efforts to cause an increase in value in the digital asset? Would purchasers reasonably believe such efforts will be undertaken and may result in a return on their investment in the digital asset?
      • Are purchasers "investing," that is seeking a return? In that regard, is the instrument marketed and sold to the general public instead of to potential users of the network for a price that reasonably correlates with the market value of the good or service in the network?
    • The list of contractual or technical ways to structure digital assets so that they function more like a consumer item and less like a security includes:

      • Is token creation commensurate with meeting the needs of users or, rather, with feeding speculation?
      • Are independent actors setting the price or is the promoter supporting the secondary market for the asset or otherwise influencing trading?
      • Is it clear that the primary motivation for purchasing the digital asset is for personal use or consumption, as compared to investment? Have purchasers made representations as to their consumptive, as opposed to their investment, intent? Are the tokens available in increments that correlate with a consumptive versus investment intent?
    • The SEC will continue to focus on the economic substance of transactions in determining if the securities laws should apply. In particular, the SEC states that the securities laws generally will apply where transactions involve raising capital from investors to fund a venture.
    • Finally, Hinman further confirmed that current offers and sales of ether and bitcoin are not securities transactions.
  • Federal court upholds that virtual currencies are commodities
    • On 6 March 2018, the United States District Court for the Eastern District of New York confirmed that virtual currencies are commodities within the anti-fraud jurisdiction of the Commodity Futures Trading Commission (the CFTC). The order, which came in the form of a preliminary injunction, follows the CFTC's 18 January 2018 civil enforcement action against Patrick K. McDonnell and his company CabbageTech, doing business as Coin Drop Markets (CDM), alleging that McDonnell had induced customers to send money and virtual currencies to CDM in exchange for virtual currency trading advice and purchasing on customers' behalf. The CFTC also alleged that McDonnell and CDM misappropriated investors' funds.
    • The Court considered whether virtual currencies are commodities under the Commodity Exchange Act (CEA) and whether the CFTC has jurisdiction over commodity fraud that is not tied to the sale of derivatives products. The court held that virtual currencies "fall well-within the common definition of 'commodity,'" and thus the CFTC maintains the jurisdictional authority to stop spot trade virtual currency fraud under the CEA. Further, the order clarified that the CFTC may exercise jurisdiction over spot transactions in virtual currencies when there is potential fraud, even if the fraud is not in conjunction with derivatives based on virtual currencies.
  • Virtual commodity self-regulatory organization proposed

    • On 13 March 2018, Gemini, a virtual currency exchange, released a proposal to create the first self-regulatory organization for U.S. virtual commodity exchanges. The so-called Virtual Commodity Association (VCA), as envisioned, would be a non-profit, independent regulatory organization that would operate to foster responsible virtual commodity markets by requiring members to implement specified sound practices and supervising members' implementation of such practices. The VCA would also encourage greater co- operation with relevant regulators in an effort to assist with the maturation of the virtual commodity industry.
    • The proposal noted that the VCA would not operate any markets, be a trade association or provide regulatory programs for security tokens or security token platforms. Initially, the VCA would be open to trading facilities that offer users the ability to transact in the virtual commodity spot markets, but may offer membership to additional categories of market participants in the future.

William Hinman's speech is available at:

Our related client publication is available at:

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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