Rule 10b-17 Compliance - Reminder
Rule 10b-17 Compliance – Reminder for OTC Listed Companies
Companies with shares publicly traded on a national exchange in the United States (“National Exchange Companies”), such as the NYSE or the NASDAQ, as well as companies with securities listed over-the-counter (“OTC Companies”), such as on OTCQB or OTC Pink, must comply with the disclosure requirements of Rule 10b-17 (“Untimely Announcements of Record Dates”) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”).
Rule 10b-17 applies to any issuer that has a “class of securities publicly traded by the use of any means or instrumentality of interstate commerce.” In general, the rule requires an issuer to file certain information with the Financial Industry Regulatory Authority (“FINRA”) at least 10 days prior to the record date of certain corporate actions, such as cash and stock dividends, stock splits or reverse splits, or rights or other subscription offerings.
In 2010, FINRA enacted Rule 6490 which codifies the requirements of Rule 10b-17, requiring issuers to provide timely notice to FINRA of such certain corporate actions and other corporate actions, such as mergers, acquisitions and bankruptcies. Rule 6490 applies to both National Exchange Companies and OTC Companies. FINRA may also review an issuer corporate action based on third party information when it believes that such action is necessary to protect the market and the investors1.
An issuer that fails to notify FINRA of a proposed corporate action potentially violates 10b-17 of the Exchange Act and may be subject to significant sanctions.2
OTC Companies in particular should keep in mind their compliance requirements under Rule 10b-17 because National Exchange Companies are subject to stock exchange rules that typically impose comparable requirements of which most National Exchange Companies are already aware.
SEC issues a Staff Report on Review of Disclosure Requirements in Regulation S-K
In December 2013, the U.S. Securities and Exchange Commission (“SEC”) released its report regarding the SEC staff review of the disclosure requirements under Regulation S-K, pursuant to Section 108 of the Jumpstart Our Business Startups Act (the “JOBS Act”). The full report can be found here.
Regulation S-K is a central depository of the disclosure provisions applicable to offerings by U.S. domestic issuers. The registration forms and regulations often refer to the disclosure requirements in Regulation S-K rather than repeating the requirements in each registration form and regulation. The purpose of the review was to evaluate ways in which the disclosure requirements can be simplified and modernized for all issuers. In the report, the SEC stated that in light of technical advances in the ways that businesses operate and communicate with investors and the ways that capital markets function and how market participants receive and use information, it believes that the disclosure requirements should be reevaluated to ensure that relevant and adequate information is disclosed to the investors.
The report mentions a few potential areas for further study, including (i) a principle-based approach disclosure (similar to management discussion and analysis (MD&A) provided by issuers), (ii) evaluation of whether further “scaled” disclosure requirements, in which the disclosure requirements vary depend on the size of the issuer, should be applied (resulting in simpler disclosure requirements for smaller issuers), (iii) evaluation of the methods of information delivery and presentation, for instance a “company profile” with information that changes infrequently, while other information would be provided more regularly; and (iv) improving the readability of disclosure documents and discouraging repetition (such as through the use of hyperlinks).
The staff also identified a few specific areas that should be further reviewed, such as (i) combining sections related to risk factors, legal proceedings and risk information into one requirement, (ii) review of description of business and properties disclosure requirements for continuing relevance (for instance, many businesses no longer require a physical presence or can easily substitute their physical locations without any material impact on their businesses), (iii) reviewing corporate governance disclosure to confirm that material information is presented effectively; for instance, including information in a filing only when changes occur should be evaluated; and (iv) addressing concerns that executive compensation disclosure is too long and technical.
It is too early to assess the impact of this report on disclosure practices in the future; however, if some of these principles are adopted, it may impact disclosures made by foreign private issuers, including in their Annual Report on Form 20-F.
Power Shift to Shareholders Reinforces Need to Engage Shareholders
A series of legal and structural changes in the U.S. corporate governance and proxy voting landscape have increased shareholder power in recent years. More dependent on the support of shareholders than ever before, U.S. companies have begun to respond by providing shareholders with more thorough and thoughtful proxy disclosure, and by engaging with shareholders in novel ways during the non-proxy season. At the same time, shareholder activism has gone mainstream, reinforcing the trend to engage with shareholders as a way to inoculate those shareholders against supporting an activist agenda. All companies with U.S. shareholders should be aware of these trends and consider what steps to take in this era of growing shareholder power.
Shareholder power has been increasing for several years as various proxy “fixes” and “plumbing changes” have been either imposed by regulators or widely adopted by corporate America in response to shareholder pressure. Majority voting has largely replaced plurality voting for uncontested director elections at larger companies, and voting by brokers for such elections without explicit directions from the shareholders they represent has been eliminated. Poison pill and classified boards arrangements have been repealed and now exist only at a minority of large public companies. By Securities and Exchange Commission (“SEC”) rulemaking, companies may no longer easily exclude proxy proposals by shareholders for annual or special meetings to permit direct shareholder nomination of directors. Finally, all domestic U.S. companies registered with the SEC (but not foreign private issuers) are now required to hold a non-binding shareholder vote on executive compensation at least once every three years (“Say-On-Pay”).
With shareholder power on the rise, institutional investors, prompted by a different SEC rule change requiring them to adopt procedures to ensure that they vote their securities in the best interest of their clients, have increasingly turned to proxy advisory firms to help manage the voting process.3 Without the resources to adequately investigate proxy proposals at each public company in their portfolio, many institutional investors meet their regulatory obligations by relying heavily on the views expressed by these third party advisory firms. However, fueled by the tremendous growth in the institutional ownership of public company shares, these advisory firms have amassed immense and increasingly controversial power. For example, Say-On-Pay proposals that receive negative recommendations from such proxy advisory firms receive on average 30% less shareholder support than those that receive positive recommendations.4
Provided with more tools to influence corporate behavior than ever before, shareholders are increasingly pushing for changes in corporate policy and behavior. Unlike shareholder activism of a generation ago, today’s activists are better funded, more sophisticated, and, perhaps because a succession of corporate corruption scandals have reduced trust in corporate management, often receive far more support than did prior efforts. While many activists remain focused on encouraging corporate strategic alternatives, share buy-back programs, and greater dividend payouts, a growing number push for more incremental change and have indicated that they intend to remain involved for the long-term. In addition, new activist hedge funds have emerged in recent years who have amassed billions of dollars that they direct toward the targets of their activism. Rather than routinely supporting management and shunning such activists as they once did, institutional investors have done an about face in recent years and increasingly side with activists (sometimes even investing in activist hedge funds). Finally, the media increasingly portrays shareholder activists in a positive light as corporate reformers, rather than as in a negative light as corporate raiders.
Faced with increasing pressure from shareholders generally and activists in particular, and under the watchful eye of proxy advisory firms, companies have responded. First, they are enhancing disclosure in proxy statements regarding such hot button topics as executive compensation, board composition, and audit committee reporting. In addition, they are increasingly highlighting in proxy statements their outreach efforts to shareholders and any changes made in response to shareholder feedback.5 Second, companies are more frequently communicating with shareholders outside of the proxy season in order to generate goodwill and support for company policies – before any proxy issues or activist shareholders arise. This communication takes a variety of forms, including one-on-one meetings between shareholders and company officers and/or directors and more lengthy dialogues with important institutional shareholders. In other words, shareholder meetings are not just for IR departments anymore. This trend marks such a radical departure from the much more limited contact with shareholders in decades past that the current period has been called the “The Era of Engagement”.6
In light of these changes, all companies with U.S. shareholders should periodically review their corporate governance structures before being forced by shareholder pressure to do so. In addition, companies should pay more attention to their shareholder base by monitoring that base for changes in shareholder composition and warning signs of pending shareholder activity or discontent in the ranks. For example, this could include more closely monitoring quarterly conference calls, internet traffic, and public beneficial ownership filings. In addition, companies should consider appropriate outreach efforts to shareholders throughout the year. Such efforts are most effective if initiated before the pressure of an important proxy vote or even greater pressure of a proxy challenge. The risks to your company associated with doing nothing may have become too great to ignore.
1 INRA Regulatory Notice 10-38 “Obligation of Issuers to Provide Notice of Company-Related Actions”
3 Two proxy advisory firms dominate this sector: Institutional Shareholder Services, and Glass, Lewis & Company.
4 “Say on Pay, A Review of Key Vote Results and Trends”, Towers Watson, May 28, 2013 (available at: https://www.boardmember.com/uploadedFiles/Home/Research/SayonPaySummary.pdf).
5 See “Key Developments of the 2013 Proxy Season”, Ernst & Young, June 2013 (available at: http://www.ey.com/Publication/vwLUAssets/Key_developments_of_the_2013_proxy_season/$FILE/Key-developments-of-the-2013-proxy-season.pdf).
6 “2013 Annual Governance Review”, Georgeson (available at: http://www.georgeson.com/us/resource/Pages/acgr.aspx).