May 26, 2015

Securities and Governance Update - May 2015

SEC Re-Examines Exclusion of Shareholder Proposals That Directly Conflict with Company Proposals; Companies Consider Preemptive Action on Proxy Access

By Kimberly K. Rubel and Jennifer J. Card

With a single statement the SEC upended the private ordering of how shareholder proposals are often dealt with in the height of proxy season.  Historically, it has been well settled that companies may exclude shareholder proposals on the basis that “the proposal directly conflicts with one of the company’s own proposals to be submitted to shareholders at the same meeting.”[1]  On January 16, 2015, the SEC issued a statement from Chair Mary Jo White indicating that, due to questions regarding the proper scope and application of that exclusion under Rule 14a-8(i)(9), she had directed the SEC staff to review the rule and report to the Commission on its review.  The SEC’s Division of Corporation Finance subsequently announced that, in light of Chair White’s direction, it would express no views on the application of Rule 14a-8(i)(9) during the current proxy season.  As a result of these announcements, the granting of “no action” relief for proposals that directly conflict with a company proposal effectively ceased, leaving companies to consider other options and creating uncertainty in the midst of an already hectic proxy season.


In December 2014, the SEC staff concurred with Whole Foods Market, Inc. that it could exclude a shareholder proposal on proxy access under Rule 14a-8(i)(9) on the basis that the shareholder proposal directly conflicted with the company’s own proposal.  The shareholder proposal would give a group of shareholders owning 3% of the company’s shares for three years the right to include nominees for director in the company’s proxy materials.  In contrast, the company proposal sought to provide proxy access for a single shareholder owning 9% of the company’s shares for five years.  The SEC staff granted no action relief, but subsequently reconsidered its position and stated that it would express no views on the application of Rule 14a-8(i)(9).  As a result, while the rule remains valid, the SEC staff has not granted and will not grant relief under this exclusion until it completes its review of Rule 14a-8(i)(9).  This had a ripple effect beyond Whole Foods and impacted other companies attempting to determine whether they could exclude shareholder proposals.  It also opened the door for advisory firms, such as ISS and Glass Lewis, to opine on the matter and to push for further strides toward shareholder-friendly governance.

Practical Implications

The unavailability of no action relief under Rule 14a-8(i)(9) primarily impacted public companies’ reactions to shareholder proposals on proxy access, but it also implicated other important matters in corporate governance such as shareholder special meeting rights and shareholder action by written consent.  This proxy season, when presented with a shareholder proposal that otherwise might be excludable under Rule 14a-8(i)(9), companies considered the following alternatives in lieu of the availability of no action relief:

  1. Include the shareholder proposal and exclude the company proposal;
  2. Include the shareholder proposal and the company proposal (dual proposals);
  3. Exclude the shareholder proposal after seeking declaratory relief from a court and include a company proposal;
  4. Exclude the shareholder proposal and include a company proposal; or
  5. Exclude the shareholder proposal and do not include a company proposal.

Alternatively, a company could attempt to negotiate with the proponent to have the shareholder proposal withdrawn.  Some companies requested that the SEC staff reconsider their previously submitted no action requests on an alternative basis for relief, such as Rule 14a-8(i)(10) where a company had “substantially implemented” a proposal.

None of these options presented a particularly palatable approach to companies that ordinarily would have sought to exclude such proposals via the normal avenue of no action relief.  In addition, the presentation of dual proposals posed potential for confusion.  In cases where dual proposals were presented, great care was required to clarify in a company’s proxy statement what impact each proposal would have if approved by shareholders.

ISS and Glass Lewis clearly preferred that companies select the option most protective of shareholder rights.  ISS announced that it will generally recommend a vote against one or more directors if a company omits a properly submitted shareholder proposal when the company has not obtained (a) voluntary withdrawal of the proposal by the proponent, (b) no action relief from the SEC or (c) a U.S. District Court ruling that it can exclude the proposal.  Where none of these are feasible options, companies were generally left with the choices of (1) including the shareholder proposal and excluding the company proposal or (2) including the shareholder proposal and the company proposal.  Otherwise, the company risks ISS recommending a vote against its directors.  Likewise, Glass Lewis announced that it will review proxy access proposals, including alternative company proposals, on a case-by-case basis and will consider whether the company proposal varies materially from the shareholder proposal in minimum ownership threshold, minimum holding period and maximum number of nominees to determine whether the company’s response is reasonable.  In certain cases, Glass Lewis may recommend against certain directors if the company proposal varies materially from the shareholder proposal without sufficient rationale.

What’s Next?

Thus far this year, there have been mixed results.  Many companies targeted by proxy access proposals opted to include the shareholder proposal and exclude a company proposal, with many recommending a vote “against” the shareholder proposal.  Some companies included dual or “competing” proposals, but generally recommended voting “against” the shareholder proposal. 

Shareholder proposals on proxy access voted on to date have received a slim majority of the votes on average, but some shareholder proposals have failed and, in some instances, companies have received a majority of the votes in favor of a more restrictive company proposal.

The developing story – and one that we expect to continue in the off-season and into the next proxy season – is the efforts by companies to preemptively adopt their own proxy access provisions without waiting for a shareholder proposal.  Preemptive action effectively removes a company from the fray of private ordering and the uncertainty surrounding the Rule 14a-8(i)(9) exclusion, thereby enabling the company to better focus on its core business and strategic operations.  Preemptive action also presents a company as responsive to shareholders and enables a company to adopt proxy access on its own terms, even if it facilitates access to the ballot.  In any event, proxy access and the Rule 14a8-(i)(9) exclusion is – and will continue to be – a key issue impacting public companies and their governance efforts.

[1] Rule 14a-8(i)(9) of the Securities Exchange Act of 1934, as amended ("Rule 14a-8(i)(9)").

Regulation A+ Final Rules

By Brian Lynch and Matthew Havey

The SEC recently adopted rules to allow companies to raise up to $50 million by offering and selling securities through a new exemption, without filing a registration statement.  The rules, commonly referred to as “Regulation A+,” were issued under Section 3(b) of the Securities Act of 1933 and will become effective on June 19, 2015.  The new rules and the Regulation A+ adopting release can be found here: (the “A+ Adopting Release”).

Regulation A+ (or “A+”) implements Title IV of the JOBS Act and is a substantially expanded version of Regulation A, an existing (but little-used) exemption from registration under the Securities Act for smaller issuances of securities.  The new A+ rules create two tiers of offerings, Tier 1 and Tier 2.  Some of the more significant elements of A+ are summarized below.

Offering Size 

Tier 1 will allow offerings of up to $20 million in a 12-month period, with no more than $6 million of sales by selling securityholder affiliates.  Tier 2 will allow offerings of up to $50 million in a 12-month period, with no more than $15 million of sales by selling securityholder affiliates.  In the case of an issuer’s first offering pursuant to Regulation A+ and any subsequent A+ offering qualified within one year thereafter, sales by any selling securityholders (regardless of affiliation with the issuer) are limited to 30% of each offering.

If convertible securities or warrants are included in the A+ offering and may be converted, exercised or exchanged for other issuer securities within one year of the A+ offering or at the discretion of the issuer, the full value of those derivative securities will be considered issued in the A+ offering and their aggregate value will use up the relevant offering limit value of Tier 1 or Tier 2, as applicable.

Offering Disclosure

Tier 1 and Tier 2 offerings must be made through an offering statement on Form 1-A, which must be filed with the SEC via EDGAR. The SEC remarked in the A+ Adopting Release that disclosure on Form 1-A is “akin to what is required of smaller reporting companies in a prospectus for a registered offering.”  Of particular note, Form 1-A requires (1) disclosure concerning material disparities between the A+ offering price and the cost of shares purchased by insiders in the preceding year, (2) annual financial statements for two full years (or since inception, if for a lesser period) and for applicable interim periods and (3) disclosure of business operations for the past three years (or since inception, if for a lesser period).  

In connection with the larger permitted offering size, Tier 2 imposes requirements upon issuers beyond those set forth in Tier 1.  For instance, in a Tier 2 offering, issuers must provide audited financials prepared in accordance with U.S. GAAS or standards issued by the PCAOB.  In either case, the Tier 2 issuer's auditor must be independent under Rule 2-01 of Regulation S-X, but need not be PCAOB-registered.  In contrast, Tier 1 issuers may file unaudited financial statements on Form 1-A so long as the issuer has not obtained audited financial statements for another purpose (e.g., as required under commercial loan agreement obligations). 

Liability Considerations

Unlike other exempt private placements, A+ offerings are subject to liability under Section 12(a)(2) of the Securities Act.  As a result, liability obligations could arise in the event A+ offering materials or oral communications include a material misleading statement or material omission.

Post-Offering Reporting 

After an A+ offering, Tier 2 issuers must file annual, semiannual and current reports. Compared to traditional Exchange Act reporting companies, however,  Tier 2 issuers have a less burdensome post-offering reporting obligation associated with these filings.  In contrast, Tier 1 issuers are not subject to annual, semi-annual or current report filing obligations. As a general proposition, full Exchange Act reporting obligations could arise when an issuer has assets exceeding $10 million and exceeds certain levels of stockholders of record or non-accredited investors.  For Tier 2 issuers that otherwise could cross into full Exchange Act reporting obligations through an A+ offering by surpassing shareholder triggers for Exchange Act reporting, a conditional exemption from registration under Section 12(g) of the Exchange Act of 1934 has been implemented as part of the A+ Adopting Release, provided, among other things, the issuer uses a registered transfer agent, the issuer complies with ongoing reporting obligations under A+, and the issuer has less than $50 million in annual revenues or less than $75 million in public float as of relevant measurement dates.

State Law Coordination 

One of the key features of Regulation A+ is that qualification and registration under state securities laws (i.e., blue sky laws) are preempted for Tier 2 offerings only.  It is expected that this aspect of A+ should enable more widespread use for issuers than the previous iteration of Regulation A, because a common complaint and deterrent of issuers considering Regulation A offerings had been the difficulty in navigating state blue sky laws.  Tier 1 offerings, on the other hand, will still require blue sky review.  States also retain jurisdiction to investigate and prosecute fraud, require “notice filings” of documents filed with the SEC, charge filing fees, and suspend offerings within a given state to enforce notice and fee requirements, in each case for both Tier 1 and Tier 2 offerings.

The following chart recaps the most critical components of the foregoing provisions of A+:


Regulation A


Regulation A+

Tier 1 Offerings

Regulation A+

Tier 2 Offerings

Maximum raise

$5 million

(in 12-month period)

$20 million

(in 12-month period)

$50 million

(in 12-month period)

Maximum sales by affiliate shareholders of the issuer


$1.5 million

$6 million*

$15 million*

Blue sky review




* Subject to the following additional limitation in the one-year period commencing with the issuer's first offering qualification under A+: the portion of each offering attributable to the aggregate value of affiliate and non-affiliate selling shareholders' shares cannot exceed 30% of the aggregate offering.

Investor Limitations 

In a Tier 2 offering, a non-accredited investor generally is limited to purchasing no more than ten percent of either the investor’s net worth or annual income, whichever is greater, while accredited investors are not subject to those limits.  There are no express federal investor investment limits for Tier 1 offerings under A+, but as a practical matter, Tier 1 offerings may entail investor limitations as a by-product of applicable state blue-sky regulatory regimes that can impose their own investor limits, depending upon the jurisdictions where securities are being offered or sold.

Who’s Eligible for A+?

The SEC has narrowed the field of issuers eligible for Regulation A+ offerings.  Among other things, an issuer under Regulation A+ must have its principal place of business in the United States or Canada.  There are a number of exclusions, as well.  Perhaps most importantly, it is not available to companies that are already Exchange Act reporting companies.  Further, an A+ eligible issuer cannot be: a registered investment company; a development stage “blank-check” shell company; an issuer whose Exchange Act registration has been revoked or suspended within the preceding five years; or an issuer that has not filed ongoing reports required by A+ during the preceding two years.  Regulation A+ also expanded the “bad actor” disqualification in existing Rule 262 to match the new “bad actor” provisions in Regulation D.

Test-the-Waters Features

Another key facet of an A+ offering is that it allows potential issuers to “test the waters” before the offering.  This enables issuers to solicit interest in a potential offering from the general public before filing an offering statement with the SEC.  This is more beneficial than many other exempt offerings (where general public solicitation is generally prohibited) and emerging growth company (“EGC”) public offerings, where solicitation is limited to sophisticated QIBs and institutional investors.  “Test the waters” materials need not be submitted to the SEC prior to use, but ultimately must be filed with the SEC in connection with the filing of the issuer’s offering statement. 

Confidential SEC Filing Benefits of A+

As long as an issuer has not previously sold securities pursuant to an A+ offering, it is able to confidentially furnish non-public offering statements and amendments for SEC staff review before publicly filing them with the SEC, provided that all of those documents are publicly filed at least 21 days before the offering circular is qualified by the SEC.  However, A+ non-public materials do not have the same confidentiality protections as those associated with EGC submissions, and it is possible that A+ non-public materials may be available to the public in certain circumstances through FOIA requests.

A+ Takeaways and Tips

While the A+ rules are generally favorable, many practitioners and some of the SEC’s commissioners have expressed regret that A+ did not do more to facilitate capital formation.  As a result, there are important takeaways not only for the A+ offering process, but also for post-offering secondary trading of shares.

Tier 1 capital raising, with its deference to state securities commission review, is likely to be inefficient and prone to the same negative complexities that led to the old Regulation A rarely being used over recent decades.  As a result, presently there appears to be little advantage to using Tier 1 over other alternative exemptions from registration currently available, including Rule 506 under Regulation D. 

While Tier 1 A+ offerings appear to provide little current utility, there is no restriction within A+ for completing Tier 2 offerings involving offering proceeds of less than $20 million.  Thus, state preemption may be available for smaller offerings as long as issuers are willing to comply with all the requirements of Tier 2, including audited financial statement requirements, investor limits and post-offering reporting requirements. While much remains to be seen regarding how A+ offerings will be embraced by the markets and regulators alike, the use of Tier 2-compliant A+ offerings may ultimately prove to be an effective way to raise less than $20 million in an exempt offering under the federal securities laws.

Finally, it is worth nothing that the A+ Adopting Release specifically stated that the SEC consciously chose not to fully preempt state regulation over secondary trading of shares issued in Tier 2 offerings.  Moreover, it reserved the SEC's ability to review market developments for purposes of implementing potential future rule changes that could affect both primary and secondary A+ markets.  In this regard, it is worth emphasizing that while the Tier 2 exemption preempts state regulation of issuances and resales of shares within the contours of an A+ offering, subsequent (i.e., post-A+) resales of shares should be planned with a careful eye to ensure compliance with state securities laws.  In addition, there are federal limitations associated with certain resales outside of an A+ offering.  As a consequence, advance planning consideration should be given to (1) judicious use of shares that are sold by selling stockholders in an issuer’s initial qualification of shares through A+, (2) the subsequent use of continuous offering statements for selling shareholders, particularly affiliates, and (3) the availability of state and federal exemptions for secondary trading of other shares outside of an A+ offering.

Audit Committee Dialogue from the PCAOB

By Elizabeth A. Diffley

The Public Company Accounting Oversight Board (“PCAOB”) recently published a communication to audit committees, its new Audit Committee Dialogue, the first of a series designed to provide audit committees with helpful insights from the PCAOB’s inspections of public company auditors. 

The PCAOB provides oversight of the work of accounting firms that audit publicly traded companies and periodically inspects accounting firms for compliance with the PCAOB’s rules and auditing standards.  Each year, the PCAOB conducts hundreds of inspections focusing on how the accounting firm conducted selected audits and the effectiveness of the accounting firm’s quality control policies and procedures. Inspections are designed to identify if there are deficiencies in how accounting firms perform audits and if there are weaknesses in quality controls over public company auditing.

In this first publication of Audit Committee Dialogue, the PCAOB identified several key recurring areas of concern, as well as new risks that it is monitoring, and provided helpful sample questions for audit committees to discuss with their accounting firms.  In addition to audit committees using these questions to assist with their oversight responsibilities, parties performing auditor and financial due diligence of public companies, including underwriters, lenders and their counsel, may wish to pose similar questions during their due diligence investigations. The sample questions may also be helpful to company management and its audit firm in developing the audit plan for the upcoming year.  The PCAOB has previously provided audit committees with sample questions to ask their accounting firms about PCAOB inspections, which remain relevant.

Recurring Areas of Concern

PCAOB inspections have identified frequent significant deficiencies in the following areas:

  • Auditing over internal control over financial reporting (“ICFR”)
  • Assessing and responding to risks of material misstatement 
  • Auditing accounting estimates, including fair value measurements
  • In cross-border audits, deficient “referred” work – work performed by other audit firms and sued by the signing audit firm


Inspections have often found that the auditor did not perform sufficient procedures to test the effectiveness of ICFR or to sufficiently evaluate if the identified ICFR deficiencies constituted material weaknesses.  In particular, the PCAOB notes that audits of ICFR do not achieve their objectives if material weaknesses remain undetected until a material misstatement occurs and highlights the existence of the weakness, but points to evidence that delayed identification of material weaknesses frequently occurs. For example, of reported material weaknesses in 2012 and 2013 audit reports, 77% were in connection with, or after, the issuer’s disclosure of a related financial reporting error that required a restatement or adjustment.  Sample questions to ask the auditors include:

  • What are the points within the company’s critical systems processes where material misstatements could occur?  How has the audit plan addressed the risks of material misstatement at those points? How will you determine whether controls over those points operate at a level of precision that would prevent or detect and correct a potential material misstatement?
  • If the company or the auditor has identified a potential material weakness or significant deficiency in internal control, what has been done to probe the accuracy of its description? Could the identified control deficiency be broader than initially described? Could it be an indication of a deficiency in another component of internal control?

Material Misstatement

The PCAOB notes that auditors do not always properly identify the audit risk or respond effectively to risks.  The report highlights that when a company’s business and environment change, the audit plan should address those changes. Further, integrated audit plans for large companies sometimes provide for insufficient procedures at certain locations or business segments that are significant contributors to the results of operations and that involve higher risk of material misstatement.  In particular, the PCAOB’s findings indicate that audit firms may rely on entity-level controls but fail to sufficiently test those controls.  Sample questions to ask the auditors include:

  • Which audit areas are designated as having significant risks of material misstatement and what audit procedures are planned to address those risks?
  • In your view, how have the areas of significant risk of material misstatement changed since the prior year? What new risks have you identified? What is your process to make sure that it identifies new or changing risks of material misstatement and tailors the audit plan appropriately? How is the engagement partner involved?
  • How does the audit plan address the varied risks in a multi-location environment?  If you assume that controls are uniform across multiple locations, how do you support that assumption?


Estimates warrant significant audit attention because they involve subjective factors and judgments, which make them susceptible to management bias and material misstatement.  The PCAOB has identified a large number of significant deficiencies in the auditing of accounting estimates over many years in areas such as revenue, allowances for loan losses, inventory reserves, fair value measurements, tax-related estimates and, particularly when economic conditions deteriorate, asset impairments.  Sample questions to ask the auditors include:

  • How do you obtain a thorough understanding of the assumptions and methods the company used to develop critical estimates, including fair value measurements?
  • How have you assessed whether management has identified all separable intangible assets that, while not included in the financial statements, must nevertheless be valued in connection with assessing goodwill for possible impairment (e.g., customer-related intangibles and in-process research and development)? Have you considered contrary information that suggests the existence of such assets that management has not identified?

Referred Work in Cross-Border Audits

PCAOB inspectors have found significant problems in more than 40% of the “referred” work engagements of non-U.S. firms in connection with audits of multinational companies.  The deficiencies arose in critical areas such as revenue, inventory and controls and often arose where those areas were significant to the issuer’s financial statements or ICFR. Sample questions to ask the auditors are as follows:

  • How does the engagement partner assess the quality of the audit work performed in other jurisdictions? Were the firms that participate in the audit recently inspected by the PCAOB? If yes, what does the engagement partner know about the results?
  • How do you review the work? Do you visit other countries to review the audit work done there? What steps do you take to make sure that the work is performed by persons who understand PCAOB standards and U.S. GAAP and financial reporting requirements?
  • As part of planning the audit, do you consider performing additional steps if the referred work is in an area that has recently been the subject of a significant number of PCAOB inspection findings?

Potential Emerging Risks

The PCAOB also identified potential emerging risks that are being incorporated into its inspection planning for 2015: increase in merger and acquisition activity, falling oil prices, undistributed foreign earnings, and maintaining audit quality when growing other business lines.

Mergers and Acquisitions

The PCAOB has identified that audit team members may lack substantial experience in M&A and auditing business combinations, leading to an increased risk of deficiencies when M&A activity is on the rise. For example, one problem has been a failure to detect that management had not identified all of the intangible assets that needed to be valued, such as customer-related intangible assets. A sample question for auditors follows:

  • Do you have the expertise necessary to address the audit issues that may arise from the reporting requirements related to business combinations as well as other effects of a business combination that may bear on financial reporting, such as the effects on segment reporting? If not, how will the engagement team obtain or develop that expertise?

Falling Oil Prices

The PCAOB plans to examine how auditors approach the risks of material misstatement resulting from changes in oil prices, noting that falling oil prices impact companies in a number of industries and may affect valuation and impairment judgments and the collectability of loans and receivables.  Sample questions to ask the auditors include:

  • Have declining oil prices been identified as a risk factor and changed your approach to testing related accounting estimates? Will you require different evidence to support any assumptions and estimation methods used by the company that may depend on a certain level of oil prices?
  • How might the estimated effects of falling oil prices be factored into estimates of the company’s future undiscounted net cash inflows used in the assessments of possible impairments of long-lived assets? How might those effects affect the possible need for recording or adjusting a deferred tax valuation account?

Undistributed Foreign Earnings

The PCAOB has identified problems with firms’ ability to audit management’s assertions, as well as in auditing income tax accounting and related disclosures regarding undistributed foreign earnings that U.S. companies have asserted will be indefinitely reinvested outside the United States and therefore are not subject to U.S. taxes.  The PCAOB also highlighted that, if a company faces legal liability or sanctions based on a strategy developed by its audit firm, the audit firm’s independence and ability to continue as the auditor could be compromised.  Accordingly, the PCAOB suggests that audit committees may find it useful to maintain and monitor a list of past tax strategy engagements for potential effects on the audit.  Sample questions to ask the auditors include:

  • What is the nature and extent of audit evidence gathered related to management’s assertions about indefinite reinvestment? Is there contrary evidence? If so, how did you consider the contrary evidence?
  • Have you considered whether the company’s MD&A disclosure, including disclosure regarding liquidity and capital resources, is consistent with, or contradicts, management’s indefinite reinvestment assertion?

Audit Firm Growth and Expansion

The PCAOB notes that the largest audit firms are experiencing an increase in the percentage of revenue from advisory services and a decrease in the percentage of revenue from audit services in the recent past as firms have acquired consulting firms or otherwise grown their consulting practices.  It has identified a concern about the effects these developments may have on audit quality.   A sample question for auditors follows:

  • Has your engagement team been affected by any changes in the firm’s business model? Has the engagement team lost key auditors or specialists to other lines of business? How are you ensuring that the quality of the audit team will remain high over time?

Services and Industries

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