The Financial CHOICE Act, which has passed the House of Representatives and is awaiting Senate approval, contains a number of provisions that rollback some of the regulatory changes effected by the Dodd-Frank Wall Street Reform and Consumer Protection Act and amend securities law exemptions and disclosure rules, private equity fund formation, recordkeeping and reporting rules and bank regulations. The Senate may modify the Act or pass alternative financial reform legislation that would need to be aligned with the Financial CHOICE Act through a House and Senate conference committee. Regardless of the ultimate resolution of this legislative effort, the Financial CHOICE Act contains a number of provisions that offer salutary reforms to securities, fund formation and management and banking laws that deserve due consideration by Congress in its ultimate action on the legislation.
According to the U.S. Chamber of Commerce Foundation, the number of public companies in the U.S. has declined by over 50% over the past two decades from 7,332 in 1996 to 3,200 in 2015. Stated on a per capita basis, the number of U.S. companies dropped from 2.7 public companies per capita in 1996 to 1.1 public companies per capita in 2015. This decline has been attributed in large measure to the increase in the cost, complexity and time burden of regulatory compliance with securities laws and regulations resulting from the adoption of the Sarbanes-Oxley Act of 2002 and Dodd-Frank.
The Financial CHOICE Act contains several notable amendments to public company disclosure, governance, registration eligibility and proxy requirements that merit consideration for passage or alternative legislation by the Senate. If a number of these securities law changes are ultimately enacted into law, some of the legal disincentives to make use of the public capital markets may be reduced or eliminated. Those amendments include:
- Exemption from Internal Controls Evaluation. Issuers with market capitalizations of less than $500 million and depository institutions with assets of less than $1 billion would be exempt from the Sarbanes-Oxley Act of 2002 requirement of an independent auditor evaluation of internal controls. This would have the effect of increasing the current exemption that is available to public companies with market capitalizations of less than $75 million and emerging growth companies. According to a January 3, 2017 article by the Financial Executives Institute, 61 % of the respondents to a June 2016 survey, conducted by The SOX & Internal Controls Professionals Group —a group of professionals involved in implementing and managing Sarbanes-Oxley compliance or internal controls—reported that their annual spend on Sarbanes-Oxley Act compliance and internal controls evaluations was $1.5 million or less and an additional 15% of the respondents reported spending over $1.6 million. As a result, smaller issuers could achieve substantial cost savings through the adoption of this exemption.
- Form S-3 Eligibility. Companies with exchange-listed securities would be eligible to use the short form Securities Act registration statement on Form S-3 in addition to companies with a non-affiliate market float of $75 million or more. This reform would recognize the general availability and use of web-based disclosure on the Securities and Exchange Commission’s EDGAR system for companies that achieve either the $75 million public float threshold or have exchange-listed securities.
- Say- on-Pay and Say-on-Frequency. The Securities Exchange Act requirement for a say-on- pay vote would be changed from at least triennially to each year in which there has been a material change in executive compensation. The say-on-frequency vote requirement to hold a shareholder vote at least once every six years as to whether say-on-pay votes should occur annually, biannually or triennially would be eliminated. This change appears to involve a conversion from a prescriptive time-oriented approach to say-on-pay votes—an approach that mandates the precatory vote on executive compensation—to those times when compensation changes are effected.
- Shareholder Proposals. The eligibility standard for required inclusion of a shareholder proposal would be amended to require that the shareholder hold at least 1% of the issuer’s securities to be eligible to vote on the matter (rather than the lesser of $2,000 or 1% of securities) or such greater percentage as may be prescribed by the SEC, and to increase the shareholder’s required holding period for those shares from one to three years. Further, it would raise the shareholder vote thresholds for inclusion on previously failed and resubmitted shareholder proposals in public company proxy statements from 3% to 6% in favor if the proposal was proposed once within the past five years, from 6% to 15% if the proposal was proposed twice in the past five years and from 10% to 30% if the proposal was proposed three or more times in the past five years. The impact of these changes would be to weed out proposals that have been soundly defeated and to increase the minimum stakes and tenure needed for shareholders to be eligible to influence a public company’s governance. The eligibility threshold increases, in particular, may significantly decrease the number of shareholder proposals that a reporting company would be required to include in its proxy statements. Lastly, the Act prohibits the inclusion of proposals provided by a shareholder on behalf of another shareholder, thereby necessitating that the shareholder take action in its own name. This particular piece of the legislation would require shareholders to hold the requisite percentage of issuer stock in their own name, rather than beneficially, for at least three years and could have a chilling effect on shareholder proposals. This result would be welcomed by issuers while being viewed negatively by activists and advocacy groups.
- Universal Access. The Act would prohibit the SEC from requiring that a proxy solicitation for the election of directors use a single, or so-called universal, proxy that includes both the issuer’s slate of director nominees and an insurgent’s or activist’s slate on the proxy card and would allow shareholders to select among both groups of nominees in a contested election. This provision would set aside currently-proposed SEC rulemaking to adopt a universal proxy requirement.
- Clawbacks. The Act would limit the scope of executive officers subject to clawbacks of their compensation upon an accounting restatement. Under the current provision of the Securities Exchange Act, any current or former executive officer would be subject to the clawbacks. The Act would limit that scope to executive officers that had control or authority over the financial reporting that resulted in the accounting restatement. Although this section of the Securities Exchange Act was added by the Dodd-Frank Act, the SEC has not completed adoption of implementing rules.
- Repeals of Certain Governance Provisions of the Dodd-Frank Act. The Act also proposes to repeal a number of the more onerous provisions of the Dodd-Frank Act that pertained to corporate governance matters of reporting companies, several of which remain subject to final rulemaking. For instance, the conflict minerals rule—already under re-evaluation by the SEC—would be eliminated, as would pay ratio disclosure requirements, mine safety disclosures, disclosures regarding employee and director hedging and resource extraction disclosures. Many public companies have found these requirements to be burdensome, and further, many view these disclosure requirements as having limited utility to shareholders. The proxy access provisions of the Dodd-Frank Act, already largely vacated by the courts, would also be eliminated.
- XBRL. The Act would exempt emerging growth companies and companies with annual revenues under $250 million from the SEC’s requirements for XBRL coding of documents. This exemption would provide qualifying companies with relief from the cost and management oversight responsibilities of assuring compliance with the SEC’s interactive data format for tagging information in SEC filings.
The proposed changes to securities law disclosure, Form S-3 eligibility and proxy requirements for public companies represent a substantial step forward toward reducing the regulatory burden of the securities laws on public companies. Enactment of these changes into law could afford issuers substantial cost savings and a decreased regulatory burden. Those results could help to reverse the trend toward avoiding the public markets or listing on foreign markets, and increase the attractiveness of public market capital raising as a means to fuel company growth.
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