Perhaps it's time for some guidance to help understand the various forms of guidance the Securities and Exchange Commission is publishing these days.
The SEC has long published different forms of guidance to help corporate filers and the investing public understand its rules and procedures, with each guidance format carrying its own shade of formality, officiality, and legal application. The result is a mish-mash of various views, reasoning, and pronouncements that can be difficult for corporate issuers, securities lawyers, and others to wade through for direction.
The SEC has hinted in the past that it would work to simplify the many types of guidance, but that doesn't seem to be happening. Just this month the SEC introduced yet another form: the “CF Disclosure Guidance.” (The “CF” designates it as coming from the Division of Corporation Finance.) The first one addressed the topic of reporting reverse mergers and was labeled a “staff observation.”
The Division of Corporation Finance even issued a disclaimer with the guidance: “This guidance is not a rule, regulation, or statement of the Securities and Exchange Commission. Further, the Commission has neither approved nor disapproved its content.” In short, it's a helpful hint with no legal standing or SEC backing.
“This staff observation is used to highlight some of the more common mistakes made by companies. If they'd put this in the C&DI format, it would have gotten lost,” says Michael Littenberg, partner at law firm Schulte Roth & Zabel. (“C&DI” stands for “Compliance & Disclosure Interpretations,” yet another form of guidance, that reads like a Q&A form for fine points of corporate disclosure.)
Although SEC staff interpretations come in varieties of formats, each one serves a different purpose, and they are extremely helpful, says Carol McGee, partner at law firm Alston & Bird. “It's not the best situation given the different formats, but these interpretations are incredibly helpful to provide guidance to users,” she says.
Among the many layers of guidance are:
Compliance and Disclosure Interpretations. Issued by the SEC staff at the Division of Corporation Finance, C&DIs are the most easily understood format of all the guidance issued by SEC members. Interpretations of new and proposed rules are in question-and-answer form. Staff members use C&DIs for technical interpretation of rules based on fairly narrow questions asked by legal practitioners and companies. They highlight the more important features of new rules, such as definitions to determine who is subject to a rule, effective dates of rules, and how to comply with different requirements under the subsets of each rule.
“I am not a huge fan of the single format. One-size-fits-all does not work especially when you are dealing with different aspects of regulations.”
—Michael Littenberg,
Partner,
Schulte Roth & Zabel
CF Disclosure Guidance or Staff Observation. Guidance on disclosure to a broad group of issuers who have all committed the same error in their filings to the SEC. Common mistakes are highlighted in this type of guidance.
Staff Financial Reporting Manual. In theory, this is an internal reference document to help Division of Corporation Finance staff study issuers' filings. In reality, it also gives filers themselves insight into how the SEC staff interpret their own rules. While the manual comes with a warning that it should not be used to interpret SEC rules, its regular updates provide a good Staff Accounting Bulletin. “SABs” are staff guidance to deal with accounting methods required in SEC regulations. SEC staff will provide the entire paragraph of the rule that asks for accounting measures to be in place, give an example of a hypothetical situation, and use the language of the regulation to demonstrate how accounting transactions should be recorded based on the situation.
DETERMINING WAIVERS
The following excerpt from the SEC's 'Statement on Well-Known Seasoned Issuer Waivers' outlines the Commission's framework for determining waivers:
We will consider the factors outlined below when we evaluate the appropriateness of granting a waiver from ineligible issuer status. A waiver, which could include conditions or undertakings, may be granted if a review of all of the facts and circumstances in light of the factors outlined below leads us to conclude that granting a waiver would be consistent with the public interest and the protection of investors.
Nature of the Anti-fraud Violation
In determining whether a waiver should be granted, we will consider two threshold factors relating to the nature of the anti-fraud violation: first, whether the anti-fraud violation stems from the issuer's own disclosures about itself; and second, whether the anti-fraud violation is scienter based. Our focus is on the reliability of the issuer's current and future disclosures. If the anti-fraud violation does not involve the issuer's own disclosures—for example, the issuer is a broker-dealer, and the anti-fraud violation stems from its broker-dealer activity, not from material misstatements or omissions in its own filings—then it may be less likely to cast doubt on the reliability of the issuer's current and future disclosures. In this case, a waiver request would likely be granted, even if the anti-fraud violation is scienter based.
On the other hand, if the anti-fraud violation involves the issuer's own disclosures, then it more directly raises questions about the reliability of the issuer's current and future disclosures. In addition, if the issuer's conduct in making material misstatements or omissions was intentional or reckless, then the likelihood of its future disclosures not being reliable may be greater than if the issuer's conduct was not intentional or reckless. Consequently, absent exceptional circumstances, a waiver request involving an anti-fraud violation that is scienter based and stems from the issuer's own disclosures would likely not be granted. If the anti-fraud violation is not scienter based, then we will consider the request in light of the following additional factors.
Non-Scienter Based Anti-fraud Violation Involving Issuer Disclosure
If the anti-fraud violation is not scienter based and stems from the issuer's own disclosures, then we will consider factors such as those outlined below in deciding whether to grant the waiver. No single factor is determinative.
Remedial Steps Taken by the Issuer. We will consider the remedial measures the issuer has taken to prevent a recurrence of the misconduct, including changes in key personnel, undertakings specifically designed to prevent future fraudulent disclosures, improvements to internal controls and disclosure controls and procedures and disclosures about those improvements. The effectiveness of these actions would help support a conclusion that, despite past violations, the issuer's disclosures to the markets would be more likely to be reliable in the future.
Pervasiveness and Timing of the Misconduct. We will look at the seriousness and pervasiveness of the misconduct by the issuer and its officers, directors and employees, including the culpability of individuals and the age of the misconduct. Fraudulent conduct and disclosures resulting from the actions of a few individuals not in positions of authority or leadership could create fewer questions about the reliability of an issuer's future disclosures than a pattern or history of misconduct by senior management or a culture or tone at the top demonstrating a lack of commitment to good disclosure. Changes in personnel would also be relevant to this factor. Likewise, older misconduct could create fewer questions about the reliability of an issuer's future disclosures than more recent misconduct.
Impact on the Issuer If the Waiver Request Is Denied. We will weigh the severity of the impact on the issuer if the waiver request is denied against the facts and circumstances of the anti-fraud violation to assess whether the loss of WKSI status would be a disproportionate hardship in light of the nature of the issuer's misconduct. We will also look at whether the issuer's loss of WKSI status could have harmful effects for the markets as a whole, in light of the issuer's significance to the markets and its connectedness to other market participants, in considering whether a waiver would be consistent with the public interest and the protection of investors.
Source: SEC Statement on Well-Known Seasoned Issuer Waivers.
Staff Legal Bulletin. The legal bulletins explain legal terminology used in particular rules and general and specific requirements to comply with the law, and they indicate mistakes companies often make in their filings based on the staff's experience dealing with those requirements. Similar to SABs, in a legal bulletin the rule is laid out in the initial paragraph followed by additional explanation to clarify the definition used. Charts showing a compilation of no-action requests by companies and the staff's responses are listed for referral.
Other Material. Aside from those major forms of guidance are various other missives: no-action letters, SEC comments on corporate filings, and other correspondence (the “Dear CFO” open letter, for example). And don't forget the speeches and testimony of SEC officials and precedent-setting enforcement actions.
And There's More
Even inside particular types of guidance, formats differ. For example, C&DIs are usually in Q&A style, but in July the SEC published a statement about Well-Known Seasoned Issuer waivers published more as an explanatory statement than Q&A. The language was similar to language used in official regulations published in the Federal Registrar.
Legal practitioners familiar with the staff interpretation document say although the WKSI statement is an entirely different format of guidance issued by the SEC, the layout fit the purpose to share the SEC's information on policy issues. The document is used to present the SEC's policy statement and to demonstrate how it will exercise authority provided under a 2005 regulation to grant waivers to those who meet the exemption guideline.
Commenting on the WKSI statement, McGee says although the pronouncement restates everything on the rule, staff at the Division most likely used that format because of the stringent guidelines imposed by the original rule. “The staff is trying to tell the people who asked questions on the waiver's eligibility: this is what the rules say, this is what you should do, and do not bother to put in anything else,” she says.
No-action letters and other written correspondence between the SEC and companies play an important part in relaying the SEC's positions, especially in specific circumstances. Companies can present precise information to staff members and highlight the unique problems they face. Staff members, in turn, review the questions, consider the language used in the regulation, and provide the answer in a simple letter format.
Some corporate lawyers say they are not bothered by the multiple layers of guidance, which they say is necessary to convey different points. “I think it's important to keep in mind that many of the correct answers to the questions the staff answers are fact-specific. It is a very difficult task to efficiently provide transparent guidance that can be applied generally,” McGee says. Guidance given in a single, universal format might be easier to understand, she says, but reality imposes its own constraints on that idea.
Littenberg says he prefers the multi-format approach, as different formats are required to better address different topics. “I am not a huge fan of the single format. One-size-fits-all does not work, especially when you are dealing with different aspects of regulations,” he says. He adds that the staff interpretations have been written in plainer language in recent years, and guidance's availability online makes it that much more helpful to users.
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