Update: California State Assembly Passes AB 3129 Requiring State Approval of Private Equity Healthcare Deals
California’s AB 3129, which would require private equity firms and hedge funds to obtain prior approval to consummate certain healthcare-related transactions, is now one step closer to becoming law following the State Assembly’s May 22, 2024 passage of the pending legislation. The legislation is now being considered by the California State Senate, where approval must be obtained prior to the end of the legislative session in August if it is to be enacted into law this year.
As previewed in our prior blog post, if enacted, AB 3129 would require private equity firms and hedge funds to file an application with the state Attorney General at least 90 days in advance of a transaction involving the acquisition or change of control of healthcare facilities and provider groups and in most cases, await approval to close the transaction. Furthermore, the bill would place significant restrictions on the ability of private equity and other investors to implement “friendly PC-MSO” and similar arrangements, which are widely used today by stakeholders as an investment structure to avoid violating California’s prohibition on the corporate practice of medicine.
While the bill has not yet been enacted into law, the State Assembly’s passage of the bill does represent positive momentum for proponents of the legislation, and stakeholders should be aware of the legislation’s broad implications on the structuring and consummation of healthcare-related transactions in the state.
A Ticking Time Bomb—Universal Injunctive Relief at Risk – SCOTUS Today
The U.S. Supreme Court has stayed the nationwide injunction that had been blocking the enforcement of the Corporate Transparency Act (CTA) while the merits of the CTA are pending a decision in the U.S. Court of Appeals for the Fifth Circuit, which will hear oral argument on March 25 in McHenry v. Texas Top Cop Shop, Inc.
The CTA requires more than 32 million existing businesses to disclose their beneficial owners. That number is expected to grow by five million new businesses per year. Texas Top Cop Shop, a firearms retailer, has challenged the CTA’s constitutionality.
During this interim period, it is unclear what, if any, action the Treasury Department’s Financial Crimes Enforcement Network (FinCEN) will take. Today’s decision does not reinstate the previous January 13 filing deadline. Throughout the tortured history of this case, FinCEN has updated earlier compliance deadlines, but with a new administration, it is possible for the agency to await the action of the Fifth Circuit, which many believe is a commodious environment for firearms purveyors. Others stress the importance of a law designed in part to disclose foreign and domestic criminals who use anonymous U.S. companies to launder profits from drugs such as fentanyl or mask cybercrime-related transactions.
The purpose of this post is not to give legal advice but to describe important developments in the law. We do recommend that affected businesses consult with their own counsel as they survey the road ahead. We also caution, with respect to this current chapter in the life of the CTA, that there is a ticking time bomb that not only might undermine the enforcement of this act but also might augur fundamental change to the remedies available across administrative law writ large.
The Supreme Court’s order is a simple one, occupying eleven lines of text. What follows that text, also concise, is potentially more important. Justice Jackson dissented from the grant of the stay, believing that imminent injury is unlikely given the expedition being offered in the Fifth Circuit. However, the more impactful statement is that of Justice Gorsuch, who concurred in the granting of the stay. In doing so, he stated that he not only agreed “that the government is entitled to a stay of the district court’s universal injunction” [emphasis added], but that he would “go a step further and . . . resolve definitively the question whether a district court may issue universal injunctive relief.”
The issue of the geographic scope of injunctive relief has been discussed before in this blog and elsewhere, but Justice Gorsuch is attempting to give it new energy.
With what many observers think will be the retirement of at least one justice during the new Trump term and President Trump’s likely appointment of a significantly right-of-center successor adding to that leaning in the Court, it is not improbable for Justice Gorsuch’s preference to gain sufficient traction to provide at least the necessary four votes to grant cert. in a given case, and maybe a fifth vote to set off the decisional explosion. This is an issue upon which I’d place the “to be confirmed” warning label.
The Path & The Practice Podcast Episode 120: Akshay Verna, COO (Spotdraft) [Podcast]
This episode of The Path & The Practice features a conversation with special guest Akshay Verma. Akshay is COO at Spotdraft. In this discussion he details a path that began in New Delhi, India. He reflects on a childhood passion for sports and pop culture and details his journey, including his decision to attend UC Berkeley for undergrad, working as a paralegal in big law before attending Santa Clara University School of Law, and then beginning his career as an environmental lawyer. Akshay reflects on pivoting from legal practice to the business side of law, including the years he spent as the head of legal operations a Meta. Akshay reflects on the role of legal operations professionals and gives wonderful advice on the importance of embracing feedback.
Akshay’s Profile:
Title: Chief Operating Officer
Company: Spot Draft
Hometown: San Francisco, CA
College: UC Berkeley
Law School: Santa Clara University School of Law
Fifth Circuit Vacates SEC’s Approval of Nasdaq’s Diversity Rules
On December 11, 2024, the US Court of Appeals for the Fifth Circuit ruled that the Securities and Exchange Commission (SEC) lacked statutory authority to approve Nasdaq’s board diversity rules. Subject to certain exceptions, the diversity rules required, among other things, that Nasdaq-listed companies publicly disclose the demographic makeup of their boards of directors, and that boards with five or more directors include at least two “diverse” directors.
Fifth Circuit’s Ruling in Alliance for Fair Board Recruitment v. SEC
In its majority opinion, the Fifth Circuit held that the Nasdaq diversity rules were unrelated to the purpose of the Securities Exchange Act of 1934 and, as such, the SEC had no authority to approve the diversity rules. The court reasoned that US Congress enacted the Exchange Act specifically to protect investors in securities by establishing a regulatory oversight regime. Thus, the authority granted to the SEC under the Exchange Act is limited to the prevention of fraud and misrepresentation or concealment of material financial risks, and to stabilize the market from speculation-driven instability.
The SEC argued that the Exchange Act was also intended to remove barriers to the open market and promote justice and equitable trade principles, but the court held that if Congress intended to grant the SEC authority to impose such demographic regulations, the Exchange Act would have stated so explicitly.[1]
Nasdaq’s Proposed Diversity Rule
Nasdaq filed its proposed diversity rules with the SEC on December 1, 2020, and the diversity rules were approved by the SEC on August 6, 2021. The diversity rules, subject to certain exceptions, required a Nasdaq-listed company with five or more directors to:
Establish a board with at least one director who self-identifies as female and one director who self-identifies as Black or African American, Hispanic or Latinx, Asian, Native American or Alaska Native, Hawaiian or Pacific Islander, two or more races or ethnicities, or as LGBTQ+.
Submit an explanation for its lack of compliance if a company’s board does not meet such requirements.
Submit public disclosures detailing the demographic composition of its board.
What Is Next?
In a December 12, 2024, statement, Jeff Thomas, Nasdaq’s Global Head of Listings, confirmed that Nasdaq will not seek to appeal the decision, and that companies seeking Nasdaq listing or listed on the Nasdaq stock markets will not need to comply with the diversity rules. However, the SEC may seek to appeal the Fifth Circuit’s decision to the US Supreme Court, though it remains unclear whether the Supreme Court would agree to consider the case. Congress could also consider amending the Exchange Act, enabling the imposition of board diversity requirements.
Takeaways
Absent a reversal by the Supreme Court or new legislation passed by Congress, Nasdaq-listed companies will no longer be required to adhere to the requirements of the diversity rules and may establish board compositions at their discretion. However, publicly held corporations should expect ongoing scrutiny related to their diversity, equity, and inclusion initiatives generally.
[1] Loper Bright Enterprises v. Raimondo, 603 US 369 (2024).
Maria Ortega Castro also contributed to this article.
The State of Play for Reverse Stock Splits by Nasdaq- and NYSE-Listed Issuers
Introduction
Issuers listed on the Nasdaq Stock Market and the New York Stock Exchange (NYSE) often conduct reverse stock splits to maintain compliance with each exchange’s US$1.00 minimum share price requirement. A reverse stock split typically increases the price for a share of stock by consolidating outstanding shares at a ratio selected by the issuer such that, following the reverse split, each stockholder maintains its approximate ownership percentage and overall investment value, but the issuer has fewer shares outstanding with a higher price per share. Over the past several years, Nasdaq has implemented a series of rule changes making it more difficult to use reverse stock splits to regain compliance with its minimum share price requirement and that otherwise impact the process for executing a reverse split. Recently, the NYSE proposed a new rule of its own that restricts an issuer’s ability to use a reverse split to regain compliance with its minimum share price requirement. Issuers with stock prices near or below US$1.00 per share need to understand how these rule changes may affect whether, when, and how they can implement a reverse stock split to maintain their stock exchange listings.
Nasdaq Stock Market Rules
A Nasdaq-listed issuer’s primary equity security must maintain a minimum bid price of US$1.00. If the trading price of a primary equity security closes under US$1.00 per share for 30 consecutive business days, the issuer will generally have 180 days to regain compliance with the minimum bid price requirement. At the end of the 180-day compliance period, the issuer can be granted an additional 180-day compliance period by notifying Nasdaq of its intent to cure the deficiency, including by effecting a reverse stock split. Prior to recent rule changes, if the issuer had not cured the minimum bid price deficiency by the end of the second compliance period, it could appeal delisting of its stock by requesting a review by a hearings panel. Such a request would automatically stay any suspension or delisting action, up to an additional 180 days, pending the hearing and the expiration of any additional compliance period granted by the hearings panel following the hearing. Under the prior Nasdaq rules, it was possible for a company to be out of compliance with the bid price requirement for 540 days, or approximately 18 months, if all the possible compliance periods were exhausted.
Removal of Stay Period After Second 180-Day Compliance Period
Nasdaq’s most recent rule change relating to reverse stock splits was approved by the US Securities and Exchange Commission (SEC) on 17 January 2025. Under the new Nasdaq Listing Rule 5815(a)(1)(B)(ii)d, when an issuer has been afforded a second 180-day compliance period and does not regain compliance by the bid price of its stock closing at US$1.00 per share or greater for a minimum of 10 consecutive business days prior to the end of the second 180-day period, a request for a hearing no longer stays the suspension and delisting of the security pending the Nasdaq panel’s decision. Instead, effective upon the expiration of the second 180-day compliance period, trading of the issuer’s securities on Nasdaq will be automatically suspended and move to the over-the-counter (OTC) market while any appeal is pending.
Reduced Availability of Compliance Periods for Use of Multiple Reverse Splits
An amendment to Nasdaq Listing Rule 5810(c)(3)(A)(iv) included in the 17 January 2025 rule changes provides that an issuer is not eligible for any compliance period to cure a deficiency under the minimum bid price requirement if it has effected a reverse stock split over the prior one-year period. This change follows another recent amendment to Rule 5810(c)(3)(A)(iv), effective in 2020, not allowing a compliance period in the event the issuer has effected one or more reverse stock splits with a cumulative ratio of 250 shares or more to one during the two-year period preceding noncompliance with the minimum bid price requirement. Any issuer that receives a delisting determination under these circumstances can appeal for a hearing before a Nasdaq panel (during which time the suspension of trading of its securities will be stayed).
Accelerated Delisting for Trading Price at or Below US$0.10
Rule 5810(c)(3)(A)(iii), which was included in the 2020 rule changes, provides that Nasdaq will issue a delisting determination with respect to a security that has a closing share price of US$0.10 or less for 10 consecutive business days. Under these circumstances, the issuer is ineligible for any compliance period, but suspension of trading of its securities will be stayed while any appeal is pending.
Updated Process for Effecting Reverse Stock Split
In November 2024, the SEC approved an amendment to Nasdaq Listing Rules 5250(e)(7) and IM-5250-3, advancing the deadline by which an issuer executing a reverse stock split must submit a Company Event Notification Form to Nasdaq to no later than 12:00 PM ET at least 10 calendar days prior to the proposed market effective date of the split. Previously, the rules only required the form to be submitted five business days in advance. The Company Event Notification Form is required to include, among other things, the dates of board approval and stockholder approval of the reverse stock split, the ratio for the reverse stock split, and the new CUSIP number for the post-split stock, as well as a draft of the public disclosure of the reverse stock split, which must be issued by 12:00 PM ET at least two business days prior to the effective date of the split. Nasdaq will not process a reverse stock split, and will halt trading in the stock, if an issuer does not satisfy the requirements of Rules 5250(b)(4) and (e)(7). This amendment becomes effective on 30 January 2025.
New York Stock Exchange Rules
Under Section 802.01C of the NYSE Listed Company Manual (Manual), an issuer is out of compliance if the average closing price of its listed security is less than US$1.00 per share over a consecutive 30 trading-day period (Price Criteria). The issuer can regain compliance with the Price Criteria if, on the last trading day of any calendar month during a six-month cure period, the listed security has a closing share price of at least US$1.00 and an average closing share price of at least US$1.00 over the prior 30 trading-day period. If an issuer determines to cure the Price Criteria deficiency by a reverse stock split, it must obtain shareholder approval by no later than its next annual meeting. The Price Criteria deficiency will be cured if the price remains above US$1.00 for at least 30 trading days following the split.
On 15 January 2025, the SEC approved a rule amendment proposed by the NYSE to address concerns over the excessive use of reverse stock splits to maintain minimum listing prices. Specifically, Section 802.01C of the Manual is amended to provide that an issuer that fails to meet the Price Criteria is not eligible for any compliance period if it has effected a reverse stock split over the past one-year period or has effected one or more reverse stock splits over the prior two-year period with a cumulative ratio of 200 shares or more to one, and in such case the NYSE will instead immediately commence suspension and delisting procedures. Additionally, the amendment precludes issuers from conducting a reverse stock split if it would result in the company’s security falling out of compliance with any of the continued listing requirements of Section 802.01A of the Manual.
Conclusion
Issuers listed on the Nasdaq or NYSE that are out of compliance with the minimum bid price rule or at risk of falling below a US$1.00 share price should be proactive in confirming that a reverse stock split will be effective to cure the deficiency in the event that their stock price does not increase organically. Additionally, these issuers should prepare a timeline for the reverse stock split prior to scheduling their shareholder meetings in order to accommodate the more complex processes and advance notice requirements under stock exchange rules.
Identity Verification—What You Need to Know
Background
The Economic Crime and Corporate Transparency Act 2023 (the Act) seeks to prevent economic crime and to enhance the transparency of companies and other legal entities.
It is part of a wider policy of government to tackle corporate abuse, money laundering, fraud and identity theft. The Act provides greater powers to the registrar of companies (the Registrar) and (together with the Economic Crime (Transparency and Enforcement) Act 2022) underpins the government’s commitment to strengthen the corporate registration framework and transform the role of Companies House.
Identity Verification
A key component of the reforms set out in the Act is the introduction of an identity verification regime, with the objective of improving the accuracy and reliability of the information held by the Registrar and preventing fraudulent appointments.
Who Will Be Subject to the Identity Verification Process?
New and existing company directors, people with significant control of a company (PSCs)1 and those presenting documents for filing at Companies House will need to comply with the provisions of the Act and verify their identity with the Registrar.2
How to Comply With Identity Verification
There are two methods for complying with identity verification:
Directly with Companies House; and
Indirectly through an authorised corporate service provider (ACSP).
Direct verification with Companies House will be, in the main, via a digital service and the verified person will be linked to a document such as a passport or driving licence (a primary identity document). Technology will be used to match a photograph taken by the individual to their likeness in the primary identity document. Companies House will provide alternatives for those without access to, or otherwise unable to use, the digital service.
Indirect verification will involve using a third party such as a legal adviser or formation agent authorised by the Registrar as an ACSP. The ACSP regime requires such third parties to be registered with a supervisory body for anti-money laundering purposes (for example, the Solicitors Regulation Authority for solicitors in England and Wales) and, therefore, have an existing obligation to conduct due diligence on their clients. An ACSP will be able to provide a service to verify the identity of those individuals subject to the regime. ACSPs must carry out verification in accordance with the required standards set out in legislation and this must be confirmed in a statement by the ACSP to the Registrar.
An individual (including an ACSP) will be given a unique identifier number once verified. It is expected that individuals will only be required to verify their identity once (unless Companies House requires otherwise) but individuals will need to confirm their identity for each new appointment.
When Do the Identity Verification Provisions Come Into Effect?
Companies House published a policy paper on 24 October 2024, outlining a transition plan for the changes set out in the Act with the following expected timelines in relation to identity verification (the timeline is subject to parliamentary time being available):
By spring 2025, introduce the first steps to allow professional service providers to register to become ACSPs. This will allow them to carry out identity verification services for their clients. Additionally, Companies House will allow individuals to complete voluntary identification verification.
By autumn 2025, commence the new identity verification requirements where all directors and PSCs for new incorporations will be required to verify their identity as part of the incorporation process. Identity verification will also be compulsory for all newly appointed directors and new PSCs. There will be a transition period of 12 months for existing directors of existing companies to comply with identity verification (companies will be required to provide identity verification credentials for their directors when their confirmation statement is due) and existing PSCs will also be subject to identity verification by way of transitional arrangements.
By spring 2026, Companies House will require identity verification for those presenting documents for filing (including the requirement for a third-party service provider filing on behalf of a company to be registered as an ACSP).
By the end of 2026, it is expected that the transition period will be completed for all those subject to the identity verification regime and Companies House will start sanctions for any noncompliance.
Next Steps
The Act introduces some of the most significant changes to Companies House since corporate registrations were established and the identity verification regime is a key part of the reforms.
Companies should prepare by ensuring that the board is up to date with the timetable for the reforms and ensure that directors, PSCs (and relevant officers of relevant legal entities and those presenting documents for filing at Companies House have identity documentation readily available.
Footnotes
1 The identity verification regime extends to relevant officers of registrable relevant legal entities (corporate PSCs).
2 It is anticipated that reforms applying to limited partnerships will be introduced no sooner than spring 2026 and are not covered in this alert.
Landmark Fifth Circuit Ruling Further Limits SEC Rulemaking
What Happened
On December 11, 2024, an en banc panel of the US Court of Appeals for the Fifth Circuit vacated the US Securities and Exchange Commission’s orders approving a series of Nasdaq rules regarding board diversity.[1] Beyond the immediate impact of the decision on board diversity efforts, the opinion will have far broader consequences for future rulemaking by self-regulatory organizations and the SEC itself. This alert considers the administrative law implications of the Fifth Circuit opinion on the SEC and the myriad of self-regulatory organizations it oversees.
The Bottom Line
Over the past 20 years, a series of appellate cases vacating SEC actions has placed a growing number of limitations on the agency’s ability to issue orders and engage in rulemaking. But the Fifth Circuit’s Nasdaq case stands out because it clarifies substantial limits around several commonly-accepted assumptions underlying SEC rulemaking that have to date largely gone unchallenged.
Since the case involves Section 19(b) of the Securities Exchange Act of 1934 (the “Exchange Act”), which lays out the procedure by which the SEC approves rules of self-regulatory organizations, the decision applies to a wide variety of SEC registrants who make use of the Section 19(b) process to issue their own rules and regulations. These entities include stock exchanges, clearing agencies, the Municipal Securities Rulemaking Board (“MSRB”), the Financial Industry Regulatory Authority (“FINRA”) and the Public Company Accounting Oversight Board (“PCAOB”). Of course, the SEC itself is also bound by the holding.
The Fifth Circuit opinion includes an exhaustive analysis of the Exchange Act from an historical, academic and textual perspective. The decision aligns with recent Supreme Court and Fifth Circuit precedent that seeks to preserve federalism, limit overreach by administrative agencies and construe statutes narrowly according to their plain meaning. Since courts typically interpret each of the SEC’s other primary statutes in a manner consistent with interpretations under the Exchange Act, the Fifth Circuit’s decision should also apply to rulemakings under the Securities Act of 1933, the Investment Advisers Act of 1940 and the Investment Company Act of 1940. This is a landmark administrative law case impacting the SEC and the self-regulatory organizations it oversees, and the case’s impact on future SEC rulemaking is significant.
The Full Story
In 2021, Nasdaq sought SEC approval under Section 19(b) of the Exchange Act of three separate listing requirements regarding board diversity. In two separate orders, the SEC approved new Nasdaq listing rules requiring most Nasdaq-listed companies to (1) publicly disclose board diversity statistics using a uniform format on an annual basis (the “Disclosure Rule”) and (2) have, or publicly disclose why they do not have, at least one self-identified female director and at least one director who self-identifies as an underrepresented minority (the “Diversity Rule”). A third SEC order approved a Nasdaq rule providing complimentary access to a board recruiting tool intended to aid Nasdaq-listed companies in complying with the first two rules (the “Recruiting Rule”).
Two groups challenged the SEC’s approval orders in separate litigation, alleging various statutory and constitutional infirmities. The petitions for review were eventually consolidated before the Fifth Circuit. In 2023, a three-judge Fifth Circuit panel denied the petitioners’ petitions for review and upheld the SEC’s approval of the Nasdaq rules.[2] But the Fifth Circuit subsequently granted en banc review, and the en banc panel reversed the panel decision by a vote of 9-8 (with one recusal). The full court’s majority vacated the Disclosure Rule and the Diversity Rule, and dismissed as moot the challenge to the Recruiting Rule since no companies had sought to use the recruiting tool. Nasdaq has stated publicly that it will not appeal the decision further, and with the change in presidential administrations, the SEC is not likely to take further action either. A summary of key portions of the opinion and key takeaways follows.
1. Disclosure for disclosure’s sake is not authorized under the Exchange Act
In its opinion, the Fifth Circuit first focused on the SEC’s assertion that any disclosure-based rule is related to the purposes of the Exchange Act, and thus within the SEC’s authority to adopt.[3] In response, the court undertook a detailed historical analysis of the underpinnings of the Exchange Act as enacted in 1934, as well as key amendments to the statute adopted in 1975 relevant to Nasdaq.
First, the court concluded that the “text and history of the original Exchange Act indicate Congress enacted it to protect investors and tackle the manipulation and speculation that Congress thought fueled the Great Depression.”[4] The Exchange Act also placed limits on solicitation of proxies to ensure fair elections for corporate boards.[5] But, according to the court, “nothing in the original Act required disclosure for disclosure’s sake.”[6] Instead, the court reasoned, the Exchange Act “was uniformly directed at preventing market abuses.”[7]
Next, the court determined that while Congress passed the original Exchange Act in 1934 “to protect investors and the American economy from speculative, manipulative and fraudulent practices,” it amended the statute in 1975 “to further these goals and . . . to remove barriers to the development of a national market system.”[8] The court conceded there may also be “other purposes buried in the Exchange Act’s voluminous text,” but that its review of the statute’s history “makes clear that disclosure of any and all information about listed companies is not among them.”[9] Thus, the court concluded that before the SEC approves an SRO rule, “it must do more than posit that the rule furthers some ‘core disclosure purpose’ that is found nowhere” in the Exchange Act.[10] Instead, the SEC must establish that the rule has “some connection to an actual, enumerated purpose of the Act.”[11] Later in the opinion, the court revisited this theme to double-down on the notion that “full disclosure” by itself is not a “core purpose” of the Exchange Act.[12]
Key Takeaways: In recent years, the subject matter of SEC disclosure requirements for public companies has expanded markedly through rulemakings involving a range of topics including cybersecurity, executive compensation, greenhouse gas emissions, climate change, and human capital, to name just a few. Among the justifications for each of these rulemakings has been the notion that the Exchange Act is a disclosure statute, and while there is a theoretical limit to the outer reaches of disclosure, the SEC has yet to reach that frontier. This case will require a fundamental rethinking of this line of reasoning and a redrawing of that outer boundary. It will, therefore, limit future SEC disclosure rules.
2. The purposes of the Exchange Act are narrowly construed
To support the rules, the SEC contended that they were designed to “promote just and equitable principles of trade” and “remove impediments to and perfect the mechanisms of a free and open market and a national market system,” each as contemplated in Section 6(b)(5) in the Exchange Act. Analyzing academic literature, SEC releases, other caselaw and even Webster’s dictionary to place these phrases in context, the court concluded that the Disclosure Rule and Diversity Rule were “far removed” from just and equitable principles of trade, and “had nothing to do with the execution of securities transactions.”[13] Notably, the court cited the Supreme Court’s recent decision in Loper Bright Enterprises v. Raimondo, which eliminated so-called Chevron deference, for the proposition that statutes can only be “sensibly understood . . . by reviewing text in context.”[14]
Key Takeaways: The federal securities laws are replete with aspirational and mystical-sounding terminology such as “just and equitable principles of trade” and “to protect investors and the public interest.” While there have been some prior cases attempting to assign meaning to such wording, the SEC often deploys an “I know it when I see it” approach to interpreting these and similar phrases in its authorizing statutes, and over the years few of its orders doing so have been subject to judicial review. Here the court took the SEC to task and concluded that this kind of terminology indeed has a more precise meaning.
3. To “protect investors and the public interest” is not independent grounds to act
The SEC also pointed to its mandate under the Exchange Act to “protect investors and the public interest” to justify the rules. In perhaps the most important section of the opinion, the court determined that this phrase is a “catch all” phrase that must be interpreted by references to the canons of noscitur a sociis (“a phrase is given more precise content by the neighboring words with which it is associated”) and ejusdem generis (“a general or collective term at the end of a list of specific items is typically controlled and defined by reference to the specific items that precede it”).[15] When read in the context of the other language surrounding the public interest provision in the Exchange Act, the court concluded that the Disclosure Rule and Diversity Rule were not related to that purpose. The court was also skeptical of the SEC’s rationale that simply satisfying “the demand of some important investors” was stand-alone grounds to justify rulemaking, and it rejected that argument as well.[16]
Key Takeaways: The SEC has frequently justified past rulemakings on the grounds that an action was in the public interest. For example, the agency’s controversial rulemaking on climate and greenhouse gas emissions (subject to a pending Eighth Circuit challenge) cites this provision as authority for those rules. The Fifth Circuit’s opinion here suggests that this justification, without more, may be insufficient. Likewise, in recent rulemakings the SEC has also cited investor demand as compulsion for the SEC to act, and that too may not survive future judicial scrutiny.
4. The major questions doctrine applies to the SEC
The court’s opinion also considered the application of the major questions doctrine under the Supreme Court’s 2022 decision in West Virginia v. EPA and its rapidly-expanding progeny. In brief, this doctrine generally provides that absent an express grant of authority, Congress does not impliedly grant administrative agencies the power to make decisions regarding significant political or economic issues. Parties challenging SEC rulemaking have increasingly cited the doctrine since the West Virginia decision was announced, and in this decision the Fifth Circuit provided a robust analysis of the application of the doctrine to SEC rulemaking.
Here, the court considered the significant economic and political implications of the Nasdaq rules and quickly concluded “this is a major questions case.”[17] The court was particularly concerned that the SEC appeared to be “stepping outside its ordinary regulatory domain of market manipulation and proxy voting and intruding into the province of other agencies.” The court was also troubled that the SEC appeared to be intruding on the rights of states to regulate corporate governance.[18]
Key Takeaways: The major questions doctrine as applied to the SEC will without a doubt cabin the agency’s most ambitious plans for future rulemaking when planned actions lack explicit statutory authority. This outcome will be a welcome development for those who wish the SEC to return to its roots as a market-oriented regulator that focuses its disclosure agenda on material financial information. Those who wish to see the SEC continue to expand its oversight of corporate behavior may be disappointed.
The Fifth Circuit’s deference to the states’ role as the primary regulators of corporations is also notable. Since the enactment of the Sarbanes-Oxley Act in 2002, the SEC has increasingly asserted itself into core areas of corporate governance, such as through the constant expansion of the universe of permissible shareholder proposals under Rule 14a-8 and ever-increasing “comply or explain” disclosure requirements around board and management oversight of the business. As described below, the Fifth Circuit also addressed comply-or-explain rules in its opinion. In total, the ruling may serve as an opportunity for the SEC to reconsider existing mandates regarding corporate governance couched as disclosure requirements.
5. Two wrongs don’t make a right
In defense of the rules, the SEC and Nasdaq cited another stock exchange’s listing requirement regarding board diversity. The Fifth Circuit was not persuaded that the prior rule justified the one before the court. Instead, it noted that the “SEC cannot nullify the statutory criteria governing exchange rules by repeatedly ignoring them.”[19] Said differently, an agency “cannot acquire authority forbidden by law through a process akin to adverse possession.”[20]
Key Takeaways: Another common defense of recent SEC rulemakings has been that the SEC has passed similar rules in the past without challenge, hence it is free to do so again in the future. This line of reasoning is also suspect going forward. Instead, the SEC must find independent authority and justification for each future rule and order.
6. Public-shaming rules are suspect
The SEC and Nasdaq also defended the rules by arguing that they were mere disclosure rules that did not seek to “remake the boardrooms of America’s corporations.”[21] The court found that the administrative record did not support this assertion, and noted that corporations not meeting the diversity requirements were compelled to explain themselves under the Disclosure Rule. The court seemed most troubled by this latter point, ruling that this approach was not a disclosure requirement, but rather “a public-shaming penalty” for failing to abide by the government’s preferred policy outcomes.
Key Takeaways: For decades the SEC has adopted rules under the “comply or explain” model as a way of nudging registrants to engage in the SEC’s preferred behavior even when the agency may not be authorized to compel that conduct directly. The theory is that most companies would rather not disclose a lack of alignment with the SEC’s preferred practice on a given topic (even if compliance is not mandatory), thus they will change behavior so as to avoid a potentially embarrassing disclosure. This case calls into question the “comply or explain” approach, at least when there is a shaming element to it, and may serve to limit its use going forward.
[1] Alliance for Fair Board Recruitment v. SEC, Case No. 21-60626 (5th Cir. Dec. 11, 2024) (en banc decision).
[2] Alliance for Fair Board Recruitment v. SEC, 85 F. 4th 226 (5th Cir. 2024) (panel decision).
[3] Slip Op., supra note 1, at 11.
[4] Id. at 17.
[5] Id.
[6] Id.
[7] Id.
[8] Id. at 22.
[9] Id.
[10] Id.
[11] Id.
[12] Id. at 38
[13] Id. at 25-7.
[14] Id. at 26 (internal citations omitted).
[15] Id. at 28 (internal citations omitted).
[16] See id. at 31.
[17] Id. at 34.
[18] Id. at 35.
[19] Id. at 38.
[20] Id. (citations omitted).
[21] Id.
FCA Consults on Second Phase of Enforcement Investigation Proposals
Following the UK Financial Conduct Authority (FCA)’s February 2024 consultation on changes to its Enforcement Guide and publicising enforcement investigations (CP 24/2) (First Consultation), the FCA has issued a further consultation on its proposals in November 2024 (CP 24/2, part 2) (Second Consultation). The Second Consultation sets out changes to the FCA’s initial proposals in response to feedback from the First Consultation.
Background
The First Consultation outlined the FCA’s proposed changes to how it publicises its enforcement investigations. The FCA aims to increase transparency about its enforcement work and its deterrent effect, and to disseminate best practice. The FCA also proposed wider changes to its Enforcement Guide to reduce duplication and make information about its processes more accessible.
Many stakeholders considered the proposals set out in the First Consultation to be somewhat controversial, sparking a high volume of comments and concerns. Chapter 2 of the Second Consultation summarises the common issues raised in responses to the First Consultation.
Since the First Consultation closed to responses on 30 April 2024, the FCA has been extensively engaging with stakeholders and responding to requests for information from parliamentary committees. In an oral evidence session before the House of Lords Financial Services Regulation Committee, Nikhil Rathi, FCA Chief Executive, and Ashley Alder, FCA Chair, noted the FCA recognised the strength of feedback and would be seeking further consultation on “fundamentally reshaped” proposals.
Second Consultation
In response to feedback, the FCA recently launched the Second Consultation setting out revised proposals in an attempt to address the concerns raised and provide clarity on the proposals.
In particular, the Second Consultation made a number of key changes to the original proposals:
Negative Impact Considerations. The FCA proposes to consider the negative impact (such as reputational risks) of a firm when considering the public interest test of whether the firm shall be named and announcement of the investigation.
Public Confidence Considerations. The FCA will have regard to any serious disruption to the public confidence of the UK financial system in relation to public interest considerations of investigation or enforcement announcements.
Staged Consideration. The FCA will provide its public interest consideration at each stage of the announcement process, including whether there should be any announcement at all, when the announcement should be made and details in the announcement.
Greater Notice to Firms. The firm under investigation will have ten days’ notice ahead of any public announcements and an additional two days’ notice if the FCA proceeds with any announcement, which is a significant increase compared to the one day’s notice to firms under the First Consultation.
Proposal Timelines. The FCA also confirmed that once the proposals are in effect, it will not make any proactive announcements in relation to ongoing investigations at the time, but may provide confirmation of ongoing investigations upon enquiries where the public interest test is satisfied.
Next Steps
The Second Consultation closes on 17 February 2025. The FCA Board expects to take a decision on the revised proposals in Q1 2025.
The First Consultation, Second Consultation and transcript of oral evidence session are available here, here and here, respectively.
Larry Wong contributed to this article.
A Look at the Sustainability Aspects of the EU-Mercosur Free Trade Agreement
In December 2024, the EU and the Southern Common Market (Mercosur), which comprises of Argentina, Bolivia, Brazil, Paraguay and Uruguay,concluded negotiations on an EU-Mercosur partnership agreement, with the deal creating a free trade agreement (FTA) between the regions.The EU-Mercosur FTA follows an ongoing EU policy to negotiate sustainability provisions for EU FTAs.
Chapter on Trade and Sustainable Development
The FTA incorporates a chapter on Trade and Sustainable Development (TSD chapter) containing labour and environmental provisions that are strongly based on the existing multilateral frameworks (e.g. conventions of the International Labour Organization (ILO) and multilateral environmental agreements). The TSD chapter, originally announced in 2019, contains limited new and binding sustainability commitments by the EU and Mercosur (the parties).. Nevertheless, it does incorporate certain key provisions, such as a requirement that parties do not weaken, derogate from, fail to effectively enforce or misapply environmental or labour protection to encourage trade or investment.
Importantly, the TSD chapter is excluded from the scope of the general dispute settlement mechanism of the FTA. Instead, the TSD chapter contains its own dispute resolution mechanism. Noticeably, and contrary to the general dispute settlement mechanism, the TSD chapter does not provide for the suspension of concessions in case of breach (i.e. the retaliatory reversal of a benefit arising under the FTA). It therefore appears less easily enforceable than other parts of the FTA.
The Trade and Sustainable Development Annex
The FTA also incorporates a new annex to the TSD chapter, negotiated after 2019, which brings clarifications on the TSD chapter. It also specifically entrusts a sub-committee on trade and sustainable development created by the TSD chapter with monitoring its effective implementation, as well as that of listed multilateral agreements (including the Paris Agreement, conventions on hazardous chemicals and waste, and various ILO conventions and protocols).
The EU and Mercosur commit not to weaken protection afforded in their environmental laws, and to implement measures to prevent deforestation and stabilise or increase forest cover from 2030. They will collaborate in designing initiatives that support sustainable interregional value chains.
Within a year of the entry into force of the FTA, the parties will also establish a list of products from Mercosur countries deemed to contribute to forest and vulnerable system preservation. Such products should be given trade incentives by the EU (possibly including preferential EU market access).
A key aspect of the annex is that the EU recognises that the FTA and actions taken to fulfil it will be favourably considered in its risk classification of countries. As such, Mercosur countries could receive preferential treatment over non-Mercosur countries as part of the implementation of the EU Deforestation Regulation (EUDR).
The annex also provides that documentation, licenses, information and data from certification schemes and traceability and monitoring systems recognised, registered or identified by Mercosur countries must be used as a source by EU authorities to verify compliance of products with EU traceability requirements (this could e.g. be the case for the purposes of the EU Corporate Sustainability Due Diligence Directive (CS3D).
In addition, the FTA incorporates a new provision specifying that remaining part of the United Nations Framework Convention on Climate Change and its Paris Agreement is an “essential element” of the FTA.
A Real Sustainability Commitment?
The EU-Mercosur FTA constitutes a new stage in the evolution of TSD chapters incorporated in EU trade agreements since the conclusion of the EU-Korea FTA in 2009. The precise normative value of sustainability commitments under the EU-Mercosur FTA remains unclear. However, it appears that there could be concrete consequences for the implementation of key EU legislation, such as the EUDR or the CS3D. Overall, the FTA constitutes an opportunity for companies in both blocs, as well as insight into future policies of their governments.
The negotiated text now needs to be ratified by both the EU and Mercosur. The path ahead in the EU seems unclear. Some EU Member States may argue that it constitutes a so-called “mixed agreement” extending beyond the EU’s exclusive competences, for which approval is needed in each of the EU’s 27 Member States (thus rendering ratification more complex). Furthermore, some Member State governments have expressed their outright opposition to the FTA’s adoption.
Other EU FTAs
On 17 January 2025, the European Commission and Mexico reached an agreement to modernize the existing EU-Mexico Global Agreement, including new sustainability provisions. Additionally European Commission president Ursula von der Leyen has also identified sustainability as an objective as part of the recent relaunch of trade negotiations with Malaysia.
Client Alert: Corporate Transparency Act Reporting Continues to be Suspended
On January 2, 2025, FinCEN announced that it is once again temporarily suspending the mandatory reporting requirements under the Corporate Transparency Act (CTA) due to ongoing litigation regarding the constitutionality of the law. This is the result of an order issued on December 26, 2024 by the U.S. Court of Appeals for the Fifth Circuit which vacated the Fifth Circuit’s decision on December 23, 2024 to stay the nationwide injunction on complying with the CTA issued on December 3, 2024 by the U.S. District Court for the Eastern District of Texas in Texas Top Cop Shop, Inc., et al. v. Garland, et al., No. 4:24-cv-00478 (E.D. Tex.).
Our prior client alert on this subject can be found here: Client Alert: Corporate Transparency Act Beneficial Ownership Information Reporting On Hold – Sherin and Lodgen.
In vacating the stay of the injunction, the Fifth Circuit found that it wished “to preserve the constitutional status quo while the merits panel considers the parties’ weighty substantive arguments.” A hearing has been scheduled for March 25, 2025 where the Fifth Circuit’s merits panel will consider the DOJ’s appeal of the U.S. District Court’s ruling.
While there is no legal requirement to file under the CTA at this time, reporting companies may continue to voluntarily submit filings if they wish to do so. We continue to monitor developments in this evolving situation. Our recommendation to our clients is that they continue to prepare to comply with the CTA in the event it is reinstated by FinCEN.
Reminder for Public Companies Granting Stock Options and Stock Appreciation Rights: Don’t Forget New Item 402(x) Disclosure
As public company issuers prepare for the 2025 reporting season, issuers should be reminded (or made aware) of the new executive compensation-related disclosure requirements. On December 14, 2022, the Securities and Exchange Commission (SEC) adopted rules setting forth new disclosure requirements for awards of stock options and stock appreciation rights (SARs) under new Item 402(x) of Regulation S-K (Item 402(x)). For a public company with a fiscal year that ended December 31, 2024, these new disclosure requirements will take effect beginning with its forthcoming annual report on Form 10-K (or, if applicable, the proxy statement for its annual meeting) to be filed in 2025.
General Instruction G(3) to Form 10-K provides, in part, that the information required by Part III (which includes the Item 402(x) disclosure) may be incorporated by reference from the reporting company’s definitive proxy statement filed pursuant to Regulation 14A for a meeting of shareholders involving the election of directors (an “annual meeting proxy statement”), if such annual meeting proxy statement is filed with the SEC not later than 120 days after the end of the fiscal year covered by the annual report on Form 10-K (for this new Item 402(x) disclosure, such date is April 30, 2025). If a reporting company’s annual meeting proxy statement is not filed with the SEC in the 120-day period, then the new Item 402(x) disclosure must be filed as part of the annual report on Form 10-K, or as an amendment to the Form 10-K, not later than the end of the 120-day period.1
Item 402(x) Purpose
Item 402(x) requires narrative and tabular disclosure on a public company’s policies and practices relating to awards of stock options and SARs that are granted close in time to the disclosure of material nonpublic information (MNPI). For these purposes, “close in time” means within a period starting four business days before and ending one business day after the filing or furnishing of a quarterly report on Form 10-Q, an annual report on Form 10-K or a current report on Form 8-K that discloses MNPI (such period, the Covered Period). Item 402(x) serves to increase transparency and protect against actual or perceived timing issues (e.g., potential insider trading concerns) surrounding awards of stock options or SARs that are granted “close in time” to the disclosure of MNPI that would boost the value of the underlying stock price shortly after grant.
Narrative Disclosure Requirement
Narrative disclosure on a public company’s policies and practices relating to the timing of awards of stock options and SARs in relation to the disclosure of MNPI is required whether or not the company has granted such awards within the Covered Period. This disclosure is not required for full-value awards, such as awards of restricted stock or restricted stock units. Specifically, the narrative disclosure must describe the following:
how the board of directors determines when to grant such awards (e.g., whether such awards are granted on a predetermined schedule);
whether and how the board of directors takes MNPI into account when determining the timing and terms of such award; and
whether the company has timed the disclosure of MNPI for the purpose of affecting the value of executive compensation.
Tabular Disclosure Requirement
If, during the last completed fiscal year, a company granted awards of stock options or SARs to one or more named executive officers during the Covered Period, the company must disclose in a tabular format, as illustrated below,2 the following with respect to each such grant: (1) the name of the named executive officer; (2) the grant date of the award; (3) the number of securities underlying the award; (4) the per-share exercise price of the award; (5) the grant date fair value of the award; and (6) the percentage change in the closing market price of the underlying securities between the trading day ending immediately prior to and the trading day beginning immediately following the disclosure of MNPI.
Inline XBRL Requirement
Consistent with other recently promulgated disclosure rules, the information required to be disclosed pursuant to Item 402(x) (i.e., both tabular and narrative disclosure) must be tagged in Inline XBRL.
Action Items
Public company issuers should consider adopting formal equity grant practices, policies or guidelines that align with the new disclosure requirements or revisiting their existing equity grant practices, policies or guidelines to address the timing of awards of stock options and SARs in relation to the disclosure of MNPI. Issuers should also consider implementing policies and procedures to prevent the granting of equity awards within the Covered Period if the additional scrutiny that might come with tabular disclosure would be undesirable.
1 The first applicable fiscal year covered by the new disclosure requirements is the first full fiscal year beginning on or after April 1, 2023. For public companies (other than smaller reporting companies) with a fiscal year [that] ended on or after March 31, 2024, the new disclosure requirements must have been satisfied (or must be satisfied) on the annual report on Form 10-K covering such fiscal year.
For smaller reporting companies, the first applicable fiscal year covered by the new disclosure requirements is the first full fiscal year beginning on or after October 1, 2023 (i.e., the new disclosure requirements must be satisfied on the annual report on Form 10-K and annual meeting proxy statement for fiscal years ending on or after September 30, 2024).
2 For smaller reporting companies, this table will only apply to the named executive officers determined under Item 402(m)(2) of Regulation S-K, which consists of the principal executive officer (PEO) and the next two most highly compensated executive officers other than the PEO who were serving as executive officers at the end of the last completed fiscal year.
Jonathan Weiner also contributed to this article.
Can Reincorporation and Share Increase Proposals Be Bundled?
In this earlier post, I commented on the preliminary proxy materials filed by P.A.M. Transportation Services, Inc. (nka PAMT Corp) At the time, my interest was the company’s proposal to reincorporate in Nevada from Delaware. On October 31 of last year (which coincidentally is the anniversary of Nevada’s admission as a state), the stockholders approved the proposal. Interestingly, the proposal had changed.
The company originally bundled the reincorporation proposal with an increase in the authorized number of shares. This caught the eyes of the staff at the Securities and Exchange Commission, which commented:
We note that Proposal Three seeks approval of redomestication of the Company from a corporation organized under the laws of the State of Delaware to a corporation organized under the laws of the State of Nevada. We also note that approval of the redomestication includes approval of an increase in the authorized shares of the common stock of the Company from 50,000,000 shares to 100,000,000 shares. Please provide your analysis as to why you are not required to unbundle this proposal and provide shareholders with separate votes regarding these changes. Please refer to Rule 14a-4(a)(3) of Regulation 14A and Question 101.02 to Exchange Act Rule 14a-4(a)(3) Questions and Answers of General Applicability (Unbundling under Rule 14a-4(a)(3) Generally), available on our website.
The company responded by unbundling the proposal and ultimately the stockholder approved both proposals. A decade ago, I pointed out a logical inconsistency in the staff’s position with respect to bundling. See What’s The Matter With The SEC’s Unbundling Interpretation? More fundamentally, the SEC staff should not be making comments on governance that are unrelated to disclosure. Whether a proposal may or may not be bundled is fundamentally a question of state law.