Welcome to the first edition of Saul Ewing’s Public Companies Quarterly Update series.  Our intent is to, on a quarterly basis, highlight important legal developments of which we think public companies should be aware.  This first edition is related to developments during the first quarter of 2023.

What You Need to Know:

• NYSE and NASDAQ will require every listed company to have a written clawback policy in place to recover incentive-based compensation from company executives.
• The SEC added a number of technical substantive requirements that must be satisfied for a 10b5-1 trading plan to provide an effective defense against a claim of insider trading.
• Along with the added substantive requirements, companies will also be required to publicly disclose information about their officers’ and directors’ 10b5-1 trading plans.
• In addition to the new disclosure requirements for companies, directors and officers will be required to provide information about trading plans when reporting trades on Forms 4 or 5.
• Company directors and officers can no longer defer publicly reported gifts of their company’s securities until after year-end.
• A recent SEC enforcement action serves as a reminder for issuers to regularly assess the adequacy of disclosure controls and appropriateness of “standard” agreements.

NYSE and NASDAQ Release Clawback Proposals

On February 22, 2023, the NYSE and Nasdaq each released their respective versions of proposals for amended listing standards to implement the SEC’s clawback rule mandated by Section 954 of the Dodd-Frank Act.  As amended, the listing standards of each exchange will require issuers to adopt, and comply with, a written clawback policy,  disclose the policy, disclose any clawbacks triggered by the policy and file the policy as an exhibit to their annual reports.  These changes to the listing standards were mandated by Rule 10D-1 of the Securities Exchange Act of 1934 (the “Exchange Act”) adopted by the SEC in October 2022.

These new listing standards are still subject to SEC approval.  However, Rule 10D-1 requires that these new listing standards be effective no later than November 28, 2023.  Companies will be required to adopt a clawback policy no later than 60 days after the effective date of the new listing standards, which could be earlier than November 28, 2023 (depending on the timing of SEC approval).

New Proposed Listing Standards Related to Clawback Policies

The new listing standards will require every company to have a written clawback policy providing that it will recover from its executive officers the amount of any erroneously awarded incentive-based compensation reasonably promptly after the company is required to make an accounting restatement due to material noncompliance with financial reporting requirements. The Nasdaq rule release explicitly states that the clawback is required on a “no fault” basis, without regard to whether any misconduct occurred or whether an executive officer bears responsibility for the errors.

As used in the rules “incentive-based compensation” is any compensation that is granted, earned or vested based wholly or in part upon the attainment of a “financial reporting measure.”  “Financial reporting measures” are measures that are determined in accordance with the accounting principles used in preparing the company’s financial statements, or derived from such information.  Stock price and total shareholder return are also financial reporting measures. The Nasdaq rule release notes that incentive-based compensation does not include equity awards that vest exclusively based on a specified time of employment or bonus awards that are either discretionary or based on meeting subjective objectives other than financial reporting measures.  

The clawback policy must provide for the recovery of the amount of incentive-based compensation received by the executive officer that exceeds the amount of incentive-based compensation that otherwise would have been received had it been determined based on the amounts in the restated financials, and must be computed without regard to any taxes paid.  The rules allow for reasonable estimates in circumstances where a mathematical recalculation cannot be directly derived from the information in an accounting restatement, such as when the compensation is based on stock price or total shareholder return.

The clawback policies, as well as any events that would trigger a clawback, must be publicly disclosed in an issuer’s SEC filings. Companies are explicitly prohibited from indemnifying any executive officer or former executive officer against the loss of erroneously awarded compensation.

Proposed Consequences of Noncompliance

The new rules prohibit initial or continued listing for companies that are not in compliance with the clawback policies. Under the new NYSE rule, if a company has not recovered erroneously awarded compensation reasonably promptly after a clawback obligation is incurred, then the NYSE will immediately suspend trading and commence delisting procedures. If a NYSE listed company fails to timely adopt a clawback policy, the NYSE will send a written notice to the company which will initiate a process that could result in delisting if the company does not bring itself into compliance.  The Nasdaq amended rules provide that a company that has failed to comply is required to submit a plan to regain compliance to the Nasdaq staff and provides discretion of the Nasdaq staff to give the issuer up to 180 days to cure the deficiency.

The clawback requirements apply to all listed companies, including foreign private issuers, emerging growth companies and smaller reporting companies.  The Nasdaq rules also clarify that the rules generally apply to controlled companies and debt issuers, with limited exceptions.

10b5-1 and Related Amendments

On February 27, 2023 the SEC’s most recent amendments to Rule 10b5-1 of the Exchange Act went into effect. Rule 10b5-1 provides an affirmative defense to the Exchange Act’s prohibition on trading on the basis of material nonpublic information (“insider trading”) when an insider satisfies certain of the rule’s conditions, including, for example, entering into a written trading plan (a “10b5-1 plan”) in good faith and while not in position of material nonpublic information.

The amendments have added a number of additional conditions to Rule 10b5-1 to address SEC concerns related to insiders using 10b5-1 plans in ways that undermined the rule’s objectives. In connection with the amendments, the SEC also adopted new disclosure requirements relating to insider trading policies and procedures, the adoption, modification and termination of insider trading plans, and certain other trading arrangements by officers and directors.

New Requirements for 10b5-1 Trading Plans

First, the amendments add a cooling-off period that applies to all persons (other than an issuer of securities) seeking to rely on 10b5-1 plans. Officers and directors are subject to a minimum cooling-off period equal to the greater of 90 days following their adoption of a 10b5-1 plan, or two business days following disclosure of the issuer’s financial results in a periodic report for the quarter in which the 10b5-1 plan was adopted (subject to a maximum required period of 120 days). All persons other than officers and directors are subject to a minimum cooling-off period of 30 days following their adoption of a 10b5-1 plan.

Second, officers and directors seeking to rely on 10b5-1 plans must include a representation in the plan certifying that as of the date of its adoption, they are not aware of any material nonpublic information, and that they are adopting the plan in good faith and not as part of a scheme to evade the Exchange Act’s prohibition on insider trading.

Next, the amendments prohibit, subject to certain limited exceptions, persons who have multiple overlapping 10b5-1 plans in any one or more classes of securities of a company from qualifying for the affirmative defense provided by Rule 10b5-1.

Lastly, the amendments condition the availability of Rule 10b5-1’s affirmative defense on all persons entering into 10b5-1 plans acting in good faith with respect to that plan.

New Disclosure Requirements

In addition to amending Rule 10b5-1 itself, the SEC also adopted new Item 408 under Regulations S-K (“Item 408”). Item 408 requires quarterly disclosure regarding the adoption or termination of 10b5-1 plans or other non-10b5-1 plan trading arrangements of officers and directors, including the name and title of the person and a description of the material terms (other than executing price) of the plan or other trading arrangement. Item 408 also requires disclosure of a company’s insider trading policies and procedures.

Finally, the SEC has adopted certain revisions to Forms 4 and 5 that we cover in more detail under the heading “Section 16 Update.”

Section 16 Update

In December 2022, the SEC adopted rule amendments impacting the reporting deadlines for officers and directors (“Reporting Persons”) on Forms 4 and 5 pursuant to Section 16 of the Exchange Act. Mandatory compliance with certain of these amendments began on February 27, 2023, with the balance becoming effective on April 1, 2023.

New Requirements for Gift Reporting

As of February 27, 2023, the reporting of dispositions of company securities by gifts can no longer be deferred until after year-end. Previously, Reporting Persons could report dispositions by gift up to 45 days after their company’s fiscal year-end using Form 5. The amended rules now require these gifts be reported on Form 4 in accordance with its filing deadline. As a result, dispositions by gift are now generally required to be reported on Form 4 within two business days after the date the gift is made^[1].

Two nuances that may ease a reader’s mind: the amended rule does not apply to (i) acquisitions by gift or (ii) dispositions by gift made before February 27, 2023. As a result, the reporting of acquisitions by gift and of dispositions by gift that occurred prior to February 27, 2023 can continue to be deferred for reporting on Form 5.

New Requirements for 10b5-1 Trading Plan Reporting

Beginning on April 1, 2023, Reporting Persons will be required to check a box on Forms 4 and 5 indicating whether a transaction included in the report was executed pursuant to a trading plan “intended to satisfy” Rule 10b5-1. It is important to note that because these reports will be filed after the amendments to Rule 10b5-1 trading plans became effective (covered in more detail under the heading “10b5-1 and Related Amendments”), the check box on Forms 4 and 5 should only be checked if the Reporting Person’s plan complies with the amended requirements. Whether or not a Reporting Person is able to check the box, the amendments require Reporting Persons to disclose, in a footnote, the date the relevant trading plan was adopted.

Mind The Gap:

Activision Blizzard Settles with the SEC for $35 Million

Best known for its beloved games Candy Crush®, World of Warcraft®, and Call of Duty®, the prominent video game producer Activision Blizzard, Inc. (“Activision”) has suffered from a flurry of legal claims brought against it in the past two years, stemming from allegations of sexual harassment and suppression of employee complaints.

Activision recently settled with the SEC for $35 million related to allegations of violating the Exchange Act. The SEC entered a cease-and-desist order against [NGA1] Activison, to which the company agreed without admitting or denying the SEC’s findings, for violating [NSE2] the Exchange Act in two ways: (1) failing to maintain disclosure controls and procedures and (2) using separation agreements that required former employees to notify Activision of any requests from administrative agencies in connection with reports or complaints.

As for the first basis, the SEC found Activision to be in violation of Rule 13a-15(a), which requires public companies to maintain disclosure controls and procedures such that the company can be informed as to information that may need to be disclosed to the public. The SEC based its analysis on Activision’s annual and quarterly reports where Activision disclosed that its “success depends to a significant extent on [its] ability to identify, attract, hire, retain, motivate, and utilize the abilities of qualified personnel,” and that an inability to do so would have a negative impact on its business. While the SEC noted that Activision disclosed risk factors related to its employees, it alleged the company did not have adequate disclosure controls and procedures in place to ensure that it was capturing and assessing information related to those risk factors, such as workplace misconduct. [NGA3] 

With respect to the second alleged violation of the Exchange Act, Activision’s standard separation agreement included language requiring former employees to notify Activison of any disclosures to administrative agencies about the company, including to the SEC.  This notification requirement created a chilling effect on whistleblowers; impermissible even if “Blizzard” is in your name. The SEC alleged that this provision in the company’s separation agreements violated Rule 21F-17, which provides that a company cannot take an action that might impede someone from communicating directly with the SEC about a potential securities law violation.

Thirty five million dollars later, and it seems that Activison failed to answer the SEC’s call of duty. The settlement serves as an important reminder for [NGA4] companies, particularly companies that may not have updated their employment-related agreements or reviewed their disclosure controls in some time.

Closing Thoughts

The SEC has been busy on both the rulemaking and enforcement fronts on these and other matters throughout the first quarter of this year.  This update is not intended as a substitute for individualized legal advice [VJS5] .  We encourage you to reach out to any of the authors or your regular attorney contact at Saul Ewing if you have specific questions or would like to discuss how these updates or any other recent developments may apply to you.

[1] A gift that occurs pursuant to the terms of a Rule 10b5-1 trading plan may, in certain circumstances, be reported as late as five business days after the date the gift is made.