Securities Regulation Daily Outgoing CorpFin director believes effective disclosure and compliance are rooted in principles-based approach
Wednesday, November 18, 2020

Outgoing CorpFin director believes effective disclosure and compliance are rooted in principles-based approach

By John Filar Atwood

Division director Bill Hinman urges companies to ask, "What should I do?" rather than just "What can I do?" when addressing corporate hygiene and complying with federal securities laws.

When drafting disclosure, considering appropriate corporate hygiene, and complying with the federal regulatory framework, companies should look beyond merely what they are required to do and instead consider what they should do, according to Division of Corporation Finance Director Bill Hinman. In his view, no matter how the financial markets evolve over time, good things can happen when companies, management teams, boards of directors, and advisers strive to meet the meaning and intent, not just the letter, of the law.

In remarks at Practising Law Institute’s corporation governance conference, Hinman, who previously announced his intention to leave his post at the end of the year, discussed how a principles-based approach has served the Division well since he became director in May 2017. The approach was useful in its handing of digital assets, he said, as well as in its overall approach to both disclosure and rulemaking.

Corporate hygiene. He noted that the same principles that are used in corporate compliance can also apply to the current hot topic of corporate hygiene. The term generally refers to the way a company ensures that its officers and directors are following trading policies and avoiding trading at times when the market is not well informed. Some examples of where companies can practice good corporate hygiene include the design and operation of insider trading policies, the operation of Rule 10b5-1 plans, and the grant of stock option and other equity awards, he stated.

A well-designed insider trading policy has controls that prevent senior executives and directors from trading once a company comes into possession of material non-public information, even if an individual officer or director did not personally have knowledge of the information, according to Hinman. He noted that in 2018, the Commission issued guidance to assist public companies in preparing disclosure about cybersecurity risks and incidents and encouraging them to consider how their insider trading policies prevent trading on material nonpublic information related to such incidents.

A strong Rule 10b5-1 plan should help to eliminate any suggestion of impropriety or unfairness, he continued. Conversely, a poorly-designed plan can result in questions about impropriety and unfairness even when the plan is technically in compliance with the securities laws. Questions often center around the timing of plan implementation, and amendment or termination when trading occurs, or does not occur, around those events, he said.

Hinman advised that companies can help demonstrate that Rule 10b5-1 plans are executed in good faith by requiring mandatory waiting periods before trading can commence or recommence after a plan is adopted, amended, or terminated. In his view, boards of directors and their compensation committees should consider the interplay between company share repurchase plans and trading by directors and senior executives when approving, amending, or terminating Rule 10b5-1 plans.

With respect to stock options, Hinman said that companies should consider whether it is appropriate to issue stock options and other equity compensation to executives while the company may be in possession of material non-public information. Stock options with exercise prices at or above fair market value provide an incentive for recipients to work toward increasing company value, he noted, but if a company grants an award based on the fair market value or trading price of its stock while the market is not in possession of material information, a number of undesirable results may occur.

Disclosure. In the area of disclosure, Hinman described the principles-based approach as one in which the Commission articulates an objective, then allows a company to satisfy that objective by providing disclosure appropriately tailored to its facts and circumstances. He believes this is especially effective in eliciting disclosure about complex and evolving areas such as climate change, Brexit, cybersecurity, and the LIBOR transition.

He cited COVID-19 as one example of when the principles-based approach worked well. Coupled with guidance provided by the division, the approach provided the flexibility companies needed to disclose information about how COVID-19 was affecting their business, prospects, and financial condition without the Commission having to adjust its rules, he said.

Rulemaking. Hinman also reviewed some of the rulemaking initiatives undertaken during his tenure in which a principles-based approach was used. He noted that the amendments to modernize Regulation S-K disclosure requirements emphasize a principles-based approach by requiring disclosure of information that is material to an understanding of the general development of a company’s business.

Other examples are the proposed amendments to MD&A and the guidance on the use of key performance indicators and metrics in MD&A. Hinman also cited the rulemakings designed to encourage companies to go public and engage in registered capital raising transactions such extending the "test-the-waters" accommodation and revising the financial disclosure requirements for guaranteed or collateralized debt offerings.

Rules to increase access to private markets also followed this approach, he said. These included amendments to the accredited investor definition as well as the recommended rule changes designed to harmonize the exempt offering framework.

Hinman said that while he was in charge of the Division, rulemakings attempted to improve the securities markets overall, not to favor either the public or private markets. Creating, maintaining, and improving on a system where all types of companies can raise capital efficiently and investors are properly protected is beneficial to everyone, he concluded.

MainStory: TopStory CorporateFinance PublicCompanyReportingDisclosure Covid19 CorporateGovernance GCNNews

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