The Hoover Institution and other Stanford-affiliated entities recently published the results of a survey of senior decision-makers at 47 of the largest institutional investment firms and asset managers in North America, Europe & Asia on sustainable investing priorities. The survey found that when it comes to ESG issues, there’s climate change and corporate governance, and then there’s everything else. This excerpt summarizes some of the key findings:
– When asked which ESG factors fund managers explicitly consider as part of an investment decision, climate change ranks as the most important, selected by 78% of respondents. After this, the next four factors are all governance-related: board structure (72%), ownership structure (72%), board diversity (65%), and quality of financial reporting (57%).
– The least important ESG factors according to respondents are the ratio of CEO pay to the pay of the average worker (20%), pollution and waste byproducts (24%), packaging and product waste (24%), and raw material sourcing (26%).
– Most investors (67%) consider ESG quality as one of many factors when making an investment decision; 2% use it to screen out potential investments, while 11% do not rely on it at all. Overall, 59% say ESG is important, while 41% say it is not.
Since investors appear to be most interested in governance and climate-related issues, I found another one of the survey’s conclusions a little surprising. The survey found that 98% of investors believe that governance risks are appropriately reflected in stock prices and 76% believe that climate risks are mostly or somewhat reflected in those prices. In contrast, only 50% said environmental risks (other than climate change) and 46% said social risks are reflected in stock prices. If that’s what these investors think, shouldn’t the risks that aren’t appropriately reflected in the market price for company stocks be more of a priority to them?
Last month, Dave blogged about the SCOTUS’s decision in the Macquarie case, in which the Court held that a company’s “pure omission” to disclose information concerning known trends required by Item 303 of Regulation S-K could not serve as the basis for a private securities fraud claim. The decision may have some companies wondering whether they’re off the hook for known trends disclosures, but a recent Weil memo makes it clear that they aren’t.
The memo points out that the decision doesn’t affect the SEC’s ability to bring an enforcement action for failure to comply with Item 303’s disclosure requirements, and that any protection that it provides against private claims may turn out to be very limited:
As the Court itself stated: “For one thing, private parties remain free to bring claims based on Item 303 violations that create misleading half-truths.” A half-truth by its nature is an affirmative statement that may be literally accurate, but it is nonetheless misleading due to the failure to provide additional qualifying information. “In other words, the difference between a pure omission and a half-truth is the difference between a child not telling his parents he ate a whole cake and telling them he had dessert.”
So following Macquarie, a claim that was once asserted as a pure omission of required SEC disclosure may instead be recast as a claim that other affirmative statements in the disclosure were rendered misleading by such omission. The practical result is that companies may continue to face litigation and liability exposure as a result of such omission.
For instance, consider the SEC’s examples of currently known trends and uncertainties that may require disclosure in the MD&A, such as a reduction in the company’s prices, an erosion in its market share and the likely non-renewal of a material contract. It would seem that a plaintiff in such cases would seek to identify affirmative statements in a company’s public disclosures that were rendered misleading (i.e. “half-truths”) as result of the failure to disclose the known trend or uncertainty. For example, if a company makes statements regarding the impact on revenues of a material contract, knowing that the material contract is not likely to be renewed, a plaintiff might argue that these statements are actionable “half-truths” under Rule 10b-5 if the company omits to disclose the potential non-renewal of that contract.
The memo also notes that while Rule 10b-5 may not be available to private plaintiffs in a pure omissions case, Section 11 of the Securities Act does provide for liability based on material omissions of information required to be included in a Securities Act registration statement.
Check out our latest “Timely Takes” Podcast featuring Orrick’s J.T. Ho & his monthly update on securities & governance developments. In this installment, J.T. reviews:
– Climate disclosure rules developments
– New DEI case law from the 4th Circuit
– AI developments on the disclosure & enforcement front
– Cybersecurity guidance and Corp Fin staff comments
-ISS & Glass Lewis developments
As always, if you have insights on a securities law, capital markets or corporate governance issue, trend or development that you’d like to share in a podcast, we’d love to hear from you. You can email me and/or Meredith at john@thecorporatecounsel.net or mervine@ccrcorp.com.
On Friday, the SEC’s Division of Enforcement announced enforcement proceedings against the BF Borgers CPA PC accounting firm and its sole partner, Benjamin Borgers, for alleged “deliberate and systemic failures” to comply with PCAOB standards in audits and reviews incorporated in more than 1,500 SEC filings from January 2021 through June 2023. As this excerpt from the SEC’s press release illustrates, the allegations are jaw-dropping:
The SEC’s order finds that, among other things, the Respondents failed to adequately supervise and review the work of the team performing the audits and reviews; did not properly prepare and maintain audit documentation, known as “workpapers;” and failed to obtain engagement quality reviews, without which an audit firm may not issue an audit report. According to the SEC’s order, of 369 BF Borgers clients whose public filings from January 2021 through June 2023 incorporated BF Borgers’s audits and reviews, at least 75 percent of the filings incorporated BF Borgers’s audits and reviews that did not comply with PCAOB standards.
The SEC’s order further finds that, at Benjamin Borgers’s direction, BF Borgers staff copied workpapers from previous engagements for their clients, changing only the relevant dates, and then passed them off as workpapers for the current audit period. As a result, the order finds, BF Borgers’s workpapers falsely documented work that had not been performed. Among other things, the workpapers regularly documented purported planning meetings – required to discuss a client’s business and consider any potential risk areas – that never occurred and falsely represented that both Benjamin Borgers, as the partner in charge of the engagement, and an engagement quality reviewer had reviewed and approved the work.
The SEC’s order in this case reads like a litany of every SEC rule & statutory provision that an auditor could conceivably violate (or cause its client to violate) in connection with an audit or review engagement. The case was settled on a neither admit nor deny basis, but not surprisingly, the SEC absolutely clobbered both respondents in terms of the sanctions it imposed. In addition to hefty monetary penalties, the SEC essentially put an end to both respondents’ public company practice by issuing an order under Rule 102(e) denying them the privilege of appearing or practicing before the SEC as an accountant.
BF Borgers may not have been well known to many of our readers before last Friday, but the firm has been a fairly significant player, particularly among small cap issuers. The firm ranked 8th in overall market share for public company audits last year & ranked 6th in market share for non-SPAC initial public offerings. It also was the auditor for a particularly high-profile public company, Trump Media, and . . . umm. . . [This marks the point where I stopped writing and bit my tongue so hard I had to go to the ER for stitches.]
It’s hard to overstate the mess that the BF Borgers scandal creates for its public company clients. In an effort to provide some guidance to those clients, Corp Fin’s Office of the Chief Accountant issued a statement highlighting their disclosure and reporting obligations. In addition to flagging the Item 4.01 8-K report required in connection with a change in accountants, the statement highlights the impact on companies with respect to their future SEC filings:
– Form 10-K filings on or after the date of the Order may not include audit reports from BF Borgers. Each fiscal year presented must be audited by a qualified, independent, PCAOB-registered public accountant that is permitted to appear or practice before the Commission.
– Form 10-Q filings on or after the date of the Order may not present financial information that has been reviewed by BF Borgers. Each quarterly period presented must be reviewed by a qualified, independent, PCAOB-registered public accountant that is permitted to appear or practice before the Commission.
– Form 20-F filings on or after the date of the Order may not include audit reports from BF Borgers. Each fiscal year presented must be audited by a qualified, independent, PCAOB-registered public accountant that is permitted to appear or practice before the Commission.
That means that companies are going to need to re-audit all of the years covered by a BF Borgers audit report for their next 10-K and re-do prior interim reviews for periods presented in upcoming 10-Qs. Unfortunately, for some of those companies, that may be the least of their problems.
For instance, the timing of the SEC’s action means that former Borgers clients face a looming 10-Q deadline, and even with a Rule 12b-25 extension, it may be practically impossible to retain a new accountant and complete the required review by the extended 10-Q deadline. Under the circumstances, I expect that any new accounting firm will need to do a lot of additional work before it will issue a review report and that audit committees will want to have those numbers scrubbed very hard before signing off on a 10-Q filing containing them. The bottom line is that many of these companies are going to be late filers.
What’s more, given all the work that Borgers apparently didn’t do on hundreds of audits, once new auditors start poking around, my guess is we’re likely to see a fair share of these companies conclude that restatements of prior audits are necessary – which will open up a “whole ‘nother bag of snakes.”
By now, BF Borgers’ audit clients and their lawyers may feel like their heads are spinning, and with good reason. This is a mess, and there are going to be a lot of challenging issues for those companies and their advisors to address during the coming weeks. My guess is that the Staff will have more to say at some point about this situation, but in the meantime, we have resources that can help. These include:
Last month, the PCAOB released this spotlight, Inspection Observations Related to Auditor Use of Data and Reports. The report focuses on auditors’ use of information produced by the company (“IPC”), such as invoices and shipping documents, and information from external sources, such as customer purchase orders and bank records, which must be both “sufficient” in quantity and “appropriate” (i.e., relevant and reliable).
In issuing the report, the PCAOB hopes to “help auditors understand how the testing of IPC and information from external sources is properly performed” by describing recent staff observations on this issue. 17% of identified deficiencies in the 2021 and 2022 inspection cycles related to insufficient testing procedures over the accuracy & completeness of IPC or other data or the controls over that data.
What does this mean for companies? Internal audit teams should take note! This Radical Compliance blog says this “advice” from the PCAOB “has a habit of soon becoming new demands placed upon you by your auditor.” That could mean more control testing by audit firms — and higher fees — and more required of internal accounting folks and internal audit. The blog has tips for anticipating auditor concerns, moving towards more robust systems and documenting controls.
Last spring, I blogged that the requirement for auditors to identify “critical audit matters” (CAMs) has not been living up to the PCAOB’s hopes & dreams. As part of its continuing effort to ensure that audit opinions communicate decision-useful information to investors (something that’s surprisingly been questioned as of late), the PCAOB’s Investor Advisory Group has recently announced that it’s soliciting public input from investors, analysts, issuers and auditors on the most “decision-useful” CAMs from public company audit reports in 2023 10-Ks and 20-Fs. The IAG asks that all “nominations” be submitted by June 30 and accompanied by an up to 300-word explanation.
The IAG will select its top 3 and report out publicly later this year. It’ll be interesting to see how these stack up to the most common CAMs!
The transcript for our recent “Conduct of the Annual Meeting” webcast featuring J.M. Smucker’s Peter Farah, Broadridge’s William Kennedy, Intuit’s Erick Rivero, and Carl Hagberg of The Shareholder Service Optimizer is now available. During the program, our panelists shared some really practical tips to make your solicitation and annual meeting run smoothly. Here are just a few:
– Ask Broadridge (and other service providers) each year about their technology improvements for virtual meeting platforms — the capabilities have exponentially expanded in a few short years. Not only that, but they still want to hear what other features you’d like to see next year.
– Most technology issues are user error on the company side. Have an audio-visual and IT professional in the room with you or at the ready and consider dress rehearsals. Make sure you mimic the conditions of your annual meeting (e.g., have key participants in the same location).
– Consider reserving a back-up meeting room, even for internal participants in a virtual meeting.
– “Close the marketing gap” by making it easier for shareholders (particularly retail) to vote. Consider adding a QR code to your proxy statement that takes people directly to the voting platform.
– Disclose how you plan to handle Q&A upfront, in your proxy statement. And, if you have an in-person or virtual meeting, physically hand the rules of conduct to each in-person attendee and ask that they read, understand and observe them.
– If the CEO chairs the meeting, also have an independent director ready and available for Q&A to handle questions that aren’t appropriately addressed by the CEO (e.g., on CEO compensation).
– Consider saying in your proxy or rules of conduct that you may answer appropriate questions on your website to the extent you didn’t address during the meeting. This is appreciated by shareholders and useful if you have technical issues.
– In-person meeting security needs to be for everybody — not just management and the board.
If you are not a member of TheCorporateCounsel.net, email sales@ccrcorp.com to sign up today and get access to the full transcript – or sign up online.
This Cooley PubCo blog discusses the latest development in the now five-year-long saga involving the SEC’s proxy advisor rulemaking. In February, Liz shared that a federal district court had ruled in favor of ISS in its lawsuit challenging the SEC’s 2020 rule that would have subjected proxy advisors to enhanced regulations by saying they engage in the “solicitation” of proxies. She noted that the National Association of Manufacturers was considering an appeal.
The Cooley blog says that both NAM and the SEC have now filed notices of appeal. “NAM first on April 16, with the SEC following a week later on April 23. Subsequently, the clerk of the DC Circuit filed an order consolidating the two appeals and setting out a schedule for various submissions by the parties.”
The blog highlights that the SEC and NAM are head-to-head in another lawsuit involving the same rulemaking.
As noted above, in this case brought by ISS, NAM favored the 2020 amendments, which led it to intervene on the side of the SEC (and also to its becoming a defendant). It may be a little head-spinning, but NAM also has a separate case challenging the proxy advisor rules against the SEC before the Fifth Circuit. In July 2022, NAM filed a complaint against the SEC, asking that the 2022 amendments to the proxy advisor rules—which, as noted above, reversed some of the key provisions in the 2020 rules, including the company-favorable condition that would have required company engagement—be set aside under the APA and declared unlawful and void. In September, NAM filed a motion for summary judgment, characterizing the case as “a study in capricious agency action.”
In December 2022, the Federal District Court for the Western District of Texas issued an Order granting summary judgment to the SEC and Gensler and denying summary judgment to NAM in that litigation. (See this PubCo post.) NAM appealed, and in August 2023, a three-judge panel of the Fifth Circuit heard oral argument on NAM’s appeal.
Since that case is ongoing and a decision has yet to be issued, the blog notes that the two opposing parties, SEC and NAM, in a brief moment of concurrence roundtable, jointly advised the Court of their appeals in the ISS litigation.