Monthly Archives: August 2015

August 31, 2015

Pay Ratio: Media Tries to Sleuth Out Ratios Based on 3rd-Party Data

I’m wrapping up a comprehensive “pay ratio” chapter for the 2016 edition of our “Executive Compensation Disclosure Treatise” (order your copy now – 1600 pages!) and came across this article by Quartz. Here’s an excerpt:

Starting in 2018 [Broc’s correction], US companies will have to report the ratio of their CEO’s pay to the average employee’s salary to the Securities and Exchange Commission. But why wait? Salary-data aggregator Glassdoor put together a ranking of pay ratios for companies in the S&P 500 based on the median employee pay data it has and CEO pay data from company filings. At the top: David Zaslav of Discovery Communications with an astounding ratio of 1,951-to-one, followed by the chiefs at Chipotle (1,522), CVS (1,192), and Walmart (1,133).

The biggest takeaway? We have no idea what these ratios really look like. Estimates are wildly inconsistent. And it’s unclear how much better things will be under the new rules since companies will get to choose how they calculate employee pay.

A recent analysis from Payscale, also an online salary aggregator, came out with an entirely different ranking and vastly lower ratios. Larry Merlo of CVS tops its list, but with a ratio of 422-to-one, compared to 1,192 from Glassdoor. Payscale’s highest estimated ratio would only make the 37th spot on Glassdoor’s ranking.

A separate Bloomberg analysis computed average worker pay in a different way, using publicly available data, and came up with a whole other set of estimates and rankings. Bloomberg puts the average salary at JP Morgan at $124,959, compared to $65,344 from Glassdoor. Consequently, Glassdoor’s estimate of the pay ratio is twice as high.

To make it more confusing, Glassdoor isn’t universally higher. Bloomberg has ex-McDonald’s CEO Don Thompson in first place with a pay gap ratio of 644 to one. Glassdoor puts the ratio at 422.

Some caveats are in order for data from sites like Payscale and Glassdoor. Their salary data is self-reported by employees, and not entirely reliable. And as Glassdoor notes, CEO pay varies highly from year to year, due to things like stock options and bonuses. Employees tend to underreport such earnings to Glassdoor, and the distribution of people who report on the site may be skewed in terms of pay or seniority. Some companies have already disputed the average salaries reported by Glassdoor.

Here’s a note that I received from a member in response:

According to this Reuters article, the Glassdoor study (which I couldn’t find anywhere on Glassdoor’s website) used “CEO compensation figures reported by 441 S&P 500 companies through Aug. 14 and user reports about salaries at those companies. Only companies for which Glassdoor had 30 or more worker salary reports were included. The data could be skewed if workers under-counted tips or bonuses, Glassdoor said.” Anyone using Glassdoor or Payscale stats as reliable is irresponsible – but some journalists obviously are (here’s a NY Times example and here’s a new one from

Pay Ratio: Investor & Proxy Advisor Views?

If you want a preview of how proxy advisors & institutional investors perceive the coming pay ratio disclosures, check out this Bloomberg article. Of course, we’ll have representatives from ISS, Glass Lewis, BlackRock, CalSTRS and Capital Research and Management at our upcoming “Proxy Disclosure Conference/Say-on-Pay Workshop” to discuss that and more…

Drafting Effective CD&As

In this podcast, Sharon Podstupka of Pearl Meyer & Partners provides some insight into how to draft more effective CD&As (here’s the related report findings), including:

– What are the benefits of having a non-lawyer involved in drafting the CD&A?
– What are arguments that can “win the day” at companies who have senior management not interested in drafting user-friendly CD&As?
– How does creating more usable disclosure impact the timeframe for drafting proxy disclosure?
– Do you see companies planning in advance for the pay ratio rules? And if so, in what ways?

– Broc Romanek

August 28, 2015

SEC’s Filing Fees: Going Down 13% for Fiscal Year 2016!

Yesterday, the SEC issued this fee advisory that sets the filing fee rates for registration statements for 2016. Right now, the filing fee rate for Securities Act registration statements is $116.20 per million (the same rate applies under Sections 13(e) and 14(g)). Under the SEC’s new order, this rate will dip to $100.70 per million, a 13.3% drop. Nice to see another reduction after last year’s 10% drop (which combined with a drop in the rate two years ago, offsets a hefty price hike from three years ago).

As noted in the SEC’s order, the new fees will go into effect on October 1st like the last four years (as mandated by Dodd-Frank) – which is a departure from years before that when the new rate didn’t become effective until five days after the date of enactment of the SEC’s appropriation for the new year – which often was delayed well beyond the October 1st start of the government’s fiscal year as Congress and the President battled over the government’s budget.

Board Succession Planning Databases

In this podcast, Equilar’s David Chun discusses the latest in Equilar’s line of services – BoardEdge, including:

– What is “BoardEdge”?
– How does it compare to a company hiring a recruiter?
– Any surprises since you launched?

Our “Q&A Forum”: The Big 8500!

In our “Q&A Forum,” we have blown by query #8500 (although the “real” number is much higher since many of the queries have others piggy-backed on them). I know this is patting ourselves on the back, but it’s over 14 years of sharing expert knowledge and is quite a resource. Combined with the Q&A Forums on our other sites, there have been well over 28,000 questions answered.

You are reminded that we welcome your own input into any query you see. And remember there is no need to identify yourself if you are inclined to remain anonymous when you post a reply (or a question). And of course, remember the disclaimer that you need to conduct your own analysis and that any answers don’t contain legal advice.

– Broc Romanek

August 27, 2015

I Doubt Apple’s CEO Violated Reg FD With His “China” Email to Jim Cramer

Yesterday, I ran a popular poll about whether folks thought that Apple’s Tim Cook violated Regulation FD by emailing CNBC host Jim Cramer about how Apple was faring in China. The poll results indicated that 15% thought it was nowhere near a violation – and 21% indicated it might look that way to the untrained eye (but that it wasn’t). 29% thought it was clearly a violation – and 29% thought it was a toss-up and depended on how the SEC approached it (7% didn’t realize that Seinfeld is available around-the-clock on Hulu these days).

In my blog about it, I indicated that the facts as we know them are semi-sparse. Based on the facts as we know them, here’s my 10 cents:

1. I Agree That The Optics Aren’t Good – In a great illustration of “perception matters,” a plain face reading of the email that Cook sent to Cramer makes the securities lawyer in me cringe. The 2nd paragraph is about how Apple is experiencing strong growth in China, etc. Even worse is the start of the 3rd paragraph about “our performance so far this quarter is reassuring.” This all comes after Cook’s intro about how Apple doesn’t give mid-quarter updates. This “perception” is probably why so many in our community think it’s a clear-cut violation.

2. But Communications to Journalists Aren’t Reg FD Violations – To the extent Cook’s email was directed to Cramer as a member of the media (so intention matters) – and reasonably understood that way – there likely isn’t a problem (absent other facts). This is supported by this excerpt from the SEC’s adopting release in 2000:

Rule 100(b)(1) enumerates four categories of persons to whom selective disclosure may not be made absent a specified exclusion. The first three are securities market professionals — (1) broker-dealers and their associated persons, (2) investment advisers, certain institutional investment managers and their associated persons, and (3) investment companies, hedge funds, and affiliated persons. These categories will include sell-side analysts, many buy-side analysts, large institutional investment managers, and other market professionals who may be likely to trade on the basis of selectively disclosed information. The fourth category of person included in Rule 100(b)(1) is any holder of the issuer’s securities, under circumstances in which it is reasonably foreseeable that such person would purchase or sell securities on the basis of the information. Thus, as a whole, Rule 100(b)(1) will cover the types of persons most likely to be the recipients of improper selective disclosure, but should not cover persons who are engaged in ordinary-course business communications with the issuer, or interfere with disclosures to the media or communications to government agencies.[FN]

[FN 27] While it is conceivable that a representative of a customer, supplier, strategic partner, news organization, or government agency could be a security holder of the issuer, it ordinarily would not be foreseeable for the issuer engaged in an ordinary-course business-related communication with that person to expect the person to buy or sell the issuer’s securities on the basis of the communication. Indeed, if such a person were to trade on the basis of material nonpublic information obtained in his or her representative capacity, the person likely would be liable under the misappropriation theory of insider trading.

I’ve always wondered (or worried) about the journalist exception when the journalist is a conduit for the market. It’s possible that FN 27 wasn’t written to address this type of situation. For example, it may have been included to assure company officials that communicating high demand to a supplier in an effort to secure additional supplies would not violate Reg FD – even if the supplier is a “holder’ (which likely should have been written in the regulation as “owner”) of company securities.

And the thing about the press is that it’s not usually a very good way to plan for Reg FD compliance (although the live interview situation is probably not subject to the usual concerns about what the press will actually report – and when they’ll actually report it publicly).

3. Doubtful Directed to Cramer In His Investor Capacity – So far at least, there is no indication that Cook intended his email to be received by an investor. If so, any misuse by Cramer would create problems for Cook. Barring that type of situation, this is merely an exclusive with media. Done all the time.

As I understand it, Cramer is the manager of a charitable trust fund (at least, he’s portrayed that way), as well as the talking head on his own show. But if you ask 100 people what Jim Cramer does, my hunch is that at least 99 will say “media personality” or “news show host” – not “fund manager.”

On the other hand, there certainly is the argument that intent of the communicator is not intended to part of Reg FD – that it’s more mechanical. Instead, Cook might have a strong argument – similar to the “intent” concept – that the email to Cramer was not sent under circumstances that were reasonably foreseeable to Cook that Cramer would purchase or sell securities on the basis of the information contained in the email. More particularly, it seems reasonable that Cook could conclude that MSNBC has a policy, applicable to Cramer, that – to the extent it even allows trading in public securities – material information received by its personnel must be disseminated broadly before the personnel can trade securities of a company that is the subject of the information (or discuss the information in a selective forum, essentially equivalent to a “tip”). Thus, it seems reasonable that Cook could conclude that Cramer – even to the extent he is a manager of a fund that holds Apple stock – would be required to broadcast the material information in the email and allow for appropriate dissemination before using the information for another purpose. Presumably, that would not constitute a violation of Reg FD.

By the way, I have always wondered how MSNBC got comfortable with Cramer trading while running his own show, but that’s another ball of wax. And don’t forget to check out our comprehensive 119-page “Regulation FD Handbook“…

Conflict Minerals: GAO Says Most Companies Unable to Determine Source

On the same day that the SEC’s rules were dealt a blow by the DC Circuit last week (see our memos about that posted in our “Conflict Minerals” Practice Area), the GAO delivered this 60-page report about 2014 disclosures – not 2015! – and concludes that most companies were unable to determine the source of their conflict minerals. (And that conclusion seems unlikely to change in the report on 2015.) Here’s an excerpt from this Cooley blog:

Of those studied, 99% reported performing reasonable country-of-origin inquiries (RCOI) for the conflict minerals they used. The GAO spoke with some of the companies, which reported that they had “difficulty obtaining necessary information from suppliers because of delays and other challenges in communication.” According to the report, the vast majority of companies (94%) also conducted due diligence on the source and chain of custody of the conflict minerals they used, but 67% reported that they were unable to determine the source of the minerals (i.e., whether they came from the covered countries) and, not surprisingly, “none could determine whether the minerals financed or benefited armed groups in those countries.”

The report also indicates that 24% reported that the conflict minerals they used did not originate in covered countries, while 4% reported that they did source from the covered countries, but “indicated that they are or will be taking action to address the risks associated with the use and source of conflict minerals in their supply chains.” Only 2% indicated that their conflict minerals came from scrap or recycled sources.

The report estimates that only 47% of companies reported that they received responses from the suppliers they surveyed, while only 19 companies in the sample had response rates of 100%.

Shareholder Approval: SEC Seeks Comment on NYSE’s “Early Stage Companies” Proposal

As noted in this MoFo blog, the SEC is seeking comment by next Monday for the the NYSE proposal to amend the shareholder approval rules (Sections 312.03(b) and 312.04) to exempt an “Early Stage Company” from having to obtain shareholder approval before issuing shares for cash to related parties (or their affiliates or entities in which they have a substantial interest), so long as the company’s audit committee (or a comparable committee comprised solely of independent directors) reviews and approves of the transactions prior to their completion. An “Early Stage Company” is defined as a company that has not reported revenues greater than $20 million in any two consecutive fiscal years since its incorporation; however, the company will lose that designation (and will not be able to regain it) at any time after listing on the NYSE that it files a Form 10-K with the SEC in which it reports two consecutive fiscal years (including periods prior to listing) in which it has revenues greater than $20 million in each year.

– Broc Romanek

August 26, 2015

Poll: Did Apple’s CEO Violate Reg FD With His “China” Email to Jim Cramer?

A member asked me to run a poll on whether folks thought that Apple CEO Tim Cook’s email to CNBC host & fund manager Jim Cramer about China trends violated Reg FD. The facts as we know them are semi-sparse. This MarketWatch article contains some scant Reg FD analysis – as well as a copy of CEO Cook’s email.

Take a moment to participate in this anonymous poll:

survey service

Corp Fin Updates Financial Reporting Manual: How Delinquent Filers Can “Catch-Up”

Yesterday, Corp Fin posted an updated Financial Reporting Manual to provide guidance about how delinquent filers can make a “catch-up” filing. This guidance seems to reflect the long-standing position taken in Corp Fin’s Office of Chief Counsel about how companies that haven’t filed their ’34 Act reports in a long time can come back into compliance without filing all of their missed reports (since most of those missed reports would provide little value to investors at this point). Read Section 1320.4 of the Manual – but the guidance essentially is that Corp Fin has the discretion to allow a company to catch-up:

– By filing the last due Form 10-K (with “all material information that would have been included in those filings”) and any subsequent 10-Qs due since that last 10-K (the Manual doesn’t mention the 10-Qs but that is the Staff’s position)
– This discretion doesn’t absolve the company of any potential liability it has for being delinquent (nor preclude SEC Enforcement action)
– Catching up this way doesn’t mean that the company is now “current” for S-3/S-8/Rule 144 or Reg S purposes “until it establishes a sufficient history of making timely filings”

Jeff Riedler is retiring next week as Assistant Director of AD1’s Office of Health Care and Insurance.

October Conference Hotel Nearly Sold Out; Yesterday’s “Pay Ratio Workshop” Archive Available!

As it typically does a few months ahead of the event, our conference hotel in San Diego – the Manchester Grand Hyatt – is nearly sold out. We have procured an overflow hotel next door – the San Diego Marriott Marquis – for which you can obtain comparable room rates if you reserve online thru this page. But you’ll want to try the Manchester Grand Hyatt first – obtain a discounted rate there by following these instructions. This hotel relates to our popular conferences – “Proxy Disclosure Conference” & “Say-on-Pay Workshop” – to be held October 27-28th in San Diego and via Live Nationwide Video Webcast.

Those conferences are paired with the audio archives that are up from yesterday’s “Pay Ratio Workshop.” You can register at anytime to gain immediate access to these archives and also gain access to our October pair of conferences. Register Now! Here’s a list of the archived 9 panels for the “Pay Ratio Workshop”:

– “Overview: The Final Rules”
– “Getting Ready for Compliance: Sampling & Other Data Issues”
– “Streamlining Your Compliance Efforts”
– “Board Presentations: What To Tell Boards Now”
– “Disclosure: Handling the Transition Period”
– “Parsing Model Disclosures: US-Only Workforces”
– “Parsing Model Disclosures: Global Workforces”
– “Parsing a Recent Pay Ratio Disclosure”
– “How to Handle PR & Employee Fallout”

– Broc Romanek

August 25, 2015

Today’s “Pay Ratio Workshop” – Includes 22-Pages of Annotated Model Disclosures!

Surprise! We decided to pre-record all of the nine panels for today’s “Pay Ratio Workshop.” So if you’re among the many that have registered, you can access all nine panels right now! When you get to this Conference page, just click on a panel’s name – or the “Audio” link adjacent to a panel. Register now if you haven’t yet!

The Course Materials include 22-pages of annotated model pay ratio disclosures (in Word to facilitate your starting point!) – and 128-pages of detailed analysis of executive pay disclosures made during the 2015 proxy season.

The Course Materials alone are worth the price of admission. But this 4-hour audio-only event is paired with our much lengthier “Proxy Disclosure Conference” & “Say-on-Pay Workshop” that are being held in October. Register Now! Here’s a list of the 9 panels for the “Pay Ratio Workshop” (& the agendas for all three events):

– “Overview: The Final Rules”
– “Getting Ready for Compliance: Sampling & Other Data Issues”
– “Streamlining Your Compliance Efforts”
– “Board Presentations: What To Tell Boards Now”
– “Disclosure: Handling the Transition Period”
– “Parsing Model Disclosures: US-Only Workforces”
– “Parsing Model Disclosures: Global Workforces”
– “Parsing a Recent Pay Ratio Disclosure”
– “How to Handle PR & Employee Fallout”

pay ratio

– Broc Romanek

August 24, 2015

Tomorrow’s “Pay Ratio Workshop” – Includes 22-Pages of Model Pay Ratio Disclosures!

In the wake of the pay ratio rules being adopted, get a handle on what you need to do now during tomorrow’s “Pay Ratio Workshop.” The Course Materials for tomorrow include 22-pages of annotated model pay ratio disclosures (in Word to facilitate your starting point!) – and 128-pages of detailed analysis of executive pay disclosures made during the 2015 proxy season. The Course Materials alone are worth the price of admission.

But there’s more! This 4-hour audio-only event is paired with our much lengthier “Proxy Disclosure Conference” & “Say-on-Pay Workshop” that are being held in October. Register Now! Here’s a list of the 9 panels for the “Pay Ratio Workshop”:

– “Overview: The Final Rules”
– “Getting Ready for Compliance: Sampling & Other Data Issues”
– “Streamlining Your Compliance Efforts”
– “Board Presentations: What To Tell Boards Now”
– “Disclosure: Handling the Transition Period”
– “Parsing Model Disclosures: US-Only Workforces”
– “Parsing Model Disclosures: Global Workforces”
– “Parsing a Recent Pay Ratio Disclosure”
– “How to Handle PR & Employee Fallout”

pay ratio

– Broc Romanek

August 21, 2015

Survey Results: Board Portals

Below are the results from our recent survey on board portals:

1. When it comes to board portals, our company:
– Doesn’t have one and isn’t considering using one in the near future – 3%
– Doesn’t have one but is considering whether to use one – 13%
– Adopted one within the past two years – 16%
– Adopted one more than two years ago – 68%

2. For those with board portals, our company:
– Licensed an off-the-shelf portal – 94%
– Built it in-house – 0%
– Hired a service provider to build a custom portal – 6%

3. For those with off-the-shelf board portals, we have:
– Asked whether our vendor has ever had a security breach – 13%
– Investigated our vendor’s security – 70%
– Plan to investigate our vendor’s security in the near future – 10%
– Not worried about our vendor’s security – 7%

Take a moment to participate in our “Quick Survey on ‘What is a Perk?’” and our “Quick Survey on Annual Meeting Conduct.”

Reminder: Keep Cautionary Language Up-to-Date

Check out this D&O Diary blog (& this Mintz Levin blog and Reuters article) about a recent decision in Harman International Industries Securities Litigation, in which the US Court of Appeals for the DC Circuit held that – despite cautionary language – the “safe harbor” under the PSLRA for forward-looking statements was not applicable for certain statements. The ruling noted that “safe harbor” protection was not available because the cautionary language was misleading in light of historical facts and was not tailored to the specific forward-looking statements the company made. The Court’s decision serves as an important reminder to keep cautionary language up-to-date. Here’s an excerpt:

The PSLRA safe harbor was designed to facilitate dismissal of challenges to forward-looking statements at the pleadings stage, before any discovery. But as Harman shows, even on a motion to dismiss, courts will take a hard look at the cautionary language and dismiss the complaint only if the cautionary language truly is meaningful. That means eschew boilerplate, be specific, don’t misstate historic facts and, above all, update your language as things change.

See also this blog that looks at the risks of disclosure post-PSLRA. Here’s an excerpt:

What role does public disclosure by a defendant firm play in the outcome of securities fraud class actions? In a recent article we study this question and find when a defendant firm discloses more via press releases and conference calls, it is more likely to experience an adverse outcome in litigation. While the possibility of private legal liability likely improves the quality and integrity of disclosure, it may also make firms reluctant to release information to financial markets. These compelling findings should be of interest to companies and legal practitioners as they evaluate corporate disclosure decisions and policies, as well as to legal scholars and lawmakers by improving our understanding of the relation between disclosure and private litigation.

pay ratio

– Broc Romanek

August 20, 2015

Could Pay Ratio Disclosure Lead to Employee Misunderstanding & Lost Productivity?

In the wake of the pay ratio rules being adopted, this is one of the topic du jours. And it’s one that will be tackled during our “Pay Ratio Workshop” next Tuesday, August 25th during the panel entitled “How to Handle PR & Employee Fallout.” Register Now! This is an audio-only event (whose archive will be up immediately if you can’t attend live).

Here’s a list of the nine panels that will span over four hours of practical instruction on Tuesday:

– “Overview: The Final Rules”
– “Getting Ready for Compliance: Sampling & Other Data Issues”
– “Streamlining Your Compliance Efforts”
– “Board Presentations: What To Tell Boards Now”
– “Disclosure: Handling the Transition Period”
– “Parsing Model Disclosures: US-Only Workforces”
– “Parsing Model Disclosures: Global Workforces”
– “Parsing a Recent Pay Ratio Disclosure”
– “How to Handle PR & Employee Fallout”

ESG: 75% of Investors Consider

Recently, the CFA Institute released these survey results showing that nearly 75% of respondents said that they take ESG issues into consideration in the investment process. In addition, 64% of respondents consider governance issues, 50% consider environmental issues and 49% consider social issues. Only 27% don’t consider ESG issues…

Corp Fin: Shelly Luisi Promoted to Associate Director

Congrats to Shelly Luisi for her promotion to Associate Director in Corp Fin! As noted in this press release, Shelly previously served as a Senior Associate Chief Accountant in the SEC’s Office of the Chief Accountant. I believe this is the first time that someone from OCA was promoted into a Front Office gig within Corp Fin…

– Broc Romanek

August 19, 2015

Conflict Minerals: SEC Loses 1st Amendment Rehearing

Below is news from Hunton & Williams’ Scott Kimpel (also see this Cooley blog):

Yesterday, the DC Circuit Court of Appeals finally issued its opinion on rehearing in NAM v. SEC and, by a 2-1 vote, reaffirmed its earlier decision that the SEC’s conflict minerals rules violate the First Amendment to the extent they require companies to describe their products as not being “conflict free.” The DC Circuit first issued its ruling in April 2014, but parts of the opinion were called into question by a subsequent DC Circuit opinion in American Meat Institute v. Department of Agriculture. Yesterday’s opinion reconsidered the earlier holding in light of American Meat.

The Corp Fin Staff has been rumored to be waiting for this ruling before it issues any further interpretive guidance on the conflict mineral rules. One area where guidance would be helpful concerns the interplay between the DC Circuit opinions and the rule’s two-year transition provisions, which – but for the DC Circuit’s ruling – would otherwise cease to apply to Forms SD filed in 2016. A recent Wall Street Journal article posited that issuers would have to begin obtaining third party audits over their conflict minerals reports in 2016, but the court’s holding calls this conclusion into question because the audit requirement is premised on the same constitutionally infirm language the court struck down. Corp Fin Director Keith Higgins issued a statement in April 2014 indicating that an independent private sector audit “will not be required unless a company voluntarily elects to describe a product as ‘DRC conflict free’ in its Conflict Minerals Report.”

Is Director Higgins’s statement still valid? Should issuers make any other changes to conflict minerals reporting in the future? The Staff may now feel empowered to answer these questions. The next Form SD is due May 31, 2016.

Pay Ratio Rules Published in the Federal Register

Yesterday, the SEC’s pay ratio rules were published in the Federal Register – so they have an effective date of October 19, 2015. That’s not the compliance date however…

In the wake of the pay ratio rules being adopted, you need to get a handle on what to do now – as there are tasks you should be accomplishing way ahead of your disclosure obligation. Tune into our “Pay Ratio Workshop” next Tuesday, August 25th – an audio-only event (whose archive will be up immediately if you can’t attend live). Register Now!

Here’s a list of the nine panels that will span over four hours of practical instruction on Tuesday:

– “Overview: The Final Rules”
– “Getting Ready for Compliance: Sampling & Other Data Issues”
– “Streamlining Your Compliance Efforts”
– “Board Presentations: What To Tell Boards Now”
– “Disclosure: Handling the Transition Period”
– “Parsing Model Disclosures: US-Only Workforces”
– “Parsing Model Disclosures: Global Workforces”
– “Parsing a Recent Pay Ratio Disclosure”
– “How to Handle PR & Employee Fallout”

Why the SEC’s Pre-Existing Relationship Test is the Mirror Image of California’s

Here’s a blog by Keith Bishop comparing one of the new CDIs to California’s limited offering exemption…

Check out this Bloomberg article entitled “SEC Allows Tweets for Startups Raising Money”…

– Broc Romanek

August 18, 2015

CFO Survey: 20% of Companies Distort Earnings Within GAAP

This new paper discusses the results of a survey of approximately 400 public and private company CFOs about earnings quality, with an emphasis on GAAP-conforming earnings misrepresentation (i.e., not fraud).

Key results include:

– CFOs say that the key characteristics of high quality earnings are sustainability, the ability to predict future earnings, and backing by actual cash flows. More specific features include consistent reporting choices through time, and minimal use of long‐term estimates. The factors that determine earnings quality are about half controllable (corporate governance, internal controls, proper accounting and audit function), and half noncontrollable or innate (nature of the business, industry membership, macroeconomic conditions).
– CFOs believe that in any given year 20% of companies intentionally misrepresent their earnings using discretion within GAAP. The magnitude of the typical misrepresentation is quite material – about 10 cents on every dollar. While most misrepresentation results in the overstatement of earnings, a full one‐third of firms that are misrepresenting are intentionally lowballing their earnings.
– Main consequences from poor earnings quality are investor confusion and lack of trust in management, leading to stock price declines and higher cost of capital. CFOs acknowledge that investor confusion could also result in higher bid‐ask spreads and lower analyst following but think that such effects are minimal for most sizable firms. In addition, firms with poor earnings quality frequently attract considerable short interest.
– CFOs provide a list of red flags (see Table 2, pg. 17) that outside observers like analysts and investors can use to identify poor earnings quality. Lack of correlation between earnings and cash flows is the top choice, followed by unwarranted deviations from industry or other peer norms. Presence of lots of accruals and one‐time charges, and consistently beating analyst forecasts, also score highly.

The chief motivations to misrepresent earnings are to influence stock price and in response to outside pressure to hit earnings benchmarks. Here is a relevant excerpt:

Most CFOs think there is unrelenting pressure from Wall Street to avoid surprises. As one CFO put it, “you will always be penalized if there is any kind of surprise.” As a result “there is always a tradeoff. Even though accounting tries to be a science, there are a hundred small decisions that can have some minor impact at least on short‐term results. So that is a natural tension, and one that, depending on the company, the culture, and the volatility of the company, can be a source of extreme pressure or it can be a minor issue.”

See my previous blogs on long-term/short-term behaviors, creating a formal framework for accounting judgments, and audit committee oversight in connection with accounting changes, and our “Investor Composition” Practice Area.

Push Toward Elimination of “Quarterly Capitalism”

Replacing quarterly financial reports with less frequent updates was reportedly among the ideas suggested at the Institute of Corporate Directors’ recent conference in Toronto. The theme of the conference was short-termism. Quarterly reporting, aka, quarterly capitalism, is deemed to drive a short-term outlook and short-term behaviors, as companies repeatedly scramble to meet earnings expectations.

The Financial Post article notes the recent change in the UK by the FCA that allows companies to forgo mandatory quarterly reporting and report only twice a year. The UK’s largest asset manager, Legal & General, recently announced that it had sent a letter to each of the FTSE 350 company boards supporting the change and asking those companies to discontinue quarterly financial reporting:

“Reporting which focuses on short-term performance is not necessary to building a sustainable business as it may steer management to focus more on short-term goals and away from future business drivers… ‘For many businesses, we believe, reducing the time spent on frequent reporting could help management to focus more on long term strategies and articulate more on market dynamics and innovation drivers that will enhance their performance over time.'”

See also this FT article and my previous blog on earnings call practices.

More on “The Mentor Blog”

We continue to post new items daily on our blog – “The Mentor Blog” – for members. Members can sign up to get that blog pushed out to them via email whenever there is a new entry by simply inputting their email address on the left side of that blog. Here are some of the latest entries:

– “Fresh Eyes” in the Boardroom
– Survey: Auditor Evaluations Falling Short
– Governance Roadshows for Mid-Caps
– Reframing the Board Succession Dialogue
– Adapting to Mainstream Shareholder Activism


– by Randi Val Morrison