Monthly Archives: April 2016

April 15, 2016

Trump & Sausages!

This blog was not hacked. I scrapped what I had planned to post so that I can try a little social experiment. Below is a poll about whether you only bothered to read this blog because it said “Trump & Sausages.” But don’t fear, this blog really is about those two topics – and in the context of our community!

Annual Meeting Disturbed By (Thrown) Sausages!

As noted in this article from “The Guardian,” a fight between shareholders over free sausages at Daimler’s annual meeting broke out. The company served 12,500 sausages to the 5500 shareholders who attended. That’s a lot of meat! Brings back memories of Animal House’s “food fight” scene. “That boy is a P-I-G, pig”…

A Real Trump Deal Cube!

If you’re relatively new to this blog, you missed my year of running a March Madness-style contest pitting the hundreds of toys in my “Deal Cube Museum.” I was showing off the museum to a friend recently & was reminded that it does indeed include a Trump deal cube!

Poll: How Often Do You Read This Blog?

Take this anonymous poll about how often you read this blog:

customer survey

Broc Romanek

April 14, 2016

The Reg S-K Reboot Begins!!!

No!!! No!!! No!!!

I don’t want the SEC to modernize Regulation S-K! That means I’ll have to update 1500 pages of our “Handbooks“! At least the SEC is not touching Item 402 – at least not yet.

Anyways, the SEC voted yesterday to issue this 341-page concept release on a big slice of Regulation S-K – the Item 100-300 series. 341 pages! (No, I didn’t read it last night – I was enjoying JJ Grey!) I’ll be posting the related memos as they arrive in our “Regulation S-K” Practice Area (and our “Disclosure Effectiveness” Practice Area).

Here’s an excerpt of this blog by Cooley’s Cydney Posner with notes from the open Commission meeting (also see this WSJ article):

Although the concept release has not yet been posted nor have any of the Commissioners’ remarks, the presentations and discussion at the meeting indicated that the release will address three basic topics: framework, line items and presentation and delivery.

Framework. The staff observed that, although there are some prescriptive and structured elements, the current requirements are largely principles-based, with disclosure determined on the basis of “materiality” as defined in TSC Industries, Inc. v. Northway, Inc., specifically, whether there is a substantial likelihood that a reasonable investor would consider the information important in decision-making and whether a reasonable investor would view the information to significantly alter the “total mix” of information available. However, Chair White also recognized the importance of not burying material information in an avalanche of trivia. Considering the costs and benefits, including the expressed interests of shareholders in receiving more information and the expressed interests of companies in efficiencies, how should the disclosure requirements be structured? Should some level of investor sophistication be assumed? As Commissioner Stein suggested, should the system be re-imagined? for example, she questioned why the release did not address concepts as basic as the form-based system.

Line items. The discussion indicated that the release addresses six items: core company disclosure, company performance (primarily financial), risk, securities, industry guides and exhibits. The release also considers whether the categories for scaled disclosure are appropriate and whether recent topics of interest and shareholder engagement should be added to the requirements, for example, stock buybacks and sustainability. In addition, the release hints at the prospect of semi-annual, instead of quarterly, reporting.

Presentation and delivery. Here, the release will consider various approaches to presenting and accessing the disclosure and ways to reduce repetition, including cross-references, incorporation by reference, hyperlinks, company websites and standardization versus flexibility. Stein expressed the concern that, in considering whether the quantity of information is excessive, the SEC needs to balance that with concerns about the quality of information. In addition, she observed that a re-imagined delivery system should take into account that different generations may prefer to have their information delivered in different ways, for example, a younger audience may prefer to receive information through tweets.

Technical question: So why is this a “concept release” – but the S-X counterpart was just a “request for comment”? Maybe to satisfy the FAST Act’s requirement for an S-K study? No idea. Here’s the opening statements from the various Commissioners about the concept release…

Deferred Prosecution Agreements: DC Circuit Limits District Court Review

Here’s a summary of this Cleary Gottlieb memo (see more memos in our “White Collar Crime” Practice Area):

In a case with significant implications for the power of district judges to review the terms of deferred prosecution agreements (“DPAs”) between the Department of Justice (“DOJ”) and corporations to resolve criminal investigations, on April 5, 2016, the United States Court of Appeals for the District of Columbia Circuit took the extraordinary step of granting a writ of mandamus and vacated a lower court decision that had the practical effect of rejecting a DPA between the DOJ and an aerospace services company, Fokker Services, B.V. The case has significant implications in light of a judiciary that has been increasingly questioning the terms (and in some instances, the wisdom) of the DOJ’s decisions to enter into DPAs.

Anti-Bribery Study: 600 CCOs Weigh In

I couldn’t resist blogging about this new Hogan Lovells’ study on anti-bribery & corruption because I just love the microsite that the firm created to house the thing. The microsite not only houses the study, but it has a self-assessment compliance quiz & more. The study is based on interviews with 604 chief compliance officers (CCOs) and equivalent roles in more than 600 of the world’s largest organizations in Europe, U.S. and Asia. The study’s findings include:

– Commercial priorities push anti-bribery and corruption down the agenda
– 57% of chief compliance officers say sales culture is a major threat
– 28% of companies fail to tailor global anti-bribery programs to local markets
– 53% of companies train half their staff or less in anti-corruption
– Significant business operations “hidden” from chief compliance officers

I think this will be a trend going forward where firms work harder on their marketing to showcase the hard work that they’ve done…

Broc Romanek

April 13, 2016

More on “10-K/10-Q Comment Letters: Cut in Half Over 5 Years?”

A while back, we blogged about a study showing a five-year decline in the number of Form 10-K & 10-Q comment letters issued by Corp Fin. We ran a poll as to why the number of comment letters has declined – and most folks thought it was due to companies doing a better job with their disclosures (34%); followed by Corp Fin being too busy reviewing deals (31%) and the fact that there are fewer public companies these days (9%; there’s been a 30% reduction in the number of public companies since 2000).

But here’s a response from Reid Hooper of Covington & Burling about a possible reason that we didn’t poll on:

The reason why the number of Form 10-K/10-Q comment letters has been falling for the past few years is relatively straight-forward. The Corp Fin Staff has a much higher materiality threshold. One reason could be a shift in Staff focus from commenting on ’34 Act reports to a “fuller” review of repeat issuer registration statements. Another reason for the possible change in the staff’s materiality threshold could be due to the change from a rules-based exam report to a more principles-based approach when reviewing Form 10-K/10-Qs.

Comment letters on a Form 10-K are now just 1-2 comments (depending on the reviewer & group) – and the comments will now almost always be “futures” comments. In those instances where the Staff may seek an amendment to a Form 10-K/10-Q, the comments generally relate to a material disclosure matter rather than a mere matter of technical compliance.

After hearing Corp Fin Director Keith Higgins this weekend at the ABA conference, it appears that Reid is indeed correct. Keith talked about how Corp Fin has raised its materiality threshold in issuing comments – and how the Office of Disclosure Standards has assisted the Division in being more consistent about the type of comments issued. Corp Fin’s comments are more likely to impact the significance of disclosure these days – rather than ensure mere compliance with a regulation that doesn’t necessarily elicit disclosure that has real meaning.

Keith also noted that the Staff tends to issue more industry-specific comments these days. And he felt we were doing a better job in drafting – so that we can take some credit for the reduction in comments…

Here’s Congressional testimony about the SEC’s budget from Chair White yesterday. It looks like Corp Fin won’t be increasing its head count. And that Corp Fin reviews the filings of 9100 companies. And today is a big day – the SEC Commissioners meet on a Reg S-K concept release!

PCAOB: “Auditor Supervision of Other Auditors” Proposal

Yesterday, the PCAOB proposed changes to a slew of existing auditing standards that would strengthen existing requirements and impose a more uniform approach to a lead auditor’s supervision of other auditors. Here’s the proposing release.

Auditors that Prepare the Corporate Tax Return Tend to Do So Cautiously

Here’s a nugget from Baker & McKenzie’s Dan Goelzer: An academic study finds that the corporate tax returns of companies that retain their financial statement auditor to prepare the return take less aggressive tax positions than do returns prepared by either the company itself or by other kinds of external advisers. The study, “Auditors, Non-Auditors, and Internal Tax Departments in Corporate Tax Aggressiveness,” was conducted by Kenneth J. Klassen, University of Waterloo, Petro Lisowsky, University of Illinois at Urbana–Champaign Norwegian Center for Taxation, and Devan Mescall, University of Saskatchewan. It is based on a review of uncertain tax positions reported under FASB Financial Interpretation No. 48 (FIN 48) by companies in the S&P 1500 during 2008-2009, coupled with information obtained from the IRS regarding the signer of the corporate return.

The full text of the study appears in the January-February 2016 issue of the American Accounting Association’s publication, The Accounting Review (available for purchase). The study’s abstract states:

“Using confidential data from the Internal Revenue Service on who signs a corporation’s tax return, we investigate whether the party primarily responsible for the tax compliance function of the firm—the auditor, an external non-auditor, or the internal tax department—is related to the corporation’s tax aggressiveness. We report three key findings: (1) firms preparing their own tax returns or hiring a non-auditor claim more aggressive tax positions than firms using their auditor as the tax preparer; (2) auditor-provided tax services are related to tax aggressiveness even after considering tax preparer identity, which supports and extends prior research using tax fees as a proxy for tax planning; and (3) Big 4 tax preparers, in particular, are linked to less tax aggressiveness when they are the auditor than when they are not the auditor.”

The authors explanation of their findings is that the auditor has more downside risk if tax positions underlying the return are rejected by the IRS than do other tax preparers, including the company’s tax staff. The auditor’s higher risk exposure stems from two sources: “(1) financial reporting restatement risk due to an audit failure related to the tax accounts; and (2) reputation risk, in that the auditor-preparer’s work is more visible and sensitive to the firm’s leadership.”

As to the later point, the authors argue that audit committee pre-approval of auditor tax services, required under the Sarbanes-Oxley Act, exposes the board to potential embarrassment if the company’s tax positions are rejected and that this risk incentivizes the auditor to be more cautious. “[I]f the firm employs its auditor for tax services, then its audit committee has explicitly sanctioned this relationship under the requirements of the Sarbanes-Oxley Act of 2002 (SOX). Therefore, the board of directors, as well as managers, may bear additional costs if negative tax outcomes result * * *, relative to the case if the tax work was conducted separately from the audit.” The authors also note that the PCAOB’s rules prevent the financial statement auditor from advising the company to use tax strategies that have tax avoidance as a significant purpose and do not meet the standard of “at least more likely than not to be allowable.” Other return preparers are not subject to this limitation.

Comment: Traditionally (i.e., since the early 2000s), non-audit services, including tax preparation, have been regarded as potential threats to auditor independence and therefore to audit quality. The theory behind this view is that the greater the aggregate fees the auditor is generating from the client, the less inclined the firm’s personnel will be to risk the relationship by challenging management’s views on financial reporting issues. This study looks at the issue from another perspective – promoting tax compliance – and suggests that, when viewed through that lens, auditor return preparation creates positive incentives. Of course, an audit committee considering whether to approve return preparation as a non-audit service would need to weigh a variety of factors, in addition to the auditor’s potential tax conservatism, including (1) cost of the service, relative to other options; (2) the level of in-house tax expertise; (3) the value, in the company’s circumstances, of having more than one perspective on the tax reserve; and (4) the risk of disagreements between the preparer and the auditor resulting in additional FIN 48 disclosures.

Broc Romanek

April 12, 2016

Our New “Non-GAAP Financial Measures Handbook”

Spanking brand new. By popular demand, this comprehensive “Non-GAAP Financial Measures Handbook” covers a challenging topic, from the basics to everything you want to know about Regulation G, Item 10(e) of Regulation S-K & Form 8-K’s Item 2.02. This one is a real gem – 89 pages of practical guidance – and its posted in our “Non-GAAP Disclosures” Practice Area. Big HUGE hat tip to Joe Alley of Arnall Golden Gregory for authoring this beast! This is a hot topic, as noted in my blog last week entitled “Non-GAAP Financial Measures: Will the SEC Curb Their Use?“…

Also see this memo – “Top 10 Questions to Ask When Using a Non-GAAP Measure” – that I just posted in our “Hot Box” on our home page…

EDGAR: The SEC’s New “Announcement” Service

On my “wish list” from the SEC, I’ve had a wish that the SEC would inform us when EDGAR is experiencing problems – or problems are resolved – through a blog or other sort of channel. Good news! The SEC’s Filer Support team recently implemented an “announcement” functionality on the “Information for Filers” page. It’s a RSS news/announcement feed that folks can sign-up to receive an email every time that Filer Support has something important to note (i.e. EDGAR closings, change in support hours, etc.).

Each announcement will be posted on both the “Information for Filers” page – and this “Announcements” page. I’m not certain whether the announcements will include information about outages & other problems – but fingers crossed…

Board Diversity: Shareholder Nominees Come Under Fire

A few months ago, I blogged about an interview with SEC Chair White about board diversity & activism – but that interview tackled the two topics separately. This recent Bloomberg article has raised eyebrows as it shows that – since 2011 – only 7 of the 174 people nominated to boards by five of the largest US activist funds have been women. Here’s an excerpt from this Davis Polk memo about this news:

This is not a surprise given that shareholder activist funds often nominate their employees, and to date their senior employees remain predominantly men. (A “pipeline” problem does not, of course, fully explain the numbers since shareholder activist funds also nominate independent directors who are not employees.) These news reports echo Andrew Ross Sorkin who raised the question last year of whether shareholder activists target women CEOs, noting that although only 23 women lead companies in the S&P 500, nearly a quarter of them have been in the crosshairs of shareholder activists. We recognize that shareholder activists are not alone in having room for improvement when it comes to diversity – most of the companies they target and the professional services firms that advise on these matters could improve in this area as well.

Broc Romanek

April 11, 2016

SEC Commissioner Nominees: Political Spending Disclosure Throws a Wrench

Last Thursday, the Senate Banking Committee met to approve the two SEC Commissioner nominees – but rather than going through the motions of a routine approval, a group of Democrats essentially forced a postponement after demanding that the SEC propose rules requiring political contributions disclosure. Here’s an excerpt from this WSJ article by Andrew Ackerman:

A revolt by Democratic lawmakers is jeopardizing the nominations of two White House picks for the Securities and Exchange Commission, threatening to further hamper the short-handed agency struggling to complete key rules. During what was expected to be a routine vote Thursday, a group of Democratic senators drew a line in the sand, demanding that the markets regulator adopt new rules forcing companies to disclose spending on political activities—an issue on which the commission’s current chairman, along with the nominees, have been noncommittal.

Four Democrats on the Senate Banking Committee, including Sens. Charles Schumer of New York and Robert Menendez of New Jersey, said they would oppose the SEC picks, after which the panel postponed the vote. The battle reflects growing desires by Democratic lawmakers and their allies to expand the SEC’s work beyond typical investor-protection issues. It also shows intensifying divisions within the party over the proper qualifications and policies for financial nominees. “The SEC needs commissioners who believe in and support campaign spending transparency, and unfortunately these nominees have yet to answer that call,” Mr. Schumer said in a written statement, adding the two nominees were “fence-sitting” on the issue.

The concerns cast a cloud over the ability of both SEC nominees—Lisa Fairfax, a Democrat, and Hester Peirce, a Republican—to win Senate confirmation, according to Senate aides. The SEC is now down to just three members, two less than its full complement, after two left the agency late last year. If the SEC remains with only three members for a prolonged period, it could be difficult for Chairman Mary Jo White to advance her agenda in what is likely her final year at the markets regulator.

The strength of the opposition is surprising, as the banking panel has easily advanced “paired” Democratic and Republican nominees in the past. That some Democrats are refusing to back Ms. Fairfax is also surprising because she was seen as a compromise pick after the White House’s favored selection for the SEC slot, a well-known corporate securities lawyer, ran into Democratic opposition last summer over his ties to industry. White House nominees for financial positions have faced increasing resistance from Democrats as the party is torn by internal debate over the proper qualifications and policies for such officials, an argument that has also spilled into the Democratic presidential contest.

Conflict Minerals: SEC Not Appealing to SCOTUS

As noted in this letter from Attorney General Loretta Lynch to House Speaker Paul Ryan, the SEC has decided not to appeal the result in SEC v. NAM to the US Supreme Court. As noted in this alert, this doesn’t impact the Form SDs being prepared now and Corp Fin’s April ’14 guidance remains as the last word…

PCAOB: Updated Standard-Setting Agenda

Last week, the PCAOB posted an updated standard-setting agenda that outlines milestones on various standard-setting projects…

Broc Romanek

April 8, 2016

PCAOB Staff Observations: Audit Committee Communications

A few days ago, the PCAOB issued this 9-page “Staff Observations Report” describing inspection observations related to auditor communications with audit committees, finding that 93% of the audits inspected in 2014 passed muster. Here’s an excerpt from the related press release:

Inspections staff identified deficiencies in complying with the new standard in 7 percent of the relevant audits inspected. Those deficiencies did not by themselves result in an insufficiently supported audit opinion, but nevertheless constituted departures from the requirements of the standard and indicated a potential defect in firms’ systems of quality control. Inspections staff also identified deficiencies related to other PCAOB rules and standards requiring communications with audit committees, such as communications concerning independence.

During interviews with inspections staff, audit committee chairs generally indicated that effective two-way communication with their auditors had occurred. Some audit committee chairs noted that after the effective date of the standard, there had been improvements in the robustness and formality of communications with their auditors, including more in-depth discussions with the auditor about audit progress, significant risk areas, and audit findings. Other audit committee chairs noted that their auditors had been communicating the matters required under the standard even before the standard came into effect and, accordingly, they had not observed a significant change in their communications with their auditors in 2013.

Auditor Engagement: PCAOB Requests Comment on How AS #7 Is Faring

A few days ago, the PCAOB issued this “request for comment” to check how the implementation of AS #7, “Engagement Quality Review” has been faring since it’s adoption in 2009…

Non-GAAP Financial Measures: Will the SEC Curb Their Use?

As noted in this Bob Lamm blog & Cooley blog, this WSJ article reports that SEC Chair White said that the SEC is considering whether to restrict the use of non-GAAP financial measures. In remarks, Chair White said: “[y]our investor relations folks, your CFO, they love the non-GAAP measures because they tell a better story….We have urged for some time that companies take a very hard look at what you are doing with your non-GAAP measures. We have a lot of concern in that space.” These comments from Chair White follow similar ones that she made back in January.

Then a week or so later, SEC Chief Accountant Jim Schnurr delivered this speech, in which he said companies should expect the SEC Staff to remain vigilant in its review of non-GAAP measures and their compliance with existing rules Here’s an excerpt from that: “The proliferation of non-GAAP reporting measures among registrants, and reliance and reporting by analysts, should warrant increased focus by management and the audit committee,” he said. “I believe the focus should go beyond determinations that the measures comply with the Commission’s rules and include probing questions on why, in contrast to the GAAP measure, the non-GAAP measure is an appropriate way to measure the company’s performance and is useful to investors.”

More on our “Proxy Season Blog”

We continue to post new items regularly on our “Proxy Season 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:

– Stats: How Retail Holders Vote
– Proxy Access: T. Rowe Price’s Updated Policy
– Proxy Access: The Latest Stats
– Mobile Proxy Statements: Remember the “Tracking Cookie” Prohibition
– A Closer Look at Buffett’s Annual Shareholders Letter
– ESG: Glass Lewis to Include Ratings in Reports

Broc Romanek

April 7, 2016

Shareholder Engagement: How the DOJ’s ValueAct Lawsuit Poses Problems

A few days ago, the DOJ brought an enforcement action against ValueAct for failing to comply with the HSR waiting period requirements. Here’s an excerpt from this great memo by Davis Polk’s Arthur Golden, Tom Reid and Laura Turano (& other memos are being posted in our “Shareholder Engagement” Practice Area):

We believe that this case will be important to watch because of the types of statements and actions by ValueAct that are cited by the DOJ as evidence of an intent to influence the business decisions of both companies. For example, the complaint identifies internal discussions at ValueAct regarding proposing changes to Halliburton’s executive compensation plan, and a meeting between ValueAct and Halliburton’s CEO during which ValueAct detailed its preferred approach to executive compensation, commented on Halliburton’s current compensation plan and proposed specific changes to the plan, as evidence of an intent to influence the business decisions of Halliburton. While this may have been part of a broader demonstration of lack of investment intent, it does seem to be (by itself) a typical subject of discussion with investors who do not seek to influence management or major corporate actions.

Although the ValueAct complaint will cause those shareholder activists who buy shares with an intention to engage with management and other shareholders to consider more carefully whether they are required to file for HSR clearance rather than rely upon the protection of the “passive investment” exemption, the practical impact of this may be limited. Some shareholder activists do not rely on the investment intent exemption but instead structure their investments so as to not be made by a special purpose entity that would exceed the “size of person” threshold (thus enabling the entity to buy up to $312.6 million of shares before a filing would be required) and split their investments across multiple special purpose entities to avoid an HSR filing while they acquire large stakes in the target company.

But, the ValueAct complaint should serve as a reminder to institutional investors that have traditionally considered themselves to be passive investors for HSR purposes. In the past, we have noted how institutional investors, which have typically engaged in quiet outreach, are taking an increasingly active and public role on corporate governance matters, and we have observed that the line between shareholder activists and institutional investors is blurring. Once an institutional or similar traditionally passive investor crosses the line—either by cooperating with shareholder activists in certain situations or by taking an increasingly assertive role with its portfolio companies—such an institution will have to examine whether it can claim to have a truly “passive” intent at the time of any future share purchases. It is important to note that this determination is often not a “one time” consideration given the frequent portfolio rebalancing and other holding changes of traditional institutional investors. For example, if the investor loses its “investment intent,” the subsequent acquisition of any additional shares may require a filing if the investor’s total holdings will exceed the applicable HSR threshold. Although an HSR filing, in the absence of substantive antitrust issues, is unlikely to significantly delay the strategy of a shareholder activist or a traditional institutional investor, it does involve notification of the target company, could chill cooperation among shareholder activists and institutional investors somewhat and certainly adds an important compliance component to their planning.

DOJ Kicks Off FCPA Enforcement Pilot Program

A few days ago, the DOJ’s Fraud Section released this “guidance memorandum” containing three initiatives, including an FCPA Pilot Program that will reduce fine beyond what is now available under the US Sentencing Guidelines for companies that voluntarily disclose possible FCPA violations, fully cooperate and implement timely and appropriate remediation. We’re posting related memos in our “FCPA” Practice Area.

Conflict Minerals: What You Can Learn from Our CY15 IPSAs & Auditability Reviews

In addition to the two blogs I posted this week on our “Proxy Season Blog” about Apple’s Form SD, check out this blog by Elm Sustainability Partners about what they learned from their IPSAs and auditability Reviews…

Also see my entry on “The Mentor Blog” today about “Who Should Be on the Conflict Minerals Team?“…

Broc Romanek

April 6, 2016

Audit Response Letters:’s Centralization

Here’s something that Locke Lord’s Stan Keller & I recently wrote: is an electronic centralized service available to audit firms to outsource the audit confirmation process. This service is now being offered to process audit response letters. Under it, audit firms send audit letter requests to – and receive audit letter responses from – law firms of an auditor’s clients using the portal.

There are several issues that law firms have identified with this process (some real, some perhaps imagined) – and it’s a work in progress. A threshold concern for a law firm is the “terms of use” that the site purports to impose on users of the system. In its most recent form, several aspects of the “terms of use” present issues. It’s possible for law firms to individually negotiate these – but a more practical approach is for the bar as a whole to work with to come up with acceptable standard terms.

Another concern is getting comfortable that the request for confidential information is coming from – or is authorized – by the client. This can be addressed by an actual signed (albeit electronic) request from the client on the portal – or by a confirmatory email from the client (which might be done as a standing authorization). Also of concern is the confidentiality of the audit response letter on a third-party system (particularly when the letter describes loss contingency matters). considers its portal to be a mere conduit for transmission of information to the auditor – but unlike the mails or a delivery service, the information remains on the portal. The site also indicates that the security of its portal has been approved by a third-party rating service – and one might suspect it is no less secure than a law firm’s own servers. Finally, the question has been asked whether supplying the information to a third-party portal might affect the attorney-client privilege. However, most commenters believe that since the portal is not an intended recipient, this should not be a problem.

There are two aspects of the new system: one is for receipt of requests and the other is for transmission of law firm responses. The issues identified don’t necessarily relate to both aspects. Thus, if there is concern over confidentiality of responses, a request could be received through the portal – and the response could be handled the old-fashioned way. Some audit firms and companies appear to prefer the convenience of a centralized request system – and law firms may face pressure to accommodate those preferences. Indeed, for law firms that use a centralized approach for handling audit response requests, there can be advantages participating in the new electronic system because requests can more easily be directed to a designated person or group within the law firm.

For now, however, until the issues have been resolved, particularly concerns with the “terms of use,” many law firms are declining to participate for both requests and responses – instead, they are asking for requests directly from clients and responding with letters sent directly to the auditors. This may change over time.

I’m heading to Montreal tomorrow for the ABA Business Law Section’s Spring Meeting – the “Audit Responses Committee” meets on Saturday morning at 10 am & is on the agenda. Come on out…

Internal Controls: A Consultant Can’t Do Your Job

Here’s a note from Simpson Thacher’s Yafit Cohn (see the full memo):

Recently, the SEC settled an enforcement action against a company, its senior officers, audit engagement partner and consultant, due to alleged failures to “properly implement, maintain, and evaluate” internal controls over financial reporting. Here are three takeaways:

1. Listen to Your Consultants…But the Buck Stops with You – Management must give careful consideration to input from consultants, among other sources. However, management maintains ultimate responsibility for ICFR assessment, so management should not rely upon a consultant’s conclusions when it possesses knowledge suggesting that there may be a material weakness in the ICFR.

2. Heed the Rules – Management must properly evaluate the severity of any internal control deficiencies and correctly apply the standards codified by the SEC in determining the ICFR’s effectiveness. In particular, the SEC’s recent action reminds us that:
– The “presence of an actual error is not a prerequisite to concluding that a material weakness exists.” Rather, management must consider “whether there is a reasonable possibility that a material misstatement will not be timely detected or prevented.”
– The effectiveness of ICFR must be assessed as of the end of the fiscal reporting period, and thus, “[p]lanned or anticipated remedial efforts are irrelevant to the analysis.”

3. Documentation is Key – Management must create and maintain adequate documentation supporting any conclusions regarding the severity of any ICFR deficiency and the effectiveness of the company’s ICFR.

Transcript: “FAST Act – Gearing Up”

We’ve posted the transcript for our recent webcast: “FAST Act: Gearing Up.”

Broc Romanek

April 5, 2016

FASB Modifies Accounting Rules for Stock-Based Compensation

Here’s a blog by Gibson Dunn’s Ron Mueller, Sean Feller and Krista Hanvey (also see these memos on

On March 30, 2016, the Financial Accounting Standards Board (FASB) released Accounting Standards Update (ASU) 2016-09, which amends ASC Topic 718, Compensation-Stock Compensation, to require changes to several areas of employee share-based payment accounting.

In an effort to simplify share-based reporting, among other things, the update revises requirements in the following areas:

Minimum Statutory Withholding: The new standard permits share-based withholding up to the maximum statutory tax rates, whereas currently an employer may only withhold up to the minimum statutory tax rate without causing the award to be classified as a liability.
Accounting for Income Taxes – The revised standard will require recording the tax effects of share-based payments at settlement or expiration on the income statement, whereas ASC 718 previously provided for tax benefits in excess of compensation cost and tax deficiencies to be reported in equity to the extent of any previous excess benefits, and then to the income statement. Under the new rule excess tax benefits are also to be classified with other operating income tax cash flows as an operating activity.
Forfeitures – Whereas accruals of compensation cost are currently based on the number of awards that are expected to vest, the revised standard allows an entity to make an entity-wide accounting policy election to either estimate the number of awards that are expected to vest or account for forfeitures when they occur.
Intrinsic Value Accounting for Private Entities: Under the update, nonpublic entities will be permitted to make a one-time accounting policy election to switch from measuring all liability-classified awards at fair value to intrinsic value.

With respect to share-based withholding on equity awards, ASC Topic 718 currently provides that equity awards cannot provide for share withholding in excess of an employer’s minimum statutory withholding requirements in order to qualify for equity treatment under the rule. As revised, the rule will now permit withholding up to the maximum statutory tax rate without causing the award to be classified as a liability. In addition, cash paid by an employer when directly withholding shares for tax-withholding purposes should now be classified as a financing activity.

For public companies, the new rules will become effective for annual reporting periods beginning after December 15, 2016, and interim reporting periods within such annual period. For all other entities, the new rules will take effect for annual reporting periods beginning after December 15, 2017, and interim periods within annual periods beginning after December 15, 2018.

In light of the new accounting rules, companies will want to review their equity compensation plans and award agreements to determine if they will allow for withholding up to the statutory maximum. In connection with this, issuers that are subject to the reporting requirements of Section 16(a) of the Securities Exchange Act of 1934, as amended, should review their award agreements with any Section 16 officers and, in order to obtain the exemption under Rule 16b-3 for share withholding in excess of amounts that were previously allowed, may need to provide for compensation committee approval of any new terms that allow for share-based withholding above what was previously authorized.

Transcript: “Key Steps to an Effective Compensation Committee”

We’ve posted the transcript for our recent webcast: “Key Steps to an Effective Compensation Committee.”

According to this note, the Senate Banking Committee will vote on the two SEC Commissioner nominees this Thursday…

T+2 Settlement Gathers Momentum

Here’s this blog by Jill Radloff:

FINRA is seeking comment on proposed amendments to FINRA rules shortening the securities settlement cycle to two days. The rulemaking notice cites a September 2015 letter in which SEC Chair White responded to industry groups expressing her strong support for industry efforts to shorten the trade settlement cycle to T+2 and urging the industry to continue to pursue the necessary steps towards achieving T+2 by the third quarter of 2017. SEC Chair White also indicated that she instructed SEC staff to develop a proposal to amend Exchange Act Rule 15c6-1(a) to require settlement no later than T+2.

Exchange Act Rule 15c6-1 currently establishes “regular way” settlement as occurring no later than T+3 for all securities, except for government securities and municipal securities, commercial paper, bankers’ acceptances, or commercial bills. In anticipation of the SEC’s changes to Rule 15c6-1 to facilitate settlement no later than T+2 and to ensure that FINRA acts in concert and conformity with the impending rule changes by other self-regulatory organizations, or SROs, FINRA is proposing definitional changes to its rules pertaining to securities settlement by, among other things, amending the definition of “regular way” settlement as occurring on T+2. The proposed technical changes would implement the anticipated rule changes of the SEC and the other SROs.

The Municipal Securities Rulemaking Board, or MSRB, has also filed a rule proposal with the SEC to define regular-way settlement for municipal securities transactions as occurring on a two-day settlement cycle.

Broc Romanek

April 4, 2016

Pre-IPO Private Placements: The SEC Speaks on Unicorns

As noted in this MoFo blog by Anna Pinedo, SEC Chair White recently delivered this speech out at Stanford that addressed a broad range of issues affecting the technology sector, including how many private companies defer their IPOs, rely on exempt offerings to raise capital and rely on private secondary markets to create liquidity for shareholders.

Chair White also talked about unicorn financings (here’s a recent survey of unicorn financings). Here’s an excerpt from her speech:

A current feature of the pre-IPO financing market that puts these questions in sharp (and local) relief is one that has gathered considerable attention recently – unicorns. Of course, this audience knows that I am speaking not of the creatures of fantasy, but of private start-up firms with valuations that exceed $1 billion. By one count, there are nearly 150 unicorns worldwide, many based here in Silicon Valley. And, they do not appear to be an endangered species. One survey shows that there were 52 unicorn financings in the last three quarters of 2015 compared to 37 such financings over the 12 months that ended in March 2015.

Beyond the hype and the headlines, our collective challenge is to look past the eye-popping valuations and carefully examine the implications of this trend for investors, including employees of these companies, who are typically paid, in part, in stock and options. These are areas of concern for the SEC and, I hope, an important focus for entrepreneurs, their advisers, as well as investors.

At the SEC, the questions we are asking do not fundamentally differ from the questions we ask about all transactions. They include whether the information supplied to investors is accurate and complete – that is, whether it accurately reflects the performance and prospects of the company. Making sure that is so becomes more compelling when the transactions are smaller and the investors are more retail. And, for those involved in advising, investing and nurturing unicorns, there is an important related question – how do $1 billion valuations affect all of the relevant investors – both those investing in the unicorn round, and those that came before and after, whether in private or public transactions.

It is axiomatic that all private and public securities transactions, no matter the sophistication of the parties, must be free from fraud. Exchange Act Section 10(b) and Rule 10b-5 apply to all companies and we must be vigorous in ferreting out and punishing wrongdoers wherever they operate. In the unicorn context, there is a worry that the tail may wag the horn, so to speak, on valuation disclosures. The concern is whether the prestige associated with reaching a sky high valuation fast drives companies to try to appear more valuable than they actually are.

Nearly all venture valuations are highly subjective. But, one must wonder whether the publicity and pressure to achieve the unicorn benchmark is analogous to that felt by public companies to meet projections they make to the market with the attendant risk of financial reporting problems. And, yes that remains a problem. We continue to see instances of public companies and their senior executives manipulating their accounting to meet various expectations and projections.

CII Targets Newly-Public Companies on Governance

As noted in this press release, CII has adopted a new policy for IPOs to ensure they have sound governance frameworks, such as a “one share, one vote” structure, simple majority vote requirements, independent board leadership and annual elections for directors.

REITs: Corp Fin Issues Game Changing Rule 144 Guidance

Recently, as noted in this Bass Berry memo (& these other memos), Corp Fin issued Rule 144 interpretive guidance for the common situation involving the exchange of operating partnership (OP) units into shares of the parent REIT. The interpretive guidance provides that, under certain conditions, the holding period for REIT common stock acquired upon an exchange of units in the REIT’s OP commences upon the unit holder’s acquisition of the OP units, rather than at the time the REIT common stock is acquired. The Staff’s guidance provides long-awaited relief to REITs structured as umbrella partnerships or “UPREITs” that seek to issue OP units as part of their consideration for real estate acquisitions through their OPs.

Broc Romanek