October 31, 2018

Microcaps: A 62-Page “Lay of the Land”

This unique 62-page study from the IRRCi & Annalisa Barrett examines governance practices at 160 companies with less than $300 million in market cap (that works out to about 10% of all exchange-listed microcaps – though keep in mind there are about 10k publicly-traded microcaps when you count all the ones that aren’t listed on a major exchange). Here’s some interesting takeaways (also see this survey of 2017’s “Micro IPOs”):

– 73% are listed on Nasdaq, 19% on the NYSE American, and 8% on the NYSE

– 32% of the studied companies have been public for 10-20 years – and only 6% were founded in the last 5 years

And here’s how the microcaps compare to Russell 3000 companies on some governance “hot topics”:

– 93% have a one-share, one-vote structure

– Director tenure & age is comparable, but boards tend to be smaller (7 directors on average, versus 9) – and less diverse (61% are all-male)

– 62% separate the Chair/CEO roles (comparable to the Russell 3000) – but among companies that combine the role, 70% lack a lead independent director

– 71% of companies have three committees – audit, compensation & nominating/governance (even though Nasdaq doesn’t require a standing nominating committee)

– Only 11% have adopted a majority standard for director elections

– Median director pay was just under $75k – and 32% still pay board meeting attendance fees

– Only 16% disclose having director stock ownership guidelines

Why the discrepancies between small & mid-sized companies? Lots of us are probably hoarse from repeating that the markers of good governance aren’t “one-size-fits-all.” And when it comes to private ordering via shareholder activists, it looks like these companies either fly under activists’ radar (for now) or have too much insider ownership to be worth targeting. Insiders own 10% or more of the stock at over half of the studied companies – and only one of them had a shareholder proposal in last year’s proxy statement.

Comment Trends: Corp Fin’s “Top 10”

This 120-page report from EY – and the related 14-page summary – note that Corp Fin issued 25% fewer comment letters last year. The volume is down by more than half since 2014! It remains to be seen whether the SEC’s cybersecurity focus and companies’ adoption of new accounting standards will reverse that trend. For now, you can get your ducks in a row on these “top 10” most frequent areas of comment:

1. MD&A: especially disclosure of key performance indicators (note, in her speech last week, SEC Commissioner Kara Stein floated the idea that auditors could be more involved in assessing the accuracy of KPI disclosure)

2. Non-GAAP: continued focus on concepts from May 2016 CDIs – especially CDIs 100.01, 100.04, 102.07 and 102.11 (I blogged more about this yesterday)

3. Fair Value Measurements: be ready to justify your valuation techniques & inputs

4. Segment Reporting: Staff is looking for inconsistencies between filings and other public information, and expects companies to monitor for changes on an ongoing basis

5. Revenue Recognition: companies can provide a better understanding of their judgments on performance obligations, etc.

6. Intangible Assets & Goodwill: especially the impairment analysis, recognition & measurement

7. State Sponsors of Terrorism: liquidity, risk factors & results of operations for companies with operations in identified countries

8. Income Taxes: including deferred tax assets and accounting for tax reform

9. Acquisitions & Business Combinations: requests for analysis to ensure that the company properly applied the Regulation S-X “significance” tests

10. Contingencies: focus on disclosure about reasonably possible losses and the clarity & timeliness of loss contingency disclosure

PCAOB Opens Door to “CAM” Improvements

This recent speech from PCAOB Chair Bill Duhnke says that the PCAOB is already planning a post-mortem review of the “critical audit matters” requirement – and will consider changes if necessary. Here’s an excerpt (also see this WilmerHale blog):

Once the initial implementation of critical audit matters begins in June 2019, we plan to assess experiences and results, and determine whether we need to take further action—including whether to issue guidance or amend the standard. As part of this assessment, the staff plans to engage with auditors, investors, financial statement preparers, and audit committee members, through requests for comment, interviews, surveys, and other outreach to learn about their experiences.

After a reasonable period of time following completion of implementation in December 2020, we will conduct a post-implementation review to analyze the effectiveness of the new requirements. As part of that exercise, the staff will reevaluate the costs and benefits of the standard, including any unintended consequences, to understand the overall impact on the audit profession, public companies, and users of financial statements. To the extent that review suggests changes should be made, we will consider such changes at that time.

And according to Chair Duhnke, that’s not all that the PCAOB is planning – several standard-setting projects are in the works, which could impact accounting estimates and require more rigorous evaluations of specialists that are engaged by auditors. And here’s a couple of other things for audit committees to expect:

– Audit firms will be ramping up their quality control procedures, since that’ll be a focus for 2019 inspections

– More interaction with the PCAOB during the inspection process – a knock on your door doesn’t necessarily signal that your company’s audit firm is in trouble

Liz Dunshee