April 22, 2020

SEC & PCAOB Officials Issue Joint Statement on “Emerging Market” Risks

Yesterday, SEC Chair Jay Clayton and a group of senior SEC & PCAOB officials issued a joint statement warning about the risks posed by “emerging market” investments.  While the statement addresses all emerging markets, it focuses on the 500 lb. gorilla of those markets – China. Here’s an excerpt from the introduction:

Over the past several decades, the portfolios of U.S. investors have become increasingly exposed to companies that are based in emerging markets or that otherwise have significant operations in emerging markets. This exposure includes investments in both U.S. issuers and foreign private issuers (“FPIs”) that are based in emerging markets or have significant operations in emerging markets. During this time, China has grown to be the largest emerging market economy and the world’s second largest economy.

The SEC’s mission is threefold: protect our investors, preserve market integrity and facilitate capital formation. Ensuring that investors and other market participants have access to high-quality, reliable disclosure, including financial reporting, is at the core of our efforts to promote each of those objectives. This commitment to high-quality disclosure standards—including meaningful, principled oversight and enforcement—has long been a focus of the SEC and, since its inception, the PCAOB.

Our ability to promote and enforce these standards in emerging markets is limited and is significantly dependent on the actions of local authorities—which, in turn, are constrained by national policy considerations in those countries. As a result, in many emerging markets, including China, there is substantially greater risk that disclosures will be incomplete or misleading and, in the event of investor harm, substantially less access to recourse, in comparison to U.S. domestic companies. This significant asymmetry holds true even though disclosures, price quotes and other investor-oriented information often are presented in substantially the same form as for U.S. domestic companies.

The statement details risks and related considerations specific to “issuers, auditors, index providers & financial professionals.” These include concerns about the quality of financial information, the PCAOB’s continuing inability to inspect workpapers in China, the limited ability of U.S. authorities to bring enforcement actions in emerging markets, the limited rights & remedies available to shareholders, and the failure of passive investment strategies to account for these risks.

The statement also addresses concerns about disclosure, and emphasizes the importance of robust risk factor disclosure for companies with operations in emerging markets:

In light of both the significance and company-specific nature of the risks discussed in this statement, we expect issuers to present these risks prominently, in plain English and discuss them with specificity. Issuers based in emerging markets should consider providing a U.S. domestic investor-oriented comparative discussion of matters such as (1) how the company has met the applicable financial reporting and disclosure obligations, including those related to DCP and ICFR and (2) regulatory enforcement and investor-oriented remedies, including as a practical matter, in the event of a material disclosure violation or fraud or other financial misconduct more generally.

The statement was issued jointly by Chair Clayton, PCAOB Chair Bill Dunkhe, SEC Chief Accountant Sagar Teotia, and the Directors of Corp Fin & IM. With that kind of firepower mustered behind the statement, I think it’s fair to say that they aren’t fooling around here. Public companies based in China or with significant operations there should take a hard look at their risk factor disclosures, because it seems likely that they will be scrutinized closely by the Staff the next time their filings are pulled for review.

Covid-19 Crisis: Companies Adopt Emergency Bylaws to Ensure Board Operations

With all of the disruptions resulting from the Covid-19 pandemic, many companies are looking at board and management continuity issues, and some companies have opted to adopt an emergency bylaw to help address these issues. This recent Simpson Thacher memo discusses Section 110 of the DGCL, which allows companies to adopt emergency bylaws and sets forth what may be included in them.  Among other things, these bylaws may permit companies to expand the class of persons who may call a board or committee meeting, and relax notice and quorum requirements for such a meeting.

Yesterday, Mastercard filed an Item 5.03 8-k announcing that its board had adopted an emergency bylaw, which provides that:

– a Board or committee meeting may be called by any director or officer by any feasible means, and notice of the meeting may be provided only to the directors that can be feasibly reached and by any feasible means; and

– the director(s) in attendance at the meeting shall constitute a quorum and may appoint one or more of the present directors to any standing or temporary committee as they deem necessary and appropriate

Mastercard isn’t the only company that has adopted an emergency bylaw in recent weeks. John Bean Technologies also adopted a similar provision, and other companies have long had emergency provisions in their own bylaws (see this Jack In The Box filing from 2005).  If your bylaws don’t contain an emergency provision, now may be a good time to consider adopting one.

Transcript: “Activist Profiles & Playbooks”

We have posted the transcript for the recent webcast: “Activist Profiles & Playbooks.”

John Jenkins