As we move closer to the finish line for 2020, our faithful correspondent Nina Flax of Mayer Brown is back with an uplifting “list” to focus on some of the positives she’s experienced (here’s our last list from Nina):
It has been a while since I have written a list. I have, as I am sure many of you have, struggled with COVID and WFH. Every day, there is something new, ridiculous, sad, frustrating, amazing to add to the items that elicit an “it’s 2020!” response. Despite having been stuck on I-80 with my son in the car exactly when the LNU Lightning Complex jumped the highway and shut down traffic (perhaps the subject of a future list), I am extremely grateful today that I have literally and figuratively found my way through the impending wall of smoke to find these things:
1. Dinner with my son. My son eats dinner at 5pm, if even that late some days. I cannot explain it other than that is when he is hungry, so that is when he eats because we prefer him to not be hangry. Before WFH, I very rarely made it home in time to actually eat dinner together. I have made it a point to try to do that almost every day – force myself to take the 30 minute break to have that time. Sometimes we talk about high/lows, sometimes we go around saying something we are grateful for, sometimes we take turns doing mad-lib style storytelling, mostly we just sit down and laugh about something. I have never been happier. (Except for one day I remember before child where I never got out of bed and slept for about 12 hours in between watching TV?)
2. More movement. Before WFH, my close colleague and I would take breaks from sitting at our desks and walk in circles around our office building to talk through legal issues – conceptual or drafting – it really helped. With WFH, air permitting, you will frequently find me walking up and down my driveway while on calls. Moving helps me focus. Moving helps me process. Moving helps me be creative – professionally and personally.
3. Appreciativeness. Not grand gratefulness in a trendy mindfulness way. Being away from people has made me appreciate people more. And miss them. Before, I would go out of my way to write a holiday time card to each colleague that I had worked with or collaborated with over the year that I valued. Very personalized, very intentional. Now, I go out of my way to say thank you for the small things. Thank you for responding so quickly. Thank you for taking my call. Thank you for the follow up. Thank you for taking the lead. Thank you for your collaboration. This of course also applies to my personal life. Thank you for always being there for me. Thank you for taking the time to answer my questions. Thank you for going to the grocery store. Thank you for getting the ridiculously howling dog to stop howling. Thank you for organizing this friends call. Thank you for passing along this interesting article. Thank you for the book suggestion. Thank you for checking in on my parents. Thank you for scheduling this outside, socially distanced playdate. Thank you for being you.
4. Knitting and Other Old Loves. This is more of a re-found. I picked up knitting in law school, but for whatever reason I stopped knitting before I met my husband. In the COVID-induced cleaning and house reorganizing, I re-discovered my needles. Then I found a great store, took my son and he picked out three colors. Side note: It was an amazing moment of pride that he picked colors that completely epitomize South Florida – citrus (bright yellow), tangerine (bright orange) and electric (a bright aqua). Second side note: I love the way that people name colors. My husband and I used to play a game where I would try to guess the name of a color (and often came pretty close). Back to the knitting point, my son now has a fantastic hat and matching cowl (if I do say so myself, but really, others have said so too). I am working on matching mittens and looking forward to giving knitted gifts to many in the coming months. For other old loves, I have picked up drawing and painting again in a way that I have not enjoyed since I first went to college intending to major in art and minor in chemistry (no, I have no idea what I was thinking back then; yes, I do know how I ended up here).
5. New Curiosities. There are many reasons that through this year I have felt more drawn to nature. I have been making fun informational cards about leaves, shells, flies and bees for my son. I have a list of nature books (of course, as an Amazon list) that I want to read. I have a nature journal. I have a stack of articles and studies from an amazingly supportive friend who has always been intensely focused on sustainability. I watched My Octopus Teacher as soon as I could and cried. I am feeling inspired.
I think I will pull that last sentence down to here – I am feeling inspired. In the face of all of the negative from 2020, my inspiration enables me to laugh that it snowed chocolate in Olten, to hug my husband, son and dogs enough to make up for all of the other hugs I am missing out on (I am a hugger), to deal with frustrations in different ways, to drive initiatives I feel strongly about, to focus on kindness and caring, to not compromise on expectations, to accept whatever may happen, to know that I can make a change, to know that I will survive. Maybe resiliency that I read so much about in the context of children is really about inspiration?
**End note: I promise that this time has not been all positive for me. There have been very hard negatives. Without those, I would not be here now. I am sure I will face negatives in the future. I am hoping this time helps me meet those challenges more adeptly, with stronger mental health. I hope the same for all of you.
Enforcement Director Stephanie Avakian to Leave SEC
Last week, the SEC announced that Enforcement Director Stephanie Avakian will depart from the Commission by the end of the year. Stephanie began her career at the SEC and began her latest tour in 2014. She’s led the Enforcement Division over the last four years as Co-Director and then Director. Deputy Director Marc P. Berger will serve as Acting Director upon her departure. The SEC’s press release includes a long list of the Enforcement Division’s accomplishments under Stephanie’s leadership – and here’s a statement from Commissioner Elad Roisman.
Last month, I blogged that former SEC Chief Accountant Wes Bricker is working on an initiative at PwC that would translate sustainability reporting standards into an XBRL taxonomy. He isn’t the only one who sees promise in that coupling. In recent remarks, SEC Commissioner Allison Herren Lee – who has made it clear she wants to work on standardized ESG disclosure – said she might also support expanding XBRL to ESG reporting and other non-financial data. Here’s an excerpt (also see this blog from shareholder proponent Jim McRitchie pronouncing his opinion that N-PX data tagging would be the most important SEC rulemaking for advancing corporate sustainability):
What kind of data are we talking about here? The most basic information that an investor might want: how their money is being voted in corporate elections, and whether their shares are being voted in their best interest or in accordance with their instructions. We could bring much greater clarity and transparency to investors regarding how their voting rights are being exercised with the simple expedient of finalizing this rule and adding a requirement, as discussed in the proposal, to tag the Form N-PX voting data.
N-PX filings are voluminous in nature but would likely require relatively few, straightforward data tags. Thus we could potentially take a large body of important information and dramatically increase its usability through a relatively simple taxonomy.
Another area that could benefit from structured data to support usability and comparability is in the area of climate change and other ESG risks and impacts. As you all know, climate and other ESG-related metrics are of ever-increasing importance to investors, surpassing even traditional financial statement metrics for many. Of course, there are currently little to no standardized climate or ESG disclosure requirements. Indeed much of that disclosure occurs voluntarily and outside of SEC filings altogether. As I have said elsewhere, developing standardized climate and ESG disclosure requirements should be a top priority for the Commission. As we consider this, we should also consider how to make the data disclosed under such requirements as usable as possible, including through tagging requirements.
Much of our structuring requirements so far have been backward looking – requiring us to consider how to structure information that is currently disclosed in a non-structured manner. As we consider new climate and other ESG requirements, we would have the opportunity to simultaneously consider how to make those requirements amenable to structuring. Instead of an ex post facto application of structuring requirements, the two could develop in tandem.
Finally, I’ll just mention briefly, MD&A and earnings releases. As commenters including XBRL have pointed out,[18] disclosures under MD&A may benefit from some simple block tagging that could greatly enhance comparability of certain relatively consistent types of information disclosed in MD&A. And earnings releases, particularly given their often market-moving nature, appear to be another well-suited candidate for tagging.
ESG CAMs: Coming Soon to an Audit Report Near You?
I blogged a little while back ago about the PCAOB’s analysis of the “critical audit matter” disclosure requirement. Although most CAMs related to goodwill, revenue recognition, other intangibles and business combinations, there have been 3 so far – all for foreign private issuers – that cover the impact of climate change on financial statements. In this recent speech, PCAOB Board member Robert Brown predicts that there will be more to come. Here’s an excerpt:
In one report on Form 20-F, the auditor discussed management’s estimates that were inconsistent with the 2050 “net zero” commitment.” The auditor also observed that deprecating the assets in line with net zero targets would result in additional reductions to net income that were not reflected in the financial statements. The report also discussed how the auditor challenged management’s assertion that carbon-emitting equipment could be used in alternative ways after a net-zero target date that supported management’s estimate of operation until 2070.
Another audit report discussed how climate change and the global energy transition impacted the capitalization of exploration and appraisal costs. The auditor also focused procedures on the risk that oil and gas price assumptions could lead to material misstatements of the financial statements. Another audit report described the effect that long-term price assumptions incorporating the potential impact of climate change could have on asset values and impairment estimates.
Considering the increasing frequency that environmental trends, events, and uncertainties, including the lower commodity prices and margins resulting from a COVID-19 economic environment, can affect material accounts or disclosures in a public company’s financial statements, I expected to see more auditor reports describing them in the future.
”Shares Outstanding” XBRL Tags: Watch Those Zeros!
The SEC recently announced that DERA Staff has observed that some periodic reports show significant differences between the number of “Entity Common Stock Shares Outstanding” that’s XBRL-tagged on the filing cover page and the number of “Common Stock Shares Outstanding” that’s XBRL-tagged on the balance sheet. While there could be some differences due to the cover page number being as of “the latest practicable date” and the balance sheet being as of quarter-end, some filers have been disclosing three additional zeros in one value compared to the other – without any explanation in the filing about a significant change to capital structure. Make sure to check your scaling before you submit your filing!
It’s official: companies conducting Rule 506 offerings in New York need to file a completed Form D through the NASAA Electronic Filing Depository in order to notify the state. That’s according to guidance issued earlier this month by the New York Attorney General – which brings NY in line with other states with respect to these notice filings and also says that no Form 99’s or Form 99 renewals will be accepted after February 1st. Also see this Mintz memo and these revised regulations for broker-dealers.
This is big news for anyone doing private placements in New York. For years, practitioners have relied on the New York State Bar Association’s interpretive opinion that said the provisions of the Martin Act requiring a Form 99 filing were preempted by NSMIA, and that no New York filing was required. The biggest practical takeaway from this new guidance is that if you’ve been doing that, you need to stop. The guidance also specifies that the Form D must be complete – including by listing all related persons and all persons receiving or expected to receive sales compensation.
House Passes “Holding Foreign Companies Accountable Act”
Members of Congress have found something to agree on: regulating China-based companies. The House has passed the “Holding Foreign Companies Accountable Act” – which would amend the Sarbanes-Oxley Act to prohibit listing on US exchanges of foreign companies for which the PCAOB has been unable to inspect audit work papers. The Senate previously approved this legislation – and the President is expected to sign the bill into law. This is separate from the SEC proposal on the same topic that is expected before year-end.
Under the bill, the SEC would be required to identify companies that have registered public accounting firms that are located in foreign jurisdictions and for which the PCAOB is unable to inspect work papers. If the Commission determines that a company has 3 consecutive non-inspection years, it must prohibit the securities from being traded on a national securities exchange or over-the-counter. Companies must also submit documentation to show they aren’t owned or controlled by a governmental entity and disclose information about relationships to the Chinese Communist Party.
This CNBC article notes that Americans might miss out on some pretty significant investment opportunities if this law comes to fruition – and that foreign countries like China might welcome the chance to build up their own exchanges. One of the bill’s Senate sponsors even notes in this press release that 224 U.S.-listed companies are located in countries where there are obstacles to PCAOB inspections, and these companies have a combined market capitalization of more than $1.8 trillion. Maybe that’s why the bill gives a three-year lead-time for compliance and opportunities for correction and relisting. In addition, the co-audit solution that is expected to be included in the SEC’s proposal might help the Commission find a way to balance investor protection with investment opportunities.
Bob Stebbins to Depart From SEC’s “OGC”
Last week, the SEC announced that Bob Stebbins will depart from the SEC in early January – after serving over three and a half years as the Commission’s General Counsel. The SEC’s Office of the General Counsel has a wide range of responsibilities – so Bob played a role in all of the rulemaking, enforcement and other activities that we cover in this blog. The press release says he advised on more than 85 rules, hundreds of interpretive releases and 2750 enforcement actions! He also advised on CARES Act implementation for the Treasury Department. SEC Chair Jay Clayton issued this statement to commend Bob on his service.
Liz blogged earlier this year about the rise in premiums for directors and officers (D&O) liability policies. Now after a rise in lawsuits relating to diversity concerns among executives and directors, a recent Business Insurance article says some insurers are starting to take a fresh look at company diversity practices and top-level succession planning before renewing or pricing D&O coverage. The price of D&O coverage fluctuates but in a market when premiums were already rising, this added scrutiny isn’t likely to help matters for some companies.
With investors, proxy advisors and Nasdaq calling for increased diversity disclosures, insurer focus on the issue seems like a natural progression. The article says some insurers have been meeting with companies to better understand diversity plans and inquiring about which directors are retiring and companies’ plans to replace them.
Suggestions for Moving Beyond Numerical Board Diversity Targets
Not too long ago, John blogged about how companies may focus on overboarding as one way to move forward with increasing board diversity. A recent report from The Conference Board, ESGAUGE and others that analyzes Russell 3000 and S&P 500 board composition trends provides several suggestions to help companies move beyond simply setting numerical board diversity targets. Lending credibility to the need to go beyond setting numerical targets, the report cites various stats showing the lack of progress toward greater board diversity.
With investors (and now insurers!) increasingly looking for action and progress on diversity initiatives, companies might want to start thinking about steps they can take to show progress in working toward improved board diversity. Diversity of course goes beyond gender and race/ethnicity and the report discusses the importance of diverse skill sets and age diversity and suggests boards make diversity part of the ongoing board succession planning process. The report offers one take on what boards can do to help improve diversity, and at minimum some of these ideas may help get a dialogue started. The report mentions requiring a diverse slate of director candidates and beyond that, here are more of the report’s suggestions:
– Endorse a model where every other board seat vacated by a retiring board member is filled by a woman or the model described in the recent California law requiring directors from underrepresented communities
– Ensure nominating committees are diverse
– Consider diversity when making board and committee leadership appointments
– Get ahead of investor demands for information about board diversity and include more narrative information about the racial and ethnic background of directors as part of a broader explanation of the multiple dimensions of diversity on company websites.
– When it comes to director tenure, the report says boards should consider how best to achieve a mixture that includes long-serving directors, along with those in the middle and new directors. For disclosure, companies should consider disclosing the range of tenures to investors and consider adopting an average tenure and similar policies that encourage a healthy level of turnover but avoid the shortfalls of rigid term limits.
– Strengthen the director evaluation process to ensure that specific cases of long tenure are examined holistically and in light of other assessment factors such as the board’s overall gender, age, racial and ethnic diversity, skill sets, and rate of board refreshment.
– Look outside the C-Suite for potential director candidates. To help ensure newly minted directors have the requisite experience and abilities, put robust processes in place for identifying, recruiting, onboarding and engaging directors to help them succeed. As companies increasingly seek individuals with specific skill sets, such as cybersecurity and human capital management, looking outside the C-suite can bring different perspectives and problem-solving approaches. Boards should examine their own culture to ensure that they and management are providing a genuinely inclusive environment.
November-December Issue of “The Corporate Counsel”
The November-December issue of “The Corporate Counsel” print newsletter was just posted – and also mailed (try a no-risk trial). The topics include:
Yesterday, the SEC announced that it settled an enforcement proceeding against GE arising out of allegedly misleading disclosures in its power and insurance businesses. The SEC’s investigation had been underway at GE for the last couple of years after the company disclosed it was taking large charges in each of those business areas – here’s an excerpt from the press release:
According to the SEC’s order, GE misled investors by describing its GE Power profits without explaining that one-quarter of profits in 2016 and nearly half in the first three quarters of 2017 stemmed from reductions in its prior cost estimates. The order also finds that GE failed to tell investors that its reported increase in current industrial cash collections was coming at the expense of cash in future years and came primarily from internal receivable sales between GE Power and GE’s financial services business, GE Capital. In addition, the order finds that from 2015 to 2017, GE lowered projected costs for claims against its long-term care insurance portfolio and failed to inform investors of the corresponding uncertainties resulting from lower estimates of future insurance liabilities at a time of rising costs from long-term health insurance claims.
Without admitting or denying the SEC’s findings, GE consented to a cease-and-desist order, agreed to pay the $200 million penalty and to report for one year to the SEC regarding certain accounting and disclosure controls in its power and insurance businesses. The $200 million penalty is big, and as reported in this WSJ article, the penalty is much higher than the amount GE previously set aside to resolve the matter. Even with the settlement, the SEC’s announcement says that the investigation is ongoing, which could mean it’s determining whether to bring charges against individuals.
As noted in the WSJ, in the time since the investigation began, GE has a new CEO and, in 2021, a new auditor. In reporting the settlement, GE’s Form 8-K included this statement about its financial reporting, along with information about corrective measures the company has taken:
The SEC’s order makes no allegation that prior period financial statements were misstated. This settlement does not require corrections or restatements of GE’s previously reported financial statements, and GE stands behind its financial reporting.
GE cooperated with the SEC over the course of its investigation. As noted in the order, GE has taken a number of steps since the time periods covered by the investigation to enhance its investor disclosures regarding power and insurance trends and risks, as well as enhancing internal controls on its insurance premium deficiency testing (also known as loss recognition testing) process and adding disclosure controls and procedures concerning its insurance liabilities.
Critical Audit Matters: A Look at the S&P 100
A few weeks ago, Liz blogged about the PCAOB’s analysis of the impact of the “critical audit matter” disclosure requirement. Last week, the Center for Audit Quality issued its report with observations of CAMs contained in audit reports for large accelerated filers and it takes a deeper dive into the S&P 100. Here’s some of the findings from review of the S&P 100 audit reports:
– Average number of CAMs per audit report was 1.98
– Drivers that led to matters being a CAM appeared to include a high degree of judgment by management related to the matter that led to a high degree of auditor judgment to assess or evaluate management’s conclusions. Some CAM communications also described the audit effort and involvement of professionals with specialized skills and knowledge as principal considerations for the matter being considered a CAM.
– Of the 198 CAMs identified in audit reports for the S&P 100, 51% of them were in these 4 categories:
Taxes (32 CAMs)
Goodwill and/or intangibles (28)
Contingent liabilities (23)
Revenue (18)
The remaining 49% of CAMs were spread across 23 different categories and were less prominent from a trend perspective – business combinations, sales returns and allowances, pensions and other post-employment benefits, and asset retirement and environmental obligations were all topics that S&P 100 auditors identified as CAMs.
Transcript: “Doing Deals Remotely”
We’ve posted the transcript for the DealLawyers.com recent webcast: “Doing Deals Remotely.”
Liz blogged last summer about how some short-term activists were making a pivot to ESG and wondered whether this trend would intensify. There have been whispers that investors want to see more climate expertise on boards – but not much has come of that so far. Earlier this week, though, the WSJ reported that Engine No. 1 LLC, a new activist investor with a focus on sustainability, has taken aim at Exxon Mobil:
Engine No. 1 LLC, an investment firm launched by Chris James last week, is preparing to send a letter to Exxon ’s board urging the Irving, Texas-based company to focus more on investments in clean energy while cutting costs elsewhere to preserve its dividend. The letter, a copy of which was viewed by The Wall Street Journal, identifies four people the firm plans to nominate to Exxon’s 10-person board.
The article also identifies CalSTRS as one shareholder that supports Engine No. 1’s cause. CalSTRS issued a press release confirming that it intends to support Engine No. 1’s alternate slate of board members, which includes a link to Engine No. 1’s proxy fight website.
We’ll see where this goes — the WSJ article notes that it’s possible the campaign will fall flat. A CNBC article discussing the matter says that for a long time, Exxon would’ve been an unthinkable target for activists given its size. In an effort to get large investors on board with the campaign, CalSTRS reached out to Larry Fink, BlackRock’s CEO, although the article notes the pension fund hasn’t received a reply. But Exxon’s shareholders have been at the forefront of climate-related shareholder proposals before. In 2017, shareholders approved a climate change proposal at Exxon, and back then climate proposals weren’t seeing much success.
Audit Fees: Effect of Negative Auditor Attestation Persists for Several Years
Audit Analytics recently released a report looking back at 18 years of audit and non-audit fees paid by accelerated and large accelerated filers. The report covers the period 2002 through 2019 and is heavy on data – but what I found interesting was an analysis of fees paid by 105 companies that disclosed ineffective ICFR during FY 2016. Although one would expect that an adverse auditor attestation could lead to increased fees, the report says those higher fees persist for several years. Here’s an excerpt:
Companies that disclosed an adverse auditor attestation paid more non-audit fees, including audit related, the year of the disclosure. These same companies experienced an increase in audit fees that peaked the year after the disclosure. An increase in fees attributed to negative auditor attestation persists for at least three years after the disclosure when fees, excluding audit related, ranged 54-83% higher than average and when including audit related, were 48-76% higher than average.
The report also includes detailed trend data showing the split between audit and non-audit fees. In a bit of good news, the amount of non-audit fees was the lowest ever paid in 2019 at $112 per $1 million in revenue if audit related fees were included and $58 if excluded. Average audit fees paid per $1 million in revenue dropped to $495 in 2019 after several years of running above $500.
Benefits of Audit Partner Rotation?
The recent SEC amendments to the auditor independence rules generally provide more flexibility to companies when selecting an auditor. One topic about auditors that’s been quiet for a while now, is “auditor rotation.” One reason could be because the five-year rotation requirement in the United States for audit engagement partners seems to have quieted calls for auditor rotation. Now findings from two recent studies suggest auditor partner rotation doesn’t deliver many benefits.
A CFO.com article discusses findings from two studies that analyzed the two most frequent reasons in favor of auditor rotation: assumptions that personal ties developed over time between auditors and clients can compromise the accountants’ independence and as a result, audit quality; and that mandating rotations brings a fresh look to audits that likely enhances quality of reporting.
The first study from Auditing: A Journal of Practice and Theory found that there was no significant fall-off in reporting quality over the course of partners’ five-year tenures and little or no evidence that fresh looks make for improved audits. If anything, the study found a decline in audit quality with a new engagement partner, possibly reflecting less knowledge about the client than the previous engagement partner.
In another study, this one from Accounting Review, findings indicated audit quality over the five-year rotation cycle is unrelated to the length of the audit partner’s tenure with clients, except for restatement announcements, which were more frequent in the first two years after rotation. This study suggests there is a benefit of fresh looks but at the same time found that other important indicators of audit quality do not. The researchers concluded that for the average client engagement, mandatory [partner] rotation appears to be short enough to prevent capture or complacency and at the same time finding only limited evidence of fresh-look benefits – potentially because audit firms anticipate and invest resources to reduce potential disruption from mandatory audit partner rotations.
With these two studies suggesting audit partner rotation has little impact on overall audit quality, perhaps the real benefit of mandatory audit partner rotation is that it calms those who’ve called for periodic audit-firm rotation.
Efforts are ramping up for year-end reporting and one topic many companies are starting to get their arms around is the new human capital resources disclosure. We’ve been posting memos about the new HCR disclosure requirement in our “Human Capital Management” and “Regulation S-K” Practice Areas and one memo that can help shed some light on how companies are approaching the disclosure requirement is this FW Cook memo. The memo summarizes a review of the first 50 Form 10-Ks filed by large companies after November 8th and provides some high-level observations:
Length: Word length varied dramatically, ranging from nine words to 1,582 words. The median disclosure was 369 words long.
Topics: FW Cook decided to answer the question about which topics were covered by more extensive disclosures by only giving credit for a topic if the discussion was more than a brief mention and only gave credit for a factor if the discussion was significant. The test for ‘significance’ required a level of detail that made discussions more than generic. The results of the review suggest 13 common disclosure topics – they’re listed in order of prevalence along with the percent of disclosures describing each topic:
In terms of how human capital resource disclosures might evolve, FW Cook predicts that the disclosures will increase in length as the filing season progresses. This is not an assertion that longer disclosures are required, but more of an observation that legally required disclosures tend to grow, not shrink. We’ve all seen how this can happen – the memo notes that when one company sees how its competitor spends 100 words extolling the importance of its culture or diversity efforts, etc., there may a strong tendency to respond in kind.
With the disclosure being principles-based, each company’s human capital resource disclosure will of course be tailored to its specific circumstances. Beyond the early “trend” information about disclosure length and topics, the report includes examples of these early disclosures that might help spur ideas as companies start preparing human capital resource disclosure. For more sample human capital resource disclosures, see this blog from The SEC Institute.
Quick Survey: Human Capital Management – And Resources to Help Prepare Your HCM Disclosure!
To help understand how human capital management disclosure topics might vary by market-cap, we’ve expanded our HCM survey to capture the data this way. Check it out and enter the topics your company is considering including in its disclosure.
Last Friday, the SEC announced it settled an enforcement proceeding against The Cheesecake Factory for misleading Covid-19 disclosures. Among other things, early in the pandemic as the company began transitioning to a take-out and delivery service model, the proceeding alleges the company failed to adequately inform investors of the extent the pandemic had on the company’s operations and financial condition. This excerpt from the SEC’s press release summarizes the allegations:
As set forth in the SEC’s order, in its SEC filings on March 23 and April 3, 2020, The Cheesecake Factory stated that its restaurants were “operating sustainably” during the COVID-19 pandemic. According to the order, the filings were materially false and misleading because the company’s internal documents at the time showed that the company was losing approximately $6 million in cash per week and that it projected that it had only 16 weeks of cash remaining. The order finds that although the company did not disclose this internal information in its March 23 and April 3 filings, the company did share this information with potential private equity investors or lenders in connection with an effort to seek additional liquidity. The order also finds that, although the March 23 filing described actions the company had undertaken to preserve financial flexibility during the pandemic, it failed to disclose that The Cheesecake Factory had already informed its landlords that it would not pay rent in April due to the impacts that COVID-19 inflicted on its business.
The Cheesecake Factory proceeding is the SEC’s first enforcement action against a public company for misleading investors about the financial effects of the pandemic and shows the difficulties companies encountered early on in the pandemic. Without admitting or denying the SEC’s findings, The Cheesecake Factory consented to a cease-and-desist order and agreed to pay a $125,000 penalty. If you’re thinking the $125,000 penalty seems fairly light, the SEC’s press release does note the company’s cooperation in the proceeding. At minimum, the action serves as a cautionary reminder about the importance of accurate disclosures, even those made back at the outset of the pandemic, and that the SEC is continuing to scrutinize Covid-related disclosures.
Enforcement Proceedings: Earning Extra Credit for Cooperation
As mentioned in the SEC’s press release about The Cheesecake Factory, cooperation factored into the SEC’s determination to accept the settlement. When the SEC closed out its fiscal year, some may have read news reports of an SEC enforcement matter involving inaccurate disclosures concerning BMW’s U.S. retail sales volume while it conducted bond offerings. A Simpson Thacher memo outlines key takeaways from the case – one being that the SEC may give extra credit for cooperation during the pandemic. Here’s the memo’s takeaways:
First, the case serves as a reminder that the SEC continues to focus on bond offering disclosures, even in the absence of findings or allegations that proper disclosures would have impaired the company’s ability to make interest payments or repay the principal to bondholders. The memo reminds bond issuers to exercise caution in describing particular data points as important business barometers.
Second, the memo also notes that the case demonstrates that the SEC is prepared to give special credit for cooperation during the pandemic. The SEC’s order is also notable in its detailed description of BMW’s cooperation, and its express reference to challenges raised by the global COVID-19 pandemic. Specifically, the order commends the company for complying with the SEC’s requested schedule and its prompt collection and production of ‘a significant volume of electronic documents, including documents that would otherwise have been difficult and time-consuming for [the SEC] to obtain; documents from sources outside of the company’s corporate offices, such as BMW employees working from remote locations; and translations of key documents’ The order notes that the company additionally made several current and former employees available for interviews with the SEC, and provided the SEC with ‘presentations and narrative submissions that highlighted critical facts.’
Insofar as the items the SEC cites as evidence of BMW’s cooperation are part of the standard cooperation checklist, the case may be suggestive of the SEC’s willingness, during the COVID-19 pandemic, to accord extra credit for what some might view as ordinary course cooperation. At a minimum, the case may serve as useful precedent for other companies negotiating settlements with the SEC to argue that their cooperation during the pandemic warrants a reduced penalty (or even reduced charges).
This K&L Gates blog includes practical considerations about cooperation gleaned from remarks by Enforcement Division Associate Director Anita Bandy at the recent SEC Speaks conference:
Cooperation is largely still evaluated under the factors announced in the “Seaboard Report” issued by the SEC in 2001. The seminal consideration is whether the cooperation substantially enhanced the quality and efficiency of the investigation. In a recent case, for example, the respondent was forthcoming and proactive and, notwithstanding the complexity of the matter and the difficulties presented by collecting evidence internationally during the pandemic, worked to produce quickly documents and witnesses such that the investigation was resolved within ten months. As a result of this cooperation and other substantial remediation efforts, the Commission imposed a reduced penalty.
Tomorrow’s Webcast: “Modernizing Your Form 10-K: Incorporating Reg S-K Amendments”
Tune in tomorrow at 11 a.m. Eastern for our webcast – “Modernizing Your Form 10-K: Incorporating Reg S-K Amendments” – to hear Scott Kimpel of Hunton Andrews Kurth, John Newell of Goodwin Procter and Kenisha Nicholson of Wilson Sonsini discuss how the SEC’s recent amendments to modernize Regulation S-K will affect your next Form 10-K, including, among other things, how to tackle human capital disclosures, the impact on disclosure controls & procedures and other interpretive issues.
If you attend the live version of this program, CLE credit will be available in the following 10 states: CA, FL, IL, NC, NJ, NY, PA, TX, VA, WA. In order to receive CLE credit, you need to fully respond to the pop-up prompts throughout the live webcast. Please see these CLE FAQs for more information.
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Prof. Sarah Haan of Washington & Lee Law School recently posted a draft article online that’s eye opening, to say the least. In short, her thesis is that a trend that scholars have overlooked – the explosive growth in the percentage of stock owned by women during the early decades of the 20th century – played a major role in the development of the modern paradigm for public company corporate governance. Here’s an excerpt from the article’s abstract:
Corporate law scholarship has never before acknowledged that the early decades of the twentieth century, a transformational era in corporate law and theory, coincided with a major change in the gender of the stockholder class. Scholars have not considered the possibility that the sex of common stockholders, which was being tracked internally at companies, disclosed in annual reports, and publicly reported in the financial press, might have influenced business leaders’ views about corporate organization and governance.
This Article considers the implications of this history for some of the most important ideas in corporate law theory, including the “separation of ownership and control,” shareholder “passivity,” stakeholderism, and board representation. It argues that early twentieth-century gender politics helped shape foundational ideas of corporate governance theory, especially ideas concerning the role of shareholders. Outlining a research agenda where history intersects with corporate law’s most vital present-day problems, the Article lays out the evidence and invites the corporate law discipline to begin a conversation about gender, power, and the evolution of corporate law.
Some of the language in the abstract may make the article sound a little wonky, but in reality, it’s accessible and engaging. It sounds cliché to call a work “groundbreaking,” but I can’t come up with a better word to describe this one. I’m sure they’ll be plenty of back & forth among governance scholars on the merits of Prof. Haan’s arguments, but my take is that she may have put her finger on something that’s been hiding in plain sight for a long time.
Revenue Recognition: E-Commerce Disclosures a Sleeper Issue?
Many companies have seen their e-commerce sales explode as a result of the pandemic and, not surprisingly, many have also called this growth out in earnings releases & other disclosures. This Bass Berry blog says that the new requirement to disclose “disaggregated revenues” under ASC 606 may be a “sleeper issue” for some of these companies. Here’s an excerpt:
Under ASC 606-10-50-5, a public company must “disaggregate revenue recognized from contracts with customers into categories that depict how the nature, amount, timing, and uncertainty of revenue and cash flows are affected by economic factors.” Additionally, per the implementation guidance in ASC 606-10-55-90, when selecting the type of category (or categories) to use to disaggregate revenue, an entity should consider how the information about the entity’s revenue has been presented for other purposes, including the following:
– Disclosures presented outside of the financial statements such as MD&A, earnings releases and investor presentations.
– Information regularly reviewed by our Chief Operating Decision Maker (CODM).
– Any other information similar to the information identified in (1) and (2) that is used by the company or users of the financial statements to evaluate the company’s financial performance or make resource allocation decisions. (emphasis added)
In determining the categories to include, ASC 606-10-55-91 says that an entity should consider the following examples:
– The type of good or service (e.g., major product lines).
– Geographical region (e.g., country or region).
– Market or type of customer (e.g., government or non-government customers).
– Type of contract (e.g., fixed-price or time-and-materials).
– Contract duration (e.g., short- or long-term).
– Timing of transfer of goods or services (e.g., point-in-time or over time).
– Sales channels (e.g., direct to customers or through intermediaries).
The blog acknowledges that the company’s accounting staff and its outside auditor will make the final analysis on this issue, but suggests that the continued focus on e-commerce in public company disclosures might prompt more companies to conclude that they should disaggregate revenues by sales channels, including e-commerce sales. It also cautions that disaggregate revenue disclosure continues to be an area of interest for the Staff, and cites a recent comment letter exchange as an example of some of the issues that might be raised.
Blockchain & Beyond: FinHub Gets an Upgrade
In 2018, the SEC announced the establishment of “FinHub” within Corp Fin. Since then, FinHub has served as a resource for public engagement on blockchain & other FinTech-related issues and initiatives. Yesterday, the SEC announced that FinHub was being upgraded to an independent office. This excerpt from the SEC’s press release explains the decision:
Designating FinHub as a stand-alone office strengthens the SEC’s ability to continue fostering innovation in emerging technologies in our markets consistent with investor protection. The office will continue to lead the agency’s work to identify and analyze emerging financial technologies affecting the future of the securities industry, and engage with market participants, as technologies develop.
FinHub’s existing Director, Valerie Szczepanik will continue to serve in that capacity, and will “coordinate the analysis of emerging financial innovations and technologies across the SEC’s divisions and offices and with global regulators and will advise the Commission and SEC staff as they develop and implement policies this area.”
The SEC’s pre-Thanksgiving rulemaking frenzy gave my colleagues Liz & Lynn plenty to blog about over the last couple of weeks. In contrast, the well has been a little dry this week in terms of breaking news. That’s left me scrambling a bit for blog topics. I knew I had a couple of SPAC-related blogs in the hopper, but SPACs aren’t a topic with broad appeal outside of the folks in the IPO and M&A crowd. So, I wanted to hold off on them until I found a lead blog that would make the topic more relatable & interesting.
Fortunately, I recently stumbled across just what I was looking for – a SPAC story featuring a bona fide A-List celebrity! That’s because no less than Jay-Z himself has decided to participate in the SPAC boom. According to this Bloomberg article, he has signed on to serve as an officer for a cannabis SPAC:
Subversive Capital Acquisition Corp., a special-purpose company that’s growing in the cannabis business, said it acquired two California companies and named Shawn “Jay-Z” Carter as its chief visionary officer. Subversive is buying Caliva, a cannabis brand with direct-to-consumer sales, and Left Coast Ventures Inc., a producer of cannabis and hemp products. The deals will create a new holding company and include $36.5 million of equity commitments from new and existing shareholders.
The holding company, which will be called TPCO Holding Corp., expects revenue from the combined entities to be $185 million in 2020 and $334 million next year. The deals’ aim is to “both consolidate the California cannabis market and create an impactful global company.” The new company aims to reach 75% of California consumers and Jay-Z will run its brand strategy and work on a related project to reform criminal justice.
Jay-Z may be the only A-lister to become an exec at a cannabis-related business, but he’s far from the only celeb backing one. We’ve already blogged about Snoop Dogg’s venture capital activities targeting “The Chronic”, and the cannabis beverage brand Cann recently announced a number of its own celebrity investors, including the likes of Gwyneth Paltrow & Rebel Wilson.
If you think I get unduly excited when I find an excuse to blog about celebs – well, you’re probably right. The truth is that I’m a frustrated gossip columnist who would dearly love a gig on TMZ or Page Six.
To SPAC or Not to SPAC? That is the Question. . .
This Cooley blog has a lot of information about how the SPAC market continues to grow & evolve, but there’s one aspect of it in particular that I thought readers of this blog might find interesting – a discussion of the differences and similarities between a SPAC transaction and a traditional IPO. This excerpt addresses timing considerations:
Despite common misconceptions, the timeline for completing a de-SPAC transaction and an IPO are comparable—often between four to six months, although that timeframe can vary depending on SEC review and comment. In a SPAC transaction, parties can expect to take approximately four to six weeks to negotiate a business combination agreement and line up a PIPE, and then another two to four months to prepare and file a joint Form S-4/proxy and deal with any SEC comments. Just as it would in a traditional IPO, the target must be prepared to provide the required financial information and other documentation necessary to operate as a public company, including PCAOB financials.
Other topics addressed include lockups, SEC review, Rule 144 limitations applicable to SPACs, & governance matters. The blog also addresses key trends in de-SPAC transactions, which represent the biggest difference between the SPAC & traditional IPO route to the public market.
SPACs: Auditor Market Share
One of the interesting things about SPAC deals is the relative absence of the involvement of Big 4 audit firms. In fact, as this Audit Analytics blog reviewing auditor market share for SPACs makes clear, the market is dominated by two non-Big 4 firms:
When it comes to blank check initial public offerings (IPOs), two firms dominate the market: Withum and Marcum. Together, these two firms account for 90.2% of all blank check IPOs from January 1, 2019 to September 30, 2020, with 156 companies raising over $47.7 billion. Only two Big Four firms audited a blank check company at the time of IPO during this period; KPMG, with three clients, and PwC, with one.
What accounts for the relative absence of Big 4 firms from the blank check/SPAC market? An earlier blog suggests some reasons:
While blank check IPOs and SPACs have raised billions and can offer a quick public offering, the type of transaction can pose unique challenges, especially for auditors tasked with preparing the necessary filings. There are special considerations and nuances for these transactions and based on these complexities; it is not surprising that some audit firms have specialized teams for SPACs, while others prefer to focus business elsewhere.
Non-Big 4 firms’ dominance of this part of the IPO market isn’t a new development. The blog says that while the Big 4 had over 70% of the market share for all IPOs from 2004-2019, they had only 6.5% of the market share for blank check IPOs.