We’ve blogged a few times about the SEC’s use of data analytics in enforcement. This Troutman Pepper memo says that the SEC is increasingly data-driven in its approach to identifying potential enforcement targets for enforcement actions. This excerpt highlights some specific areas where the SEC’s data analytics tools are being brought to bear:
Recent enforcement actions suggest that the SEC is targeting quarterly public filings. Quarterly reports are not subject to the same accounting oversight as annual reports. Recent cases highlighted by the agency as examples of data-based enforcement actions suggest that the SEC’s focus with data-based investigations is on quarterly reports and other areas where manipulation may be more likely to occur.
Reading between the lines of the press releases surrounding recent enforcement actions and other SEC commentary, it appears that the targets for these new enforcement initiatives are relatively small manipulations to figures that can have an outsized effect by causing a company to meet analysts’ EPS expectations or attain other quarterly results that, while not necessarily material in and of themselves, can have a significant impact on analyst and investor expectations or outlooks.
The memo says that the takeaway from recent enforcement actions a recurring pattern of meeting or barely exceeding EPS estimates may attract the SEC’s attention, particularly if that performance seems to be driven by “a single category that may register as an outlier against a company’s previous filings.” That kind of targeting suggests that the SEC’s data analytics tools are allowing it to zero in on previously hard-to-detect violations that in the past would have required significant resources to identify.
Apparently, public companies aren’t the only entities that prefer the occasional Friday news dump when it comes to controversial announcements. At approximately 4:00 pm eastern time on Friday, the SEC announced that it had removed PCAOB Chair William Duhnke and had designated Duane DesParte to serve as acting Chair. At the same time, the SEC announced that it was seeking candidates to replace all five current members of the PCAOB board. This article by Politico’s Kellie Mejdrich provides an overview of the politics behind the shakeup. Here’s an excerpt:
The sudden firing followed mounting pressure from [Senators] Warren, Sanders and several left-leaning groups who in recent weeks called on SEC Chair Gary Gensler to replace the entire board leading the PCAOB. The progressives warned that the agency, which was established after the Enron and WorldCom accounting scandals to inspect public company audits, was failing to crack down on corporate wrongdoing and was captured by industry.
Warren said Duhnke’s removal was “absolutely the right move” and she signaled that she would push for a bigger shakeup. The SEC, which is also responsible for hiring the PCAOB’s leaders, may grant her wish. The agency said it would seek candidates for all five of the regulator’s board positions, even as three of its members who serve five-year terms remain in place.
Over on the Radical Compliance blog, Matt Kelly reviews Duhnke’s “tumultuous and controversial” tenure as Chair of the PCAOB and provides some thoughts about what the changes are likely to mean for auditors and compliance professionals.
The SEC’s action prompted a dissenting statement from commissioners Peirce & Roisman, who said that the SEC acted in an “unprecedented manner that is unmoored from any practical standard that could be meaningfully applied in the future.” Mindful of the fact that under the leadership of Jay Clayton, the SEC took similar action to replace all incumbent PCAOB board members in 2017, the dissenting commissioners said that action was distinguishable, since most of the board members who were replaced at that time were serving after their terms had expired.
The dissenters didn’t mention the fact that the SEC’s 2017 action was also unprecedented. As the WSJ noted at the time, it represented the first time that PCAOB directors who desired a second term had ever been denied that opportunity by the SEC. That action was followed up by the SEC’s controversial decision to deny board member Kathleen Hamm a second term in 2019.
In light of the history here, the dissenters sound a bit like Captain Renault from Casablanca. C’mon guys, the PCAOB has been a political football for some time now, and what’s sauce for the goose is sauce for the gander.
A few weeks ago, I blogged about efforts to come up with a fix for the accounting issues associated with SPAC warrants identified in the joint statement from Corp Fin leadership. According to this White & Case memo, discussions between the accounting firms active in the SPAC market and the Staff have resulted in a consensus on how to structure SPAC warrants to permit them to be classified as equity & not as liabilities for financial reporting purposes.
The memo walks through the steps necessary to achieve equity treatment for pre-IPO SPACs, and this excerpt addresses the alternatives available to post-IPO SPACs to address their outstanding warrants:
SPACs that have completed their IPOs need to consider, in connection with their initial business combinations, whether to amend their warrant agreements to implement the changes to classify their warrants as equity instruments after the consummation of the business combination.
If the post-business combination company will only have a single class of common stock, the tender offer provision described above will not preclude equity classification because it would only be triggered when there is a change in control. In that case, only the private placement warrants would need to be addressed. If the post-business combination company will have a dual class structure (e.g., where certain former owners of the target company receive super-voting stock in the business combination), then the public warrants also will need to be addressed.
There are three approaches to be considered:
– Accept liability treatment for the warrants on a going forward basis;
– Seek the approval of warrantholders to amend the warrant agreement concurrently with the solicitation of approval of the SPAC’s stockholders for the business combination; or
– Rely on the “warrant table,” if applicable, or a tender/exchange offer after the consummation of the business combination, to “redeem” or repurchase some or all of the then-outstanding SPAC warrants.
The memo says that if the parties desire to amend the warrant agreement, they will need to review that agreement’s amendment provisions in order to determine whether the holders of public warrants or private placement warrants need to approve the proposed changes.
We’ve posted the transcript for our recent webcast: “Capital Markets 2021.” If your practice involves capital markets transactions, you’ll want to check this out. Panelists Katherine Blair of Manatt, Sophia Hudson of Kirkland & Ellis, and Jay Knight of Bass Berry & Sims participated in an in-depth discussion of a number of topics, including:
– The State of the Capital Markets
– The SPAC Phenomenon
– Equity Financing Alternatives for Public Companies
– Debt Financing Alternatives: Investment-Grade/Non-Investment-Grade Issuers
– Recent Offering/Issue Trends
This Equilar blog shares the result of the latest Gender Diversity Index. Progress on that aspect of representation has accelerated over the past several years. Check out these stats, collected as of March 31st:
– 24.3% of all board seats in the Russell 3000 were occupied by women – The percentage of women in board seats rose 3.4% from Q4 2020 and 10.5% from one year ago.
– For the first time, the percentage of boards with zero women has dropped below 5%.
– Seventy boards had gender parity in Q1 2021, which was one fewer than the previous quarter but 10 more than in Q1 2020.
– There were 256 Russell 3000 boards with at least 40% women in Q1 2021, or 8.8% of the index, in comparison to just 6.5% of boards (189) with at least 40% women a year earlier in Q1 2020. This is nearly four times the number of boards with at least 40% women compared to four years ago.
– In California, which has the highest number of boards of any state by a long stretch (489), just one lacked a woman (0.2%). Overall, the state of California has seen a gradual uptick in the percentage of women directors since its board gender diversity statute went into effect (17% in 2018 to 28% in 2021).
The blog points out that women held only 15% of board seats at the end of 2016, when Equilar’s Gender Diversity Index was first published. At that time, even 20% representation seemed like a stretch, in light of minuscule gains in prior years. State laws, investor pressure and shifts in public opinion have led to big advancements since then.
However, these nudges aren’t standalone solutions. Parity is still a distant possibility in light of the fact that only 41% of new board seats are going to women, especially because board turnover is infrequent.
The GDPR turned 3 last week. This BBC article takes a look at the biggest fines so far, and what led to them. The inclusion of a couple US companies shows that if you’re doing a lot of business in Europe, you need to be extra vigilant on data privacy & cybersecurity.
This 20-page memo from Baker Hostetler takes a deep dive into data security and incident response plans. It gives 14 key takeaways on the front page that are worth checking out. Since we’re on the topic of GDPR today, I’ll highlight the EU regulatory update from page 13. Here are a few nuggets:
– Timing Is (Still) Everything – Much of the focus on GDPR’s notice obligations has been on the 72-hour deadline for notifying a data protection authority (DPA). While some DPAs accept delays accompanied by explanations, others take a much narrower view of the permissible bases for extending the deadline. In particular, the Dutch DPA has taken a hard stance that the need to further investigate the incident and its effects is not a sufficient reason for delayed notice. Several other DPAs, including in Ireland and Sweden, fined companies for failing to notify within the 72-hour deadline. Companies subject to the GDPR should be prepared to move quickly to make an initial, timely notification that may require follow-up once a more complete analysis is ready.
– Data Controller Responsibility – DPAs tend to have the greatest interest and assess the largest fines in incidents where the DPA finds fault with the company’s responsibility for EU personal data, particularly where there are repeat data breaches. In particular, DPAs have assessed how companies — identify and respond to data breaches, implement and maintain organizational and technical measures to safeguard personal data, assess third-party vendors, conduct data protection-related risk assessments, and document data breaches.
– Mitigating Circumstances – DPA enforcement actions in 2020 drew particular attention to a number of mitigating factors in determining fines, and we expect these to be of continuing relevance this year – financial hardship, actions taken to minimize harm to individuals, cooperation with the DPA, appropriate notice to the regulator and individuals, other fines already imposed for the same incident, and absence of prior violations.
The memo also predicts that enforcement will expand during 2021 because more countries are implementing data breach notification procedures. But, since DPAs are just as overworked as the rest of us, they seem less likely to follow up on incidents that involved a small number of individuals or less-sensitive personal data, or companies without a significant EU footprint. Here’s a checklist for compliance for US companies.
Yesterday, ExxonMobil filed its Form 8-K to report the voting results from its annual meeting. The preliminary count, which is not yet certified, indicates that Engine No. 1 won three board seats on the company’s 12-member board, one more than had been predicted after the meeting last week. Engine No. 1 had waged a campaign based on the impact of Exxon’s fossil fuel strategy on its financial performance.
The activist’s win is especially shocking in light of the fact that Exxon had appointed three other directors earlier this year in an attempt to appease investors. Two of those new directors – Michael Angelakis and Jeff Ubben – had the highest number of votes out of anyone. The third – Wan Zulkiflee (former CEO of Petronas) – was voted off the board after only four months of service.
The dissident directors who appear to have been elected are Kaisa Hietala (environmental scientist and former Neste EVP), Greg Goff (former CEO of Andeavor) and Alexander Karsner (strategist/PE investor/formerly at Google X and the Department of Energy). As Lynn blogged last week, shareholders also approved shareholder proposals calling for more disclosure of climate lobbying and other political activities, which weren’t supported by the board.
This probably won’t be the last we’ll hear of Engine No. 1. While it was busy making a big name for itself last week with Exxon, it also managed to file a pre-effective amendment to a registration statement to launch an ETF, which identifies Schulte Roth & Zabel as outside counsel, lists “activism” as a risk factor, and also includes this nugget:
Principal Investment Strategies: The Fund seeks investment results that closely correspond, before fees and expenses, to the performance of the Morningstar US Large Cap Select Index (the “Underlying Index”), which measures the performance of the 500 largest U.S. stocks by market capitalization, as determined by Morningstar, Inc. The Underlying Index consists of securities from a broad range of industries. As of March 31, 2021, the Underlying Index is represented by securities of companies in sectors including, but not limited to, consumer, energy, financial services, healthcare, technology, and utilities. The components of the Underlying Index are likely to change over time and the Underlying Index and the Fund are rebalanced on a quarterly basis. To the extent that the securities in the Underlying Index are concentrated in one or more industries or groups of industries, the Fund may concentrate in such industries or groups of industries. As of March 31, 2021, the Underlying Index is not concentrated in an industry or group of industries.
The Fund seeks to encourage transformational change at the public companies within its portfolio through the application of proxy voting guidelines developed by the Adviser that are based on a commitment to protecting and enhancing the value of its clients’ assets and to aligning shareholder and stakeholder interests through favoring actions that encourage companies to invest in their employees, communities, customers and the environment.
Our Adviser intends to measure the investment made by companies in their employees, communities, customers and the environment with financial, operational, and environmental, social and governance (“ESG”) metrics that are provided by (i) the companies themselves, (ii) third-party data providers, and (iii) the Adviser itself. These metrics include, but are not limited to, wages, workforce diversity, employee health and safety, capital expenditures, carbon emissions, and land use, among others. The Fund’s proxy voting guidelines will apply to all companies held by the Fund. The Adviser will generally follow the recommendations of an independent third party proxy voting service retained by the Adviser to implement the proxy voting guidelines when determining how to vote on any specific matter.
The Fund will invest at least 80% of its Assets in securities included in the Underlying Index.
With about 2 weeks to go before the expiration of the time frame that the SEC had set to collect public input on the possibility of climate change disclosure rules, the Commission has held at least a couple dozen meetings with corporate leaders and trade organizations. In connection with those meetings, companies including Apple and Salesforce have spoken out in support of rulemaking. Most seem to be falling in line with support for principles-based disclosure.
Uber is one of the only companies so far that has taken the extra step of submitting a comment letter. In it, the ride-sharing company says it supports using existing principles-based frameworks to harmonize climate disclosures. Here’s an excerpt:
We support a climate disclosure framework that incorporates TCFD or SASB standards and is generally principles-based, so as to be sufficiently flexible to adapt to market and scientific developments and to accommodate the needs of public companies in various industries and at differing stages in their life cycles. We believe this approach would build upon years of thought leadership and stakeholder engagement by TCFD and SASB whose recommendations and standards are already utilized as a basis for voluntary reporting on climate change by many public companies…
…Incorporating the TCFD or SASB frameworks into a new,comprehensive and harmonized climate disclosure framework, promulgated by the Commission, will facilitate faster and more widespread adoption which would ultimately serve the best interests of investors.
In addition, we encourage the Commission to consider requiring that companies perform a company-specific materiality assessment to identify the ESG issues most relevant to their businesses. We believe that the most useful ESG disclosures will be grounded in the specific issues that are relevant to the particular company,as opposed to generic ESG disclosures that may or may not apply in a company’s individual circumstances.
Not everyone supports mandatory disclosure. I blogged about a First Amendment threat by West Virginia’s AG. The US Chamber of Commerce seems to be opposed to any legislation or Commission rules that would require ESG disclosures, and this letter argues that extra disclosure would have a disproportionate effect on smaller companies.
About a year ago, everyone was jumping on the SASB bandwagon and predicting it would become investors’ preferred disclosure framework. According to Morrow’s recent Institutional Investor Survey, though, sentiment has shifted. Here are some takeaways from 49 participants that collectively have $29 trillion in assets under management:
– 75% prefer the TCFD reporting framework
– 53% prefer SASB (down from 77% a year ago)
– 39% prefer proprietary in-house frameworks focused on material topics (up from 9% last year)
The TCFD framework encourages companies to use existing disclosure processes to report on climate-related risks and opportunities – focusing on governance, strategy, risk management, and metrics & targets. SASB is very industry-based and has been adopted by many companies as a way to map through and disclose financially material ESG information.
These two frameworks are also complementary in some ways – both are incorporated in the World Economic Forum’s “Stakeholder Capitalism Metrics” – which is part of the effort that was announced last fall to promote a single comprehensive reporting system. With standard-setters collaborating, companies becoming more mature in their own reporting, investors evolving the type of info they want, and an SEC proposal potentially on the horizon, it will be interesting to see where this all stands in another year.