Last week, the Center for Audit Quality posted the final highlights from the June 15th Joint Meeting of the SEC Regulations Committee and the SEC Staff to its website’s SEC Regulations Committee page. One of the topics addressed in the highlights related to the new Form 10-K clawbacks-related checkboxes. The CAQ highlights address whether the restatement checkbox should be checked if there is disclosure in the financial statements about an error in previously issued quarterly financial statements, but not for any annual periods. Here’s an excerpt from the notes:
In connection with the new rule and rule amendments for the recovery of erroneously awarded compensation in the event of a required accounting restatement, a check box with the following language was added to the cover page of Form 10-K:
If securities are registered pursuant to Section 12(b) of the Act, indicate by check mark whether the financial statements of the registrant included in the filing reflect the correction of an error to previously issued financial statements.
A similar check box was not added to the cover page of Form 10-Q.
The retrospective correction of a material error in a registrant’s previously filed interim financial statements might be presented in the disclosure required by Item 302(a) of Regulation S-K within an unaudited note to the annual financial statements included in a Form 10-K. However, those financial statements might not disclose the correction of an error to any annual periods as the error being corrected only existed in the interim periods.
For example, assume a registrant presents (in an unaudited note to the financial statements for the fiscal year ended 20X3 in Form 10-K) the correction of material misstatements in its financial statements for the interim periods ended 03/31/X3, 06/30/X3, and 09/30/X3. The error only affected those interim periods. The annual periods presented in the 20X3 Form 10-K were not impacted by the errors. The Committee asked the staff whether the registrant in this example would need to select the check box.
The staff indicated that in the above scenario, it would not object if the checkbox referred to above was not checked. The staff noted that the registrant should provide the disclosures required by S-K 402(w).
Earlier this week, the SEC announced settled charges against Maximus, Inc. “for failing to make required disclosures that it employed the siblings of one of its executive officers” and that Maximus agreed to pay a civil penalty of $500,000. According to the order, in late 2019, the company’s board promoted a business segment leader and longtime employee to be an executive officer of the company. Maximus’s annual reports and proxy statements for 2019 through 2021 disclosed that the company had no related person transactions even though the newly-appointed officer’s two siblings were also longtime company employees and both received annual compensation of greater than $120,000. The order includes the following reminder:
Disclosure of related person transactions “involving the employment of immediate family members” is required “when the threshold for disclosure has been met and the immediate family member has or will have a direct or indirect material interest.” Information required to be disclosed concerning any such related person transaction includes the name of the related person, the basis on which the person is a related person, the related person’s interest in the transaction, and the approximate dollar amount of the related person’s interest in the transaction.
Our “Related Party Transactions Disclosure Handbook” has tons of practical guidance on this topic, including how to calculate the amount paid to the family member employee, and reminds companies to thoroughly vet contextual disclosure, such as statements that the “individual received compensation ‘commensurate with that provided to other employees in similar positions.’”
In late August, the SEC announced charges against Impact Theory, LLC, an LA-based media and entertainment company, for conducting an unregistered offering of crypto asset securities in the form of NFTs. The cease-and-desist order is novel, in that this is the first time that the SEC has applied the Howey test to NFTs. But, guess what? There’s already been a second time! (More on that below.)
This Dechert alert describes the Impact Theory order, but first starts with this reminder:
NFTs are digital asset tokens similar to cryptocurrency. However, each NFT possesses unique characteristics that distinguish NFTs from each other, such as being tied to ownership of a specific piece of art. Many NFTs operate on the Ethereum (“ETH”) blockchain.
The SEC cited a number of statements by company representatives when discussing the elements of the Howey test:
[T]he SEC provided facts purporting to show that the sale of KeyNFTs constituted a “common enterprise” or “scheme” between investors. Specifically, according to the SEC, Impact Theory claimed that a purchase of a KeyNFT constituted an investment in what would be a “thriving community” in Impact Theory’s vision.
Last, the SEC claimed that investors possessed an expectation of profits to be derived from the efforts of Impact Theory because the company repeatedly told investors that their money would be put into development efforts and create additional projects to add value to the company. Per the SEC, Impact Theory expressed that such development efforts would enrich investors, including statements that NFTs were the “mechanism by which communities will be able to capture economic value from the growth of the company that they support” as well as claims that investors would be ecstatic that they would be “getting all this value” from their investment.
As a result of these findings, the SEC concluded that investors “understood Impact Theory’s statements to mean that the company’s development of its projects could translate to appreciation of the KeyNFTs’ value over time.”
In accepting the settlement offer, the SEC considered remedial actions taken by the company — including instituting repurchase programs in December 2021 and August 2022, in which it offered to buy back NFTs — and the company’s undertaking to revise programming code underlying the NFTs to eliminate any royalty that Impact Theory might otherwise receive from any future secondary market transactions.
The second NFT enforcement action I alluded to above involved an $8 million offering of “Stoner Cat NFTs” to finance an animated web series — each of which “was associated with a unique still image of one of the characters in the Stoner Cats web series, with different expressions, apparel, accessories, and backgrounds.” SEC Enforcement Division Director, Gurbir S. Grewal, is quoted in the press release as saying: “Regardless of whether your offering involves beavers, chinchillas or animal-based NFTs, under the federal securities laws, it’s the economic reality of the offering – not the labels you put on it or the underlying objects – that guides the determination of what’s an investment contract and therefore a security.”
Commissioners Peirce and Uyeda, who dissented in both settlements, fear that this stifles fan crowdfunding, which is much needed by artists, creators, and entertainers. Pointing to the unique images and exclusive content that purchasers received, the dissent likened these NTFs to 1970s Star Wars collectibles:
To the delight of millions of children that holiday season, the toy company Kenner sold “Early Bird Certificate Packages,” redeemable for future Luke Skywalker, Princess Leia, and R2-D2 action figures and membership in the Star Wars fan club. The sales of these certificates helped to build a die-hard community of Star Wars fans. Would those I.O.U. certificates, which could be re-sold, constitute investment contracts? Using the analysis of today’s enforcement action, the SEC should have parachuted in to save those kids from Star Wars mania.
Yesterday, the SEC announced proposed amendments to Rules 10 and 11 of Regulation S-T and Form ID. The amendments relate to potential technical changes to EDGAR, which the SEC is collectively referring to as “EDGAR Next.” The proposal was informed by public input and feedback provided in response to the SEC’s September 2021 request for information. As Liz noted when she blogged about that request, EDGAR changes seemed necessary to put an end to “fake SEC filings” and to make the filing process more reliable. This is the SEC’s response to those issues.
As explained in the 146-page proposing release, if adopted, the amendments would require EDGAR filers to identify and authorize two to twenty individuals to serve as account administrators, responsible for managing a filer’s EDGAR accounts through a dashboard on the EDGAR Filer Management website. The role of the account admins is distinguished from the role of tech admins and users with more limited access but permitted in larger numbers. The release also describes the proposed mechanics of delegating administrator and user roles. These mechanics are intricate enough that the release has four org charts/diagrams describing the authorization of the different roles and a table setting out the functions of each role — including account admins, users, tech admins, delegated admins and delegated users.
Maybe most importantly, each individual would need to use individual account credentials (obtained through Login.gov, a secure sign-in service of the General Services Administration) and multi-factor authentication to access the account and make filings, which will go along way in helping the SEC Staff and registrants identify any individuals making potentially problematic filings. EDGAR Next would also offer filers “optional Application Programming Interfaces (‘APIs’) for machine-to-machine communication with EDGAR, including submission of filings and retrieval of related information.” Think custom software used by companies and financial printers/filing agents, for example, to schedule filings and make bulk submissions.
The proposal will be subject to a 60-day comment period following publication in the Federal Register. In addition to seeking comments on the proposed release, the SEC is encouraging testers to provide feedback on technical functionality. The press release also announced that the SEC plans to open to the public a beta software environment for filer testing and feedback in just a few days, on September 18, 2023. The EDGAR Next—Filer Access and Account Management page on SEC.gov has information about signing up for beta testing and lots more information about the proposal and related technical changes.
In his supporting statement, Chair Gensler highlights that the most recent meaningful update to EDGAR account access protocols was over a decade ago and equates the current process of having one login per company to “having a family passing around one shared login and password for a movie-streaming app.” He touts that these actions “would further secure login protocols by requiring every person filing something into EDGAR to login with individual credentials and to use multi-factor authentication.”
Last week, the SEC announced another enforcement action against a company for using separation agreements that violated whistleblower protection rules. The SEC’s Enforcement Division has been on the lookout for these provisions for years — in 2016, the SEC launched a campaign to enforce these rules and brought another enforcement action on this topic as recently as last year.
In this latest enforcement action, the SEC took issue with the company’s use of separation agreements that included a waiver of rights to monetary awards in connection with filing claims or participating in government agency investigations. The order found that those waivers impeded participation in the SEC’s whistleblower program since employees were required to forgo “important financial incentives that are intended to encourage people to communicate directly with SEC staff about possible securities law violations.”
I’m not positive that this was the first of this type of enforcement action against a privately held company, but the SEC highlighted that the respondent in this enforcement action was privately held in its announcement. The press release included this quote from a Regional Director:
“Both private and public companies must understand that they cannot take actions or use separation agreements that in any way disincentivize employees from communicating with SEC staff about potential violations of the federal securities laws,” said Jason J. Burt, Regional Director of the SEC’s Denver Office. “Any attempt to stifle or discourage this type of communication undermines our regulatory oversight and will be dealt with appropriately.”
As Liz blogged last week, this year Glass Lewis is running a policy survey seeking feedback on specific governance, sustainability, and executive compensation topics, which is a departure from its less formal approach in prior years. NYSE’s ESG Advisory group recently highlighted in its ESG Top 5 newsletter that the survey is open to the broader community. The newsletter summarizes the survey’s topics as follows:
[G]overnance themes covered focus heavily on overboarding (should committee chair roles count as more than one board), mitigating factors for allowing multi-class shares, and one of our favorites, the validity of the “loyalty share” voting classes that give extra voting rights to long-term holders. On the E&S front, GL asks about the non-financial inputs to exec comp programs, as well as how to evaluate biodiversity and company GHG targets.
For valuable insight from ISS and Glass Lewis, sign up for our “Proxy Disclosure & 20th Annual Executive Compensation Conferences,” and do it soon because they’re happening next week already! As Liz recently highlighted, our panel on “Navigating ISS & Glass Lewis” features a conversation with Rachel Hedrick – who is VP of US Executive Compensation Research at ISS – and Krishna Shah – who is Director of North America Executive Compensation at Glass Lewis – moderated by Davis Polk’s Ning Chiu.
In late August, the SEC announced an enforcement action involving multiple accounting failures by Plug Power — including failures to properly account for right-of-use assets and lease liabilities for sale-leasebacks, properly classify and present certain R&D activities as cost of revenue, properly estimate loss accruals for extended-maintenance contracts and properly account for bonus expense and certain conversions of Plug’s convertible preferred stock. These issues were identified during the audit of the company’s 2020 financial statements, and the company filed a Form 12b-25 and subsequently restated annual financial statements for 2018 and 2019 and interim quarterly financial statements for 2019 and 2020.
Although the company began implementing a remediation plan in 2021 — including hiring 60 new employees in accounting, finance and internal audit — the SEC seemed particularly concerned that some material weaknesses remained, as disclosed in the company’s 10-K for 2022. As highlighted by this Cooley PubCo blog, in addition to a civil penalty of $1.25 million, the settlement also includes an additional penalty of $5 million if Plug fails to comply with any undertakings — including that it fully remediate the material weaknesses in ICFR and ineffective DCP within one year.
The blog also notes an important point Plug got right in this process — it indicated in its Form 12b-25 that there could be adjustments to prior periods, signaling a possible restatement. The SEC took issue with forms missing this disclosure in other administrative proceedings in late August.
As a reminder, enforcement has been very focused on restatements and material weaknesses recently. As I blogged back in May, according to this Cornerstone Research report, in 2022, enforcement actions referring to announced restatements and/or material weaknesses in internal control reached the highest level in recent years and also grew as a percentage of all actions initiated during the year.
A week after the Plug Power enforcement action, the SEC announced settled charges against Fluor Corporation and five current and former officers and employees alleged to have caused Fluor’s violations. Fluor agreed to pay a civil penalty of $14.5 million and the officers and employees agreed to penalties ranging from $15,000 to $25,000.
Unlike Plug Power, the SEC’s investigation predated the company’s decision to restate. The investigation was prompted by Fluor’s August 2019 announcement of “$714 million in pre-tax charges stemming from an ‘operational and strategic review’ of sixteen projects.” As a result of the SEC’s inquiry, Fluor undertook an internal investigation in 2020 that identified material weaknesses in ICFR and material errors in its financial statements, causing the company to restate its annual and quarterly financial statements for 2016 through the third quarter of 2019. Here’s a summary of the accounting failures from the SEC’s announcement:
The SEC’s order found that Fluor, a global engineering, procurement, and construction company, bid on the two projects relying on overly optimistic cost and timing estimates and subsequently experienced cost overruns that worsened over time. Fluor then failed to sufficiently maintain internal controls to account for the projects in accordance with the percentage of completion accounting method under U.S. generally accepted accounting principles (GAAP). According to the SEC’s order, Fluor failed to include all anticipated costs that were known or should have been known in each project’s respective forecasts—thereby delaying loss recognition on each. Additionally, Fluor improperly incorporated revenue from unapproved change orders in the forecasts of one of the projects, including change orders that had not yet been submitted to, or had already been rejected by, the customer.
The SEC’s press release stressed the importance of appropriate estimates — and the SEC’s continued focus on controls and recordkeeping.
“Dependable estimates and the internal accounting controls that facilitate them are the backbone of percentage of completion accounting and are critical to the accuracy of the financial statements that investors rely on,” said Carolyn Welshhans, Associate Director in the Division of Enforcement. “We will continue to hold companies and individuals accountable for serious controls failures and resulting recordkeeping and reporting violations.”
Check out the latest edition of our “Timely Takes” Podcast featuring John’s discussion with J.T. Ho, partner at Orrick, Herrington & Sutcliffe LLP. John and J.T. are planning on J.T.’s “Fast Five” being a new monthly podcast feature, which piggybacks off of a brief monthly email that J.T. prepares for clients. I think our members will love this format since it gives a quick take on timely securities law and corporate governance hot topics. In this 9-minute podcast, John and J.T. discuss varied and timely topics, including:
– The SEC’s Cybersecurity Disclosure Rules – Recent Changes to the Delaware General Corporation Law
– Potential Advantages of Self-Reporting to the SEC
– Board Oversight of Corporate Political Statements
– Topics to Watch Over the Coming Months
If you have insights on a securities law, capital markets or corporate governance issue, trend or development that you’d like to share, we’d love to hear from you. Just shoot us an email at mervine@ccrcorp.com or john@thecorporatecounsel.net.
On September 19, at our “2nd Annual Practical ESG Conference” — which you can attend virtually as a standalone event or bundle with our PDEC Conferences and save — our very own Dave Lynn and Lawrence Heim and an amazing group of ESG practitioners from diverse backgrounds will deliver usable, practical guidance on the hottest ESG topics, in a candid and conversational format.
On September 20-21, we’ll help you prepare for the upcoming proxy season with the “2023 Proxy Disclosure Conference.” This conference is timed to give you the very latest action items that you’ll need to prepare for the flurry of year-end and proxy season activity.
On September 22, we’ll discuss all things executive compensation at the “20th Annual Executive Compensation Conference.” A wide range of panelists will address hot topics in executive compensation today — from ESG metrics to clawbacks.
Here’s the full agenda – and all of our experienced speakers. It is not too late to register! You can sign up online, by emailing sales@ccrcorp.com, or by calling 1-800-737-1271. You can still bundle the Conferences together to get a discounted rate.