I kick off my Halloween-themed blogs with a scary horror story:
The opening scene is set in the 1990s, and a company has filed a registration statement with the SEC. The Staff review process is taking longer than expected, and the company desperately needs to raise money through a private placement so it can keep the lights on through the completion of the IPO. The company completes the private placement and discloses it in an amendment to its Form S-1, but then, a jump scare! The Staff raises a comment questioning whether the company has a valid exemption from registration for the private placement when it occurred while the Form S-1 was on file. Suffice it to say, this horror story does not end well – the Metaphysics monster exacts its revenge on the poor unsuspecting company.
This week, while I was teaching my exempt offerings class the concept of integration, it really hit me how the Commission’s thoughtful approach in 2020 to adopting a comprehensive integration rule really changed the landscape for public and private offerings, making the scary horror story above a relic of the past. Securities lawyers of a certain vintage will no doubt remember many stressful evenings analyzing an integration issue utilizing the unwieldy five factor test, while trying to piece together all of the random Commission and Staff integration lore to see if something could bring some level of certainty to the situation. Today, a securities lawyer need only pull up Rule 152, without being burdened with the five factor test and the numerous interpretations that made integration a pretty scary realm to navigate.
I have the advantage of being able to tell a significant piece of the story of integration’s evolution in the first person, as I worked with Marty Dunn to bring his “integration manifesto” into being (much like Frankenstein’s monster) through interpretive guidance that was included in a 2007 Regulation D proposing release. That guidance went on to serve as the foundation for the Commission’s approach in Rule 152, bringing about much needed relief to a scary part of the regulatory landscape.
If you would like to read the full story of Marty’s integration manifesto and the evolution of the integration doctrine, I encourage you to review the article “Wither the Integration Doctrine? A New Approach Dawns This Spring” in the January-February 2021 issue of The Corporate Counsel.
When I was writing the blog last year around this time, I lamented that I really miss Halloween. I noted that once my kids aged out of trick-or-treating and I moved to a scary house at the end of a long driveway in a dark forest, I was no longer able to enjoy the holiday as I once did, and I now find myself attending to professional obligations on Halloween rather than dressing up in a ridiculous costume and littering my yard with over-the-top decorations. I received some great feedback on that blog, as others in our community recounted the same estranged relationship with Halloween, or expressed the fear that their own enjoyable times during Halloween were about to come to an end.
In my ode to Halloween today, I recount my top five takeaways from the holiday that stick with me to this day:
1. Embrace the creativity – I can distinctly remember being ten years old and making a Darth Vader costume out of a football helmet and some black construction paper in the year when the first Star Wars movie premiered, and being very satisfied with my handiwork. I am sure that the adults who answered the door when I was trick-or-treating were scratching their heads, wondering what the heck my costume was supposed to be. Fast forward thirty years later, and I found myself making a very realistic R2D2 costume out of white plastic trash can for my son, who was just as fascinated with Star Wars as I was in 1977. Once again, I was very satisfied with my handiwork, although this time the adults definitely recognized the costume!
2. Trust, but verify – A lasting impression from my childhood Halloween excursions was the process of pouring all of the candy onto the floor and closely inspecting the pieces for tampering, usually looking for inserted razor blades for some reason. The message from this exercise was clear – sure, we trust you to go out and beg for candy from the neighbors, but we don’t trust them enough to let you eat uninspected candy. This bit of childhood trauma was only confirmed when I was trick-or-treating with a group of friends and we knocked on the door of a house where a 1970s-style teen party was occurring, and the person answering the door said to his friends, “there are some trick-or-treaters here, let’s give them some drugs.” Needless to say, these Halloween experiences helped formulate a worldview that not everyone out there is looking out for my best interests.
3. Have fun, but consider others – Today, the focus of Halloween festivities is on the “treat,” but not the “trick.” As a lad, I must admit that I engaged in my fair share of the “trick” part of trick-or-treating, which never involved anything particularly malicious or destructive, but was no doubt quite annoying. In today’s world of doorbell cameras and iPhones, we certainly never would have gotten away with those shenanigans. Now that I have entered what I like to call the “get off my lawn” phase of my life, I truly regret having given into the temptation and peer pressure that led to the “trick” part of “trick-or-treating.”
4. Choose your costume carefully – Several years ago, I was driving my son and his college freshmen roommates around Washington DC trying to find Halloween costumes on Halloween-eve, only to find that all of the stores were completely cleaned out. We finally found a costume store in the suburbs that was fully stocked, but the freshmen had a very hard time selecting their costumes. This was at a time (which could still be the case today) when a number of people were being called out on social media and in the news for Halloween costumes that they once wore long ago, and it had the in terrorem effect of making all Halloween costumes seem potentially problematic to somebody. We eventually got the group outfitted, but it took a while! In any event, I think it is much better to be safe than sorry, because it is really not worth offending someone when you are just wearing a silly costume as a grown adult on Halloween.
5. Enjoy the moment – While I was working in demanding jobs and had a long commute when my kids were young, I would always make it a priority to get home before the trick-or-treating commenced, because the kids would always be so excited about the holiday. While it can be stressful at times to try to make everything happen in that one evening, it was always worth the effort to see their smiles and to hear their laughter as we navigated the spooky sights around the neighborhood. It was also nice to see all of the neighbors out and about and being friendly in a way that did not usually occur on all of the other days of the year. If you are still in the mode of celebrating Halloween with your family and neighbors, I encourage you to enjoy those moments while you still can!
Yesterday, the SEC announced four new members of the Small Business Capital Formation Advisory Committee. The announcement notes:
The new Commission-appointed committee members are:
– Jennifer Newton – Managing Attorney and Founder, StartSmart Counsel; Miami
– Rose Standifer – Partner, Foley Hoag LLP; Denver
– Wendy Stevens – Partner, Forvis Mazars LLP; New York
– Emily Underwood – Clinical Professor of Law, Bluhm-Helfand Director of the Innovation Clinic, The University of Chicago Law School; Chicago
In addition to the 14 appointed members, the current committee members include the SEC’s Small Business Advocate, and three non-voting members appointed by the SEC’s Investor Advocate, the North American Securities Administrators Association, and the Small Business Administration, respectively. The committee also has an observer appointed by the Financial Industry Regulatory Authority.
The committee provides advice and recommendations to the Commission on rules, regulations, and policy matters relating to small businesses, including smaller public companies. Committee members represent a diverse spectrum of entrepreneurs, investors, and advisers who work with early-stage private companies and smaller public companies, including minority- and women-owned small businesses. Additional information about the committee, its members, and prior meeting materials is available on the committee webpage.
After having been sworn in for a second term as Chair of the PCAOB last week, PCAOB Chair Erica Williams delivered a speech outlining the PCAOB’s efforts toward meeting its strategic plan yesterday at the 2024 PCAOB International Institute on Audit Regulation. The speech outlines steps that the PCAOB has taken to meet its objectives of modernizing its standards, enhancing its inspections and strengthening enforcement.
On the topic of modernizing standards, Chair Williams notes:
Today, the PCAOB is taking unprecedented action, and our actions are necessary. Protecting investors depends on updated standards and rules—and that’s why this Board is taking great strides to meet this challenge.
While we are committed to getting this agenda done to meet the rapidly evolving capital markets, we are even more committed to making sure it’s done right.
We take public comments very seriously, reading each and every one, and ensuring that the full range of voices and feedback are taken into account. We will—and we have—reopened comment periods when necessary and have asked follow-up questions to ensure we understand the feedback received before moving forward.
Additionally, ahead of the effective dates for these standards and rules, we are committed to providing firms with resources to help them update their methodologies and train their staff on the upcoming changes.
On the topic of enhancing inspections, Chair Williams notes in her speech:
In recent years, the PCAOB has found that audit deficiencies, particularly Part I.A. deficiencies, are unacceptably high.
Part I.A findings are serious. They mean the audit firm failed to obtain sufficient appropriate evidence to support its opinion, and audit opinions were signed without completing the audit work required to verify the accuracy of the financial statements.
Part I.A deficiencies include things like failing to perform any procedures at all to test revenue or the costs of inventory, as well as instances where the auditor did not identify and test any controls over long-lived assets and depreciation expense. Simply put, these deficiencies are not just serious, but they go to the heart of the audit.
These Part I.A deficiencies are relevant when assessing the quality of work done by an audit firm. But audit quality is complex, and it escapes simplistic proxies or measures.
And on the topic of strengthening enforcement, Chair Williams states:
Enforcement has been a critical tool at our disposal, and we focus on cases that involve serious matters that put investors at risk: audit failures in cases involving financial statement fraud, taking on client work that firms can’t complete, altering work papers, and not performing sufficient work before signing audit opinions.
We examine the facts and circumstances of every case and have not hesitated to impose bars on bad actors, revoke firms’ registrations, and impose civil monetary penalties—among many other options on the table under this Board.
We have issued approximately $35 million in fines this year alone. We have also required functional changes to a firm’s supervisory structure for the very first time. And we have required firms to retain an independent monitor to drive improvements and best protect investors.
The speech wraps up by noting: “Protecting investors is a noble profession—and one that I’m proud to be part of. Trustworthy audits help give people confidence, which powers investment and capital formation to move our economies forward and improve the lives of the people we serve.”
John recently noted that the PCAOB added a “Fraud Risk Resources” page to its website, which is intended to assist auditors in complying with their obligations to consider fraud during the course of an audit, while also providing useful information for audit committees in understanding their obligations. The Center for Audit Quality (CAQ) has also made resources available on this topic with its new publication “The Role of the Auditor: Assessing and Responding to Fraud Risk.” The CAQ notes:
Shifts in the economy, geopolitical landscape, and technological developments have created an environment in which companies are potentially more vulnerable to fraud. In recent years, as major corporate failures and scandals continue to be in the spotlight, fraud has become a growing area of focus. Regulators, investors, and other interested parties expect auditors to remain vigilant and to think critically about fraud.
The mitigation of fraud risk is most effective when all participants of the financial reporting ecosystem fulfill their roles in deterring and detecting fraud. Auditors, although often the last line of defense due to the scope and timing of their engagements, are among the many stakeholders whose influence and responsibilities have a significant impact on fraud deterrence and detection.
Auditors should continually strive to enhance their professional skepticism to effectively assess and respond to fraud risks, including considering when it may be important to elevate the basic level of skepticism that is applied throughout the process of any audit and being cognizant of biases that can impede professional skepticism.
The auditor’s fraud risk assessment is an iterative process that occurs throughout the audit and is a critical element of planning and performing an audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or by fraud. Auditors may consider the following as they plan and perform their fraud risk assessment and design procedures to address identified fraud risks…
This publication provides insights into practices, tools, and considerations that can help auditors, especially those with less experience, enhance their professional skepticism and overall approach to assessing and responding to the risks of material misstatement resulting from fraud during the audit. It also provides clarity and understanding of the auditor’s current role and responsibilities related to fraud, which may provide insights for those who are involved in evaluating and using financial reporting information as well as for policymakers and regulators.
As with the PCAOB’s resources on fraud risk, this CAQ publication can be a useful resource for counsel and the audit committee to better understand the auditor’s role in assessing and responding to fraud risk.
One of the things that I often find myself saying is that I have been very fortunate to have had several mentors over the course of my career who really helped me understand how to succeed as a lawyer, and I am eternally grateful for their guidance. I have tried to pay that forward by serving as a mentor to friends, colleagues, college students, law students and really anyone else who seeks me out to serve as a mentor. That is why I was thrilled when we relaunched The Mentor Blog here on TheCorporateCounsel.net, and our that Contributing Editor, Meaghan Nelson has been providing some great advice on the blog since its return. Some of the notable topics include:
I encourage you to check out The Mentor Blog and all of Meaghan’s insights. If you are not a member of TheCorporateCounsel.net and do not have access to all of our practical resources, email sales@ccrcorp.com or sign up online.
Nasdaq recently released its 2024 Global Governance Pulse survey, which provides insight into five key areas of focus for boards. Nasdaq notes:
A thoughtful governance model enables boards to fulfill their duties and provide effective oversight of organizations. Each board must determine the appropriate governance approach that aligns with the organization’s needs and meets prescriptive requirements imposed through relevant legal and regulatory bodies.
Nasdaq’s 2024 Global Governance Pulse survey was conducted in July, capturing information on corporate governance trends and practices and anticipated 2025 board priorities. The survey included questions that explored five key areas:
– CEO evaluations and management oversight
– Board composition and culture
– Governance practices, processes, and tools
– Board evaluations
– Strategic and risk topics on the horizon
The survey collected 872 qualified responses from board members, executives, and governance professionals across organizations and sectors. On the topic of the skills and experience that respondents thought would most enhance the board’s composition and ensure alignment to the organization’s strategy 35% of respondents specifically cited AI and machine learning. In close second was cybersecurity and data privacy, coming in at 34% and 30% noted industry experience.
In terms of the top areas that will impact an organization’s success in the next 12 months, 44% of respondents cited access to capital, resource allocation, and cost controls, 43% cited economic conditions, and 39% identified clearly defined and articulated strategy and goals.
Yesterday, the SEC posted a new “Office Hours” video with SEC Chair Gary Gensler, this time on the topic of systemic risk in artificial intelligence. Drawing a comparison to the disturbing 2013 romantic comedy Her, starring Scarlett Johansson and Joaquin Phoenix, Gensler discusses how AI may pose risks to financial stability in the future, given the potential dependency on a small number of AI base models. The main concern is that the base model – or data aggregator – may send a similar signal to many individual actors, leading many of them to make similar decisions. This network interconnectedness could lead a significant number of financial institutions to all head off the proverbial cliff simultaneously, leading us to the next financial crisis.
I must admit that this is an AI nightmare that I had not really considered until Chair Gensler brought it up. The fact that one or a few AI models could have such an impact on the financial markets is pretty terrifying. Thank you, Chair Gensler, for giving me another reason to not go to sleep at night.
I have always been fascinated with systemic risks in the financial system. Even before I became a lawyer, I wrote a Comment titled “Enforceability of Over-the-Counter Financial Derivatives,” which was published in the ABA Business Law Section publication, The Business Lawyer (see Vol. 50, No. 1 (November 1994)). My Comment explored concerns with enforceability in the then-nascent financial derivatives market, following a decision of the British House of Lords that derivative agreements involving certain municipalities were unenforceable. I like to think of that Comment as the starting point of my illustrious publishing career!
Tune in later today – Tuesday, October 29th – at 2:00 pm Eastern for our webcast, “Surviving Say-On-Pay: A Roadmap for Winning the Vote in Challenging Situations.” Get practical tips for scenarios that companies frequently encounter – from D.F. King’s Zally Ahmadi, Compensia and CompensationStandards.com’s Mark Borges, Orrick’s JT Ho, Foot Locker’s Jenn Kraft, and Tesla’s Derek Windham.
Members of this site are able to attend this critical webcast at no charge. The webcast cost for non-members is $595. If you’re not yet a member, subscribe now by emailing sales@ccrcorp.com – or call us at 800.737.1271.
We will apply for CLE credit in all applicable states (with the exception of SC and NE, which require advance notice) for this 60-minute webcast. You must submit your state and license number prior to or during the program using this form. Attendees must participate in the live webcast and fully complete all the CLE credit survey links during the program. You will receive a CLE certificate from our CLE provider when your state issues approval, typically within 30 days of the webcast. All credits are pending state approval.
On Friday, the SEC’s Small Business Capital Formation Advisory Committeereleased the agenda for its meeting on Wednesday, November 13, 2024. The meeting will include a discussion of how venture capital fund managers are raising capital, including the limits of arm’s length fundraising and challenges facing emerging fund managers. The Committee’s meeting will be open to the public via webcast on www.sec.gov. The press release announcing the meeting notes:
The committee, which provides advice and recommendations to the Commission on rules, regulations, and policy matters relating to small businesses, will continue its exploration of ways to expand early-stage capital raising by focusing on how certain fund managers, including emerging fund managers and diverse fund managers, are accessing capital. Committee members will hear from Professor Sabrina Howell, from the New York University Stern School of Business, who will present her upcoming academic paper that examines venture capital fund manager use of relationship-based versus arm’s length public advertising approaches to fund-raising. Professor Howell will discuss the advantages and challenges of public advertising for traditionally underrepresented managers.
Staff members from the SEC’s Division of Investment Management will provide a brief overview of the registration framework applicable to private fund advisers and their funds, including those exemptions from the registration requirements of the Investment Advisers Act of 1940 and the Investment Company Act of 1940, which may be relied upon by emerging fund managers.
The committee will discuss the challenges that emerging fund managers report facing when seeking to raise investment funds and will hear from Karen Kerr, PhD, Board Member and Charter Class, Kauffman Fellows and Managing Director, Exposition Ventures, about how new fund managers can be supported and promoted through fellowship programs. As part of this discussion, the committee will explore ways to address some of the challenges facing emerging fund managers and consider whether regulatory or other solutions could be undertaken to further support these fund managers and the early-stage companies in which these managers invest.
The agenda for this meeting, meeting materials and information about the webcast are available on the Committee’s webpage.