Broc Romanek is Editor of CorporateAffairs.tv, TheCorporateCounsel.net, CompensationStandards.com & DealLawyers.com. He also serves as Editor for these print newsletters: Deal Lawyers; Compensation Standards & the Corporate Governance Advisor. He is Commissioner of TheCorporateCounsel.net's "Blue Justice League" & curator of its "Deal Cube Museum."
Here’s news from Lynn Turner: On Wednesday, the European Commission proposed new legislation that would result in much greater oversight of the auditing profession within the European Union. Much of the legislation catches Europe up to the current status of regulation of the profession in the U.S. This is interesting in that ten years ago, politicians, Ambassadors, businesses, audit firms, etc. from the EU vehemently opposed Sarbanes-Oxley. Now in many regards, they are embracing it – but only after their investors have paid a very serious price for past lack of action.
The “devil is in the details” of the proposal, such as:
– While in the US investors have been asking for a separate report from the auditors providing information the auditors know, the EC would require such a report but prohibit it from being made available to investors.
– The EC proposal discusses the “client” of the auditor being the company, rather than investors.
– The EC would require substantial expansion of the audit report, in what appears to be a very positive development, including requiring the auditor to set forth how they assessed materiality. The PCAOB has also taken up this topic, but not yet issued a proposal.
– The EC would require auditors to disclose financial information. But that information is very, very limited such as to revenues, which the firms already disclose. It does not require disclosure of basic financial information necessary for any regulator to assess the financial stability, liquidity, viability or performance of the firms they are charged with regulating. In 2008, The U.S. Treasury Committee made a recommendation with respect to increasing transparency of the audit firms, which the PCAOB has yet to act on.
– While mandatory rotation is proposed every 6 years, there are mechanisms put in place to extend this out for up to 12 years. The PCAOB has previously taken up this topic in the US and issued a concept release, but has not yet issued a proposal.
– The EC proposes that non-CPA’s be allowed to own audit firms. This is a change the large audit firms have been requesting for over a decade, as a way to monetize their stock and let the older partners reap the benefit. This is a very dangerous proposal as it would allow for outside investors, or allow the firm to go public, putting the profit motive far ahead of the public interest obligation, and likely resulting in significantly lower audit quality. This idea has been debated and rejected here in the US. It also raises very serious independence issues, for example, when a private equity or hedge fund invests in a CPA audit firm, would the audit firm be able to audit other companies the investment firm holds? If so, could investors ever believe the audit firm would ever bring to light a problem in the company, such as an Olympus, if it would have negative consequences for the investment fund?
Ultimately, the real problem is the fact the company being audited still pays the bill. That is not changing under the EC proposal and will remain as the real problem, just as it is for credit rating companies. Until that problem is directly addressed it is likely audits will remain problematic, although some of the proposals may be beneficial.
EU Proposes Disclosure Requirements for Payments to Governments for Natural Resources Development
It’s not only Sarbanes-Oxley that is being somewhat cloned in Europe. As this memo summarizes, the EU recently issued two proposals to amend the European Union Transparency Directive that together contain new requirements for the disclosure of payments to governments by certain companies engaged in natural resource extraction or logging. This is a big deal for companies in the extractive industry with operations in the EU a la Dodd-Frank.
In the “Dodd-Frank Blog,” Jill Radloff of Leonard Street & Deinard provides an update on the OECD Conflict Minerals Project, including this new OECD report that establishes a baseline of current due-diligence practices of downstream companies.
EU Summarizes Comments on its Governance Green Paper
Recently, the European Union issued a summary of the 400+ comments submitted in response to its corporate governance green paper that it proposed back in April.
As expected, SIFMA and International Swaps and Derivatives Association filed this complaint on Friday in US District Court for DC to challenge the CFTC’s new rule that seeks to curb excessive speculation (like proxy access, this rule was approved 3-2 by the CFTC Commissioners). The groups have petitioned the higher US Court of Appeals for the DC Circuit to hear the case – which is the court that ruled against the SEC in the proxy access lawsuit filed by the Business Roundtable and US Chamber of Commerce a few months back. And like that lawsuit, this one claims the CFTC didn’t conduct a proper cost-benefit analysis. Here’s a Reuters article – and here’s a NY Times’ DealBook article.
Senate Bill to Encourage Small Company Capital Formation
Catching up to the House activity in this area, Senators Charles Schumer (D-N.Y.) and Pat Toomey (R-Pa.) issued this press release last week about their new bill that would establish a new category of issuers – “emerging growth companies” – that would have less than $1 billion in revenues before the IPO and less than $700 million in public float after the IPO, along with scaled regulatory burdens – egs. freed from say-on-pay and just two years of financials rather than three – as part of a transitional “on-ramp” status that could last as long as 5 years, and more.
Auditor Tenure, Financial Officer Turnover and Financial Reporting Trends
Audit Analytics just wrapped up this study that provides data that should help to facilitate commentary on the PCAOB’s concept release regarding auditor independence and rotation. Highlights from the research include the following:
– Both the Russell 1000 and the Russell 2000 companies with auditor tenure of five years or less paid more in audit fees (per million dollars in revenue) than companies with longer tenure.
– 16.1% of the Russell 1000 companies have engaged the same auditor for 40 or more years. This percentage drops to 4.1% for the Russell 2000.
– About 50% of both the Russell 1000 and Russell 2000 companies experienced a CFO departure during the six-year period from 2005 to 2010.
– Over 96% of both the Russell 1000 and Russell 2000 companies with 40 or more years of auditor tenure experienced a turnover in an audit committee member during the six years under review.
– US accelerated filers were first required to provide SOX 404 certifications in annual reports for fiscal years ending on or after November 15, 2004. Ineffective ICFRs (SOX 404) for the Russell 1000 have significantly declined, from 8.21% in 2005 down to .83% in 2010. Adverse SOX 302 disclosures have declined in a similar fashion.
– During the six years under review, quantitative data concerning restatements and late filings (NT disclosures) reflect a steady and substantial improvement in financial reporting.
– Pursuant to Section 408(c) of Sarbanes-Oxley, the SEC is reviewing a company’s filings every three years; an analysis of SEC comment letters, however, show a more frequent oversight of the larger companies, particularly in the last three years, with over 65% of the Russell 1000 receiving a letter in each calendar years and over 50% of the Russell 2000 receiving a letter.
Last week, the PCAOB approved its 2011-2015 Strategic Plan and 2012 fiscal-year budget of approximately $227.7 million, which is a 11.4% hike from last year. Now the budget must be approved by the SEC…
Yesterday, the SEC gave us a little holiday present when it announced that the releasing of comment letters and response letters would be reduced to “no earlier than 20 business days” from when Staff review is complete from the “no earlier than 45 days” standard that has been in effect since these types of documents were first made public in ’05. The new standard commences on January 1st.
Note that the new standard uses “business days” rather than mere “days” in it – so the reduction is roughly a third, not a half as might appear at first blush. Yes, I’m a lawyer who loves the fine print…
Three interesting pieces of Senate testimony yesterday:
We are grateful that our blog has made the ABA Journal’s Blawg 100 for the fourth year in a row. You may recall that our blog won the voting contest among the 100 two years ago (the first year that the Journal put the Blawg 100 head-to-head in a round of voting) and we were winning it last year until the last day when two other blogs mysteriously received a huge number of votes. This year, we aren’t actively campaigning – but if you care to vote, here are the steps you need to take:
a. If you voted last year:
1. You likely need to recover your password by simply inputting your email address. You will promptly receive an email with your password and screen name in it.
2. Once you have your password, you should login to their site
3. Once logged in, go to the “Business Law” category and scroll down to TheCorporateCounsel.net Blog (it’s at the 3rd from the top) and click on the blue “Vote Now” symbol to the left of that.
b. If you didn’t vote last year:
1. Register to vote – it’s free (if you’re an ABA member, your ABA id/password won’t work for the ABA Journal’s site unfortunately as they are separate)
3. Once logged in, go to the “Business Law” category and scroll down to TheCorporateCounsel.net Blog (it’s at the 3rd from the top) and click on the blue “Vote Now” symbol to the left of that.
In this podcast, Dave Lynn and Marty Dunn engage in a lively discussion of the latest developments in securities laws, corporate governance, and pop culture, including:
– ISS Policy on Say-on-Pay Voting Results
– ISS Policy on Choice of Venue Proposals
– The SEC’s Latest Capital Formation Initiatives
– Marty’s Volt
By the way, ISS is holding webcasts next week to discuss the updates to its US and European policies.
SEC’s Inspector General Being Investigated by SEC’s General Counsel
Last week, Bloomberg ran this article noting that the SEC’s general counsel is investigating whether the SEC’s Inspector General David Kotz acted appropriately when he gave a 75-minute video interview to CrashProofRetirement.com, which was also uploaded on YouTube in 12 different segments (here is one segment for example). Kotz claims he cleared his appearance with the SEC’s Ethics Office – but questions have been asked about whether his appearance should be considered “investment advice.”
Our December Eminders is Posted!
We have posted the December issue of our complimentary monthly email newsletter. Sign up today to receive it by simply inputting your email address!
Last week, the SEC announced a settlement with Fifth Third Bancorp over some Reg FD violation allegations. No civil penalty was imposed upon Fifth Third based on its cooperation with the investigation. Here’s the SEC’s order. And here’s a Wachtell Lipton’s memo from Edward Herlihy and Matthew Guest about the action:
Last week, the SEC instituted a cease-and-desist order against Fifth Third Bancorp in connection with its redemption of trust preferred securities (TruPS) in May 2011. The SEC charged that in effecting the redemption Fifth Third “selectively disclosed,” in violation of Regulation FD, that it would redeem a class of its TruPS for about $25 per share. At the time the securities were trading at about $26.50 per share. The SEC stated Fifth Third did not issue a Form 8-K or other public notice of the redemption until it became aware that investors who appeared to have learned of the redemption had been selling the securities to buyers who appeared to be unaware of the redemption. Fifth Third, which compensated harmed investors and agreed to adoption and implementation of various additional policies and procedures, settled the SEC’s enforcement action without admitting or denying the allegations.
Fifth Third’s early redemption of their TruPS in May 2011 was triggered through Dodd-Frank’s phasing out of Tier 1 Capital treatment for TruPS generally. As indicated in our July 2010 memo “Potential Opportunities for Issuers of Trust Preferred Securities under the Collins Amendment,” bank holding companies have taken the opportunity presented by Dodd-Frank to redeem relatively costly TruPS under the regulatory capital provisions of their particular issuances where applicable. As noted in that memo, employing this redemption strategy requires careful coordination with regulators and consideration of all applicable circumstances, importantly including disclosure obligations.
Apart from their changing capital treatment and related redemptions, TruPS have frequently been a sort of fulcrum security in acquisitions of troubled institutions. Several notable transactions, including Ford Financial’s recapitalization of Pacific Capital in 2010, included conditions around effecting discounted tender offers of TruPS which have often proven difficult in execution. Several other deals, including BB&T’s recently announced BankAtlantic transaction, have attempted to solve the issue of TruPS at the holding company level by focusing on bank-level transactions.
It is clear that in the coming months TruPS will continue to be a focus in numerous capital and strategic transactions. Companies considering redemptions or other transactions involving their TruPS, while coordinating closely with their bank regulators and other relevant constituencies, should not lose sight of the various “capital treatment events” in the underlying trust documents as well as related corporate and securities law issues.
It’s been over a year since the SEC last brought a Reg FD enforcement case…
Study: Consequences of Private Meetings with Investors
In the “IR Web Report Blog” today, Pam Agnew summarizes how a new study has found significant evidence that hedge funds benefit from information they obtain in private meetings with company executives, adding to mounting research suggesting that selective access to management undermines regulators’ fair disclosure objectives. Check it out.
Poll: Which Development is More Crazy?
As we stare into the abyss of another financial crisis – and thus gear up for more reform down the road – below is an anonymous poll:
As expected given his 9 specific questions that he wanted covered during a recent hearing, Southern District of New York Judge Jed Rakoff rejected the proposed $285 million settlement between the SEC and Citigroup related to the sale of mortgage securities yesterday. This Dealbook Blog includes the Judge’s 15-page order – and here’s a statement from SEC Enforcement Director Rob Khuzami. As noted in this WSJ article, the Judge is not kind to the SEC in his order – he has set a July 16th trial date.
Whistleblowers Coming Out of the Woodwork: To Both the SEC and Internally
As I blogged recently, the SEC’s Office of Whistleblower issued its first annual report in which it disclosed that it already had received over 300 tips in just a few months. Then there is this recent CFO.com article noting that employees are reporting internally at a higher clip. It will be interesting to see if these trends continue – I think they will given that employees now have greater awareness about whistleblowing generally since companies are conducting campaigns for folks to blow the whistle internally first. We have posted memos analyzing this new report in our “Whistleblowers” Practice Area.
Updating Your Whistleblower Procedures: How to Apply Six Sigma and Lean Methodologies
From Lynn Turner: “Investors should be concerned by the two new PCAOB inspection reports released last week that indicate a significant increase in deficient audits performed by half of the Big 4 audit firms. As this Bloomberg Businessweek article notes, PWC had deficiencies in 37% of its audits examined and KPMG had deficiencies in 22% of its audits. These reports raise a question as to whether investors are getting value for the money being spent on audits – and they follow the recent report criticizing audits by Deloitte & Touche. Here is a letter from Senator McCaskill raising questions with respect to Deloitte audits.
It is interesting to note these reports no longer discuss which specific issuer had a restatement, but rather just note how many restatements there were. This is apparently a step backwards away from transparency, making it harder for readers to determine which issuers restated and rendering the reports of lesser value. Another unanswered question is how many, if any, of the audit partners involved have become the subject of PCAOB disciplinary actions.
The PwC report notes several recurring deficiencies in basic testing of a company’s revenues, internal controls and support for asset values. On these audits, there is not just one partner, but a second partner as well as an experienced manager. It really raises questions about the quality controls of the firm, given the high deficiency rate.
The KPMG report notes deficiencies in auditing allowances for loan losses, asset valuations, and internal controls. The reports highlight how auditors fail to test, or to test adequately, the value of assets such as investments, including testing the information received by pricing services. Deficiencies in such testing and deficiencies in pricing services processes were recently discussed at a PCAOB SAG meeting.
On some of these audits, the deficiencies cited raise a question about whether the audit committees are really overseeing the audits performed in a reasonable manner or merely going through the motions. It also appears that efforts by Congress, the business community and the SEC (under a prior Chairman) to “dumb down” audits of internal controls has worked, and the audits of internal controls may not hold a lot of value given the number of deficiencies noted.”
This past week, the United Kingdom High Pay Commission (an independent inquiry into executive compensation) released the results of its year-long study of executive pay. Entitled “Cheques With Balances: why tackling high pay is in the national interest,” the report includes 12 recommendations on ways to combat spiraling executive compensation.
The one that I found most interesting is the recommendation that the current shareholder advisory vote on executive compensation be made “forward-looking.” By this, the Commission means that shareholders would be given the opportunity to vote on a company’s proposed remuneration arrangements for the next three years (following the date of the vote). This would include future salary increases, bonus awards, and all ancillary benefits (such as pension arrangements).
As the Commission notes, this approach would give shareholders a genuine say in the remuneration to be paid to executives, not just the ability to “approve” or “ratify” the pay packages that have already been implemented. It almost goes without saying that this would be a radical departure from the current structure of shareholder advisory votes on executive pay (both in the UK and the US). Given that the concept of shareholder advisory votes originated in UK a mere decade ago, the proposal bears watching – if only to see how it is received in the UK corporate and investor communities.
More on “The Mentor Blog”
We continue to post new items daily on our blog – “The Mentor Blog” – for TheCorporateCounsel.net members. Members can sign up to get that blog pushed out to them via email whenever there is a new entry by simply inputting their email address on the left side of that blog. Here are some of the latest entries:
– Who “Owns” Your Social Media Policy?
– The Reality of Section 220 Claims for Books and Records
– Accounting That Comes in Flavors
– “Fifth Call” as Effective Means of Communication
– Department of State Speaks on Conflict Minerals
Last week, as noted in this press release, Senators Jack Reed (D-RI) and Chuck Grassley (R-IA) introduced the “PCAOB Enforcement Transparency Act of 2011.” This bill will make PCAOB disciplinary proceedings public to bring auditing deficiencies at the firms they audit to light in a timely manner. This is in reaction with what happened with Deloitte recently, as I noted in this blog.
Sarbanes-Oxley requires PCAOB’s disciplinary proceedings to be kept confidential through charging, hearings, initial decision, and appeal, which enables firms that engage in misconduct to drag out the proceedings for years while the investors are kept in the dark. In comparison, nearly all administrative proceedings brought by the SEC against public companies, brokers, dealers, investment advisers, and others are open, public proceedings.
House Bill Would Require Shell Companies & LLPs to Disclose Contact Information
Last week, as reported in this Reuters article, a new bill has been introduced in the House would require shell companies and limited liability partnerships to provide names and contact information when they are formed. This is at least the 3rd time that this type of bill has been introduced and it’s heavily supported by law enforcement agencies.
Judges Needed for Fordham Securities Law Moot Court Competition
Each spring, Fordham Law School hosts the Kaufman Memorial Securities Law Moot Court Competition, which has a rich tradition of bringing together complex securities law issues, talented student advocates and top legal minds. Next year’s Kaufman Competition will take place on March 23-25, with a final round panel of Judge Kelly of the Tenth Circuit; Chief Judge Kozinski of the Ninth Circuit; Judge Martin of the Sixth Circuit; Judge Posner of the Seventh Circuit; Judge Jane Richards Roth of the Third Circuit; and SEC Commissioner Paredes.
They are currently soliciting folks to judge oral argument rounds and grade competition briefs. No securities law experience is required to participate and CLE credit is available – here is contact information to participate.
On Friday, I attended the always useful “Dialogue with the Director” session during the ABA’s Business Law Section’s Annual Fall Meeting. Here are a few notes:
– It was standing-room only in the room, quite a difference from recent years. This was surprising given the dearth of recent final rulemakings – so my take it that this may be a more of a byproduct of fewer deals rather than increased interest in what is happening at the SEC.
– Meredith noted she recently participated in her 8th testimony on the Hill during her tenure, which is quite a lot. Her latest was a Senate Banking subcommittee hearing last week where all six Division Directors and the head of OCIE gave updates about their activities. Here is the testimony given during that hearing.
– Corp Fin has finalized most of its required Dodd-Frank rulemakings that had a deadline. They are now actively writing proposals and final rules for the topics that they are still required to tackle under Dodd-Frank in the wake of the SEC revising its processes to ensure future rulemakings comply with the dictates of the court’s decision in the proxy access lawsuit.
– For these remaining rulemakings, there are no timetables yet for when they would be proposed or finalized – but Meredith noted that Senator Menendez pressed her during the hearing last week to propose the pay disparity rules by the end of the year, noting that Corp Fin would try mightily to meet that timeframe but there were no promises (my note: remember that even if Corp Fin made a recommendation to the Commission on a rulemaking, it is out of the Division’s control as to when the Commission acts upon it). There is also the compensation committee/advisor proposal that is outstanding – even when the SEC finalizes its rules on that, the exchanges then have to revise their listing standards.
– Any no-action requests related to shareholder proposals that deal with private ordering of proxy access will be processed within Corp Fin in the normal course. Meredith intends to read them herself too.
– On proxy plumbing, a proposal regarding proxy advisors would likely be the first output from the concept release commentary. Meredith reminded the audience that the SEC’s jurisdiction in this area only extends so far – so that an item like conflicts of interest with a company or proponent could be the subject of a rulemaking, but that others like lack of competition within the industry is not. Regarding complaints that proxy advisor recommendations are made often based on inaccurate information, Meredith noted that there didn’t seem to be much evidence to support those claims – rather, those situations typically involved disagreements based on judgment calls.
– The SEC likely won’t conduct rulemaking in areas where Congress has a bill floating right now, such as restrictions on general solicitation and Section 12(g) thresholds.
Yesterday, this NY Times article slammed the way that law schools teach and noted how “for decades, clients have essentially underwritten the training of new lawyers, paying as much as $300 an hour for the time of associates learning on the job.”
SEC Releases Long-Awaited IFRS Comparison Papers
As described in this article on “Accounting Today,” the SEC Staff released two papers a few days ago. One 52-page paper compares IFRS with US GAAP and the other 65-page paper analyzes IFRS in practice at foreign companies. FEI’s blog includes some comments from the SEC’s Chief Accountant Jim Kroeker related to these papers.
