Earlier this week, the SEC announced settled enforcement proceedings against Fiat-Chrysler arising out of allegedly misleading disclosures about its compliance with emissions standards. Here’s an excerpt from the SEC’s press release:
The SEC’s order found that in February 2016, FCA represented in both a press release and an annual report that it conducted an internal audit which confirmed that FCA’s vehicles complied with environmental regulations concerning emissions. As found in the order, FCA’s statements did not sufficiently disclose the limited scope of its internal audit, which focused only on finding a specific type of defeat device, or that the audit was not a comprehensive review of FCA’s compliance with U.S. emissions regulations. In addition, at the time FCA made these statements, engineers at the U.S. Environmental Protection Agency (EPA) and California Air Resource Board (CARB) had raised concerns to FCA about the emissions systems in certain of its diesel vehicles.
Under the terms of the SEC’s order, Fiat-Chrysler consented to a cease & desist order enjoining it from committing or causing future violations of Section 13(a) of the Exchange Act and Rules 12b-20 and 13a-16 thereunder. The company also agreed to a $9.5 million civil monetary penalty.
The announcement of this proceeding follows on the heels of a significant setback in the SEC’s enforcement action against Volkswagen arising out of that company’s use of a “defeat device” to thwart emissions tests. As discussed in this Mintz memo, a California federal court recently dismissed a significant portion of the SEC’s securities claims against Volkswagen on the grounds that they were previously released by the DOJ.
I’m inclined to be a little more forgiving toward Fiat-Chrysler than I am toward Volkswagen. Sure, this conduct seems to be less egregious, but the real reason is that I have a sentimental attachment to the company. My first car was a 1972 Dodge Polara, and my current dream car is an Alpha-Romeo Stelvio Quadrifoglio – both of which are currently under the Fiat-Chrysler corporate umbrella. Of course, in the real world I still drive a 2012 Equinox that eats oil and has a broken tail light that I busted when I accidentally hit it with a garbage can I was dragging in from the curb a few months ago.
By the way, if it seems like there are more high-profile enforcement actions this week than usual, don’t forget that the SEC’s fiscal year ends today, so Enforcement needs to put cases to bed now if they’re going to count in this year’s stats.
Board Diversity: The Impact of Geography
Improved oversight and risk management are some of the advantages often associated with board gender diversity. However, a recent study suggests that the advantage that boards with female directors have when it comes to improved oversight doesn’t derive from the gender of those directors, but from their location.
The study says that what makes the difference is that fact that female directors are generally more geographically distant from the companies that they serve than their male counterparts. According to the study, this makes them more reliant on hard data and less reliant on things like CEO schmoozing when it comes to making tough decisions. Here’s the abstract:
Using data on residential addresses for over 4,000 directors of S&P 1500 firms, we document that female directors cluster in large metropolitan areas and tend to live much farther away from headquarters compared to their male counterparts. We also reexamine prior findings in the literature on how boardroom gender diversity affects key board decisions.
We use data on direct airline flights between U.S. locations to carry out an instrumental variables approach that exploits plausibly exogenous variation in both gender diversity and geographic distance. The results show that the effects of boardroom gender diversity on CEO compensation and CEO dismissal decisions found in the prior literature largely disappear when we account for geographic distance.
Overall, our results support the view that gender-diverse boards are “tougher monitors” not because of gender differences per se, but rather because they are more geographically remote from headquarters and hence more reliant on hard information such as stock prices.
Check out this episode of the @DenselySpeaking podcast, in which Greg Shill leads a discussion with one of the study’s authors about its implications and some of the other ways geography influences governance. I’ve never really considered the impact of geography on corporate governance, but the discussion makes an interesting case for the idea that geographic considerations can play a big role in a wide range of governance concerns.
ICFR: Newly Public Companies & Material Weaknesses
This Audit Analytics blog takes a look at how newly public companies have fared when it comes to internal control over financial reporting. This excerpt summarizes the results of its analysis:
To get a sense of how prepared new IPOs are in terms of ICFR, this analysis looks at the effectiveness of controls as disclosed by SEC registrants in the first management report on ICFR after the IPO year. The amount of reports disclosing ineffective ICFR after an IPO has increased from 12% in 2010 to 21% in 2018, with a high point of 24% in 2016.
As an important note, 2019 is excluded from the above longitudinal analysis on ineffective ICFR after an IPO due to incomplete data; less than 20% of IPOs conducted in 2019 have subsequently filed a management’s report on ICFR. However, based on the reports currently available, 39% have disclosed a weakness in internal controls.
For comparative purposes, a 2019 study referenced in this FEI blog found that 23% of all SEC filers reported a material weakness in 2018. However you slice it though, the trend line for new public companies is not good – and remember, most IPO companies aren’t required to have their auditors vouch for management’s assessment of ICFR.
Ernst & Young recently issued its annual review of Staff comment letters. The number of comment letters issued during the year ended June 30, 2020 declined by 15% over the prior year. That represents the continuation of a four-year trend that has seen the number of comment letters decline by nearly 2/3rds since 2016.
EY attributes the decline to the Staff’s continued use of a “risk-based” approach to the review process, which involves concentrating on larger filers and reviewing their filings more frequently. Here’s a list of the 10 topics that were most frequently the subject of SEC comments:
1. Non-GAAP financial measures
2. Management’s discussion and analysis
3. Revenue recognition
4. Segment reporting
5. Fair value measurements
6. Intangible assets and goodwill
7. Contingencies
8. Inventory and cost of sales
9. Income taxes
10. Signatures/exhibits/agreements
The list is pretty similar to last year’s, although revenue recognition comments led the way in 2019. Contingencies and inventory & cost of sales were the only additions to this year’s top 10 list, while comments on state sponsors of terrorism and acquisitions and business combinations failed to make the cut this year.
SEC Enforcement: “EPS Initiative” Snares First Two Companies
Corp Fin isn’t the only SEC division that takes a risk-based approach to its work. Yesterday, the Division of Enforcement announced settled enforcement proceedings against two companies for allegedly manipulating their reported earnings per share. Here’s an excerpt from the SEC’s press release announcing the proceedings:
The Securities and Exchange Commission today filed settled actions against two public companies for violations that resulted in the improper reporting of quarterly earnings per share (EPS) that met or exceeded analyst consensus estimates. The actions are the first arising from investigations generated by the Division of Enforcement’s EPS Initiative, which utilizes risk-based data analytics to uncover potential accounting and disclosure violations caused by, among other things, earnings management practices.
The proceedings, which were settled on a “neither admit nor deny” basis, involved allegedly inappropriate accounting adjustments that enabled the companies to present misleading earnings performance. Both companies consented to cease and desist orders and civil monetary penalties. Two accounting executives at one of the companies also consented to cease & desist orders, civil monetary penalties and temporary bars to practicing before the SEC.
This is the first I’ve heard about an “EPS Initiative,” but the Enforcement Division’s increasing emphasis on data analytics is something that the agency has publicized for some time. For example, this BakerHostetler memo discusses comments made by the Enforcement Division’s Chief Accountant, Matthew Jacques, at a conference last fall:
Mr. Jacques disclosed that the Division of Enforcement has also invested time and energy in technology to better detect fraud, such as the increased use of data analytics, to allow the SEC to detect complex fraud faster and catch bad actors more quickly. Mr. Jacques stated that the SEC will evaluate potential accounting cases brought to its attention based on considerations such as the egregiousness of the conduct, the size of the company and the SEC’s priorities.
My guess is that we’ll be hearing more from Enforcement’s EPS Initiative in the coming months. Cases targeting earnings shenanigans seem like a nice fit with the SEC’s current focus on violations that impact “Main Street investors,” and they also highlight the agency’s ability to leverage its resources through the application of technology.
Sustainability: CII Calls for Companies to Use Standard Reporting Metrics
Last week, the CII adopted a statement a statement urging companies to report on their sustainability performance using standardized metrics established by independent private sector standard-setters. In its press release announcing the adoption of the new statement, the CII provided some insight about why it decided to adopt the statement now:
The CII statement comes at a pivotal time for the future of sustainability reporting, with five leading sustainability standard setters recently releasing a document declaring intent to work together toward comprehensive reporting, and the International Federation of Accountants recently proposing the creation of a sustainability standards board that would exist alongside the International Accounting Standards Board. While CII does not endorse any particular framework or independent standard setter, these developments clearly indicate momentum toward the broad objectives described in the statement.
The CII’s statement says that “standards that focus on materiality, and take into account appropriate sector and industry considerations, are more likely to meet investors’ needs for useful and comparable information about sustainability performance.” The statement also endorses the idea that, over time, companies should obtain external assurance of the sustainability performance disclosures.
Last week, ISS released the results of its 2020 policy benchmark survey. Here are some of the highlights:
Pandemic-Related Issues
1. ISS policy guidance in response to COVID-19 pandemic: With respect to ISS’s policy guidance issued in response to the pandemic, a significant majority of both investor (62%) and non-investor respondents (87%) indicated that ISS should carry this or similar guidance into 2021 and continue to apply flexible approaches where warranted through at least the 2021 main proxy seasons.
2. Annual Meetings: Regarding the question on the preferred shareholder meeting format, absent continuing COVID-19 health and social restrictions, almost 80% of investor respondents chose “Hybrid” meetings, with the possibility for shareholders to attend and participate in the meeting either in-person or via effective remote communications. On the other hand, a plurality of non-investor respondents (42%) indicated a preference for in-person meetings, with virtual meetings used only when there is a compelling reason (such as pandemic restrictions).
3.Expectations regarding compensation adjustments: When asked about executive compensation in the wake of the pandemic, 70% of investor respondents indicated that the pandemic’s impact on the economy, employees, customers and communities and the role of government-sponsored loans and other benefits must be considered by boards, incorporated thoughtfully into decisions to adjust pay and performance expectations, and be clearly disclosed to shareholders. Among non-investor respondents, 53% indicated that many boards and compensation committees will need flexibility to make reasonable adjustments to performance expectations and related changes to executive compensation.
4.Adjustments to short-term/annual incentive programs: Regarding short-term/annual incentive programs and the respondents’ views on what is a reasonable company response under most circumstances, 51% of investors and 54% of non-investors indicated that both (1) making mid-year changes to annual incentive metrics, performance targets and/or measurement periods to reflect the changed economic realities and (2) suspending the annual incentive program and instead making one-time awards based on committee discretion could be reasonable, depending on circumstances and the justification provided.
Non-Pandemic-Related Issues
5. Director accountability to assess and mitigate climate risk: Investors ranked the top three actions that appropriate for shareholders to take at a company that isn’t effectively not effectively reporting on or addressing its climate change risk as follows: (1) engage with the board and company management (92%); (2) consider support for climate-related shareholder proposals (87%); and (3) consider support for shareholder proposals seeking greenhouse gas reduction targets (84%).
Notably, three-quarters of investors responded that they would consider a vote against directors who are deemed to be responsible for poor climate change risk management. Non-investors overwhelmingly favored engagement with the board and company management as the most appropriate action (93%) while other possible actions were far less popular.
6. Sustainable development goals: When asked whether the UN’s SDG framework to be an effective way for companies to measure environmental and social risks and to commit to improving environmental and social disclosures and actions, 44% of non-investors said “yes,” while 51% said “no.” Investor responses were “yes” (44%) and “no” (56%).
7.Auditors and audit committees: ISS often considers the relative level of non-audit services and fees compared to audit-related services and fees when assessing auditor independence of the external auditor. When asked what other factors (when disclosed) they considered relevant to the evaluation of auditor independence & performance, 88% of investors said significant audit controversies. That edged out significance/frequency of material restatements, which was cited by 83% of investors. Significance/frequency of material restatements (67%) topped the list for non-investors.
When asked what information should be considered by shareholders in evaluating a company’s audit committee, the most popular response among investors was significant controversies relating to financial reporting, financial controls or audit (93%). Skills and experience of audit committee members (97%) topped the list for non-investors.
8. Racial and ethnic diversity: When asked should all corporate boards provide disclosure of the demographics of their board members including directors’ self-identified race and/or ethnicity, 73% of investors indicated all boards should disclose this information to the full extent permitted under relevant laws. Only 36% of non-investors gave the same response, while 32% said boards should only disclose this information where it is mandated in jurisdictions where they operate.
9. Independent board chairs: 85% of investors said that an independent chair is their preferred model, but 47% said that company-specific circumstances may justify other models. On the other hand, 38% said that non-independent chairs should only be allowed in emergency or temporary situations. Nearly half of non-investor respondents indicated that there was no single preferred model for board leadership.
PPP Loans: The SBA is MIA On Loan Forgiveness
According to this recent “American Banker” article, the SBA isn’t off to a great start when it comes to acting on PPP loan forgiveness applications. In fact, this excerpt suggests that it hasn’t gotten off to any start at all:
More banks, weary of waiting on legislative fixes, are moving ahead with processing Paycheck Protection Program forgiveness applications. Many of those lenders have become more frustrated by a lack of communication from the Small Business Administration.
The $1.6 billion-asset NexTier Bank in Kittanning, Pa., submitted the first of 95 applications on Sept. 15, while the $2.2 billion-asset First Choice Bancorp in Cerritos, Calif., has processed about 200 applications in recent weeks. The $1.4 billion-asset IncredibleBank in Wausau, Wis., has submitted 50 loans since the forgiveness portal opened on Aug. 10. Each is still waiting for a response from the SBA.
“We have not yet had a single one validated,” said Robert Franko, First Choice’s president and CEO. “To our knowledge, no one has yet received forgiveness,” Franko added. “There’s no question borrowers are tired of waiting. We have an automated system and everything can be done online.”
Lenders and borrowers aren’t the only ones dissatisfied with the SBA’s performance. According to this recent GAO report, the SBA’s guidance on the loan forgiveness process leaves some remaining uncertainty about some aspects of the lenders’ role in the process, and its plans for overseeing the loan forgiveness process are still incomplete.
The GAO report said that the SBA had received approximately 56,000 forgiveness applications as of Sept. 8. According to the American Banker article, “The GAO report did not mention any approvals, and other lenders said they know of no applications that have made their way through the review process.”
Fantasy “Stockball”? Score a TD & Get Stock for Free!
A member tipped us off to a new twist on “fantasy football.” Apparently, the online financial services & investment platform SoFi is offering a promotion where you can win up to $100 in stock for every touchdown your NFL team scores in one game. When I first saw this, I immediately thought about all of those enforcement actions that the SEC brought against companies that gave away securities for “free” during the late 90s. The SEC has also had occasion to crack down on this practice more recently, in the context of ICO “airdrops.”
This free stock promotion is different from the ones that have given the SEC heartburn. Instead of using its own stock, SoFi is giving away shares (or fractional shares) of other companies that it holds in its inventory. It turns out that SoFi isn’t the only online investment platform that gives away stock as a promotion – apparently Robinhood does something similar.
I like fantasy football, but I’m not into online trading. I’m also a Cleveland Browns fan, which means that it’s far from a sure thing that my team is going to score a touchdown on any given Sunday. So, I think I’ll take a pass on “fantasy stockball” and stick to my fantasy football league, where my team – “Myles Garrett’s Helmet Helpers” – is off to a 3-0 start. And yes, this entire blog was just an excuse to tell you that.
Public companies took a lot of heat for taking PPP funds, but despite some well-publicized decisions to return the funds, this Bryan Cave blog says that the vast majority of public company borrowers decided to keep the money:
Based on a review of SEC filings, Bryan Cave Leighton Paisner identified over 850 borrowers who indicated that they had received PPP loan approvals. 107 of these borrowers, or roughly 12 percent, subsequently indicated that they either ultimately did not accept the loan, or returned the loan proceeds. About 25% of public companies who returned their loans had PPP borrowings that were less than the $2 million threshold for review indicated above.
Of the 759 public companies that elected not to return their PPP funds, approximately 73% received $2 million or less, while the remaining 27% had PPP loans of more than $2 million. About 8% of the public company recipients received less than $100,000, while over 55% received less than $1 million.
By our calculations, about 200 public companies with PPP loans in excess of $2 million elected to retain their PPP loans. About 60% of these loans were for between $2 and $5 million, 36% were for between $5 and $10 million, and 4% were for in excess of $10 million.
While public companies taking out PPP loans were sometimes unfairly criticized, other large borrowers took some heat as well. Stlll, the blog says that despite all the sound & fury, over 75% of PPP borrowers approved for a PPP loan in excess of $5 million decided to keep the money.
Supply Chain Finance: The Accounting Backstory
When I first saw the references to “supply chain financing” in Corp Fin’s Covid-19 guidance, I wasn’t really sure what the big deal was. I’m guessing that some others were also a little surprised to see how prominently supply chain financing featured in that guidance – and in recent Staff comment letters.
If you’re wondering where this all came from, check out this Jim Hamilton blog, which discusses the history of Staff concerns about accounting and disclosure issues surrounding supply chain financing, and says they can be traced all the way back to 2003. The basic issue is the appropriate classification of the obligation that arises when a purchaser gets financing from a lender to pay its vendors. The trouble is, as the Big 4 pointed out in a 2019 letter to FASB, U.S. GAAP currently offers little guidance on the question of how to account for these arrangements.
The blog reviews the accounting issues involved and the comment letters that the SEC has issued addressing supply chain financing disclosure. This excerpt summarizes the results of that comment letter review:
SEC staff have engaged in some comment letter dialogs with companies regarding supply chain financing. The theme of these dialogs is that SEC staff saw something unusual in the company’s filings, the company replies that the supply chain issue is nonmaterial, and the SEC accepts the companies’ promises of additional disclosure in future filings.
As Liz noted in her recent blog on this topic, the Staff’s interest pre-dates the pandemic, because it began issuing comments on supply chain financing in mid-2019. Perhaps it’s not a coincidence that the Big 4 reached out to FASB looking for guidance on the topic at around the same time.
Restatements: Common Reasons for “Big Rs” & “Little Rs”
Everybody makes mistakes, but when the accountants do, it’s terrifying. This Audit Analytics blog takes a look at how companies opted to correct errors in financial statements during 2019, and identifies the leading causes of “Big R” restatements and “Little R” out-of-period adjustments.
The five most common issues cited in Big R restatements in 2019 were revenue recognition (16.7%), cash flow statement classification errors (16.1%), securities – debt, quasi-debt, warrants & equity (15.3%), taxes (13.0%) and liabilities (12.2%). By way of comparison, the five most common issues cited in Little R restatements in 2019 were taxes (22.3%), revenue recognition (16.3%), expense recording (9.9%), inventory (9.9%), and value/diminution of PPE intangibles or fixed assets (7.4%)
Everyone involved in the SEC reporting process breathes a sigh of relief when it is determined that a particular error can be corrected through an out-of-period adjustment, because that means the prior period financial statements don’t have to be restated. (Okay, the fact that the CFO’s probably not going to prison either also may help explain the sighs of relief.)
But the blog points out that irrespective of their scale, restatements and out-of-period adjustments negatively impact the financial reporting of a company – and that even immaterial errors may predict future material weaknesses and errors in financial statements.
Last December, Corp Fin issued CF Disclosure Guidance Topic No. 7, which addresses the procedures for submitting a “traditional” confidential treatment request (i.e., one that doesn’t take advantage of the streamlined procedures for redacting confidential information in exhibits that were put into place last year). Yesterday, Corp Fin updated that guidance to address alternatives for handling expiring confidential treatment requests.
In essence, the updated guidance gives a company with an expiring CTR three alternatives: it may refile the unredacted exhibit, extend the confidential period pursuant to Rules 406 or 24b-2, or transition to the rules governing the filing of redacted exhibits under Regulation S-K Item 601. The guidance walks companies through the procedural steps involved with each of these alternatives.
Enforcement: SEC Brings Action for Failing to Deliver Final Prospectus
Here’s something you don’t see every day – last week, the SEC brought settled enforcement actions against an issuer and an underwriter for failing to deliver final prospectuses in connection with various shelf takedowns. Here’s an excerpt from the SEC’s press release announcing the proceedings:
The SEC’s orders find that NFS and FuelCell violated the prospectus delivery provisions of Section 5(b) of the Securities Act of 1933. The order charging NFS finds that it violated the underwriter prospectus delivery provisions of Securities Act Rule 173, and failed reasonably to supervise the traders that sold the FuelCell securities within the meaning of Section 15(b)(4)(E) of the Securities Exchange Act of 1934 and Section 203(e)(6) of the Investment Advisers Act of 1940.
Without admitting or denying the SEC’s findings, NFS and FuelCell have agreed to cease and desist from committing or causing any future violations of the charged provisions. In addition, NFS has agreed to be censured and has agreed to disgorge $797,905 in commissions, pay prejudgment interest of $163,288, and pay a penalty of $1,500,000. The SEC’s order against FuelCell recognized the company’s cooperation and self-report, both of which the SEC considered in determining not to impose a penalty against the company.
The genesis of the problem appears to have been the company’s failure to file 424(b) prospectuses in connection with its ATM offerings. That in turn led to violations of Section 5 by both the company and its underwriter. Their misfortune is our gain, however, because the SEC’s orders are a primer on the prospectus delivery requirement and the interplay between the statute and the rules governing the filing and delivery of the final prospectus.
I know from my own experience and from our Q&A Forum that there’s not a lot out there that ties all of these requirements together – and these orders do. Here’s the NFS order and here’s the FuelCell order.
By the way, I missed this enforcement action when it was first announced, but fortunately Ann Lipton flagged a Bloomberg Law article on it on her Twitter feed. If you practice corporate or securities law and you don’t follow Ann on social media, you’re making a big mistake. As my cousins from Maine would say, she’s “wicked smaht” & she posts all the time. You’ll learn a lot from her.
Wu-Tang Clan: Shkreli Shaolin Saga Coming to Netflix
We haven’t checked in on America’s most entrepreneurial hip-hop artists in some time, but the Wu-Tang Clan is back in the Business section of the paper again. It seems that Netflix is making a movie about the saga of fraudster Martin Shkreli, his $2 million purchase of the group’s “Once Upon a Time in Shaolin” album & his subsequent bizarre & convoluted beef with the Wu-Tang Clan. Here’s an excerpt from this Stereogum.com article:
There were seemingly endless twists and turns in the Shkreli/Wu-Tang saga, many of them diligently chronicled at this very website. Now, as Collider reports, the narrative will become the basis for a movie to be released via Netflix, also titled Once Upon A Time In Shaolin. Paul Downs Colaizzo (Brittany Runs A Marathon) will direct the film based on a script by Ian Edelman (How To Make It In America). Wu-Tang ringleader and longtime filmmaker RZA is producing the movie in cooperation with Brad Pitt’s production company Plan B. The story reportedly follows the auction for the album and its messy aftermath.
Speaking of RZA, here’s an interview with him in which he discusses the concept behind the Shaolin album, as well as his regrets about how it ended up in the hands of an “evil villain.” Check out our “Wu-Tang Clan” Practice Area for more Wu-Tang news.
In the corporate governance debate, there’s perhaps no more pejorative term than “short-termism.” But this “Institutional Investor” article cites a recent study that says short-term investors may not be so bad after all:
Short-term investors are widely seen as bad for the companies they invest in, because they are likely to focus on immediate changes in stock value — potentially at the expense of the company’s long-term profitability. But new research suggests that there may be times when a short-term focus can actually help companies perform better over the long run. The study, expected to be published in the scholarly journal Management Science, found that companies with more short-horizon investors — who trade stocks regularly — adapted more quickly when their competitive environments changed “radically.”
“Under these circumstances, firms and economies with disproportionately more short-term investors may appear more dynamic and avoid stagnation, indicating that short-horizon investors perform an important function in the economy,” wrote authors Mariassunta Giannetti (Stockholm School of Economics) and Xiaoyun Yu (Indiana University).
To put this a little more bluntly than the authors do, the study suggests that those who believe that short-term investors light a fire under corporate management may well have a point.
Public Offerings: ATMs Thrive in Pandemic
“At-the-market” offerings provide companies with flexibility to access the capital markets quickly, and that can be a very attractive option during times of volatility. Bloomberg Law recently published an analysis of second quarter ATM offerings, and the results indicate that this particular alternative to a traditional public offering has been very popular during the Covid-19 pandemic:
At-the-market (ATM) offerings surged in the second quarter of 2020, driven by a need for cheap capital and encouraged by continued investor buying during the pandemic downturn. The value of ATM deals far outpaced any other quarter since Q2 2009. Already through Aug. 10, ATM offerings have raised nearly $33 billion on 251 deals valued at least $1 million, exceeding 2019’s entire haul by $5.5 billion on 15 fewer deals.
According to Bloomberg Law, 108 at-the-market deals raising $14.2 billion were completed during the second quarter alone. That outpaced the first quarter of 2020, which saw 80 deals come to market and raise $9.1 billion. But you don’t have the full picture about just how hot ATM deals are until you realize that the number of deals and the amount raised during the first quarter of 2020 outstripped those metrics for every previous quarter during the past decade – and that the current quarter is on pace to surpass the second quarter.
Shelf Registrations & Takedowns: A Quick Reference
If you’ve read my blogs for any amount of time, you already know I’m a sucker for quick reference materials that I can pull out of a real or virtual desk drawer, glance at for 5 minutes, and then successfully fake my way through a conference call on the topic. This Mayer Brown memo on shelf registration statements & takedowns is the latest addition to my desk drawer.
The memo is only 10 pages long, but it provides a readable & comprehensive overview of topics that include eligibility issues, the types of transactions for which a shelf registration statement may be used, the benefits of WKSI status and liability considerations. Check it out!
We’ve been keeping an eye on pandemic risk factors since the “Before Time” (seriously, we first mentioned them in January). Most recently, we blogged about how to handle 1st quarter Covid-19 risk factor disclosure in 2nd quarter filings. Now, this Bass Berry blog takes a look at what kind of pandemic risk factor disclosures companies actually made in their second quarter filings. The blog says that 97% of the 75 Nasdaq & NYSE company filings surveyed included Covid-19 related risk factors. This excerpt provides some insight into the content of those disclosures:
During our review, we noted that updates to the COVID-19 risk factor disclosure included in second quarter Form 10-Qs generally coalesced around certain topics such as uncertainty regarding the duration of the COVID-19 pandemic, impact of the economic downturn, and changes in consumer behaviors both during and potentially after the pandemic.
In addition, some common themes arose in certain industries such as healthcare, with updated disclosures regarding the uncertainty around vaccine efficacy and deployment, and travel and energy, with updated disclosure highlighting potential risks resulting from prolonged social distancing and stay-at-home orders. Such emerging themes reveal that COVID-19 may be having a similar impact on peer companies and, as a result, an ongoing review of peer company risk factor disclosures should be undertaken.
These disclosures don’t appear to be static – according to the blog, approximately 2/3rds of the companies surveyed updated Covid-19 risk factor disclosure from their 1st quarter Form 10-Q disclosure. As for the 3% of companies that didn’t include a specific risk factor, all included language to the effect that the pandemic could exacerbate or heighten the risk factors that were previously disclosed in their Form 10-K.
Non-GAAP: EBITDAC Revisited
During the 1st quarter reporting cycle, some companies that were hit hard by the initial phase of the pandemic attempted to quantify its effect on their operations and present non-GAAP financial data that backed out Covid-19’s impact. As Liz blogged a couple of months ago, early returns from the 2nd quarter suggested that this practice was growing in popularity. According to this Brian Cave blog, more recent information on 2nd quarter reporting suggests that companies are shying away from “EBITDAC” disclosure, but that some are getting to the same place in a more stealthy fashion:
While few companies used the EBITDAC label as noted above, some appeared to be using the concept without the label. For example, some adjusted their adjusted EBITDA for COVID-19 expenses or presented gross margin without COVID-19 impacts. Such COVID-19 adjustments may be more likely to draw SEC scrutiny during ordinary periodic filing reviews, especially when viewed in hindsight. The staff has taken the position that “presenting a performance measure that excludes normal, recurring, cash operating expenses necessary to operate a registrant’s business could be misleading.”
The blog reminds companies of the Staff’s position in CF Disclosure Guidance: Topic 9 that it is inappropriate to present non-GAAP financial information “for the sole purpose of presenting a more favorable view of the company” & that management should highlight why it finds the measure useful and how it helps investors assess the pandemic’s impact on the company’s financial position and results of operations.
IPOs: Surfing Legend Joins the Lineup
A company called Laird Superfood recently filed an S-1 for an initial public offering. The company focuses on “highly differentiated plant-based and functional foods,” and currently offers “Superfood Creamer coffee creamers, Hydrate hydration products and beverage enhancing supplements, and roasted and instant coffees, teas and hot chocolate.”
As someone who once ate McDonald’s at The Louvre, you probably wouldn’t tag me as a guy who’d be real interested in “highly differentiated plant-based and functional foods,” and you’d be right. But it turns out that one of the co-founders of the company is Laird Hamilton, who is a surfing legend & somebody I’ve been a huge fan of ever since I saw him in the 2004 big wave surfing film, “Riding Giants.”
Am I a surfer? Gimme a break – I’m a fat old man who lives in Ohio. But I loved this movie for some reason, and Laird Hamilton is clearly its star. Check out this sequence about his spectacular ride on the “heaviest wave ever” at Teahupo’o (“Chopu”) in Tahiti.
Yesterday, the SEC scheduled an open meeting for August 26th. The meeting’s agenda features a couple of big potential rule amendments. This excerpt from the meeting’s Sunshine Act notice says that the first agenda item is:
Whether to adopt amendments to modernize the description of business, legal proceedings, and risk factor disclosures that registrants are required to make pursuant to Regulation S-K. These disclosure items, which have not undergone significant revisions in over 30 years, would be updated to account for developments since the rules’ adoption or last revision, to improve disclosure for investors, and to simplify compliance for registrants. Specifically, the amendments are intended to improve the readability of disclosure documents, as well as discourage repetition and the disclosure of information that is not material.
There have been so many S-K-related proposals floating around that it’s sometimes hard to keep track, but this one relates to potential changes to Item 101, 103 & 105 that were proposed almost exactly a year ago. It’s worth noting that this is the proposal that raised the idea of requiring some kind of “human capital” disclosures – and it will be interesting to see what any final rule has to say about that topic.
SEC Open Meeting: “Accredited Investor” & “QIB” Definitions Also Up to Bat
The second item on next week’s agenda is also significant – and controversial. The Sunshine Act notice says that the SEC will consider:
whether to adopt amendments to the definition of “accredited investor” in Commission rules and the definition of “qualified institutional buyer” in Rule 144A under the Securities Act to update and improve the definition to identify more effectively investors that have sufficient financial sophistication to participate in certain private investment opportunities. The amendments are the product of years of efforts by the Commission and its staff to consider and analyze possible approaches to revising the accredited investor definition.
The SEC split 3-2 on the decision to issue these proposals last November, with Commissioner Allison Herron Lee & then-Commissioner Robert Jackson dissenting. As proposed, the amendments to the “accredited investor” definition would expand the number of investors eligible for that status by allowing individuals to qualify based on their professional knowledge, experience or certifications. The proposed amendments also would expand the list of entities that may qualify as accredited investors.
Business Interruption Insurance: Covid-19 Plaintiffs Get a Win
We’ve previously blogged about the challenges facing companies trying to assert claims under business interruption policies for pandemic-related losses, and the early returns from court cases involving these claims weren’t encouraging. One of the biggest challenges that plaintiffs have faced is persuading insurers & courts that their claims involve “physical loss,” which is a necessity under most policies in order to trigger coverage.
However, Alison Frankel blogged about a recent decision by a federal judge in Kansas City involving claims against Cincinnati Insurance that gives plaintiffs some reason for hope – and may even provide a roadmap for these claims. Here’s an excerpt:
The Kansas City plaintiffs, unlike plaintiffs in some of the previous cases, argued that the coronavirus – as a widespread, airborne virus that was rampant in the community – had likely infected their properties. It was the presence of the virus, they argued, that had rendered their businesses unsafe and unusable, forcing the shutdowns that triggered their insurance coverage.
Cincinnati, represented by Litchfield Cavo and Wallace Saunders, argued that COVID-19 did not trigger business interruption insurance coverage because it did not cause tangible, physical damage like a fire or hurricane. The coronavirus, Cincinnati argued, can be cleaned from surfaces or will otherwise die naturally within days, leaving no physical trace. Moreover, the insurer argued, the salons and restaurants hadn’t even shown the virus was actually present within their properties.
Judge Bough, however, said that under the ordinary meaning of “physical loss,” the policyholders suffered a loss when the spread of coronavirus led to prohibitions or restrictions on their businesses.
In the Judge’s view, although the coronavirus may not have caused physical damage, the insurer’s business interruption policy also covered physical loss – and a business may suffer physical loss if its premises are rendered unusable. Here’s what Alison says is the key takeaway for potential plaintiffs:
Argue that your business was likely contaminated by the coronavirus as it spread across the country through unseen droplets – and that the presence of the virus led to a physical loss, even if the particles did not cause lasting physical damage.
If you’re an investment grade issuer & want to lower your cost of capital the next time you go to market, this Politico article says you’d be well advised to use the money to fund ESG related projects, as Alphabet and Visa have recently done. This excerpt says there’s simply not enough ESG product to meet market demand:
This is a big year for investment-grade corporate debt — fueled in part by actions the Federal Reserve took in March allowing large companies to borrow more cheaply from private lenders. But the vast majority is not aligned with environmental, social and governance principles, said Jonny Fine, head of Investment Grade Syndicate at Goldman Sachs who played an integral role in the Alphabet deal. “The proportion of ESG this year is no different. It’s a very small part of our market overall,” Fine said. “The only difference we’re seeing in 2020, because we’ve had health care crises and racial divisions across the U.S., is the S in ESG has become much more important.”
So far this year, companies have issued nearly $1.5 trillion in new investment-grade debt. Less than 2 percent of that adheres to ESG standards. This reflects a problem in financial markets, Fine added. Right now, there aren’t enough ESG assets to satisfy demand from investors, who clamored for the bonds issued by Alphabet and Visa. Companies need to develop sustainability frameworks so they don’t miss out on the wave of cheap financing. “There is a very clear cost of capital disadvantage for a company that doesn’t have strong ESG principles,” Fine said.
Granted, Alphabet & Visa are both premium credits, but the pricing on their ESG-related debt was pretty phenomenal. Alphabet issued $5.75 billion at 0.8%, while Visa raised $500 million at 0.75%.
Unicorn IPO Litigation: Hung Up by Happy Talk?
One of my favorite snarky things to do is to make fun of Unicorn IPO filings. I know the poor lawyers involved must pull their hair out over some of the over-the-top statements that the underwriters & business folks insist on including in the prospectus, but a federal court’s decision in Uber’s IPO litigation may give those lawyers more leverage when arguing to tone things down.
This excerpt from a recent Jim Hamilton blog on a California federal judge’s denial of Uber’s motion to dismiss the case explains how the company’s prospectus “happy talk” made the plaintiffs’ claims stickier than they might otherwise have been:
The purchaser alleged that Uber’s registration statement omitted material facts about the legality of Uber’s business model, its passenger safety record, and its financial condition. Uber countered that each of these three categories was adequately disclosed, and the court agreed that the disclosures were well beyond boilerplate. Given the facts alleged, however, the court also concluded that the offering documents created an impression of a state of affairs that was materially different from what actually existed.
Specifically, Uber represented that while it had faced trouble in the past, it was on “a new path forward.” Despite this optimistic impression, the purchaser plausibly alleged that Uber was still using its old “playbook,” continuing, for example to view pay fines for violating local laws as a cost of doing business and intentionally delaying layoffs and restructuring to mislead the markets. Thus, the court said, what was disclosed was not enough to render what was not disclosed not misleading.
Mind you, the court reached this conclusion despite the fact that Uber’s lawyers included a 48-page Risk Factors section addressing many of these issues.
What’s in a Name? Hester Peirce is Okay with “Crypto Mom” Moniker
SEC Commissioner Hester Peirce was just reconfirmed by the Senate – along with new Commissioner Caroline Crenshaw. On the occasion of her reconfirmation, one intrepid tweeter (@BarbarianCap) asked if she was okay with her “Crypto Mom” nickname. In response, she tweeted: “It’s better than a lot of other names I have been called.” Me too, Commissioner, me too.
The Center for Audit Quality recently issued a report on Covid-19’s potential implications for this year’s audit. While we’ve touched on things like going concern issues in prior blogs, one of the matters discussed in the report that I haven’t seen before is how the pandemic may influence the determination of “Critical Audit Matters,” or CAMs. Here’s what the report has to say on this topic:
While COVID-19 in and of itself, or going concern uncertainty, would not necessarily meet the definition of a CAM, the pandemic could increase the subjectivity and complexity of a specific audit area such that it meets the definition of a CAM, when it otherwise may not have prior to the pandemic. In addition, for audits of large-accelerated filers, COVID-19 also could result in CAMs that were previously identified and communicated in the auditor’s report being expanded to include new assumptions that were especially challenging or complex due to the pandemic and/or result in changes to the auditor’s response to a previously identified CAM.
Until now, the requirement to disclose CAMs in an auditor’s report has been limited to large accelerated filers, but all issuers will have to comply with it for audits covering fiscal years completed on or after December 15, 2020 – so this is one that needs to be on everybody’s radar screen.
Critical Audit Matters: Due Diligence Questions
While we’re on the subject of CAMs, this recent Mayer Brown blog notes that because CAMs provide information about audit matters that required complicated auditor judgments & how the auditor responded to those matters, they are particularly helpful for people who are conducting due diligence. If you’re looking for something to get you started, they’ve also provided this template for due diligence questions regarding CAMs.
Audit Committees: PCAOB’s Conversations With Committee Chairs
Earlier this month, the PCAOB issued a report on its conversations with audit committee chairs about how audit committees are thinking about the effect of COVID-19 on financial reporting and the audit as they perform their oversight duties. This excerpt from a recent Wilmer Hale memo provides an overview of the results of those discussions:
Increased risks associated with remote work. The most common theme among audit committee chairs that recently met with the PCAOB dealt with risks regarding remote work arrangements, with most audit committee chairs describing the rapid shift to remote work arrangements as “effective.” This was equally applicable to the company’s employees and outside auditors.
Given the greater reliance on cloud computing in remote work environments, a number of audit committee chairs noted that they have been discussing cyber-related controls within the scope of the audit and increasing the focus on the controls’ effectiveness. Based on insights shared from audit committee chairs, the Summary includes a list of example questions that audit committees may want to discuss with their auditors regarding risks related to remote work arrangements.
Increased audit committee communications with the auditor. The Summary notes that a majority of audit committee chairs cited COVID-19 as a basis for more frequent communication between auditors and audit committees. Among the topics audit committees may want to discuss with auditors, in light of COVID-19, the Summary lists a handful of considerations, including challenges to completion of the audit, the cadence of communication with auditors and management, changes in the audit plan and potential disclosure changes resulting from COVID-19.
The memo says that audit committee chairs reported three forms of auditor communication that they have found useful: discussions about trends auditors are seeing, particularly those pertaining to industry peers; presentations about audit areas that may require greater attention due to the pandemic, and audit firm resources and webinars with industry-specific content.
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