The SEC’s settlement with United Continental on Friday shows that it’s a very short trip from a violation of corporate policy to a books & records violation. The proceeding involved United’s decision to re-institute a non-profitable route from Newark Airport in order to benefit the former chair of the Port Authority.
The reinstitution of the route departed from United’s normal procedures and the requirements of its corporate ethics policy. The SEC’s order lays out its view of the legal implications of those departures:
Contrary to United’s Policies, the required written authorization of the Director – Ethics and Compliance Program or of the Board of Directors was not requested or obtained before initiating the South Carolina Route, and, thus, required records were not created or maintained. United thereby violated Section 13(b)(2)(A) of the Exchange Act. United also violated Section 13(b)(2)(B) by failing to devise and maintain a system of internal accounting controls that was sufficient to provide reasonable assurances that assets are used, and transactions are executed, only in accordance with management’s general or specific authorization, including in a manner consistent with United’s Policies.
This Steve Quinlivan blog has more details – & suggests that this proceeding marks the arrival of the “Domestic Corrupt Practices Act.”
“Dela-fornia” Corporations, Part II: Abstentions Won’t Protect A Director
I recently blogged about Keith Bishop’s discussion of the wide-ranging applicability of California’s corporate statute to foreign corporations. Keith recently blogged again on this topic – this time, he focused on Section 316 of the statute, which addresses director liability for unlawful loans & distributions. Here’s an excerpt:
Given the potential for personal liability, some directors, deciding that discretion is the better part of valor, may simply abstain in any vote to approve these actions. However, abstaining is neither valorous nor efficacious. Section 316(b) deems that a director who abstains from voting will be considered to have approved the action if he or she was present at the board or committee meeting at which any of the above actions was taken. To avoid the risk of liability under Section 316(a), a director must either not show up or vote against these actions.
Does this requirement apply to foreign corporations? For the most part, the answer is yes.
“Boardroom War Z”: CII & Canada Take Aim at “Zombie Directors”
As Broc blogged recently on the “Proxy Season Blog,” the Council of Institutional Investors & the Canadian Government have targeted “zombie directors” – directors who failed to achieve a majority vote, yet remain in office. Cooley’s Cydney Posner highlights the CII’s zombie director initiative at Russell 3000 companies, while this FinancialPost article describes proposed legislation that would mandate majority voting for directors of Canadian public companies.
In a press release describing its efforts to have the undead removed from boardrooms, the CII points out that directors who don’t receive majority shareholder support only rarely leave the board:
From 2013 to Oct. 26 2016, uncontested directors in the Russell 3000 did not win majority support 164 times at 104 companies. Total rejections amounted to 195, as 22 directors failed to obtain majority support more than once. Strikingly, out of these 195 rejections, only 36 directors stepped down from their boards as of Oct. 26, 2016. This represents a turnover rate of 18 percent.
Yesterday, the SEC announced that Chair Mary Jo White will leave her position when President Obama leaves office on Inauguration Day. Last week, Broc blogged that Mike Piwowar will almost certainly become interim Chair since he’s the sole sitting GOP Commissioner. Former Commissioner Paul Atkins is heading the financial regulatory transition team for the incoming Administration – and speculation about White’s possible successor has already begun…
Brexit: UK Parliament Must Okay EU Withdrawal
These memos in our “Europe” Practice Area address the recent UK High Court decision to require the UK government to seek approval of British Parliament before notifying the EU of its intention to withdraw. A few weeks ago, the High Court held that the government did not have the constitutional authority to notify the European Council of the UK’s decision to leave the EU without the prior approval of Parliament. The UK government has announced that it intends to appeal the judgment to the UK Supreme Court. That appeal will be heard in December, with a ruling expected in January…
Brexit: Topics for Audit Committees & Management
This Grant Thornton memo gives some advice to audit committees about the topics that they should discuss with management as a result of Brexit. These include:
– Does management have a strategic plan to manage risks and lessen negative effects? Has the organization done a thorough Brexit risk assessment? What hedging strategies are in place for foreign exchange exposure and how does Brexit affect those strategies? To what extent is the company exposed to debt denominated in pounds sterling?
– How will Brexit affect the carrying value of assets or business units exposed to the UK or EU?
– Will the company see significant translation gains and losses in terms of functional currency? Are foreign subsidiaries using the right functional currency?
– How will Brexit affect historical guidance? How will Brexit affect customers and suppliers and the company’s interactions with them? How will this affect existing guidance?
– What are the implications for communications? How and what does the company plan to communicate to stakeholders about the effect of Brexit – including investors, customers, vendors and employees?
– How will Brexit affect the company’s financial statements? For entities that have significant exposure, what should they expect to see in the June 30 quarter, and what might they see going forward?
The audit committee & management should also discuss what kind of additional regulatory compliance and reporting burdens might result from Brexit, as well as whether there are potential benefits – such as lower borrowing costs resulting from a delay in Fed interest rate increases.
This blog from Steve Quinlivan notes a recent settled SEC enforcement proceeding against PowerSecure International involving allegedly inadequate segment reporting. Here’s an excerpt:
According to the SEC, PowerSecure’s Form 10-K for the year ended December 31, 2015, outlined errors in prior period disclosures and revised its segment reporting disclosure to reflect information for the years ended 2012 to 2014 on a basis consistent with its 2015 reportable segments. In its 2015 filing, PowerSecure also concluded that its disclosure controls and procedures for that three year period were not effective due to a material weakness in its internal control over financial reporting that it identified in 2015 related to its misapplication of GAAP related to segment reporting.
Segment reporting has long been an area of intensive focus by Corp Fin. Determining the appropriate reportable segments is often a complex process involving a lot of judgment – & this means that staff comments often create some anxiety for a company’s accounting personnel.
In my own experience, I’ve seen a number of clients receive multiple, highly detailed comments probing how they determined their reportable segments. Responding to these comments often results in several rounds of follow-up comments – & has occasionally culminated in a Staff request for a conference call involving several Staff accountants & senior company officials. Those calls are fun. . .
This is another area where a regular review of peer company comments & responses can be a very valuable exercise. Comment letters often provide an early warning of the Staff’s interest in segment reporting practices within a particular industry & allow companies to see how their peers have responded to challenges to their own decisions about reportable segments.
For many years, I have been raising the possibility of climate change-related corporate and securities litigation. However, despite my best prognostication, the climate change-related corporate and securities lawsuits have basically failed to materialize – that is, until now. On November 7, 2016, investors filed a purported securities class action lawsuit in the Northern District of Texas against Exxon Mobil Corporation and certain of its directors and officers.
The lawsuit specifically references the company’s climate change-related disclosures, as well as the company’s valuation of its existing oil and gas reserves. One lawsuit doesn’t make a trend, and many of the lawsuit’s allegations relates specifically to Exxon Mobil and its particular disclosures. Nevertheless, the filing of the lawsuit raises the question whether there may be other climate change-related disclosure cases ahead.
Securities Class Actions: Are We Headed into a Perfect Storm?
Here’s an excerpt from this blog by Lane Powell’s Doug Greene:
Although I don’t know if we’re about to enter a period of quirky cases, like stock options backdating, I’m confident that we’re going to experience a storm of securities class actions caused by a convergence of factors: an increasing number of SEC whistleblower tips, a drumbeat for more aggressive securities regulation, a stock market poised for a drop, and an expanded group of plaintiffs’ firms that initiate securities class actions.
The first Schedule 14N! Back in July, Broc ran a poll asking when we’d see the first proxy access nominee – only 11% of responders thought it would happen this year. The other 89% were wrong – including the 24% who said ‘never’! Here’s the intro from this Gibson Dunn blog:
In what appears to be the first use of a company’s proxy access bylaw, GAMCO Asset Management filed today a Schedule 13D/A and a Schedule 14N announcing that it has used the proxy access bylaw at National Fuel Gas (NFG) to nominate a director candidate for election at NFG’s 2017 Annual Meeting. According to the 13D/A, GAMCO and its affiliates beneficially own in the aggregate approximately 7.81% of NFG’s Common Stock and yesterday delivered a letter to NFG nominating Lance A. Bakrow to the Board of Directors.
NFG amended its bylaws in March 2016 to include a proxy access bylaw & its terms are pretty typical:
The Bylaws provide that a shareholder, or a group of up to 20 shareholders, owning 3% or more of the Company’s outstanding Common Stock continuously for at least three years may nominate and include in the company’s proxy materials directors constituting up to 20% of the board, provided that the shareholders(s) and the nominee(s) satisfy the bylaw requirements. Here is NFG’s proxy access bylaw.
In this blog, Davis Polk’s Ning Chiu also lays out the circumstances…
Delaware Says “No” to Director’s Books & Records Request
Every now & again there’s a case that isn’t likely to have a big practical impact, but is worth noting just because it exists – and the Delaware Chancery Court’s recent decision in Bizarri v. Suburban Waste Services is that kind of case. Most corporate lawyers believe that directors have a virtually unlimited right to access books & records. As this blog from Francis Pileggi notes, it turns out that there are some limits after all:
This opinion provides a rare instance in which the court denies a director unfettered access to the books and records of a corporation on whose board he serves, but this case also involves somewhat extreme facts which are not often replicated.
The court found during trial that the director and stockholder, who was also a member and manager of an affiliated LLC, engaged in efforts to compete with and inflict reputational harm on the entities. The plaintiff’s actions in that regard were “driven by his intense hatred of the entities’ other two owners and principals.” Together with the familial relationship of the plaintiff with one of the entities’ main competitors, it makes the “prospect of the plaintiff misusing the books and records both real and troubling.”
There’s a strong presumption in Delaware that a director is entitled to “unfettered access” to books & records – and it’s up to the company to demonstrate an improper purpose. This is one of the rare cases where the company was able to meet that burden.
CEO Succession: Boards Pass Over Corporate “Fredos”
This Stanford study concludes that boards are pretty good about identifying which potential CEO candidates should be “passed over” – like Fredo in The Godfather:
Our data modestly suggests that corporate boards do a reasonable job of identifying CEO talent. Fewer than 30% of the executives passed over among large corporations are recruited by other firms as CEO. Most (over 70%) are not.
If an executive who is passed over has valuable skills that make him or her a viable CEO candidate, it is likely that another corporation would identify and hire that individual. Furthermore, candidates who are recruited to new firms after being passed over appear to perform worse (relative to benchmarks) than those who were selected at the original company.
I guess Fredo also is a good example of the potential dangers of a disgruntled senior executive.
This DLA Piper memo discusses the early returns from the DOJ’s pilot program to encourage FCPA self-reporting and cooperation, and identifies a new enforcement approach – “declinations with disgorgement.” Consistent with the previously disclosed terms of the program, companies avoiding prosecution have agreed to disgorge all profit realized from their violations. Two recent cases in which the DOJ has elected not to pursue FCPA prosecutions also had several other features in common:
In each instance the DOJ cited the fact that the company self-disclosed. But of seeming equal importance were the robustness of the companies’ internal investigations and the sweeping remediation undertaken. Rounding out the reasons for DOJ’s decision to bring no charges were the agreement to disgorge all profits, which each company agreed not to use for any tax deduction or to accept reimbursement from insurance or any other source, and the obligation to continue to fully cooperate.
The obligation to continue full cooperation includes providing “all known relevant facts about the individuals involved in or responsible for the misconduct,” who are expressly carved out of the declination and could still face prosecution.
SEC: Fix Compliance Program Fast to Avoid FCPA Monitor
This BakerHostetler memo shares some important advice from Kara Brockmeyer, Chief of the SEC’s FCPA Unit:
For a company that violated the FCPA, but wishes to avoid a monitor, the company should be making immediate improvements to its compliance program to prevent future violations so that at the end of the investigation it will be able to demonstrate a track record of having an effective program that is working to prevent violations.
Even a state of the art compliance program will not be effective in convincing the SEC not to impose a monitor if the program has been in place only two months. As Brockmeyer noted, “the late to the party company [in implementing effective compliance measures] is much more likely to get a monitor imposed.”
This November-December issue of the Deal Lawyers print newsletter was just posted – & also sent to the printers – and includes articles on:
– Disclaimers & Limits on Claims Outside of the Contract
– Due Diligence: Patient Protection & Affordable Care Act Considerations
– FCC Licenses: The Forgotten Stepchildren of M&A
– Reverse Break-Up Fees: Move Along, Nothing to See Here
– The Takeaways: Two Chancery Decisions on Informed, Uncoerced Stockholder Approval
Remember that – as a “thank you” to those that subscribe to both DealLawyers.com & our Deal Lawyers print newsletter – we are making all issues of the Deal Lawyers print newsletter available online. There is a big blue tab called “Back Issues” near the top of DealLawyers.com – 2nd from the end of the row of tabs. This tab leads to all of our issues, including the most recent one.
And a bonus is that even if only one person in your firm is a subscriber to the Deal Lawyers print newsletter, anyone who has access to DealLawyers.com will be able to gain access to the Deal Lawyers print newsletter. For example, if your firm has a firmwide license to DealLawyers.com – and only one person subscribes to the print newsletter – everybody in your firm will be able to access the online issues of the print newsletter. That is real value. Here are FAQs about the Deal Lawyers print newsletter including how to access the issues online.
In this edition of “Strange But True Corporate Stories,” we present Hexagon – a Swedish company that held its quarterly earnings call last week. The company had good news to report – sales & earnings were both up. Was there any bad news? No, nothing really. . . well . . .maybe there’s this one tiny issue that wasn’t worth mentioning during the call:
Swedish measurement technology firm Hexagon has defended the time it took to announce the arrest of its chief executive for alleged insider trading after it came to light he was under arrest during last week’s earnings call with analysts.
After being detained in Sweden on Oct. 26, Ola Rollen was allowed by the Swedish Economic Crime Authority to present Hexagon’s third-quarter results in a conference call on Oct. 28, the agency told Reuters on Tuesday, adding two of its police officers were with Rollen during the call. Analysts on the call were not told Rollen had been arrested or that police were in the room.
The company finally announced – three days after the conference call – that authorities had accused its CEO of insider trading in connection with an investment in a Norwegian company.
My favorite part of this story is the idea of two police officers sitting with the CEO while he was on the conference call. I’m sorry, but I can’t get the picture of Joe Friday & Bill Gannon out of my head.
Board Survey: Positive Trends on Cybersecurity
According to this BDO survey, boards are becoming more engaged on cybersecurity issues, investments to defend against cyber-attacks are increasing, and more companies are putting cyber-breach response plans in place.
Approximately three-quarters (74%) of public company directors report that their board is more involved with cybersecurity than it was 12 months ago and 80% say they have increased company investments during the past year to defend against cyber-attacks, with an average budget expansion of 22 percent. This is the third consecutive year that board members have reported increases in time and dollars spent on cybersecurity. The survey also identified improvements in the number of boards with cyber-breach response plans in place (from 45% to 63%).
That’s the good news. The bad news is that only 27% of companies surveyed are sharing information about cyber-attacks with entities outside of their business – a practice that needs to become more prevalent for the safety of critical infrastructure and national security, particularly at larger organizations.
“You’re Fired!”: Board Governance & CEO Turnover
This Stanford study starts with the proposition that one measure of good governance is a board’s willingness to terminate an underperforming CEO, & then looks into what governance characteristics result in stricter board oversight of the CEO. The study concludes that companies are likely to terminate an underperforming CEO, and identifies the following governance factors associated with stricter CEO monitoring:
– Independent/outside directors
– Experienced/engaged directors
– Significant institutional ownership
– Companies with access to replacement candidates
The study also suggests that “busy boards” – those where a majority of the directors serve on three or more boards – provide worse CEO oversight & are less likely to fire an underperforming CEO.
Yesterday, ISS announced the latest release of its governance ratings product – which also was renamed to “QualityScore” from “QuickScore.” Here’s the 139-page technical document. In addition to board diversity and board refreshment areas being added, one area that appears to have been updated involves proxy access – with subscribers now being able to view the details of a company’s proxy access bylaw provision.
Last year, ISS included a question on proxy access, but that was “zero weighted” & was included for informational purposes only. This year, it counts. The QualityScore will give credit to a company for having proxy access – but the existence of any “problematic provisions”- e.g. counting mutual funds under common management as separate shareholders under the aggregation limit, requiring a pledge to hold shares past the annual meeting date, providing the board with broad & binding authority to interpret the proxy access provision or combinations of other problematic provisions – could be deemed sufficient to “nullify the proxy access right” & result in no credit being given. See this Gibson Dunn blog for a larger summary of the changes.
As noted in this blog from Davis Polk’s Ning Chiu, the data verification period began yesterday – and runs through November 11th. QualityScores will be published on November 21st.
By the way, with this rebranding to “ISS QualityScore,” it now has made more name changes than Jefferson Airplane. My favorite was GRid 2.0…although CGQ was nice…
“Hulk-O-Mania” Redux: New Questions on 3rd Party Litigation Funding
If you follow high-brow websites like TMZ and “The Hollywood Reporter” as religiously as I do, you’re no doubt up-to-speed on the controversy surrounding billionaire Peter Thiel’s funding of Hulk Hogan’s recent invasion of privacy suit against Gawker Media. The Hulkster rang the bell to the tune of $140 million in that lawsuit, but Thiel’s role in the case has focused new attention on third-party litigation funding – and that attention hasn’t been limited to the media.
As this D&O Diary blog points out, a pair of recent court decisions in Pennsylvania & Delaware have raised new questions about the legal issues that have long surrounded litigation funding arrangements:
One of the most interesting and important recent litigation-related developments has been the rise of third-party litigation funding. An important part of this development has been the more or less general view that there is nothing improper about these kinds of arrangements and, in particular, that litigation funding does not represent improper champerty or maintenance, as long as the actual plaintiff continues to control the case.
However, a recent decision from a Pennsylvania appellate court suggests that the somewhat unusual litigation funding arrangement involved in an attorney fee dispute was “champertous” and therefore invalid. This decision and another recent decision from Delaware nullified the specific funding arrangements presented to the courts in those cases; the question is what these decisions may say about litigation funding in general.
Some of the broad-brush language employed by the courts in these two cases might cause concern to litigation funders. However, each of these cases involved highly unusual circumstances – the funding arrangements the courts were asked to review were very different from the straightforward funding structures that litigation funding firms typically employ.
Our November Eminders is Posted!
We have posted the November issue of our complimentary monthly email newsletter. Sign up today to receive it by simply inputting your email address!
The SEC recently announced insider trading charges against a board member (who also happens to be a lawyer) who allegedly purchased securities of a target company during a board committee meeting where the deal was being discussed. Here’s an excerpt from the SEC’s press release:
According to the SEC’s complaint, Cope learned confidential details about the planned merger during a board executive committee meeting on Jan. 5, 2016, and proceeded to place his first order to purchase Avenue Financial stock while that executive committee meeting was still in progress. He allegedly placed four more orders within an hour after the meeting ended.
If proven to be true, that’s just. . . wow.
The stock exchanges’ computer surveillance of trades make it so easy to catch insider traders in situations like these that it’s kind of amazing to me that people keep trying. Anyone who has ever done a deal has seen that FINRA inquiry letter that identifies people who engaged in unusual trading around the time of the announcement & asks if anyone on the deal team had any contact with them. These lists are rarely short & they definitely let you know that Big Brother is watching.
The fact that people still roll the dice in this kind of environment reminds me of what Director Joel Coen said about where the title of the Coen Brothers first movie – Blood Simple – came from. He said that the title came from a Dashiell Hammett story: “It’s an expression he used to describe what happens to somebody psychologically once they’ve committed murder. . . They go ‘blood simple’ in the slang sense of ‘simple,’ meaning crazy.”
Poll: Insider Trading in Target Company’s Stock
survey software
John & Broc: Corporate Officer Liability
Broc & I had a lot of fun taping our 5th “news-like” podcast. This 6-minute podcast is about corporate officer liability & the World Series battle of Cubs v. Indians. I highly encourage you to listen to these podcasts when you take a walk, commute to work, etc.
This podcast is also posted as part of our “Big Legal Minds” podcast series. Remember that these podcasts are also available on iTunes or Google Play (use the “My Podcasts” app on your iPhone and search for “Big Legal Minds”; you can subscribe to the feed so that any new podcast automatically downloads…
Yesterday, the SEC proposed amendments to the proxy rules that would require parties in a contested election to use universal proxy cards that would include the names of all director nominees. The proposal would permit shareholders to vote by proxy for their preferred combination of board candidates – as they could do if they attended the meeting & voted in person. Here’s the 243-page proposing release (and see Ning Chiu’s blog).
The proposed rules would:
– Allow shareholders to vote for the nominees of their choice by requiring proxy contestants to provide shareholders with a universal proxy card including the names of both management & dissident nominees.
– Enable parties to include all nominees on their universal proxy cards by changing the definition of a “bona fide nominee” in Rule 14a-4(d).
– Eliminate the Rule 14a-4(d)(4)’s “short slate rule,” since dissidents would no longer need to round out partial slates with management’s nominees.
– Require proxy contestants to notify each other of their respective director candidates by specific dates.
– Require dissidents to solicit shareholders representing at least a majority of the voting power of shares entitled to vote on the election of directors.
– Require proxy contestants to refer shareholders to the other party’s proxy statement for information about that party’s nominees and inform them that it is available for free on the SEC’s website.
– Require dissidents to file their definitive proxy statement with the SECby the later of 25 calendar days prior to the meeting date or five calendar days after the registrant files its definitive proxy statement.
The SEC also proposed amendments to Rule 14a-4(b), which would require proxy cards to include an “against” voting option for director elections when that vote has a legal effect, & also enable shareholders to “abstain” in a director election governed by a majority voting standard.
The ability to provide a “withhold” voting option when an “against” vote has legal effect would be eliminated. In addition, the proposed amendments to Item 21(b) of Schedule 14A would require disclosure about the effect of a “withhold” vote in an election of directors.
SEC Modernizes Rules 147/504 – & Rule 505 of Reg D Goes Poof!
The changes to the Rule 147 safe harbor include amendments updating Rule 147 & adoption of a new Rule 147A:
– Amended Rule 147 will remain a safe harbor under Section 3(a)(11) of the Securities Act, so that issuers may continue to use the rule for offerings relying on current state securities law exemptions.
– New Rule 147A – which is based on the SEC’s general exemptive authority under Section 28 of the Act – will be identical to Rule 147, except that it would not condition the safe harbor on Section 3(a)(11)’s requirement that offers be made only to in-state residents & would permit companies to be organized out-of-state. Sales would continue to be permitted only to in-state residents.
The amendments to Regulation D are intended to facilitate regional offerings. The final rules amend Rule 504 to increase the amount of securities that may be offered and sold from $1 million to $5 million. The rules also apply “bad actor” disqualifications to Rule 504 offerings. In light of the changes to Rule 504, the final rules repeal Rule 505 of Regulation D.
Amended Rule 147 and new Rule 147A will be effective in 150 days; revised Rule 504 will be effective in 60 days; and the repeal of Rule 505 will be effective in 180 days – all timed from publication in the Federal Register.
My Favorite Deal: Take Me Out to the Ballgame
Watching the Indians & Cubs in the World Series brings back a lot of memories – not only of baseball, but of my favorite deal. Most sports fans would give a kidney to spend a couple of months hanging out with – or just around – their favorite teams. I had that chance in 1998, when I was part of the underwriters’ counsel team for the Cleveland Indians’ initial public offering.
Working on that deal is still the most fun I’ve ever had practicing law – and there were plenty of legal challenges as well. The best part of the deal was that we were in the loop on trades, contract extensions, etc. well before everybody else was. You can keep your million dollar stock tips – this is the kind of material non-public information that I want!
Corp Fin took an interest in our deal too – or at least a couple of the reviewers did. On the day the deal priced, we’d asked to go effective at 4:00 pm, but by 4:30, we still hadn’t heard from the reviewer. I called my counterpart at company counsel, and she placed a couple of calls to the Staff to check on the status.
Finally, she called me around 4:45 to let me know that she’d spoken with the SEC, and we were effective. She was laughing when she told me this. When I asked why, she said the reviewers were apologetic for not calling sooner – but they had been distracted arguing about who was the best right hand power hitter in the American League.
The deal was criticized at the time, but investors got a pretty good return when the Dolan family purchased the team less than two years later – the 1998 IPO price was $15.00, and the team sold in early 2000 for more than $22.00 per share. However, there was another investment angle to the IPO – the memorabilia factor. I confess to setting aside some prospectuses for myself – and that turned out to be a pretty good investment too.
This Audit Analytics blog highlights a recent study that suggests PCAOB regulation may be good for an auditor’s business:
In a recent paper titled “Regulatory Oversight and Auditor Market Share,” authors Daniel Aobdia and Nemit Shroff look into the PCAOB’s role in contributing to the perception of an auditor’s assurance value, and whether or not it has an effect on an auditor’s market share. If external stakeholders perceive the PCAOB inspection process to increase the quality of an inspected firm’s audit, then, they hypothesize, the demand for the inspected firm’s audits will increase.
Since all accounting firms that audit US publicly-traded companies are subject to PCAOB oversight, the study looked abroad to measure the effect of regulation on market share. The study concluded that firms with positive PCAOB inspection reports realized bottom-line benefits:
PCAOB-inspected firms do indeed see an increase in market share relative to the firms that are not inspected by the PCAOB. According to the data, the average inspected auditor’s market share increased by 0.4 to 0.9 percentage points, or 3.5% to 6.4%. When looking at only auditors who received substantial negative criticism, however, they found that, true to their hypothesis, the auditors experienced no change in market share.
The study notes that the effect of a favorable PCAOB inspection was particularly significant in countries with higher levels of corruption. Firms with good inspection outcomes saw an increase of 0.5 to 1.4% in high-corruption countries, while those in countries with a lower level of corruption only saw an increase of -0.4 to 0.4.
“Critical Audit Matters” Disclosure: Insurance Policy for Auditors?
As Cooley’s Cydney Posner points out in this blog, accounting firms have not been big fans of the PCAOB’s proposal to make audit reports more informative through disclosure of “critical audit matters” – or “CAMs.” Under the latest version of the proposal, critical audit matters would be defined to include any matter communicated to the audit committee that is material to the financial statements, and involves especially challenging, subjective, or complex auditor judgment.
According to a recent study, auditors may want to rethink their opposition to this proposed disclosure requirement:
It’s somewhat ironic to see the results of the study showing, among other things, that disclosure of CAMs could help protect auditors from legal exposure if a misstatement were subsequently discovered in the CAM area.
The study concluded that the “types of CAMs illustrated by the PCAOB are more likely to prompt a ‘disclaimer effect’ by warning users of the inherent subjectivity and complexity associated with auditing CAM areas. Specifically, we find that CAM disclosures lead to less confidence in the CAM area before a misstatement is revealed and less assessed auditor responsibility after a misstatement is revealed in the CAM area.”
Transcript: “Middle Market Deals – If I Had Only Known”
We have posted the transcript for our recent DealLawyers.com webcast: “Middle Market Deals: If I Had Only Known.”
