In late February, the PCAOB issued its most recent inspection reports on the Big 4 accounting firms, and according to this WSJ article, the results were not great:
Several U.S. accounting giants had greater deficiencies in their audits of public companies’ 2021 financial statements compared to the previous year, according to annual inspection reports released Wednesday by the Public Company Accounting Oversight Board. The regulator, which compiles its findings with a lag, inspected 215 audits conducted by the Big Four accounting firms in the U.S.—Deloitte, Ernst & Young, KPMG and PricewaterhouseCoopers—down from 220 a year earlier. Deloitte, EY and PwC had an average deficiency rate of about 24%, up from roughly 13% a year earlier.
What about KPMG? The article says that KPMG’s deficiency rate was redacted from the PCAOB’s inspection report for some reason, so we don’t have data on that right now.
It seems to me that these latest inspection reports are a relevant data point to consider when contemplating the proposed revised NOCLAR standard discussed in this morning’s first blog. In an environment in which the nation’s top audit firms are evidently struggling with quality control issues & are confronting a growing shortage of accountants, adopting a demanding new auditing standard on noncompliance with laws and regulations may not just be a bad idea, but a potential recipe for disaster.
In a recent decision in In re Lottery.com Securities Litigation, (SDNY 2/24), a federal judge held that corporate statements concerning preliminary results for a completed quarter constituted “forward looking statements” protected under the “bespeaks caution” doctrine. The case arose out of a series of allegedly false and misleading statements by the target of a de-SPAC transaction made before and after completion of the merger.
One of the challenged statements was an October 21, 2021 press release announcing the company’s results for its third fiscal quarter, which ended on September 30, 2021. The plaintiffs alleged that since the results disclosed were for a completed quarter, they should not be regarded as forward looking statements. The Court disagreed:
The 10/21/21 Press Release’s statements regarding Lottery’s preliminary revenue results are nonactionable under the bespeaks-caution doctrine because they, too, are “statements whose truth [could not] be ascertained until some time after the time they [we]re made.” In re Philip Morris, 89 F.4th at 428 (citation omitted). Plaintiffs contend that these statements were “simply not forward-looking” because they “concern[ed] revenue results for Q3 2021, a quarter that had already closed when the statement was made.” Lottery Class Opp. at 13.
Although this line of reasoning has some intuitive appeal, the Court disagrees. When applying the bespeaks-caution doctrine, courts in the Second Circuit generally treat “corporate statements of projections as to corporate earnings” as forward-looking statements, “without regard to whether the last day of the covered earnings period had passed.” Lopez v. Ctpartners Exec. Search Inc., 173 F. Supp. 3d 12, 39 (S.D.N.Y. 2016).
Citing the Lopez case, the Court went on to say that just because a quarter has been completed, that doesn’t mean its results have been finalized, and that insofar as a press release offers a “preliminary” calculation of those results “based on currently available financial and operating information and management’s preliminary analysis of the unaudited financial results for the quarter,” it involves forward-looking statements.
In January, the voluntary compliance period under the SEC’s Filing Fee Modernization Rule began and filers became eligible to voluntarily file fee data in Inline XBRL format. Yesterday, the SEC announced that it had posted “How do I” guidance on preparing iXBRL fee exhibits. If you’re not feeling particularly motivated to click through to the SEC’s website this morning, here’s the guidance in its entirety:
Filers can prepare an Inline XBRL filing fee exhibit (EX-FILING FEES) and submit it to EDGAR for processing with an option to construct structured filing fee information within EDGAR using the Fee Exhibit Preparation Tool (FEPT).
Filers using the FEPT to prepare an Inline XBRL Filing Fee exhibit as part of EDGAR Link Online (ELO) should refer to the EDGAR Filing Fee Interface Courtesy Guide (PDF, 1.2 mb). FEPT includes features such as prompts, explanations, and automated calculations to produce a filing fee exhibit in submission-ready format. Filers using FEPT to construct the EX-FILING FEES in EDGAR generally will receive error and warning messages before they submit both test and live filings.
Filers using XBRL should refer to the EDGAR XBRL Guide (Filing Fee Extract) (PDF, 0.5 mb). Constructing the Filing Fee Exhibit outside of FEPT, however, will provide filers with error and warning messages after they submit both test and live filings.
EDGAR will validate the Inline XBRL fee data submission and generally will issue warnings for any validation failures caused by incorrect or incomplete structured filing fee-related information until an announced date of approximately November 1, 2025, when it will suspend filings rather than issue warnings.
Note that accelerated filers will be required to submit fee data in iXBRL beginning on July 31, 2024 and all other filers will be required to do so on July 31, 2025.
The latest issue of The Corporate Counsel has been sent to the printer. It is also available now online to members of The CorporateCounsel.net who subscribe to the electronic format. The issue includes the following articles:
– Enforcement: What the SEC’s Record-Setting Year Means for Disclosures & Compliance
– Related Person Transactions: Navigating Common Transaction Types & Disclosure Issues
Please email sales@ccrcorp.com to subscribe to this essential resource if you are not already receiving the important updates we provide in The Corporate Counsel newsletter.
According to a recent Bloomberg Law article, the percentage of S&P 500 companies including AI-related disclosure in their 10-Ks has increased from 28% in 2021 to 41% in 2023. That trend hasn’t escaped the SEC’s notice. As Dave noted in a recent blog, Corp Fin Director Erik Gerding recently observed that the Staff is focused on AI disclosures in SEC filings and cautioned that, among other things, companies need a basis for their claims.
That message was re-enforced by SEC Chair Gary Gensler in a speech delivered at Yale Law School earlier this week. Chair Gensler covered a wide range of AI-related topics in his remarks, and at one point zeroed in on the issue of “AI washing”:
As AI disclosures by SEC registrants increase, the basics of good securities lawyering still apply. Claims about prospects should have a reasonable basis, and investors should be told that basis. When disclosing material risks about AI—and a company may face multiple risks, including operational, legal, and competitive—investors benefit from disclosures particularized to the company, not from boilerplate language.
Companies should ask themselves some basic questions, such as: “If we are discussing AI in earnings calls or having extensive discussions with the board, is it potentially material?”
These disclosure considerations may require companies to define for investors what they mean when referring to AI. For instance, how and where is it being used in the company? Is it being developed by the issuer or supplied by others?
Gary Gensler’s message about avoiding “boilerplate” echoed another comment from Erik Gerding referenced in Dave’s blog. The Corp Fin director also observed that the Staff is seeing a lot of boilerplate in AI disclosures, particularly in the “Risk Factors” discussion. By the way, this is the second time in less than three months that the SEC Chair has flagged AI washing as a big area of concern for the SEC in public remarks. I guess public companies can’t say they haven’t been warned.
CEOs at companies involved in high-profile financial reporting or governance scandals often find themselves out of a job and face difficulties finding new executive positions. Interestingly, a new study points out that these “tainted” CEOs don’t face the same challenges when it comes to keeping existing board seats or obtaining new ones.
The study concludes that the likely explanation for this is that the value they add outweighs their baggage, which can be managed by limiting their role on the board. Here’s an excerpt from a recent CLS Blue Sky blog by the authors of the study:
Our empirical tests yield five key findings. First, firms with powerful CEOs or weak monitoring are not more likely than other firms to appoint tainted executives to their boards. In contrast, tainted executives tend to join the boards of less visible firms or those with greater advising needs. Second, firms generally avoid placing tainted directors on nominating and governance committees, both of which have important monitoring responsibilities. Instead, these directors often serve on committees that play more of an advisory role.
Third, the skills of tainted and non-tainted appointees are similar, and the evolution of board-level skills is comparable in firms appointing tainted and non-tainted executives to their boards. Fourth, after appointing tainted executives to their boards, firms perform better than a matched control sample. This effect is more pronounced for firms with greater advising needs. Importantly, firms with tainted appointees are not monitored less effectively.
The study also says that shareholder satisfaction with board’s performance remains stable or even improves after these tainted CEOs become directors, suggesting that their appointments meet the needs of the board.
We’ve posted the transcript for our recent webcast – “The ABCs of Schedule 13D and Schedule 13G”, which featured Barnes & Thornburg’s Scott Budlong, Simpson Thacher’s Jennifer Nadborny, Gibson Dunn’s David Korvin and Gunderson’s Andrew Thorpe. The webcast covered the following topics:
– Overview of Schedule 13D and 13G requirements
– Amendments to Schedule 13D and 13G filing deadlines
– Amendments and Guidance on Derivative Securities
– Guidance on Schedule 13D “groups”
– Recurring beneficial ownership reporting issues
– Implications of the amendments and guidance for activism and hostile M&A
Our panelists provided insights into the basics of beneficial ownership reporting, the changes to the reporting scheme resulting from the amendments, and the implications of the SEC’s new guidance on cash settled derivatives and Schedule 13D “group” formation.
The SEC did an interesting thing in the adopting releases for its long-anticipated Schedule 13D & 13G amendments and its overhaul of SPAC regulation. Instead of adopting the most controversial aspects of the rule proposals, the agency opted to issue guidance setting forth its views on the issues they addressed. It seems to me that in an unfriendly judicial environment, a strategy like this for dealing with controversial proposals may offer a lot of advantages for the SEC, at least in the short term.
First of all, SEC guidance statements are non-binding and as this excerpt from a CRS article notes, that makes them a much more flexible tool for the agency than rulemaking:
Guidance is subject to fewer procedural requirements than legislative rules. Legislative rules typically must undergo the informal rulemaking process set forth in the APA, which generally requires that agencies publish a notice of proposed rulemaking in the Federal Register and allow members of the public an opportunity to submit comments on the proposed rule. Final rules generally must be published in the Federal Register at least 30 days before becoming effective, and are then subject to judicial review immediately after taking effect. By contrast, the APA exempts guidance from the notice-and-comment and delayed effective date requirements.
The article also highlights a second advantage that guidance enjoys over rulemaking. The ability to avoid compliance with the APA makes guidance more difficult to challenge in court than new rules are – particularly when that guidance is positioned as “clarifying” existing SEC positions:
In deciding whether guidance is reviewable, courts have considered factors such as the consequences of the guidance, including whether it confers rights or imposes legal obligations beyond those in existing statutes or regulations, and the agency’s characterization and application of the guidance. Courts have also evaluated whether interpretive rules merely interpret or clarify preexisting requirements, or whether they effect a substantive change in existing law or policy.
Guidance may have advantages to the SEC in terms of flexibility and reduced risk of judicial second-guessing, but why come out with an aggressive rule proposal in the first place if guidance is going to be the end result? The market’s reaction to the SEC’s rule proposal on underwriter status in de-SPAC transactions may provide a clue.
If you’ve been following the SPAC saga, you know that as part of the SEC’s initial rulemaking proposal, it offered up a new Rule 140a, which the agency said was intended to “clarify” that an underwriter in a SPAC IPO is also on the hook for subsequent de-SPAC related financings. That prompted a lot of wailing & gnashing of teeth among industry participants about the effect of the proposed rule – but as this Davis Polk memo on the new SPAC rules points out, it also prompted a significant change in market practice:
[W]e think financial institutions participating in de-SPAC transactions are going to continue to take a conservative approach, as they largely have done since the announcement of proposed Rule 140a – treating these transactions more akin to a traditional IPO than a traditional public M&A transaction in terms of potential liability pitfalls.
So, even though the SEC backed away from the proposed rule and substituted guidance, in this case simply offering up the proposed rule was enough to prompt the kind of change in behavior the SEC sought. Since market participants know well that enforcement often follows closely on the heels of guidance, the guidance contained in the adopting release is likely to continue to reinforce this change in behavior.
The issuance of guidance in an adopting release isn’t unprecedented, but its potential benefits to the SEC in the current environment and the agency’s decision to take that approach to the most controversial aspects of two recent high-profile rulemaking initiatives makes me wonder if we may see it more frequently in the future.
While there are a lot of advantages for the SEC in issuing guidance documents instead of adopting the most controversial aspects of proposed rules, there’s also a downside. The ability to use agency guidance as a tool depends on the policy preferences of the folks running the agency, and those change with each change in administrations.
For instance, in 2018, former President Trump issued an executive order curbing the use of agency guidance by enhancing Congress’s ability to review and reject guidance documents. In turn, President Biden revoked that executive order on his first day in office. So, while guidance in lieu of rulemaking has its advantages, its downside is that it’s pretty easy to change with a change in the direction of the prevailing political winds.
Of course, the bigger issue is whether this is any way to run a railroad – but that one’s above my pay grade.
We’ve recently passed the 12,000-query mark in our “Q&A Forum.” Of course, as Broc would always point out when he wrote one of these Q&A milestone blogs, the “real” number is much higher since many queries have others piggy-backed upon them. Over the years, we’ve collectively developed quite a resource. Combined with the “Q&A Forums” on our other sites, there have been well over 35,000 individual questions answered – including over 10,500 that Alan Dye’s answered over on Section16.net.
As always, we welcome – in fact, we actively encourage – your input into any query you see that you think you can shed some light on for other members of our community. There is no need to identify yourself if you are inclined to remain anonymous when you post a reply (or a question). And of course, remember the disclaimer that you need to conduct your own analysis & that any answers don’t constitute legal advice. Also, please keep in mind that the Q&A Forum is not an outsourced research service – we all have day jobs and aren’t in a position do research projects!
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