At its last meeting, FASB proposed several changes that would impact segment reporting. These include requiring disclosure of the title & position of its chief operating decision maker and enhanced disclosure of significant expenses. This excerpt from a WSJ article on the proposal summarizes the proposed changes to expense disclosure:
U.S. public companies would have to start breaking out big-ticket expenses incurred by their business divisions under a new proposal from the U.S. accounting standards-setter aimed at helping investors get a clearer view of financial performance. Companies usually split their operations into segments by business line or geography. They are required to disclose a measure of their profits or losses by operating segment in financial statements, but don’t have to go into much more detail.
Under a proposal from the Financial Accounting Standards Board, companies would have to disclose significant expenses in those divisions, which could cover things like labor, technology fees, rent or cost of goods sold.
In addition, FASB proposes to permit companies to report multiple measures of a segment’s profit or loss, so long as at least one of those measures is one that is most consistent with those used in measuring the corresponding amounts in the consolidated financial statements. FASB’s staff is drafting a proposed Accounting Standards Update and interested parties will have 75 days to comment on the proposal.
The front office of my favorite MLB team has a reputation for the effective use of analytics. Like most jaded Cleveland fans, I’ve often thought they’ve opted for that approach because the club has no money & data scientists are a lot cheaper than power hitters. Nevertheless, I give the Guardians’ brain trust a lot of credit for doing things like extracting some real value in exchange for an un-signable star like Francisco Lindor. Oh, and I also give them a lot of credit for not being the Browns brain trust. Don’t even get me started on those freakin’ guys. . .
Geez, where was I going with this – oh yeah, SEC Enforcement! Anyway, this Holland & Knight blog picks up on Liz’s recent blog about the trio of insider trading enforcement actions that the SEC brought late last month and details the role that data analysis tools may have played in each of those cases. If you read that blog, it’s hard not to conclude that when Big Brother has access to Big Data, insider trading is even dumber than it used to be.
Section 404 of the Sarbanes-Oxley Act requires companies to review their internal control over financial reporting and report whether or not it is effective. Non-accelerated filers are required to provide management’s assessment of the effectiveness of their ICFR, while larger companies are required to accompany that assessment with an attestation from their outside auditors.
Audit Analytics recently issued its annual report on the most recent round of auditor attestations & management-only assessments of ICFR. This recent blog reviews the results of the past 18 years of experience under SOX 404, and makes several interesting observations:
– In FY 2021, 5.8% of SOX 404(b) auditor attestations disclosed ineffective internal controls. In contrast, 23.7% of management reports and 41.9% of management-only reports disclosed ineffective controls. These percentages represent increases from the levels seen in FY 2020, across all three report types.
– The report includes a thorough breakdown of the control and accounting issues contributing to an ineffective control assessment. Notably, in FY 2021, a recurring control issue cited in adverse SOX 404 reports related to a lack of qualified accounting personnel. Other issues stem from this lack of highly trained company accounting professionals. This includes the inability to enforce a “segregation of duties” within the accounting function.
The blog notes that the significantly higher percentage of management-only reports disclosing ineffective controls reflect the demographics of companies required to file these reports. Large companies must file auditor attestations along with management reports on ICFR, while smaller companies are permitted to file management-only reports.
The recurring references to the lack of qualified accounting personnel are particularly troubling. Over the past few years, there have been numerous media reports about a potential shortage of accountants. It looks like the chickens have come home to roost on this issue this year, and that the shortage will continue to place stress on companies’ internal controls in the future.
A recent 2nd Circuit decision pared back the scope of the claims for which compensation may be received under Dodd Frank’s whistleblower provisions. Here’s the intro from this Sheppard Mullin blog on the decision:
In Hong v. SEC, No. 21-529 (2d Cir. July 21, 2022), the Court held that a person who provides the Securities and Exchange Commission (“SEC”) with information about potential securities laws violations is entitled to receive a whistleblower award under Section 21F of the Securities Exchange Act (15 U.S.C. § 78u-6) if the SEC itself brings a qualifying action, but not when the SEC shares the whistleblower’s information to other agencies who then bring an action in partial reliance upon it.
In this case, the whistleblower tipped the SEC off to some alleged shenanigans involving his employer bank’s portfolio of residential mortgage-backed securities. The SEC didn’t take action but shared his information with the DOJ & the Federal Housing Finance Agency. Ultimately, the bank settled with the agencies for $10 billion, so you can understand why this guy was hoping for a big payday.
However, the SEC contended that it wasn’t on the hook for whistleblower claims resulting from actions by other agencies. It said that in order for actions by other agencies to qualify as “related actions” under Section 21F, there must also be an underlying SEC action. The 2nd Circuit applied Chevron deference to the SEC’s interpretation of the scope of Dodd-Frank’s whistleblower provisions & ultimately ruled in the agency’s favor.
The blog says that the decision sets definitive limits on the reach of the Dodd-Frank Act’s whistleblower incentives and may also affect an individual’s assessment of whether to risk their career to come forward with information on potential wrongdoing.
We continue to receive questions from members in our Q&A Forum (see Topic #11109) and via email about when the SEC will announce the inflation adjustment to the emerging growth company revenue cap that the JOBS Act requires it to issue every five years. Unfortunately, we’ve not heard anything on this front, so to our knowledge, it’s still on the agency’s “to do” list as it was the last time that we blogged about it.
Yesterday, the Senate passed the 755-page Inflation Reduction Act of 2022. Among its other provisions, the legislation imposes an excise tax equal to 1% of the fair market value of any stock that a company repurchases during its fiscal year (see p. 31). I remember a tax prof in law school saying something like excise taxes are always simple, because the government just takes a slice off the top, which probably explains why this part of the statute is only about 6 pages long. This excerpt from a Congressional Research Service report provides an overview of the excise tax provision:
A provision in H.R. 5376 would impose a 1% excise tax on the repurchase of stock by a publicly traded corporation. The amount subject to tax would be reduced by any new issues to the public or stock issued to employees. The tax would not apply if repurchases were less than $1 million or if contributed to an employee pension plan, an employee stock ownership plan, or other similar plans.
The tax would not apply if repurchases were treated as a dividend. It would not apply to repurchases by regulated investment companies (RICs) or real estate investment trusts (REITs). It also would not apply to purchases by a dealer in securities in the ordinary course of business. The excise tax would apply to purchases of corporation stock by a subsidiary of the corporation (i.e., a corporation or partnership that is more than 50% owned by the parent corporation). The tax would also apply to purchases by a U.S. subsidiary of a foreign-parented firm. It would apply to newly inverted (after September 20, 2021) or surrogate firms (i.e., firms that merged to create a foreign parent with the former U.S. shareholders owning more than 60% of shares).
In general, excise taxes can be deducted to determine profits subject to the corporate tax, so that the tax is reduced by the corporate tax rate (21%). That is, for a profitable corporation each dollar of excise tax reduces profits taxes by 21 cents. The language specifies that this tax would not be deductible, so there would be no corporate profits tax offset.
You probably noticed that this summary describes the House version of the bill, but the Senate version appears to be the same. The rationale for the excise tax – beyond the horse trading required to get Senator Krysten Sinema (D – Ariz.) to support the legislation – is that dividends and repurchases should have similar tax consequences. This excerpt from the Center on Budget Policy and Priorities’ statement on the legislation summarizes that position:
Dividends are generally taxable when shareholders receive them. Under a stock buyback, in contrast, shareholders who sell their shares to the corporation at a gain owe capital gains tax but shareholders who don’t sell their shares — typically the overwhelming proportion — see the value of their shares rise but don’t pay tax on the gain until they sell. Their wealth increases but their taxes don’t. By imposing a 1 percent excise tax on share buybacks, this provision is designed to correct this tax policy inefficiency.
The legislation now goes back to the House, where it is expected to pass and subsequently be signed into law by President Biden. Check out this resource for more technical details on the legislative process.
While companies and stockholders are extremely fond of stock buybacks, many other people don’t think as highly of them. In fact, a lot of commentators are vehemently opposed to them. For instance, this excerpt from a 2020 HBR article essentially says that they’re something that only a Bond villain could love:
With the majority of their compensation coming from stock options and stock awards, senior corporate executives have used open-market repurchases to manipulate their companies’ stock prices to their own benefit and that of others who are in the business of timing the buying and selling of publicly listed shares. Buybacks enrich these opportunistic share sellers — investment bankers and hedge-fund managers as well as senior corporate executives — at the expense of employees, as well as continuing shareholders.
Critiques like these have gotten some traction, and to a certain extent are reflected in the SEC’s recent proposals for additional disclosure on buybacks. While I doubt that Ernst Blofeld would oppose a buyback of SPECTRE’s stock, a couple of recent studies have popped up suggesting that buybacks aren’t bad, just mostly misunderstood. The first study, from three finance profs, says that critics who side with the views expressed in the HBR article have it all wrong. Here’s an excerpt from the abstract:
Repurchases account for a tiny fraction of the trading volume in a typical stock, making their price impact too small to facilitate short term price manipulation. Price appreciation following repurchases is modest and does not reverse on average, suggesting prices increase due to repurchases signaling firms’ good prospects. Also, we find no evidence that CEOs of repurchasing firms are paid excessively or that repurchases crowd out valuable investment opportunities.
The second study, from the Bipartisan Policy Center, says that greater attention should be paid to the good things that buybacks enable companies to accomplish, and that repurchases should be evaluated under a dynamic approach that takes into consideration the best ways to ensure the most efficacious use of capital in the U.S. economy:
When one looks at repurchases through a dynamic, instead of a static, approach, the benefits appear to have a much broader impact on society. Repurchases provide investors, including those beneficiaries with 401ks and pensions that are invested market wide, with additional financial resources that they otherwise would not have had. These additional resources may in turn be reinvested or saved, which can provide needed capital for small companies and others to facilitate innovation and growth.
Your mileage may vary when it comes to the arguments on the relative merits of stock repurchases, but there’s one thing that nobody’s arguing about – the amounts involved are huge & getting bigger all the time. According to S&P Global, buybacks by companies in the S&P 500 during the first quarter of 2022 were $281.0 billion. That’s a 4% increase over the record $270.1 billion expended during the 4th quarter of 2021. Furthermore, S&P said that over the 12-month period ending in March 2022, companies spent a record $985 billion on buybacks, up 97.2% from the prior12-month period’s $499 billion.
I’m generally agnostic about buybacks, but those numbers give me pause, because at their current rate, they suggest that our largest public companies can’t more productively deploy nearly $1 trillion of their assets per year in their own businesses. The magnitude of those numbers makes me wonder whether buybacks are a solution to a capital misallocation problem or whether they’re just evidence that our capital markets have a huge capital misallocation problem.
Dave recently blogged about some of the potential implications of the SCOTUS’s decision in West Virginia v. EPA for the SEC’s proposed climate disclosure rules. This Freshfields blog also addresses that issue, and suggests that the decision make create some significant challenges to the SEC moving forward:
The Court’s ruling may complicate the finalization, enactment and enforcement of the SEC’s proposed rule, which is contemplated to be adopted later this year. If the SEC’s proposed rule is adopted in its current or similar form, critics may challenge it under the major questions doctrine by citing the Supreme Court’s reasoning in West Virginia v. EPA, and, in doing so, arguing that the SEC is relying on ambiguous statutory text to claim a significant expansion of power in a subject matter in which it lacks expertise.
Some have argued that the SEC’s statutory authority is “relatively clear,” and draw a distinction between the EPA’s direct regulation of emissions from coal plants and the SEC’s efforts to enhance disclosure. A former SEC attorney speculated that, if a claim is brought, the SEC could argue that the applicable court rely on the “Chevron doctrine” rather than the major questions doctrine. The Chevron doctrine requires courts to accept an agency’s interpretation of an ambiguous law if it is “rational” and “reasonable.” Notably, there is no discussion of the Chevron doctrine in the Court’s opinion in West Virginia v. EPA; however, the dissent noted that courts can “circumvent a Chevron deference analysis altogether” by interpreting a statute as negating an agency’s claimed authority.
It isn’t just the SEC’s proposed climate change disclosure rules that may face a challenge based on West Virginia v. EPA. As this Dechert memo points out, the major questions doctrine may also come into play when “the SEC or other financial regulators seeking to regulate markets involving cryptocurrencies and other blockchain products,” or when agencies like the FTC seek to alter traditional understandings of antitrust and competition law.
Some very heavy hitters have argued that the SEC’s authority to promulgate these rules is pretty clear. Having read some arguments to the contrary, I’m less sanguine about the SEC’s chances in federal court if it adopts rules along the lines it has proposed. Regardless of the legal merits of their arguments, I think the proponents may have failed to “read the room”. The arguments advanced for the SEC’s authority to require climate disclosure appear to be premised on the view that this authority is virtually limitless, and that’s just not where the federal courts are right now when it comes to agency power.
Kevin LaCroix keeps close tabs on securities class action filings, and recently blogged on the “D&O Diary” about how the first half of 2022 is shaping up in comparison with prior years. This excerpt summarizes his findings:
The number of securities class action lawsuit filings in the first half of 2022 remained at the lower levels that prevailed last year and below the more elevated levels that prevailed during the period 2017-2020. Though the number of securities class action lawsuit filings in the year’s first six months is below the recent higher levels, the number of suits filed is still consistent with long-term averages. The difference in the number of filings so far this year and the elevated numbers during the recent period were both largely due to merger objection lawsuit filings patterns.
According to my tally, there were 103 federal court securities class action lawsuits filed in the first half of 2022. That first half number annualizes to a projected year-end total of 206, which would be slightly below the 211 federal court securities class action lawsuits filed in 2021 and well below the 319 federal court securities suits filed in 2020.
Kevin goes on to explain that while there’s still a booming business in federal court merger objection filings, most of these cases are not being filed as class actions, but as individual lawsuits. That’s why they don’t show up in the stats.
