There’s a point at which I should no longer be shocked by scandals involving the Big 4. I guess I’m not there yet, because I was really taken aback by the enforcement proceeding against EY that the SEC announced yesterday. This excerpt from the SEC’s press release describes the conduct that led to the proceeding:
EY admits that, over multiple years, a significant number of EY audit professionals cheated on the ethics component of CPA exams and various continuing professional education courses required to maintain CPA licenses, including ones designed to ensure that accountants can properly evaluate whether clients’ financial statements comply with Generally Accepted Accounting Principles.
EY further admits that during the Enforcement Division’s investigation of potential cheating at the firm, EY made a submission conveying to the Division that EY did not have current issues with cheating when, in fact, the firm had been informed of potential cheating on a CPA ethics exam. EY also admits that it did not correct its submission even after it launched an internal investigation into cheating on CPA ethics and other exams and confirmed there had been cheating, and even after its senior lawyers discussed the matter with members of the firm’s senior management. And as the Order finds, EY did not cooperate in the SEC’s investigation regarding its materially misleading submission.
That’s a really ugly set of admissions. Not surprisingly, the sanctions imposed on the firm are no bargain either. In addition to a $100 million civil money penalty – the largest ever imposed by the SEC on an auditor – the SEC’s order imposes a set of sweeping undertakings on the firm.
The undertakings begin by requiring EY to investigate the “sufficiency and adequacy of its quality controls, policies, and procedures relevant to ethics and integrity” and to responding to SEC information requests. It then must report the results of that investigation to the SEC. That report must set forth in writing how the policies and procedures are “designed and implemented in a manner that provides reasonable assurance of compliance with all professional standards” referenced in the order.
The SEC’s order goes on to require EY to retain two independent consultants. The first consultant must conduct an independent review of the policies & procedures that EY is required to investigate and report on to the SEC. The second will work in conjunction with a special review committee comprised of senior EY personnel to conduct a review of the firm’s conduct relating to its response to the SEC’s information request, “including whether any member of EY’s executive team, General Counsel’s Office, compliance staff, or other EY employees contributed to the firm’s failure to correct its misleading submission.” Subject to certain limitations, the order requires EY to adopt the recommendations made by either of the two consultants.
The order also imposes various certification and training requirements and requires the firm to provide a copy of the SEC’s order to all of its public company and broker dealer audit clients. This last requirement seems to me to be the equivalent of requiring EY to lay the order on the table of the audit committees that have retained it. That should make for some interesting conversations.
Check out Commissioner Peirce’s dissenting statement, which provides a less damning perspective on EY’s conduct surrounding the firm’s response to the SEC’s information request, and this WSJ article, which provides additional details & background on the case.
During the early days of the pandemic, many companies opted to meet their capital needs by issuing convertible debt. Fueled by continuing low interest rates, convertible debt remained attractive to investors through 2021, but as this WSJ article indicates, higher interest rates & the pullback in tech stocks have resulted in the convert market cratering in 2022:
Few investments have delivered positive returns this year, as investors have struggled with the implications of stubbornly high inflation and rapidly rising interest rates. But the performance of convertible bonds, in some respects, “is still a little bit shocking,” said Michael Youngworth, convertible bonds strategist at BofA Global Research. The reason for the surprise isn’t just the magnitude of convertible bonds’ losses but how they have fallen short of their promise. A major selling point has long been that convertible bonds offer investors the potential gains from stocks, with bonds’ downside protection.
One issue is that stock declines this year have been particularly concentrated in the type of high-growth technology companies that make up a large portion of convertible bond issuers. But that is only part of the story.
This year, convertible bonds have captured 46% of their underlying stocks’ performance when the stocks have climbed but 49% of their performance when they have declined. That puts them on track for the worst upside-to-downside capture ratio in records going back to 1995 and only the second year when the ratio has been less than one, according to BofA Global Research data.
Nature abhors a vacuum, so just as the smart money rushes out of converts, it looks like a golden opportunity has emerged for the dumb money to rush in. Behold, the crypto folks have discovered convertible debt!
Bloomberg Law reports that SEC Commissioner Allison Herren Lee, whose term expires at the end of the month, will join the faculty of NYU Law School after she leaves the SEC:
Lee will be appointed an adjunct professor and senior fellow at the law school’s Institute for Corporate Governance and Finance, teaching a seminar on law and business in the fall, a school official confirmed Thursday. She announced earlier this year she would leave the Securities and Exchange Commission, following the Senate confirmation of a successor. Jaime Lizarraga, the nominee for Lee’s seat, won Senate approval Thursday.
In its October 2021 release reopening the comment period for its proposed clawback listing standard rules, the SEC floated the idea of including “little r” restatements as triggers for a compensation recovery analysis under the rules. Earlier this month, the SEC’s Department of Economic Research and Analysis issued a memorandum addressing the impact of including little r restatements with the scope of the rules. This excerpt says that while requiring little r restatements to be included would increase the total number of restatements that might trigger clawbacks, those restatements may be less likely to trigger a recovery of previously paid comp (also see Liz’s blog on CompensationStandards.com):
We estimate that “little r” restatements may account for roughly three times as many restatements as “Big R” restatements in 2021, after excluding restatements by SPACs. Accordingly, if the final rules were to encompass both types of restatements, it would increase the total number of restatements that could potentially trigger a compensation recovery analysis that may result in recovery.
However, “little r” restatements may be less likely than “Big R” restatements to trigger a potential recovery of compensation. For example, “little r” restatements may be less likely to be associated with a decline in previously reported net income, 19 and on average they are associated with smaller stock price reactions. As a result, if the final rules were to encompass both “Big R” and “little r” restatements, while there would be an increase in the number of restatements that would be included, the overall number of recoveries may not increase in proportion to the increase in the number of restatements that would be included. This, in turn, would mitigate the potential impact of including “little r” restatements on the expected benefits and costs associated with the proposed rules.
The DERA memo noted that one potential downside of including little r restatements is that by expanding the rule’s scope, it may “encourage managers to make suboptimal operational decisions rather than suboptimal accounting decisions to meet financial targets.” However, the memo also points out that such a decision would “mitigate the potential for the proposed rules to create an incentive for managers to report misstatements as “little r” restatements rather than “Big R” restatements.” Given the agency’s jaundiced view about the abundance of little r restatements, my guess is that this latter point may carry a lot of weight when it comes to the final rule.
Speaking of things that might carry some weight, the CII recently submitted a comment letter reiterating its support for including little r restatements within the scope of the clawback rules.
With final rules expected as soon as this fall, We’ll be sharing the latest updates on clawbacks at our “Proxy Disclosure & 19th Annual Executive Compensation Conference” coming up in October. Our session on “Clawbacks: Where Things Stand” – with Davis Polk’s Kyoko Takahashi Lin, CompensationStandards.com’s Mike Melbinger, Gibson Dunn’s Ron Mueller, and Hogan Lovells’ Martha Steinman – will give you practical action items to take in response to SEC rulemaking and recent enforcement activity, as well as investor expectations. Here’s the full agenda for the Conferences – 18 sessions over 3 days. Sign up online, email sales@ccrcorp.com, or call 1-800-737-1271.
We’ve been operating in a low inflation environment for so long that I think the last time anybody cared about the impact of inflation on inventory accounting was when I was taking my undergrad Financial Accounting 101 class – and in case anybody from the Division of Enforcement is reading, I want to point out that this was my only accounting class. Unfortunately, inflation is back, and according to this WSJ article, so are investor concerns about its impact on companies that use the “Last In, First Out” (LIFO) method of accounting for inventories:
In 2021, approximately 15% of companies in the S&P 500 used LIFO as their primary inventory method and 50% used FIFO, according to Credit Suisse Group AG , citing annual reports. The remainder used an average-cost method, a combination of methods, or methods that couldn’t be determined, Credit Suisse said.
Investors are scrutinizing accounting methods like the use of LIFO amid recent declines in the stock market to ensure they fully understand business models in their portfolios, said Ron Graziano, a managing director at Credit Suisse. “It really matters when it matters, and it matters a lot right now,” he said.
The article cites examples of some LIFO companies that reported big reserve increases associated with LIFO for their most recent reporting period and providing forward-looking disclosure about the potential impact of LIFO accounting for their full fiscal years.
If investors are scrutinizing LIFO companies more carefully, it almost goes without saying that those companies need to be prepared for the Staff to take a close look at disclosure practices as well. In addition to addressing the potential impact of inflation on LIFO inventory valuations and their current and future results of operations in the Risk Factors & MD&A sections of their filings, companies should keep an eye out for potential comment trends on LIFO issues.
I did a quick search on EDGAR and haven’t found any 2022 comment letters referencing LIFO that have been released yet, but I did find a handful of comment letters from 2021 that raised issues that are likely to be relevant this year as well. These include:
– Comments directed at non-GAAP presentations that exclude changes in LIFO reserves, which the Staff has challenged as potentially involving “tailored accounting.” The company in question was able to successfully resolve this comment.
– Comments seeking clarification (see comment # 3) as to whether LIFO inventory was reported at the lower of cost or market or lower of cost or net realizable value in accordance with ASC330-10-35-1B through -7. Here’s the company’s response with the requested clarifying disclosure.
– The usual “equal prominence” comment on non-GAAP measures that exclude changes in LIFO reserves.
LIFO accounting may be an issue for only a relatively small percentage of public companies, but it’s a subpart of the much broader issue of how inflation is affecting all public companies’ results of operations and financial condition. In that regard, although the SEC’s 2020 Regulation S-K modernization rules eliminated specific line-item disclosure requirements concerning the impact of inflation and changes in prices, discussion of these matters is still required if they are part of a known trend or if they have had or the company reasonably expects them to have a material impact on key income statement line-items.
Good morning! I know everyone was expecting to see Dave Lynn at the helm of this week’s blogs, but “Dave’s not here” – so you’re stuck with me for another week. The good news is that Emily will handle “The Mentor Blog” this week.
White & Case recently published its annual survey of ESG disclosure practices in SEC filings. The survey reviewed annual meeting proxy statements and annual reports of 50 Fortune 100 companies and identified trends in ESG disclosures from 2020-2022. Given the SEC’s comment letters on climate disclosure & the fact that everyone knew a climate rule proposal was on the way when proxy season began, it’s not surprising that environmental topics were the fastest growing category of ESG disclosures. Trailing close behind were disclosures about human capital management – again, that’s not surprising in light of the SEC’s recent rulemaking in the area.
While the top two spots were claimed by the usual suspects, the third fastest growing category of ESG disclosure was one that made the list for the first time this year – E&S goals and targets. This excerpt provides some details on the survey’s findings concerning these disclosures:
For the first time in White & Case’s annual survey, E&S Goals and Targets made the top seven categories, rising to the third spot with the largest increase in disclosure. This reflects the heightened focus by investors on companies setting specific targets with respect to environmental and social priorities.
Seventy-six of the filings surveyed (or 76%) increased their disclosure related to E&S goals and targets. In total, all but one of the surveyed companies (49 out of 50) included some form of E&S goal or target. Of these, 32 companies included the disclosure in their Form 10-K and 48 companies included it in their proxy statement. Of the 49 companies that included E&S goals and targets, seven companies included them for the first time in their 2022 disclosures.
The survey says that it wasn’t just qualitative disclosures about ESG goals targets that grew this year. A total of 44 companies, or 88% of those surveyed, included quantitative metrics. Of this amount, 18 included such disclosure in their Form 10-K (compared to 11 in 2021) and 42 included it in their proxy statements (compared to 26 in 2021).
Preparing & filing the Form 144 for insider transactions has traditionally been a job that’s fallen to the brokerage firm involved in the trade. But with the recent amendments imposing a mandatory electronic filing requirement for Form 144, this Bryan Cave blog suggests that responsibility for those filings may end up on the General Counsel’s plate:
The SEC estimated in the adopting release that only approximately 25 percent of Form 144 filers have already prepared a Form ID and obtained a CIK number for EDGAR filings. As a result, approximately 75 percent of Form 144 filers will need to file a Form ID for the first time to obtain a CIK code and gain access to file on EDGAR. In practice, the burden of helping prepare Form IDs and obtain CIK numbers often falls to company counsel rather than the company insider, and the process in recent years has taken several days, due in part to COVID-19 slowdowns and challenges.
Although in the past, broker-dealers executing sales for affiliates generally handled the preparation and submission of paper Form 144 filings, it is unclear whether Form 144 filers and/or company counsel will be comfortable sharing CIK codes and sensitive Form ID information with broker-dealers, who may not have developed processes to collect, securely store, and properly update all of the EDGAR access credentials for each client required to file a Form 144
Fortunately, there’s an extended transition period for the portion of the amendments that imposes the electronic filing requirement for Form 144, which should provide some time to sort this out. In the adopting release, the SEC said that this new requirement will kick in six months from the date of publication in the Federal Register of the SEC’s adoption of an updated version of the EDGAR Filer Manual addressing the Form 144 changes. That’s expected to happen on September 22, 2022, so assuming those changes hit the Federal Register promptly, the electronic filing requirement shouldn’t go into effect until March 2023 at the earliest. Given that new procedures may be needed and that the requirement is going to hit all Rule 144 filers at once, now is the time to start coordinating with brokers.
One sure sign of a tumbling stock market is a rise in the number of companies thinking about reverse splits to support their stock prices and/or preserve their exchange listings. SoFi Technologies is probably the most high-profile example of this potential trend. The formerly high-flying Fintech company’s stock has lost 60% of its value this year, and it’s asking shareholders to approve a proposed charter amendment at its upcoming annual meeting to permit it to engage in a reverse split if the board so determines.
A major consideration for any company considering asking for shareholder approval of a reverse split is how ISS & Glass Lewis are likely to react to such a proposal. This recent Goodwin blog sheds some light on that issue:
ISS generally recommends voting for management proposals to implement a reverse stock split if the number of authorized shares will be proportionately reduced, or the effective increase in authorized shares is equal to or less than the allowable increase calculated in accordance with ISS’ Common Stock Authorization policy. ISS will recommend voting on a case-by-case basis if the proposal does not align with either of the two criteria above, taking into consideration, among other factors, a stock exchange notification of potential delisting. Glass Lewis notes that it may recommend voting against a proposal to conduct a reverse stock split if the Board does not state that it will reduce the number of authorized common shares in a ratio proportionate to the split.
By the way, if your company is thinking about a stock split or a reverse stock split, be sure to check out our article on “Unpacking Stock Splits” which appeared in the July-August 2019 issue of The Corporate Counsel.
Dealing with analysts in an earnings call can sometimes be a challenging and even somewhat confrontational process for any CEO, but a recent study cited in an IR Magazinearticle says that male securities analysts are much tougher in their questioning of female CEOs than they are of their male counterparts. This excerpt from the article discusses the study’s findings and some of their implications:
Analyzing transcripts of 39,209 earnings conference calls, including with Apple, Microsoft and Facebook, we found that male analysts’ questions to CEOs were more aggressive than those of female analysts and that this contrast doubled when the CEO was female. We also found that when male analysts challenged female CEOs, they were more aggressive than when questioning men.
Our findings lay bare yet another challenge female leaders face in the workplace, and with workplace gender diversity linked to everything from increased productivity to improved performance, staff retention and collaboration throughout a business, the ramifications are enormous.
The findings are of particular relevance to the finance industry and investors, as the way analysts ask questions sends signals to the capital markets. When investors following earnings conference calls witness analysts asking verbally aggressive questions, it could signal to them that the analysts are not happy with a company’s performance.
The study’s authors say that its findings are a classic example of ‘in-group bias’, a psychological theory that says we give preferential treatment to those we regard as belonging to the same group as us. This theory suggests that male securities analysts question female CEOs more aggressively because they see them as outsiders and a threat to their sense of identity and self-esteem.
