Last year, I blogged about an SEC enforcement action to halt an unregistered ICO that was being conducted in the most “best practices” way possible – through a “Simple Agreement for Future Tokens.” Under this structure, the company sells “pre-token” securities to accredited investors, which flip into non-security tokens at or after launch of a platform on which to use them. In this particular case, the SEC took issue with the fact that there would be no established cryptocurrency ecosystem at the point when the pre-tokens flipped to tokens.
On Friday, the SEC announced that it had settled the enforcement action – and the results aren’t encouraging for the crypto crowd. Here’s the highlights:
– The company agreed to return more than $1.2 billion to the initial purchasers in the offering
– The company’s paying an $18.5 million civil penalty
– For the next 3 years, the company has to notify the SEC before participating in the issuance of any digital assets
Yikes. The announcement includes this quote from the Chair of the SEC Enforcement Division’s Cyber Unit: “New and innovative businesses are welcome to participate in our capital markets but they cannot do so in violation of the registration requirements of the federal securities laws.” But with this SAFT arrangement drawing ire, a lot of folks are wondering how exactly a token offering would do that.
Reg S-T: Corp Fin Extends Temporary Relief for Signatures
In March, John blogged about Corp Fin’s temporary relief for manual signature retention requirements under Rule 302(b) of Regulation S-T. Last week, the Staff updated that statement to say that it’ll remain in effect until a date specified in a public notice, which will be at least two weeks from the date of the notice. So while the Staff continues to expect compliance, it won’t recommend enforcement if:
– a signatory retains a manually signed signature page or other document authenticating, acknowledging, or otherwise adopting his or her signature that appears in typed form within the electronic filing and provides such document, as promptly as reasonably practicable, to the filer for retention in the ordinary course pursuant to Rule 302(b);
– such document indicates the date and time when the signature was executed; and
– the filer establishes and maintains policies and procedures governing this process.
The Staff also extended for an indefinite period its temporary relief for submission of paper forms under Rule 144 and other rules – which had been set to expire June 30th. For more detail, see this Cooley blog.
Last week, the SEC, Corp Fin, the Division of Investment Management and the Division of Trading & Markets also issued this joint statement, which summarizes all of the relief & assistance that the Commission provided during the pandemic to accommodate capital raising & reporting, and says the Commission won’t be extending the relief that gave companies additional time to file disclosure reports that were due on or before July 1st.
But not everyone is happy about “deregulatory” efforts by the SEC these last few months – here’s a letter to SEC Chair Jay Clayton from Chair of the House Financial Services Committee, Congresswoman Maxine Waters (D-CA), calling for the Commission to halt rulemakings unrelated to the pandemic.
Climate Change Litigation: The Next “Mass-Tort” Frontier?
BP is facing state court action for nuisance claims from the cities of Oakland & San Francisco, after the Ninth Circuit denied the company’s motion to remove the case to federal court and dismiss the claims. This Wachtell Lipton memo predicts that the decision will invite “countless actions by states, municipalities, and private litigants in state courts all over the country” – and that liabilities will extend far beyond the energy sector.
Meanwhile, as Reuters reported a couple weeks ago, PG&E is pleading guilty to 84 counts of involuntary manslaughter in connection with the 2018 Camp Fire. Although no individuals will be held criminally accountable, this plea is pretty unique because the company is admitting criminal guilt. The company is also paying up to $19 million in fines & costs accepting tighter oversight – and pledging billions of dollars to improve safety and help wildfire victims. The company cited more than $30 billion in potential wildfire damages when it filed for bankruptcy, and it’s reached various settlements and rate agreements as part of the Chapter 11 plan.
Last fall, John blogged about a Caremark claim surviving a motion to dismiss. This was a big deal because at the time it was the second case in a year that the Delaware courts declined to dismiss at the pleading stage following decades of routinely doing so. Now, earlier this week the Delaware Court of Chancery issued a 41-page opinion in Hughes v. Hu and declined to dismiss another Caremark claim.
In the most recent case, Vice Chancellor Laster held that the plaintiff adequately pled that the director defendants, who served on the company’s audit committee, breached their fiduciary duties by failing to oversee the company’s financial statements and related party transactions. The plaintiff alleged that the directors’ failures led to the company’s need to restate its financial statements, thereby causing the company harm.
The Court found the allegations in this case support inferences that the board members did not make a good faith effort to do their jobs. The Audit Committee only met when spurred by the requirements of the federal securities laws. Their abbreviated meetings suggest that they devoted patently inadequate time to their work. Their pattern of behavior indicates that they followed management blindly, even after management had demonstrated an inability to report accurately about related-party transactions.
For instance, documents that the Company produced indicated that the Audit Committee never met for longer than one hour and typically only once per year. Each time they purported to cover multiple agenda items that included a review of the Company’s financial performance in addition to reviewing its related-party transactions. On at least two occasions, they missed important issues that they then had to address through action by written consent. According to the Court, the plaintiff was entitled to the inference that the board was not fulfilling its oversight duties.
Last fall, John wondered whether Caremark was becoming a more viable theory of liability or the board’s conduct in recent cases was just more egregious. It’s still early…we’ll see if any other pleading-stage dismissals show up in 2020 to form more of a pattern.
The facts in Hughes seem pretty egregious and the Court’s opinion says the defendants face a substantial likelihood of liability under Caremark. But, as Steve Quinlivan notes at the end of his blog, the Court hasn’t found any of the defendants liable for the actions alleged in the complaint.
PCAOB Wants Comments on CAM Requirements
The PCAOB wants comments on experiences so far with the new CAM disclosure requirement. Comments are encouraged from all interested stakeholders and should be submitted by June 15, 2020. Information on the comment process can be found on this PCAOB Request for Comment. The Comment Request includes a list of questions for consideration and asks commenters to provide data, evidence or other specific examples to support comments.
The PCAOB says it’s conducting an interim analysis to understand how auditors responded to the CAM requirements, how investors are using CAM disclosures and audit committee and preparer experiences. From there, the PCAOB will consider whether additional guidance or other steps may be appropriate. The PCAOB plans to report its interim review findings toward the end of the year.
Speaking of CAMs, according to a recent Audit Analytics’ blog, so far disclosure of the audit committee’s role regarding CAMs isn’t too prevalent. The blog says the firm reviewed 770 S&P 1500 proxy statement disclosures filed between July 1, 2019 and March 31, 2020 to look for disclosures about the audit committee’s role with CAMs.
Of course, the new disclosure requirement relating to CAMs requires auditors to share any CAMs with the audit committee as part of the draft auditor report, but the audit committee doesn’t need to approve or determine CAMs. So, even though there’s been a trend of expanding audit committee disclosure, audit committees wouldn’t necessarily need to say much about how they’re engaging in the new disclosure requirement – although the blog does say we’ll probably see more of this disclosure as time goes on. Here’s some of their findings:
In the first quarter 2020, they found slightly over 6% of S&P 1500 proxy statements filed included CAMs in audit committee disclosure – the majority of which included mention in the audit committee report of the proxy
Of proxy statements that included audit committee disclosure of CAMs, 61% were from the S&P 500 – although, overall most companies haven’t included this disclosure in proxy statements
When disclosure is included in the proxy statement, it often identifies the audit committee’s role as either reviewing the CAMs, discussing CAMs with the independent auditor or both
Our May Eminders is Posted!
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Yesterday, Corp Fin issued 2 new CDIs addressing the interplay of Form 12b-25 and Corp Fin’s modified Covid-19 exemptive order that it issued last week providing SEC filing relief for companies affected by the Covid-19 crisis. Here they are:
Question 135.12
Question: A registrant expects that due to COVID-19 it will be unable to file a report of the type covered by Rule 12b-5 on timely basis without incurring an unreasonable effort or expense. It is uncertain as to its ability to file the required report within the applicable 12b-25(b)(2)(ii) period. Should the registrant instead furnish a report on Form 8-K or 6-K, as applicable, relying on the COVID-19 Order (Release No. 34-88465 (March 25, 2020))?
Answer: As a condition to its use, the COVID-19 Order requires, among other things, that the registrant furnish certain specified statements by the later of March 16, 2020 or the original due date of the required report. If the registrant only files a Form 12b-25 by the original due date of the required report, it will have not met the condition of the COVID-19 Order to provide the statements called for by the original filing deadline on a furnished Form 8-K or Form 6-K. Unless this condition is met, the 45 day relief period provided in COVID-19 Order will not be available. Registrants unable to rely on the COVID-19 Order are encouraged to contact the staff to discuss collateral consequences of late filings. [March 31, 2020]
Question 135.13
Question: Can a registrant that filed a Form 12b-25 subsequently rely on the COVID-19 Order (Release No. 34-88465 (March 25, 2020)), to extend the filing deadline for the subject report?
Answer: The COVID-19 Order is conditioned on a registrant having furnished a Form 8-K or Form 6-K by the later of March 16, 2020 or the original due date of the report. A Form 12b-25 filing does not extend the original due date of a report. Therefore, unless a registrant that filed a Form 12b-25 also furnished a Form 8-K or Form 6-K by March 16, 2020 or the original due date of the report, it would not be able to rely on the COVID-19 Order.
On the other hand, a registrant that relies on the COVID Order for a report will be considered to have a due date 45 days after the original filing deadline for the report. As such, the registrant would be permitted to subsequently rely on Rule 12b-25 if it is unable to file the report on or before the extended due date. Registrants unable to rely on the COVID-19 Order are encouraged to contact the staff to discuss collateral consequences of late filings. [March 31, 2020]
Heightened Insider Trading Risk
With the ongoing Covid-19 pandemic, there is heightened risk for insider trading as more people might have access to material non-public information (MNPI). We’ve blogged before about the need to maintain confidentiality of MNPI and with nearly everyone working remotely, this seems especially important now. The SEC has made clear that it’s focused on securities fraud during the current crisis. Last week, the Co-Directors of the SEC’s Division of Enforcement issued a statement about the impact of Covid-19 on market integrity. Here’s an excerpt:
In these dynamic circumstances, corporate insiders are regularly learning new material nonpublic information that may hold an even greater value than under normal circumstances. This may particularly be the case if earnings reports or required SEC disclosure filings are delayed due to COVID-19. Given these unique circumstances, a greater number of people may have access to material nonpublic information than in less challenging times. Those with such access – including, for example, directors, officers, employees, and consultants and other outside professionals – should be mindful of their obligations to keep this information confidential and to comply with the prohibitions on illegal securities trading.
In this interview transcript on CNBC, SEC Chairman Clayton reiterated this message saying “anyone who is privy to private information about a company or about markets needs to be cautious about how they use that private information. That’s sort of fundamental to our securities laws and that applies to government employees, public officials, etc. And the STOCK Act codifies that.”
These recent statements come on the heels of reports about Congressional trades right before the market downturn, which are now reportedly being investigated by the DOJ and SEC. But if companies haven’t already done so, now would be a good time to review who has access to inside information and compliance procedures to see whether extra steps are necessary to minimize insider trading risk.
Transcript: “The Coronavirus: What Should Your Company Do Now?”
We have posted the transcript from our recent webcast: “The Coronavirus: What Should Your Company Do Now?”
Last fall, Broc ran the 2nd Annual “Cute Dog” Contest. Baker Botts earned bragging rights with Jude Dworaczyk’s “Penny the Hair Bow Aficionado” representing the firm. Some members responded asking that we run the contest again and some suggested a future “cute cat” contest, which we will try to get on deck for some time in 2020. So, with all the heavy news lately, let’s take a look at more “cute dog” photos – and one cute rabbit! The poll is at the bottom of the blog.
1. Gibson Dunn’s Lori Zyskowski – Snickers the “Snowdoodle”
2. Norfolk Southern’s Ginny Fog – Barnaby the “Chillin’ Lounger”
3. Covington & Burling’s Reid Hooper – Midnight and Hercules the “Dynamic Duo”
4. Travelers’ Wendy Skjerven – Mulligan the “Prince of Second Chances”
5. Our own John Jenkins – Shadow the “Backseat Driver”
6. Sidley Austin’s Andrea Reed – Peaches the “City Slicker”
Vote Now: “Cutest Dog Contest”
Vote now in this poll – anonymously – for the dog that you think is the cutest:
survey hosting
Cyan Agonistes: Del. Supreme Ct. Upholds Federal Forum Provisions
Sharing a blog entry here that John posted yesterday on DealLawyers.com as it’s of interest to many: In its 2018 Cyan decision, the SCOTUS unanimously held that class actions alleging claims under the Securities Act of 1933 may be heard in state court. It also held that if those claims are brought in a state court, they can’t be removed to federal court. Some corporations responded to Cyan by adopting “federal forum” charter provisions compelling shareholders to bring 1933 Act claims only in federal court. Much to the chagrin of the defense bar, the Delaware Chancery Court struck those provisions down in Sciabacucchi v. Salzberg, (Del. Ch.; 12/18).
Yesterday, the Delaware Supreme Court unanimously reversed the Sciabacucchi decision. In Justice Valihura’s sweeping 53-page opinion, the Court rejected claims that federal forum provisions were contrary to any Delaware law or policy, and read Section 102(b) of the DGCL as a broad enabling statute that provides Delaware corporations with more than enough flexibility to include a federal forum provision in their certificates of incorporation.
Section 102(b)(1) authorizes the certificate to include “any provision for the management of the business and for the conduct of the affairs of the corporation” and “any provision creating, defining, limiting and regulating the powers of the corporation, the directors, and the stockholders, or any class of the stockholders.” While that authority can’t be used to adopt provisions that violate law or public policy, the Court concluded that a federal forum provision, or FFP, didn’t raise either of those concerns:
First, Section 102(b)(1)’s scope is broadly enabling. For example, in Sterling v. Mayflower Hotel Corp., this Court held that Section 102(b)(1) bars only charter provisions that would “achieve a result forbidden by settled rules of public policy.” Accordingly, “the stockholders of a Delaware corporation may by contract embody in the [certificate of incorporation] a provision departing from the rules of the common law, provided that it does not transgress a statutory enactment or a public policy settled by the common law or implicit in the General Corporation Law itself.”
Further, recognizing that corporate charters are contracts among a corporation’s stockholders, stockholder-approved charter amendments are given great respect under our law. In Williams v. Geier, in commenting on the “broad policies underlying the Delaware General Corporation Law,” this Court observed that, “all amendments to certificates of incorporation and mergers require stockholder action,” and that, “Delaware’s legislative policy is to look to the will of the stockholders in these areas.” Williams supports the view that FFPs in stockholder-approved charter amendments should be respected as a matter of policy. At a minimum, they should not be deemed violative of Delaware’s public policy.
The Court rejected claims that the language added to Section 115 of the DGCL in 2015 codifying the Boilermakers decision permitting exclusive forum bylaws represented an implicit recognition that FFP provisions were impermissible. It also rejected the Chancery’s effort to limit Section 102(b)’s reach to matters covered by the “internal affairs” doctrine, and said that the Chancery’s decision took a narrower approach to what constituted “internal affairs” than either applicable federal or Delaware precedent.
On a personal note, I’d like to express my thanks to the Delaware Supreme Court for giving me something to blog about that’s completely unrelated to the Covid-19 pandemic & for allowing me to fulfill my dream of using the word “agonistes” in a blog title. Now, when somebody googles John Milton or Gary Wills, they may stumble across me! That’s the closest thing to literary immortality that a fat guy in pajamas pounding on a keyboard can reasonably hope to achieve. . .
COVID-19: First Securities Lawsuits Filed
With all the market turmoil, one more unfortunate outcome from COVID-19 is possible securities lawsuits – and it didn’t take long. A memo from Jenner & Block says stock drop class actions have been filed against two companies. First, there’s a suit against a cruise line operator alleging the company misrepresented the impact of COVID-19 by minimizing the likely impact on its operations.
Another suit has been filed against a pharmaceutical company. In this case, the suit alleges the company misrepresented its progress on a COVID-19 vaccine. Hopefully these cases aren’t indicative of a coming trend. Bottom line as noted in the memo – it’s hard to say whether these cases will be successful but companies should take extra care when making any public statements about the potential impact of COVID-19 on their business.
According to this report, Chief Audit Executives (CAEs) don’t think that companies are doing a very good job evaluating corporate governance. The report was issued by the Institute of Internal Auditors and the Neel Center for Corporate Governance at the University of Tennessee. The report says that IIA and the Neel Center partnered to develop what they call the “American Corporate Governance Index” (ACGI) that’s based on eight guiding principles of corporate governance.
The report is based on survey responses from 128 Chief Audit Executives of publicly traded U.S. companies. Survey respondents answered questions anonymously, so scores aren’t assigned to individual companies, by indicating their level of agreement or disagreement with specific statements and scenarios.
Emphasizing the difficulty in overseeing corporate governance across all levels of an organization, the report’s survey questions were designed to capture the effectiveness of corporate governance enterprise wide. Key findings include:
– 10% of Index companies scored an F
– Many companies are willing to sacrifice long-term strategy in favor of short-term interests
– More than one-third of board members are not willing to offer contrary opinions or push back against the CEO
– Boards fail to verify the accuracy of information they receive
– Independent boards drive stronger governance
– Companies are vulnerable to corporate governance weaknesses or failures – the report says that the majority of respondents reported no formal mechanism for monitoring or evaluating the full system of corporate governance
– Regulation does not correlate with stronger governance
Aside from the report’s key findings, it also said that CAE’s reported when corporate governance is formally evaluated, internal audit completes the evaluation 75% of the time, and when not, it’s often done by the GC’s office or under the direction of the board governance committee, at which point “it is more likely to be a compliance ‘check-the-box’ exercise”. Reading that CAE’s say regulation doesn’t correlate with stronger governance, regulations aside, I suspect many wouldn’t support dropping ‘check-the-box’ governance evaluations.
Insider Trading: Ex-Legal Department Employee Gets Caught
Last year, John blogged about how lawyers seemed to be getting caught in the cross-hairs of insider trading cases. It can be a little unnerving to read of these cases, especially when lawyers know better and company legal departments have policies and safeguards in place to mitigate insider trading risks.
But, here we are again. I recently saw this story about a SEC settlement involving a now ex- in-house legal department employee. According to the story, the employee, who was a legal assistant, got his hands on an update to the company’s board about a pending acquisition – the update was marked “strictly confidential”. The ex-employee then purchased shares in the target company and tipped his 86-year old father who also purchased the target’s shares. The story says the ex-employee got cold feet and sold his shares in the target but his father hung on for the acquisition announcement and resulting gain. Both the son and father agreed to pay civil penalties of about $20,000 with the father also giving up the illicit profit.
Bottom line – just don’t do it! For anyone wanting to brush-up on insider trading considerations, check out the “Insider Trading” Handbook available on our website that includes a sample insider trading policy as well as discussion of the scope and content for insider trading policies.
Our March Eminders is Posted!
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It looks like the SEC didn’t waste much time in finding its big company poster child for key performance indicators (KPI). Yesterday, the SEC issued a press release announcing an enforcement proceeding where it brought charges against Diageo plc for disclosure failures. The enforcement proceeding is right on the heels of the SEC’s KPI interpretive release that John blogged about just a couple of weeks ago. Here’s the crux of what the SEC had to say:
According to the SEC’s order, employees at Diageo North America (DNA), Diageo’s largest and most profitable subsidiary, pressured distributors to buy products in excess of demand in order to meet internal sales targets in the face of declining market conditions. The resulting increase in shipments enabled Diageo to meet performance targets and to report higher growth in key performance indicators that were closely followed by investors and analysts. The order finds that Diageo failed to disclose the trends that resulted from shipping products in excess of demand, the positive impact the overshipping had on sales and profits, and the negative impact that the unnecessary increase in inventory would have on future growth. The order further finds that investors were instead left with the misleading impression that Diageo and DNA were able to achieve growth in certain key performance indicators through normal customer demand for Diageo’s products.
Without admitting or denying the findings in the SEC’s order, Diageo agreed to cease and desist from further violations and to pay a $5 million penalty.
You can find memos about the SEC’s KPI interpretive release posted in our “MD&A” Practice Area.
SEC Public Statement on Coronavirus
Yesterday, the SEC issued a public statement on the effects of the coronavirus on financial reporting. In late January, John blogged about Chairman’s Clayton’s statement addressing disclosure implications from the coronavirus outbreak.
Yesterday’s statement said SEC Chairman Clayton, Corp Fin Director Hinman, SEC Chief Accountant Teotia and PCAOB Chairman Duhnke met with the leaders from the Big 4 audit firms to continue discussions around difficulties in conducting audits in China and other emerging markets. In these discussions, they also discussed the “potential exposure of companies to the effects of the coronavirus and the impact that exposure could have on financial disclosures and audit quality, including, for example, audit firm access to information and company personnel.” Here’s an excerpt from the SEC’s statement:
The coronavirus effects on any particular company may be difficult to assess or predict, because actual effects may depend on factors beyond the control and knowledge of issuers. However, how issuers plan and respond to the events as they unfold can be material to an investment decision, and we urge issuers to work with their audit committees and auditors to ensure that their financial reporting, auditing and review processes are as robust as practicable in light of the circumstances in meeting the applicable requirements.
Specifically, we emphasized: (1) the need to consider potential disclosure of subsequent events in the notes to the financial statements in accordance with guidance included in Accounting Standards Codification 855, Subsequent Eventsand (2) our general policy to grant appropriate relief from filing deadlines in situations where, in light of circumstances beyond the control of the issuer, filings cannot be completed on time with appropriate review and attention. In addition, if issuers have questions regarding the reporting of matters related to the potential effects of the coronavirus, including potential subsequent event disclosure, we welcome engagement on these matters.
The SEC’s statement says that companies are encouraged to contact the SEC regarding any need for relief or guidance.
PCAOB Conversations with Audit Committee Chairs
The PCAOB recently issued a report that summarizes information gathered from conversations with nearly 400 audit committee chairs. The conversations were primarily focused on audit quality and provide insight on a variety of topics including audit committee perspectives of the auditor, new auditing and accounting standards and technology and innovation. Here’s an excerpt about what audit committees are saying works well:
– Reviewing other audit firms’ inspections reports to see if there are any lessons learned or questions about potentially similar issues that could be discussed with your auditor
– Conducting an assessment – on at least an annual basis – of the engagement team and audit, including discussions around what went well and what could be improved
– Using outside consultants or experts to educate the audit committee on new or complex accounting standards
The report also provides an overview of PCAOB 2019 inspections and touches on how the PCAOB selects audits for inspection, what an inspection entails and what happens when a deficiency is identified.
When it comes to “cyber response plans,” the planning stage is a lot more useful if it’s actually been tested. A blog discussing the recently issued SEC OCIE Cybersecurity and Resiliency Observations says if you’re not practicing what to do when you experience a cyber attack, you’re not being realistic about your chances of effectively responding to it.
Although the SEC OCIE observations are primarily directed toward broker-dealers and investment advisors, the recommendations seem worthwhile for any company, one being testing and monitoring:
Establishing comprehensive testing and monitoring to validate the effectiveness of cybersecurity policies and procedures on a regular and frequent basis. Testing and monitoring can be informed based on cyber threat intelligence.
It also recommends testing the incident response plan and potential recovery times, using a variety of methods including tabletop exercises. If an incident occurs, implement the plan and assess the response after the incident to determine whether any changes are necessary.
This recent blog from McGuireWoods is helpful because it summarizes how to run an effective tabletop exercise to test your response plan. Here’s a few recommendations:
– Objectives – set ground rules for the exercise, who speaks first, is there a budget for the response, level of detail to be provided, determine the focus of the exercise – detection, containment, etc.
– Evaluation – think about how to evaluate the exercise, identify a note-taker during the exercise, detail the evaluation process
– Full participation – ensure key participants coordinated their responses, ensure contractual partners are included, determine who has authority to resolve disagreements
– An experienced facilitator – bringing in an experienced facilitator can help ensure all areas have a voice and that the exercise stays on track so the result is measurable
Tips for Improving Data Privacy Provisions
Besides testing your cyber response plan, another thing to consider is the data privacy provision in contracts. I recently came across this memo in CFO.com that provides 8 tips for improving data privacy provisions in contracts. Most of us can think of a few service provider arrangements at our companies that we know house sensitive customer or employee data. The last thing we want is for that service provider to experience a data breach and soon we are pulled into the crisis with them.
Improving data privacy provisions of these contracts can boost risk management efforts – here’s an excerpt from the memo with some of the tips:
– Synch the indemnification and limited liability provisions – no need to have a great indemnification provision if it’s all wiped away by a limited liability provision that says the vendor’s liability is limited to some small dollar amount
– Avoid early termination fees – especially important if you’ve already been working with the vendor in certain capacities, early termination as a result of a data breach seems reasonable and it’s hard to see what costs the vendor would have a right to recover
– Vendor should agree to comply with all applicable data privacy and security laws – with rapidly changing laws, the vendor may not want to do so but stressing that you don’t accept carve outs for this is necessary – how do you explain to the board that you have a vendor that doesn’t agree to abide by all applicable laws?
Tomorrow’s Webcast: “Audit Committees in Action – The Latest Developments”
Tune in tomorrow for the webcast – “Audit Committees in Action: The Latest Developments” – to hear Deloitte’s Consuelo Hitchcock, EY’s Josh Jones and Gibson Dunn’s Mike Scanlon discuss recent SEC, FASB & PCAOB guidance impacting audit committees, evolving practices for audit committee charters, agendas and meetings and how the audit committee should manage its relationship with the independent auditor.
Don’t miss the latest episode of the “Dave & Marty Radio Show” – in which Dave Lynn and Marty Dunn engage in a lively discussion of the latest developments in securities laws, corporate governance, and pop culture. Topics in this 24-minute episode include:
– Recommendations for tuning up your risk factors
– Early trends in the shareholder proposal season
– Evolving musical tastes in a world of technological innovation
Newer Sustainability Reporting Frameworks are Picking up Global Endorsements
This year has already seen significant endorsements of the newer sustainability reporting frameworks: the Sustainability Accounting Standards Board (SASB) and the Task Force for Climate-related Financial Disclosures (TCFD).
As Lynn blogged last month, Blackrock’s annual letters from CEO Larry Fink note that Blackrock is more strongly encouraging its portfolio companies to provide sustainability disclosure in accordance with SASB’s industry-specific standards and the TCFD’s recommendations, including a company plan for operating under a global warming scenario of 2 degrees Celsius or lower. To back up its “encouragement”, Blackrock will increasingly vote against management and boards whose companies aren’t “making sufficient progress on sustainability-related disclosures and the business practices and plans underlying them.”
A related endorsement came out of Davos last month, where the World Economic Forum’s International Business Council (IBC) – which includes 140 large global companies — supported the development of an ESG reporting framework that also relies on existing disclosure frameworks, including SASB and TCFD. A draft framework has been proposed by the Big Four accounting firms, which have actively supported many of the sustainability reporting initiatives and are well placed to do third-party audits of the corporate ESG disclosures.
This growing support for SASB and TCFD is consistent with the report that Glenn Davis and I co-authored last September, “Sustainability Reporting Frameworks: A Guide for CIOs”, for the Council of Institutional Investors (CII). The text of this Guide is intended to be a quick read for pension fund CIOs and other readers, who want to learn:
The main differences between the primary reporting frameworks (summarized further in a brief Appendix)
Related considerations for fund CIOs and their staffs
Open issues for the future
For ESG reporting geeks who want more, the 50+ footnotes link to related research and articles, plus helpful disclosure examples.
Skipped Class the Day Insider Trading was Covered?
Insider trading stories really do make me shake my head in disbelief and I did that when reading a recent story. In this case, the SEC caught up with a recent college grad for insider trading – within the grad’s first year on the job as a junior investment banker. The action seems pretty cut and dry – within the first year out of college and while working as a junior investment banker, the grad learned of a pending deal, bought call options and sold them for a profit shortly after the deal was announced. Here’s an excerpt from the SEC’s press release:
The grad agreed to settle with the SEC and consented to the entry of a judgment permanently enjoining him from violating the antifraud provisions of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder and ordering him liable to pay disgorgement of his ill-gotten trading profits, with interest, which will be offset by the amount of any forfeiture ordered against the grad in a parallel criminal action. In a separate administrative proceeding instituted on December 23, 2019, the grad consented to be barred from association with any broker, dealer, investment adviser, municipal securities dealer, municipal advisor, transfer agent, or nationally recognized statistical rating organization, and from participating in any penny stock offering.
On the same day the SEC filed its action, the U.S. Attorney’s Office for the Southern District of New York announced parallel charges against him. The grad pleaded guilty in the criminal action, and in January 2020 he was sentenced to five years of probation and ordered to forfeit approximately $126,000.
According to this story, the grad is reportedly the former study body president at NYU’s Stern School of Business and at one time gave advice to first-year students to “hold on to your values”. Not sure what values this person had in mind. It’s hard to imagine that someone wouldn’t understand the concept of insider trading even if the person missed class the day the prof covered it. But, it’s sad to think this could be another case where the person just thought they wouldn’t get caught…
This memo from the Journal of Accountancy gives me LSAT flashbacks. Based on remarks from an SEC Professional Accounting Fellow, it explains that while critical audit matters tend to be a subset of critical accounting estimates, some CAMs have not been reported as critical accounting estimates by management. Here’s an excerpt:
For example, one auditor reported that evaluation of the identification of related parties and related-party transactions was a critical audit matter, but there wasn’t a critical accounting estimate related to that topic.
Sometimes, Collins said, an auditor identifies a critical audit matter that is a component of a related critical accounting estimate. For example, one critical audit matter related to a goodwill impairment analysis for a specific reporting unit that was considered at risk for impairment. Management’s critical accounting estimate, meanwhile, related to goodwill impairment more broadly.
The memo also quotes SEC Deputy Chief Accountant Marc Panucci as urging auditors and companies to approach critical audit matters as a blank sheet of paper each year. Often, they might end up being the same from year to year, but auditors won’t know that until they’ve considered the facts & circumstances of each each individual audit.
Disclosure Reform: Are ESG Risks “Material”?
Over the past couple of years, the SEC has taken a few small steps toward “disclosure reform” – with its 2018 “Disclosure Update & Simplification” and 2019 “Fast Act Modernization” amendments – as well as with its more recent proposal to modernize Items 101, 103 and 105 of Reg S-K. Although the most recent proposal drew thousands of comments – including from Big Yoga! – none of the recent or anticipated rule changes would overhaul ESG risk disclosure in the way that some investors say they want.
One of the main objections to even considering rules on this topic is that the info wouldn’t be material. To get a sense of who shares that view, a recent study published in the Villanova Law Review takes a closer look at the comment letters submitted in response to the SEC’s 2016 Concept Release – apparently there were 25,000 comments but only 375 “unique” responses. Here’s an excerpt:
The findings here confirm that concerns about investors’ disclosure overload are overblown and indeed, outdated. While many investors support some streamlining of risk-related disclosure, most investor comments focus on the under-disclosure of material information, not the reverse.
The empirical results discussed in Part III below confirm that respondents’ support for, or opposition to, ESG disclosure reform has less to do with ESG and more to do with their underlying views on materiality, the value of prescriptive disclosure, and how satisfied they are with the current state of reporting.
At the same time, this study also finds a surprising level of agreement among respondents on a number of the SEC’s proposals to simplify risk-related disclosures, particularly with regard to market risk disclosures and MD&A.
What I found refreshing was that the study confirmed the SEC, investors and business community all agreed that risk disclosures are extensive but frequently generic and boilerplate – and there was general agreement for more principles-based disclosure. The study provides another entry point for conversations about ESG risk disclosure – e.g., consideration needs to be given to not only increased compliance costs that companies would incur with expanded disclosure but also costs to investors of under-disclosing material ESG information.
Tomorrow’s Webcast: “Conflict Minerals – Tackling Your Next Form SD”
Join us tomorrow for the webcast – “Conflict Minerals: Tackling Your Next Form SD” – to hear our own Dave Lynn of Morrison & Foerster, Ropes & Gray’s Michael Littenberg, Lawrence Heim of the Responsible Minerals Initiative and Deloitte’s Christine Robinson discuss what you should now be considering as you prepare this year’s Form SD.
With the comment period for the SEC’s proposed rules on regulating proxy advisors and the shareholder proposal process closing today – February 3rd – let’s take a peek at some of the comment letters submitted so far on these topics – available here and here, respectively.
First, among other things, T. Rowe Price has asked the SEC to refocus on proxy infrastructure – e.g. end-to-end vote confirmation – and to go back to the drawing board. That’s similar to recent recommendations from the SEC’s Investor Advisory Committee – I blogged last week on our “Proxy Season” Blog that the Committee wants the SEC to revisit its priorities and re-do the proposals.
Some letters focus primarily on the proposal dealing with regulation of proxy advisors (see this letter from Value Edge Advisors, Nell Minow), while others focus primarily on the proposal dealing with the Rule 14a-8 shareholder proposal process (like this one from First Affirmative) – and some address both (e.g., Neuberger Berman).
The Council of Institutional Investors issued a press release criticizing the proposals and then submitted two letters, one on the regulation of proxy advisors and another on the Rule 14a-8 shareholder proposal process, each is 65 pages long. Here’s an excerpt from CII’s press release:
The two proposals are the most significant attempt by the SEC to limit the voice of shareholders since the Commission was created in 1934. They would tighten regulation of proxy advisory firms and shareholder proposals in ways that CII believes are fundamentally flawed and unnecessary. If adopted, both proposals would introduce complexity and micromanagement in proxy voting and in shareholder-company engagement processes that have worked well for decades. CII urges the SEC to withdraw both proposals and focus instead on festering problems in the proxy voting system.
Here are a few other letters worth noting:
– Boston Trust Walden (signatories include, among others, As You Sow, Mercy Investment Services, NYC Comptroller, Trillium Asset Management)
– Principles for Responsible Investment (sign-on letter – signatories include, among others, BMO Global Asset Management, ClearBridge Investments, Legal & General Investment Management, MFS Investment Management, New York State Comptroller, Wellington Management Company)
Aside from traditional comments to the SEC, at least one asset manager has criticized the proposed rules in a letter to clients – here’s a client letter from Daniel Loeb’s Third Point (comments on rule proposal on pg 4).
As reported in the NY Times and Reuters, in a speech last week, SEC Commissioner Roisman defended the proposals and said that some of the comments are based on misinformation but he is “open to changing his mind” on the direction of the proposals.
And, even though the comment period closes today, comments will continue to roll in…
CalPERS and CalSTRS Report on Climate-Related Financial Risk
CalPERS has issued its first report on climate-related financial risk of its public market portfolio, including the fund’s alignment with the Paris Agreement and California climate policy goals and the exposure of the fund to long-term risks.
Among information included in the report is a summary of public market exposures and anticipated climate-related financial risks in sectors noted by the TCFD as most exposed to climate risks and opportunities. The report also provides an analysis of how CalPERs work on climate change is aligned with the Paris Agreement and California climate policy goals and it outlines some of CalPERS engagement activities. Engagement activities have included meeting in person with company management and in some cases board members about climate risk.
CalSTRS also filed its first report on climate-related financial risk under California Senate Bill 964. CalSTRS’ report, titled “Green Initiative Task Force“, includes additional content compared to prior reports in that it says the report analyzes CalSTRS climate risk exposure and describes how it supports California’s climate goals. The report also is structured to align with the TCFD framework of recommended climate-related financial disclosures – governance, strategy, risk management, and metrics and targets.
The reports also summarize CalPERS and CalSTRS proxy voting on environmental proposals during the 2019 proxy season – each fund typically supports proposals asking for improved environmental risk reporting unless it believes that the company already provides adequate disclosure about these risks. In 2019, CalPERS and CalSTRS each supported 54% of environmental proposals.
As noted in the reports, California Senate Bill 964 requires CalPERS and CalSTRS to publicly report this information every three years until January 31, 2035. Because this was CalPERS first report, in the report CalPERS states that it welcomes the California legislature’s feedback. So, let’s check back in three years and see how the report has evolved. In the interim, CalSTRS report says that it will provide an annual update highlighting its low-carbon transition activities.
Our February Eminders is Posted!
We have posted the February issue of our complimentary monthly email newsletter. Sign up today to receive it by simply entering your email address!
