In connection with yesterday’s AICPA conference, SEC Chief Accountant Wes Bricker provided this statement on financial reporting & auditing issues that he’s been discussing with SEC Chair Jay Clayton and others. As you’d expect, a lot of the statement is aimed toward auditors – e.g. what they should be doing to improve quality. But the statement also emphasizes the role of companies in the financial reporting process – with plenty of recommendations for audit committees and management:
– Internal controls – particularly where there are close calls as to a significant deficiency or material weakness, audit committees should pay extra attention to the adequacy of & basis for the company’s ICFR assessment, and seek training if necessary (citing this enforcement action). It’s vital to focus not just on actual misstatements but also whether it’s reasonably possible that a material misstatement won’t be prevented or detected in a timely manner.
Also remember that it’s the company’s responsibility to develop, maintain & assess ICFR – and that the thresholds for auditor attestation don’t change these requirements (it’s not obvious whether this remark is intended to foreshadow a change to the attestation requirement, which was discussed as a future possibility when the SEC increased the smaller reporting company threshold and in today’s Senate testimony by SEC Chair Jay Clayton). This blog from Cooley’s Cydney Posner reports that several members of the OCA Staff also discussed internal controls issues at yesterday’s AICPA Conference – with tips on how to assess controls and how to adequately disclose a material weakness.
– CAMs – conduct a “dry run” so that the auditors & audit committee can discuss issues. It’s also important to understand that CAMs aren’t intended to duplicate management’s MD&A disclosure of critical accounting estimates.
– Continuing education for audit committees – audit committee members must have time, commitment and experience to do the job well. Just possessing financial literacy may not be enough to understand the financial reporting requirements fully or to challenge senior management on major, complex decisions. Audit committees must stay abreast of these issues through adequate, tailored, and ongoing education.
– Audit committee agendas – must be balanced toward understanding accounting, ICFR and reporting requirements. For example, as business, technology, accounting, and reporting requirements change, it is crucial that the audit committee understand management’s approach for designing and maintaining effective internal controls.
– Voluntary disclosure – OCA Staff encourages audit committees for listed public companies of all sizes to communicate how the listing requirements related to the “appointment, compensation, and oversight of the work of any registered public accounting firm. . .” are carried out, especially among smaller companies. There are positive disclosure trends among S&P 1500 companies when it comes to disclosing considerations in appointing the audit firm, fee negotiations and evaluations – but there are opportunities for more progress among mid- and small-cap companies.
– Company processes to ensure auditor independence – emphasizing the role of companies to promote compliance by regularly monitoring corporate structural changes or other operational events that may result in new affiliates or business relationships and timely communicating these changes to the auditor, as well as evaluating the sufficiency of these monitoring processes & practices. Also note that the OCA Staff is assessing comments on the auditor independence “loan” rule – final rulemaking is expected in 2019.
– Auditor communications – to enhance oversight, audit committees should consider requesting additional voluntary information from the auditor to understand their level of investment in quality control functions, the connection of technology to audit quality and how audit firm performance compares to others.
– New GAAP standards – continue to focus on implementing & refining compliance with new standards on revenue recognition, leases & current expected credit losses
“Accredited Investor” Verification: SEC Enforcement is Watching
Last week, the SEC issued a cease-and-desist order against CoinAlpha Advisors for a Reg D offering gone wrong – which shows that Enforcement will take issue with relying on self-completed questionnaires to verify accredited investor status under Rule 506(c). Here’s an excerpt from Steve Quinlivan’s blog:
The SEC alleged CoinAlpha did not have pre-existing substantive relationships with nine of the fund’s investors and engaged in a general solicitation of public interest in the securities offering through CoinAlpha’s website, which was generally accessible without password protection. Additionally, CoinAlpha engaged in general solicitation through blog postings, and media interviews and digital asset and blockchain conferences, accessible both via live attendance and through the Internet. Despite collecting accredited investor questionnaires and representations from investors certifying to their accredited investor status, Respondent did not take reasonable steps to verify that investors in the Fund were accredited investors.
During the subsequent SEC investigation, CoinAlpha retained a third party who determined that all 22 investors were accredited investors.
The SEC found CoinAlpha engaged in an unregistered public offering. CoinAlpha did not admit or deny the SEC’s findings.
– What led you to write “The Governance Revolution”?
– What are the most important messages in the book?
– When it comes to some of the hazards of the board process, what is “The State Dinner” all about?
– What about “Bullying”?
– What has been the biggest surprise for you in reaction to the book?
Mock me all you want, but before I had kids I was a fanatic for live music of all genres – and watching Snoop Dogg in the pouring rain at an “indie” rap festival stands out as one of the most memorable performances I’ve seen. And since one of my other hobbies is cooking, my worlds collided when I read this Bloomberg article about Snoop’s new 192-page cookbook – “From Crook to Cook.”
Apparently, the compilation has all the (cannabis-free) edibles you need for a solid Thanksgiving…and lots more. Snoop is probably picking up some of Martha Stewart’s cooking game, now that they have an (Emmy-nominated!?) VH1 show together – but no doubt his creations have some special twists. If anyone out there actually buys this book and tries a recipe, please let me know how it is. I’m already intrigued by this concept for sweet potato pie, as described by Bloomberg:
“These days everyone is into pumpkin spice, but I skip the pumpkin—sweet potato pie is a real ’hood staple and Broadus family favorite. [Pop-culture fact: Snoop was born Calvin Cordozar Broadus.] A little orange makes the sweet potato flavor stronger, and that’s what you’re here for, right?”
Nearly 30% of companies highlight quantitative information at the top of their earnings release – and after writing my fair share of headlines, I can understand why! Numbers are succinct, eye-catching, and (presumably) accurate. But a recent study shows that this practice may lead to some pretty big swings in stock price – and might foreshadow lower earnings over the long-term. This article summarizes the findings – here’s an excerpt:
The study of more than 17,000 earnings releases over an 11-year period finds that increasing headline salience (for example, when earnings exceed forecasts, headlining by how much), gives a hefty lift to a firm’s stock price beyond the rise that is normally occasioned by good news. On average, adding one strong performance number to a headline increases a results-inspired boost by an extra one third in the three-day period around the announcement.
Citing psychology research, the professors see this extra boost as due to the effectiveness of headline numbers in attracting investor attention. In addition, “an initial favorable impression can lead investors to underweight contradictory information elsewhere in the report.”
But investors beware: after a quick stock-price lift, salience likely portends a considerable reversal over the 60 days following the earnings announcement, a reversal greater than the initial boost that the salience bestowed. In other words, as the professors write, “investors not only undo their initial reaction due to salient headlines but even revise their beliefs in the opposite direction in the subsequent period.” In sum, “headlining quantitative information incites investor overreaction to the earnings news at the time of the earnings announcement…This suggests that headline salience misleads investors.”
And here are some other interesting takeaways:
– Companies that flaunt strong current results in headlines tend to have lower long-term earnings (beyond the current quarter)
– High salience is strongly correlated with increased insider stock sales in the month following earnings announcements and also with the recent vesting of executives’ stock
– Both 3-day stock returns and 60-day reversals increased with greater headline salience, both being higher as the number of headline statistics increased (for example, from zero to one or from one to two).
– While headline salience is effective when earnings exceed analyst forecasts, that is not the case when they do not. In other words, greater salience does not spur investor interest when earnings barely meet or fall short of predictions.
– Headlined earnings numbers have more effect when expressed as percentages than when stated in dollars.
Farewell to Penny Stocks?
I mentioned in a blog last month that there are an estimated 10k publicly-traded microcaps – but most aren’t listed on an exchange (h/t to Adam Epstein for that stat). But we might see a decline in those numbers if the secondary market evaporates – and there are signs that it’s heading in that direction. Here’s the intro from this Forbes op-ed by Richard Levick:
An event that rather significantly affects the financial markets has just occurred without much if any fanfare in the financial press. Bank of America’s Merrill Lynch announced that, as of September 30, it will not allow clients to sell microcap stocks, known as penny stocks, without a regulatory review and will outright ban sales of the riskiest ones. The bank had already discontinued purchases in July.
If enough other financial institutions follow suit, the penny stock market could disappear altogether. As of this writing, Morgan Stanley and UBS have not followed Merrill’s lead, according to sources cited by CNBC reports, but investors sense a chill wind has begun to blow. Shares from companies valued under $300 million and traded for under $5 on an over-the-counter market are the ones affected – in other words, virtually the entire microcap market.
Since I was in Washington DC for the Fall Meeting of the ABA Business Law Section, I thought I’d arrive a day early to attend the SEC’s “Proxy Process Roundtable.” Broc encouraged me to share the “look & feel” of the experience for those that have never visited the Mothership. So here’s eight interesting things that I noticed:
1. Lots of Speakers on Panels – There were three panels for the roundtable – each scheduled for 90 minutes. One panel had 10 speakers, another had 11 – and one had 14! That one ended up running over two hours – and one of the panelists didn’t even get to introduce himself till the very end. For comparison, we’re setting the agendas right now for next year’s “Women’s 100” events – and we have 9 speakers for all of our panels for an entire day.
In some cases, it was hard to get a good feel for a speaker’s views & ideas because their speaking time was limited (but some panelists definitely didn’t let that stop them!) – and as a listener it was hard sometimes to stay focused for such a long discussion, with no audience interaction. This is what a 14-speaker panel looks like – a total of 21 people up on the dais with all the SEC officials…
2. Short Opening Remarks – Chair Clayton limited his opening remarks to allow more time for the panelists to share their views. Remarks from Commissioner Stein, as well as Commissioner Roisman and Corp Fin Director Bill Hinman, were also very brief. In fact, the first panel started about 30 minutes early! Bill did take a moment to pay tribute to Evelyn Y. Davis, though.
3. Surprising In-Person Turnout – Broc warned me that the roundtable might be lightly attended. He said that in the old days, the SEC’s open Commission meetings & roundtables were well-attended. But now that they are webcast, people understandably watch online. So it was surprising to see that more than a hundred people were there in person, despite DC having the worst November snowstorm in 29 years. Here’s a picture of what the audience looked like.
4. NAM/Chamber’s Campaign Encouraged Attendance – Recently, the National Association of Manufacturers & the US Chamber have been running ads against proxy advisors – including full-page spreads in the WSJ and Washington Post. They’ve spent six figures on their media campaign! Here’s what the ads looked like. As part of this campaign, the groups operate ProxyReforms.com – a site that had been encouraging folks to attend the last panel of the day (the one about proxy advisors).
5. Minor Infotainment (for a Conference) – Although not as riveting perhaps as “Bodyguard” (new Netflix series that Broc recommends; I haven’t seen it), the panels tended to be more entertaining than a typical conference panel. There were speakers on all sides of the issues & sparks flew on more than one occasion.
Chair Clayton, the Commissioners & Corp Fin Staff emphasized throughout the day that they were hoping to get some specific recommendations. A surprising number of panelists thought the shareholder proposal rules and proxy advisor framework is okay ‘as-is.’
This wasn’t everyone’s view (tended to be people who could be disadvantaged if the rules change, though not in every case) – and there were calls for targeted improvements like giving all companies some time to respond to voting reports before they’re public and some tweaks to the proposal submission thresholds. But when it came to proxy plumbing, there were more calls for change – maybe even a total overhaul. Even speakers that weren’t on that panel said they thought that’s where the SEC should focus its time & resources.
6. A Tweet War? – Recently, John blogged about “Tweet Fight! Nell Minow v. Main Street Investors Coalition.” For this roundtable, there was some live tweeting from the audience under #proxyroundtable – with most of the tweets coming from opposite ends of the spectrum: Main Street Investors Coalition v. ValueEdge Advisors (for whom Nell Minow is a part of) – as well as Minerva Analytics and others.
7. Going Through Security – Broc also shared stories about the old days & how visitors to the SEC used to be able to go upstairs and deliver packages, etc. without even checking in. Now, he warned me to go early, because you need to get a badge & go through a metal detector. They were efficient – but with the large attendance, I’m pretty sure it took me longer than airport security! In the morning line, I happened to befriend a fellow Minnesotan. And it was in the after-lunch line that I learned of the Main Street Investors Coalition’s ad campaign. So it wasn’t time wasted.
8. DC is Magical? – The night before the roundtable, Broc picked me up at the airport and we grabbed dinner at “The Wonderland Ballroom.” We soon met Frank Namin – who saddled up next to us and seemed to be this establishment’s resident magician. We had close-up seats as he fashioned a rose from a cocktail napkin – then levitated it (seriously, it levitated one foot away from us – just stayed floating in the air!) – along with many other illusions. Free entertainment! And nearly as exciting as that “Proxy Advisors” panel…
Broc’s Take: The Proxy Process Roundtable Might Not Mean Much
Broc’s ten cents on this topic is that it’s akin to oral arguments during a Supreme Court case. Broc believes that oral arguments don’t have a major impact how the SCOTUS Justices intend to vote except in rare instances (this study seems to argue otherwise). Broc doesn’t believe the roundtables really mean much – particularly with so many people on each panel. He recalls only one notable instance where a roundtable was truly worth listening too – when Evelyn Y. Davis was on a shareholder proposal roundtable in the early 2000s. Evelyn put on quite a show.
Broc feels there is some value to roundtables. The speakers can connect with each other. And even more importantly, the SEC Commissioners can get a sense of what each speaker is all about – and figure out which ones they might want to contact privately to learn more about a particular idea. But remember, we did this entire “song & dance” over a decade ago with “proxy plumbing” – with a roundtable & everything – and not much came out of that. But maybe this time will be different…
Poll: Will the Proxy Process Roundtable Mean Anything?
Let us know how you feel about the impact of the SEC’s roundtables in this anonymous poll:
Recently, I paid a visit to my old firm (Fredrikson & Byron) to interview my former colleague Zach Olson, a partner in the M&A group – about his side gig as a professional wrestler. You may have seen John’s blog about Zach’s bold adventures on “The Mentor Blog,” but I wanted to get more info about this unique endeavor – and how a deal lawyer has time (and nerve) for it.
In our 19-minute podcast, Zach confirmed my suspicion that he’ll dive into just about anything he thinks is remotely interesting. We also covered:
– How do you think your skills as a lawyer help you in the ring?
– How do you think your skills as a wrestler help you in negotiations/practicing?
– What’s been the most surprising thing about wrestling since you started?
– What’s the most common question people ask you?
MSCI Plans to Launch New “Dual-Class” Indexes
I have to say, MSCI strikes me as the “middle child” of stock indexes. “Dual-class” (or more) share structures have been a hot-button issue, especially since Snap’s IPO. Unlike FTSE Russell & S&P Dow Jones – which both quickly announced last August that they’d exclude companies with unequal voting rights – MSCI took 18 months to gather everyone’s opinions. And as I’ve blogged, it turns out that institutional investors are more interested in a regulatory fix that encourages equal voting structures, versus restrictions by indexes. So recently, MSCI announced a compromise that’s intended to satisfy everyone.
As described in this WSJ article, in early 2019, MSCI will launch a new suite of market indexes that exclude companies with unequal voting structures. They’ll be an addition to MSCI’s existing indexes, which will continue to include broader investment alternatives. Here’s what MSCI says about its solution (also see this Davis Polk blog – and this “Money Stuff” column that questions the impact of choices like this on so-called “passive” investors):
MSCI supports fully the one share one vote principle as we believe that having equal voting rights should be an important consideration in equity investing. The one share one vote principle has also gathered overwhelming support from participants in the consultation. The treatment of unequal voting structures in equity benchmarks, however, has proven to be a polarizing question among international institutional investors.
For instance, while many participants felt strongly that benchmarks should be adjusted to reflect unequal voting structures, other participants highlighted that the question of unequal voting rights should be addressed holistically by the stakeholders that are responsible for operating, regulating and investing in equity markets. These stakeholders include, among others, securities regulators, stock exchanges, asset owners and asset managers.
MSCI continues to believe that global market benchmarks, such as the MSCI Global Investable Market Indexes, should aim to represent the broadest investment opportunity set available to international institutional investors based solely on the investability of the underlying markets. Investable market benchmarks should not be constrained by specific investor opinions, preferences or constraints including governance issues. This point has been articulated by many international investors, including asset owners and managers globally, who clearly highlighted the critical need to find the right balance between investor views and comprehensive representation of the investable equity universe.
We recently wrapped up Lynn, Borges & Romanek’s “2019 Executive Compensation Disclosure Treatise” — and it’s printed. This edition has the latest insights from the first year of pay ratio disclosure – as well as Corp Fin’s recently-updated proxy CDIs. All of the chapters have been posted in our “Treatise Portal” on CompensationStandards.com.
How to Order a Hard-Copy: Remember that a hard copy of the 2019 Treatise is not part of a CompensationStandards.com membership so it must be purchased separately. Act now as this will ensure delivery of this 1620-page comprehensive Treatise soon. Here’s the “Detailed Table of Contents” listing the topics so you can get a sense of the Treatise’s practical nature. Order Now.
Here’s another “list” installment from Nina Flax of Mayer Brown (here’s the last one):
Before I begin this list, I am going full “open kimono” on some of my crazy here. My husband counted a while ago the number of books I had bought for our son – at the time I think we were still under 1000. We have two shelves in his closet that are taken up by “closet books” (i.e. books for him when he is a bit older), we have three book shelves in his room for books, we have three ledges in his room covered with books, we have two baskets around his reading chair in the hallway upstairs filled with books, we have books in various places in his playroom, we have two baskets downstairs with books by his work table, we have board books all along our fire mantle and another area in our living room storage area with more books.
I love books and I want my son to love books. And I love having so many options for books always in the house because (i) I love reading to my son and (ii) I feel personally satisfied by reading stories to him when I don’t have the bandwidth at the moment to read my own long books. I am fully aware that this is an addiction – I am okay with that.
As for what I consider Amazon “stalking” – (i) it is on a wish list, (ii) I regularly check that wish list, (iii) I monitor for price drops, (iv) I consider when checking my wish list whether to purchase the item, (v) I sometimes read updated reviews/see if another newer product should replace the stalked product on my list, etc. However, books are rarely replaced or removed from lists.
1.Gail Gibbons Books: If you have kids and haven’t read How A House Is Built, you should read it; I have read it about 100 times (not kidding – it is a popular and ongoing request). Gail Gibbons is an author I came across when looking for train books, and we now have over 15 of her titles. They are entirely digestible for children, but fun for adults too, and always well illustrated. I have a separate “Gail Gibbons Wish List.”
2. Other Children’s Books: For this category of things I stalk, I actually have three wish lists – “Most Desired Books,” “Science Books” & “Other Books”. I really am not kidding. I check “Gail Gibbons” and “Most Desired Books” frequently to see if any prices have dropped – and books only make it on my Most Desired Books if I have read them or watched a YouTube video of someone else reading them or am reasonably confident that I will definitely like them (e.g., in Spanish and written by an author that I have already purchased books from).
3. Books for Me: Paper copies are usually on the “My Most Desired Things” wish list. I am currently obsessed with the Taschen Basic Art Series. Also, every time I hear about a book I think I might want to read, it gets added to my “Kindle Books” wish list or my “Work Books” wish list.
4. Random Things I Think I Might Want But Don’t Want to Spend Money On (Yet): Which either fall on the “My Most Desired Things” wish list or my “Other Things I Might Want” wish list (the former checked more frequently because, as mentioned above, it also includes books, the latter checked less frequently because it does not include books). These include refillable dental floss made from silk, a wood rotating Scrabble board, a larger Klean Kanteen coffee mug (the one I have definitely is too small for my caffeine addiction, and they have cool new caps), a Buddha Board, puzzles that are beautiful and hard, a tagine, and an under desk elliptical (it has good reviews, and I do have a standing desk…). I promise that the way I have things grouped makes sense (to me).
5. Survival Supplies: I am not a doomsday survivalist, but moving to California and shortly thereafter experiencing two minor earthquakes during the night has made me curious about supplies. I stalk the more “normal” ones that I might actually use, like a hand crank back-up power turbine or a medical kit, as well as those that if I camped might make sense but maybe could be included in a birthday or father’s day gift for my husband, like a stormproof match kit or wound sealing powder or sponge.
6. Socks: I have supported and continue to support a local non-profit that provides assistance to homeless pregnant women. They are always in need of supplies for the babies and siblings, and in the winter (even though it is not THAT cold here), what could be better than knowing you helped someone have warmer feet? I can regularly find good quality socks for under $1.00/pair because of my “Socks” wish list.
In case this wasn’t apparent, one of the reasons I love stalking on Amazon is because I have so many lists, and regularly create new wish lists, move things around, delete old ones, etc. It is list heaven. It used to have a cherry on top, but then Amazon deleted the ability to filter by discount – I am still not pleased and hoping they bring that function back.
We continue to post new items daily on our blog – “Proxy Season Blog” – for TheCorporateCounsel.net members. Members can sign up to get that blog pushed out to them via email whenever there is a new entry by simply inputting their email address on the left side of that blog. Here are some of the latest entries:
– Proxy Advisors: Six Senators Support House Bill
– Another Year, Another No EYD
– ISS Summary: How Proxy Season Is Faring
– How Blockchain May Be Used in the Proxy Process
– Communicating Culture: Amazon’s Shareholder Letter
This unique 62-page study from the IRRCi & Annalisa Barrett examines governance practices at 160 companies with less than $300 million in market cap (that works out to about 10% of all exchange-listed microcaps – though keep in mind there are about 10k publicly-traded microcaps when you count all the ones that aren’t listed on a major exchange). Here’s some interesting takeaways (also see this survey of 2017’s “Micro IPOs”):
– 73% are listed on Nasdaq, 19% on the NYSE American, and 8% on the NYSE
– 32% of the studied companies have been public for 10-20 years – and only 6% were founded in the last 5 years
And here’s how the microcaps compare to Russell 3000 companies on some governance “hot topics”:
– 93% have a one-share, one-vote structure
– Director tenure & age is comparable, but boards tend to be smaller (7 directors on average, versus 9) – and less diverse (61% are all-male)
– 62% separate the Chair/CEO roles (comparable to the Russell 3000) – but among companies that combine the role, 70% lack a lead independent director
– 71% of companies have three committees – audit, compensation & nominating/governance (even though Nasdaq doesn’t require a standing nominating committee)
– Only 11% have adopted a majority standard for director elections
– Median director pay was just under $75k – and 32% still pay board meeting attendance fees
– Only 16% disclose having director stock ownership guidelines
Why the discrepancies between small & mid-sized companies? Lots of us are probably hoarse from repeating that the markers of good governance aren’t “one-size-fits-all.” And when it comes to private ordering via shareholder activists, it looks like these companies either fly under activists’ radar (for now) or have too much insider ownership to be worth targeting. Insiders own 10% or more of the stock at over half of the studied companies – and only one of them had a shareholder proposal in last year’s proxy statement.
Comment Trends: Corp Fin’s “Top 10”
This 120-page report from EY – and the related 14-page summary – note that Corp Fin issued 25% fewer comment letters last year. The volume is down by more than half since 2014! It remains to be seen whether the SEC’s cybersecurity focus and companies’ adoption of new accounting standards will reverse that trend. For now, you can get your ducks in a row on these “top 10” most frequent areas of comment:
1. MD&A: especially disclosure of key performance indicators (note, in her speech last week, SEC Commissioner Kara Stein floated the idea that auditors could be more involved in assessing the accuracy of KPI disclosure)
2. Non-GAAP: continued focus on concepts from May 2016 CDIs – especially CDIs 100.01, 100.04, 102.07 and 102.11 (I blogged more about this yesterday)
3. Fair Value Measurements: be ready to justify your valuation techniques & inputs
4. Segment Reporting:Staff is looking for inconsistencies between filings and other public information, and expects companies to monitor for changes on an ongoing basis
5. Revenue Recognition: companies can provide a better understanding of their judgments on performance obligations, etc.
6. Intangible Assets & Goodwill: especially the impairment analysis, recognition & measurement
7. State Sponsors of Terrorism: liquidity, risk factors & results of operations for companies with operations in identified countries
8. Income Taxes: including deferred tax assets and accounting for tax reform
9. Acquisitions & Business Combinations: requests for analysis to ensure that the company properly applied the Regulation S-X “significance” tests
10. Contingencies: focus on disclosure about reasonably possible losses and the clarity & timeliness of loss contingency disclosure
PCAOB Opens Door to “CAM” Improvements
This recent speech from PCAOB Chair Bill Duhnke says that the PCAOB is already planning a post-mortem review of the “critical audit matters” requirement – and will consider changes if necessary. Here’s an excerpt (also see this WilmerHale blog):
Once the initial implementation of critical audit matters begins in June 2019, we plan to assess experiences and results, and determine whether we need to take further action—including whether to issue guidance or amend the standard. As part of this assessment, the staff plans to engage with auditors, investors, financial statement preparers, and audit committee members, through requests for comment, interviews, surveys, and other outreach to learn about their experiences.
After a reasonable period of time following completion of implementation in December 2020, we will conduct a post-implementation review to analyze the effectiveness of the new requirements. As part of that exercise, the staff will reevaluate the costs and benefits of the standard, including any unintended consequences, to understand the overall impact on the audit profession, public companies, and users of financial statements. To the extent that review suggests changes should be made, we will consider such changes at that time.
And according to Chair Duhnke, that’s not all that the PCAOB is planning – several standard-setting projects are in the works, which could impact accounting estimates and require more rigorous evaluations of specialists that are engaged by auditors. And here’s a couple of other things for audit committees to expect:
– Audit firms will be ramping up their quality control procedures, since that’ll be a focus for 2019 inspections
– More interaction with the PCAOB during the inspection process – a knock on your door doesn’t necessarily signal that your company’s audit firm is in trouble
According to this Audit Analytics blog, 97% of the S&P 500 use at least one non-GAAP metric in their SEC filings. That’s up from 76% in 2016, and only 59% in 1996.
And not only are more companies using non-GAAP metrics, the number of metrics used in each filing has shot up. This CFO.com article says that the number has tripled in the last 20 years – from 2.35 to an eye-catching 7.45. It also says that when it comes to Reg G compliance, there’s room for improvement:
Under Regulation G, which sets forth the regulatory framework companies are required to follow in presenting non-GAAP metrics, any EBITDA metric that excludes from income any items other than interest, taxes, depreciation, and amortization must be labeled as “adjusted EBITDA.”
However, according to Audit Analytics, among 46 companies that labeled a non-GAAP metric as EBITDA in 2017, more than half (24) excluded an item other than those. For example, two companies excluded acquisition-related items and two others excluded impairment-related costs.
There’s nothing inherently wrong with using non-GAAP metrics – in many cases, shareholders think that information is useful. But proper labeling and reconciliation is key – Corp Fin is still commenting on this – and in a speech last week, SEC Commissioner Kara Stein even floated the idea that auditors could take on a greater role in public disclosure, including offering assurance about the fair presentation of non-GAAP measures. All that to say, just because you might see other companies intentionally or unintentionally hide the ball, that doesn’t mean you should do it too. Check out our “Non-GAAP Handbook” for all the latest guidance.
Non-GAAP Comments: No More “Low-Hanging Fruit”?
It’s not just your imagination – Corp Fin’s been issuing fewer non-GAAP comments this year. But as detailed in this Audit Analytics blog, the number & percentage of these comments are still above 2015 levels.
Although non-GAAP comments continue to focus on areas that were clarified in the May 2016 CDIs, this Cooley blog points out that the Staff has moved on from easy-to-fix issues like undue prominence (possibly because companies have self-corrected). Now, they seem to be more focused on whether there’s adequate disclosure for individually-tailored accounting adjustments and “free cash flow” presentations. Here’s more detail:
– 12.3% of the non-GAAP comments referenced individually-tailored accounting – and this WSJ article explains how complex the topic can be. The Staff typically requests that companies remove individually-tailored recognition & measurement adjustments from non-GAAP measures – or explain how they considered the guidance in Question 100.04 of the non-GAAP CDIs and concluded that the adjustments were appropriate.
– The percentage of companies receiving comments referencing presentation of free cash flow & CDI 102.07 has increased significantly since 2016. And an increasing percentage of companies received a comment on the required presentation of the three major categories of the statement of cash flows when a non-GAAP liquidity measure is used (Question 102.06). Since the presentation of free cash flow is a non-GAAP liquidity measure, an increase in comments related to the three major categories of the statement of cash flows may indicate that companies are receiving both comments related to one item of financial reporting.
In monitoring SEC comment letters, we came across this SEC comment letter recently made public. While we acknowledge the term “pro forma” is often used by companies when adjusting their GAAP results to provide additional meaningful information to investors, this comment by the Corp Fin Staff serves as a reminder that the Staff generally dislikes non-GAAP measures titled as “pro forma” when the information is not presented in compliance with the pro forma rules in Article 11 of Regulation S-X.
In this situation, the company agreed to delete the words “pro forma” and instead use the words “as adjusted.” The comment was issued in connection with the Staff’s review of an initial public offering Form S-1.
This Proxy Insight article compiles annual voting data from the 10 largest mutual funds and compares how they voted on high-profile proposals (also see this Willis Towers Watson summary of recent stewardship reports). Here’s a couple highlights:
– The four biggest asset managers voted to ratify GE’s auditor – even though a shocking 35% of GE’s shareholders voted “against”
– For executive pay, Vanguard and State Street are following through with more stringent policies – and Goldman Sachs supported 8% fewer say-on-pay proposals than last year (and they’re not alone – as I recently blogged on CompensationStandards.com, enhanced policies led CalPERS to vote against 43% of say-on-pay proposals this year)
Also, if your shareholder base includes pension funds, a recent study says you’ll have a harder time getting their support – even if ISS & Glass Lewis recommend in favor of the board’s recommendations. This article explains:
Pension funds were 36.2 percent more likely than mutual funds to vote in favor of shareholder proposals, and 7.1 percent less likely to vote for management proposals, according to finance and accounting professors Ying Duan, Yawen Jiao, and Kinsun Tam. “They are most supportive of shareholder proposals submitted by other public pension funds, followed by those submitted by labor unions,” the authors added.
Beyond being more prone to support other shareholders, pension funds were also likelier to vote against recommendations made by proxy advisors. According to the study, only two of the 48 funds — the Orange County Employees Retirement System an Oregon Public Employees Retirement System — always followed the guidance issued by their proxy firms.
Corp Fin’s “Financial Reporting Manual”: Now Mobile-Friendly!
Over a year ago, Edgar was hacked – and we speculated about applying insider trading law to “hack & trade” schemes. This blog from John Stark – President of John Reed Stark Consulting and former Chief of the SEC’s Office of Internet Enforcement – outlines successful enforcement efforts under this theory from 2005 – 2016, and criticizes the lack of any more recent action. Here’s an excerpt:
Since the EDGAR data breach, the SEC has not brought any outsider trading cases — zero, zilch, nada – and the topic of outsider trading seems markedly absent from the current laundry list of SEC enforcement priorities and concerns.
Indeed, a recent NYT op-ed by SEC Commissioner Robert J. Jackson, Jr. and former SDNY U.S. Attorney Preet Bharara entitled, “Insider Trading Laws Haven’t Kept Up With the Crooks,” hinted at a significant rift within the SEC Commissioners about outsider trading, raising questions whether the SEC will file any future outsider trading cases ever again.
But this threat must be stopped. No longer are social security numbers, credit card information and the like the primary focuses of hackers. Information is the target – and public companies and the SEC in its EDGAR database have a lot of it. Indeed, crooks from anywhere in the world can now use their cyber-wares to orchestrate corporate espionage and remotely trade stock based on stolen secrets.
The SEC should get with the virtual program and redouble its efforts at policing outsider trading, an alarming and futuristic category of wrongdoing. The SEC has experienced first-hand the humility and alarm of playing the dupe in some offshore outsider trading scheme, and is clearly the best equipped to fight back. For more than 80 years, the SEC’s dedicated and vigilant enforcement staff has stood as a proud sentinel for investors, and SEC Chairman Clayton should cut the SEC enforcement staff loose and refuse to allow a preposterously strict reading of the ’34 Act’s broadly vested anti-fraud provisions to stand in its way.
– Board Gender Diversity: The policy announced last year will take effect in 2019 – Glass Lewis will generally recommend voting against the nominating committee chair of a board that has no female members, but they’ll closely examine the company’s disclosure of its board diversity considerations and other relevant contextual factors.
– Conflicting & Excluded Proposals: The policy lays out how Glass Lewis will evaluate conflicting proposals on special meeting rights – for one thing, they’ll typically recommend against members of the nominating & governance committee when a company excludes a shareholder proposal in favor of a management proposal of an existing special meeting right. And in limited circumstances, Glass Lewis may recommend against members of the governance committee if a company excludes any conflicting proposal based on no-action relief, if Glass Lewis believes the exclusion is detrimental to shareholders. See this blog from Davis Polk’s Ning Chiu.
– Diversity Reporting: Glass Lewis will now generally recommend in favor of shareholder proposals requesting additional disclosure on employee diversity and those requesting additional disclosure on the steps that companies are taking to promote diversity within their workforces.
– Environmental & Social Risk Oversight: Glass Lewis has codified its approach to reviewing how boards are overseeing environmental and social issues – if mismanagement of these risks has threatened or diminished shareholder value, Glass Lewis may recommend against the directors responsible for E&S oversight.
– Officer & Director Compensation: In its say-on-pay recommendation, Glass Lewis will consider excise tax gross-ups, severance and sign-on arrangements, grants of front-loaded awards, clawback provisions, and CD&A disclosure for smaller reporting companies. And they’ve clarified their approach to peer groups, pay-for-performance, the use of discretion, director compensation and bonus plans.
– Auditor Ratification: Glass Lewis will consider additional factors for auditor ratification proposals, including the auditor’s tenure, a pattern of inaccurate audits, and any ongoing litigation
or significant controversies which call into question an auditor’s effectiveness. In limited cases, these factors may contribute to a recommendation against auditor ratification.
– Virtual Shareholder Meetings: The policy announced last year will take effect in 2019. For companies opting to hold their annual meeting by virtual means, and without the option of attending in person, Glass Lewis will examine the company’s disclosure of its virtual meeting procedures and may recommend voting against the members of the governance committee if the disclosure does not ensure that shareholders will be afforded the same rights and opportunities to participate as they would at an in-person meeting.
– Written Consent Shareholder Proposals: In instances where companies have adopted proxy access and a special meeting right of 15% or lower, Glass Lewis will generally recommend against shareholder proposals requesting that companies adopt a shareholder right to action by written consent.
– Clarifying Updates: No changes here, but Glass Lewis has codified its approach to director and officer indemnification, quorum requirements, director recommendations on the basis of company performance, and OTC-listed companies.
Dual-Class: CII Petitions Exchanges to Require Sunset
On Wednesday, CII announced that it had filed an NYSE petition and a Nasdaq petition to curb listings of dual-class companies. Specifically, the petitions ask the exchanges to amend their listing standards to require that – going forward – companies seeking to list that have multiple share classes with differential voting rights include in their governing documents provisions that convert the share structure within seven years of the IPO to “one, share-one, vote.”
The petitions have support from BlackRock, T. Rowe Price, CalSTRS and CalPERS. CII cites several factors that support the concept of time-based sunsets, and also observes:
The SEC believes it lacks the statutory authority to compel U.S. exchanges to amend their listing rules. Over the past year, providers of benchmark indexes — FTSE Russell, MSCI and S&P Dow Jones — have stepped into the breach, with varying curbs on multi-class companies in indexes that are used widely by institutional investors. A listing standard would put all dual-class companies on the same footing.
Director Survey: Lots of Underperforming Colleagues
– 45% of directors think that at least one person on their board should be replaced – and only 30% think their board is “very effective” at dealing with underperforming directors
– 94% agree that board diversity brings unique perspectives to the boardroom – and 84% think it enhances board performance. But 52% think board diversity efforts are driven by political correctness – and 48% think shareholders are too preoccupied with the topic
To me, these responses imply that directors do see the value in diversity – but are frustrated about being pushed to refresh their boards (even underperforming directors have staying power) and look for new directors outside of their typical network. Which means they’ll get to it when they’re good & ready, dagnabbit! Also, keep in mind that over 75% of the survey participants aren’t diverse and are likely accustomed to the status quo (the survey details some pretty wide gaps in perspective between female & male directors).
The survey also looks at other “hot topics,” like cybersecurity and the board’s evolving role in overseeing corporate culture. Here’s what directors think about those subjects:
– 87% of directors think that inappropriate tone at the top leads to problems – while 79% also blame middle management and 74% point to “short-termism”
– 71% think that employee engagement surveys are one of the best ways to scope out problems with corporate culture
– The percentage of directors that said company strategy should “very much” take social issues such as health care, resource scarcity and human rights into account increased between 7 to 10 percentage points from last year
– Boards continue to shift responsibility for oversight of cybersecurity – 36% of directors say the job falls to their full board, up from 30% last year – and 21% say their board has moved cybersecurity oversight from one committee to another
