Here’s something that I blogged yesterday on CompensationStandards.com: A member of Congress is now using pay ratio data to examine income inequality. This study from Rep. Keith Ellison’s staff (D-Minn) looked at pay ratios from 225 large companies that were responsible for employing more than 14 million workers. When it comes to “extreme gaps,” it “names names” – and it also seems to assume that companies that excluded portions of their workforce were doing so to keep their ratio down.
This article describes the findings – here are the main ones:
1. Pay ratios ranged from 2:1 to 5000:1. The average was 339:1 – compared to 20:1 in 1965
2. 188 companies had a ratio of more than 100:1 – so the CEO’s pay could be used to pay the yearly wage for more than 100 workers
3. Median employees in all but 6 companies would need to work at least one 45-year career to earn what their CEO makes in a single year
4. The consumer discretionary industry had the highest average pay ratio – 977:1
I think it’s easy to become numb to high CEO pay when you work with it all the time and you’re focused on the mechanics of programs and disclosures. This study is a reminder that no matter how useless pay ratio seems to companies, people outside of this field are paying attention – and they’re synthesizing the data not just to compare companies, but to show that outsized executive pay is a pervasive issue that interests many.
Pay Ratio: Customer Fallout?
As highlighted in Rep. Keith Ellison’s study, the consumer discretionary industry is shaping up to have the highest average pay ratios – 977:1 among the S&P 500. That compares to a supposedly ideal ratio among consumers of 7:1, according to this study. And while the high numbers aren’t surprising given the workforce for most of those companies, this WSJ article says it could impact their bottom line. Here’s the high points:
A recent study found that consumers are significantly less likely to buy from companies with high CEO pay ratios. First, it found that sales declined for Swiss companies when their high pay ratios were publicized.
In a follow-up experiment, people had the chance to win a gift card to one of two retailers. In the absence of pay-ratio information, 68% of people chose one retailer’s card and 32% chose the other. But when participants were informed that the first of those retailers had a 705:1 pay ratio and the second had a 3:1 ratio, just 44% of people chose gift cards from the first retailer while 56% chose the second.
It’ll be interesting to see whether this holds true in “real life,” where customers probably aren’t looking at pay ratios at the same time they’re making a purchase – and may not have the option to buy from a company with a 3:1 ratio. The lowest ratios I’ve seen for that industry are around 100:1.
By the way, here’s this CNBC piece entitled “Companies with Closer CEO Pay Ratios May Generate Higher Profit Per Worker.”
Last week, two Parliament committees issued their final report on the collapse of Carillion – which had been the UK’s second-largest construction group. The situation has been called the British “Enron” and could lead to sweeping reform. As described in this ”Financial Times” article, the report comes down hard on the Big Four auditors – and also blames the implosion on the board and lax regulations. It includes these findings:
– Carillion’s directors elected to increase its dividend every year, come what may. Even as the company very publicly began to unravel, the board was concerned with increasing and protecting generous executive bonuses.
– Government should refer the statutory audit market to the Competition and Markets Authority. Possible outcomes considered should include breaking up the audit arms of the Big Four, or splitting audit functions from non-audit services. The lack of competition in the audit market “creates conflicts of interest at every turn.”
– In its failure to question Carillion’s financial judgements and information, KMPG was “complicit” in the company’s “questionable” accounting practices, “complacently signing off its directors’ increasingly fantastical figures” over its 19 year tenure as Carilion’s auditor.
– The regulators are wholly ineffective – they only started investigating after the company collapsed and are more interested in apportioning blame than in proactively challenging companies and averting avoidable failures.
– The regulators’ mandate should be changed to ensure that all directors who exert influence over financial statements can be investigated and punished.
Also, the British have a way with words. Here are comments from one MP:
“Same old story. Same old greed. A board of directors too busy stuffing their mouths with gold to show any concern for the welfare of their workforce or their pensioners. This is a disgraceful example of how much of our capitalism is allowed to operate, waved through by a cozy club of auditors, conflicted at every turn. Government urgently needs to come to Parliament with radical reforms to our creaking system of corporate accountability. British industry is too important to be left in the hands of the likes of the shysters at the top of Carillion.”
Some advocates have been pushing companies to put together “integrated reports.” To illustrate how easy they think it is to do so, a couple of researchers recently prepared this 40-page mock “Integrated Report” for ExxonMobil (starts at page 18). As they describe in this Forbes article, they used publicly-available info – the 10-K, proxy statement, citizenship report, annual report, etc. – and said it took them about 40 hours to edit & organize it into the framework.
Some might say that the 40-hour estimate to draft an integrated report isn’t realistic. Perhaps their effort overlooks the amount of time associated with ensuring the various components of an integrated report work together appropriately – and all the layers of review that a company (who has real potential liability for the end product) must go through.
By the way, according to this announcement, the next step for these researchers is to create an “Integrated Report Generator Tool” – which will “provide stakeholders with a way to create integrated reports.”
Poll: Challenges of Drafting Integrated Reports
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Bank Examiners Can’t Override Privilege: 7-Firm Memo
This “7-Firm Memo” asserts that bank examiners aren’t entitled to privileged material from financial institutions – and shouldn’t condition favorable examination results & relationships upon “voluntary” waivers. The analysis relies heavily on recognition of the attorney-client privilege by the SEC & DOJ. Both agencies have said they don’t require privilege waivers in order to deem a company “cooperative.”
Every few years, we survey annual meeting practices (we’ve conducted about a dozen surveys on this & related topics). Here’s the results from our latest one:
1. To attend our annual meeting, our company:
– Requires pre-registration by shareholders – 16%
– Encourages pre-registration by shareholders but it’s not required – 8%
– Requires shareholders to bring an entry pass that was included in the proxy materials (along with ID) – 14%
– Encourages shareholders to bring an entry pass but it’s not required – 11%
– Will allow any shareholder to attend if they bring proof of ownership – 76%
– Will allow anyone to attend even if they don’t have proof of ownership – 11%
2. During our annual meeting, our company:
– We hand out rules of conduct that limit each shareholder’s time to no more than 2 minutes – 30%
– We hand out rules of conduct that limit each shareholder’s time to no more than 3 minutes – 35%
– We hand out rules of conduct that limit each shareholder’s time to no more than 5 minutes – 5%
– We announce a policy that limits each shareholder’s time to no more than 2 minutes (but rules are not handed out) – 3%
– We announce a policy that limit each shareholder’s time to no more than 3 minutes (but rules are not handed out) – 0%
– We announce a policy that limit each shareholder’s time to no more than 5 minutes (but rules are not handed out) – 3%
– There is no limit on how long a shareholder can talk (subject to the inherent authority of the Chair to cut off discussion at any time) – 24%
3. For our annual meeting, our company:
– Provides an audio webcast of the physical meeting, including posting an archive – 24%
– Provides an audio webcast of the physical meeting, but does not post an archive – 3%
– Has provided an audio webcast of the physical meeting in the past, but discontinued that practice – 3%
– Is considering providing an audio webcast of the physical meeting but haven’t decided yet – 0%
– Provides a video webcast of the physical meeting (or is considering doing so) – 8%
– Does not provide an audio nor a video webcast of the physical meeting – 62%
4. At our annual meeting, our company:
– Announces the preliminary results of the vote on each matter (unless special circumstances arise such as a very close vote) – 89%
– Doesn’t announce the preliminary results of the vote on each matter – 11%
5. For our annual meeting:
– Our CEO makes a presentation and takes Q&A from the audience – 90%
– Our CEO makes a presentation but no Q&A from the audience – 3%
– We are considering revising next year’s format to eliminate the CEO presentation – 3%
– We are considering revising next year’s format to eliminate the Q&A – 3%
– We are considering revising next year’s format other than the CEO presentation and Q&A but haven’t decided yet – 3%
Also see the transcript for our recent webcast: “Conduct of the “Annual Meeting.”
Board Diversity: Some Progress
This Bloomberg article highlights stories of boards who are achieving some diversity by appointing people who are first-time directors – and who aren’t sitting or retired CEOs. Here’s an excerpt:
Waste management company Republic Services Inc. has been looking for diverse directors since 2011, after a 2008 merger with Allied Waste Industries left it with an all-male board, including one black man. “Change meant bringing people into the waste business who had other experiences,” says CEO Don Slager. “Prior to the merger, frankly, they were just a bunch of garbage men.”
As part of this push, the company enacted some new policies, including a mandatory retirement age of 73 for directors. A variety of experience also was a priority, Slager says. Candidates ideally would bring expertise in areas not already represented, such as logistics and financial reporting. “When you drop a layer below the C-suite, it opens you up to a whole new group of people who are the future leaders of these organizations,” he says.
While the article notes that in 2017, 45% of appointees to S&P 500 boards were novice directors – and a majority of incoming directors were women or minorities – it also states that white men still hold more than 75% of these seats. Not to detract from the companies highlighted as gender diversity success stories in the article – because I do think they’re being thoughtful about this and making progress – but they’ve actually just achieved the “three women” benchmark that Broc’s blogged about…
Age Diversity: Stats on Boards’ “Next Generation”
According to this PwC article, 90% of directors say that age diversity is important – a higher number than gender, race & other forms of diversity. Yet “young directors” – defined as anyone 50 or under – held only 6% of S&P 500 board seats in 2017, and the average age of independent directors increased to 63.
Not surprisingly, the information technology, consumer discretionary & consumer staples industries are the most likely to have at least one director – and technology expertise and active industry knowledge are commonly-cited skills.
Also see this EY report on the traits of first-time directors in 2017.
There’s nothing hotter right now than data analytics. “Big data” can yield some big opportunities – so it would seem that boards would seek this information out when strategizing the big picture. At a minimum, boards should be at least oversee how their companies are using data analytics. This KPMG memo throws out some key questions for boards to consider:
— How is the data being collected and organized within the company and who is involved? Ultimately, who is responsible?
— Can the data be trusted? How is the quality and integrity of the data assessed?
— Does the company have a data ethics policy to protect the brand reputation and reduce legal risk?
— Does the company have the right talent, skills, and resources required to implement/manage its D&A activities?
— Has the company scoped out the near-term and longer-term opportunities for its use of D&A, including financial reporting and predictive analytics?
Trends in Board Cybersecurity Oversight
This recent EY webcast about the board’s cybersecurity oversight role included a poll of director & executive attendees. It appears that most companies aren’t making big changes in response to the SEC’s cybersecurity guidance from earlier this year. Here’s what else they found:
1. Which emerging technology does your board expect to have the greatest impact on the company’s strategy?
– Artificial Intelligence (AI)/Machine Learning and Internet of Things (IoT) – tied at 23%
– Blockchain and Robotic Process automation – tied at 19%
2. As a board member, which of the following do you think is most important to enhance the company’s cyber maturity posture?
– Enhancing data protection and privacy policies – 32%
– Continuously educating and testing the workforce on cybersecurity related matters – 22%
– Improving cyber threat intelligence gathering – 18%
3. How often are your board and management team conducting tabletop exercises and crisis scenario exercises?
– Annually – 31%
– Ad hoc basis/rarely – 30%
– Twice a year or never – tied at 18%
4. Given the recent SEC cybersecurity guidance, do you expect a material change in your disclosure controls process and procedures during your next quarter-end?
– No – 60%
– Yes – 40%
Delaware has amended its data breach law for the first time since enacting it in 2005 (see this Pepper Hamilton memo). To help companies comply with the new requirements, it’s now launched this website with template forms. According to this Morgan Lewis blog, the forms can be used for the required data breach notices to the Delaware Attorney General as well as consumers – and the website also provides a link for consumers to file complaints.
A few years ago, Broc blogged about a VC appointing a robot director. Turns out their announcement was a play on words. But when it comes to director recruitment – the future is now? This paper shows that directors selected using an algorithm would perform better – based on shareholder approval numbers & company profitability – than individuals selected by the company’s board. Here’s an excerpt of the findings from this “Harvard Law” blog:
The differences between the directors suggested by the algorithm and those actually selected by firms allow us to assess the features that are overrated in the director nomination process. Comparing predictably unpopular directors to promising candidates suggested by the algorithm, it appears that firms choose directors who are much more likely to be male, have a large network, have a lot of board experience, currently serve on more boards, and have a finance background.
In a sense, the algorithm is saying exactly what institutional shareholders have been saying for a long time: that directors who are not old friends of management and come from different backgrounds are more likely to monitor management. In addition, less connected directors potentially provide different and potentially more useful opinions about policy. For example, TIAA has had a corporate governance policy aimed in large part to diversify boards of directors since the 1990s for this reason.
An important benefit of algorithms is that they are not prone to the agency conflicts that occur when boards and CEOs together select new directors. Institutional investors are likely to find this attribute particularly appealing and are likely to use their influence to encourage boards to rely on an algorithm such as the one presented here for director selections in the future.
SIFMA’s Report to Help More Companies Go & Stay Public
In this recent report, SIFMA (“Securities Industry & Financial Markets Association”) – which represents brokers, banks & asset managers – gives its two cents about what’s behind the declining number of public companies, why this is bad, and how to fix it. Not surprisingly, they suggested reducing the compliance burden (as opposed to SEC Commissioner Rob Jackson’s recent suggestion that underwriters need to reduce their fees). This Gibson Dunn memo summarizes the many recommendations:
1. Expand & lengthen the EGC exemptions under the JOBS Act
2. Encourage more research coverage of EGCs and other small public companies by allowing investment banks & analysts to jointly attend pitch meetings and relaxing restrictions on communications during an offering
3. Reduce the “administrative burden” of public reporting and the influence of activist shareholders & proxy advisory firms
4. Allow all companies to use Form S-3 – and allow underwriters to communicate on behalf of WKSIs before filing a registration statement
5. Implement a revenue-only test for smaller reporting companies, and raise the cap so that more companies would qualify
6. Tailor the equity market structure for small public companies, by allowing smaller tick sizes and limiting their shares to fewer exchanges (however, smaller exchanges are arguing this would be anti-competitive)
And see this “Radical Compliance” blog for another hypothesis on declining IPOs: the real issue isn’t that companies are afraid of going public because of fees or compliance, the issue is that it’s easy to stay private because there’s loads of money in that space…
ISS Launches a New “Help Center”
ISS has migrated its communications to a new portal – the “ISS Help Center.” This Weil blog has more details:
The ISS Help Center may be used by companies, law firms, consultants, and other third-parties who register. It includes FAQs & allows you to connect with ISS about research reports, engagement, peer groups, and equity plan verification – among other matters.
ISS will no longer take questions via email to the Global Research Help Desk and is eliminating various other legacy global e-mail addresses that were previously used to submit inquiries to ISS.
SEC Commissioner Mike Piwowar – whose term expires in early June & who served briefly as Acting SEC Chair last year – will leave the SEC by early July, after serving nearly five years. Here’s an excerpt from the WSJ article:
Mr. Piwowar’s departure would leave the agency with four commissioners, meaning some votes could be deadlocked if the SEC’s two Democrats oppose measures favored by Chair Jay Clayton, a Trump administration appointee. That could slow Mr. Clayton’s progress on his priorities, which include stricter rules for brokers advising retail investors and lightening the regulatory burdens on public companies.
In theory, the White House and Senate could move quickly and nominate replacements for both Mr. Piwowar and Democratic SEC Commissioner Kara Stein, whose term ended last year. The Senate usually considers candidates for commissioners in pairs – one Republican and one Democrat.
Supplemental Pay Ratios: Not So Many (So Far)
Here’s something that I blogged last week on CompensationStandards.com: One of the big unknowns for the first year of mandatory pay ratio was whether companies would include supplemental ratios using a different methodology from the required rules. What situations would justify that extra effort? This Pearl Meyer blog notes that of the first 1039 companies to file proxies this year, only 99 have included a supplemental ratio. That’s less than 10%. Here’s what else they found:
– Most of the supplemental ratios were significantly lower than the required pay ratio.
– The desire to smooth out the impact of one-time or multi-year grants to a CEO was the most commonly occurring reason to provide a supplemental ratio.
– The most profound decrease from the required ratio occurred when companies provided a supplemental ratio that excluded part-time and seasonal employees.
– 14 companies provided a supplemental ratio that was greater than the required ratio, mostly likely to avoid a drastic increased ratio in 2019.
It’s possible that supplemental ratios will become more common in the future, as companies try to explain year-over-year pay ratio changes…
SEC’s Information Security Program: Not “Effective”
Recently, the SEC’s Inspector General released its audit results for the SEC’s information security program – as required by the “Federal Information Security Modernization Act.” Although the SEC’s program has improved, it didn’t meet the criteria to be deemed “effective” as of September 30, 2017. The SEC is supposed to submit a corrective action plan by mid-May that covers the audit’s 20 recommendations.
And in recent testimony before the House Appropriations Financial Services Subcommittee, SEC Chair Jay Clayton discussed the SEC’s new Chief Risk Officer position, its incident response procedures, and its ongoing internal investigation of last fall’s high-profile Edgar hack.
In recent years, as SEC rulemaking has stalled on topics like proxy access and political spending disclosure, “private ordering” has become the catalyst for ESG changes (see Broc’s earlier blog about how that’s faring). This may have been due partly to Department of Labor interpretive bulletins from 2015 and 2016 which assured ERISA fiduciaries – i.e. pension plans – that they could consider ESG factors in making investment decisions.
1. Fiduciaries must avoid too readily treating ESG issues as being economically relevant to any particular investment choice
2. Fiduciaries may not incur significant plan expenses to (i) pay for the costs of shareholder resolutions or special shareholder meetings, or (ii) initiate or actively sponsor proxy fights on environmental or social issues
As noted in a CII alert, the most significant impact of the guidance likely will be on shareholder engagement. Earlier guidance – the bulletin says – didn’t suggest that it’s always appropriate for plans to engage with the board or management of companies in their portfolios. The guidance “was not meant to imply that plan fiduciaries, including appointed investment managers, should routinely incur significant plan expenses” to fund advocacy or campaigns on shareholder resolutions or proxy fights on environmental or social issues at portfolio companies. It appears that this new field assistance bulletin shifts the burden to pension funds to prove there are tangible activism benefits in every case. This creates a negative presumption that most ESG factors are not economically significant.
The change in tone will undoubtedly elicit angst among governance & sustainability advocates. It’s the latest in a long history of back-and-forth: the DOL’s 2015 & 2016 bulletins were issued in response to a 2008 bulletin, which walked back 1994 guidance. Also see this Davis Polk blog entitled “Are the Reports that the DOL Guidance Will Lead to the Demise of ESG-Focused Plans Greatly Exaggerated?”…
Sustainalytics’ ESG Ratings Now on Yahoo! Finance
Here’s the intro from this blog by Davis Polk’s Ning Chiu:
Some companies may not be aware that since February, their Yahoo Finance web page includes a separate tab with the ESG scores from Sustainalytics. The Sustainalytics quote page shows a company’s numerical rating for three categories, environment, social and governance, along with the overall ESG score. Scores range from 1 to 100.
There is also a graphic representation of the score that, according to the Sustainalytics press release, will be tracked against the average in each category and plotted over time. The graph, currently reflecting data from 2014 to now, is intended to display trends of how a company ranks against industry peers.
Our May Eminders is Posted!
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Every few years, we survey the practices relating to blackout & window periods (we’ve conducted over a dozen surveys in this area). Here’s the results from our latest one:
1. Does your company ever impose a “blanket blackout period” for all or a large group of employees?
– Regularly before, at, and right after the end of each quarter – 78%
– Only in rare circumstances – 15%
– Never – 7%
2. Does your company allow employees (that are subject to blackout) to gift stock to a charitable, educational or similar institution during a blackout period?
– Yes, but they must preclear the gift first – 47%
– Yes, and they don’t need to preclear the gift – 16%
– No – 30%
– Not sure, it hasn’t come up and it’s not addressed in our insider trading policy – 7%
3. Does your company allow employees (that are subject to blackout) to gift stock to a family member during a blackout period?
– Yes, but they must preclear the gift first – 37%
– Yes, and they don’t need to preclear the gift – 14%
– No – 38%
– Not sure, it hasn’t come up and it’s not addressed in our insider trading policy – 11%
4. Are your company’s outside directors covered by blackout or window periods and preclearance requirements?
– Yes – 100%
– No – 0%
5. Our company’s insider trading policy defines those employees subject to a blackout period by roughly:
– Stating that all Section 16 officers are subject to blackout – 3%
– Stating that all Section 16 officers “and those employees privy to financial information” are subject to blackout – 4%
– Stating that all Section 16 officers “and others as designated by the company” are subject to blackout – 38%
– Stating that all Section 16 officers “and those employees privy to financial information and others as designated by the company” are subject to blackout – 35%
– All employees – 16%
– Some other definition – 4%
– Our company doesn’t have an insider trading policy- 0%
Please take a moment to participate anonymously in these surveys:
This “Harvard Law” blog claims that companies that use the word “stockholder” hold the sinister view that investors are passive and powerless book-entries:
Today, the term “stockholder” gives off a whiff of a Mad Men-era world where investors were bystanders. Nearly all institutional investors have junked “stockholder” for “shareholder” when referring to themselves. They see their roles not as passive holders of electronic notations but as parties sharing responsibilities for performance when they invest in a company.
That’s why Blackrock CEO Larry Fink recently wrote to corporate boards referring to investors conspicuously as “owners”— the word “stockholder” is nowhere to be found.
So, the blog concludes that the move to “shareholder” was caused by greater attention to investor rights and long-term stewardship. Maybe it’s just me – but I think we’re reading too much into this terminology. I interned for a Delaware Justice – we always used “stockholder” since that’s the word used in the DGCL. But I use “shareholder” for companies incorporated in states that follow the Model Business Corporation Act or otherwise use that terminology in their statute. On this site, we almost always use “shareholder” – but we do that because it’s easier, not as a statement on investor rights. This blog might’ve eliminated my last hope that actions matter more than words.
On the other hand, maybe there’s something to it. Keith Bishop pointed out that even though the blog focuses on the “shareholder v. stockholder” distinction – the nomenclature it’s really trying to argue for is “shareowner.” Here’s his note:
It is my understanding that shareholder activists have adopted the term “shareowner” as a way of signaling that they are more than passive investors (i.e., they are owners, not mere holders). CalPERS, for example, refers to itself as a “shareowner”. I haven’t run across any corporate statutes that have adopted the term, however. As for Delaware, the DGCL uses the term “stockholder”. Incongruously, however, Rule 23.1 of the Delaware Court of Chancery Rules refers to “shareholder”.
Poll: “Shareholder” v. “Stockholder”?
Please take our anonymous poll about your views on investor terminology:
We haven’t heard much about auditor rotation since the PCAOB’s concept release about that topic in 2011. That concept release didn’t go too far due to controversy. But at GE, proxy advisors appear to be taking a closer look at the company’s longstanding relationship with its auditor. Here’s the intro from Cydney Posner’s blog (also see this WSJ article):
It’s certainly a rare event, but both ISS and Glass Lewis have recommended voting against a proposal to ratify the appointment of GE’s auditor, KPMG at the GE annual shareholders meeting. Most often, the issue of auditor ratification is not very controversial—in fact, it’s usually so tame that it’s one of the few matters at annual shareholders meetings considered “routine” (for purposes of allowing brokers to vote without instructions from the beneficial owners of the shares). Are we witnessing the beginning of a new trend?
In its analysis justifying its negative recommendation, ISS observed that the SEC is currently investigating GE’s revenue recognition practices and internal controls related to long-term service agreements, as well as a $9.5 billion increase in future policy benefit reserves for the GE’s insurance operations. ISS also cites commentators who suggested that GE and its auditors “must have or should have been aware of the issues—particularly the increasing insurance liabilities—for years.” These accounting issues, together with KPMG’s issuance of unqualified reports on the financial statements, were the basis of the recommendation by ISS against ratification of the auditors. Not to mention that KPMG has been GE’s auditor for a long time—by a “long time,” I mean 109 years! And notwithstanding major changes in the management team, ISS observed, the board, stressing the benefits of auditor tenure, still reappointed KPMG.
In addition, ISS also saw no discussion in the proxy statement regarding how or whether the board took into account KPMG’s role in GE’s two accounting problems or any other regulatory issues involving KPMG, including auditor independence allegations (which both ISS and GL indicate were alleged to involve GE) that KPMG settled with the SEC in 2014 or the indictments in 2018 of KPMG employees.
Glass Lewis also indicated that it usually supports management’s choice of auditor except when GL believes the auditor’s “independence or audit integrity has been compromised.” In its analysis, GL raised the same concerns as ISS regarding the SEC investigation of GE and problems at KPMG, noting in particular the large increase in fees to KPMG in the prior year, as well as its long tenure as GE’s auditor, which has “thrown KPMG’s effectiveness and relationship with the Company into question.”
Also note this article which highlights how the new changes to the audit report include disclosure of the length of an auditor’s tenure at that company. The article notes: “At the time of writing, 21 of the Dow 30 companies had released their annual reports (those with Dec. 31 year-ends). The average auditor tenure at those companies was 66 years.”
1. Why have audit regulators such as the PCAOB – which has now been in business for 15+ years – been unable to improve the quality of audits to high-quality?
2. Why is the goal to have 71% of audits comply with professional standards? Do investors really have to pay for audits when 29% are found to be defective?
3. Does this system even work? The regulators very rarely fine an auditor for deficient work. And auditors have a conflict of interest since they’re paid by the company being audited.
4. How can the IFIAR manage and inspect for quality – when their report says they’re having a difficult time figuring out how to measure it? Perhaps that’s the reason over one in every four audits is deficient.
The inconsistency among IFIAR member findings is also concerning. Those who conducted fewer inspections were much more likely to find a significant failure to satisfy audit standard requirements. There was a 62% finding rate for members inspecting 20 or fewer audits – a 46% finding rate for members inspecting 21-40 – and a 30% finding rate for members inspecting 41 or more.
The two areas with the highest rate & greatest number of findings were:
– Accounting Estimates: most findings related to failure to assess the reasonableness of assumptions
– Internal Control Testing: most commonly, auditors failed to obtain sufficient persuasive evidence to support reliance on manual controls. The next most common finding was that auditors failed to sufficiently test controls over – or the accuracy & completeness of – data or reports produced by management
“You Get What You Pay For”: Audit Fee Pressure Lowers Audit Quality?
There’s some concern among audit firms that they’re being required to “do more with less.” Rigorous work is required to comply with Sarbanes-Oxley and other regulations – but clients are looking for ways to reduce or maintain fee levels. As a consequence, 80% of firms have seen a reduction in the profitability of audit services.
Studies are starting to show that this fee pressure is negatively impacting audit quality. This latest white paper finds that there’s a higher rate of misstatements among firms that are shifting their focus to more profitable non-audit services. Interestingly, the analysis also shows that the decline in audit quality is more common at large audit offices than small ones.
Some people in our community are wondering whether this information will affect auditor regulations and shareholder ratification votes. I’m not holding my breath – this study just confirms what many people have been observing for decades, and shareholders seem to ignore audit fee info.
Yesterday, Corp Fin issued two new CDIs about non-GAAP financial measures that are used in connection with business combinations. They’re a follow-on to CDI 101.01 – which we blogged about last fall. This Wachtell Lipton memo provides an overview (also see this Cooley blog):
While CDI 101.01 helped address the recent spate of frivolous litigation claiming that projections disclosed to explain the assumptions underlying a financial advisor’s fairness analyses require GAAP reconciliation, plaintiffs’ lawyers subsequently seized on the fact that the CDI did not explicitly clarify whether the GAAP reconciliation requirements apply to projections shared with bidders or the board and opportunistically continued to pursue weak disclosure claims.
The underlying logic of the initial CDI plainly applies to these circumstances too: disclosure of internal forecasts to bidders or the board is not intended to communicate performance expectations to investors, and reconciling them to GAAP is neither useful nor required. Corp Fin has now helpfully confirmed that the same considerations animating the initial CDI extend to these additional factual circumstances.
SEC Impersonators: “This Is What Fraud Sounds Like”
Scammers impersonating the SEC aren’t something new (here’s a blog about one such scam). Yesterday, the SEC issued a warning – along with a one-minute audio recording – about SEC impersonators who are pretending to execute trades in an attempt to dupe people into giving them money or account info. Crazy stuff. Here’s an excerpt:
“The audio recording is what fraud sounds like,” said Lori Schock, Director of the SEC’s Office of Investor Education and Advocacy. “We included the recording in our Investor Alert so investors can hear the lies and high pressure tactics imposters use to cheat potential victims out of their money.”
Transcript: “Conduct of the Annual Meeting”
We’ve posted the transcript for our recent webcast: “Conduct of the Annual Meeting.”
Following up on Broc’s blog about the passing of Julie Yip-Williams, there will be a memorial service for Julie on Saturday, May 5th at 5:30 pm, at St. Ann & Holy Trinity Church (157 Montague St, Brooklyn). In lieu of flowers, her family requests that memorial contributions be made to the “Colorectal Cancer Alliance” in Julie’s name.
