Wow. As reported last week by Reuters, the SEC has moved to dismiss all active misconduct proceedings against accountants that had been pending before administrative law judges – 8 in total. This Jones Day memo gives more detail:
The Supreme Court recently held in SEC v. Jarkesy that the SEC’s in-house administrative proceedings violate the Seventh Amendment’s right to jury trial to the extent they adjudicate claims that are “legal in nature,” such as fraud charges and civil penalties. Jarkesy did not directly address, however, other kinds of enforcement actions the SEC historically adjudicates in-house, including proceedings under Rule 102(e) of the SEC Rules of Practice, which is the SEC’s primary tool for regulating the professionals appearing before it. Among other things, Rule 102(e) empowers the SEC to censure or bar professionals found to have engaged in “improper professional conduct,” which, for accountants, can include repeated violations of applicable professional standards. But Rule 102(e) proceedings can only be brought administratively.
The SEC seems now to believe that Jarkesy precludes litigating Rule 102(e) proceedings administratively. In August 2024, the SEC dismissed two contested Rule 102(e) proceedings against accountants who allegedly failed to conduct audits in accordance with professional standards. The SEC previously had moved to stay each case pending a decision in Jarkesy. Notably, while one of the cases involved a claim for civil penalties thus plainly implicating Jarkesy the other sought only remedial and cease-and-desist relief. It may also be significant that each accountant had sued the SEC in federal court to challenge its use of administrative proceedings.
Jones Day goes on to note that the SEC hasn’t publicly announced any policy against using ALJs for disciplinary proceedings. But the dismissal of all pending cases is a pretty big deal! It remains to be seen whether cases pending before the PCAOB will also be dropped. Interestingly, this move by the Enforcement Division came at the same time as the SEC approved PCAOB rule standards that lower the liability standard for individual auditors’ contributory liability (from recklessness to negligence) – which Commissioners Peirce and Uyeda opposed.
All of the recent actions on PCAOB rules had me wondering: what is going on with the NOCLAR proposal? Based on the PCAOB’s rulemaking page – which was last updated when the rule was proposed in June 2023 – the answer appears to be “not much.” At least, not publicly.
For now, a lot of folks are hoping that “no news is good news.” Compliance officers, executives, auditors and other concerned parties submitted nearly 200 unique comment letters – and the PCAOB received additional feedback via a roundtable in April. We’ll continue to watch for updates…
As Dave noted last week, the SEC continues to pay attention to “AI washing” by public companies. Over on “The D&O Diary,” Kevin LaCroix points out that the plaintiffs’ bar has also been watching. A recent complaint shows how they are scrutinizing statements about AI opportunities. If those opportunities are delayed or fail to materialize, they are alleging that the statements were materially misleading. Here’s an excerpt from Kevin’s summary:
The complaint alleges that these statements about the company’s AI-related initiatives “created the false impression that” the company “possessed reliable information pertaining to the Company’s ability to develop and incorporate AI throughout the software development cycle in order to optimize code generation thereby increasing market demand.” In truth, the complaint alleges, there was “weak market demand for the Company’s touted AI features,” and the company was incurring increased expenses involving its China joint venture.
The complaint alleges that “the truth emerged” on March 4, 2024, when the company released its first fiscal quarter 2024 earnings report. Among other things, the company announced that it needed more time to build its pipeline and close deals on new products. The company also lower its 2025 guidance. The complaint alleges that the company’s share price declined 21% on this news.
This is far from the first AI-related securities lawsuit. Kevin shared another example just a few months ago. He notes that the rise in AI-related litigation – including newer claims based on “AI washing” – is one of the top D&O trends for 2024. Companies should be aware of this risk when making any public statements about their AI opportunities.
As we emerge from “AI summer” – and take stock of the heightened interest of the SEC and the plaintiffs’ bar in corporate AI disclosures – it’s a good time to revisit the Board’s role in overseeing the unique risks that companies may face in this brave new world of artificial intelligence (and the regulations that will apply to its use).
This Skadden memo provides a good starting point for that exercise. It summarizes key risks (based on the NIST framework), how they may vary across different industries, and the current regulatory landscape in the U.S. and Europe (which many U.S.-based companies will have to contend with). The memo offers these “guiding principles” for AI corporate governance:
1. Understand the company’s AI risk profile. Boards should have a solid understanding of how AI is developed and deployed in their companies. Taking stock of a company’s risk profile can help boards identify the unique safety risks that AI tools may pose.
2. Be informed about the company’s risk assessment approach. Boards should ask management whether an AI tool has been tested for safety, accuracy and fairness before deployment, and what role human oversight and human decision-making play in its use. Where the level of risk is high, boards should ask whether an AI system is the best approach, notwithstanding the benefits it may offer.
3. Ensure the company has an AI governance framework. The board should ensure that the company has such a framework to manage AI risk, and then reviews it periodically to make sure it is being properly implemented and monitored, and to determine the role the board should have in this process.
4. Conduct regular reviews. Given the rapid pace of technological and regulatory developments in the AI space, and the ongoing discovery of new risks from deploying AI, the board should consider implementing regular reviews of the company’s approach to AI, including whether new risks have been identified and how they are being addressed.
5. Stay informed about sector-specific risks and regulations. Given how quickly the technology and its uses are evolving, boards should stay informed about sector-specific risks and regulations in their industry.
You can find details on all of the latest AI developments in our “Artificial Intelligence” Practice Area. AI developments will also be on the agenda for our “2024 Proxy Disclosure & 21st Annual Executive Compensation Conferences.” For example, we have a panel titled “In-House Insights: Governing and Disclosing AI,” which will feature Kate Kelly of Meta, Erick Rivero of Intuit and Derek Windham of Tesla to discuss how AI is being utilized in the in-house legal functions at public companies. If you can’t make it to the Conferences in person, we also offer a virtual option. Register today by visiting our online store or by calling us at 800-737-1271.
Okay, we’ve established a few guiding principles for board oversight of AI. But how do you actually put those principles into action – for artificial intelligence and technology more generally? This Deloitte memo suggests that, for some boards, it may be helpful to cover some of the issues outside of regular meetings of the full board. For example:
– Audit committee meetings. Given that audit committees are focused on tracking major risks and compliance issues, it’s one place where technology is often discussed. “With the boards I serve on, technology is always in the conversation since there’s so much going on. We’re always discussing technology—if not in the primary board then in the audit committee meetings,” says Wong.
– Board strategy workshops. Smaller, less formal groups may also create opportunities for in-depth technology discussions. “During one of our quarterly board meetings, we had the board spend six hours with the extended senior leadership team in workshopping sessions where each breakout explored a different theme, like technology strategy,” says Burkey. “Being part of that process was great. You weren’t having that 12-minute conversation around the board table; you were really participating in a very meaningful and productive exchange.”
– Compensation committees. Today, compensation committees have responsibilities that extend beyond just overseeing a company’s compensation and benefit policies. They are increasingly focused on the overall talent experience, retention rates, and skills gaps, as well as coordinating succession planning with the nominating committee. One technology executive from a vehicle retailer recommended these committees look at progress against transformation goals when discussing leadership compensation, especially given the technology function’s capacity to transform businesses and corporate strategies: “Besides talent, how boards construct their compensation and reward system for management, and how they hold them accountable, can be tied to overall business transformation goals. Having a business transformation goal could be one of the parameters to determine compensation.”
The memo reports that 38% of surveyed executives say that their company has some form of “technology committee” to oversee tech-related issues. It also suggests questions that board members can ask their CIO or CTO to help ensure they’re getting the right information, including:
– How can our organization mitigate potential technological blind spots?
– What is our technology talent bench strength?
– What incremental, technology “easy wins” are possible if resources are unconstrained?
See Meredith’s blog a few weeks ago for even more suggestions…
When we last checked in on the litigation over the SEC’s climate disclosure rule, the SEC had indicated that, if the rule survives litigation, it would provide a new implementation period for companies to come into compliance. Now things are heating up on the docket, with both sides submitting their briefs (along with many “intervenors”). Based on the calendar, most briefs should be in by now, with the petitioners’ response due mid-September.
This blog from Cooley’s Cydney Posner recaps the SEC’s key arguments in support of its authority to adopt the rule. Here’s an excerpt:
The SEC maintains that its “approach to climate-related information has been consistent with its longstanding interpretation of its statutory authority: the Securities Act and the Exchange Act authorize the Commission to mandate disclosures that protect investors by facilitating informed investment and voting decisions.” Each disclosure requirement in the rules is designed to elicit information with that goal and is therefore “necessary or appropriate in the public interest or for the protection of investors.” For example, the requirements to disclose Scope 1 and Scope 2 GHG emissions are a central measure of exposure to transition risk, one of the business and financial risks facing companies. Consequently, the SEC argues, the information is elicited is “necessary or appropriate in the public interest or for the protection of investors” and within the SEC’s authority.
Petitioners’ arguments, the SEC contends, set up a “strawman—challenging reimagined rules that the Commission did not enact and criticizing a rationale that the Commission expressly disclaimed.” Contrary to petitioners’ arguments, the rules were adopted “to advance traditional securities-law objectives of facilitating informed investment and voting decisions,” not to “influence companies’ approaches to climate-related risks or to protect the environment.” As reflected in the extensive factual record, the rules respond to “changed facts, including subsequent market and regulatory developments,” such as the current importance of climate-related risk information to investor decision-making and investor interest in detailed, consistent and comparable information. In adopting the rules, the SEC emphasized that they “do not ‘determine national environmental policy or dictate corporate policy,’” and emphasized that it “is ‘agnostic as to whether and how issuers manage climate-related risks so long as they appropriately inform investors of material risks.’” In addition, the rules “do not ‘prescribe any particular tools, strategies, or practices with respect to climate-related risk.’”
The blog also summarizes the Commission’s response to challenges under the Administrative Procedure Act and the First Amendment. As I mentioned, there are a lot of amicus briefs on both sides – here is one from 17 First Amendment scholars that defends the rule. Here’s a summary of their arguments:
The Knight Institute’s amicus brief, filed in support of the rule, makes four arguments. First, securities disclosure requirements that inform and protect investors do not ordinarily raise First Amendment concerns. Second, the climate disclosure rule falls within this longstanding tradition of securities disclosure requirements. Third, at most, the rule should be evaluated under the framework that the Supreme Court established in Zauderer v. Office of Disciplinary Counsel of the Supreme Court of Ohio, 471 U.S. 626 (1985). Finally, the rule survives Zauderer’s scrutiny.
It’s anyone’s guess what will happen to this rule, but there’s a chance that the court’s decision will be a mixed bag. The SEC acknowledges that possibility in its brief. Cydney notes:
While the SEC urged the court to agree with its conclusions that all of petitioners’ challenges fail, if the court were to determine otherwise, the SEC requests the court to remand, not vacate, and to sever any provision that the court determines to be unlawful.
In a decisive move that it previewed earlier this year, the California State Teachers’ Retirement System recently announced that it voted against the boards of directors at a record 2,258 companies this past proxy season – which is up from a then-record of 2,035 companies in 2023. This is out of about 10,000 meetings globally.
Although many companies have paused (or at least not accelerated) efforts on climate disclosure while we wait out litigation over the SEC’s rule, CalSTRS’ voting policies continue to matter because it is one of the largest pension funds in the world, with over $341 billion in assets. The pension fund articulates its expectations as follows:
CalSTRS expects all portfolio companies to accomplish the following, to help effectively manage the risks and opportunities associated with climate change:
– Publish a report on sustainability-related disclosures that aligns with the International Financial Reporting Standards, which took over the monitoring of companies’ progress on climate-related disclosures from the Task Force on Climate-related Financial Disclosure (TCFD).
– Disclose Scope 1 and Scope 2 greenhouse gas (GHG) emissions. Scope 1 emissions come from a company’s operations and Scope 2 emissions are from the generation of power a company uses.
In addition to the above disclosures, CalSTRS expects the highest global emitting companies on the Climate Action 100+ focus list and other high-emitting companies to also set appropriate targets to reduce GHG emissions, as this is an important step to reach a net zero portfolio by 2050 or sooner.
The press release says there has been improvement in methane emissions reporting over the past year, and that 10 companies have joined the Oil and Gas Methane Partnership 2.0 (OGMP 2.0), a United Nations-led framework committed to the measurement, reporting and mitigation of methane emissions, as a result of CalSTRS-led engagements.
Thanks to everyone who has reached out with well-wishes since I shared in April that I was going under the knife. It has always meant a lot to me to be part of this community and get to be connected on a personal level with so many of our readers and members, and this latest experience only underscored what a thoughtful community it really is. It’s been great to return to the blog this week!
As I shared a few months ago, I had some reservations about taking a medical leave. I still have several months ahead of me on this recovery journey – but the hardest part is behind me, and I’m very happy about that! And I have to say, the cardio improvements are even better than I’d imagined.
While this endeavor has renewed my gratitude for the everyday routines that we all sometimes take for granted, I am still definitely in learning mode when it comes to handling setbacks with grace and patience. And the biggest lesson for me – by far – has been the reminder that we are all connected (and that’s a good thing). I have had to depend on people in new ways and I’m happier than ever to lend a hand to others who are going through challenging times.
Thank you again to *everyone* who supported me during my leave, and to all of you for welcoming me back. I’m looking forward to catching up with you in the months to come and hopefully seeing many of you in San Francisco!
For more than thirty years, one of the most prevalent strategies for insider trading has gone undetected and unaddressed. This Article uncovers the techniques by which executives and directors sell overvalued stock worth more than $100 billion per year, shifting losses to ordinary investors. The basic idea is that insiders conceal their suspicious trades by publicly reporting them (as they are required to do) in ways that confuse or discourage investigators.
We develop a taxonomy of concealment strategies, complete with suggestive examples. We then empirically test our taxonomy using a database of essentially all stock trades since 1992. We find that insiders who trade using the subterfuges we describe outperform the market by up to 20% on average.
Worse yet, we find evidence that this simple subterfuge works. Essentially no one has ever been prosecuted for undertaking one of these suspicious trades. Nor do journalists or scholars seem to appreciate them. Accordingly, we call for scholars and prosecutors to cast a wider net in their studies and market surveillance, then discuss implications for the design of insider-trading reporting requirements and related legal rules.
That’s the abstract from “Insider Trading by Other Means,” a new 66-page research paper by Sureyya Burcu Avci, Cindy A. Schipani, H. Nejat Seyhun and Andrew Verstein, which is published in the Harvard Business Law Review. This Bloomberg article points out that this paper isn’t the group’s first foray into insider trading analytics: their earlierresearch on “insider giving” was cited in the SEC’s 2022 rule changes on insider trading and Rule 10b5-1 plans and supported the Commission’s decision to require insiders to report gifts on Form 4 within 2 business days.
Now, the authors are taking aim at Form 4 transaction codes. Specifically, “J codes” that are used to report transactions that don’t fall into any other transaction code category. They are calling for action – and it’s fair to think the SEC Enforcement Division will listen, given its focus on insider trading and fondness for data analytics (and according to a 2004 blog from Alan on Section16.net, they’ve investigated transaction codes before). Here’s an excerpt:
[I]nvestigators have been unduly passive with respect to insider trading proxies. Code J is a strong signal that insider trading may be underway. Investigators should, at the very least, treat suspicious J transactions as worthy of inquiry. Indeed, they should probably go further and prioritize J-coded transactions more aggressively than ordinary S transactions.
This recommendation is even stronger where the filing bears other worrying marks. J transactions are required to include an explanatory footnote. Filings that lack an explanation, or which use the wrong transaction code, are out of compliance with the law. Transactions with the issuer, or distributions from investment funds, may appear to be benign, but our tests indicate that these are especially likely to be suspiciously timed. Accordingly, investigators should take these keywords to be informative proxies.
Most centrally of all, investigators should take late-filed J-coded transactions to be highly suspicious. Our findings indicated intense abnormal returns with J-coded transactions are reported long after the transaction took place. In most cases, these transactions are already improper, and worthy of investigation for that reason. But even if delayed filing is sometimes justified, the overall trend remains strong. Investigators should scrutinize even lawfully delayed J-coded transactions because such transactions are strongly associated with abnormal profits.
Likewise, investigators should examine more closely the transactions between insiders and their corporations. We found that J-coded transactions discussing SEC Rule 16b-3 were suspiciously well timed, despite the SEC’s view that these transactions are often benign. Plainly, the story is more complicated.
When scrutiny unearths false or deceptive Form 4 filings, prosecutors should take aggressive action.
Despite the findings, my own experience is that the vast majority of folks are truly attempting to correctly report transactions under a complex Section 16 regulatory regime. So, how do we stay out of the crosshairs? The authors note that this is an area where “the law abides partially in the craft wisdom about what is commonplace and acceptable” – but they mention a great resource:
Romeo and Dye’s two-volume handbook offers more than 1000 pages of practical guidance, focused just on the details of how to fill out the one-page Form-4 and its peers. Romeo and Dye also publish a treatise on Section 16 law, more generally.
Forgive me for including a shameless plug, but I have to admit I would struggle in my day job if I didn’t have access to Peter and Alan’s vast array of accumulated wisdom. If you aren’t already a member of Section16.net, you should sign up. And more urgently, make sure to catch the star himself, Alan Dye, at our “Proxy Disclosure & 21st Annual Executive Compensation Conferences,” October 14th and 15th! We have an awesome agenda filled with expert practitioners who will share their insights. Alan, Dave, John, Meredith and I love this community and we are very eager to see as many folks as possible in person in San Francisco! Register and book your hotel room today, if you haven’t already done so. Virtual attendance is also still an option if you’re not able to join the party in person!
Earlier this year, I shared on our Proxy Season Blog that Glass Lewis and at least one big asset manager are considering “director commitment policies” as part of their review and voting recommendations/decisions. A blog from Stefan Padfield of the National Center for Public Policy Research recaps the proponent perspective on this topic, with a novel proposal submitted to several companies this past season that requested directors to:
“disclose their expected allocation of hours among all formal commitments set forth in the director’s official bio, with allocation being permissible “on a weekly, monthly, or annual basis.”
The Corp Fin Staff agreed with several companies that this proposal could be excluded from the proxy statement on the basis of micromanagement. Another company did not seek no-action relief, submitting the proposal to a vote by stockholders, where it received support from about 3% of the voting power. But Stefan says the NCPPR is undeterred:
Given the ever-increasing responsibilities of corporate directors, as well as generally increasing demands on their time, limiting oversight of overboarding to counting board seats and CEO spots is unsustainable. Accordingly, we will likely be submitting a similar proposal next season and urging the SEC staff to reconsider its conclusion in Johnson & Johnson. Asking prospective directors how they intend to allocate their hours among their often numerous commitments should not be viewed as improper micromanagement but rather basic accountability fully within the ambit of shareholders to request.
Be on the lookout for more on this topic as we head into 2025…
