On Friday, the SEC’s Chief Accountant, Paul Munter, issued a statement on the responsibilities of lead auditors to conduct high-quality audits when involving other auditors. He notes this has become a prevalent practice:
The increasing integration of world economies and the resultant globalization of multinational public companies has led to increased use of, and more significant roles for, accounting firms and individual accountants other than the lead auditor (“other auditors”) on many issuer audit engagements.
In 2021, for example, 26 percent of all issuer audit engagements and 57 percent of large accelerated filer audits involved the use of other auditors by the lead auditor. In some cases, engagements include the use of other auditors that may not even be registered with the Public Company Accounting Oversight Board (“PCAOB”) and that work in countries with different business cultures and languages from those of the lead auditor.
Here’s the part that’s most relevant to audit committees & companies – and those of us who advise them:
Audit committees make significant contributions to financial reporting through their critical oversight of the independent auditors. With respect to the use of other auditors, audit committees should be actively engaging with the lead auditor to consider the sufficiency of their quality control system, specifically those policies and procedures around supervision and evaluation of the audit work performed by other auditors. This also includes giving careful consideration to the lead auditor’s use of other auditors, especially in areas of significant risk, and engaging in related dialogue in response to communication requirements. Potential questions that audit committees could be asking their auditors include, but are not limited to the following:
– Are there other participating accounting firms that play a substantial role in the audit?
– If so, are they registered with the PCAOB and subject to PCAOB inspections?
– How does the lead auditor supervise the audit work performed by other auditors?
– How does the lead auditor assure that the work is being performed by other auditors that understand the requirements of the applicable financial reporting framework and the PCAOB’s auditing and related professional standards?
We also remind issuers and audit committees that if an unregistered firm plays a substantial role in the audit, the issuer’s financial statements are considered to be “not audited.” Any accompanying annual report, proxy statement, or registration statement containing or incorporating by reference such financial statements creates potential liabilities for the issuer and others, and may result in time consuming and costly remediation efforts. Therefore, management and audit committees should engage with the auditors regarding the PCAOB registration status of other auditors.
The statement also covers lead auditor’s responsibilities in these situations and how those responsibilities are incorporated in PCAOB standards. Paul has been preaching the need to pay attention to audit quality in a series of speeches over the past several years – including this one focused on engagement structures specific to China-based audits, commentary on auditor independence, and this 2021 year-end statement that flags “audit quality” as a key focus area.
The SEC’s proposed climate disclosure rules aren’t yet final, but companies should still be paying close attention to the Commission’s 2010 interpretive release. A recent PwC analysis of Corp Fin’s 2022 disclosure review activity underscores why: climate disclosure has broken into the “top 3” most prevalent topics that are drawing comments on Form 10-K & 10-Q filings – a trend that was noticeable as early as Q1 last year.
If you haven’t already made sure that your CSR/ESG/Sustainability report and your SEC filings are consistent with each other – not just “not conflicting” but also in terms of expansiveness – now is the time to do that. PwC explains:
These comments are largely focused on information related to climate change-related risks and opportunities that may be required in a company’s description of business, legal proceedings, risk factors, and management’s discussion and analysis of financial condition and results of operations. In these letters, the staff frequently commented on:
– inconsistencies between a registrant’s corporate social responsibility report and its SEC filings;
– the lack of disclosure in a registrant’s SEC filing of the risks, trends, and impact of climate change for the registrant and its business; and
– the lack of disclosure in a registrant’s SEC filings related to pending, or existing climate-related legislation and regulations that could have a material impact on a registrant’s business.
The memo gives several examples of specific comments that have been issued. Here’s a few:
– We note that you provided more expansive disclosure in your corporate social responsibility report (CSR report) than you provided in your SEC filings. Please advise us what consideration you gave to providing the same type of climate-related disclosure in your SEC filings as you provided in your CSR report.
– Disclose the material effects of transition risks related to climate change that may affect your business, financial condition, and results of operations, such as policy and regulatory changes that could impose operational and compliance burdens, market trends that may alter business opportunities, credit risks, or technological changes.
– There have been significant developments in federal and state legislation and regulation and international accords regarding climate change that you have not discussed in your filing. Please revise your disclosure to identify material pending or existing climate change-related legislation, regulations, and international accords and describe any material effect on your business, financial condition, and results of operations.
Other areas of focus during the past year included several “old favorites”: MD&A, non-GAAP, segment reporting, revenue recognition, disclosure controls, and more. We’re posting info about comment letter trends in our “Comment Letter” Practice Area, which is also where you can find our “SEC Comment Letter Process Handbook.” The Handbook shares guidance on how to navigate the response process and includes insights from Sidley’s Sonia Barros & Sara von Althann, who both spent time on the Staff.
Two years ago, I wrote that anticipating Larry Fink’s annual letter to CEOs, a 10-year tradition which typically has arrived in January, was like waiting for Moses to come down from the mountain. He softened his tone last year. Now, it’s apparent a “vibe shift” has arrived. Mr. Fink has finally made it clear…in March…that this year, there will be no pontificating to CEOs. At least, not as directly as in years past.
Instead, he’s sticking to updating BlackRock’s investors – via an 18-page letter published last week. That hasn’t stopped corporate folks from poring over his commentary for hints on how the world’s largest asset manager might vote at annual meetings this year, and what its priorities will be.
The term “ESG” doesn’t appear anywhere in the letter. That’s a sign of the times since that terminology, and investors’ involvement in encouraging ESG disclosures, has become a lightning rod for politicians (and wannabe politicians). However, it would be a bridge to far to declare that this means that ESG has been “cancelled” or that BlackRock has given up on long-term, sustainable value creation. The letter still gives plenty of play to the importance of solid corporate governance in the midst of evolving risks & opportunities – e.g., talking about the “price of easy money” in the wake of recent financial industry issues, and how that compares to BlackRock’s strong returns. The asset manager’s co-founder, Chair & CEO is also still continuing to beat the “climate transition” drum, although that message keeps getting refined away from directing portfolio companies what to do and towards how this is a choice for BlackRock’s investor clients:
Better data is essential. More than half of the companies in the S&P 500 now voluntarily report Scope 1 and Scope 2 emissions. I expect that number will continue to rise. But as I have said consistently over many years now, it is for governments to make policy and enact legislation, and not for companies, including asset managers, to be the environmental police.
Transition toward lower carbon emissions will reflect the regulatory and legislative choices governments make to balance the need for secure, reliable and affordable energy with orderly decarbonization.
We know that the transition will not be a straight line. Different countries and industries will move at different speeds, and oil and gas will play a vital role in meeting global energy demands through that journey. Many of our clients see the investment opportunities that will come as established energy companies adapt their businesses. They recognize the vital role energy companies will play in ensuring energy security and a successful energy transition.
He goes on:
Some of the most attractive investment opportunities in the years ahead will be in the transition finance space. Given its importance to our clients, BlackRock’s ambition is to be the leading investor in these opportunities on their behalf.
I wrote last year that the next 1,000 unicorns won’t be search engines or social media companies. Many of them will be sustainable, scalable innovators – startups that help the world decarbonize and make the energy transition affordable for all consumers. I still believe that. For clients who choose, we’re connecting them with these investment opportunities.
The letter also touts BlackRock’s new “voting choice” initiative and has this to say about stewardship activities:
Making these decisions requires understanding how companies are responding to evolving risks and opportunities. Changes in globalization, supply chains, geopolitics, inflation, monetary and fiscal policy, and climate all can impact a company’s ability to deliver durable value. Our stewardship team works to promote better investment performance for our clients, the asset owners. The team does that by understanding how a company is responding to these factors where financially material to the company’s business, and by advocating for sound governance and business practices. For many of our clients who have entrusted us with this important responsibility, BlackRock’s stewardship efforts are core to what they are seeking from us.
At the same time, we believe that adding more voices to corporate governance can further strengthen shareholder democracy. But democracy only works when people are informed and engaged. As more asset owners choose to direct their own votes, they need to make sure they are investing the time and resources to make informed decisions on critical governance issues. Proxy advisors can play an important role. But if asset owners rely too much on a few proxy advisors, then their voice may fall short of its potential. I certainly believe that the industry would benefit from more proxy advisors who can add diversity of views on shareholder issues.
Amid these shifts, companies will also need to find new ways to reach their shareholders who choose to direct their own votes, and robust disclosures and advances in the proxy ecosystem will become even more important.
I blogged about BlackRock’s 2023 voting guidelines a few months ago. If they’re a big shareholder at your company, make sure to review those and their “Global Principles” as you head into annual meeting season.
Here’s an update from John’s DealLawyers.com blog yesterday (make sure to connect with him at Tulane if you’ll be there this week!):
On Friday, Corp Fin finished its long-awaited build-out of the Tender Offer Rules & Schedules CDIs by issuing 34 CDIs addressing a wide range of interpretive issues. As anyone who’s ever researched tender offers knows, most of the Staff’s guidance has been scattered across the old Telephone Interps & other locations on the SEC’s website, with only a handful of topics addressed in the CDIs. All of that guidance has finally been consolidated into a single location. The intro to the page provides some insight into where all of the new CDIs came from:
These Compliance and Disclosure Interpretations (“C&DIs”) comprise the Division’s interpretations of the tender offer rules. Many of the C&DIs replace the interpretations previously published in the Tender Offer Rules and Schedules Manual of Publicly Available Telephone Interpretations, Excerpt from November 2000 Current Issues Outline, and Excerpt from March 2001 Quarterly Update to Current Issues Outline (namely, C&DIs 101.05 through 101.16; 104.01; 104.02; 130.01 through 130.03; 131.01 through 131.03; 144.01; 146.01; 149.01; 158.01; 161.01; 162.06; 162.07; 163.01; 164.01; and 181.01). C&DI 101.04 replaces Question 2 in the Schedule TO section of the July 2001 Interim Supplement to Publicly Available Telephone Interpretations.
As this Gibson Dunn blog points out, there’s not a lot that’s new here in terms of substantive guidance. Still, there’s so much that’s new to this page on the SEC’s website that I think you may find this version that I dug up from the Internet Archive showing what the page looked like before Friday’s changes helpful. Members of DealLawyers.com can also access this redlined copy of the CDIs that I posted in our “Tender Offers” Practice Area.
By the way, I know that many of our readers will be in attendance at the Tulane Corporate Law Institute later this week. I’ll be there as well and hope to have a chance to meet you during the conference. I’m easy to find – just look for a guy who appears to be a cross between Butterbean & Sir Topham Hatt!
On the criminal enforcement front, I blogged last week on CompensationStandards.com that the DOJ has provided important guidance on a new pilot program that could reduce criminal fines for companies that are able to show that they’ve clawed back incentives from employees who were involved in the misconduct. Companies can also get credit for showing compliance-related compensation incentives, which this Gibson Dunn memo says could include:
– A prohibition on bonuses for employees who do not satisfy compliance performance requirements;
– Disciplinary measures for employees who violate applicable law and others who both (a) had supervisory authority over the employee(s) or business area engaged in the misconduct, and (b) knew of, or were willfully blind to, the misconduct; and
– Incentives for employees who demonstrate full commitment to compliance processes.
In addition, the DOJ updated guidance on corporate monitorships, employee personal devices & use of messaging platforms. The DOJ also continues to emphasize that it may give leniency when companies fully cooperate with investigations and remediate the problems, which John blogged about earlier this year. We’re posting memos about what the DOJ is looking for in our “Compliance Programs” Practice Area.
Tune in tomorrow at 2pm Eastern for the webcast – “Managing Enterprise-Wide Risks: The Intersection of ERM & Legal” – to hear Orrick’s J.T. Ho, Tesla’s Derek Windham, NetScout’s Jeff Levinson, American Express’s Ming-Hsuan Elders, and WestRock’s Stephanie Bignon discuss the role of the legal department in enterprise risk management, how ERM differs from traditional risk management, what you need to consider when implementing an ERM program, the SEC’s focus on ERM disclosures, and the relationship between ERM & ESG.
This program is very timely not only in light of recent Delaware court decisions – but also because it comes as companies are navigating banking industry issues that may affect corporate financing, risk & decision-making. Don’t miss it!
Members of this site are able to attend this critical webcast at no charge. If you’re not yet a member, try a no-risk trial now. Our “100-Day Promise” guarantees that during the first 100 days as an activated member, you may cancel for any reason and receive a full refund. The webcast cost for non-members is $595. You can sign up by credit card online. If you need assistance, send us an email at info@ccrcorp.com – or call us at 800.737.1271.
CLE credit is available! We will apply for CLE credit in all applicable states (with the exception of SC and NE who require advance notice) for this 1-hour webcast. You must submit your state and license number prior to or during the program. Attendees must participate in the live webcast and fully complete all the CLE credit survey links during the program. You will receive a CLE certificate from our CLE provider when your state issues approval; typically within 30 days of the webcast. All credits are pending state approval.
Big news on the “insider trading” front. Earlier this week, the SEC announced that it had filed a civil complaint against the CEO & Chair of a healthcare company for his allegedly improper use of a Rule 10b5-1 trading plan. The SEC is seeking a jury trial in California. In addition, the DOJ announced parallel criminal charges and unsealed a grand jury’s indictment. Whoa! From the DOJ’s press release:
According to court documents, between May and August 2021, Peizer, 63, a resident of Puerto Rico and Santa Monica, California, allegedly avoided more than $12.5 million in losses by entering into two Rule 10b5-1 trading plans while in possession of material, nonpublic information concerning the serious risk that Ontrak’s then-largest customer would terminate its contract.
In May 2021, Peizer allegedly entered into his first 10b5-1 trading plan shortly after learning that the relationship between Ontrak and the customer was deteriorating and that the customer had expressed serious reservations about continuing its contract with Ontrak. The indictment alleges that Peizer later learned that the customer informed Ontrak of its intent to terminate the contract. Then, in August 2021, Peizer allegedly entered into his second 10b5-1 trading plan approximately one hour after Ontrak’s chief negotiator for the contract confirmed to Peizer that the contract likely would be terminated.
In establishing his 10b5-1 plans, Peizer allegedly refused to engage in any “cooling-off” period – the time between when he entered into the plan and when he sold stock – despite warnings from two brokers. Instead, Peizer allegedly began selling shares of Ontrak on the next trading day after establishing each plan. On Aug. 19, 2021, just six days after Peizer adopted his August 10b5-1 plan, Ontrak announced that the customer had terminated its contract and Ontrak’s stock price declined by more than 44%.
If convicted, the CEO faces a maximum penalty of 25 years in prison on the securities fraud scheme charge and 20 years in prison on each of the insider trading charges.
These are the first-ever criminal allegations that relate exclusively to the use of a Rule 10b5-1 plan – and only the second SEC enforcement action. Hold on to your hats, though, because there are likely more to come. As I blogged a few months ago, the SEC’s Enforcement Division has been on the lookout for problematic Rule 10b5-1 plans, after notching its first settlement last September. Like the SEC, the DOJ also says that it has a “data-driven initiative” to identify executive abuses of 10b5-1 trading plans.
While this case – on its face – seems to afford some pretty useful facts for the regulators, it also serves as a giant red flag for any insiders who want to throw caution to the wind and quickly sell shares outside of the as-amended Rule 10b5-1 plan requirements. In this article, the defendant’s lawyer complains that the SEC & DOJ filed their cases without notice, following some “good faith” discussions. So, this initiative appears to be a “full steam ahead” endeavor – which is not a promising environment for anyone whose trades fall in a grey area.
Because trading under a plan that complies with the new requirements of Rule 10b5-1 is not an exclusive affirmative defense, the SEC’s newly effective rules on this topic also require quarterly disclosures of “non-Rule 10b5-1 trading plans” adopted by insiders. This Nelson Mullins blog from Gary Brown & Charles Vaughn asks, “what does that even mean?”
The blog offers a side-by-side comparison of a “real” Rule 10b5-1 plan & a “non-Rule 10b5-1 trading plan” – and closely analyzes whether any distinction actually exists. Here’s the conclusion:
The side-by-side comparison and analysis of a “non-Rule 10b5-1 trading arrangement” and a “Rule 10b5-1 plan” reveals that the only real differences are the cooling off periods and the certification requirements for issuer officers and directors under a “Rule 10b5-1 plan.” No one would realistically dispute that they may not enter into a trading arrangement with a lack of good faith or with the intent to circumvent the securities laws. The prohibition on multiple or overlapping plans is somewhat of a “throwaway”; courts had already ruled that those arrangements were indicators of a lack of good faith in entering into such plans, which resulted in those plans failing to provide an affirmative defense.
Does that mean that a “non-Rule 10b5-1 trading arrangement” is simply one that either:
– does not contain the required “cooling off” period; or
– if adopted by a director or officer, did not contain the required certification?
Take the examples of the limit orders referenced above – if you added a cooling off period and a certification to either order, would that convert it into a “real” Rule 10b5-1 plan? If that indeed is the case, the only difference is that one provides an affirmative defense while the other simply negates proof of “scienter” – an element of a Rule 10b-5 case.
Gary & Charles say that the confusing definition & its related disclosure requirement is going to result in a lot of extra work. Here’s why:
Absent additional SEC guidance, companies must approach these new requirements with extreme care and, in our judgment, err on the side of providing more disclosure than may be necessary regarding “non-Rule 10b5-1 trading arrangements.” That path will require quarterly inquiries to corporate officers and directors about those arrangements. Section 16 reports generally report only trades; therefore, a review of those filings might not reflect the adoption, modification or termination of either “non-Rule 10b5-1 trading arrangements” or “real” Rule 10b5-1 plans.
For companies to meet their new quarterly disclosure obligations, their insider trading policies – which must be filed with the SEC as exhibits – must now require pre-clearance and approval of not only “real” Rule 10b5-1 plans but the host of transactions that might constitute “non-Rule 10b5-1 trading arrangements.”
The blog concludes with language that could’ve made the rule more clear. Unfortunately, that’s not the world we’re living in.
Just a couple of days ago, I blogged that “early returns” from the universal proxy card regime show that the sky isn’t falling (yet). While that may be true for the moment, this HLS blog from Keir Gumbs – Broadridge CLO, SEC/Covington/Uber alum, & long-time friend to many in this community – suggests we also aren’t out of the woods. Keir highlights new Corp Fin guidance on Voting Instruction Forms, which arose as part of the aborted Trian/Disney proxy contest, and could “open the floodgates” to successful activist campaigns. Here’s an excerpt:
Specifically, the staff of the SEC’s Division of Corporation Finance has taken the position that:
– a voting instruction form should mirror the proxy card to the furthest extent possible, including with respect to the instructions relating to signed, but unmarked cards, partially marked proxy cards and overmarked proxy cards, and
– a soliciting party can include the instructions of their choosing so long as the disclosure in the proxy statement, proxy card and voting instruction form are clear to investors.
The SEC took this position in response to a new approach to proxies and VIFs advocated for by the Trian Group. Specifically:
– Unmarked but Signed Proxies and Voting Instructions – Trian Group took the position that unmarked proxy cards and VIFs should be instructed as “FOR” their nominee to the Board and “WITHHOLD” on all of the nominees recommended by The Walt Disney Company.
– Overmarked Voting Instructions – Trian Group took the position that overmarked proxy cards and VIFs (where a shareholder votes “FOR” more directors than available seats) should be marked “FOR” their nominee to the Board, “FOR” the 10 unopposed management nominees and “WITHHOLD” on the one opposed management nominee.
– Partially Marked Voting Instructions – Voting instructions were to be executed exactly as cast i.e., whichever Director nominees get a “FOR” vote will be marked as a “FOR” and the remaining nominees will be marked as “WITHHOLD”
The key to this new approach is disclosure. From the SEC’s perspective, these and similar changes are acceptable under the proxy rules as long as the soliciting party is clear regarding these outcomes.
Keir goes on to explain that this guidance is “meaningfully different” from how this issue has been addressed in the past – where unmarked proxy cards & VIFs would be completed in accordance with management’s recommendation, partially marked proxy cards & VIFs would be submitted only with respect to those items, and overmarked proxy cards & VIFs were returned to banks or brokers for further instructions. Here’s more detail:
The big change resulting from the new SEC guidance most directly impacts how Broadridge processes overmarked VIFs (e.g., voting for 12 nominees when there are only 11 seats that are up for re-election). Historically Broadridge has pulled out overmarked VIFs and sent them to the relevant bank or broker for further instruction from the relevant investor. Now, instead of sending such forms for further instructions, the SEC guidance requires that firms rewrite overmarked VIFs to follow the instructions from the soliciting party regarding such votes. This means, as was the case in the Trian/Disney contest, that an overmarked card could be voted in favor of the soliciting party’s candidates to the Board with withhold votes for the other side’s candidates.
Here’s the good news, per Keir:
One might wonder what this portends for proxy contests based on past practice. There, the news is good. As a starting matter, investors voting online can’t overvote, and we [at Broadridge] are updating our systems to ensure that they can’t undervote either. This means that the proposed changes should not impact voting by institutional investors, which typically represent 70% or more of shares entitled to vote and who largely vote online using the voting tools provided by ISS, Glass Lewis and Broadridge. This also helps for online voting by retail investors, which typically represent 20-25% of shares entitled to vote a proxy. Excluding online voting, we are left principally with the 5-6% of shares that are voted using paper VIFs.
The pool gets even smaller – of the 5-6% of shares that are voted through paper VIFs, a very small percentage – typically less than 0.05% of shares – include overmarks. Those are the VIFs that are most impacted by the new SEC guidance.
Keir agrees that it’s too early for grand predictions about the impact of universal proxy. But he makes clear that we are witnessing a lot of big changes to proxy voting right now. Keir shares that Broadridge is making several changes to accommodate the changing mechanics of proxy contests – including the increasing ability of retail investors to easily vote. Those include Broadridge’s online voting app (ProxyVote), working on pass-through voting solutions, and providing end-to-end vote confirmation. That’s a lot of action!
We’ve just posted the registration links for our “2023 Proxy Disclosure & 20th Annual Executive Compensation Conferences” – which will be held virtually September 20th – 22nd. That’s right, this event has been serving up practical guidance, direct from the experts, for two decades!! For this milestone year, there will be plenty to talk about – and we hope you can join us.
We’re particularly excited about the fact that Corp Fin Director Erik Gerding will be sitting down with our very own Dave Lynn for an interview about his latest views on Corp Fin priorities & expectations.
This interview in itself is a compelling reason to be there. But if you (or your boss) need more convincing, consider these benefits (feel free to pass these along to whomever approves your budgeting requests):
– The Conferences are timed & organized to give you the very latest action items that you’ll need to prepare for the flurry of year-end and proxy season activity. Why spend time & money tracking down piecemeal updates to share with your higher-ups & board – all while you’re under a deadline and have other pressing obligations, increasing the risk of mistakes – when you can get all of the key pointers at once?
– Unlike some conferences, the on-demand archives (and transcripts!) will be available at no additional charge to attendees after the event, and you can continue to access them all the way till July 2024. That means you can continue to refer back to the sessions as issues arise. Again, saving time & money.
– Due to new SEC rules, the shareholder proposal environment, the increasing emphasis on risk oversight and pressures that companies are facing from both ends of the political spectrum, the performance of boards, individual directors and – thanks to Delaware’s latest spin on Caremark, individual officers – will be subject to greater & greater scrutiny in the coming proxy seasons. That could affect director elections, as well as your company’s ability to raise capital, and your directors’ and officers’ exposure to derivative claims. Our expert panelists will be sharing practical action items to protect your board & officers – and risks to watch out for. Facing a low vote for any director is a nightmare scenario, even if you’re not the target of a proxy contest. This event will empower you to avoid that situation.
– There’s an “early bird” rate!! We understand budgets are very tight and that more cuts could be coming. If you sign up now, you get the best price. This helps us plan ahead, and helps you save money. Register online by credit card – or by emailing sales@ccrcorp.com. Or, call 1.800.737.1271.
You can get a “sneak peek” right now at the topics & speakers who will be joining us. As you can see, it’s an illustrious group. We’ll be sharing more about the session agendas in the weeks & months to come!
