Yesterday, EY announced that it is moving forward with partner votes to separate the firm into two distinct organizations, which it has been considering for several months and is aimed at helping avoid conflicts of interest between consulting and audit work. As I blogged in May, the breakup would be a big deal if it happens – but it is not completely novel. This NYT article explains how the split could be effected:
One way EY can achieve a split is by spinning off its consulting arm into a company that could file for an initial public offering. The auditing business would probably remain a private partnership.
One outcome of the split may be that, once separated from the accounting business, the advisory and consulting operations will be more profitable as they’re less constricted by conflict-of-interest rules that could limit the services they can provide to clients.
This WSJ article gives more detail on the dollars involved:
The firm’s 13,000 partners are expecting multimillion-dollar payouts from the split. To pay for that, EY is planning to raise about $11 billion in a public sale of a 15% stake in the consulting company, which will also borrow some $18 billion, according to Mr. Di Sibio. He said a large portion of this money would be used to pay partners, but declined to specify the amount.
It sounds straightforward, but this is going to be an exceedingly complex transaction due to auditor independence rules. Just last week, the SEC’s Acting Chief Accountant Paul Munter issued a statement about “critical points to consider when contemplating an audit firm restructuring” – so the SEC is watching. It’s not clear yet whether EY audit clients would have any reason to be skittish – there are probably decks already in the works to reassure everyone.
To move forward, in addition to regulatory approvals in some countries, EY’s 13,000 audit partners also need to approve the breakup. It will take some time to get the vote, but people are probably somewhat on board already since this has been socialized for several months. The WSJ reports that, at this time, the rest of the “Big 4” accounting firms are not planning to follow EY’s lead.
In remarks yesterday at SEC Speaks, Chair Gensler cut right to the chase about crypto tokens:
Of the nearly 10,000 tokens in the crypto market, I believe the vast majority are securities. Offers and sales of these thousands of crypto security tokens are covered under the securities laws.
Some tokens may not meet the definition of a security — what I’ll call crypto non-security tokens. These likely represent only a small number of tokens, even though they may represent a significant portion of the crypto market’s aggregate value.
This isn’t too surprising given recent enforcement activity. In July, I blogged that Coinbase submitted a rulemaking petition that called on the SEC to adopt rules that provide more clarity on the framework for digital assets as securities.
The fact that Coinbase’s petition is 32 pages long gives you a sense for how complex regulating crypto as a security could be. In his Bloomberg column yesterday, Matt Levine pointed out how difficult it would be for the SEC to simply apply pre-existing disclosure requirements to tokens. Here’s an excerpt:
I do not think that that sort of adaptation is trivial. Think about what you would want to know about a crypto project before investing in it. Some of what you would want to know — things like the qualifications of the founding team, their financial incentives and conflicts of interest, where the money is going, how the project is capitalized, how they see the market, what their business plan is, etc. — is very similar to what you’d want to know before investing in the stock of a company. But a lot would be different. You might care a lot less about the funding and capital structure of the entity that employs the developers to build the project, and a lot more about the structure and tokenomics of the decentralized project itself. You might care a lot about the decentralized self-executing code of that project, since DeFi projects are constantly getting hacked, and you might want some sort of high-level summary of that code and its vulnerabilities rather than just a GitHub repository. In a truly decentralized project, the people issuing the tokens might just not have access to some of the things — biographies of key players, audited financials — that are required in normal stock offerings.
And it’s not like most tokens these days are just sold by project developers for cash to retail investors to raise money to build the projects. This used to be true, in the “initial coin offering” boom of 2017, but the SEC shut that down pretty hard. Now tokens are more likely to be earned (by mining, by staking, by running a hotspot) by ordinary participants, and if developers want to raise money they sell tokens to venture capital firms with long lock-ups. (You can sell securities to “accredited investors,” like VCs, without registering them with the SEC.) Adapting the securities-law framework to crypto would mean looking at how crypto tokens actually come into the hands of retail investors, and thinking about what sorts of protections they need in those transactions.
The SEC understandably believes that tokens should be regulated as securities, but coming up with workable rules is a big undertaking, and there are no signs that a tailored crypto framework is in process.
Now that the SEC’s universal proxy rules are effective, everyone is anxious to see what impact they’ll have – and what issues the new process will create for companies facing a proxy contest. John shared a roundup of recent commentary yesterday on DealLawyers.com. One thing that a number of experts are pointing out is that battles will get more personal now that all of the candidates are on one card. Here’s a prediction from Okapi Partners’ Bruce Goldfarb in a recent Forbes article:
It is a near-certainty that future proxy campaigns are going to focus more on the personal attributes of the individual candidates. Each side will need to make a strong case for the qualifications of each person nominated for a board seat. This process may lead to each side publicly “dissing” the capabilities, experience, and perhaps even the integrity of the other side’s nominees.
This means you’ll want to carefully consider your director bios, skills, and all of the surrounding disclosures going in to 2023 – presenting your directors as personable & savvy candidates who bring important benefits to the company. What’s also important to remember is that this change isn’t happening in a vacuum – it is coming at a time when director skill-sets and oversight structures are already under the microscope. Aon’s Karla Bos sent me this pondering based on a post from Michael Levin at The Activist Investor:
Obviously just getting a director onto the ballot doesn’t mean it’s easy to get them elected, but it certainly could garner additional attention. I wonder if, as navigating the UPC process becomes clearer, there might be an increase in nominations of qualified “ESG directors” in lieu of submitting ESG shareholder proposals? Or will that possibility simply accelerate the trend of companies pursuing constructive shareholder engagement with “little-a” activists?
This may not be something we see right out of the gate, but it’s not outside of the realm of possibility. It was only a year ago that ExxonMobil lost board seats in a campaign that put “ESG” concerns in the spotlight. CalSTRS warned at the time that it was just the beginning of an “activist stewardship” trend – where “universal owners” will be prepared to replace directors if they feel that engagements are ineffective. I also blogged at that time about a playbook for responding to (or heading off) ESG-themed activist inquiries. More recently, Emily noted on our “Proxy Season Blog” that when looking at responsiveness to ESG proposals, large asset managers are also developing escalation pathways for director votes.
For practical insights on how to work with your shareholders and protect your board from activists, join us in October for “Next-Gen Activism: Are You Prepared?” – with Davis Polk’s Ning Chiu, Okapi Partners’ Bruce Goldfarb, SGP’s Rob Main, and Wachtell Lipton’s Sabastian Niles. This critical session is part of our “Proxy Disclosure & 19th Annual Executive Compensation Conferences” – happening virtually October 12th – 14th. Here’s the full agenda – 18 sessions over 3 days, including a dialogue with Corp Fin’s Renee Jones and essential guidance from lots of other heavy-hitters. Sign up online, email sales@ccrcorp.com, or call 1-800-737-1271.
In addition, check out the agenda for our “1st Annual Practical ESG Conference” – which is happening virtually on Tuesday, October 11th. This event will help you avoid ESG landmines and anticipate opportunities. You can bundle the Conferences together for a discount.
Across the pond, 54% of FTSE 100 companies now have voluntarily established a dedicated ESG committee, according to a recent Bloomberg article. Here’s what the article says about US practices:
Large US companies appear to be moving less quickly. An analysis for 2020-2021 showed that only 13% of S&P 500 companies assign responsibility to an ESG/sustainability committee, while 7% indicated that the full board has primary ESG responsibility, according to data compiled by Deloitte. Meanwhile, 53% of S&P 500 boards use the nominating and governance committee for primary oversight.
For more resources, see our the memos in our “ESG” Practice Area here on TheCorporateCounsel.net and the even more comprehensive page – including checklists, surveys & more – about “Board Oversight of E&S Issues” that we have going on PracticalESG.com. If you’re not already a member with access to this guidance, sign up now and take advantage of our no-risk “100-Day Promise” – During the first 100 days as an activated member, you may cancel for any reason and receive a full refund.
Here we go again, this time from a new report on board refreshment policies from The Conference Board, ESGAUGE, and other collaborators:
As US corporations seek to increase diversity of backgrounds, skills, and professional experience on their boards, they face a central hurdle: limited board turnover that creates few openings for new directors. Indeed, the percentage of newly elected directors in the S&P 500 has remained flat over the past several years.
Broc griped about the stalemate on board diversity as far back as 2017, and The Conference Board’s recommendations to overcome the impasse are pretty much unchanged from when I blogged about the lack of director turnover and its impact on board composition over a year ago. In that regard, consistency is a good thing – it now just requires execution. Here’s what the current-year analysis says:
Companies have a variety of board refreshment tools at their disposal to increase diversity of backgrounds, skills, and professional experience on their boards. The tools that focus on triggering discussions of turnover or reinforcing a culture of board refreshment may be particularly valuable.
These include overboarding policies, policies requiring directors to submit their resignation upon a change in their primary professional occupation, guidelines on average board tenure, individual director evaluations as part of the annual board self-evaluation process, and informal discussions that set an expectation that directors do not need to serve until they are required to leave, but rather should consider whether their contributions are still relevant to the needs of the company. Unlike policies that mandate turnover, such as term limits and retirement policies, these more flexible tools can lead to a more thoughtful process in proactively aligning board composition with the company’s strategic needs.
An encouraging finding from this report is that there has been an uptick in individual director evaluations & use of independent facilitators:
Almost all companies disclose conducting some form of annual board evaluation (which, for NYSE companies, is mandated by listing standards) — and the combination of full board, committee, and individual director evaluations is growing in popularity. As of July 2022, 99 percent of S&P 500 and 97 percent of Russell 3000 companies disclosed carrying out board evaluations. In the S&P 500, conducting full board, committee, and individual director evaluations has become the most common practice (52 percent of companies reported this combination as of 2022 compared to 37 percent in 2018). Indeed, in the S&P 500, the practice of conducting only board and committee evaluations has declined from 58 percent in 2018 to 46 percent as of 2022. Although the Russell 3000 has seen a similar pattern, with a rise in full board, committee, and individual evaluations (from 18 percent in 2018 to 34 percent as of July 2022), 60 percent of Russell 3000 companies continue to conduct only full board and committee evaluations.
Companies are increasingly disclosing their use of an independent facilitator for board evaluations — and larger companies are more likely to disclose hiring an independent facilitator than their smaller counterparts. As of July 2022, 29 percent of S&P 500 companies and 15 percent of Russell 3000 firms disclosed hiring an independent facilitator for board evaluations versus 14 percent of S&P 500 and 6 percent of Russell 3000 companies in 2018. In 2022, 42 percent of the largest companies, with annual revenues of $50 billion and over, disclosed their use of an independent facilitator, but only 5 percent of the smallest companies with annual revenues of under $100 million did so.
Overboarding remains one of the primary reasons for votes against directors, as Emily noted earlier this year on our “Proxy Season Blog.” While State Street and Vanguard allow for some flexibility in applying their overboarding policies, this Financial Times article says that BlackRock’s recent votes show that it has been less forgiving, at least at Big Tech.
The article identifies directors at Salesforce, Twitter, Alphabet, and Amazon whose re-elections were opposed by BlackRock due to “overcommitment” – which for non-executives, BlackRock defines as serving on more than 4 public company boards. The article says that Alphabet changed its overboarding policy this year due in part to BlackRock pressure.
In the voting summary that BlackRock released in July, the asset manager said that it voted against 182 directors in the Americas because of overboarding concerns – which is less than the number of directors who got the “thumbs down” for independence, board diversity or misaligned compensation decisions, but still within its “top 4” reasons for not supporting director elections.
Make sure to visit the “Overboarding” resources in our “Board Composition” Practice Area to keep up with all of the policies you need to know – and protect your directors. If you’re not already a member with access to this useful resource, sign up now and take advantage of our no-risk “100-Day Promise” – During the first 100 days as an activated member, you may cancel for any reason and receive a full refund.
Yesterday, the SEC’s Acting Chief Accountant, Paul Munter, issued a statement to say that the SEC & PCAOB are skeptical of alternative audit engagement structures that companies might attempt to use as a workaround to HFCAA compliance. The statement follows the tentative deal that the PCAOB has reached with China-based regulators regarding inspections – and the apparently growing practice of some China-based firms to switch to US-based lead audit firms in an effort to avoid delistings. Here’s the bottom line:
Issuers and accounting firms looking to avoid the uncertainty about whether they will be in compliance with HFCAA may be tempted to engage in an efficient breach of other applicable legal and audit requirements. Such issuers and accounting firms should be forewarned that doing so may well result in investigations and enforcement actions by the PCAOB, the Commission, or both, and that the attendant liabilities may attach not only to the accounting firms and their associated persons, but also to issuers, their audit committees, and officers and directors. Any attempt by issuers or accounting firms to engage in such an efficient breach and avoid the consequences of HFCAA in contravention of other legal and audit requirements should therefore be avoided.
Reuters reported yesterday that Digital World Acquisition Corp., the SPAC that’s attempting to merge with Donald Trump’s social media venture, has so far failed to get the approval from 65% of shareholders that’s necessary to extend the deadline to complete the deal.
Management is once again postponing the vote tally, this time until Thursday – and if that doesn’t pan out, the sponsors will sink in more of their own funds in order to extend the life of the SPAC by three months. The deal has been on hold while the SEC and others investigate how it came about – here’s more detail from the article:
Digital World has disclosed that the SEC, the Financial Industry Regulatory Authority and federal prosecutors have been investigating the deal with TMTG, though the exact scope of the probes is unclear.
The information sought by regulators includes Digital World documents on due diligence of potential targets other than TMTG, relationships between Digital World and other entities, meetings of Digital World’s board, policies and procedures relating to trading, and the identities of certain investors, Digital World has said.
Per the playbook, the media company blames political bias for the regulatory scrutiny of this transaction. But what that statement misses is that the SEC and others are searching for ways to kill SPAC deals regardless of who’s involved. In a separate enforcement action announced yesterday, the Commission charged a New-York based investment adviser with failing to disclose conflicts of interest relating to SPAC sponsor compensation and failing to timely file a Schedule 13D. The investment adviser agreed to a censure and a $1.5 million penalty to settle the charges.
If you haven’t already received a comment letter, be aware that Corp Fin is taking a close look at disclosure of board leadership structures and risk oversight functions. These comments are going to many companies – it’s not apparent that this initiative is focusing on companies in particular industries or with particular governance structures. What’s the Staff looking for? Here’s one of the comments:
Please expand your discussion of the reasons you believe that your leadership structure is appropriate, addressing your specific characteristics or circumstances. In your discussion, please also address the circumstances under which you would consider having the Chair and CEO roles filled by a single individual, when shareholders would be notified of any such change, and whether you will seek prior input from shareholders.
Other comments suggest that the Staff is seeking detailed disclosure about how the board administers the risk oversight function and the role of the independent chair or lead independent director.
So far, it sounds like all of the comments request that changes be made in future filings, versus amending earlier disclosures. It is striking how far beyond any specific disclosure line items these comments seek to go, but at the same time the requested disclosures seem innocuous enough that some companies may just agree to the disclosures to make it go away.
If you’re working on a response to this or any other Staff comments, make sure to consult our “SEC Comment Letter Process” Handbook – which includes fresh, practical insights from Sidley’s Sonia Barros and Sara von Althann on how to best navigate that process. If you’re not already a member with access to this useful resource, sign up now and take advantage of our no-risk “100-Day Promise” – During the first 100 days as an activated member, you may cancel for any reason and receive a full refund.
Back in 2011, the SEC found itself on the losing end of litigation over its “proxy access” rulemaking, after the US Chamber of Commerce challenged the Commission’s economic analysis. In its July lawsuit against the SEC that takes issue with the rollback of 2020 proxy advisor rules, the Chamber is once again leveraging this argument.
Critiques of the SEC’s cost-benefit figures aren’t new, but they have become particularly acute in light of the current rulemaking agenda. This WSJ article says that it is a major theme in recent comments to the SEC’s proposal to enhance ESG disclosure by investment companies.
Compliance costs are also top-of-mind for companies facing down the SEC’s climate disclosure proposal. Among other impacts, this 27-page Gibson Dunn memo dives into what public company oil & gas companies are telling the SEC about their expected regulatory burden if and when that proposal is adopted. Here’s an excerpt:
The Commission estimates that annual direct costs to comply with the proposed rules (including both internal and external resources) would range from $490,000 (smaller reporting companies) to $640,000 (non-smaller reporting companies) in the first year and $420,000 to $530,000 in subsequent years.
52% of public company letters and 43% of industry association letters raised concerns about the actual (and economic) cost of the Proposed Rules. Many believe the SEC underestimated the implementation costs, and a handful of companies provided quantitative estimates as to actual cost.
Sample Comments:
• “We are . . . concerned about the cost, complexity and practicability of complying with parts of the Proposal (in particular, the proposed amendments to Regulation S-X) that will be borne by registrants of all sizes, and which we believe, will significantly exceed the estimates set forth in the Proposal. Our company expects implementation costs in the $100-500 million range, and annual costs for on-going compliance in the $10-25 million range — costs that will ultimately be borne by investors and the public markets.”
• “This additional reporting [on GHG emissions] will come at a high costs: EPA estimated if it lowered its own de minimis reporting thresholds from 25,000 to 1,000 metric tons of CO2e per year it would cost an additional $266 million (in 2006 dollars). . . . EPA updated the reporting requirements for petroleum and natural gas systems in 2010. In doing so, EPA estimated that the incremental cost to reduce the bright line threshold from 25,000 to 1,000 would cost an additional $54.43 million (2006 dollars). . . . Based on EPA’s figures, the Proposed Rule could mean an additional cost to [the company] of $7,000,000 or more in 2006 dollars just to track and report Scope 1 emissions from additional facilities. These figures also suggest that the Commission has not fully accounted for the cost of this rule.”
• “[The company] estimates the cost of voluntarily reporting Scope 3 GHG emissions to be more than $1 million. . . . This does not include accounting personnel to incorporate Scope 3 emissions reporting into our Form 10-K or any commercial efforts needed to amend contracts or attempt to gather and verify Scope 3 emissions data across our value change to the extent it can be identified. Furthermore, [the company] estimates implementing the amendments to Regulation S-X would also be in the millions of dollars.”
• “[A small cap public company] estimate[s] that the total annual cost of satisfying the disclosure requirements set forth in the Proposal would be approximately $500,000 to $800,000, which would be significant for a company of our size.”
• “We believe the Commission’s cost estimates are significantly understated for large accelerated filers. . . . Currently, [the company’s] climate-related disclosures activities in line with TCFD recommendations require time and several million dollars in costs for data and information collection, IT system solutions, services provided and other related tools, techniques, and expertise. This does not include the significant additional time and cost of assurance of our performance data and disclosures.”
• “[W]e believe the SEC has significantly underestimated the costs of compliance, which we believe would be many multiples of the projected $640,000 per year initially and would likely increase over time.”
• “The cost of registrants trying to report in alignment with just certain aspects of TCFD for their first time on a voluntarily basis can be around $500,000. This does not account for the level of rigor, financial line items, attestation, and liability costs associated with complying with this Proposed Rule. The actual cost for complete alignment to TCFD could be up to $1,000,000 per registrant over several years. This does not include the annual cost associated with preparing for and conducting attestation.”
• “[B]y only considering the costs of compliance to the public companies that are required to file, SEC misses completely the costs to companies that supply SEC filers, the largest being the induced requirement to gather and report their GHG emissions to the filing company as a condition of their supply relationship. . . . [B]ecause filing companies will have to undertake the herculean task of estimating their Scope 3 emissions, they will have no other choice but to require their suppliers to provide their GHGs, even if those suppliers have no regulatory requirement otherwise to report to SEC or EPA.”
While these comments don’t seem to be moving SEC Chair Gary Gensler to give up on these proposals, they could influence parts of the final rules. The risk of not heeding these concerns could be that industry groups pounce on the economic analyses in court – like the Chamber is already doing – and the rules get vacated post-adoption.
