The SEC’s Acting Chief Accountant Paul Munter published another statement last week to focus on the gatekeeping responsibilities of auditors – this time, in relation to fraud detection. He expressed concern in light of recent developments and conversations that auditors are passing the buck on fraud detection. In his view, that’s not okay, because:
Auditors must plan and perform an audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud.
The statement urges auditors not to treat PCAOB Auditing Standard 2401 as an “exhaustive checklist” for fraud risk considerations and related responses. The implication is that maybe that’s been happening.
Mr. Munter identifies “good practices” that presumably go beyond auditors’ current approach to fraud detection. Companies can expect auditors to get nosier about these topics – and possibly others – as auditors work these points into their “New & Improved Fraud Detection Checklist.” His (paraphrased) suggestions include:
– Auditors should consider publicly-available information (including from new sources available during the course of the audit) and objectively evaluate how such information impacts risk assessment and the audit response. For example, auditors should evaluate whether publicly-available information contradicts information received from management.
– Are employees required to annually certify acknowledgement of a code of ethics? That’s a good start, but auditors should also consider whether that is a meaningful demonstration of the company’s commitment to integrity and ethical values. For example, are employees able to anonymously share their views on the company’s tone at the top through, for example, a culture survey? How are the survey results obtained and shared with leadership?
– Is the company’s whistleblower hotline simply a compliance checkbox, or does the issuer have a culture that encourages whistleblowers who see something to actually say something? For example, an auditor may want to discuss with the audit committee the nature of the whistleblower hotline’s operation.
– An auditor should also pay close attention to an issuer’s approach to its own fraud risk assessment as this can provide insight when evaluating the issuer’s control environment.
– Technology plays an increasingly important role in the audit and automated tools and techniques may assist the auditor in applying the fraud lens. Access to granular data and information can increase transparency into underlying transactions, which through the use of technology may provide useful insights to assist with identifying unusual or unexpected relationships or assisting auditors in performing more robust planning analytics.
This is an interesting backdoor nudge from the OCA Staff on corporate culture practices. I guess that as the “bad guys” continue to get more sophisticated, fraud detection has to keep pace – even if it means that code of ethics & whistleblower expectations go beyond what regulations expressly require.
Late last week, Insightia/Diligent released its “Proxy Voting Snapshot” (available for download), which summarizes year-over-year voting trends from the five largest institutional investors – BlackRock, Vanguard, State Street, Fidelity and JPMorgan.
This summary is the preview to Insightia’s deeper dive on voting trends that is coming later this month, based on analysis of annual N-PX filings. Here are the key takeaways:
– The five largest institutional investors decreased their support of environmental and social shareholder proposals by an average 15.1 and 13.5 percentage points, respectively, between the 2021 and 2022 proxy seasons.
– Combined, the top five investors voted the dissident card 25 times out of 83 (30.1%) in proxy contests held during the 2022 proxy season, compared to 14 times out of 58 (24.1%) one season prior.
– The top five’s alignment with Institutional Shareholder Services (ISS) and Glass Lewis recommendations declined by an average of 4.1 and 3.2 percentage points, respectively, between the 2021 and 2022 proxy seasons.
– Support for advisory “say on pay” proposals from the top five investors decreased by an average of 1.4 percentage points between the 2021 and 2022 proxy seasons.
Stewardship teams have gotten out in front of the narrative on ESG proposals, signaling for months that support for these proposals would be lower this year because many of the “asks” were too prescriptive. So, that data point is not too surprising. Plus, because proponents are likely to adapt their proposals to this feedback as we look to the 2023 proxy season – and because SEC no-action relief remains scarce – it’s unlikely that these support levels will dampen proponent enthusiasm or make proxy season any easier for companies.
In fact, the data points here suggest that proxy season could keep getting more difficult, because investor voting behavior is becoming less predictable and doesn’t reliably align with management. Here are two examples from Insightia that support that conclusion:
– The influence of ISS and Glass Lewis appears to be waning – at least with the Big 5.
– Although activists won fewer board seats this year, the Big 5 supported more dissidents, especially at smaller companies. They were in a “swing vote” position with several high-profile proxy contests, but ended up siding with management.
In other words, directors aren’t getting a free pass to reelection these days. Luckily, since you’re reading this blog, you’ll be prepared! Start thinking now about your solicitation strategies for spring – including your budget & team.
The SEC announced yesterday that the compliance date for electronic Form 144 filing requirements will be April 13, 2023. As I blogged a few weeks ago, EDGAR is already set up to accept these filings.
If you haven’t already confirmed EDGAR accounts for all of your reporting insiders, now is the time to get the ball rolling! You’ll also likely need to discuss the new Form 144 process with the brokers that handle insiders’ transactions. According to the informal “Quick Poll” that I ran a few weeks ago, most people want the brokers to keep handling this compliance step.
As we make our way through a complicated earnings season, this WSJ article says that some companies may be looking at ways to expand the range for guidance – or implement more nimble forecasting processes. One thing that companies probably won’t do – at least for now – is back away entirely from the practice of giving guidance, which serves a Reg FD purpose in addition to generally managing expectations. This CLS Blue Sky blog explains:
Headlines during earnings season often focus on the forward-looking guidance corporate managers provide. Yet, questions remain about managers’ perceptions of the guidance process and the tradeoffs they face in deciding whether and what to guide. To gain greater insight, we surveyed 357 managers at publicly listed corporations and conducted nine in-depth interviews.
Our survey sheds light on the critical role guidance plays during earnings season. Because analysts and investors dislike surprises, our respondents said guidance provides an effective channel to manage expectations. Around earnings announcements, corporate managers commonly meet privately with analysts and investors after conference calls. Our respondents said that providing guidance allows for more open and forthcoming discussions about the future in one-on-one meetings, with less concern that the conversation will run afoul of disclosure regulation (Reg FD).
Our study also highlights some downsides of issuing guidance. We find that reporting results that fall short of guidance is a primary concern because it signals a failure to understand the business or a lack of control of the company’s operating environment. The anticipated consequences of missing guidance include reduced credibility of future guidance, increased scrutiny from sell-side analysts and the board of directors, and stock price declines.
The managers said that widespread economic uncertainty would be the only circumstance that would cause them to stop providing guidance entirely. Yet, that may also be when these Reg FD-compliant private calls will be most valuable. It will be interesting to see whether there’s a drop-off in the practice of providing guidance as recession murmurs grow louder.
For more practical guidance on this topic, make sure to mark your calendar for November 16th, 2-3pm Eastern, for our webcast, “Dissecting the Quarterly Earnings Process” – with Goodwin’s Sean Donahue, O’Melveny’s Shelly Heyduk, and Cooley’s Reid Hooper. 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.
I blogged yesterday about the climate-related results of ISS’s recent benchmark policy survey. Another topic that we expect ISS to address in its forthcoming 2023 voting policies is which companies and directors will find themselves facing adverse voting recommendations as a result of multi-class share structures.
The survey results suggest that directors holding super-voting shares and the chair of the governance committee will be in the cross-hairs under the new policy, and that 5% may be the threshold for exceptions to this policy. Here’s more detail:
Already announced in 2021, effective as of Feb. 1, 2023, ISS plans to start recommending votes against certain directors at U.S. companies that maintain a multi-class capital structure with unequal voting rights, including companies that were previously exempted from adverse vote recommendations.
In 2022, we said that we planned to apply exceptions in cases where the capital structure is not deemed to meaningfully disenfranchise public shareholders. When asked what the appropriate threshold for exemption should be, a strong majority of investor respondents agreed that there should be an exception. They were split on exactly what that threshold should be, but “no more than five percent” was the most popular threshold chosen by investor and non-investor respondents. Almost a third of investors responded that there should be no exemptions.
When asked what the appropriate target for an adverse vote recommendation, respondents favored any director who holds super-majority shares and the chair of the governance committee. Twenty-nine percent of non-investor respondents stated that there should not be votes against directors in this situation.
In cases where shareholder do not have the ability to vote against the director who holds super-majority shares, a majority of investor respondents said that shareholders should vote against whatever director was on ballot to protest against the multi-class structure.
When asked to define the most appropriate time for a sunset to begin phasing out problematic governance structures such as a classified board, a plurality of investor respondents chose “between 3 and 7 years.”
When asked whether smaller companies should be exempted from negative vote recommendations for maintaining a classified board or supermajority voting requirement, a strong majority of investor respondents said that should
not. Nearly two-thirds of non-investor respondents, on the other hand, replied that smaller companies should be exempted from either one or both of those provisions.
Both investors and non-investors supported having a supermajority vote requirement of two-thirds of shares outstanding to amend governing documents.
One thing that we can probably all agree on, is that these survey results would be more entertaining if they were unveiled in a “Family Feud” format. We may have to host a game show next year.
The other major topic that ISS asked about in this year’s benchmark policy survey was how to handle shareholder proposals on racial equity audits/civil rights audits. As I noted last month on the Proxy Season Blog, ISS backed 77% of resolutions on this topic during the 2022 proxy season – compared to 22% in 2021. Looking ahead to 2023, here’s the feedback that will be guiding ISS’s policy development:
Discussions with clients and proponents and the survey results lead ISS to conclude that investors are roughly evenly split into two camps on this issue. Approximately 42 percent of investor respondents to the survey said most companies would benefit from an independent racial equity or civil rights audit, while a slightly larger 45 percent responded that whether a company would benefit from an independent racial equity or civil rights audit depends on company-specific factors including outcomes and programs.
A majority of non-investor respondents indicated that they believe company specific criteria are the best determinations of which companies would benefit from a racial equity audit.
When asked what factors were relevant to determine whether a company would benefit from an independent racial equity or civil rights audit, “significant diversity-related controversies” were the most popular choice – being selected by a majority of investor and non-investor respondents. This was followed by whether the company disclosed workforce diversity representation statistics, such as EEO-1 type data, and has undertaken initiatives/efforts aimed at enhancing workforce diversity and inclusion, including training, projects, and pay disclosure.
The least popular choice for investor respondents was whether the company offered products or services and/or made charitable donations with a specific focus on helping create opportunity for people and communities of color.
The question asked this year was the same as the one asked in the 2021 Benchmark Policy Survey to assess any changes in sentiment over time, especially given the strong vote support that many of these proposals received at annual meetings in 2022. The responses for investor and non-investor respondents changed only slightly from last year to this one.
Just in time for another round of polarizing mid-term elections, the Center for Political Accountability and the Zicklin Center for Governance & Business Ethics at the Wharton School have issued their annual “Index of Corporate Political Disclosure & Accountability.”
If there is one thing that has become clear over the past 11 years in which this Index has been published, it’s that companies that don’t carefully monitor “political spending” are playing with fire. And it’s important to note that – in addition to candidate donations – the term “political spending” includes contributions to trade associations, committees and lobbying organizations. In the wake of the Dobbs decision this summer, we wrote:
Carefully consider political and trade association contributions. Contributions to politicians, trade associations and other advocacy organizations are already receiving major scrutiny – and that’s only going to increase. Emily blogged recently that two lobbying-related shareholder proposals received majority support at recent meetings. Many trackers now exist that monitor the alignment of corporate political donations with stated values – with several companies already in the news for donations to anti-abortion politicians, and shareholder proponents also picking up the mantle with a new iteration of “values misalignment” shareholder proposals.
Gone are the days when a board could simply confirm that the company’s donations were striking a roughly even split between Republican and Democratic organizations. Now, management may need stricter directives to ensure that each donation aligns with overall values – and the board may need to dig deeper to ensure it’s informed of any potentially controversial activities.
When it comes to S&P 500 companies, this year’s Index finds:
– The number of S&P 500 companies with policies for general board oversight of political spending is 295, up 13.9 percent from 259 companies in 2020.
– Board committee review of direct political contributions and expenditures rose to 255 companies this year from 227 in 2020, an increase of 12.3 percent; board committee review of payments to trade associations and other tax-exempt groups rose to 228 this year from 199 in 2020, an increase of 14.6 percent.
– The number of companies that fully or partially disclosed their political spending in 2021 or that prohibited at least one type of spending is 370. This is over 75 percent of the S&P 500 companies evaluated. It is a record high since CPA and its shareholder partners launched their efforts.
– The number of companies that fully or partially disclosed their political payments to state or local candidates or committees, or that prohibited them, was 334, another record and well more than three-fifths of the S&P 500.
– The number of companies that disclosed some or all of their political spending was 293. The number of companies that prohibited direct donations to state and local candidates, political parties, and committees was 136.
For the first time this year, the Index also expanded to cover Russell 1000 companies (representing approximately 90% of the US market). It’s not a stretch to think that this move will lead to more scrutiny of spending by mid-sized and smaller companies – in the form of shareholder engagements & proposals, or questions from employees and customers. Right now, there’s a pretty big gap in transparency – and potentially, policies – between large & small companies. The Index finds:
– For all non-S&P 500 companies in the Russell 1000, the average score is 12.8 percent, on a scale of zero to 100. The overall Index score for all S&P 500 companies this year, for example, is 57.0 percent.
– There are 54 companies in the non-S&P 500 portion of the Russell 1000 with general board oversight of company political spending, compared with almost six times as many, 307 companies, in the full S&P 500 with the same oversight.
For “best practice” comparisons, take a look at the full Index – as well as the policies and disclosures of the six companies that scored a winning 100: AT&T, Becton Dickinson, Consolidated Edison, Edison International, HP Inc. and Visa. Also see the resources in our “Political Contributions” Practice Area.
According to the latest CPA-Zicklin Index, most large companies say their board oversees political spending – but few smaller companies are talking about it. PwC’s annual director survey seems to support that finding. Here’s one of the takeaways:
Only 39% of directors say their board has discussed the company’s stance on social issues in the past 12 months. Even fewer—30%—say they have discussed corporate political activity.
The survey gathered responses from 700+ directors. It has some other interesting findings as well. For example, 64% of male directors say that board diversity initiatives are driven by political correctness and that shareholders are too preoccupied with the topic. With the Supreme Court poised to overturn colleges’ ability to consider racial diversity in admissions, corporate boardrooms also seem to be growing skeptical of the near-term benefits of diversity, even while acknowledging that it brings unique perspectives to decision-making and prioritizing diversity in succession planning.
On the topic of ESG oversight, the survey notes a gap between small & large companies in board understanding of ESG data controls. Specifically, directors lack confidence in the board’s understanding of climate risk/strategy and carbon emissions, compared to human capital-type topics. And compared to a year ago, 9% fewer directors view ESG issues as impacting company financial performance. Again, the results vary based on demographics – with male directors being less likely to see ESG’s connection to strategy & performance.
Last week, ISS announced the results of its 2022 benchmark policy survey. ISS received responses to the survey from 205 investors – 29% more than last year – as well as 202 companies and corporate organizations.
The results will be used to formulate the proxy advisor’s voting policies, which will be released in draft form in November and finalized in December. Here are some key climate-related takeaways:
Board Accountability on Climate Risk: ISS asked what climate actions/non-actions from Climate Action 100+ “significant emitters” would constitute a “Material Governance Failure” that would call for an ISS recommendation against a director.
– A significant majority of both investor and non-investor categories of respondents expressed that they would consider there to be a material governance failure if a company that is considered to be a significant contributor to climate change is not providing adequate disclosure with regards to climate-related oversight, strategy, risks and targets according to a framework such the one developed by the Task Force on Climate-related Financial Disclosures (TCFD).
– Investor respondents generally agreed that the boards of companies that are large greenhouse gas (GHG) emitters are failing if they do not take steps to address emissions, but support for different actions that could be taken to address emissions varied. Besides a company failing to provide adequate disclosure according to a recognized framework, the three most common choices by investor respondents as demonstrating failures were targets-related, and were (i) a company not setting realistic medium-term targets (through 2035) for Scope 1 & 2 only (50% of investors), (ii) not declaring a net-zero by 2050 ambition (47% of investors), and (iii) not setting realistic medium-term targets (through 2035) for Scope 1, 2 & 3 if Scope 3 is relevant (45% of investors). A strong majority of investor respondents (69 percent) chose at least one of those “targets” responses, which was also the case for 43 percent of the non-investor respondents.
Management Say-on-Pay Proposals: When asked “What do you consider to be the top three priorities when determining if a company’s transition plan is adequate?”, the most popular responses among investor respondents were:
(i) whether the company has set adequately comprehensive and realistic medium-term targets for reducing operational and supply chain emissions (Scopes 1, 2 & 3) to net zero by 2050 (42 percent),
(ii) whether the company’s short- and medium-term capital expenditures align with long-term company strategy and the company has disclosed the technical and financial assumptions underpinning its strategic plans (41 percent),
(iii) and the extent to which the company’s climate-related disclosures are in line with TCFD recommendations and meet other market standards (38 percent).
The appropriateness of submitting management say-on-climate plans for shareholder approval was questioned by some investor respondents who believe these proposals improperly shift the responsibility for a company’s climate transition plan away from the board and management toward its shareholders.
Climate Risk as Critical Audit Matter: A substantial majority of investor respondents (75 percent) favored seeing commentary by auditors in the audit report on climate-related risks for significant emitters. A smaller majority (64 percent) of investor respondents supported climate-related risks being included by auditors in Critical Audit Matters / Key Audit Matters (CAMs).
– A majority of investor respondents (52 percent) would favor supporting a related shareholder proposal on this issue. Voting against the re-election of audit committee members and voting against the re-appointment of auditors got somewhat lower support (42 percent and 35 percent respectively).
– In comments, several respondents – including both those who favored and opposed the inclusion of climate risks – raised the question of whether auditors currently have the expertise to accurately gauge these risks. Others wrote that this issue is currently not a market norm but may develop quickly due to regulatory requirements that are being finalized in the U.S. and EU and as the International Sustainability Standards Board (ISSB) develops its sustainability standards. Non-investor respondents tended to not support seeing auditors comment on climate-related risk.
Financed Emissions: During the 2022 proxy season, a number of shareholder proposals were filed that asked companies to restrict their financing or underwriting for new oil and gas development in line with the assumptions in the International Energy Administration’s Net Zero 2050 Scenario, which prompted us to ask a question about expectations on climate-related disclosure and performance of financial institutions.
– Around half of investor respondents said that in 2023 large companies in the banking and insurance sectors should fully disclose their financed emissions (54 percent), have clear long-term and intermediary financed emissions reduction targets for high emitting sectors (51 percent), have a net-zero by 2050 ambition including financed portfolio emissions (49 percent), or should publicly commit to disclose financed emissions at some point in the future by joining a collaborative group such as the Partnership for Carbon Accounting Financials (PCAF) and/or the Glasgow Financial Alliance for Net Zero (GFANZ) (45 percent).
– Around 30 percent of investor respondents voiced support for these companies committing to cease financing for new fossil fuel projects.
Most survey respondents also predict that investors’ expectations for climate disclosure and performance will increase over time – with heightened focus on net-zero targets, comparable climate disclosures, greater Scope 3 disclosures and more interest in corporate investment in low-carbon products and strategies.
Yesterday, the SEC announced a $361 million settlement with Barclays for an unprecedented over-issue that is every security lawyer’s nightmare:
The SEC’s order states that, following a settled Commission action against a BBPLC affiliate in May 2017, BBPLC lost its status as a well-known seasoned issuer (WKSI). As a result, BBPLC had to quantify the total number of securities that it anticipated offering and selling and pay registration fees for those offerings upon the filing of a new registration statement.
The SEC’s order notes that, given this requirement, BBPLC personnel understood that the firm needed to track actual offers and sales of securities against the amount of registered offers and sales on a real-time basis; yet, no internal control was established for this purpose. According to the SEC’s order, as a result of this failure, BBPLC offered and sold approximately $17.7 billion of securities in unregistered transactions.
As the SEC’s order states, BBPLC self-reported its over-issuances to regulators, provided meaningful cooperation during the SEC staff’s investigation, and subsequently commenced a rescission offer.
This all relates to notes and corporate debt offerings that the bank attempted to conduct via a shelf registration statement. Barclays announced the over-issue back in March. Since the securities weren’t registered, they had to offer to buy them back at the price they were sold for – which the bank estimated would lead to a $600 million loss. The rescission offer expired earlier this month. With this settlement, Barclays is paying another $200 million in civil penalties on top of the money it lost (plus disgorgement and prejudgment interest that are deemed satisfied by the rescission).
The order says that Barclays established a multi-person working group when it lost WKSI status. That group talked about calculating the total amount of securities that the business expected to offer and sell, in order to pay registration fees in advance. They also talked about the need to track actual offers & sales. But they didn’t create any process or assign responsibility for that task. The SEC’s order describes what must have been a rough week:
On March 8, 2022, a member of Group Treasury reached out to the member of the legal department who had been part of the Working Group, inquiring as to how many securities remained available to be offered and sold off of the 2019 Shelf because Group Treasury was planning on doing a sale of corporate debt securities.
Over the course of that day and the next, various BBPLC personnel attempted to calculate the cumulative amount of securities offered and sold from the 2019 Shelf in order to determine the amount of securities that remained available for sale. Over the course of these efforts, it became clear to all involved that there was no internal control in place to track in real time the amount of securities offered and sold against the amount of securities registered.
On or around March 9, 2022, BBPLC personnel concluded that securities had been offered and sold in excess of what had been registered on the 2019 Shelf. Shortly thereafter, BBPLC halted new offers and sales of securities from the 2019 Shelf and, on March 14, 2022, alerted regulators about the over-issuance and disclosed to the market that BBPLC did not have sufficient issuance capacity to support further sales from inventory and any further issuances of certain ETNs.
Here are the new controls that Barclays is adopting as part of this settlement – which are a good benchmarking reference for other companies. Barclays has to internally audit these processes in a few months and submit a report to its audit committee and the SEC Staff:
1. The centralization of oversight of BBPLC’s SEC-registered shelves in Group Treasury;
2. The maintenance of clear minimum control requirements for BBPLC’s SEC-registered shelves, including, but not limited to, a process for reviewing any change in WKSI status for BBPLC and the tracking of offers and sales off of BBPLC’s SEC-registered shelves as appropriate; and
3. The maintenance of a data repository, with appropriate controls and governance designed to ensure reliability of the data, for the purpose of tracking offers and sales, as appropriate, off of BBPLC’s SEC-registered shelves.
In the press release, the SEC cautions non-WKSIs to make sure to have internal controls to track registration statement capacity after each takedown. That’s good advice! Check out our “Form S-3 Handbook” for how exactly to do it. I do wonder, will the Staff be tracking this more? That would be a lot of work. The release here urges self-reporting if you discover unregistered sales. Hopefully you catch it before getting to $18 billion.
