In recent commentary, Vanguard has reaffirmed its view that climate risks may be material to certain portfolio companies – and has articulated high-level expectations for how boards of those companies should go about overseeing those risks. Here’s an excerpt:
Vanguard-advised funds look for portfolio company boards to effectively oversee material risks, including material climate risks, and to disclose their approaches to oversight of these risks to shareholders so that the market can price in the associated risks and opportunities. We believe that boards have a responsibility to be aware of material risks and opportunities (including those associated with climate change) as they make informed, long-term decisions on behalf of company shareholders.
We believe that boards should consider the implications of both physical risks (such as severe weather events, rising sea levels, and temperature changes) and transition risks (such as regulatory changes and technological disruption) and plan for their impacts.
We believe that boards that are most effective in safeguarding long-term investors’ interests from material climate-related risks demonstrate:
• Relevant risk competence.
• Robust oversight and mitigation of material climate risks.
• Effective disclosure of material climate risks and attendant oversight practices.
The commentary goes on to describe each of these aspects of board effectiveness in more detail – and lists typical questions to prepare to answer in Investment Stewardship meetings (which may influence your board agendas as well). It also provides recommended TCFD disclosures in a handy chart.
This is the latest in a pretty regular flow of investment stewardship commentary that Vanguard has been providing on its “insights” page. I blogged a few weeks ago on the Proxy Season Blog about the asset manager’s approach to contested elections.
Warren Buffett’s annual letter to Berkshire Hathaway shareholders came out this weekend – along with the annual report. Like last year, the Oracle of Omaha doesn’t have a lot of groundbreaking new info to share about Berkshire. This WaPo article says it’s the shortest letter in 44 years!
On page 6, Buffett takes a swipe at buyback restrictions. He criticizes the urge of an “economic illiterate or a silver-tongued demagogue” to crudely paint repurchases by as always bad for business & society and preaches the benefits of buybacks to both selling & remaining shareholders.
What caught my eye even more were his strong words about GAAP on page 5, which he shares after providing the company’s non-GAAP “operating earnings” (this is defined as GAAP income exclusive of capital gains or losses from equity holdings and totaled a record $30.8 billion last year, whereas the GAAP figure was a $22.8 billion loss):
The GAAP earnings are 100% misleading when viewed quarterly or even annually. Capital gains, to be sure, have been hugely important to Berkshire over past decades, and we expect them to be meaningfully positive in future decades. But their quarter-by-quarter gyrations, regularly and mindlessly headlined by media, totally misinform investors.
This is also a commentary on long-term versus short-term results, as Buffett is famously in the “patient, long-term” camp. In addition, Buffett says that non-GAAP adjustments shouldn’t be taken too far. A couple of pages after talking about operating earnings, he reiterates his longstanding complaints about phony metrics (see this 2017 MarketWatch article discussing how Buffett has taken issue with non-GAAP adjustments through the years). From page 7:
Finally, an important warning: Even the operating earnings figure that we favor can easily be manipulated by managers who wish to do so. Such tampering is often thought of as sophisticated by CEOs, directors and their advisors. Reporters and analysts embrace its existence as well. Beating “expectations” is heralded as a managerial triumph.
That activity is disgusting. It requires no talent to manipulate numbers: Only a deep desire to deceive is required. “Bold imaginative accounting,” as a CEO once described his deception to me, has become one of the shames of capitalism.
During the 58 years that Buffett has led Berkshire, he’s been well-regarded for this folksy, straight-shooting letter and approach to business. You get the sense he’s (still) frustrated with what feels like meddling by regulators in business decisions – not a unique view among execs! Unfortunately, as this part of the letter recognizes, fraudsters & profiteers have given the government & public plenty of reasons to be skeptical.
I blogged last month about a quest by the SEC’s Enforcement Division to obtain client names from a law firm – in order to investigate whether those clients were affected by & properly disclosed a cyber breach. The firm (Covington) has obviously been pushing back on that request.
Now, 83 heavy-hitter law firms have lined up behind Covington – as amici curiae in this 31-page brief to the DC District Court. Reuters reported on this development as well as a filing by Covington last week. The list of firms starts on page 28 – it includes Morrison & Foerster, Cravath, Debevoise, Kirkland, Latham and many other big names.
Reuters notes that a judge has scheduled a hearing for this case next month.
The SEC Enforcement Division’s “EPS Initiative” appears to be alive & well – by the looks of an “cease & desist” order from earlier this week – which resulted in a $4 million settlement (and a $75k penalty against the person who served as Chief Accounting Officer – and later, Chief Financial Officer – of the company in question). The claims were settled on a “neither admit nor deny” basis.
In the SEC’s telling, the internal controls & supporting documents for the bonus accruals left gaping holes that allowed for manipulation. Here’s an excerpt from the SEC’s order:
15. On October 7, 2015, during the closing process for the third quarter of 2015, Nash directed the accrual of $300,000 for the PB Bonus Plan, which had not yet been approved by Gentex’s Board of Directors. This journal entry was made without any supporting documentation. Additionally, Nash did not maintain documentation of any purported analysis that was required to be performed pursuant to Accounting Standards Codification (“ASC”) Topic 450, Contingencies, concerning the loss contingency associated with the PB Bonus Plan.
16. On October 8, 2015, Nash realized that the initial accrual of $300,000 would cause Gentex to miss the consensus EPS estimate of $0.27 for the third quarter of 2015. He directed a journal entry to reduce the $300,000 accrual to $100,000. The journal entry for the revised accrual was again made without any supporting documentation and Nash did not conduct any analysis that should have been performed pursuant to ASC 450-20 concerning the PB Bonus Plan.
17. In an October 9, 2015 email exchange with the CFO, the CFO asked Nash if he had reserved some money for the PB Bonus Plan. Nash responded, “100K. had [sic] 300K, but had to reduce in order to keep .27 per share.” The CFO replied, “[g]ood call. That puts in line with consensus, right?” to which Nash replied, “[y]es.”
There were other internal controls sins here too, according to the SEC – but I was surprised that this $200k accrual adjustment appears to be so central to the case. That doesn’t seem like a lot in the grand scheme of things, but the company would have missed consensus EPS estimates by one penny if the adjustment hadn’t been made – and the SEC’s data analytics tools were sensitive enough to pick up something fishy with the situation.
One moral of this story is that if the SEC comes knocking, you want to make sure to have documentation of your internal controls & accounting analysis instead of a conversation about managing EPS to the consensus number.
Here’s something I blogged yesterday for members of CompensationStandards.com:
A few pay versus performance disclosures are starting to roll in! This is something that we’ve all been eagerly awaiting – and I send my condolences to those who have had to be brave and take the first leap. These are from smaller companies – we continue to await a large-cap example. Thanks to Aon’s Corporate Governance & ESG Advisory Group for alerting us!
– Praxis Precision Medicines Form 10-K (pg. 136) – It is unclear to me why the company included this disclosure in a Form 10-K – as this Goodwin FAQ points out, the SEC rules only require pay vs. performance disclosure in proxy & information statements; it isn’t required in Form 10-K even when other Item 402 disclosure is included. But I didn’t read this filing or the company’s filing history in-depth to understand whether there is a reason they might have wanted to go ahead with it here.
– Panbela Therapeutics Form S-1/A (pg. 72) – Seems to have missed some of the disclosure requirements, but has the distinction of being the first to report under the new rule.
If you aren’t already a member of CompensationStandards.com, now is a good time to sign up. That’s where we are sharing the latest updates & analysis on the new pay vs. performance rules, along with updates on say-on-pay, ESG metrics, and other “executive compensation” hot topics. Email sales@ccrcorp.com or visit our membership center to start a no-risk trial. 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. If you have any questions, email sales@ccrcorp.com – or call us at 800.737.1271.
I blogged earlier this week on CompensationStandards.com and on this site about whether to include the two new “clawbacks”-related checkboxes on your Form 10-K cover page this year. The Dodd-Frank clawback rules are not yet effective – but the checkboxes are included on the cover page of the updated Form that the SEC has published. There was lingering confusion after Corp Fin’s CDI a couple of weeks ago.
I’ve now heard from a few folks that the Staff has confirmed in informal conversations that you should include the checkboxes (but don’t need to mark them). If you are concerned that a blank checkbox could be misleading, you could add an explanatory note to the effect that the checkboxes are blank pending adoption of the underlying rules.
When it comes to finding unconventional ways to raise cash, AMC will find a way – and selling equity to do it is a key part of the meme stock playbook, as another retailer’s offering this week showed. Two years ago, the company abandoned a proposal to increase its authorized number of common shares because its retail investors weren’t showing up to deliver the votes needed for approval of the charter amendment. That temporarily shut off the spigot of raising capital through stock sales.
Undeterred, last summer AMC used its blank check preferred provision to issue a new class of shares: APEs (that stands for “AMC Preferred Equity,” of course). Here’s the Form 8-K they filed at the time. Each APE unit has terms identical to 1/100th of a share of common stock – including voting rights – and will automatically convert to common stock if & when AMC is able to issue enough common shares to cover the conversion of all of the APEs.
Now, with the APEs unfortunately trading at a 65% discount to the equivalent common shares as of year-end, AMC is going back to its common shareholders to once again seek approval for a higher number of authorized common shares, which would trigger the preferred stock conversion, as well as to effect a 1-for-10 reverse stock split for the existing common shares. The interesting part is that with this go-round, it will include votes from the APE holders – and AMC baked in a key provision to make approval more likely. In a column last week, Bloomberg’s Matt Levine pointed out that AMC’s deposit agreement for the APEs includes this language:
In the absence of specific instructions from Holders of Receipts, the Depositary will vote the Preferred Stock represented by the AMC Preferred Equity Units evidenced by the Receipts of such Holders proportionately with votes cast pursuant to instructions received from the other Holders.
Proportionate voting! This is a bold move as at least one major brokerage firm has moved away from proportionate voting for common stock and asset managers are pushing pass-through voting despite the generally low voter turnout from retail investors. It’s too soon to know whether pass-through voting will do more harm than good to individual shareholders – the early consensus is that it will just make solicitations more complicated & costly for companies, and give proxy advisors more influence. For this specific charter amendment – and with the preferred stock in the mix – AMC has possibly found a way to bring in a vote despite these hurdles.
Last week, a jury in a securities class action lawsuit found in favor of Elon Musk for his 2018 “funding secured” tweet – in which he said he was considering taking Twitter private at $420 per share and had locked in the funding. Here’s a NYT article about the outcome. The SEC had also taken issue with those tweets, resulting in a $40 million settlement and the “Twitter sitter” – plus a lot of animosity from Elon towards the Commission.
All I can say is that I’m nearly as happy as Elon that we can finally put this saga to bed. There’s no real takeaway for other companies because the jury’s verdict appeared to rest on the determination that nobody takes Elon Musk’s tweets all that seriously – and at the same time, they trust him to get things done when he really wants to.
So, investors truly may not have cared if instead of “funding secured,” the tweet had said “I might have a handshake deal for funding” – because it’s Elon Musk and he’ll either bring in the money when he wants to, or the whole thing was a joke in the first place. Did the statement really cause people to buy Tesla stock at an inflated price? The jury apparently was not convinced of that.
The reason this doesn’t translate well to other companies is that Elon Musk has carefully (or not-so-carefully?) cultivated a free-wheeling, Teflon persona and a cult-like following. It would be difficult & risky for other public company CEOs to emulate that. We don’t give legal advice in this blog, but common sense says it’s a bad idea for others to try “going private; funding secured” announcements without a commitment letter in-hand.
Yesterday, the SEC announced an open meeting to be held next Wednesday, February 15th. The Sunshine Act Notice says that the meeting will include consideration of whether to adopt rules & rule amendments under the Securities Exchange Act of 1934 to shorten the standard settlement cycle for most securities transactions.
Presumably, this relates to the Commission’s February 2022 proposal to shorten the settlement cycle to T+1 and make other “market plumbing” changes. The proposed rules and rule amendments would be applicable to broker-dealers and certain clearing agencies.
For those who are still refining their risk factors for this year’s Form 10-K, I’m happy to share this guest post from Orrick’s JT Ho, Carolyn Frantz, Bobby Bee and Hayden Goudy:
For companies with a fiscal year end on December 31, the drafting and review process for the annual report is well underway. Companies, however, should make sure they are considering emerging practices for disclosing environmental-, social-, and governance- (“ESG”) related risk factors.
Based on our review of companies in the S&P 500, having ESG-related disclosures in the risk factors is now a common practice. For companies which have already filed their annual report for fiscal year 2022, 89% had ESG-related risk factors. These risk factors spanned a range of ESG-related topics, primarily related to climate change, but also including diversity-, other environmental-, or general ESG-related risks. This graph shows the percentage of the S&P 500 with an ESG-Related Risk Factor in the annual report (by fiscal year):
As you can see, the number of companies with an ESG-related risk factor has increased year-over-year. Less than half of the S&P 500 had an ESG-related risk factor in their annual report for fiscal year 2019. Since then, a significant number of companies have added ESG-related risk factors to their annual report, and we expect this trend to be followed by small- and mid-cap companies.
