The holiday season is barrelling towards us and many of us are daring to envision gatherings outside our own homes. But when it comes to the stock market’s New Year celebration, this year’s calendar gives no rest for the weary.
Even though Friday, December 31st is a federal holiday – meaning the SEC & Edgar are closed – the stock market is open for a full trading day that day. So, there’s extra time for something to go sideways, or at the very least for some insiders to squeeze in last minute trades (if they lack MNPI and/or are relying on a valid Rule 10b5-1 trading plan!). The market and the SEC are also open for business on Monday, January 3rd. The NYSE calendar explains that no New Year holiday will be observed by the Exchange this year because of Rule 7.2, which says in part:
When a holiday observed by the Exchange falls on a Saturday, the Exchange will not be open for business on the preceding Friday and when any holiday observed by the Exchange falls on a Sunday, the Exchange will not be open for business on the succeeding Monday, unless unusual business conditions exist, such as the ending of a monthly or yearly accounting period.
This Bloomberg article says the non-holiday is going to surprise some folks, because this is the first time in 11 years that Rule 7.2 has snatched away a day off. Here’s more detail:
While the exchange published its holiday schedule a long time ago, complete with a “—*” footnote under the New Year’s Day 2022 column, some market participants are only now realizing they’re getting stiffed on the holiday. Adding salt to the wounds, bond traders get to start their New Year’s Eve parties a little earlier: Sifma is calling for a 2 p.m. market close that day.
A coalition of UK-based investors representing $4.5 trillion recently announced – just ahead of the COP26 summit – that it had sent letters to PwC, Deloitte, KPMG and EY that escalate a years-long engagement about reflecting climate change risks in financial statements. Each letter starts off like this:
Many of us wrote in January 2019 seeking assurance that [audit firm] was integrating material climate risks into its audits wherever relevant. Specifically, we asked that [you] alert shareholders where company accounts were not considering the financial implications of either the current decarbonisation pathway, or the global transition onto a 1.5C pathway . We are writing again now as an even larger group of investors following analysis of carbon-intensive companies’ financial statements published by Carbon Tracker, which details the broad failure of both directors and auditors to act on our expectations. We would like to understand what you plan to do to address these weaknesses in [audit firm’s] audit process.
The body of the letter contains details about the particular firm’s audits, and then it goes on to threaten action at upcoming annual meetings:
We began our engagement with you almost three years ago. We cannot afford to wait another three years for [audit firm] to act. From next voting season, you should increasingly expect to see investors vote against [audit firm’s] reappointment as auditor where you fail to meet the expectations we have clearly set out in our previous correspondence, the November 2020 IIGCC paper and underlined again here.
It remains to be seen whether this shaming endeavor will spur the Big 4 to take any actions that they aren’t already taking, and whether this is a bellwether for US expectations. As Lawrence blogged earlier this year, PwC announced that it’s investing $12 billion and planning a 100,000 increase in headcount relating to ESG work. The whole industry is gearing up for what they clearly expect to be in-demand work.
With those wheels already in motion, this threat really just underscores that in the future, the Big 4 may be competing with each other on ESG expertise (or more accurately, their ability to market their ESG expertise). It’s pretty unlikely that all of the big firms will suffer a string of low votes that send huge companies to move their work to smaller firms, and that’s probably not exactly the outcome that the investors want either. But as Lawrence has written, tracking ESG progress and accurately validating ESG data will also require more than a focus on financial audits. A few places are recognizing that – here’s one that’s hiring.
Results from a new Deloitte survey of 350 global audit committee members suggest that audit committees may not feel prepared to oversee the data collection and other changes that enhanced climate change disclosures and strategies may require. The survey also shows that at this point, there’s quite a bit of variation in the climate change responsibilities that audit committees are taking on. Some committee members feel that they lack a clear mandate to do what may be expected externally.
Here are some key stats (also see this Cooley blog):
– 62% of audit committee respondents in the Americas believe that climate change has no material impact on the organization
– When it comes to climate related matters, audit committees in the Americas are most likely to have oversight responsibility for risk management (63%), the front half of disclosure in the annual report, such as narrative climate risk and TCFD info (52%), the impact of climate risks & opportunities in financials, including in relation to judgments & estimates (54%), external audit’s work in climate-change related financial statement risks (53%) and assurance of climate-related info and disclosure (42%)
– 54% of audit committee respondents in the Americas said they don’t have the information, capabilities, or mandate to fulfill climate regulatory responsibilities or climate reduction targets
– The main internal challenges in overseeing climate change was the lack of clear strategy in relation to climate for the organization (65%), followed by poor quality of data (46%)
– Although 8% of audit committees in the Americas discuss climate change at every meeting, nearly 60% of global respondents said that their audit committees do not discuss climate change at all or as a fixed agenda item.
– 52% said that some or all of their audit committee members are “climate literate” – 48% said their committees were not “climate literate” or relied on just one committee member – nearly 90% seem to want more education versus different board members
– 18% of global respondents said that their climate impact assessment is reflected in the financial statements
– 42% of global respondents said that their organization’s climate response is not as swift and robust as they would like – 58% were satisfied
EY is out with their 10th annual survey of audit committee disclosures – finding that committees are continuing to share more info about their role and work. The survey primarily looks at 2021 proxy statements from Fortune 100 companies. It also includes stats about auditor ratification support and audit committee composition at a bigger group of companies. The areas with the most year-over-year change relate to audit quality & the committee’s oversight role for non-financial risks. Here are some of the key takeaways:
– This year, 71% of reviewed companies disclosed factors used in the audit committee’s assessment of the external auditor qualifications and work quality, up from 64% last year. Only 15% of these companies made that disclosure in 2012.
– Nearly 92% of reviewed companies disclosed that the audit committee considers non-audit fees and services when assessing auditor independence vs. just 16% in 2012.
– Nearly 70% of reviewed companies stated that they consider the impact of changing auditors when assessing whether to retain the current external auditor, and 79% disclose the tenure of the current auditor. That’s up from just 3% and 23%, respectively, in 2012.
EY also found that 76% of the reviewed companies included additional disclosures around risks beyond financial reporting that were being overseen by the audit committee. Some of these top risks being overseen by audit committees include cybersecurity, data privacy, enterprise risk management and ESG. Here’s more detail on that piece:
– Nearly 70% of reviewed companies disclosed that the audit committee oversees cybersecurity matters.
– Notably, 10% of reviewed companies discussed the audit committee’s role in ESG matters, up from 6% last year. These matters include oversight of climate change risks as they relate to financial and operational risk exposures and other environmental, health and safety-related matters.
On “Critical Audit Matters,” EY found that 16 out of 72 companies discussed the audit committee’s review and discussion of CAMs with the external auditors. Only one company noted the number of CAMs identified.
As you prepare your disclosures for 2022, remember that our 49-page “Audit Committee Disclosure” Handbook can help you efficiently resolve questions that arise. It covers the regulatory requirements for audit committees as well as real-world disclosure trends.
Here are results from our recent survey on COVID-related adjustments to insider trading policies:
1. Who owns/administers your company’s insider trading policy (e.g., sets window open/close dates, determines employees subject to window periods, provides pre-clearance for transactions, etc.)?
– Corporate secretary department – 77%
– Ethics & compliance office or similar function – 11%
– Corporate stock plan department – 1%
– Combination of 1 or more of the above – 11%
2. Has your company made changes to the policy as a result of Covid-19?
– Yes, it covers more employees – 2%
– Yes, we’ve instituted an event-specific closed window period – 10%
– No – 88%
3. Has your company issued more frequent communication about the policy during the Covid-19 pandemic?
– Yes – 22%
– No – 78%
4. If you’ve issued more frequent communication about the policy, how frequent?
– Once – 67%
– Twice so far – 28%
– More often – 5%
5. If you haven’t issued more frequent communication, are you planning to do so and if so when?
– No – 69%
– Yes, within the next month – 2%
– Haven’t decided yet, will depend upon ongoing developments – 29%
As a reminder, we’ve previously posted the transcript from our webcast for members, “Insider Trading Policies & Rule 10b5-1 Plans.” We’re keeping an eye out on further SEC developments with insider trading policies – stay tuned!
Please also take a moment to participate anonymously in these surveys:
Here’s something John recently wrote on our free DealLawyers.com blog:
The question of the legality of a dividend or repurchase under Delaware law is one that often arises in leveraged recaps and other transactions involving large distributions to shareholders. The answer usually depends on whether the company has sufficient “surplus” within the meaning of Section 154 of the DGCL. The Delaware Supreme Court has held that what matters in the surplus calculation is the present value of the company’s assets & liabilities, not what’s reflected on the balance sheet. Since that’s the case, valuations are often used to determine the amount of available surplus.
While that’s a pretty common practice, there’s not a lot of Delaware case law on how the board’s valuation decisions will be assessed. That’s kind of disconcerting, particularly since directors face the prospect of personal liability for unlawful dividends or stock repurchases. Fortunately, the Chancery Court’s recent decision in In re The Chemours Company Derivative Litigation, (Del. Ch.; 11/21), provides some guidance to boards engaging in this process. Here’s an excerpt from this Faegre Drinker memo on the decision:
In this case, the board approved both dividends and stock repurchases at a time when the company also faced legacy contingent environmental liabilities that conceivably could render Chemours insolvent.
The court deferred to the board’s determination that there was sufficient surplus to permit these transactions, even though the board looked beyond GAAP-metrics to evaluate its contingent liabilities. The court held that it “will defer to the Board’s surplus calculation ‘so long as [the directors] evaluate assets and liabilities in good faith, on the basis of acceptable data, by methods that they reasonably believe reflect present values, and arrive at a determination of the surplus that is not so far off the mark as to constitute actual or constructive fraud.” This standard is consistent with the court’s prior guidance that the DGCL “does not require any particular method of calculating surplus, but simply prescribes factors,” total assets and total liabilities, “that any such calculation must include.”
As for reliance on experts, the court held that, under the DGCL, utilization of and good faith reliance on experts “fully protects” directors from personal liability arising from their surplus calculation. In reaching this conclusion, the court rejected the argument that the directors were required to second-guess the GAAP-based reserves calculated by the experts — an analysis that permitted the board to significantly reduce the size of these liabilities on Chemours’ balance sheet.
The memo goes on to provide some thoughts on the key takeaways from the decision, including the need for the board to carefully compile and review accurate data on assets & liabilities, and to retain an expert in any situation where the calculation of surplus may be an issue.
We continue to share daily posts about career issues and board matters on our “Mentor Blog” – which is available to TheCorporateCounsel.net members. Members can sign up to get that blog pushed out to them via email whenever there is a new entry by simply inputting their email address on the left side of that blog. Here are some of the latest entries:
– Time to Refresh Your Compliance Training
– C-Suite Executives Want More Effective & More Diverse Directors
– Supply Chains: How to Manage Cyber Risk
– PCAOB 2020 Inspection Reports for the Big 4+ Are Out!
– Books & Records Demands: A Primer for Boards
The SEC’s Acting Chief Accountant, Paul Munter, issued a statement earlier this week. I might be reading too much into it, but when public statements are issued out of the blue, I take it to mean that there’s some urgency and importance to the issue, and the SEC might be paying extra attention to it.
The purpose of this particular statement is to remind auditors, managers, and audit committees of the importance of auditor independence – and the need to continually monitor independence in light of business activities & relationships. Here’s an excerpt:
We continue to encourage audit committees to consider the sufficiency of the auditor’s and the issuer’s monitoring processes, including those that address corporate changes or other events that potentially affect auditor independence. This is particularly relevant in the current environment as companies seek to access public markets through new and innovative transactions, and audit firms continue to expand business relationships and non-audit services.
Management, the audit committee and the independent auditor should proactively seek to inform themselves of any potential impact to auditor independence, in fact and appearance, as companies negotiate potential transactions with third parties. This requires all parties to potential transactions to understand the filings that could be required by such transactions, the existing auditors’ relationship with counterparties, and the potential impact of transactions and the auditor’s relationships with the counterparty on the existing auditor’s ability to continue to comply with the Commission’s auditor independence rule applicable to such filings. This proactive monitoring requires management, the audit committee, and the independent auditor to each consider the potential effects of the auditor’s existing business and service relationships with other companies on the auditor’s ability to remain independent of the issuer if a contemplated transaction is consummated.
For example, it is important to understand what business relationships exist, including non-audit service relationships, between the audit firm and other entities that will, or in the future could, require an audit, become the existing audit entity’s affiliates, or result in other companies that have significant influence over the entity. Given the importance of independence as it relates to the audit of financial statements, these relationships and services and their implications to auditor independence should be carefully considered when management is negotiating the timing and substance of a transaction with third parties.
The statement also urges an understanding of the general standard of independence in Rule 2-01 of Reg S-X. This Cooley blog provides even more context and lays out the bottom line for companies:
It is important for companies to keep in mind that violations of the auditor independence rules can have serious consequences not only for the audit firm, but also for the audit client. For example, an independence violation may cause the auditor to withdraw the firm’s audit report, requiring the audit client to have a re-audit by another audit firm. As a result, in most cases, inquiry into the topic of auditor independence should certainly be a recurring menu item on the audit committee’s plate.
Earlier this week, I blogged about the PCAOB’s summary of 2020 inspection findings. A member emailed to ask whether the results of PCAOB audits are made public – because deficiencies in auditor performance could be very relevant to an audit committee’s decision to retain the auditor for the next year.
The PCAOB does indeed post inspection reports – as well as disciplinary actions. However, there’s a big lag between when inspections occur and when reports are issued. Audit committee chairs have told the PCAOB that they’re concerned about that, according to Appendix B of this Center for Audit Quality memo (pg. 14) – which also provides questions that audit committees can ask auditors about their inspections.
In his statement from earlier this week, SEC Acting Chief Accountant Paul Munter noted that the PCAOB inspection program is a key component of ensuring audit quality, and that audit committees should always be focused on audit quality. In my experience, the Big Four and some other large accounting firms always present to the audit committee about inspection findings – but you can’t count on all firms to do that. Especially OUS firms. A lot of mid-sized foreign private issuers that have a primary listing on the NYSE or Nasdaq aren’t a good fit for the Big Four, and one reason their audit quality can suffer is that their audit committees aren’t able to reliably get inspection info from smaller OUS audit firms in advance of engagement decisions.
If an audit committee is unable to access detailed inspection findings, the sample questions from the CAQ memo and the PCAOB’s summary of findings can be a starting point for digging for information.
The SEC announced yesterday that John Nester, formerly the Director of the Office of Public Affairs, is retiring from the agency at the end of this month after nearly 25 years of SEC service. Since April, John has been helping the Office of the Chief Operating Officer prepare the SEC and its Staff for success in a post-pandemic environment. As Public Affairs Director from 2006 until April 2021, John helped modernized the SEC’s external and internal communications, which doubled the agency’s web traffic!
Earlier in his SEC career, John was a member of the SEC’s investor education office, where he conceived and helped organize a national financial literacy campaign backed by state securities regulators and nearly three dozen government agencies, public service organizations, industry associations, and educational groups. John received many awards throughout his SEC tenure, including the Distinguished Service Award, which is the Commission’s highest honor. We would like to congratulate John on his career and his contributions to the SEC’s mission.
