Before last week’s holiday break, John blogged about the SEC’s approval of the NYSE direct listing proposal – we’re posting memos about the new rule in our “Direct Listings” Practice Area. A recent Wilson Sonsini memo summarizes the NYSE rule and also gives a brief update about Nasdaq’s proposed direct listings rule:
Following the SEC’s approval of the NYSE rule change, Nasdaq submitted a substantially similar proposed rule change relating to primary direct listings, and is seeking immediate effectiveness. This latest submission differs from Nasdaq’s previous proposed rule change, which remains under review by the SEC.
Also last week, the staff of the SEC Division of Trading and Markets issued a statement after receiving Nasdaq’s latest proposed rule change saying the staff intends to work to expeditiously complete its review of Nasdaq’s proposals.
Even with expeditious review, it’s uncertain whether Nasdaq’s direct listing proposal will go anywhere right now. With Chairman Clayton departing from the SEC on December 23, the Commission is down to four Commissioners and like many rule proposals this year, the Commission adopted the NYSE direct listing rule by a 3-2 vote with Commissioners Allison Herren Lee and Caroline Crenshaw dissenting.
Taking Care of Employees: Sabbaticals
Earlier this week, I blogged about how companies are focusing more on employee health and safety and a while back, Liz blogged about an ISS ESG survey that found the Covid-19 pandemic has heightened asset manager focus on social issues, including treatment of employees. One company that appears to be focusing on employee well-being is Citigroup – it’s offering a new sabbatical program and paid leave opportunities. This Employee Benefit News blog discusses the program, along with related risks:
From January the Wall Street giant will start offering 12-week sabbaticals (at 25% pay) to staff in North America who’ve been at the company for five years or more — a parting gesture from the CEO before he steps down in February. The bank will also offer a month of fully paid leave to anyone who wants to work pro bono for a charity.
The blog discusses several risks, such as the need for policies to be clearly spelled out so they’re not too onerous, employee notice requirements, and timing, as following the pandemic many employees might be eager for a break.
The blog notes larger companies that grant sabbaticals usually do so on an informal basis with company-wide policies being less common. But, as companies look for ways to show employees, investors and other stakeholders that they’re focused on employee well-being, the sabbatical program is one way to try sending that message and as stated in the headline, it’s a way to combat work-from-home fatigue.
Looking Ahead: Hope for 2021
As we’re ready to say sayonara to 2020 and look forward to 2021, I wish each of you good health and happiness. Thanks for reading – and contributing throughout the year – may we all make the most of what we hope are brighter days ahead!
Last summer, the Supreme Court’s decision in Liu reaffirmed the SEC’s authority to seek disgorgement as a remedy in enforcement actions. Following the Court’s decision, some questioned whether Liu changed or removed the five-year statute of limitations that was settled in the Supreme Court’s Kokesh decision. Russ Ryan, former Assistant Director of Enforcement and Partner with King & Spalding offered one take on this question and discussed several reasons Liulikely doesn’t give the SEC unlimited time to sue for disgorgement claims. But now, Congress stepped in and passed the National Defense Authorization Act for Fiscal Year 2021 (NDAA), which includes amendments to the Exchange Act relating to the SEC’s ability to seek disgorgement awards.
The proposed amendments provide the SEC with express statutory authority to seek disgorgement in civil enforcement proceedings pending in federal court. And, the amendments double the statute of limitations – from 5 years to 10 years – for the SEC to seek disgorgement in claims involving fraud, although it reaffirms the 5-year limitation period to seek disgorgement for non-fraud claims.
This Paul Weiss memo provides an overview of the proposed amendments and says they are a direct Congressional response to the limitations imposed by the Supreme Court in Liu and Kokesh. One potential impact of the proposed amendments is that they may increase the SEC’s power when its involved in settlement negotiations. As noted in the memo though, the full scope and actual impact of the amendments remain to be seen and the amendments raise additional issues. Here’s an excerpt:
If enacted, the NDAA will bolster the SEC’s ability to seek disgorgement in civil actions, both by doubling the statute of limitations and by providing the SEC with express statutory authority to seek such a remedy. Nonetheless, the full scope and impact of these amendments remain to be seen, and will likely require case law development. For example, it will likely fall to the courts to determine whether the SEC’s authority to seek “disgorgement”—now untethered from the SEC’s separate authority to seek “equitable relief”—will continue to be bound by the equitable limitations identified in Liu. On the other hand, the statutory authorization to require disgorgement of any unjust enrichment “by the person who received such unjust enrichment” could limit the persons subject to disgorgement even more than the Supreme Court’s decision in Liu, which permitted the SEC to seek disgorgement against affiliates of the wrongdoer in certain circumstances.
Right before last week’s holiday, the President vetoed the NDAA. The President’s reasons for vetoing the bill are unrelated to the SEC’s authority in seeking disgorgement awards – the House voted to override the President’s veto, while it’s unclear exactly when the Senate will consider the veto override.
Paycheck Protection Program: Potential Onslaught of Investigations
Throughout the last year, we blogged quite a bit about the federal government’s Paycheck Protection Program – here’s a blog about an SEC enforcement sweep of public company borrowers. As we get ready to ring in 2021 and put 2020 behind us, last week Congress allocated more funding for the program as part of the most recent economic stimulus package – John blogged about some of the changes with this most recent funding. But, this K&L Gates memo warns companies should expect a continued wave of PPP investigations in 2021.
The memo includes several stats indicating a potential onslaught of enforcement actions, including that the SBA fraud hotline received more than 100,000 complaints in 2020 (compared to 742 complaints received in 2019) and that the SEC has brought seven COVID-19 related fraud actions and has opened more than 150 COVID-19-related investigations and inquiries. For PPP lenders and recipients, the memo says now’s the time to be proactive to be able to show more than the bare minimum has been done to ensure strong compliance with the PPP program. The memo has this advice for actions companies can take now:
Overall, lenders, recipients, and any others involved in the PPP loan approval process will want to demonstrate their specific, good faith, and documented efforts to ensure that loans not only would be disbursed and received speedily, but also carefully limited to properly covered companies and individuals. In particular, companies should revisit their control processes and document the good and compelling reasons for specifically implementing them at the time (and any changes later made), initiate and conduct routine compliance checks regarding the same, identify any red flags suggesting fraudulent or other suspicious activity, and investigate them appropriately with aid of counsel.
Farewell to Jacob Stillman
Yesterday, the SEC issued a statement mourning the passing of Jacob Stillman. Jake served the Commission for 55 years, including 17 as Solicitor and passed away December 25th. Jake’s tenure at the SEC spanned 11 administrations and he is remembered as a man of great character, a lawyer with unparalleled knowledge of the securities laws, and a beloved colleague. Over the course of his career, Jake received numerous awards, among them the Federal Bar Association’s 48th Annual Justice Tom C. Clark Award for Outstanding Government Lawyer. He also was honored by his peers with the William O. Douglas Award, granted by the Association of Securities Exchange Commission Alumni.
Don’t Forget: Renew Your Membership Today!
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Yesterday, the SEC issued a statement that President Trump designated Commissioner Elad Roisman as Acting Chair of the agency. John blogged last week about former Chairman Jay Clayton’s departure – his last day was December 23. Commissioners Hester Peirce, Allison Herren Lee and Caroline Crenshaw issued a statement congratulating Commissioner Roisman’s designation as Acting Chair. Yesterday’s SEC statement follows news last week when Commissioner Peirce tweeted an early congratulations to Chair Roisman. It’s still uncertain who President-elect Biden will nominate to serve as SEC Chair but until then, Acting Chair Roisman will preside over a four-person Commission.
Growth in ESG Investing Charges Ahead
Growth in ESG investing has been well documented – here’s a recent CNBC article. Last summer, State Street Global Advisors (SSGA) released a report about growth in ESG investing and concluded that investors who were once indifferent about ESG seem to have resolved any lingering reservations. So much so, in fact, that SSGA projects over the next ten years we’ll see an eightfold increase in global ESG ETF and index mutual fund assets. SSGA bases the prediction on how the Covid-19 pandemic has exposed inequities leading investors to place more emphasis on living according to their values, including taking a stand with investment choices. The report cites three trends that will drive the ESG investing increase:
– The great reset in a turbulent 2020: The Covid-19 pandemic and its aftershocks have put a spotlight on important ESG issues such as income inequality, diversity and inclusion, social injustice, employee welfare and climate change. Many investors have concluded that they can no longer look the other way and are ready to address these ESG issues in their portfolios. Factors such as a company’s contingency planning and work environment, as well as how they treat their customers and communities, are now top-of-mind for many investors.
– Studies suggest that portfolios with ESG integration may provide downside protection when markets are struggling, underscoring ESG’s potential as a long-term investment. Some investors have expressed concerns that ESG investments would result in subpar performance and so far, those fears have proven to be unfounded.
– Beginning of an enormous intergenerational wealth transfer: as this occurs, SSGA believes ESG investing will be in the mainstream of every investment portfolio.
SSGA recently issued another memo saying that the momentum behind ESG investing will likely carry it far beyond the pandemic. The CNBC article references research from Sustainable Research and Analysis, an independent ESG research firm, and it attributes growth in sustainable investing to similar factors, while also attributing growth to the Paris climate accord, which it says sensitized investors and asset managers to think more sustainably, and the growing number of asset managers signing on to the UN Principles for Responsible Investing.
Prioritizing Employee Health & Safety: Are Chief Medical Officers Here to Stay?
John blogged not too long ago about how many consider the “S” in ESG the most difficult for companies to analyze and integrate. One aspect of “S” that is garnering a lot of attention during the pandemic is employee health and safety along with customer safety – this NYC Comptroller press release says it has submitted an initial shareholder proposal focused on worker health and safety. One way some companies are demonstrating their commitment to employee health and safety is by bringing on a chief medical officer – or if such a role is already in place, by expanding the CMO’s role.
For companies that don’t have someone fulfilling the CMO role, this HBR article asserts that it’s time to bring one on. Companies in the hospitality sector or with employees on the front lines are places where there’s a good chance to find a CMO or where they might be considering one. But, the article says even for companies with most employees working remote, it’s still important to have an in-house medical expert:
Hiring an in-house medical expert is an important signal that your leaders cares about their people. ‘Consulting outside experts’ does not suffice. You need to show that employee physical – and mental – health is a fundamental concern. One company gave its workforce direct access to the CMO on the company intranet. The idea was to give everyone ‘peace of mind [that the organization is] seeking a medical perspective to best understand how to keep our employees and communities safe.’
With so much conflicting information that’s changing by the day, it’s important to have an expert who is capable of wading through and interpreting all the data and opinions to determine the course of action that best serves your customer base. Organizations that are not built on hospitality have to decide when and how to start seeing clients and partners, attending road shows and conferences, and much more. Ultimately, business leaders have a social responsibility to set the conditions for safe and healthy behavior.
For a look at some of what’s included in the CMO role, this blog discusses how the CMO role at Salesforce has evolved since the arrival of Covid-19. As some companies scramble to hire a CMO, the blog says it’s likely more than just a passing fad.
A couple of weeks ago, the SEC announced revisions to Volume 1 of the EDGAR Filer Manual. Volume 1 of the Filer Manual is the manual that provides general information about electronic submissions on EDGAR, including the requirements for becoming an EDGAR filer. The updates clean up outdated information and also include a couple of changes intended to simplify things. Among the updates are changes allowing those submitting EDGAR access requests to use electronic notarizations and remote online notarizations, which include electronic signatures, in addition to manually signed notarizations. The SEC also amended Rule 10 of Regulation S-T to remove the manual signature requirement for Form ID notarization.
Along with those changes, the SEC also relocated some basic instructions and technical explanations previously found in Volume 1 of the Filer Manual to the more user-friendly EDGAR – Information for Filers webpage found on the SEC’s website. Among other things, these instructions cover questions relating to preparing and submitting a Form ID application, updating company information and correcting, withdrawing or deleting a filing.
Vaccines: Possible Risk Factor for Some Companies
With distribution of vaccines underway, there’s increased hope that the other side of the pandemic will come and a recent Intelligize blog discusses whether some companies should consider the vaccines as a risk factor. As many adjusted to working from home, many took advantage of online services – the blog mentions Zoom, Netflix and DoorDash as examples. But, once the lockdown is over, consumer preferences could change – the blog notes that people may prefer to go out to eat rather than having dinner delivered. Zoom’s most recent Form 10-Q included this risk factor and for companies positively impacted by the pandemic, it may be worth considering the need to include something similar:
We may not be able to sustain our revenue growth rate in the future.
We have experienced significant revenue growth in prior periods. You should not rely on the revenue growth of any prior quarterly or annual period as an indication of our future performance. We expect our revenue growth rate to generally decline in future periods. Many factors may contribute to declines in our growth rate, including higher market penetration, increased competition, slowing demand for our platform, especially once the impact of the COVID-19 pandemic tapers, particularly as a vaccine becomes widely available, and users return to work or school or are otherwise no longer subject to shelter-in-place mandates, a failure by us to continue capitalizing on growth opportunities, and the maturation of our business, among others. If our growth rate declines, investors’ perceptions of our business and the trading price of our Class A common stock could be adversely affected.
More on “Proxy Season Blog”
We continue to post new items on our blog – “Proxy Season Blog” – for 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 entering their email address on the left side of that blog. Here are some of the latest entries:
– SV 150 and S&P 100 Proxy Season Recap
– Nuggets from BlackRock’s Voting Guideline Updates
– Vanguard Engagements: Focus on Board & Workplace Diversity
Liz blogged earlier this year about the rise in premiums for directors and officers (D&O) liability policies. Now after a rise in lawsuits relating to diversity concerns among executives and directors, a recent Business Insurance article says some insurers are starting to take a fresh look at company diversity practices and top-level succession planning before renewing or pricing D&O coverage. The price of D&O coverage fluctuates but in a market when premiums were already rising, this added scrutiny isn’t likely to help matters for some companies.
With investors, proxy advisors and Nasdaq calling for increased diversity disclosures, insurer focus on the issue seems like a natural progression. The article says some insurers have been meeting with companies to better understand diversity plans and inquiring about which directors are retiring and companies’ plans to replace them.
Suggestions for Moving Beyond Numerical Board Diversity Targets
Not too long ago, John blogged about how companies may focus on overboarding as one way to move forward with increasing board diversity. A recent report from The Conference Board, ESGAUGE and others that analyzes Russell 3000 and S&P 500 board composition trends provides several suggestions to help companies move beyond simply setting numerical board diversity targets. Lending credibility to the need to go beyond setting numerical targets, the report cites various stats showing the lack of progress toward greater board diversity.
With investors (and now insurers!) increasingly looking for action and progress on diversity initiatives, companies might want to start thinking about steps they can take to show progress in working toward improved board diversity. Diversity of course goes beyond gender and race/ethnicity and the report discusses the importance of diverse skill sets and age diversity and suggests boards make diversity part of the ongoing board succession planning process. The report offers one take on what boards can do to help improve diversity, and at minimum some of these ideas may help get a dialogue started. The report mentions requiring a diverse slate of director candidates and beyond that, here are more of the report’s suggestions:
– Endorse a model where every other board seat vacated by a retiring board member is filled by a woman or the model described in the recent California law requiring directors from underrepresented communities
– Ensure nominating committees are diverse
– Consider diversity when making board and committee leadership appointments
– Get ahead of investor demands for information about board diversity and include more narrative information about the racial and ethnic background of directors as part of a broader explanation of the multiple dimensions of diversity on company websites.
– When it comes to director tenure, the report says boards should consider how best to achieve a mixture that includes long-serving directors, along with those in the middle and new directors. For disclosure, companies should consider disclosing the range of tenures to investors and consider adopting an average tenure and similar policies that encourage a healthy level of turnover but avoid the shortfalls of rigid term limits.
– Strengthen the director evaluation process to ensure that specific cases of long tenure are examined holistically and in light of other assessment factors such as the board’s overall gender, age, racial and ethnic diversity, skill sets, and rate of board refreshment.
– Look outside the C-Suite for potential director candidates. To help ensure newly minted directors have the requisite experience and abilities, put robust processes in place for identifying, recruiting, onboarding and engaging directors to help them succeed. As companies increasingly seek individuals with specific skill sets, such as cybersecurity and human capital management, looking outside the C-suite can bring different perspectives and problem-solving approaches. Boards should examine their own culture to ensure that they and management are providing a genuinely inclusive environment.
November-December Issue of “The Corporate Counsel”
The November-December issue of “The Corporate Counsel” print newsletter was just posted – and also mailed (try a no-risk trial). The topics include:
Yesterday, the SEC announced that it settled an enforcement proceeding against GE arising out of allegedly misleading disclosures in its power and insurance businesses. The SEC’s investigation had been underway at GE for the last couple of years after the company disclosed it was taking large charges in each of those business areas – here’s an excerpt from the press release:
According to the SEC’s order, GE misled investors by describing its GE Power profits without explaining that one-quarter of profits in 2016 and nearly half in the first three quarters of 2017 stemmed from reductions in its prior cost estimates. The order also finds that GE failed to tell investors that its reported increase in current industrial cash collections was coming at the expense of cash in future years and came primarily from internal receivable sales between GE Power and GE’s financial services business, GE Capital. In addition, the order finds that from 2015 to 2017, GE lowered projected costs for claims against its long-term care insurance portfolio and failed to inform investors of the corresponding uncertainties resulting from lower estimates of future insurance liabilities at a time of rising costs from long-term health insurance claims.
Without admitting or denying the SEC’s findings, GE consented to a cease-and-desist order, agreed to pay the $200 million penalty and to report for one year to the SEC regarding certain accounting and disclosure controls in its power and insurance businesses. The $200 million penalty is big, and as reported in this WSJ article, the penalty is much higher than the amount GE previously set aside to resolve the matter. Even with the settlement, the SEC’s announcement says that the investigation is ongoing, which could mean it’s determining whether to bring charges against individuals.
As noted in the WSJ, in the time since the investigation began, GE has a new CEO and, in 2021, a new auditor. In reporting the settlement, GE’s Form 8-K included this statement about its financial reporting, along with information about corrective measures the company has taken:
The SEC’s order makes no allegation that prior period financial statements were misstated. This settlement does not require corrections or restatements of GE’s previously reported financial statements, and GE stands behind its financial reporting.
GE cooperated with the SEC over the course of its investigation. As noted in the order, GE has taken a number of steps since the time periods covered by the investigation to enhance its investor disclosures regarding power and insurance trends and risks, as well as enhancing internal controls on its insurance premium deficiency testing (also known as loss recognition testing) process and adding disclosure controls and procedures concerning its insurance liabilities.
Critical Audit Matters: A Look at the S&P 100
A few weeks ago, Liz blogged about the PCAOB’s analysis of the impact of the “critical audit matter” disclosure requirement. Last week, the Center for Audit Quality issued its report with observations of CAMs contained in audit reports for large accelerated filers and it takes a deeper dive into the S&P 100. Here’s some of the findings from review of the S&P 100 audit reports:
– Average number of CAMs per audit report was 1.98
– Drivers that led to matters being a CAM appeared to include a high degree of judgment by management related to the matter that led to a high degree of auditor judgment to assess or evaluate management’s conclusions. Some CAM communications also described the audit effort and involvement of professionals with specialized skills and knowledge as principal considerations for the matter being considered a CAM.
– Of the 198 CAMs identified in audit reports for the S&P 100, 51% of them were in these 4 categories:
Taxes (32 CAMs)
Goodwill and/or intangibles (28)
Contingent liabilities (23)
Revenue (18)
The remaining 49% of CAMs were spread across 23 different categories and were less prominent from a trend perspective – business combinations, sales returns and allowances, pensions and other post-employment benefits, and asset retirement and environmental obligations were all topics that S&P 100 auditors identified as CAMs.
Transcript: “Doing Deals Remotely”
We’ve posted the transcript for the DealLawyers.com recent webcast: “Doing Deals Remotely.”
Liz blogged last summer about how some short-term activists were making a pivot to ESG and wondered whether this trend would intensify. There have been whispers that investors want to see more climate expertise on boards – but not much has come of that so far. Earlier this week, though, the WSJ reported that Engine No. 1 LLC, a new activist investor with a focus on sustainability, has taken aim at Exxon Mobil:
Engine No. 1 LLC, an investment firm launched by Chris James last week, is preparing to send a letter to Exxon ’s board urging the Irving, Texas-based company to focus more on investments in clean energy while cutting costs elsewhere to preserve its dividend. The letter, a copy of which was viewed by The Wall Street Journal, identifies four people the firm plans to nominate to Exxon’s 10-person board.
The article also identifies CalSTRS as one shareholder that supports Engine No. 1’s cause. CalSTRS issued a press release confirming that it intends to support Engine No. 1’s alternate slate of board members, which includes a link to Engine No. 1’s proxy fight website.
We’ll see where this goes — the WSJ article notes that it’s possible the campaign will fall flat. A CNBC article discussing the matter says that for a long time, Exxon would’ve been an unthinkable target for activists given its size. In an effort to get large investors on board with the campaign, CalSTRS reached out to Larry Fink, BlackRock’s CEO, although the article notes the pension fund hasn’t received a reply. But Exxon’s shareholders have been at the forefront of climate-related shareholder proposals before. In 2017, shareholders approved a climate change proposal at Exxon, and back then climate proposals weren’t seeing much success.
Audit Fees: Effect of Negative Auditor Attestation Persists for Several Years
Audit Analytics recently released a report looking back at 18 years of audit and non-audit fees paid by accelerated and large accelerated filers. The report covers the period 2002 through 2019 and is heavy on data – but what I found interesting was an analysis of fees paid by 105 companies that disclosed ineffective ICFR during FY 2016. Although one would expect that an adverse auditor attestation could lead to increased fees, the report says those higher fees persist for several years. Here’s an excerpt:
Companies that disclosed an adverse auditor attestation paid more non-audit fees, including audit related, the year of the disclosure. These same companies experienced an increase in audit fees that peaked the year after the disclosure. An increase in fees attributed to negative auditor attestation persists for at least three years after the disclosure when fees, excluding audit related, ranged 54-83% higher than average and when including audit related, were 48-76% higher than average.
The report also includes detailed trend data showing the split between audit and non-audit fees. In a bit of good news, the amount of non-audit fees was the lowest ever paid in 2019 at $112 per $1 million in revenue if audit related fees were included and $58 if excluded. Average audit fees paid per $1 million in revenue dropped to $495 in 2019 after several years of running above $500.
Benefits of Audit Partner Rotation?
The recent SEC amendments to the auditor independence rules generally provide more flexibility to companies when selecting an auditor. One topic about auditors that’s been quiet for a while now, is “auditor rotation.” One reason could be because the five-year rotation requirement in the United States for audit engagement partners seems to have quieted calls for auditor rotation. Now findings from two recent studies suggest auditor partner rotation doesn’t deliver many benefits.
A CFO.com article discusses findings from two studies that analyzed the two most frequent reasons in favor of auditor rotation: assumptions that personal ties developed over time between auditors and clients can compromise the accountants’ independence and as a result, audit quality; and that mandating rotations brings a fresh look to audits that likely enhances quality of reporting.
The first study from Auditing: A Journal of Practice and Theory found that there was no significant fall-off in reporting quality over the course of partners’ five-year tenures and little or no evidence that fresh looks make for improved audits. If anything, the study found a decline in audit quality with a new engagement partner, possibly reflecting less knowledge about the client than the previous engagement partner.
In another study, this one from Accounting Review, findings indicated audit quality over the five-year rotation cycle is unrelated to the length of the audit partner’s tenure with clients, except for restatement announcements, which were more frequent in the first two years after rotation. This study suggests there is a benefit of fresh looks but at the same time found that other important indicators of audit quality do not. The researchers concluded that for the average client engagement, mandatory [partner] rotation appears to be short enough to prevent capture or complacency and at the same time finding only limited evidence of fresh-look benefits – potentially because audit firms anticipate and invest resources to reduce potential disruption from mandatory audit partner rotations.
With these two studies suggesting audit partner rotation has little impact on overall audit quality, perhaps the real benefit of mandatory audit partner rotation is that it calms those who’ve called for periodic audit-firm rotation.
Efforts are ramping up for year-end reporting and one topic many companies are starting to get their arms around is the new human capital resources disclosure. We’ve been posting memos about the new HCR disclosure requirement in our “Human Capital Management” and “Regulation S-K” Practice Areas and one memo that can help shed some light on how companies are approaching the disclosure requirement is this FW Cook memo. The memo summarizes a review of the first 50 Form 10-Ks filed by large companies after November 8th and provides some high-level observations:
Length: Word length varied dramatically, ranging from nine words to 1,582 words. The median disclosure was 369 words long.
Topics: FW Cook decided to answer the question about which topics were covered by more extensive disclosures by only giving credit for a topic if the discussion was more than a brief mention and only gave credit for a factor if the discussion was significant. The test for ‘significance’ required a level of detail that made discussions more than generic. The results of the review suggest 13 common disclosure topics – they’re listed in order of prevalence along with the percent of disclosures describing each topic:
In terms of how human capital resource disclosures might evolve, FW Cook predicts that the disclosures will increase in length as the filing season progresses. This is not an assertion that longer disclosures are required, but more of an observation that legally required disclosures tend to grow, not shrink. We’ve all seen how this can happen – the memo notes that when one company sees how its competitor spends 100 words extolling the importance of its culture or diversity efforts, etc., there may a strong tendency to respond in kind.
With the disclosure being principles-based, each company’s human capital resource disclosure will of course be tailored to its specific circumstances. Beyond the early “trend” information about disclosure length and topics, the report includes examples of these early disclosures that might help spur ideas as companies start preparing human capital resource disclosure. For more sample human capital resource disclosures, see this blog from The SEC Institute.
Quick Survey: Human Capital Management – And Resources to Help Prepare Your HCM Disclosure!
To help understand how human capital management disclosure topics might vary by market-cap, we’ve expanded our HCM survey to capture the data this way. Check it out and enter the topics your company is considering including in its disclosure.
Last Friday, the SEC announced it settled an enforcement proceeding against The Cheesecake Factory for misleading Covid-19 disclosures. Among other things, early in the pandemic as the company began transitioning to a take-out and delivery service model, the proceeding alleges the company failed to adequately inform investors of the extent the pandemic had on the company’s operations and financial condition. This excerpt from the SEC’s press release summarizes the allegations:
As set forth in the SEC’s order, in its SEC filings on March 23 and April 3, 2020, The Cheesecake Factory stated that its restaurants were “operating sustainably” during the COVID-19 pandemic. According to the order, the filings were materially false and misleading because the company’s internal documents at the time showed that the company was losing approximately $6 million in cash per week and that it projected that it had only 16 weeks of cash remaining. The order finds that although the company did not disclose this internal information in its March 23 and April 3 filings, the company did share this information with potential private equity investors or lenders in connection with an effort to seek additional liquidity. The order also finds that, although the March 23 filing described actions the company had undertaken to preserve financial flexibility during the pandemic, it failed to disclose that The Cheesecake Factory had already informed its landlords that it would not pay rent in April due to the impacts that COVID-19 inflicted on its business.
The Cheesecake Factory proceeding is the SEC’s first enforcement action against a public company for misleading investors about the financial effects of the pandemic and shows the difficulties companies encountered early on in the pandemic. Without admitting or denying the SEC’s findings, The Cheesecake Factory consented to a cease-and-desist order and agreed to pay a $125,000 penalty. If you’re thinking the $125,000 penalty seems fairly light, the SEC’s press release does note the company’s cooperation in the proceeding. At minimum, the action serves as a cautionary reminder about the importance of accurate disclosures, even those made back at the outset of the pandemic, and that the SEC is continuing to scrutinize Covid-related disclosures.
Enforcement Proceedings: Earning Extra Credit for Cooperation
As mentioned in the SEC’s press release about The Cheesecake Factory, cooperation factored into the SEC’s determination to accept the settlement. When the SEC closed out its fiscal year, some may have read news reports of an SEC enforcement matter involving inaccurate disclosures concerning BMW’s U.S. retail sales volume while it conducted bond offerings. A Simpson Thacher memo outlines key takeaways from the case – one being that the SEC may give extra credit for cooperation during the pandemic. Here’s the memo’s takeaways:
First, the case serves as a reminder that the SEC continues to focus on bond offering disclosures, even in the absence of findings or allegations that proper disclosures would have impaired the company’s ability to make interest payments or repay the principal to bondholders. The memo reminds bond issuers to exercise caution in describing particular data points as important business barometers.
Second, the memo also notes that the case demonstrates that the SEC is prepared to give special credit for cooperation during the pandemic. The SEC’s order is also notable in its detailed description of BMW’s cooperation, and its express reference to challenges raised by the global COVID-19 pandemic. Specifically, the order commends the company for complying with the SEC’s requested schedule and its prompt collection and production of ‘a significant volume of electronic documents, including documents that would otherwise have been difficult and time-consuming for [the SEC] to obtain; documents from sources outside of the company’s corporate offices, such as BMW employees working from remote locations; and translations of key documents’ The order notes that the company additionally made several current and former employees available for interviews with the SEC, and provided the SEC with ‘presentations and narrative submissions that highlighted critical facts.’
Insofar as the items the SEC cites as evidence of BMW’s cooperation are part of the standard cooperation checklist, the case may be suggestive of the SEC’s willingness, during the COVID-19 pandemic, to accord extra credit for what some might view as ordinary course cooperation. At a minimum, the case may serve as useful precedent for other companies negotiating settlements with the SEC to argue that their cooperation during the pandemic warrants a reduced penalty (or even reduced charges).
This K&L Gates blog includes practical considerations about cooperation gleaned from remarks by Enforcement Division Associate Director Anita Bandy at the recent SEC Speaks conference:
Cooperation is largely still evaluated under the factors announced in the “Seaboard Report” issued by the SEC in 2001. The seminal consideration is whether the cooperation substantially enhanced the quality and efficiency of the investigation. In a recent case, for example, the respondent was forthcoming and proactive and, notwithstanding the complexity of the matter and the difficulties presented by collecting evidence internationally during the pandemic, worked to produce quickly documents and witnesses such that the investigation was resolved within ten months. As a result of this cooperation and other substantial remediation efforts, the Commission imposed a reduced penalty.
Tomorrow’s Webcast: “Modernizing Your Form 10-K: Incorporating Reg S-K Amendments”
Tune in tomorrow at 11 a.m. Eastern for our webcast – “Modernizing Your Form 10-K: Incorporating Reg S-K Amendments” – to hear Scott Kimpel of Hunton Andrews Kurth, John Newell of Goodwin Procter and Kenisha Nicholson of Wilson Sonsini discuss how the SEC’s recent amendments to modernize Regulation S-K will affect your next Form 10-K, including, among other things, how to tackle human capital disclosures, the impact on disclosure controls & procedures and other interpretive issues.
If you attend the live version of this program, CLE credit will be available in the following 10 states: CA, FL, IL, NC, NJ, NY, PA, TX, VA, WA. In order to receive CLE credit, you need to fully respond to the pop-up prompts throughout the live webcast. Please see these CLE FAQs for more information.
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Yesterday, the SEC continued this year’s rulemaking spree by adopting amendments to enhance and simplify the financial disclosure provisions of Regulation S-K. The amendments are significant – they eliminate the requirement for Selected Financial Data, streamline the requirement to disclose Supplementary Financial Information, and amend MD&A requirements. Here’s the 196-page adopting release – a tabular summary of the changes begins on page 8.
As noted in the SEC’s press release, the amendments reflect the Commission’s preference for a principles-based approach to disclosure. Here’s an excerpt:
The changes to Items 301, 302, and 303 of Regulation S-K sharpen the focus on material information by:
– Eliminating Item 301 (Selected Financial Data); and
– Modernizing, simplifying and streamlining Item 302(a) (Supplementary Financial Information) and Item 303 (MD&A). Specifically, these amendments:
Revise Item 302(a) to replace the current requirement for quarterly tabular disclosure with a principles-based requirement for material retrospective changes;
Add a new Item 303(a), Objective, to state the principal objectives of MD&A;
Amend current Item 303(a)(1) and (2) (amended Item 303(b)(1)) to modernize, enhance and clarify disclosure requirements for liquidity and capital resources;
Amend current Item 303(a)(3) (amended Item 303(b)(2)) to clarify, modernize and streamline disclosure requirements for results of operations;
Add a new Item 303(b)(3), Critical accounting estimates, to clarify and codify Commission guidance on critical accounting estimates;
Replace current Item 303(a)(4), Off-balance sheet arrangements, with an instruction to discuss such obligations in the broader context of MD&A;
Eliminate current Item 303(a)(5), Tabular disclosure of contractual obligations, in light of the amended disclosure requirements for liquidity and capital resources and certain overlap with information required in the financial statements; and
Amend current Item 303(b), Interim periods (amended Item 303(c)) to modernize, clarify and streamline the item and allow for flexibility in the comparison of interim periods to help registrants provide a more tailored and meaningful analysis relevant to their business cycles.
In addition, the Commission adopted certain parallel amendments to the financial disclosure requirements applicable to foreign private issuers, including to Forms 20-F and 40-F, as well as other conforming amendments to the Commission’s rules and forms, as appropriate.
The amendments will be effective 30 days after publication in the Federal Register. Once effective, early application of the amended rules is permitted so long as companies provide disclosure responsive to an amended item in its entirety. Compliance with the amended rules won’t be required until a company’s first fiscal year ending on or after the date that is 210 days after publication in the Federal Register – for calendar-year companies, that will mean mandatory compliance will begin with their Form 10-K for the 2021 fiscal year that’s filed in 2022. For registration statements, companies will be required to apply the amended rules if the registration statement on its initial filing date is required to contain financial statements for a period on or after the mandatory compliance date.
With all the recent SEC rulemaking, you’d be forgiven if you forgot that the SEC just proposed these amendments back in January – and at the time, that Commissioner Allison Herren Lee issued a dissenting statement criticizing the proposal for not addressing climate risk disclosures. The final amendments also don’t address climate risk disclosures. Commissioner Lee issued a joint statement with Commissioner Caroline Crenshaw in which they voice two concerns: first, that the amendments eliminate the contractual obligations table and second, the principles-based disclosure requirements don’t address climate risk.
The last sentence of Commissioner Lee and Crenshaw’s statement says they’re ready to start working on standardized ESG disclosure: ‘There’s no time to waste in setting to ourselves to this task, and we look forward to rolling up our sleeves to establish requirements for standard, comparable, and reliable climate, human capital, and other ESG disclosures.’
Key Performance Metrics: SEC Enforcement Goes After Execs for Misleading Disclosure
Late last week, the SEC announced that it charged two former Wells Fargo executives for their roles in the allegedly misleading “cross-sell metric” that the bank had used to measure its financial success and that got it in so much hot water back in the mid-2000s. The SEC’s order for John Stumpf, the company’s former CEO, says that he agreed to pay $2.5 million to settle the charges without admitting or denying the allegations. The SEC’s complaint against Carrie Tolstedt, who headed up the company’s core Community Bank, alleges that she committed fraud. Among other things, the SEC’s complaint seeks to ban Tolstedt from serving as a public company officer or director and force her to pay fines.
The SEC says that the cross-sell metrics were inflated by unauthorized accounts and that the executives knew or were reckless in not knowing that the disclosures about those metrics were materially false and misleading. The SEC’s press release says that both former executives signed misleading certifications in 2015 and 2016, which is a violation under SOX, something not frequently enforced by the SEC. Here’s an excerpt from the SEC’s press release:
‘If executives speak about a key performance metric to promote their business, they must do so fully and accurately,’ said Stephanie Avakian, Director of the SEC’s Division of Enforcement. ‘The Commission will continue to hold responsible not only the senior executives who make false and misleading statements but also those who certify to the accuracy of misleading statements despite warnings to the contrary.’
The November-December Issue of the Deal Lawyers print newsletter was just posted – & also sent to the printer (try a no-risk trial). It includes articles on:
– Duty of Loyalty Issues for Designated Directors and the Boards of Portfolio Companies
– Conflicted CEO Tilts Company Sale in PE Firm’s Favor
– SBA Announces New Guidance on Consent Requirements for PPP Borrower Changes of Ownership
– Court Rejects Challenge to M&A Transaction Despite Activist Pressure
– Do Reps and Warranties Policies Actually Pay Claims?
Remember that – as a “thank you” to those that subscribe to both DealLawyers.com & our Deal Lawyers print newsletter – we are making all issues of the Deal Lawyers print newsletter available online. There is a big blue tab called “Back Issues” near the top of DealLawyers.com – 4th from the end of the row of tabs. This tab leads to all of our issues, including the most recent one.
And a bonus is that even if only one person in your firm is a subscriber to the Deal Lawyers print newsletter, anyone who has access to DealLawyers.com will be able to gain access to the Deal Lawyers print newsletter. For example, if your firm has a firmwide license to DealLawyers.com – and only one person subscribes to the print newsletter – everybody in your firm will be able to access the online issues of the print newsletter. That is real value. Here are FAQs about the Deal Lawyers print newsletter including how to access the issues online.
