Good morning! I know everyone was expecting to see Dave Lynn at the helm of this week’s blogs, but “Dave’s not here” – so you’re stuck with me for another week. The good news is that Emily will handle “The Mentor Blog” this week.
White & Case recently published its annual survey of ESG disclosure practices in SEC filings. The survey reviewed annual meeting proxy statements and annual reports of 50 Fortune 100 companies and identified trends in ESG disclosures from 2020-2022. Given the SEC’s comment letters on climate disclosure & the fact that everyone knew a climate rule proposal was on the way when proxy season began, it’s not surprising that environmental topics were the fastest growing category of ESG disclosures. Trailing close behind were disclosures about human capital management – again, that’s not surprising in light of the SEC’s recent rulemaking in the area.
While the top two spots were claimed by the usual suspects, the third fastest growing category of ESG disclosure was one that made the list for the first time this year – E&S goals and targets. This excerpt provides some details on the survey’s findings concerning these disclosures:
For the first time in White & Case’s annual survey, E&S Goals and Targets made the top seven categories, rising to the third spot with the largest increase in disclosure. This reflects the heightened focus by investors on companies setting specific targets with respect to environmental and social priorities.
Seventy-six of the filings surveyed (or 76%) increased their disclosure related to E&S goals and targets. In total, all but one of the surveyed companies (49 out of 50) included some form of E&S goal or target. Of these, 32 companies included the disclosure in their Form 10-K and 48 companies included it in their proxy statement. Of the 49 companies that included E&S goals and targets, seven companies included them for the first time in their 2022 disclosures.
The survey says that it wasn’t just qualitative disclosures about ESG goals targets that grew this year. A total of 44 companies, or 88% of those surveyed, included quantitative metrics. Of this amount, 18 included such disclosure in their Form 10-K (compared to 11 in 2021) and 42 included it in their proxy statements (compared to 26 in 2021).
Preparing & filing the Form 144 for insider transactions has traditionally been a job that’s fallen to the brokerage firm involved in the trade. But with the recent amendments imposing a mandatory electronic filing requirement for Form 144, this Bryan Cave blog suggests that responsibility for those filings may end up on the General Counsel’s plate:
The SEC estimated in the adopting release that only approximately 25 percent of Form 144 filers have already prepared a Form ID and obtained a CIK number for EDGAR filings. As a result, approximately 75 percent of Form 144 filers will need to file a Form ID for the first time to obtain a CIK code and gain access to file on EDGAR. In practice, the burden of helping prepare Form IDs and obtain CIK numbers often falls to company counsel rather than the company insider, and the process in recent years has taken several days, due in part to COVID-19 slowdowns and challenges.
Although in the past, broker-dealers executing sales for affiliates generally handled the preparation and submission of paper Form 144 filings, it is unclear whether Form 144 filers and/or company counsel will be comfortable sharing CIK codes and sensitive Form ID information with broker-dealers, who may not have developed processes to collect, securely store, and properly update all of the EDGAR access credentials for each client required to file a Form 144
Fortunately, there’s an extended transition period for the portion of the amendments that imposes the electronic filing requirement for Form 144, which should provide some time to sort this out. In the adopting release, the SEC said that this new requirement will kick in six months from the date of publication in the Federal Register of the SEC’s adoption of an updated version of the EDGAR Filer Manual addressing the Form 144 changes. That’s expected to happen on September 22, 2022, so assuming those changes hit the Federal Register promptly, the electronic filing requirement shouldn’t go into effect until March 2023 at the earliest. Given that new procedures may be needed and that the requirement is going to hit all Rule 144 filers at once, now is the time to start coordinating with brokers.
One sure sign of a tumbling stock market is a rise in the number of companies thinking about reverse splits to support their stock prices and/or preserve their exchange listings. SoFi Technologies is probably the most high-profile example of this potential trend. The formerly high-flying Fintech company’s stock has lost 60% of its value this year, and it’s asking shareholders to approve a proposed charter amendment at its upcoming annual meeting to permit it to engage in a reverse split if the board so determines.
A major consideration for any company considering asking for shareholder approval of a reverse split is how ISS & Glass Lewis are likely to react to such a proposal. This recent Goodwin blog sheds some light on that issue:
ISS generally recommends voting for management proposals to implement a reverse stock split if the number of authorized shares will be proportionately reduced, or the effective increase in authorized shares is equal to or less than the allowable increase calculated in accordance with ISS’ Common Stock Authorization policy. ISS will recommend voting on a case-by-case basis if the proposal does not align with either of the two criteria above, taking into consideration, among other factors, a stock exchange notification of potential delisting. Glass Lewis notes that it may recommend voting against a proposal to conduct a reverse stock split if the Board does not state that it will reduce the number of authorized common shares in a ratio proportionate to the split.
By the way, if your company is thinking about a stock split or a reverse stock split, be sure to check out our article on “Unpacking Stock Splits” which appeared in the July-August 2019 issue of The Corporate Counsel.
Dealing with analysts in an earnings call can sometimes be a challenging and even somewhat confrontational process for any CEO, but a recent study cited in an IR Magazinearticle says that male securities analysts are much tougher in their questioning of female CEOs than they are of their male counterparts. This excerpt from the article discusses the study’s findings and some of their implications:
Analyzing transcripts of 39,209 earnings conference calls, including with Apple, Microsoft and Facebook, we found that male analysts’ questions to CEOs were more aggressive than those of female analysts and that this contrast doubled when the CEO was female. We also found that when male analysts challenged female CEOs, they were more aggressive than when questioning men.
Our findings lay bare yet another challenge female leaders face in the workplace, and with workplace gender diversity linked to everything from increased productivity to improved performance, staff retention and collaboration throughout a business, the ramifications are enormous.
The findings are of particular relevance to the finance industry and investors, as the way analysts ask questions sends signals to the capital markets. When investors following earnings conference calls witness analysts asking verbally aggressive questions, it could signal to them that the analysts are not happy with a company’s performance.
The study’s authors say that its findings are a classic example of ‘in-group bias’, a psychological theory that says we give preferential treatment to those we regard as belonging to the same group as us. This theory suggests that male securities analysts question female CEOs more aggressively because they see them as outsiders and a threat to their sense of identity and self-esteem.
Earlier this month, the SEC brought enforcement proceedings against Synchronoss Technologies & certain of its senior officers arising out of alleged accounting improprieties. The officers targeted by the SEC included the company’s former General Counsel. The charges against the GC are worth noting, because I think they reflect a perception within the Division of Enforcement that public company lawyers have greater expertise in accounting matters than most actually do.
The enforcement proceedings were based on allegations that the company improperly recognized revenue on multiple transactions and misled the company’s auditors about those transactions. The former GC was tagged for his role in allegedly causing the violations, and consented to a “neither admit nor deny” settlement under the terms of which agreed to a $25,000 civil penalty & accepted an 18 month suspension of his right to practice before the SEC. How did he get himself in hot water? The SEC’s complaint points to the following alleged actions:
– The GC knew about a billing dispute with a customer during which the customer told the company that an email on which the company had relied in booking revenue for a particular transaction did not reflect a “commitment by [Customer A] to acquire the software” and also knew about subsequent communications from the customer stating that it had not committed to purchase the software.
– The GC attended and prepared minutes for an audit committee meeting at which the CFO discussed the billing dispute with the committee and the company’s auditor, but the SEC alleged that neither the CFO nor the GC shared with the auditor the “fact or substance” of the communications from the customer, which it contended were contrary to representations made by the CFO to the auditor about the collectability of the receivable under GAAP.
– The SEC also found fault with the GC for not disclosing information to the company’s auditor that he “knew or should have known” that an acquisition was contingent upon the company’s sale of a license to an affiliate of the seller, and that the alleged patent infringement claim that license agreement was purportedly used to settle wasn’t asserted by the company until after it approached the seller to discuss the acquisition. The SEC said that these facts would have been material to the proper accounting treatment of the license fee under GAAP, and that the GC’s reps to the auditors were misleading because they made the two transactions appear separate from each other.
The SEC’s allegations that the lawyer made potentially misleading reps to the auditor about the second transaction don’t cause me a lot of heartburn, but those relating to his largely passive role in the first transaction are more troubling. That’s because under similar circumstances, I believe that many GCs would act in a similar manner.
I think most lawyers would defer to the CFO when it comes to providing auditors with information about accounting matters. There’s a good reason for this deference – most lawyers don’t have the technical expertise to reliably discern when particular statements or omissions by a CFO about a transaction might raise accounting red flags. It’s reasonable to assume that a trained accountant would pick up on how a CFO’s statements might lead auditors astray when it comes to GAAP, but I don’t think the same assumption necessarily applies to a lawyer.
This enforcement action is a reminder that lawyers need to act with extreme caution whenever they communicate – or are party to others’ communications – with auditors about something that might implicate financial reporting. But the action also appears to be premised, at least in part, on assumptions by the Division of Enforcement about lawyers’ expertise in identifying potential accounting red flags that I don’t think are usually justified.
A few years ago, the SEC brought a handful of enforcement actions targeting confidentiality provisions in employee agreements that didn’t include provisions expressly permitting the employees bound by those provisions from reporting allegations of misconduct to the SEC. There hasn’t been a lot of activity on that front in recent years, but that changed earlier this week when the SEC announced an enforcement action against Brink’s based on an overly restrictive confidentiality agreement that included an aggressive liquidated damages provision. Here’s an excerpt from the SEC’s announcement:
The SEC’s order finds that, from at least April 2015 through April 2019, Brinks used an employee confidentiality agreement that prohibited employees from disclosing confidential company information to any third party without the prior written approval of Brinks. According to the SEC’s order, the confidentiality agreement threatened current and former employees with liquidated damages and legal fees if they failed to notify the company prior to disclosing any financial or business information to third parties.
According to the order, the confidentiality agreement did not provide an exemption for potential SEC whistleblowers. The SEC’s order finds that, in 2015, shortly after the SEC had instituted its initial whistleblower protection action, Brinks modified its employee confidentiality agreement by adding a $75,000 liquidated damages provision for violations of the agreement.
The company consented to consented to the issuance of an order finding that it violated Rule 21F-17(a) of the Securities Exchange Act of 1934 and ordering it to cease & desist from future violations. The company also agreed to pay a $400,000 penalty and to comply with certain undertakings, including modifying its employment agreements to make it clear that employees were not prohibited from dropping a dime on the company to the SEC “or any other federal, state, or local governmental regulatory or law enforcement agency.”
In a statement, Commissioner Peirce objected to the requirement that the company modify its employment agreements to permit employees to report alleged misconduct to governmental or law enforcement authorities in addition to the SEC. She said that the SEC “plainly lacks statutory authority to impose such a broad requirement, and Rule 21F-17 does not purport to assert such authority” and noted that just because a company agreed to particularly broad language as part of a settlement shouldn’t be construed as an indication that other companies need to use the same or similar language.
Many of our members have asked about when the SEC might act on the many pending rule proposals it has offered up in the past several months. Yesterday, the SEC announced the issuance of the latest edition of the agency’s Reg Flex Agenda yesterday, and that document provides some clues. The Reg Flex Agenda lays out the following dates by which final action is targeted on some of the agency’s more consequential rule proposals:
These dates may or may not bear any relationship to reality, but in light of Commissioner Peirce’s statement that, with the latest edition of the agenda, the SEC has “abandoned our careful and considered approach to altering regulation in favor of effecting hasty and sweeping change,” it sure looks like at least one commissioner thinks that they do. If so, we’re in for an avalanche of rulemaking between now and September 30 when the SEC’s fiscal year ends – and the pace doesn’t appear set to slow in fiscal 2023 either.
Be sure to check out the whole agenda – in addition to rules on which final action is expected, there are plenty of new rule proposals that may be rolled out in the upcoming months, including one on Human Capital Management that’s expected by fiscal year end. With this unprecedent volume of SEC rulemaking on the horizon, you can’t afford to miss our “Proxy Disclosure & 19th Annual Executive Compensation Conferences” this year. We already have expert panels lined up to address many of these rulemaking initiatives – and you can count on our panelists to address whatever else the SEC throws our way between now and then!
While we’re on the topic of action-packed regulatory agendas, I’m beginning to wonder if the five-year inflation adjustment to the JOBS Act’s emerging growth company revenue cap may have gotten lost in the rulemaking shuffle? As a reminder, the JOBS Act requires the SEC every five years to index to inflation the annual gross revenue amount used to determine EGC status in order to reflect changes in the Consumer Price Index.
The last adjustment was made in April 2017 and coincided almost exactly with the fifth anniversary of the JOBS Act. We recently celebrated the statute’s 10th anniversary, but the SEC hasn’t announced the inflation adjustment yet. This isn’t a crisis for most companies, but as Liz blogged early last month, people are keeping an eye out for the updated cap number.
When an error in a company’s financial statements is clearly immaterial to both the current and prior period, it may be addressed through an out-of-period adjustment, in which the error is corrected in the current period’s financial statements. This Audit Analytics blog says that out-of-period adjustments in 2021 declined by 17% over 2020, continuing a trend that began in 2016. This excerpt suggests that, when coupled with a decline in the percentage of companies that issued an adjustment, the trend says some good things about the quality of financial reporting:
The percentage of companies that issued an adjustment also fell to a new low. This percentage is evidence that the decline is not due to a shrinking population of public companies. The declining frequency of adjustments combined with the declining frequency of restatements, excluding 2021 SPAC restatements, suggests that the quality of financial reporting has been improving.
The one discordant note to this otherwise upbeat conclusion is the fact that 67% of last year’s out-of-period adjustments were negative, which means that prior period errors were twice as likely to overstate results as they were to understate them. However, the percentage of negative adjustments had crept up consistently over the past several years, reaching a peak of 80% in 2020 – which means that 2021’s results represent a significant improvement.
If you’re a private company that’s part of public company value chains, you may well find yourself confronting some pretty significant – and costly – challenges imposed on you by virtue of those public companies’ need to comply with the SEC’s proposed “Scope 3” GHG emissions disclosure requirements. Scope 3 emissions include all indirect GHG emissions occurring in the upstream and downstream activities of a company’s value chain, and in case you’re wondering where public companies will look to get that kind of information, this CFO Dive article says that you need wonder no longer:
“If the private company is within the value chain, upwards or downwards, of a company that has to provide the Scope 3 metric in their report, they will be asked to help provide that information,” says Julie Rizzo, a partner in the capital markets group of K&L Gates. “They’ll roll up into that company’s Scope 3 emissions that have to go into their SEC reporting.”
Scope 3 refers to greenhouse gas emissions from companies that help a covered company make money, either by being part of its supply chain or providing other value-added services. And whether or not they are subject to SEC reporting requirements themselves, they are expected to cooperate with the covered company. That means measuring and sharing the emissions that stem from their work for that company.
“So, you’re going to have companies that aren’t necessarily thinking that they would be covered by this rule having to provide information to companies that need to provide that information,” Rizzo told Legal Dive.
Opponents of the SEC’s proposals have highlighted the potential impact of the Scope 3 emissions disclosure requirement on private companies. However, supporters discount those concerns. For example, this recent comment letter from group of Senate Democrats (see p. 5) contends that that, among other things, the requirement to provide Scope 1 and Scope 2 information will make the process of obtaining Scope 3 information – which won’t be required until a year later – easier for all parties. In addition, the signatories to that letter argue that a public company’s ability under the proposed rules to use an EPA-published emission factor in its calculations in the absence of activity data will help “some privately held companies with data collection challenges, like small family farm operations, that supply registrants responsible for Scope 3 disclosures.”