We have posted the transcript for our recent webcast – “Managing Enterprise-Wide Risks: The Intersection of ERM & Legal” – in which J.T. Ho of Orrick, Derek Windham of Tesla, Jeff Levinson of NetScout, Ming-Hsuan Elders of American Express and Stephanie Bignon of WestRock Company address the focus on enterprise risk management and the role that legal departments play in this process. Here’s an excerpt from Derek Windham’s comments on the differences between traditional risk management and enterprise risk management:
One of the biggest differences for our listeners to understand between traditional risk management and enterprise risk management is that with traditional risk management, the focus has fundamentally been more on risk avoidance. Essentially, this view treats risk as a four-letter word, whereas ERM really is about risk balancing, in recognition of the fact that some risk-taking can be a good thing.
You use the word opportunity and that’s a good concept. Often, risks can lead to opportunity and competitive advantage. Rather than being about risk avoidance, ERM is more like a framework of informed risk-taking. To weigh and balance risks effectively in this framework, you need to define your company’s risk culture and your risk appetite, and then manage risk to fit within this risk profile. In other words, you have to clearly define your strategic operational and financial risk tolerances so you can align your risk choices and optimize with return. The reason that this is one of the most important distinctions for this group to be aware of is that it directly aligns with the core functions of good business-aligned attorneys. To be most effective as business partners, it’s fundamental for attorneys to move away from the risk avoidance mindset and customize it to enable informed and strategic risk balancing by their clients.
Another core difference is highlighted by use of the word “enterprise” in ERM. Whereas traditional risk management was siloed with each department identifying and managing risks within their own towers, ERM is focused on a holistic cross-departmental view. This is an important distinction for this group because it ties directly into how the board should best oversee ERM, how management should define and execute on an ERM program and how legal can support these processes.
Yesterday, the SEC’s Office of Minority and Women Inclusion (OMWI) released its fiscal year 2022 Annual Report to Congress. This Annual Report summarizes “the SEC’s actions and achievements towards promoting diversity, equity, inclusion, and accessibility in the SEC’s workforce, increasing opportunities for minority-owned and women-owned businesses, and leveraging DEIA for mission effectiveness.”
The press release announcing Annual Report notes the following highlights:
– The representation of minorities among Senior Officers (Senior Officers are equivalent to Senior Executive Service at other federal agencies) increased from FY 2021 to FY 2022;
– 37.6 percent of the SEC contract payments made in FY 2022 were to minority- and women-owned businesses;
– The SEC increased the number of paid internship programs from FY 2021 to FY 2022; and
– 35.9 percent of the workforce identify as minorities.
The report notes how OMWI’s DEIA initiatives extend outside of the SEC. OMWI maintains a network of Diversity Partners, including minority- and women-focused professional associations and educational organizations, to further the SEC’s DEIA objectives. In fiscal year 2022, OMWI hosted its Biannual OMWI Partners Meeting to enhance these personal connections and further shared goals of promoting diversity in the financial services industry.
The SEC’s Office of Minority and Women Inclusion was created after my time at the SEC, and until recently I was not aware of the office’s history and the considerable impact that it has had on the agency. A recent SEC Historical Society event, which is available online, recounted the founding of OMWI (referred to as “OM-WEE”) and the office’s DEIA efforts over the past decade with a panel discussion involving OMWI’s Director, Pamela Gibbs, and former SEC Chairs Mary Shapiro, Mary Jo White and Jay Clayton.
OMWI was started thanks to, of all things, the Dodd-Frank Act. Section 342 of the Dodd-Frank Act required the SEC and other federal financial agencies to each establish an Office of Minority and Women Inclusion to be responsible for all matters relating to diversity in management, employment, and business activities. In accordance with Section 342 of the Dodd-Frank Act, the SEC established OMWI in July 2011.
OMWI’s efforts are both inward facing toward the SEC and outward facing toward the financial services industry. In 2015, the SEC’s OMWI and the OMWIs of the other federal financial regulators created joint standards that were issued as a Final Interagency Policy Statement Establishing Joint Standards for Assessing the Diversity Policies and Practices of the entities they regulate (Joint Standards) as required by Section 342 of the Dodd-Frank Act. The Joint Standards provide five areas that a regulated entity may consult to develop its diversity policies and practices:
– Organizational Commitment to Diversity and Inclusion;
– Workplace Profile and Employment Practices;
– Procurement and Business Practices;
– Practices to Promote Transparency and Organizational Diversity and Inclusion; and
– Self-Assessment.
It was clear from the SEC Historical Society program that the SEC’s OMWI had made a lot of progress, particularly at the agency, in promoting DEIA initiatives, while working hard to promote more diversity in the financial services industry. It is great to hear the perspectives of the former SEC Chairs on this topic, and it was particularly gratifying to hear how committed to these efforts they were during their tenures with the SEC.
When I started at the SEC way back in 1994, I was immediately struck by how much more of a diverse workplace it was as compared to the private sector companies where I had worked (I had a career as a financial analyst working for financial institutions while I was in law school). At the time, I probably chalked the differences up to working for the federal government versus working in the private sector. What I soon realized when I embarked on my career at the SEC was just how much of a difference a diverse workforce can make in terms of creating a successful, dynamic organization.
When I started in Corp Fin in 1995, Linda Quinn was the Director of Corp Fin, most of my supervisors were women, and the workforce as a whole was a very diverse group. The “Senior Staff” in Corp Fin included women and minorities, and they instilled in everyone a sense that the Division operated as a meritocracy whereby anyone in the Division, regardless of their race, ethnicity, age, gender, religion, sexual orientation, gender identity, gender expression, disability, economic status or other diverse backgrounds, could advance in their careers if they worked hard and worked well with others as a team. At a time when DEIA was not necessarily on everyone’s mind and before the agency had OMWI as a driving force for promoting DEIA, it seemed to me that the recognition of the importance of diversity was just part of the SEC’s DNA. Those early experiences taught me a lot about the value of DEIA efforts, and how important those efforts are to any organization.
In anticipation of the event, the SEC is soliciting policy recommendations on small business capital raising. These recommendations can be submitted in advance to smallbusiness@sec.gov. At the end of each day’s session, participants in the program will have the opportunity to prioritize policy recommendations related to each day’s topic, and after the event, a report will be delivered to Congress.
The agenda for the event contemplates coverage of a number of important topics:
– Exploring the Early-Stage Landscape: Trends and Strategies in Capital Raising
– Building Entrepreneurial Ecosystems: Laying the Groundwork to Support Small Businesses and Their Investors
– Investing in Small Business: Successes and Challenges Facing Smaller Funds
– Accessing the Public Markets: Becoming and Staying a Public Reporting Company
Registration for the event is required. The registration link and additional information about the 2023 Forum will continue to be updated on the forum website.
Last month, the Subcommittee on Capital Markets of the House Financial Services Committee held a hearing entitled “U.S. Public Markets Built for the 21st Century: Exploring Reforms to Make Our Public Markets Attractive for Small and Emerging Companies Raising Capital.” As noted in the Committee Memorandum, the purpose of the hearing was to examine policies designed to strengthen public markets. Testifying at the hearing were: The Honorable Michael S. Piwowar, Executive Vice President of MI Finance, Milken Institute and former SEC Commissioner; Sue Washer, Former CEO of Applied Genetics Technology Corp.; Anna Pinedo, Partner and Co-Leader of Global Capital Markets, Mayer Brown; and Stacey Bowers, Professor of the Practice, University of Denver Sturm College of Law. The Committee examined the significant decline in IPOs and whether Congress could build on the success of the JOBS Act with incremental reforms that would encourage companies to go public.
A number of legislative proposals were listed for consideration, including:
– H.R. [____], the “Improving Disclosure for Investors Act of 2023”. This bill directs the SEC to promulgate rules permitting financial firms to electronically deliver certain disclosures to investors.
– H.R. [____], the “Helping Startups Continue to Grow Act”. This bill allows certain issuers of securities regulated as emerging growth companies to continue operating under such regulations, including those related to reduced disclosures and other exemptions, for an additional five years. It also raises the maximum thresholds for companies to qualify as emerging growth companies to not more than $2 billion.
– H.R. [____], to reduce the required aggregate market value of voting and non-voting common equity shares for an issuer of securities to qualify as a well-known seasoned issuer. A well-known seasoned issuer is allowed to make expedited public offerings of securities through automatic shelf registrations.
– H.R. [____], the “Encouraging Public Offerings Act”. The bill allows issuers of securities to communicate with potential investors to ascertain interest in a contemplated securities offering, either before or after the filing of a registration statement (i.e., test the waters). The bill also allows issuers to submit a confidential draft registration statement to the Securities and Exchange Commission for review prior to public filing or within one year after the initial public offering or registration.
– H.R. [____], to expand the provision for research reports in Section 2(a)(3) of the Securities Act to cover research reports about any issuer that undertakes a proposed public offering of securities.
– H.R. [____], to update the emerging growth company (EGC) financial statement requirements to clarify that any EGC may present two years, rather than three years, of audited financial statements in both IPOs and spin-off transactions.
– H.R. [____], to establish that an emerging growth company (EGC), as well as any issuer that went public using EGC disclosure obligations, only needs to provide two years of audited financial statements.
– H.R. [____], to update the SEC and PCAOB auditor independence requirements to provide that the auditor of a private company that is transitioning to public company status (via IPO, spin-off or otherwise) must comply with SEC/PCAOB independence rules for the latest fiscal year, as long as the auditor is independent under AICPA or home-country standards for earlier periods.
– H.R. [____], to clarify that a company’s market capitalization, for purposes of testing the significance of an acquisition or disposition, may include the value of all shares, including preferred stock and non-traded common shares that are convertible into, or exchangeable for, traded common shares.
– H.R. [____], to update Section 12(g) of the Exchange Act to provide that the mandatory registration threshold of 2,000 or more holders of record shall exclude Qualified Institutional Buyers (QIBs) and institutional accredited investors. This bill also prevents the SEC from revising the definition of securities “held of record” in a way that forces companies to go public sooner than they are currently required.
– H.R. [____], to exempt certain low-revenue issuers from being required to have their management’s assessment of the effectiveness of internal controls over financial reporting attested to, and reported on, by an independent auditor, as required by SOX Section 404(b).
– H.R. [____], to codify certain SEC no action letters that allow broker-dealers to continue accepting cash or “hard dollar” payments for research reports, in order to comply with international regulations such as MiFID and MiFID II.
– H.R. [____], to permit a registered investment company to omit certain fees from the calculation of Acquired Fund Fees and Expenses
Last week, SEC Chair Gary Gensler testified before the Subcommittee on Financial Services and General Government of the of the U.S. House Committee on Appropriations. Chair Gensler was testifying in support of the Administration’s budget request for the SEC, which seeks $2.436 billion for fiscal 2024. With respect to the Division of Corporation Finance, Gensler noted in his prepared testimony:
The Division of Corporation Finance oversees the disclosures of public companies so that investors can make informed investment decisions. It’s important for investors to receive useful, timely, and accurate disclosure.
During the last three years alone, the number of reporting companies the Division oversees has increased by 18 percent to 7,836, primarily due to initial public offerings. In addition, merger activity has more than tripled 2020 levels in the last two fiscal years. In contrast, the Division’s staff is still approximately 17 percent below FY 2016.
Today’s budget request would grow the team to 454 FTEs. With this increase, the Division still would be five percent smaller than it was in FY 2016. Nonetheless, additional resources would allow the Division to serve investors more ably as markets grow and evolve.
As is always the case, the SEC faces the daunting prospect of regulating a vast landscape with very limited resources, although Gensler acknowledges that recent increases to the agency’s budget have helped bring the SEC’s staffing back up above where it was seven years ago.
Last week, the PCAOB issued for public comment a proposed new auditing standard, AS 1000, General Responsibilities of the Auditor in Conducting an Audit. In the press release announcing the proposed standard, the PCAOB describes it as follows:
If adopted, AS 1000 would reorganize and consolidate a group of standards that were adopted on an interim basis by the PCAOB in April 2003 and that address the core principles and responsibilities of the auditor, such as reasonable assurance, professional judgment, due professional care, and professional skepticism.
The proposal would also amend certain other standards that address responsibilities fundamental to the conduct of an audit. Among other changes, the amendments would (1) reinforce and clarify the engagement partner’s responsibility to exercise due professional care related to supervision and review and (2) accelerate the documentation completion date by reducing the maximum period for the auditor to assemble a complete and final set of audit documentation from 45 days to 14 days.
The PCAOB requests public comment on the proposal by May 30, 2023.
The Center for Audit Quality (CAQ) recently released its report: Audit Quality Reports Analysis: A Year in Review. In the report, the CAQ review audit quality reports voluntarily published by accounting firms. According to the CAQ, in the last three years, eight of the 14 annually inspected accounting firms issued audit quality reports. The CAQ report notes:
Audit quality reports provide stakeholders with various qualitative and quantitative firm-level audit quality metrics and other information. The metrics and other information in audit quality reports are not necessarily determinative of audit quality; however, when considered in context and in combination, they provide valuable information to stakeholders at the firm level about how an accounting firm defines, approaches, and executes its audit quality mission.
The CAQ report provides an overview of the qualitative and quantitative disclosures observed in the audit quality reports and explains how that information may be useful to stakeholders.
One of the takeaways from the CAQ’s recent analysis of audit quality reports is that recently, some firms have included discussion on how they employ data analytics and artificial intelligence or machine learning to further enhance audit quality. This trend is reflective of a larger conversation about just how artificial intelligence will fit into our professional lives going forward. I have been saying for some time that the robots will be coming for my job at some point, and I can imagine that auditors have been wondering whether the same is true for them.
In this recent article from Forbes, Joseph Brazel, who is the Jenkins Professor of Accounting at NC State University, describes a recent study published in the Review of Accounting Studies which “demonstrates that the use of artificial intelligence is significantly improving the quality and efficiency of financial statement audits, as well as displacing audit professionals.”
The study looked at investment in artificial intelligence at audit firms from the period 2010 to 2019, well before the current AI splash made by ChatGPT. One of the study’s authors notes: “Our main result is that when audit firms invest in AI, their audit quality goes up. There are fewer restatements, including material restatements, and fewer SEC investigations related to audits performed by AI-investing firms.”
The downside is that greater levels of AI adoption were followed by reductions in the audit firms’ workforces. The study noted that this effect was most prominent with audit professionals at the more junior levels of the firms. With that piece of information in mind, I guess I will continue to worry about those robots coming for me!
