Last week, the PCAOB released a staff Spotlight document, “Auditing Considerations Related to the Invasion of Ukraine.” The Spotlight highlights important considerations for auditors of issuers and broker-dealers as they plan and conduct audits in this evolving environment.
The PCAOB guidance addresses a number of audit-related matters, including:
– Identifying and assessing risks;
– Planning and performing audit procedures;
– Possible illegal acts;
– Reviews of interim financial information; and
– Acceptance and continuance of clients and engagements.
For audits nearing completion, the Spotlight addresses considerations with respect to subsequent events, other information, and auditor reporting.
In recent years, it seems that the Commission has tried to be more transparent about its own control deficiencies. This week, the Commission issued a statement providing details regarding its latest control deficiency, which this time took place in the Adjudication and Enforcement function.
One job that the Commission has which does not receive a great deal of attention is that the Commission itself serves an administrative “court,” serving in an adjudication role on certain matters. For example, if someone wishes to appeal the ruling of one of the SEC’s Administrative Law Judges, then they would go to the Commission itself as the appellate body. The Commission is supported by the Adjudication staff in the Office of General Counsel, who generally manage the process and prepare recommendations for the Commission on the matters. When I first started at the SEC I worked for the agency’s Administrative Law Judges and became familiar with this administrative process, and then worked closely with the Adjudication staff when I served as Chief Counsel of Corp Fin.
The Commission’s control deficiency related to the separation of the Adjudication staff and the staff in the Division of Enforcement. A level of separation is important to be maintained in order to preserve the integrity of the process, because the Division of Enforcement is always a party to the appellate process the plays out before the Commission. The control deficiency involved access by staff in the Division of Enforcement to certain memoranda prepared by the Adjudication Staff through databases maintained by the Office of Secretary, which the Commission described as follows:
The Commission has determined that, for a period of time, certain databases maintained by the Commission’s Office of the Secretary were not configured to restrict access by Enforcement personnel to memoranda drafted by Adjudication staff. As a result, in a number of adjudicatory matters, administrative support personnel from Enforcement, who were responsible for maintaining Enforcement’s case files, accessed Adjudication memoranda via the Office of the Secretary’s databases. Those individuals then emailed Adjudication memoranda to other administrative staff who in many cases uploaded the files into Enforcement databases.
The good news here is that, while the internal memos from the Adjudication staff were available to all of the staff in the Division of Enforcement for a period of time, the Enforcement staff attorneys who were working on the two matters identified in the Commission’s statement did not actually access those memos while they were investigating and prosecuting the matters. The Commission indicates that it is taking remedial steps to prevent this sort of thing from happening again. It is obviously a serious control lapse, given that there is already a perception (whether right or wrong) that the deck is stacked against the individuals and entities that have their cases litigated through the administrative process rather than in a court of law.
Things are moving surprisingly fast with the International Sustainability Standards Board (ISSB), which was established in November 2021 at COP26 to develop a comprehensive global baseline of sustainability disclosures. This new standard setter consolidates the CDSB and the Value Reporting Foundation (the combination of SASB and IIRC) under the auspices of the IFRS Foundation.
Wasting no time, last week the ISSB announced the publication of exposure drafts that it says build upon the recommendations of the Task Force on Climate-Related Financial Disclosures (TCFD) and incorporate industry-based disclosure requirements derived from SASB Standards. The ISSB is seeking feedback on the proposals over a 120-day consultation period closing at the end of July, and it plans to issue new Standards by the end of the year.
For more in-depth coverage of these developments, be sure to sign up for PracticalESG.com today!
Chair Gensler spoke this week at University of Pennsylvania and expressed his views on the role of the SEC in regulating various aspects of the crypto market. He focused on three areas: platforms, stablecoins and tokens. Gensler highlighted investor protection concerns in these areas and noted the role that the Commission has in protecting investors in each of these areas. In conclusion, Gensler stated:
In conclusion, new technologies come along all the time; the question is how we adjust to that new technology. But make no mistake: We already live in a digital age. That’s not what’s new here. We already can buy a cup of coffee with money stored in an app on our smartphones. The days of physical stock certificates ended decades ago. There’s nothing new about people raising money to fund their projects. Crypto may offer new ways for entrepreneurs to raise capital and for investors to trade, but we still need investor and market protection.
We already have robust ways to protect investors trading on platforms. And we have robust ways to protect investors when entrepreneurs want to raise money from the public.
We ought to apply these same protections in the crypto markets. Let’s not risk undermining 90 years of securities laws and create some regulatory arbitrage or loopholes.
As this NY Times article notes, last week Judge Terry Green of Los Angeles County Superior Court found that Assembly Bill 979, which required publicly traded companies based in California to have board members from underrepresented communities, violated the state’s constitution. Judicial Watch, which had filed the lawsuit shortly after the law was signed into law, had argued that the law was unconstitutional because it mandated quotas and therefore violated the state’s equal protection clause. In the court’s order granting summary judgment in the case, Judge Green notes:
If demographically homogeneous boards are a problem, then heterogenous boards are the immediate and obvious solution. But that doesn’t mean the Legislature can skip directly to mandating heterogenous boards. The difficulty is that the Legislature is thinking in group terms. But the California constitution protects the right of individuals to equal treatment. Before the Legislature may require that members of one group be given certain board seats, it must try to create neutral conditions under which qualified individuals from any group may succeed. That attempt was not made in this case.
There is no indication yet of what is expected next in this litigation.
The SEC kicked off its 41st Annual Small Business Forum yesterday, and the virtual programming will run through Thursday of this week. Martha Miller, the outgoing Advocate for Small Business Capital Formation, opened the program with remarks noting the need to continue to revisit policy in an ever changing vast blue ocean of capital raising activity.
Chair Gensler also spoke during the opening of the event, highlighting the work of the Office of the Advocate for Small Business Capital Formation and discussing the SEC’s guiding principles in facilitating capital formation.
Following the conclusion of the Annual Small Business Forum, the SEC Staff will develop recommendations and observations based on the discussion at the Forum and the policy recommendations submitted in advance of the Forum.
Over on the Proxy Season Blog, Liz recently highlighted a topic that comes up time and time again at this time of year – what rules apply to the annual letter to shareholders that is typically included as part of the Form 10-K wrap for the Rule 14a-3 annual report?
The letter to shareholders is not required by any SEC rule – instead, I classify it in the category of “free writing” communications that become integral to the disclosure process even though the SEC has not mandated the disclosure. Unfortunately, because the letter to shareholders is not required by any SEC rule, sometimes people are lulled into thinking that no rules apply to the letter to shareholders, which obviously could not be further from the truth. In general, my advice is to treat the annual letter to shareholders just as you would any other investor communication that is not filed with the SEC but is nonetheless subject to certain SEC rules.
First off, the annual letter to shareholders often includes non-GAAP financial measures as a means of describing the company’s performance over the past year or over a series of years. As with any other public communication (whether or not the communication is filed with the SEC), any non-GAAP financial measure included in the annual letter to shareholders is subject to Regulation G, and therefore the non-GAAP financial measure must be accompanied by the most directly comparable GAAP measure and a reconciliation must be provided. The additional requirements applicable to non-GAAP measures in Item 10(e) of Regulation S-K (and pursuant to Item 2.02 of Form 8-K) do not apply (e.g., equal or greater prominence in the presentation of the GAAP measure, a description of the reasons why the non-GAAP measure is useful), but the more fundamental requirements of Regulation G do apply. Depending on the non-GAAP measure that is used, sometimes the Regulation G requirements can be met using the Form 10-K contents that are included with the annual shareholders letter to make up the annual report to shareholders required under the proxy rules. However, if the annual letter to shareholders is intended to stand apart from the rest of the annual report and will be posted on the company’s website on a standalone basis, then it would need to comply with Regulation G on its own. Further, I find that the annual letter to shareholders often includes different non-GAAP measures and/or covers more periods than what is addressed by the Item 10(e) disclosures that are included in the annual report itself.
Second, the annual letter to shareholders often includes forward-looking information about the company’s plans and prospects, and therefore it is important to make sure that those forward looking statements are protected under the PSLRA safe harbor. How this is done may depend again on whether the letter is intended as a standalone document or is integrated with the annual report, but in any event it is important to consider whether the particular forward looking statements are identified as such and meaningful cautionary language is provided regarding such forward looking statements.
Finally, just like any communication, the annual letter to shareholders is subject to the antifraud provisions of the federal securities laws, so you want to make sure that the statements in the letter are consistent with other disclosures that are provided by the company, and that the statements do not verge too far into “marketing speak” that could get the company in trouble down the road. I often observe that this is not only an annual letter to shareholders, but also an annual letter to plaintiffs’ lawyers, so tread carefully!
As we have covered in this blog over the past year, the SEC and the PCAOB have been implementing the Holding Foreign Companies Accountable Act, which amended the Sarbanes-Oxley Act to prohibit listing on US exchanges of foreign companies for which the PCAOB has been unable to inspect audit work papers. Just last month, the SEC began identifying companies that use auditors that the PCAOB is unable to inspect or investigate completely because of a position taken by an authority of a foreign jurisdiction where the firm is located. Legislation that remains pending in Congress would accelerate the three-year time horizon for delisting under the Act to two-years, if enacted.
In a first sign toward an easing of the stalemate with China over audit work papers, last week the China Securities Regulatory Commission circulated draft revisions to its rules that would relax the restrictions on access to certain information about issuers in China and is soliciting public opinion on the draft. In particular, the draft revisions would provide that overseas competent authorities may request to investigate, including to collect evidence for investigation purpose under a cross-border regulatory cooperation mechanism, although no further details have been provided at this time.
The PCAOB recently released its report titled 2021 Conversations with Audit Committee Chairs, which shares observations derived from conversation with 240 audit committee chairs of U.S. public companies during 2021 PCAOB inspections. This is the third year that the PCAOB has published the report, which covers a wide range of topics that were on the minds of the participating audit committee chairs.
Hot topics for audit committee chairs that are addressed in the report include the use of technology in auditing, ESG, COVID-19, discussions of risks, communications with auditors, auditor strengths and areas for improvement, PCAOB inspection reports and information outside of the financial statements.
• Background on Ceres
• The factors that prompted this latest guidance from Ceres
• Key suggestions from the Ceres guidance
• How the issue of climate risk governance will play out in the 2022 proxy season
Thanks for listening to the Deep Dive with Dave podcast!
