Late Friday afternoon, the SEC issued proposed amendments under Regulation S-T aimed at promoting reliability and integrity of EDGAR submissions. If adopted, the amendments could mark the end of an era for “fake SEC filings” that we enjoy blogging about so much. But there’s still cause for celebration. In addition to aiming to curtail fake filings, the proposal is also intended to improve administration of EDGAR – for example, filing delays arising in connection with EDGAR outages (which have been a problem lately). The proposed rule specifies the Commission can take the following actions to facilitate resolution of issues that arise in connection with EDGAR submissions:
– redact, remove, or prevent dissemination of sensitive personally identifiable information that if released may result in financial or personal harm;
– prevent submissions that pose a cybersecurity threat;
– correct system or Commission staff errors;
– remove or prevent dissemination of submissions made under an incorrect EDGAR identifier;
– prevent the ability to make submissions when there are disputes over the authority to use EDGAR access codes;
– prevent acceptance or dissemination of an attempted submission that it has reason to believe may be misleading or manipulative while evaluating the circumstances surrounding the submission; and allow acceptance or dissemination if its concerns are satisfactorily addressed;
– prevent an unauthorized submission or otherwise remove related access; and
– remedy similar administrative issues relating to submissions.
The proposed rule provides that in certain circumstances, such as a threat to EDGAR, the Commission may take corrective action without first communicating with the filer. In such instances, the proposed rule sets forth a process for the Commission to notify filers and other relevant persons of actions it takes as soon as reasonably practicable.
Filers still need to ensure the accuracy and completeness of information in their EDGAR submissions and in most cases, address any errors by submitting a filer corrective disclosure. The proposed rule will be subject to a 30-day comment period after publication in the Federal Register.
SEC Comment Letters Continue Downward Trend
SEC comment letters are still around and haven’t completely disappeared but if it seems like you don’t hear as much about them, it’s because they’re declining in number. As reported in a recent Audit Analytics blog, SEC comment letters on Forms 10-K, 10-Q and 8-K continued a downward trend in 2019, a trend spanning the last nine years. The decline in 2019 seems like quite a drop-off, although much of the decline is attributed to the government shutdown in early 2019. Between 2018 and 2019, the blog says the number of comment letters fell by 30% and this was after a 32% decline between 2017 and 2018. The blog also reports that the number of conversations declined and that most reviews were resolved after one round of comments. For something to watch, the blog notes ASC 842 – the lease accounting standard – became effective in 2019 for companies with calendar year-ends so keep an eye out for any comment letter trends relating to that.
July-August Issue of “The Corporate Executive”
The July-August issue of The Corporate Executive was just posted – & also sent to the printer. It’s available now electronically to members of TheCorporateCounsel.net who also subscribe to the print newsletter at each of their locations (try a no-risk trial). This issue includes articles on:
– SEC Adopts Rules to Regulate Proxy Advisory Firm Recommendations: Where Do We Go from Here?
The Unique Role of Proxy Advisory Firms
The SEC’s First Shot Across the Bow: The 2019 Interpretive Release
ISS Responds: See You in Court!
This Means War: The SEC’s Rule Proposal
The Final Rules: Proxy Advisory Firm Regulation is Born—After a Decade in Labor!
Dissent
Next Steps
Supplemental Guidance for Investment Advisers
Status of the ISS Lawsuit
What Now?
– Considerations for the Use of Private Air Travel During the COVID-19 Pandemic
Yesterday, the SEC scheduled an open meeting for August 26th. The meeting’s agenda features a couple of big potential rule amendments. This excerpt from the meeting’s Sunshine Act notice says that the first agenda item is:
Whether to adopt amendments to modernize the description of business, legal proceedings, and risk factor disclosures that registrants are required to make pursuant to Regulation S-K. These disclosure items, which have not undergone significant revisions in over 30 years, would be updated to account for developments since the rules’ adoption or last revision, to improve disclosure for investors, and to simplify compliance for registrants. Specifically, the amendments are intended to improve the readability of disclosure documents, as well as discourage repetition and the disclosure of information that is not material.
There have been so many S-K-related proposals floating around that it’s sometimes hard to keep track, but this one relates to potential changes to Item 101, 103 & 105 that were proposed almost exactly a year ago. It’s worth noting that this is the proposal that raised the idea of requiring some kind of “human capital” disclosures – and it will be interesting to see what any final rule has to say about that topic.
SEC Open Meeting: “Accredited Investor” & “QIB” Definitions Also Up to Bat
The second item on next week’s agenda is also significant – and controversial. The Sunshine Act notice says that the SEC will consider:
whether to adopt amendments to the definition of “accredited investor” in Commission rules and the definition of “qualified institutional buyer” in Rule 144A under the Securities Act to update and improve the definition to identify more effectively investors that have sufficient financial sophistication to participate in certain private investment opportunities. The amendments are the product of years of efforts by the Commission and its staff to consider and analyze possible approaches to revising the accredited investor definition.
The SEC split 3-2 on the decision to issue these proposals last November, with Commissioner Allison Herron Lee & then-Commissioner Robert Jackson dissenting. As proposed, the amendments to the “accredited investor” definition would expand the number of investors eligible for that status by allowing individuals to qualify based on their professional knowledge, experience or certifications. The proposed amendments also would expand the list of entities that may qualify as accredited investors.
Business Interruption Insurance: Covid-19 Plaintiffs Get a Win
We’ve previously blogged about the challenges facing companies trying to assert claims under business interruption policies for pandemic-related losses, and the early returns from court cases involving these claims weren’t encouraging. One of the biggest challenges that plaintiffs have faced is persuading insurers & courts that their claims involve “physical loss,” which is a necessity under most policies in order to trigger coverage.
However, Alison Frankel blogged about a recent decision by a federal judge in Kansas City involving claims against Cincinnati Insurance that gives plaintiffs some reason for hope – and may even provide a roadmap for these claims. Here’s an excerpt:
The Kansas City plaintiffs, unlike plaintiffs in some of the previous cases, argued that the coronavirus – as a widespread, airborne virus that was rampant in the community – had likely infected their properties. It was the presence of the virus, they argued, that had rendered their businesses unsafe and unusable, forcing the shutdowns that triggered their insurance coverage.
Cincinnati, represented by Litchfield Cavo and Wallace Saunders, argued that COVID-19 did not trigger business interruption insurance coverage because it did not cause tangible, physical damage like a fire or hurricane. The coronavirus, Cincinnati argued, can be cleaned from surfaces or will otherwise die naturally within days, leaving no physical trace. Moreover, the insurer argued, the salons and restaurants hadn’t even shown the virus was actually present within their properties.
Judge Bough, however, said that under the ordinary meaning of “physical loss,” the policyholders suffered a loss when the spread of coronavirus led to prohibitions or restrictions on their businesses.
In the Judge’s view, although the coronavirus may not have caused physical damage, the insurer’s business interruption policy also covered physical loss – and a business may suffer physical loss if its premises are rendered unusable. Here’s what Alison says is the key takeaway for potential plaintiffs:
Argue that your business was likely contaminated by the coronavirus as it spread across the country through unseen droplets – and that the presence of the virus led to a physical loss, even if the particles did not cause lasting physical damage.
If you’re an investment grade issuer & want to lower your cost of capital the next time you go to market, this Politico article says you’d be well advised to use the money to fund ESG related projects, as Alphabet and Visa have recently done. This excerpt says there’s simply not enough ESG product to meet market demand:
This is a big year for investment-grade corporate debt — fueled in part by actions the Federal Reserve took in March allowing large companies to borrow more cheaply from private lenders. But the vast majority is not aligned with environmental, social and governance principles, said Jonny Fine, head of Investment Grade Syndicate at Goldman Sachs who played an integral role in the Alphabet deal. “The proportion of ESG this year is no different. It’s a very small part of our market overall,” Fine said. “The only difference we’re seeing in 2020, because we’ve had health care crises and racial divisions across the U.S., is the S in ESG has become much more important.”
So far this year, companies have issued nearly $1.5 trillion in new investment-grade debt. Less than 2 percent of that adheres to ESG standards. This reflects a problem in financial markets, Fine added. Right now, there aren’t enough ESG assets to satisfy demand from investors, who clamored for the bonds issued by Alphabet and Visa. Companies need to develop sustainability frameworks so they don’t miss out on the wave of cheap financing. “There is a very clear cost of capital disadvantage for a company that doesn’t have strong ESG principles,” Fine said.
Granted, Alphabet & Visa are both premium credits, but the pricing on their ESG-related debt was pretty phenomenal. Alphabet issued $5.75 billion at 0.8%, while Visa raised $500 million at 0.75%.
Unicorn IPO Litigation: Hung Up by Happy Talk?
One of my favorite snarky things to do is to make fun of Unicorn IPO filings. I know the poor lawyers involved must pull their hair out over some of the over-the-top statements that the underwriters & business folks insist on including in the prospectus, but a federal court’s decision in Uber’s IPO litigation may give those lawyers more leverage when arguing to tone things down.
This excerpt from a recent Jim Hamilton blog on a California federal judge’s denial of Uber’s motion to dismiss the case explains how the company’s prospectus “happy talk” made the plaintiffs’ claims stickier than they might otherwise have been:
The purchaser alleged that Uber’s registration statement omitted material facts about the legality of Uber’s business model, its passenger safety record, and its financial condition. Uber countered that each of these three categories was adequately disclosed, and the court agreed that the disclosures were well beyond boilerplate. Given the facts alleged, however, the court also concluded that the offering documents created an impression of a state of affairs that was materially different from what actually existed.
Specifically, Uber represented that while it had faced trouble in the past, it was on “a new path forward.” Despite this optimistic impression, the purchaser plausibly alleged that Uber was still using its old “playbook,” continuing, for example to view pay fines for violating local laws as a cost of doing business and intentionally delaying layoffs and restructuring to mislead the markets. Thus, the court said, what was disclosed was not enough to render what was not disclosed not misleading.
Mind you, the court reached this conclusion despite the fact that Uber’s lawyers included a 48-page Risk Factors section addressing many of these issues.
What’s in a Name? Hester Peirce is Okay with “Crypto Mom” Moniker
SEC Commissioner Hester Peirce was just reconfirmed by the Senate – along with new Commissioner Caroline Crenshaw. On the occasion of her reconfirmation, one intrepid tweeter (@BarbarianCap) asked if she was okay with her “Crypto Mom” nickname. In response, she tweeted: “It’s better than a lot of other names I have been called.” Me too, Commissioner, me too.
The Center for Audit Quality recently issued a report on Covid-19’s potential implications for this year’s audit. While we’ve touched on things like going concern issues in prior blogs, one of the matters discussed in the report that I haven’t seen before is how the pandemic may influence the determination of “Critical Audit Matters,” or CAMs. Here’s what the report has to say on this topic:
While COVID-19 in and of itself, or going concern uncertainty, would not necessarily meet the definition of a CAM, the pandemic could increase the subjectivity and complexity of a specific audit area such that it meets the definition of a CAM, when it otherwise may not have prior to the pandemic. In addition, for audits of large-accelerated filers, COVID-19 also could result in CAMs that were previously identified and communicated in the auditor’s report being expanded to include new assumptions that were especially challenging or complex due to the pandemic and/or result in changes to the auditor’s response to a previously identified CAM.
Until now, the requirement to disclose CAMs in an auditor’s report has been limited to large accelerated filers, but all issuers will have to comply with it for audits covering fiscal years completed on or after December 15, 2020 – so this is one that needs to be on everybody’s radar screen.
Critical Audit Matters: Due Diligence Questions
While we’re on the subject of CAMs, this recent Mayer Brown blog notes that because CAMs provide information about audit matters that required complicated auditor judgments & how the auditor responded to those matters, they are particularly helpful for people who are conducting due diligence. If you’re looking for something to get you started, they’ve also provided this template for due diligence questions regarding CAMs.
Audit Committees: PCAOB’s Conversations With Committee Chairs
Earlier this month, the PCAOB issued a report on its conversations with audit committee chairs about how audit committees are thinking about the effect of COVID-19 on financial reporting and the audit as they perform their oversight duties. This excerpt from a recent Wilmer Hale memo provides an overview of the results of those discussions:
Increased risks associated with remote work. The most common theme among audit committee chairs that recently met with the PCAOB dealt with risks regarding remote work arrangements, with most audit committee chairs describing the rapid shift to remote work arrangements as “effective.” This was equally applicable to the company’s employees and outside auditors.
Given the greater reliance on cloud computing in remote work environments, a number of audit committee chairs noted that they have been discussing cyber-related controls within the scope of the audit and increasing the focus on the controls’ effectiveness. Based on insights shared from audit committee chairs, the Summary includes a list of example questions that audit committees may want to discuss with their auditors regarding risks related to remote work arrangements.
Increased audit committee communications with the auditor. The Summary notes that a majority of audit committee chairs cited COVID-19 as a basis for more frequent communication between auditors and audit committees. Among the topics audit committees may want to discuss with auditors, in light of COVID-19, the Summary lists a handful of considerations, including challenges to completion of the audit, the cadence of communication with auditors and management, changes in the audit plan and potential disclosure changes resulting from COVID-19.
The memo says that audit committee chairs reported three forms of auditor communication that they have found useful: discussions about trends auditors are seeing, particularly those pertaining to industry peers; presentations about audit areas that may require greater attention due to the pandemic, and audit firm resources and webinars with industry-specific content.
Last month, the SEC issued a rule proposal that would increase the reporting threshold for Schedule 13F filings from $100 million to $3.5 billion – and oh boy, do the commenters hate it! Here’s a comment that, while fiery, is also pretty representative:
This is complete bull. You are supposed to be protecting investors, not making it easier for billion dollar hedge funds to manipulate markets. This proposal is a terrible idea and runs directly counter to the principles upon which the SEC was founded. What is the SEC thinking? This reeks of corruption.
So far, it’s mostly been retail investors who have weighed-in – and I mean a lot of retail investors. (According to a piece in the NYT DealBook yesterday, more than 1,500 people have commented to date). Apparently, some outreach to Reddit users may help explain the volume of comments. The big guns may soon fire as well. NIRI is circulating a joint comment letter for public company issuers to sign (it’s available here), and other investor and business groups and public companies are expected to comment as the deadline approaches.
Supply Chains: SEC Reporting on China Forced Labor on the Horizon?
Companies with supply chains in China should be prepared to comply with enhanced due diligence & reporting requirements. That’s the conclusion of this Foley Hoag blog, which surveys recent legislative initiatives aimed at Chinese companies’ use of forced labor from Xinjiang and other regions of the country. One pending piece of legislation could even result in an SEC reporting requirement:
A measure with more serious potential repercussions for companies is H.R. 6210, the Uyghur Forced Labor Prevention Act. H.R. 6210 lists all companies found by the Congressional-Executive Commission on China to be suspected of using the forced labor of ethnic minorities in China. Most of the companies on the list are in the processed food and apparel industries. More importantly, the measure establishes a rebuttable presumption that all goods manufactured in Xinjiang are made with forced labor; accordingly, such goods are banned under the Tariff Act of 1930 unless the Customs Border and Protection Commissioner certifies otherwise.
The bill would also impose sanctions and visa restrictions on individuals and senior Chinese officials determined to be complicit in forced labor in Xinjiang. Additionally, H.R. 6210 requires companies to certify annually to the Securities and Exchange Commission that their products do not contain forced labor inputs from Xinjiang.
The prospects for the legislation’s passage are uncertain, but the Chinese government is taking it seriously enough to have imposed sanctions on one of the bill’s co-sponsors, Sen. Marco Rubio (R-Fla.) and on the Congressional-Executive Commission on China, for which he and another co-sponsor of the legislation, Rep. Jim McGovern (D-Mass.), serve as co-chairs.
EDGAR Problems: Now It’s Personal. . .
The technical problems plaguing the EDGAR system this summer became a full-blown crisis last night – and by that I mean they directly affected me for the first time. (We priced a debt deal last night & it took a couple of hours to get the term sheet filed.) I guess the problems have been so persistent that last week, the SEC decided that it needed to post a bit of an explanation:
The SEC staff has been deploying significant technical upgrades to the EDGAR system. While these upgrades follow extensive planning and testing, unexpected performance issues that have arisen have inconvenienced filers. We apologize for these difficulties and wish to assure filers that we are working diligently to resolve the issues.
The statement goes on to say that should you experience problems or have any questions or concerns, you may contact Filer Support at (202) 551-8900, option 3, or FilerTechUnit@sec.gov. I sometimes think it might be interesting to work for the SEC, but I’ll tell you what – I definitely wouldn’t want to be the poor soul you get connected to if you hit “option 3.”
The SEC sure isn’t shying away from controversial topics this summer. Less than a month after adopting a somewhat watered-down version of its proposed proxy advisor regulations, the SEC has calendared an open meeting for next month to consider amendments to the shareholder proposal rules. Here’s an excerpt from the Sunshine Act Notice:
The Commission will consider whether to modernize and enhance the efficiency of the shareholder-proposal process for the benefit of all shareholders by adopting amendments to certain procedural requirements for the submission of shareholder proposals and the provision relating to resubmitted proposals under Rule 14a-8. The amendments being considered seek to modernize the system for the first time in over 35 years and reflect many years of engagement by Commission staff with investors, issuers and other market participants.
The SEC issued proposed rules last November that would increase the ownership thresholds for submission of proposals for inclusion in a company’s proxy statement & substantially raise the bar in terms of the favorable vote required to allow shareholders to resubmit proposals in subsequent years. Other proposed changes to Rule 14a-8(b) would subject shareholders using representatives to enhanced documentation requirements with respect to the authority of those agents, and require shareholder-proponents to express a willingness to meet with the company and provide contact & availability information.
The proposals have produced an avalanche of comments – both real and, apparently, of the “Astroturf” variety. For example, the proposal’s comments page discloses that the SEC received over 5,000 identical form comment letters opposing the proposal, but that it has also “received messages from certain of the email addresses that sent this comment letter indicating that the owner of the email address did not submit a comment letter.”
The meeting is scheduled for September 16th, which means that if rules are adopted, we’ll be all over them at our upcoming “Proxy Disclosure” & “Executive Pay” Conferences – which will be held entirely virtually over three days – September 21 – 23. We’ve offered a Live Nationwide Video Webcast for our conferences for years – one of the only events to do so – and we’re excited to build on that platform and make your digital experience better than ever. Act now to get the best price – here’s the registration information.
Proxy Advisor Regulation: ISS’s Lawsuit Against the SEC Marches On
The SEC’s new rules regulating proxy advisors may be a weaker broth than what was originally proposed, but ISS is still not happy about being on the receiving end of the proxy rules. Last year, ISS sued the SEC over its efforts to regulate the proxy advisory industry. The parties agreed to stay the proceedings pending the SEC’s action on its rule proposals, but now that those are in place, ISS says it’s “game on!” Here’s an excerpt from a statement from ISS’s CEO that was issued last week:
While last month’s rulemaking provides for certain exemptions to aspects of the SEC’s solicitation rules, we remain concerned that the rule will be used or interpreted in a way that could hamper our ability to continue to deliver to clients the timely and independent advice that they rely on to help make decisions with regard to the governance of their portfolio companies. We have today informed the U.S. District Court for the District of Columbia and the Commission of our intent to resume our lawsuit for many of the same core reasons we outlined in our October 31 complaint, as well additional concerns that we will articulate in the weeks ahead.
Over on her Twitter feed, Prof. Ann Lipton flagged a recent court filing indicating that it looks like ISS is going to amend its complaint – which originally focused on the guidance the SEC issued last August – to tackle the new rules directly. Check out the whole thread.
“Mr. Bad Example”: A Barry Minkow Docuseries?
When it comes to securities fraud, before there was Bernie Madoff, there was Barry Minkow. Then again, after there was Bernie Madoff, there was still Barry Minkow. Whether he’s scamming investors in the ZZZZ Best fraud, using his post-conviction “fraud investigation” business to faciliate his own insider trading, or fleecing the congregation of the San Diego church for which he improbably served as pastor, the guy positively sparkles with larceny. Now, this article from “Deadline” says that somebody is trying to put together a documentary series on Minkow.
I wish them better luck than the folks who got into bed with Minkow several years ago to make a movie about his life. As the article recounts, that project ran into some problems:
His life story was turned into the movie Con-Man, which he starred in alongside James Caan and Mark Hamill, but, as production was finishing, Minkow was charged with insider trading, having secretly used his Institute to short the stocks of the businesses he was investigating. While in jail, he also admits to defrauding his own church to help pay for his film.
Yeah, so that happened – and the movie was apparently horrible too. I don’t know what they plan to call the documentary, but as a big fan of the late, great Warren Zevon, may I suggest “Mr. Bad Example”?
Earlier this week, McDonald’s filed a Form 8-K to announce that it had filed this complaint in the Delaware Court of Chancery against its former CEO, Steve Easterbrook, who was terminated without cause last year following a board investigation of a consensual relationship with an employee in violation of the company’s Standards of Business Conduct. The complaint seeks to claw back severance payments – and to prevent the exercise of stock options and sale of stock issuable under outstanding equity awards. The collective value of that compensation is estimated at $57.3 million, according to this WSJ article.
The complaint alleges that Mr. Easterbrook acted fraudulently in negotiating his termination, in claiming that he did not have physical relationships with any company employees. In July, McDonald’s received an anonymous employee tip that caused the board to reopen its internal investigation. During the new investigation, the board uncovered photographic evidence of prohibited physical relationships with multiple employees in Easterbrook’s company emails. According to the complaint:
The Company was not aware of these photographs before July 2020, when it discovered them in the course of investigating the allegations regarding Easterbrook and Employee-2. Neither these photographs, nor the e-mails to which they were attached, were present on Easterbrook’s Company-issued phone when it was searched by independent outside counsel in late October 2019 because Easterbrook, with the intention of concealing their existence from the Company, had deleted them from his phone. Unbeknownst to Easterbrook, however, the deletion of the e-mails from the mail application on his Company-issued phone did not also trigger the deletion of those e-mails from his Company e-mail account stored on the Company’s servers.
The Board would not have agreed to the terms of the Separation Agreement had it then been aware of Easterbrook’s physical sexual relationships with three McDonald’s employees, his approval of a discretionary stock grant for Employee-2 while they were in a sexual relationship, and the falsity of his representation to outside counsel that he had never engaged in a physical sexual relationship with a Company employee. That conduct constituted a clear legal basis to terminate Easterbrook for cause.
The complaint references “cause” because Easterbrook’s separation agreement incorporates clawback provisions from the company’s standard severance plan, which require repayment if the plan administrator determines that the recipient committed an act that would constitute “cause” while employed. This case highlights that boards may want the “cause” definition to do more work in this day & age – and why revisiting narrowly-formulated versions on a clear day could afford the board with some additional room to maneuver if it comes to light that an executive has engaged in conduct causing reputational harm. This NYT article observes:
The lawsuit represents an extraordinary departure from the traditional disclose-it-and-move-on decorum that American corporations have often embraced when confronted with allegations of wrongdoing by senior executives. More than a few chief executives in recent years have lost their jobs after allegations of sexual or other misconduct, but for the most part they have departed quietly and the companies haven’t aired the ugly details.
In the #MeToo and Black Lives Matter eras, however, more companies are striving to position themselves as good corporate citizens, responsible not only to shareholders but also to customers, employees and society at large. Mr. Easterbrook’s successor at McDonald’s, Chris Kempczinski, has called for a new corporate emphasis on integrity, inclusion and supporting local communities.
The company launched its lawsuit just before a books & records action that Bloomberg reported was brought against the company by a group of Teamsters pension funds on Wednesday, alleging “a pervasive sexual harassment & gender discrimination problem.” This follows a class action suit filed last fall and other complaints.
The McDonald’s board is taking some heat for relying on Easterbrook’s representation that he had only one affair and not digging deeper in the initial investigation. The anonymous tip came to light last month after McDonald’s held a town hall meeting in which employees were encouraged to come forward with concerns, and the board immediately investigated the complaint. After the board & comp committee chair weathered a “vote no” campaign at this year’s meeting, they now have many months to engage with shareholders and resolve this issue. It’s probably good that the town hall wasn’t in April or May.
On a related note, this CFO.com article reports that the former COO of Pinterest is suing the company for gender discrimination and wrongful termination. Boards are busy right now – and they need to continue to pay attention to #MeToo risks as well as risks arising from the social movement for equity & inclusion. For guidance on navigating potential landmines, visit our checklist on board oversight of sexual harassment policies.
SEC Preparing Proposals to Regulate Chinese Audits
Late last week, the “President’s Working Group on Financial Markets” released a report to address the ongoing issue of the PCAOB being unable to review the work papers for audits of US-listed companies who use Chinese accounting firms – who say, according to this Bloomberg article, that “Chinese law bars them from sharing those documents on the grounds that the documents may contain state secrets.” Because of this stance, China is known as a “Non-Cooperating Jurisdiction.”
The report makes 5 recommendations – but the upshot, as explained in this WSJ article, would be to ban Chinese companies from listing on US exchanges unless they comply with US audit requirements. Here’s more detail from the report:
The PWG recommends enhanced listing standards to require,as a condition to initial and continued exchange listing in the United States, PCAOB access to audit work papers of the principal audit firm for the audit of the listed company.
Companies that are unable to satisfy this standard as a result of governmental restrictions on access to audit work papers and practices in NCJs may satisfy this standard by providing a co-audit from an audit firm with comparable resources and experience where the PCAOB determines it has sufficient access to audit work papers and practices to conduct an appropriate inspection of the co-audit firm.
In addition:
The PWG recommends that,as a specific listing standard, a more specific disclosure requirement or both, requiring enhanced and prominent issuer disclosures of the risks of investing in issuers from NCJs. These actions could include rulemaking and/or issuing interpretive guidance to clarify the disclosure requirements to increase investor awareness, and more general awareness of the risks of investing in such companies.
John blogged a few months ago about a statement from SEC & PCAOB officials on this topic. The Senate has also passed legislation that would amend Sarbanes-Oxley to prohibit the trading of securities – on an exchange or over the counter – for companies that retain an auditor whose reports cannot be inspected completely (and similar legislation has passed the House).
Now, in light of the Administration’s report, SEC Chair Jay Clayton and five other senior SEC officials, including Corp Fin Director Bill Hinman, have issued a statement to say that the SEC will prepare proposals in response to the report’s recommendations. The statement also says that the SEC staff stands ready to assist Congress with technical assistance in connection with any potential legislation regarding these matters.
These tensions don’t appear to be deterring Chinese companies from pursuing US listings – this WSJ article notes that more than 20 companies from China have gone public so far this year on Nasdaq or the NYSE, raising $4 billion in total.
Podcasts: More “Women Governance Gurus” With Courtney Kamlet & Liz
I continue to team up with Courtney Kamlet of Vontier to interview leaders in the corporate governance field about their career paths – and what they see on the horizon. Check out our latest episodes:
– Darla Stuckey, President & CEO, Society for Corporate Governance
This 40-page memo – recently commissioned & released by COSO – explains how companies can use blockchain technology to create more robust internal controls – and also highlights new controls that will be necessary because of the risks that blockchain creates. According to the memo, business use of blockchain will implicate the 5 components of COSO’s 2013 Internal Control Framework as follows:
1. Control Environment: Blockchain may be a tool to help facilitate an effective control environment (e.g., by recording transactions with minimal human intervention). However, many of the principles within this component deal primarily with human behavior, such as management promoting integrity and ethics, which, even with other technologies, blockchain is not able to assess. The greater challenge relates to the intertwining of an entity with other entities or persons participating in a blockchain and how to manage the control environment as a result.
2. Risk Assessment: Blockchain creates new risks and simultaneously helps to mitigate extant risks, by promoting accountability, maintaining record integrity, and providing an irrefutable record (i.e., a person ororganization cannot deny or contest their role in authorizing/sending a message or record).
3. Control Activities: Blockchain can act as a tool to help facilitate control activities. Blockchain and smart contracts can be a powerful means of effectively and efficiently conducting global business (e.g., by minimizing human error and opportunities for fraud). The collaborative aspects of blockchain, however, can introduce additional complexity, particularly when the technology is decentralized and there is no single party accountable for the systems that fall under ICFR.
4. Information & Communication: The inherent attributes of blockchain promote enhanced visibility of transactions and availability of data, and can create new avenues for management to communicate financial information to key stakeholders faster and more effectively. One aspect, in particular, for management to consider in applying blockchain is the availability of information to support the financial books and records, and related auditability of information transacted on a blockchain.
5. Monitoring Activities: The promise of blockchain to facilitate monitoring more often, on more topics, in more detail, may change practice considerably. The use of smart contracts and standardized business rules, in conjunction with Internet of Things (IoT) devices, may alter how monitoring is performed.
Audit Adjustment Waivers: Red Flag for Restatements & Audit Costs
Using a sample of 3,144 audits, this recent study found that the decision to waive auditor-proposed adjustments to financials may have unforeseen consequences of increased restatement risks, incentives to manage earnings, and higher audit costs. Here’s an excerpt:
We estimate that at least 80% of pre-audited financial reports contain misstatements detected by auditors, and management frequently does not make the proposed adjustments. Perhaps surprisingly, management corrects all misstatements only about 12% of the time and waives all proposed adjustments about 50% of the time.
We find that waived adjustments are linked both to lower financial reporting quality measured by material misstatements and to incentives to meet/beat analyst forecasts; the latter finding suggests disposition decisions can be an earnings-management mechanism.
We find that auditors respond to the increased restatement risk associated with management’s decisions to waive audit adjustments by increasing audit effort this period and are able to pass along at least some of these costs to their clients. The auditor’s response is persistent: auditors are likely to propose more next-year audit adjustments when clients waive adjustments in the current year, leading to increased effort (audit hours) and costs (audit fees) next year. Finally, we identify one reason managers may waive adjustments – to meet or beat analyst consensus forecast estimates.
The professors conclude that many of these waivers result from focusing on quantitative thresholds – and overlooking qualitative facts that impact the materiality of missatements.
Call for Photos: Marty Dunn Tribute
Our “Proxy Disclosure & Executive Pay Conferences” are coming up next month – and while I’m very excited about our agendas & speakers, the conference won’t be the same without Marty Dunn on the roster. We’ll be running a tribute to Marty and would appreciate any photos from the community that could help make it special. Please email me with anything you’d like to share – liz@thecorporatecounsel.net.
Some felt the statement pushed the theory of “shareholder primacy” aside – and we’ve been going around & around since then on whether this was simply a return to the BRT’s original position, whether it affects directors’ fiduciary duties, whether investors care, and whether corporate practices align with the statement. Many have steadfastly emphasized that this is just a debate on semantics and that the BRT statement didn’t change anything about how management or boards actually function, since the promotion of other stakeholders can typically be justified as something that also benefits shareholders in the long run.
Consistent with that view, this forthcoming article from Harvard Law Profs Lucian Bebchuk and Roberto Tallarita, which was also the subject of a WSJ op-ed last week, found that very few signatories involved their boards in the decision to sign the statement. Here’s an excerpt:
To probe what corporate leaders have in mind, we sought to examine whether they treated joining the Business Roundtable statement as an important corporate decision. Major decisions are typically made by boards of directors. If the commitment expressed in the statement was supposed to produce major changes in how companies treat stakeholders, the boards of the companies should have been expected to approve or at least ratify it.
We contacted the companies whose CEOs signed the Business Roundtable statement and asked who was the highest-level decision maker to approve the decision. Of the 48 companies that responded, only one said the decision was approved by the board of directors. The other 47 indicated that the decision to sign the statement, supposedly adopting a major change in corporate purpose, was not approved by the board of directors.
Bebchuck & Tallarita also looked at the corporate governance guidelines of the companies whose CEOs signed the BRT statement – and found that most of them reflect a “shareholder primacy” approach – e.g., stating that the business judgment of the board must be exercised in the long-term interest of shareholders.
I haven’t been in any of these c-suites or boardrooms, but I’d venture a guess that many had already been discussing long-termism and stakeholder governance prior to the BRT’s statement (even if they weren’t using those specific catchphrases) – with a view towards maximizing long-term shareholder value. Were the BRT commitments illusory, or just within the scope of those prior discussions? Either way, the absence of board involvement seems to indicate that no change to director fiduciary duties was intended.
This article from UCLA Law Prof Stephen Bainbridge agrees that the evidence is that most BRT members remain committed to shareholder value maximization – and suggests two possible reasons why the BRT publicly shifted its position:
First, the members may be engaged in puffery intended to attract certain stakeholders for the long-term benefit of the shareholders. Specifically, they may be looking to lower the company’s cost of labor by responding to perceived shifts in labor, lower the cost of capital by attracting certain investors, and increase sales by responding to perceived shifts in consumer market sentiment. They may also be trying to fend off regulation by progressive politicians. Second, some BRT members may crave a return to the days of imperial CEOS.
Corporate Purpose: Take 2 for the “Takeover Titans”?
Last month, I blogged about some back & forth between Skadden and Wachtell on the ongoing “corporate purpose” debate. One member pointed out that this is a revival of the old 1980s Skadden v. Wachtel debates when Joe Flom (now deceased) and Marty Lipton (clearly alive) made themselves famous in the hot times of corporate raiding by touring with show about their rival forms of takeovers and defenses.
Here’s an old University of Michigan newsletter that recounts a panel discussion including these two giants. And here’s a recent interview of Marty Lipton in “Business Law Today,” in which he comments that those touring days might have been the point when he knew he was a leader in the field:
JP: Was getting attacked by the folks from the Chicago School the time that you felt like, “OK—I’ve made it on the national stage”? When did you realize that you’re a leader in this field?
ML: I don’t know whether that’s possible to answer. I would say mid-’80s with the poison pill more than anything else. I certainly wasn’t an intellectual leader. From 1976, when Steve Brill wrote an article (“Two Tough Lawyers in the Tender-Offer Game,” NY Mag., 1976) about Flom and myself being the two lawyers on opposite sides in tender offers, I was a known quantity, and people were calling who didn’t know me but just from reputation were seeking representation in takeover situations. So it’s hard to say.
Tomorrow’s Webcast: “CEO Succession Planning in the Crisis Era”
Tune in tomorrow for our webcast – “CEO Succession Planning in the Crisis Era” – to hear Kerry Burke of Covington, Rusty O’Kelley of Russell Reynolds and Amy Seidel of Faegre Drinker discuss the CEO succession planning alternatives that are available to boards, analyze how to maintain a succession plan that’s adaptable to a dynamic business environment and highlight legal, contractual and disclosure minefields to avoid.
Last month, John blogged that the universal proxy proposal was on the SEC’s Reg Flex Agenda for finalizing in the near-term. Now, this letter from an informal “Universal Proxy Working Group” – consisting of 15 heavy-hitters from Wachtell, CII, Broadridge, CalSTRS, DF King, Wilson Sonsini, Trian, and others – is urging Corp Fin to consider common observations on the proposal as the Commission potentially nears the finish line. While the letter mostly supports the 2016 proposal, it makes a few suggestions. Here’s an excerpt:
– We support requiring disclosure on the universal proxy cards or in their accompanying materials (as well as in the definitive proxy statements), of the effect of: voting on the universal proxy card for more candidates than available board seats; voting on the universal proxy card for fewer candidates than available board seats; and signing and returning an otherwise unmarked universal proxy card.
– We support the Proposing Release’s presentation and formatting requirements, which advance the above objectives without compelling opposing sides to produce identical cards or co-ordinate the creation of a single universal proxy card. We believe both of these alternative models could cause unnecessary disruption for market participants accustomed to the circulation of two competing cards. The core improvement we seek is the ability of shareholders to use any proxy card they choose to vote for any combination of board nominees they prefer.
– We acknowledge that the presentation and formatting requirements described in the Proposing Release are not necessarily exhaustive of all appropriate requirements to ensure clarity, ease of use and fairness in an orderly process, and that further requirements, e.g., uniform presentation and formatting of the vote boxes beside the nominees, as well as standardized general colors for respective registrant and dissident cards, could be appropriate and helpful.
– While the Proposing Release centers on the universal proxy card, we would favorably view the SEC Staff having authority where necessary and appropriate to also facilitate the fair presentation of all nominees on vote instruction forms (VIFs) and electronic proxy voting platforms in the context of proxy contests.
– While the Proposing Release requires the dissident to solicit holders of shares representing a simple majority of outstanding voting power, the majority of the UPWG participants believe that requiring the solicitation of holders of two-thirds of outstanding voting power could also be workable,while commanding broader comfort that the threshold strikes an appropriate balance between providing the utility of the universal proxy system and precluding dissidents from capitalizing on the inclusion of dissident nominees on the registrant’s card without undertaking meaningful solicitation efforts. A requirement to solicit the holders of all outstanding votes would ensure that no shareholder is disenfranchised, but would not strike an appropriate balance, in the view of the majority of UPWG participants, especially taking into account the fact that dissidents generally are not reimbursed for their proxy solicitations (regardless of whether the solicitation fails or succeeds).
Other near-term SEC rulemaking initiatives appear to have less consensus support. As reported in this blog from Cooley’s Cydney Posner, an appropriations bill recently passed by the House says that SEC funding can’t be used to finalize, implement, administer or enforce rules that would:
– Change procedural requirements or raise resubmission thresholds for shareholder proposals
– Harmonize private offering exemptions without strengthening filing requirements for exempt offerings in the same or stronger manner as proposed in 2013
Cydney notes the possibility that these provisions could be jettisoned in the Senate’s version of the bill.
More on “What Does ESG Mean to You and Me?”
Lynn ran a guest blog last week from Rhonda Brauer about the meaning of ESG. We received several responses, including this 39-minute interview that our friend Keir Gumbs gave to Berkeley Law’s “ESG Beat.” It’s an engaging recap of how Keir came to work at Uber, what the company is doing on ESG issues, and who is driving that progress.
SEC Personnel Changes: On a Roll
Not only did we see Senate confirmations last week for two SEC Commissioners, the Commission also announced that Enforcement Co-Director Steven Peikin is stepping down, after three years on the job. Stephanie Avakian will remain as the Enforcement Division Director.
In addition, Lindsay McCord was named Chief Accountant in Corp Fin. The SEC’s press release notes that Lindsay has served as Acting Chief Accountant since March, and prior to that was a Deputy Chief Accountant in the Division.
The SEC isn’t the only organization making changes. The CII bid farewell to its leader Ken Bertsh last week, with Amy Borrus taking over as planned as Executive Director. Congratulations to both Ken and Amy!
