Well, it didn’t take long for the Division of Enforcement to focus everybody’s attention on the SEC’s recent guidance on the use of key performance indicators in MD&A, did it? This Fried Frank memo focuses on how that guidance may influence the use of ESG metrics in MD&A. While the guidance itself only references ESG metrics in a footnote, this excerpt says that what it had to say about them is consistent with recommendations of some well-known sustainability frameworks:
Although the Metrics Guidance is largely silent with respect to ESG metrics as a specific category, it does note that some companies “voluntarily disclose environmental metrics, including metrics regarding the observed effect of prior events on their operations.” In a footnote, the Metrics Guidance provides examples of metrics to which the guidance is intended to apply, which include a number of ESG metrics, such as total energy consumed, percentage breakdown of workforce, voluntary and/or involuntary employee turnover rate and data security breaches.
While the Metrics Guidance addresses ESG metrics only via footnote, it is consistent with the recommendations in certain voluntary sustainability frameworks that require both qualitative and quantitative disclosure associated with ESG metrics. For example, SASB’s Conceptual Framework notes that sustainability metrics should be accompanied by “a narrative description of any material factors necessary to ensure completeness, accuracy, and comparability of the data reported.”
In addition, the TCFD recommendations note that reporting companies should provide metrics on climate-related risks for historical periods to allow for trend analysis and, where not apparent, should provide a description of the methodologies used to calculate the climate metrics. Similarly, both SASB and TCFD emphasize the importance of having effective disclosure controls and governance, as well as verifying ESG data (by third-party auditors, if possible).
As the memo also points out, many companies have been criticized by stakeholders for using ESG metrics that aren’t “easily comparable, decision-useful, and verifiable.” The new guidance on MD&A key performance indicators heightens the stakes for these ESG disclosures, and companies that don’t respond appropriately may face a bigger downside than complaints about “greenwashing.”
ESG: Building Value Through Good Disclosure
This Latham memo says that companies have an opportunity to build value through their ESG initiatives & disclosure. The memo says that clear and transparent ESG disclosures can “build trust and demonstrate the company’s thoughtful management of ESG risks and opportunities.” This excerpt offers some specific suggestions for preparing ESG disclosures:
– Companies should take steps to ensure the consistency of disclosures in financial and sustainability reports.
– Even if information is included in the sustainability report, ESG information should be included in financial reports if material and called for by the regulations underpinning the disclosure documents.
– Information disclosed in sustainability reports is subject to the antifraud provisions of the securities laws even if not filed with the SEC. The information in companies’ sustainability reports should be scrutinized and verified to ensure its accuracy and completeness as if it were filed with the SEC.
– Companies should explain the importance of the ESG factors in their disclosures to help the reader to understand why the information is meaningful to the company and how it fits within the company’s strategy.
In today’s environment, I don’t think companies that want to address their ESG performance have any alternative to real transparency. The audience for ESG disclosures is increasingly sophisticated & extremely skeptical, so the historically preferred alternative of having the marketing department “put lipstick on the pig” when it comes to describing corporate ESG performance is likely to get you clobbered.
Transcript: “Conflict Minerals – Tackling Your Next Form SD”
We have posted the transcript for our recent webcast: “Conflict Minerals – Tackling Your Next Form SD.”
It’s hard to know for sure whether astroturfing is part of the SEC comment letter process. Last fall, John blogged about the flurry of comment letters received at the SEC on the S-K Modernization Proposal and the potential that some would assert this resulted from an astroturf campaign. And Broc blogged last fall about the “fishy” comment letters submitted to the SEC ahead of its proposed rulemaking on proxy advisors.
Congressional leaders are apparently taking the notion of astroturfing seriously and a recent blog from Jim Hamilton summarizes a hearing held by the Subcommittee on Oversight and Investigations of the House Financial Services Committee on alleged astroturfing of the Administrative Procedure Act (APA) process for submitting comment letters on agency rulemaking – and as a reason for the hearing, the subcommittee cited reports of astroturfing relating to proposals by several agencies, one being the SEC.
Jim Hamilton’s blog provides an interesting read of the back and forth testimony about possible solutions to concerns about astroturfing. Here’s an excerpt:
Beth Simone Noveck, a professor from New York University, testified that the notice and comment period on proposed federal regulations is sometimes referred to as the “notice and spam” period due to the volume of duplicate comment letters agencies receive. She recommended that the agencies use readily available tools to address voluminous, duplicative, and fake comments. These include machine learning to summarize voluminous comments, “de-duplication” software to remove identical comments, and filtering software to sift out “the real and the relevant.”
Others, including Steven Balla, a professor from George Washington University, and Ranking Member Barr recommended Congress focus its attention on fake comment letters not mass comments.
Ranking Member Barr questioned whether the APA should be amended to standardize the comment letter collection process as it currently allows agencies discretion for determining how they collect and post comment letters. A GAO representative noted that a 2019 GAO study recommended certain agencies clearly disclose how they post comments and associated identity information, including the SEC, and the SEC has implemented these recommendations. The SEC issued a memorandum reflecting the SEC’s internal policies for posting duplicate comments and associated identity information and added a disclaimer on the SEC’s main comment posting page.
Possible solutions aside, it doesn’t sound like the Subcommittee settled on any immediate actions and it’s unclear if there are any next steps.
SEC Extends Comment Period for NYSE Direct Listing Proposal
In December, we were tracking the NYSE Direct Listing proposal, which the SEC rejected soon after the exchange submitted it, and then right on the heels of the rejection, the exchange submitted a revised proposal. Since then, nothing but crickets…until last week, likely because the comment period was set to expire. Last Thursday, the SEC issued this notice extending the comment period for the revised proposal, which will now close on March 29th. The notice says the SEC received 8 letters with comments and it needs more time to consider the proposed rule and comments.
Might be early to jump to conclusions but judging solely on the low count of comments so far, it doesn’t sound like astroturfing is going on here.
January-February Issue of “The Corporate Counsel”
We recently mailed the January-February issue of “The Corporate Counsel” print newsletter (try a no-risk trial). The topics include:
1. Annual Season Items
– Time for a Risk Factor Tune-Up?
– Getting Back to Basics
– Rooting Out Hypothetical Risk Factor Disclosure
– Brexit – What’s Next?
– LIBOR Transition
– IP and Technology Risks Associated with International Business Operations
– Tariffs and Trade
– World Health Concerns
– Data Privacy
2. Omitting Third Year Comparisons from MD&A: The Staff Weighs In
3. More on MD&A: The Commission’s Interpretive Release on KPIs and Metrics
4. A Brave New World for Confidential Treatment: Asking for Forgiveness Instead of Permission
– A New Streamlined Confidential Treatment Process Dawns
– Self-Executing Rules
– Staff Review of Exhibits
– New Streamlined Extension Confidential Treatment Request Procedures
– Enter the Supremes: The Impact of Argus Leader
– The SEC’s New Confidential Treatment Request Guidance
It looks like the SEC didn’t waste much time in finding its big company poster child for key performance indicators (KPI). Yesterday, the SEC issued a press release announcing an enforcement proceeding where it brought charges against Diageo plc for disclosure failures. The enforcement proceeding is right on the heels of the SEC’s KPI interpretive release that John blogged about just a couple of weeks ago. Here’s the crux of what the SEC had to say:
According to the SEC’s order, employees at Diageo North America (DNA), Diageo’s largest and most profitable subsidiary, pressured distributors to buy products in excess of demand in order to meet internal sales targets in the face of declining market conditions. The resulting increase in shipments enabled Diageo to meet performance targets and to report higher growth in key performance indicators that were closely followed by investors and analysts. The order finds that Diageo failed to disclose the trends that resulted from shipping products in excess of demand, the positive impact the overshipping had on sales and profits, and the negative impact that the unnecessary increase in inventory would have on future growth. The order further finds that investors were instead left with the misleading impression that Diageo and DNA were able to achieve growth in certain key performance indicators through normal customer demand for Diageo’s products.
Without admitting or denying the findings in the SEC’s order, Diageo agreed to cease and desist from further violations and to pay a $5 million penalty.
You can find memos about the SEC’s KPI interpretive release posted in our “MD&A” Practice Area.
SEC Public Statement on Coronavirus
Yesterday, the SEC issued a public statement on the effects of the coronavirus on financial reporting. In late January, John blogged about Chairman’s Clayton’s statement addressing disclosure implications from the coronavirus outbreak.
Yesterday’s statement said SEC Chairman Clayton, Corp Fin Director Hinman, SEC Chief Accountant Teotia and PCAOB Chairman Duhnke met with the leaders from the Big 4 audit firms to continue discussions around difficulties in conducting audits in China and other emerging markets. In these discussions, they also discussed the “potential exposure of companies to the effects of the coronavirus and the impact that exposure could have on financial disclosures and audit quality, including, for example, audit firm access to information and company personnel.” Here’s an excerpt from the SEC’s statement:
The coronavirus effects on any particular company may be difficult to assess or predict, because actual effects may depend on factors beyond the control and knowledge of issuers. However, how issuers plan and respond to the events as they unfold can be material to an investment decision, and we urge issuers to work with their audit committees and auditors to ensure that their financial reporting, auditing and review processes are as robust as practicable in light of the circumstances in meeting the applicable requirements.
Specifically, we emphasized: (1) the need to consider potential disclosure of subsequent events in the notes to the financial statements in accordance with guidance included in Accounting Standards Codification 855, Subsequent Eventsand (2) our general policy to grant appropriate relief from filing deadlines in situations where, in light of circumstances beyond the control of the issuer, filings cannot be completed on time with appropriate review and attention. In addition, if issuers have questions regarding the reporting of matters related to the potential effects of the coronavirus, including potential subsequent event disclosure, we welcome engagement on these matters.
The SEC’s statement says that companies are encouraged to contact the SEC regarding any need for relief or guidance.
PCAOB Conversations with Audit Committee Chairs
The PCAOB recently issued a report that summarizes information gathered from conversations with nearly 400 audit committee chairs. The conversations were primarily focused on audit quality and provide insight on a variety of topics including audit committee perspectives of the auditor, new auditing and accounting standards and technology and innovation. Here’s an excerpt about what audit committees are saying works well:
– Reviewing other audit firms’ inspections reports to see if there are any lessons learned or questions about potentially similar issues that could be discussed with your auditor
– Conducting an assessment – on at least an annual basis – of the engagement team and audit, including discussions around what went well and what could be improved
– Using outside consultants or experts to educate the audit committee on new or complex accounting standards
The report also provides an overview of PCAOB 2019 inspections and touches on how the PCAOB selects audits for inspection, what an inspection entails and what happens when a deficiency is identified.
Responding to SEC comment letters can be tricky, so it’s always nice to read tips from Corp Fin on how to make the response process more efficient. This Deloitte memo summarizes Staff comments at a recent AICPA conference, which were aimed at helping companies respond to comment letters. Here’s an excerpt:
– Provide the Staff with contact e-mail addresses for the responding company and its outside counsel
– Before providing courtesy paper copies, ask the reviewer if copies are needed or will be used.
– Clearly and directly address the issues raised in the comments.
– Share views on materiality with the Staff early in the process to increase overall efficiency
– Don’t assume that the SEC has accepted an item solely because it has been reported similarly in another company’s filing
– When calling the Staff with an interpretive or procedural question, don’t assume that the Staff has all the facts. Responding companies should do the appropriate research, provide sufficient background information, and present an analysis that points to relevant authoritative literature
– Communicate the intended use of novel transactions up front
– Call the Staff to discuss or get clarification on a Staff comment
Also, don’t forget that members have access to our Handbook on the “SEC Comment Letter Process” – a 39-page guide to help you through responses.
Change to Nasdaq Definition of “Family Member” Approved
Last week, the SEC issued an order granting accelerated approval of Nasdaq’s amended proposal to change the definition of a “family member” for purposes of determining director independence under Nasdaq’s Listing Rules. Under the new definition:
“Family Member” for purposes of determining whether a director is independent under Nasdaq Rule 5605(a)(2) means a person’s spouse, parents, children, siblings, mothers and fathers-in-law, sons and daughters-in-law, brothers and sisters-in-law, and anyone (other than domestic employees) who shares such person’s home. As stated by Nasdaq, the purpose of the proposed rule change is to exclude domestic employees who share the director’s home, and stepchildren who do not share the director’s home, from the types of relationships that always preclude a finding that a director is independent.
This Cooley blog from Cydney Posner discusses more of the details as the new definition leaves the board to determine whether stepchildren not residing at home with the director still have a relationship with the director that could interfere with the director’s exercise of independent judgment.
More on “Cyber Response Plan Testing”
Yesterday, I blogged about the importance of testing a cyber response plan. Another great planning tool is reviewing and analyzing a real life example of how another company handled disclosure and response to a data breach.
Thanks to Jay Knight at Bass, Berry & Sims for sending along this blog that does just that – it walks through Chegg, Inc.’s disclosure and response to a 2018 data incident. The blog includes the back and forth between Chegg, Inc. and Corp Fin as they worked through the comment letter process. It’s a quick, helpful read – topics covered in the exchange between Chegg, Inc. and Corp Fin include:
When it comes to “cyber response plans,” the planning stage is a lot more useful if it’s actually been tested. A blog discussing the recently issued SEC OCIE Cybersecurity and Resiliency Observations says if you’re not practicing what to do when you experience a cyber attack, you’re not being realistic about your chances of effectively responding to it.
Although the SEC OCIE observations are primarily directed toward broker-dealers and investment advisors, the recommendations seem worthwhile for any company, one being testing and monitoring:
Establishing comprehensive testing and monitoring to validate the effectiveness of cybersecurity policies and procedures on a regular and frequent basis. Testing and monitoring can be informed based on cyber threat intelligence.
It also recommends testing the incident response plan and potential recovery times, using a variety of methods including tabletop exercises. If an incident occurs, implement the plan and assess the response after the incident to determine whether any changes are necessary.
This recent blog from McGuireWoods is helpful because it summarizes how to run an effective tabletop exercise to test your response plan. Here’s a few recommendations:
– Objectives – set ground rules for the exercise, who speaks first, is there a budget for the response, level of detail to be provided, determine the focus of the exercise – detection, containment, etc.
– Evaluation – think about how to evaluate the exercise, identify a note-taker during the exercise, detail the evaluation process
– Full participation – ensure key participants coordinated their responses, ensure contractual partners are included, determine who has authority to resolve disagreements
– An experienced facilitator – bringing in an experienced facilitator can help ensure all areas have a voice and that the exercise stays on track so the result is measurable
Tips for Improving Data Privacy Provisions
Besides testing your cyber response plan, another thing to consider is the data privacy provision in contracts. I recently came across this memo in CFO.com that provides 8 tips for improving data privacy provisions in contracts. Most of us can think of a few service provider arrangements at our companies that we know house sensitive customer or employee data. The last thing we want is for that service provider to experience a data breach and soon we are pulled into the crisis with them.
Improving data privacy provisions of these contracts can boost risk management efforts – here’s an excerpt from the memo with some of the tips:
– Synch the indemnification and limited liability provisions – no need to have a great indemnification provision if it’s all wiped away by a limited liability provision that says the vendor’s liability is limited to some small dollar amount
– Avoid early termination fees – especially important if you’ve already been working with the vendor in certain capacities, early termination as a result of a data breach seems reasonable and it’s hard to see what costs the vendor would have a right to recover
– Vendor should agree to comply with all applicable data privacy and security laws – with rapidly changing laws, the vendor may not want to do so but stressing that you don’t accept carve outs for this is necessary – how do you explain to the board that you have a vendor that doesn’t agree to abide by all applicable laws?
Tomorrow’s Webcast: “Audit Committees in Action – The Latest Developments”
Tune in tomorrow for the webcast – “Audit Committees in Action: The Latest Developments” – to hear Deloitte’s Consuelo Hitchcock, EY’s Josh Jones and Gibson Dunn’s Mike Scanlon discuss recent SEC, FASB & PCAOB guidance impacting audit committees, evolving practices for audit committee charters, agendas and meetings and how the audit committee should manage its relationship with the independent auditor.
Last month, I blogged about the first 10-K filing to include a coronavirus risk factor. As concerns about the virus’s economic impact have continued to grow, a total of 26 companies have included a risk factor or, in some cases, MD&A disclosure about the virus in their 10-K filings. This Audit Analytics blog reviews those disclosures. Here’s an excerpt:
While the economic effects of the Wuhan coronavirus are still unknown, it makes sense that the majority of references to the disease have been included in the Risk Factors section of a company’s 10-K. Most of the language seen thus far discusses the uncertainty of the disease’s effects on global macroeconomic conditions, production capabilities, and decreases in international travel; this is similar language used surrounding other risk factors such as political unrest, natural disasters, and terrorism.
However, some companies have discussed the impact of the coronavirus in the Management’s Discussion & Analysis (MD&A) section of the 10-K, indicating that some companies expect to experience significant effects. For example, Carnival Corp [CCL] disclosed in their MD&A that the travel restrictions as a result of the outbreak could have a material impact on financial performance:
Fiscal Year 2020 Coronavirus Risk
In response to the ongoing coronavirus outbreak, China has implemented travel restrictions. As a result, we have suspended cruise operations from Chinese ports between January 25th and February 4th, canceling nine cruises. We also expect that travel restrictions will result in cancellations from Chinese fly-cruise guests booked on cruises embarking in ports outside China… If the travel restrictions in China continue until the end of February, we estimate that this will further impact our financial performance by an additional $0.05 to $0.06 per share… If these travel restrictions continue for an extended period of time, they could have a material impact on our financial performance.
Other companies that have mentioned coronavirus in the MD&A section include Mondelez International, Inc. [MDLZ], Mettler-Toledo International, Inc. [MTD], and Las Vegas Sands Corp. [LVS].
If you’re looking for disclosure precedent (who isn’t?), the blog names all 26 companies that have included 10-K disclosure about the coronavirus to date. And to demonstrate that there’s nothing new under the sun, the blog also includes a chart with the number of companies that included 10-K disclosure about other recent international public health emergencies.
Board Recruitment: Want Diverse Candidates? Climb Down the Org Chart
This Bloomberg BusinessWeek article says that companies looking to enhance the gender diversity of their boards would be wise to look further down the org chart than has traditionally been the case when looking for potential directors. That’s because while many big companies are reining in CEO participation in outside boards, some are actively encouraging less senior execs to obtain board positions:
Outside corporate board gigs are a classic perk of being a chief executive officer. The side jobs offer extra pay, as well as a way to network—perhaps for the next big job. But all those top bosses filling up directors’ seats has a predictable effect. Since CEOs are an overwhelmingly white, male bunch, they tend to reinforce the lack of diversity on corporate boards.
That makes a push by Marriott International Inc. to get lower-level executives to join boards a bigger deal than it might seem. CEO Arne Sorenson says his aim is to give the hotel company’s rising stars valuable experience. Incidentally, though, of the five who have found board positions, three are women and one is a black man. The same trend is showing up at other large U.S. companies. Among the 10 companies with the most employees serving on other boards, the executives with directorships are overwhelmingly women or people of color, according to data compiled by Bloomberg.
The article points out that while Marriott’s effort to promote board participation doesn’t have a diversity goal, executives who aren’t white males are more in demand for board slots.
Transcript: “Cybersecurity Due Diligence in M&A”
We have posted the transcript for our recent DealLawyers.com webcast: “Cybersecurity Due Diligence in M&A.”
A recent paper from Stanford’s Rock Center notes that while most insider trading policies are designed to prevent violations of law, companies need to ask whether their existing insider trading policies need to cover more ground in order to be consistent with good governance practices. Here’s an excerpt:
Despite procedures designed to ensure compliance with applicable rules, news media and the public tend to be suspicious of large-scale executive stock sales.7 This is particularly the case when a sale occurs prior to significant negative news that drives down the stock price.
Public suspicion is exacerbated by inconsistent and nontransparent corporate practices—such as, lack of communication around why the sale was made, whether the general counsel approved the trade in advance, and whether the trade was the result of a 10b5-1 plan—and differing opinions about what constitutes “material” nonpublic information. Thus, an executive stock sale might pass the legal test but fail the “smell test” employed by the general public. A well-designed ITP lessens the likelihood of such a scenario.
The paper reviews 4 real-life vignettes involving insider transactions that, if not illegal, sure didn’t look very good. It raises a number of governance issues, like why companies don’t always make their insider trading policies public, mandate the use of 10b5-1 plans by senior execs or require pre-approval of all trades by the general counsel?
Shareholder Proposals: Be Careful What You Wish For?
Carl Hagberg, who has probably forgotten more about the proxy voting and annual meeting process than most of us will ever know, recently submitted a comment letter on the SEC’s proposed changes to Rule 14a-8. In addition to some colorful language about the release itself – which he calls “ponderously long, dense and maddeningly-meandering” – he contends that the current system is working reasonably well. He also claims that the proposals don’t address the ability of shareholders to use “proxies” to make proposals on their behalf, which he views as the biggest problem under the current regime.
Your mileage may vary when it comes to Carl’s arguments, but you should definitely read his letter because he knows a lot about this stuff & his letter’s kind of fun. But regardless of whether you agree with his arguments, he raises a good point about the potential unintended consequences of the proposed changes:
My most important takeaway, however, from a “common sense perspective,” is to note yet another tried and true old-saw: “Beware of what you wish for.” I guarantee that higher hurdles, if enacted, will result in institutional investors casting way more Yes-Votes for shareholder proposals than they otherwise would – simply to give proponents a decent shot at a three-year trial-run in the polls.
Quick Poll: Your Take on The 14a-8 Proposals
Carl recognizes that not everybody will agree with his take, so he suggested that we take a poll of our readers. My response was “Why not?” And so, because polls are an easy third blog, here we go – please take part in this anonymous poll.
Well, we thought that the comment process for the SEC’s proposed proxy advisor regulations was going to be a free-for-all, and it hasn’t disappointed. Lynn blogged last week about some investor comments, but representatives of other constituencies also weighed in.
Insightful comments from advocates for the proposed rules include this letter from the Society for Corporate Governance, which, among other things, highlighted the reports of its members concerning the prevalence of errors in proxy advisor reports. Leading pro-regulation advocate Bernard Sharfman also submitted a comment letter analyzing the implications of the “collective action problem” in shareholder voting that he contends is central to understanding the need for proxy advisor regulation.
On the other side of the ledger, Glass Lewis weighed in with concerns about the paperwork burdens associated with both complying with the proposed rules & satisfying the conditions for exemptions from them. This Olshan letter on the rule’s potential implications for proxy contests is also worth checking out.
And if you’re looking for “fair & balanced,” then check out this debate on proxy advisor regulation between U of Chicago B-School Prof. Steven Kaplan & ValueEdge Advisors’ Nell Minow.
And The Ridiculous . . .
On the other hand, there’s also been some commentary on the proposed rules that can most charitably be described as propaganda. Take this video, for example. Among other things, it blames proxy advisory firms for submitting climate change, abortion, gun control & other shareholder proposals on their “ultra left wing political agenda.”
There are all sorts of agenda-driven shareholder proposals – and not just from the left. One of my beefs about the proxy advisor industry is that it’s set up to cater to the “shareholders good, management bad” worldview of the investors who subscribe to them. But dreaming up lefty shareholder proposals isn’t part of what proxy advisors do.
Proxy advisors are business to make money, and that means giving their customers what they want – and their customers want to have the last word at the companies in which they invest.
How Did Proxy Advisor Regulation Get to Be Left v. Right?
The fundamental sales pitch in the video is that proxy advisor regulation is a political, “liberals v. conservatives” issue. While the video gets a lot wrong, it appears to have that part right. With the exception of a few prominent Republicans associated with activist hedge funds, this really does seem to have devolved into a left v. right issue.
I guess the short answer to the question of why proxy advisor regulation became a political litmus test is that it’s America in 2020 and everything is polarized. But what’s kind of interesting to me is how the sides align in this particular debate. Think about it – how is it “conservative” to restrict how capital providers use their advisors? How is it “liberal” to champion an unfettered free market for capital providers who continue to insist that their interests trump those of other constituencies, like workers?
Maybe I’m just trying to justify my own idiosyncratic position on this issue. I consider myself slightly left-of-center on many issues, but I absolutely agree that proxy advisors should be regulated. I don’t know, but perhaps the cause of the odd “left v. right” split here is the governance paradigm that views corporations as analogous to nation-states, and the presumption among progressive types that since that’s the case, shareholder democracy is a moral imperative. From my perspective, that’s a highly debatable proposition.
My own view is that the separation of ownership from control that characterizes the Berle & Means corporation is a feature, not a bug. I think that control of the world’s largest business enterprises by corporate managers is fundamentally less dangerous to society than putting them in the hands of an ever smaller number of institutions holding an ever increasing share of the world’s wealth. Managers are just greedy, so their agenda is pretty transparent. I don’t feel the same way about the agenda of public pension funds & giant asset managers.
Audit Analytics recently took a look at the audit fees paid by S&P 500 companies – and to say that they vary widely is a huge understatement. The average audit fees paid by S&P 500 companies were $13.0 million in 2018. Median fees were $8.3 million, with the lower quartile cut-off at $4.6 million & the upper quartile cut-off at $14.7 million. But what’s really eye-popping is the fee range – audit fees paid by the S&P 500 ranged from $800,000 to $133.3 million.
That degree of variation in audit fees is interesting, but so is this nugget about non-audit fees:
Roughly 9.5% of S&P 500 companies had non-audit fees greater than 25% of total fees in 2018. While high non-audit fees exclusively are not a red flag, they can serve as an indicator for investors and other users of financial statements to review what factors are contributing to the fees in each disclosed fee category and potentially look closer at services that have been characterized as non-audit work.
As Audit Analytics notes, the size of non-audit fees that auditors receive may raise concerns. Here’s an excerpt from this NYT article on the topic:
Most recently, the Securities and Exchange Commission issued a statement cautioning accounting firms on the provision of consulting services to their auditing clients. The commission, which did not challenge any specific services in its June 15 “interpretive release,” said its purpose was “to reinforce the sensitivity of corporate‐audit committees and corporate managers as well as accounting firms to the need for preserving independent audits.” Apparently, the commission is concerned because it fears that an accounting firm’s interest in keeping — or obtaining — a company as a consulting client may erode the auditor’s independence.
I guess I probably should have mentioned that this NYT article was published in 1979. The rules are tighter now – but after more than 40 years, it seems like the music may have changed but the song remains the same.
Proxy Access: Adopted Widely, Used Only Once
Sidley recently issued a 5-year review of proxy access developments. In addition to tracking the adoption of proxy access bylaws, the review also addresses a variety of other topics, including management & shareholder proxy access proposals, typical proxy access provisions, and proxy advisor policies on proxy access.
While noting that proxy access bylaws have been adopted by 76% of the S&P 500 and a majority of the Russell 1000, the memo also notes that such bylaws have actually been used only once. Here’s an excerpt with the details:
In 2019, for the first and only time, a shareholder included a director nominee in the proxy materials of a U.S. company pursuant to a proxy access right. In December 2018, The Austin Trust dated January 1, 2006 (with Steven Colmar as trustee) with ownership of approximately 3.8% of the common stock of The Joint Corp. filed a Schedule 14N seeking to use proxy access to nominate a director at the company’s 2019 annual meeting.
The Joint Corp. had adopted proxy access in August 2018 on standard terms after a shareholder proposal to adopt proxy access submitted by Colmar was approved (with 96% support) at the company’s annual meeting in June 2018. (The board of directors had not made a recommendation for or against the proposal.)
Both the board of directors and ISS ultimately recommended that stockholders vote for the proxy access nominee, and he was elected at the company’s May 2019 annual meeting with more than 99% support.
Tomorrow’s Webcast: Tying ‘ESG’ to Executive Pay”
Join us tomorrow for the CompensationStandards.com webcast – “Tying ‘ESG’ to Executive Pay” – to hear Aon’s Dave Eaton, Mercer’s Peter Schloth, Southern’s James Garvie, and Willis Towers Watson’s Steve Seelig discuss how to handle the growing demands – and challenges – to including ESG metrics in executive compensation plans.
With D&O insurance premiums on the rise & more Section 11 suits being filed in plaintiff-friendly state courts, IPO companies and their directors & officers face an increasingly hostile environment. This Wilson Sonsini memo points out that for some companies, a direct listing may provide a practical solution for avoiding Section 11 liability by making it impossible to satisfy the statutory requirement to trace the shares purchased to those sold in the offering. This excerpt explains why:
In a direct listing, no shares are sold by the company and therefore no capital is raised. Rather, a company files a registration statement solely to provide certain of its existing shareholders, such as early stage investors and employees, the ability to resell their shares directly to the public.
The existing shareholders include both those whose shares are registered pursuant to the company’s registration statement and those whose shares are exempt from the registration requirements of the securities laws. The shareholders have complete discretion about whether to sell their shares and all are equally able to sell shares upon the company’s direct listing – i.e., starting from the moment of the opening bell.
There are no initial allocations: any prospective purchaser can place orders with their broker of choice. Because both registered and unregistered shares are available for sale upon the company’s direct listing and the sales are conducted through anonymizing brokerage transactions, it is not possible for any purchaser to trace the particular shares she bought back to the registration statement covering the direct listing. Accordingly, no purchasers have standing to assert an offering claim under the ’33 Act.
Before we all get too carried away, the memo also points out that this is a fix that only works for those few cash-rich unicorns that don’t need to raise capital in an IPO. But the memo says there’s another potential fix that could work for the rest of the pack – with a little cooperation from their underwriters. How? Just tweak the shareholder lockups to allow some shares to be sold into the market in exempt transactions simultaneously with the IPO. That would also make tracing of shares to the IPO impossible. Well, at least until Blockchain ruins things for everybody. . .
Compliance Officers: NYC Bar Says It’s Time to Turn Down the Heat
As a former junior high school football coaching super-genius, I know I would’ve done things differently in the 4th quarter of the Super Bowl if I were coaching the 49ers instead of Kyle Shanahan. While “Monday Morning QBs” like me are merely obnoxious bores, Matt Kelly recently blogged about an NYC Bar Association report that says our regulatory counterparts cause big problems for corporate compliance officers:
The New York City Bar Association released a report on Tuesday warning that compliance officer liability continues to be a worrisome part of regulatory enforcement, and called for more guidance about when a compliance officer’s conduct can leave him or her in regulators’ crosshairs.
The report focused on compliance officers working in financial services firms, although compliance officers from any industry will appreciate the points raised. Its chief complaint is that compliance officers fear growing personal liability for failures of their firm’s compliance program, when those failures might be more due to insufficient budgets, weakly structured compliance roles, or management that just doesn’t care much about the importance of a strong compliance function.
The report also complained that enforcement actions against compliance officers suffer from hindsight bias. That is, compliance officers are supposed to implement programs “reasonably designed” to prevent violations, but you can’t really assess the quality of that effort until a violation has actually happened — which creates the risk that what seemed reasonable at the time will look unreasonable after something has gone wrong.
The report recommends that regulators take a number of actions designed to provide greater clarity to compliance officers concerning what’s expected of them, and Matt’s blog also notes that some heavy hitters in the financial services industry have endorsed the report’s recommendations.
ESG Investing: It’s a Woman’s World – And It May Stay That Way
This Fortune article says that while men dominate most areas of finance & investing, socially responsible investing is a field where women are clearly in command:
It was the usual setup for panelists at a finance conference talking about making smart investments. They were all the same gender. In this case, all women. That probably wasn’t surprising, considering the event was hosted by the United Nations-backed Principles for Responsible Investment. Still, Karine Hirn, founding partner at East Capital in Hong Kong, watched in admiration. She celebrated on Twitter: “Climate finance is at last opening up perspectives for great talent within the otherwise very unbalanced world of finance.”
Men rule that world, except for one key field: the fast-growing arena of what’s known by the shorthand ESG. There’s big money pouring in, and there are big names promoting the idea of applying environmental, social and governance standards to the business of making money.
As more money has been poured in to ESG investments, the field has attracted more men – but women may have a key advantage here: a substantial installed base of talent. Companies are fighting for ESG investing talent, and that battle favors those who’ve been involved for years – many of whom are women.
