Last week, Liz blogged about the passage of the Holding Foreign Companies Accountable Act, which amends 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. On Friday, President Trump took time from his busy schedule – which he swears does not include declaring martial law – to sign the legislation.
Shortly thereafter, SEC Chair Jay Clayton issued his own statement on the legislation – which this excerpt suggests has thrown a bit of a monkey-wrench into the SEC’s own rulemaking initiatives regarding China-based companies:
Prior to enactment of the Act, SEC staff were finalizing recommendations for proposed rules regarding enhanced listing standards for U.S. securities exchanges and auditor qualifications for the Commission’s consideration. Because of the substantial overlap between the staff’s proposal and the Act, I have directed the staff to consider providing a single consolidated proposal for the Commission’s consideration on issues related to the PCAOB’s access to audit work papers, exchange listing standards, and trading prohibitions.
The statement says that Chair Clayton has also asked the staff to consider additional issues relating to the Act’s implementation, including how its disclosure requirements can be implemented expeditiously and how any potential uncertainties can be addressed. He also acknowledged that this “pragmatic step” means that a rulemaking proposal won’t happen during his tenure.
Innovation: In-House Departments Leave Law Firms In the Dust?
This recent Thompson Hine survey on innovation in the legal profession says that in-house legal departments are way ahead of law firms when it comes to innovative approaches to legal services. This excerpt explains:
In-house legal departments continue to face extraordinary pressures — pressures that could be eased through law firm innovation. Budgets — already taking a hit before COVID-19 — are tighter than ever in the wake of the pandemic, and companies are looking for efficiencies at every turn.
But more than two-thirds of our survey respondents said their primary outside firms had made no progress in innovation over the past year. As a result, 91% of in-house law departments have taken innovation into their own hands. The changes in-house legal departments are making on their own show their priorities.
Nearly two-thirds of our buyers cited improved project management as a key change in their legal departments. Almost half have streamlined outside counsel panels, while more than 40% have implemented self-service tools and restructured departments and/or processes. Clearly, efficiency is the order of the day, particularly when you compare the numbers with those in our first survey. Sixty-three percent of in-house law departments had improved project management in 2019 vs. 8% in 2017; 41% had restructured departments or processes vs. 8% in 2017; and 33% had outsourced to alternative legal services providers in 2019 vs. 3% in 2017.
The survey suggests that law firms’ reluctance to innovate may be causing them to miss out on new business opportunities – 53% of in-house respondents would consider hiring a new law firm because it is innovative.
Cheat Sheet: 2020 Capital Markets Rulemaking
If you’re like me, you’re probably having a little trouble keeping up with the avalanche of rulemaking from the SEC over the past several months. If you find yourself in that position, you may want to hang on to a copy of Skadden’s 2020 Capital Markets Regulatory Review. This 13-page document provides a brief overview of some of the key capital markets and corporate governance reforms that have taken effect in 2020 or are poised to take effect in 2021.
We have a new podcast available to members, in which our very own Dave Lynn interviews special guests about the latest developments in securities laws & corporate governance. Two episodes are already available for your holiday entertainment!
In this 26-minute episode, Dave talks with Karen Garnett – currently a partner at Proskauer and formerly an Associate Director of Corp Fin – about disclosure effectiveness & Reg S-K. Topics include:
– The SEC’s “Disclosure Effectiveness” initiative – why was it so successful?
– Considering changes to the description of business requirement
– Human capital disclosure – what should companies do now?
– Tackling the amended risk factor disclosure requirements
– Is the Disclosure Effectiveness initiative done?
And in this 14-minute episode, Dave talks with Jay Knight – currently a partner at Bass, Berry & Sims and previously Special Counsel in Corp Fin – about Staff comments on COVID-19 disclosures. Topics include:
– Has the SEC Staff been commenting on disclosures about COVID-19 in public filings?
– What areas of comment has the Staff raised regarding COVID-19?
– What approach has the Staff taken with respect to non-GAAP financial measures in the COVID-19 era?
– Do you think the Staff will focus on COVID-19 disclosures when it reviews 10-Ks filed in 2021?
– Are there lessons to take away from the Staff’s comments as we prepare disclosures for the upcoming reporting season?
SEC & Edgar Closed Next Thursday & Friday
This executive order announces that all federal agencies – including the SEC – will be closed this upcoming Thursday for Christmas Eve (Christmas Day was already designated as a federal holiday, so the SEC and Edgar are closed that day too).
The SEC announced that, just like the past couple of years, this means Edgar will be closed on both the 24th and 25th. No filings will be accepted on those days, Edgar filing websites won’t be operational, Edgar Filer Support will be closed, and you’ll have until Monday, December 28th to make filings that would have been due on Thursday or Friday. The announcement also says that both of those days will also be treated as federal holidays for filing purposes.
Transcript: “Pay Equity – What Compensation Committees Need to Know”
We’ve posted the transcript for our recent CompensationStandards.com webcast, “Pay Equity: What Compensation Committees Need to Know.” Mintz’s Anne Bruno, BlackRock’s Tanya Levy-Odom, Equity Methods’ Josh Schaeffer, and Impax Asset Management’s Heather Smith shared their insights on these topics:
1. Why Pay Equity Is in The Spotlight
2. Differences Between “Pay Equity,” “Pay Gap” & “Pay Ratio”
3. Shareholder Expectations
4. Disclosure Trends: Pay Gaps & Pay Equity
5. How to Collect & Interpret Data
6. Remediation Strategies
7. Mechanics of Board & Committee Oversight
8. Preparing for Shareholder Engagements & Proposals
At an open meeting yesterday, the SEC adopted final rules that will require public “resource extraction” issuers to disclose payments made to the US federal government or foreign governments, if the company engages in the commercial development of oil, natural gas, or minerals. After some drama in which Congress disapproved the SEC’s 2016 rulemaking on this topic, the current iteration is based on a 2019 proposal and implements Section 13(q) of Exchange Act, which was added by Dodd-Frank a decade ago. All of the SEC Commissioners, including Chair Jay Clayton, released their own statements about the final rules.
Although the final rules will be effective 60 days after publication in the Federal Register, there’s a two-year transition period before companies will be required to submit a Form SD with this info. And unlike the “conflict minerals” Form SD that is due by May 31st of each year for all companies, this one will be due within 270 days of each company’s fiscal year end. So for calendar-year companies, the first report will likely be due at the end of September 2024. The SEC also issued this order to recognize that a company that meets resource extraction payment disclosure requirements in the EU, UK, Norway or Canada would satisfy the Section 13(q) “alternative reporting” requirements.
– Require public disclosure of company-specific, project-level payment information;
– Define the term “project” to require disclosure at the national and major subnational political jurisdiction, as opposed to the contract, level, recognizing that more granular contract-level disclosure could be used to satisfy the rule;
– Add two new conditional exemptions for situations in which a foreign law or a pre-existing contract prohibits the required disclosure;
– Add a conditional exemption for smaller reporting companies and emerging growth companies;
– Define “control” to exclude entities or operations in which an issuer has a proportionate interest;
– Limit the liability for the required disclosure by deeming the payment information to be furnished to, but not filed with, the Commission;
– Add relief for issuers that have recently completed their US IPOs; and
– Extend the deadline for furnishing the payment disclosures.
Cyber Insurance: Claims Starting to Show “Covid-19” Impact
Over the past 5 years, companies’ average cost of cyber crime has increased 72% – to $13 million – and the average number of security breaches has increased by 67%. That’s according to this 14-page summary of cyber trends from Allianz – which, not surprisingly, explains that the work-from-home environment is heightening cyber risks. It also says hackers are selling high-end malware and tools to other attackers – so companies need to be on alert for sophisticated schemes.
That advice was underscored earlier this week when news broke about a cyberattack at SolarWinds and FireEye. This CNBC article says that SolarWinds’ stock dropped 23% after the hack was announced – not a position in which any company wishes to find itself – and a few people are also now questioning recent stock sales by some large investors of that company.
Our friend Melissa Krasnow of VLP Law Group noted that the incident highlights the need to double down on vendor management processes & agreements for privacy and data security provisions, to make sure that incident response plans and business continuity plans are in place and up-to-date, and to keep using tabletop exercises to spot weaknesses and craft responses.
Here’s more detail from the Allianz report:
Through 2020, malware and ransomware incidents have already increased by more than a third, at the same time as a 50%+ increase in phishing, scams, and fraud, according to international police body, INTERPOL. The rush to adopt new cloud systems and remote access solutions, has also driven up the number of data breaches. Over a four-month period, some 907,000 spam messages, 737 incidents related to malware and 48,000 malicious URLs – all of them in relation to coronavirus– were detected by one of INTERPOL’s private sector partners.
Business email compromise schemes (see page 7) are likely to increase further with the shift in the business landscape to remote working and the economic downturn, along with damage costs from phishing scams, ransomware attacks and insecure remote access to networks. Coronavirus-themed online scams and phishing campaigns which aim to take advantage of public concern about the pandemic are unlikely to dissipate anytime soon.
The pandemic will also have a long-term impact as companies increasingly digitalize, work remotely and rely more on online sales in response, meaning cyber risks will evolve in different shapes and forms.
Farewell to Paul Sarbanes
Paul Sarbanes, the 5-term U.S. Senator from Maryland who co-wrote the Sarbanes-Oxley statute, passed away last week at the age of 87. John, Broc and I reminisced about the landmark law a few years ago on the 15th anniversary. Here’s an excerpt from Mr. Sarbanes’ NYT obituary:
While other members of Congress pursued the Enron scandal with splashy televised hearings and spirited denunciations, Mr. Sarbanes approached it by holding 10 thorough hearings to get widespread expert advice on what corrective legislation should include.
Initially opposed by many Republicans and by the powerful lobbying of the accounting industry, the measure eventually passed 97 to 0 in the Senate after another accounting failure, at WorldCom, had sent the stock market plunging.
Mr. Sarbanes saw his career as having “bookends,” as he put it in an interview for this obituary in 2013: It began in 1974 with his role in the impeachment proceedings against President Richard M. Nixon and closed with the accounting law.
As we move closer to the finish line for 2020, our faithful correspondent Nina Flax of Mayer Brown is back with an uplifting “list” to focus on some of the positives she’s experienced (here’s our last list from Nina):
It has been a while since I have written a list. I have, as I am sure many of you have, struggled with COVID and WFH. Every day, there is something new, ridiculous, sad, frustrating, amazing to add to the items that elicit an “it’s 2020!” response. Despite having been stuck on I-80 with my son in the car exactly when the LNU Lightning Complex jumped the highway and shut down traffic (perhaps the subject of a future list), I am extremely grateful today that I have literally and figuratively found my way through the impending wall of smoke to find these things:
1. Dinner with my son. My son eats dinner at 5pm, if even that late some days. I cannot explain it other than that is when he is hungry, so that is when he eats because we prefer him to not be hangry. Before WFH, I very rarely made it home in time to actually eat dinner together. I have made it a point to try to do that almost every day – force myself to take the 30 minute break to have that time. Sometimes we talk about high/lows, sometimes we go around saying something we are grateful for, sometimes we take turns doing mad-lib style storytelling, mostly we just sit down and laugh about something. I have never been happier. (Except for one day I remember before child where I never got out of bed and slept for about 12 hours in between watching TV?)
2. More movement. Before WFH, my close colleague and I would take breaks from sitting at our desks and walk in circles around our office building to talk through legal issues – conceptual or drafting – it really helped. With WFH, air permitting, you will frequently find me walking up and down my driveway while on calls. Moving helps me focus. Moving helps me process. Moving helps me be creative – professionally and personally.
3. Appreciativeness. Not grand gratefulness in a trendy mindfulness way. Being away from people has made me appreciate people more. And miss them. Before, I would go out of my way to write a holiday time card to each colleague that I had worked with or collaborated with over the year that I valued. Very personalized, very intentional. Now, I go out of my way to say thank you for the small things. Thank you for responding so quickly. Thank you for taking my call. Thank you for the follow up. Thank you for taking the lead. Thank you for your collaboration. This of course also applies to my personal life. Thank you for always being there for me. Thank you for taking the time to answer my questions. Thank you for going to the grocery store. Thank you for getting the ridiculously howling dog to stop howling. Thank you for organizing this friends call. Thank you for passing along this interesting article. Thank you for the book suggestion. Thank you for checking in on my parents. Thank you for scheduling this outside, socially distanced playdate. Thank you for being you.
4. Knitting and Other Old Loves. This is more of a re-found. I picked up knitting in law school, but for whatever reason I stopped knitting before I met my husband. In the COVID-induced cleaning and house reorganizing, I re-discovered my needles. Then I found a great store, took my son and he picked out three colors. Side note: It was an amazing moment of pride that he picked colors that completely epitomize South Florida – citrus (bright yellow), tangerine (bright orange) and electric (a bright aqua). Second side note: I love the way that people name colors. My husband and I used to play a game where I would try to guess the name of a color (and often came pretty close). Back to the knitting point, my son now has a fantastic hat and matching cowl (if I do say so myself, but really, others have said so too). I am working on matching mittens and looking forward to giving knitted gifts to many in the coming months. For other old loves, I have picked up drawing and painting again in a way that I have not enjoyed since I first went to college intending to major in art and minor in chemistry (no, I have no idea what I was thinking back then; yes, I do know how I ended up here).
5. New Curiosities. There are many reasons that through this year I have felt more drawn to nature. I have been making fun informational cards about leaves, shells, flies and bees for my son. I have a list of nature books (of course, as an Amazon list) that I want to read. I have a nature journal. I have a stack of articles and studies from an amazingly supportive friend who has always been intensely focused on sustainability. I watched My Octopus Teacher as soon as I could and cried. I am feeling inspired.
I think I will pull that last sentence down to here – I am feeling inspired. In the face of all of the negative from 2020, my inspiration enables me to laugh that it snowed chocolate in Olten, to hug my husband, son and dogs enough to make up for all of the other hugs I am missing out on (I am a hugger), to deal with frustrations in different ways, to drive initiatives I feel strongly about, to focus on kindness and caring, to not compromise on expectations, to accept whatever may happen, to know that I can make a change, to know that I will survive. Maybe resiliency that I read so much about in the context of children is really about inspiration?
**End note: I promise that this time has not been all positive for me. There have been very hard negatives. Without those, I would not be here now. I am sure I will face negatives in the future. I am hoping this time helps me meet those challenges more adeptly, with stronger mental health. I hope the same for all of you.
Enforcement Director Stephanie Avakian to Leave SEC
Last week, the SEC announced that Enforcement Director Stephanie Avakian will depart from the Commission by the end of the year. Stephanie began her career at the SEC and began her latest tour in 2014. She’s led the Enforcement Division over the last four years as Co-Director and then Director. Deputy Director Marc P. Berger will serve as Acting Director upon her departure. The SEC’s press release includes a long list of the Enforcement Division’s accomplishments under Stephanie’s leadership – and here’s a statement from Commissioner Elad Roisman.
Last month, I blogged that former SEC Chief Accountant Wes Bricker is working on an initiative at PwC that would translate sustainability reporting standards into an XBRL taxonomy. He isn’t the only one who sees promise in that coupling. In recent remarks, SEC Commissioner Allison Herren Lee – who has made it clear she wants to work on standardized ESG disclosure – said she might also support expanding XBRL to ESG reporting and other non-financial data. Here’s an excerpt (also see this blog from shareholder proponent Jim McRitchie pronouncing his opinion that N-PX data tagging would be the most important SEC rulemaking for advancing corporate sustainability):
What kind of data are we talking about here? The most basic information that an investor might want: how their money is being voted in corporate elections, and whether their shares are being voted in their best interest or in accordance with their instructions. We could bring much greater clarity and transparency to investors regarding how their voting rights are being exercised with the simple expedient of finalizing this rule and adding a requirement, as discussed in the proposal, to tag the Form N-PX voting data.
N-PX filings are voluminous in nature but would likely require relatively few, straightforward data tags. Thus we could potentially take a large body of important information and dramatically increase its usability through a relatively simple taxonomy.
Another area that could benefit from structured data to support usability and comparability is in the area of climate change and other ESG risks and impacts. As you all know, climate and other ESG-related metrics are of ever-increasing importance to investors, surpassing even traditional financial statement metrics for many. Of course, there are currently little to no standardized climate or ESG disclosure requirements. Indeed much of that disclosure occurs voluntarily and outside of SEC filings altogether. As I have said elsewhere, developing standardized climate and ESG disclosure requirements should be a top priority for the Commission. As we consider this, we should also consider how to make the data disclosed under such requirements as usable as possible, including through tagging requirements.
Much of our structuring requirements so far have been backward looking – requiring us to consider how to structure information that is currently disclosed in a non-structured manner. As we consider new climate and other ESG requirements, we would have the opportunity to simultaneously consider how to make those requirements amenable to structuring. Instead of an ex post facto application of structuring requirements, the two could develop in tandem.
Finally, I’ll just mention briefly, MD&A and earnings releases. As commenters including XBRL have pointed out,[18] disclosures under MD&A may benefit from some simple block tagging that could greatly enhance comparability of certain relatively consistent types of information disclosed in MD&A. And earnings releases, particularly given their often market-moving nature, appear to be another well-suited candidate for tagging.
ESG CAMs: Coming Soon to an Audit Report Near You?
I blogged a little while back ago about the PCAOB’s analysis of the “critical audit matter” disclosure requirement. Although most CAMs related to goodwill, revenue recognition, other intangibles and business combinations, there have been 3 so far – all for foreign private issuers – that cover the impact of climate change on financial statements. In this recent speech, PCAOB Board member Robert Brown predicts that there will be more to come. Here’s an excerpt:
In one report on Form 20-F, the auditor discussed management’s estimates that were inconsistent with the 2050 “net zero” commitment.” The auditor also observed that deprecating the assets in line with net zero targets would result in additional reductions to net income that were not reflected in the financial statements. The report also discussed how the auditor challenged management’s assertion that carbon-emitting equipment could be used in alternative ways after a net-zero target date that supported management’s estimate of operation until 2070.
Another audit report discussed how climate change and the global energy transition impacted the capitalization of exploration and appraisal costs. The auditor also focused procedures on the risk that oil and gas price assumptions could lead to material misstatements of the financial statements. Another audit report described the effect that long-term price assumptions incorporating the potential impact of climate change could have on asset values and impairment estimates.
Considering the increasing frequency that environmental trends, events, and uncertainties, including the lower commodity prices and margins resulting from a COVID-19 economic environment, can affect material accounts or disclosures in a public company’s financial statements, I expected to see more auditor reports describing them in the future.
”Shares Outstanding” XBRL Tags: Watch Those Zeros!
The SEC recently announced that DERA Staff has observed that some periodic reports show significant differences between the number of “Entity Common Stock Shares Outstanding” that’s XBRL-tagged on the filing cover page and the number of “Common Stock Shares Outstanding” that’s XBRL-tagged on the balance sheet. While there could be some differences due to the cover page number being as of “the latest practicable date” and the balance sheet being as of quarter-end, some filers have been disclosing three additional zeros in one value compared to the other – without any explanation in the filing about a significant change to capital structure. Make sure to check your scaling before you submit your filing!
It’s official: companies conducting Rule 506 offerings in New York need to file a completed Form D through the NASAA Electronic Filing Depository in order to notify the state. That’s according to guidance issued earlier this month by the New York Attorney General – which brings NY in line with other states with respect to these notice filings and also says that no Form 99’s or Form 99 renewals will be accepted after February 1st. Also see this Mintz memo and these revised regulations for broker-dealers.
This is big news for anyone doing private placements in New York. For years, practitioners have relied on the New York State Bar Association’s interpretive opinion that said the provisions of the Martin Act requiring a Form 99 filing were preempted by NSMIA, and that no New York filing was required. The biggest practical takeaway from this new guidance is that if you’ve been doing that, you need to stop. The guidance also specifies that the Form D must be complete – including by listing all related persons and all persons receiving or expected to receive sales compensation.
House Passes “Holding Foreign Companies Accountable Act”
Members of Congress have found something to agree on: regulating China-based companies. The House has passed the “Holding Foreign Companies Accountable Act” – which would amend 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. The Senate previously approved this legislation – and the President is expected to sign the bill into law. This is separate from the SEC proposal on the same topic that is expected before year-end.
Under the bill, the SEC would be required to identify companies that have registered public accounting firms that are located in foreign jurisdictions and for which the PCAOB is unable to inspect work papers. If the Commission determines that a company has 3 consecutive non-inspection years, it must prohibit the securities from being traded on a national securities exchange or over-the-counter. Companies must also submit documentation to show they aren’t owned or controlled by a governmental entity and disclose information about relationships to the Chinese Communist Party.
This CNBC article notes that Americans might miss out on some pretty significant investment opportunities if this law comes to fruition – and that foreign countries like China might welcome the chance to build up their own exchanges. One of the bill’s Senate sponsors even notes in this press release that 224 U.S.-listed companies are located in countries where there are obstacles to PCAOB inspections, and these companies have a combined market capitalization of more than $1.8 trillion. Maybe that’s why the bill gives a three-year lead-time for compliance and opportunities for correction and relisting. In addition, the co-audit solution that is expected to be included in the SEC’s proposal might help the Commission find a way to balance investor protection with investment opportunities.
Bob Stebbins to Depart From SEC’s “OGC”
Last week, the SEC announced that Bob Stebbins will depart from the SEC in early January – after serving over three and a half years as the Commission’s General Counsel. The SEC’s Office of the General Counsel has a wide range of responsibilities – so Bob played a role in all of the rulemaking, enforcement and other activities that we cover in this blog. The press release says he advised on more than 85 rules, hundreds of interpretive releases and 2750 enforcement actions! He also advised on CARES Act implementation for the Treasury Department. SEC Chair Jay Clayton issued this statement to commend Bob on his service.
Liz blogged earlier this year about the rise in premiums for directors and officers (D&O) liability policies. Now after a rise in lawsuits relating to diversity concerns among executives and directors, a recent Business Insurance article says some insurers are starting to take a fresh look at company diversity practices and top-level succession planning before renewing or pricing D&O coverage. The price of D&O coverage fluctuates but in a market when premiums were already rising, this added scrutiny isn’t likely to help matters for some companies.
With investors, proxy advisors and Nasdaq calling for increased diversity disclosures, insurer focus on the issue seems like a natural progression. The article says some insurers have been meeting with companies to better understand diversity plans and inquiring about which directors are retiring and companies’ plans to replace them.
Suggestions for Moving Beyond Numerical Board Diversity Targets
Not too long ago, John blogged about how companies may focus on overboarding as one way to move forward with increasing board diversity. A recent report from The Conference Board, ESGAUGE and others that analyzes Russell 3000 and S&P 500 board composition trends provides several suggestions to help companies move beyond simply setting numerical board diversity targets. Lending credibility to the need to go beyond setting numerical targets, the report cites various stats showing the lack of progress toward greater board diversity.
With investors (and now insurers!) increasingly looking for action and progress on diversity initiatives, companies might want to start thinking about steps they can take to show progress in working toward improved board diversity. Diversity of course goes beyond gender and race/ethnicity and the report discusses the importance of diverse skill sets and age diversity and suggests boards make diversity part of the ongoing board succession planning process. The report offers one take on what boards can do to help improve diversity, and at minimum some of these ideas may help get a dialogue started. The report mentions requiring a diverse slate of director candidates and beyond that, here are more of the report’s suggestions:
– Endorse a model where every other board seat vacated by a retiring board member is filled by a woman or the model described in the recent California law requiring directors from underrepresented communities
– Ensure nominating committees are diverse
– Consider diversity when making board and committee leadership appointments
– Get ahead of investor demands for information about board diversity and include more narrative information about the racial and ethnic background of directors as part of a broader explanation of the multiple dimensions of diversity on company websites.
– When it comes to director tenure, the report says boards should consider how best to achieve a mixture that includes long-serving directors, along with those in the middle and new directors. For disclosure, companies should consider disclosing the range of tenures to investors and consider adopting an average tenure and similar policies that encourage a healthy level of turnover but avoid the shortfalls of rigid term limits.
– Strengthen the director evaluation process to ensure that specific cases of long tenure are examined holistically and in light of other assessment factors such as the board’s overall gender, age, racial and ethnic diversity, skill sets, and rate of board refreshment.
– Look outside the C-Suite for potential director candidates. To help ensure newly minted directors have the requisite experience and abilities, put robust processes in place for identifying, recruiting, onboarding and engaging directors to help them succeed. As companies increasingly seek individuals with specific skill sets, such as cybersecurity and human capital management, looking outside the C-suite can bring different perspectives and problem-solving approaches. Boards should examine their own culture to ensure that they and management are providing a genuinely inclusive environment.
November-December Issue of “The Corporate Counsel”
The November-December issue of “The Corporate Counsel” print newsletter was just posted – and also mailed (try a no-risk trial). The topics include:
Yesterday, the SEC announced that it settled an enforcement proceeding against GE arising out of allegedly misleading disclosures in its power and insurance businesses. The SEC’s investigation had been underway at GE for the last couple of years after the company disclosed it was taking large charges in each of those business areas – here’s an excerpt from the press release:
According to the SEC’s order, GE misled investors by describing its GE Power profits without explaining that one-quarter of profits in 2016 and nearly half in the first three quarters of 2017 stemmed from reductions in its prior cost estimates. The order also finds that GE failed to tell investors that its reported increase in current industrial cash collections was coming at the expense of cash in future years and came primarily from internal receivable sales between GE Power and GE’s financial services business, GE Capital. In addition, the order finds that from 2015 to 2017, GE lowered projected costs for claims against its long-term care insurance portfolio and failed to inform investors of the corresponding uncertainties resulting from lower estimates of future insurance liabilities at a time of rising costs from long-term health insurance claims.
Without admitting or denying the SEC’s findings, GE consented to a cease-and-desist order, agreed to pay the $200 million penalty and to report for one year to the SEC regarding certain accounting and disclosure controls in its power and insurance businesses. The $200 million penalty is big, and as reported in this WSJ article, the penalty is much higher than the amount GE previously set aside to resolve the matter. Even with the settlement, the SEC’s announcement says that the investigation is ongoing, which could mean it’s determining whether to bring charges against individuals.
As noted in the WSJ, in the time since the investigation began, GE has a new CEO and, in 2021, a new auditor. In reporting the settlement, GE’s Form 8-K included this statement about its financial reporting, along with information about corrective measures the company has taken:
The SEC’s order makes no allegation that prior period financial statements were misstated. This settlement does not require corrections or restatements of GE’s previously reported financial statements, and GE stands behind its financial reporting.
GE cooperated with the SEC over the course of its investigation. As noted in the order, GE has taken a number of steps since the time periods covered by the investigation to enhance its investor disclosures regarding power and insurance trends and risks, as well as enhancing internal controls on its insurance premium deficiency testing (also known as loss recognition testing) process and adding disclosure controls and procedures concerning its insurance liabilities.
Critical Audit Matters: A Look at the S&P 100
A few weeks ago, Liz blogged about the PCAOB’s analysis of the impact of the “critical audit matter” disclosure requirement. Last week, the Center for Audit Quality issued its report with observations of CAMs contained in audit reports for large accelerated filers and it takes a deeper dive into the S&P 100. Here’s some of the findings from review of the S&P 100 audit reports:
– Average number of CAMs per audit report was 1.98
– Drivers that led to matters being a CAM appeared to include a high degree of judgment by management related to the matter that led to a high degree of auditor judgment to assess or evaluate management’s conclusions. Some CAM communications also described the audit effort and involvement of professionals with specialized skills and knowledge as principal considerations for the matter being considered a CAM.
– Of the 198 CAMs identified in audit reports for the S&P 100, 51% of them were in these 4 categories:
Taxes (32 CAMs)
Goodwill and/or intangibles (28)
Contingent liabilities (23)
Revenue (18)
The remaining 49% of CAMs were spread across 23 different categories and were less prominent from a trend perspective – business combinations, sales returns and allowances, pensions and other post-employment benefits, and asset retirement and environmental obligations were all topics that S&P 100 auditors identified as CAMs.
Transcript: “Doing Deals Remotely”
We’ve posted the transcript for the DealLawyers.com recent webcast: “Doing Deals Remotely.”
Liz blogged last summer about how some short-term activists were making a pivot to ESG and wondered whether this trend would intensify. There have been whispers that investors want to see more climate expertise on boards – but not much has come of that so far. Earlier this week, though, the WSJ reported that Engine No. 1 LLC, a new activist investor with a focus on sustainability, has taken aim at Exxon Mobil:
Engine No. 1 LLC, an investment firm launched by Chris James last week, is preparing to send a letter to Exxon ’s board urging the Irving, Texas-based company to focus more on investments in clean energy while cutting costs elsewhere to preserve its dividend. The letter, a copy of which was viewed by The Wall Street Journal, identifies four people the firm plans to nominate to Exxon’s 10-person board.
The article also identifies CalSTRS as one shareholder that supports Engine No. 1’s cause. CalSTRS issued a press release confirming that it intends to support Engine No. 1’s alternate slate of board members, which includes a link to Engine No. 1’s proxy fight website.
We’ll see where this goes — the WSJ article notes that it’s possible the campaign will fall flat. A CNBC article discussing the matter says that for a long time, Exxon would’ve been an unthinkable target for activists given its size. In an effort to get large investors on board with the campaign, CalSTRS reached out to Larry Fink, BlackRock’s CEO, although the article notes the pension fund hasn’t received a reply. But Exxon’s shareholders have been at the forefront of climate-related shareholder proposals before. In 2017, shareholders approved a climate change proposal at Exxon, and back then climate proposals weren’t seeing much success.
Audit Fees: Effect of Negative Auditor Attestation Persists for Several Years
Audit Analytics recently released a report looking back at 18 years of audit and non-audit fees paid by accelerated and large accelerated filers. The report covers the period 2002 through 2019 and is heavy on data – but what I found interesting was an analysis of fees paid by 105 companies that disclosed ineffective ICFR during FY 2016. Although one would expect that an adverse auditor attestation could lead to increased fees, the report says those higher fees persist for several years. Here’s an excerpt:
Companies that disclosed an adverse auditor attestation paid more non-audit fees, including audit related, the year of the disclosure. These same companies experienced an increase in audit fees that peaked the year after the disclosure. An increase in fees attributed to negative auditor attestation persists for at least three years after the disclosure when fees, excluding audit related, ranged 54-83% higher than average and when including audit related, were 48-76% higher than average.
The report also includes detailed trend data showing the split between audit and non-audit fees. In a bit of good news, the amount of non-audit fees was the lowest ever paid in 2019 at $112 per $1 million in revenue if audit related fees were included and $58 if excluded. Average audit fees paid per $1 million in revenue dropped to $495 in 2019 after several years of running above $500.
Benefits of Audit Partner Rotation?
The recent SEC amendments to the auditor independence rules generally provide more flexibility to companies when selecting an auditor. One topic about auditors that’s been quiet for a while now, is “auditor rotation.” One reason could be because the five-year rotation requirement in the United States for audit engagement partners seems to have quieted calls for auditor rotation. Now findings from two recent studies suggest auditor partner rotation doesn’t deliver many benefits.
A CFO.com article discusses findings from two studies that analyzed the two most frequent reasons in favor of auditor rotation: assumptions that personal ties developed over time between auditors and clients can compromise the accountants’ independence and as a result, audit quality; and that mandating rotations brings a fresh look to audits that likely enhances quality of reporting.
The first study from Auditing: A Journal of Practice and Theory found that there was no significant fall-off in reporting quality over the course of partners’ five-year tenures and little or no evidence that fresh looks make for improved audits. If anything, the study found a decline in audit quality with a new engagement partner, possibly reflecting less knowledge about the client than the previous engagement partner.
In another study, this one from Accounting Review, findings indicated audit quality over the five-year rotation cycle is unrelated to the length of the audit partner’s tenure with clients, except for restatement announcements, which were more frequent in the first two years after rotation. This study suggests there is a benefit of fresh looks but at the same time found that other important indicators of audit quality do not. The researchers concluded that for the average client engagement, mandatory [partner] rotation appears to be short enough to prevent capture or complacency and at the same time finding only limited evidence of fresh-look benefits – potentially because audit firms anticipate and invest resources to reduce potential disruption from mandatory audit partner rotations.
With these two studies suggesting audit partner rotation has little impact on overall audit quality, perhaps the real benefit of mandatory audit partner rotation is that it calms those who’ve called for periodic audit-firm rotation.
Efforts are ramping up for year-end reporting and one topic many companies are starting to get their arms around is the new human capital resources disclosure. We’ve been posting memos about the new HCR disclosure requirement in our “Human Capital Management” and “Regulation S-K” Practice Areas and one memo that can help shed some light on how companies are approaching the disclosure requirement is this FW Cook memo. The memo summarizes a review of the first 50 Form 10-Ks filed by large companies after November 8th and provides some high-level observations:
Length: Word length varied dramatically, ranging from nine words to 1,582 words. The median disclosure was 369 words long.
Topics: FW Cook decided to answer the question about which topics were covered by more extensive disclosures by only giving credit for a topic if the discussion was more than a brief mention and only gave credit for a factor if the discussion was significant. The test for ‘significance’ required a level of detail that made discussions more than generic. The results of the review suggest 13 common disclosure topics – they’re listed in order of prevalence along with the percent of disclosures describing each topic:
In terms of how human capital resource disclosures might evolve, FW Cook predicts that the disclosures will increase in length as the filing season progresses. This is not an assertion that longer disclosures are required, but more of an observation that legally required disclosures tend to grow, not shrink. We’ve all seen how this can happen – the memo notes that when one company sees how its competitor spends 100 words extolling the importance of its culture or diversity efforts, etc., there may a strong tendency to respond in kind.
With the disclosure being principles-based, each company’s human capital resource disclosure will of course be tailored to its specific circumstances. Beyond the early “trend” information about disclosure length and topics, the report includes examples of these early disclosures that might help spur ideas as companies start preparing human capital resource disclosure. For more sample human capital resource disclosures, see this blog from The SEC Institute.
Quick Survey: Human Capital Management – And Resources to Help Prepare Your HCM Disclosure!
To help understand how human capital management disclosure topics might vary by market-cap, we’ve expanded our HCM survey to capture the data this way. Check it out and enter the topics your company is considering including in its disclosure.
