Here’s the results from our recent survey on compensation committee minutes & consultants:
1. When it comes to providing comp committee minutes to consultants, our company:
– Provides upon request in electronic form only – 41%
– Provides upon request in paper form only – 5%
– Provides upon request in both electronic & paper form – 11%
– Doesn’t provide – but does allow inspection onsite – 25%
– Doesn’t provide – nor allow inspection onsite – 18%
2. Our compensation consultants ask for copies – or inspection – of committee minutes:
– Prior to each meeting – 12%
– Once a year – 4%
– On irregular basis – 25%
– They never ask for them- 59%
Section 2(a)(19)(C) of the Securities Act says that a company can lose “emerging growth company” status by issuing more than $1 billion in non-convertible debt over a rolling 3-year period. This MoFo blog reviews what counts – and what doesn’t – when determining whether you’re over the limit. This excerpt addresses the treatment of asset-backed securities:
In calculating whether an issuer exceeds this $1 billion debt limit, the SEC Staff has interpreted all non-convertible debt securities issued by an issuer and any of its consolidated subsidiaries, including any debt securities issued by such issuer’s securitization vehicles, to count against the $1 billion debt limit. As a result, asset-backed securities that are considered non-recourse debt and consolidated on a parent issuer’s financial statements for accounting purposes should be included when calculating the applicability of the $1 billion debt limit.
Issuers do get to exclude debt issued in an A/B exchange offer, since this involves simply replacing those securities with ones that are identical in all respects – except for their registered status.
Audit Reports: “Dear Audit Committee Member”
This recent blog from Davis Polk’s Ning Chiu provides a good example – in the form of a “Dear Audit Committee Member” letter – of a user-friendly way to communicate with directors about the PCAOB’s decision to modify the form of the auditor’s report to address “critical audit matters.”
Yesterday, a unanimous US Supreme Court held that the 5-year statute of limitations contained in 28 U.S.C. §2462 applies to SEC disgorgement claims. Justice Sotomayor’s opinion in Kokesh v. SEC concluded that since disgorgement involved violations of “public laws” (i.e., the harm was done to the United States, not an individual) & was punitive and non-compensatory, it was a “penalty” subject to the 5-year limitations period in the statute.
Disgorgement is a big part of the SEC’s enforcement arsenal – in fiscal 2016, the SEC obtained disgorgement orders totaling $2.8 billion, compared to only $1.3 billion in civil penalties. Nothing in the Supreme Court’s opinion prohibits the SEC from continuing to seek a disgorgement remedy, but now it’s got to keep an eye on the clock. We’re posting memos in our “SEC Enforcement” Practice Area.
The backstory in the Kokesh case may be more interesting than the opinion itself. I take that back – actually, it’s a lot more interesting.
Compliance Consultants: Coming to An Insider Trading Case Near You?
While we’re on the topic of remedies, this Drinker Biddle blog points out that a unique aspect of the SEC’s insider trading settlement with Leon Cooperman & his Omega Advisors hedge fund was the requirement that the firm retain a “compliance consultant.” Compliance consultants are a tool that the Division of Enforcement has used in other settings, but this is their first use in an insider trading case.
The blog points out that this requirement sets a precedent that could have a major impact on future cases:
The SEC’s use of this remedy may allow it to “lower the bar” for insider trading investigations knowing that it may be able to obtain settlements such as this which do not result in a suspension or bar. While the avoidance of the suspension or bar is of course paramount to individuals, an undertaking such as this involves an invasive-type relationship with a third party who – while “independent” – may have an allegiance to a regulator or a court.
The costs of a consultant – which are not insignificant – are always borne by the defendant firm, and the blog says it’s not a stretch to describe them as additional/hidden monetary penalties that over a period of years “may increase to hundreds of thousands of dollars or more.” The adoption of this new enforcement tool may turn out to be bad news for individuals and entities whom the SEC may not have considered charging before this settlement.
Our Executive Pay Conferences: Last Chance for 20% Early Bird Discount
1. The SEC All-Stars: A Frank Conversation
2. The SEC All-Stars: The Bleeding Edge
3. The Investors Speak
4. Navigating ISS & Glass Lewis
5. Parsing Pay Ratio Disclosures: US-Only Workforces
6. Parsing Pay Ratio Disclosures: Global Workforces
7. Pay Ratio: Sampling & Other Data Issues
8. Pay Ratio: The In-House Perspective
9. Pay Ratio: How to Handle PR & Employee Fallout
10. Keynote: A Conversation with Nell Minow
11. Proxy Access: Tackling the Challenges
12. Clawbacks: What to Do Now
13. Dealing with the Complexities of Perks
14. The Big Kahuna: Your Burning Questions Answered
15. Hot Topics: 50 Practical Nuggets in 60 Minutes
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This Bloomberg article says that the number of CEOs in the US & Canada fired for ethical lapses has more than doubled in the past five years:
Fourteen North American CEOs were ousted for ethical lapses from 2012 to 2016, compared with six in the preceding five-year period, according to a study of 2,500 global companies by PwC. The researchers included executives who left because of their own improper conduct or that of employees, so if, for example, a CEO was forced out because of widespread fraud in the organization, that counted as well.
The 102% increase in North American firings of wayward CEOs compares to an overall global increase of 36%. Western Europe saw these CEO terminations increase by 41%, while BRICS countries saw a 132% increase. According to one of the study’s authors, the crackdown reflects a number of factors, including shareholder activism & increased director exposure to liability for corporate malfeasance.
Did the CEO Quit – or Was it a Resig-firing?
Reading the tea leaves to determine whether a CEO was forced out is sometimes difficult. Corporate transition announcements tend to be ambiguous, and investors are often left to sort out for themselves whether the CEO was fired or resigned.
Now financial journalist Daniel Schauber has come up with a model – the “Push-out Score” – that he contends will help shed light on whether a CEO left voluntarily, or was shoved out the door. Here’s an excerpt from a Stanford article describing the model:
Unlike models that strictly categorize executive departures as forced or voluntary, the Push-out Score produces a score on a scale of 0 to 10 that amounts to a confidence level that the CEO was compelled to leave. (A score of 0 indicates that it is “not at all” likely that the executive was terminated or pressured to resign; a score of 10 indicates that termination is “evident.”)
The Push-out Score incorporates publicly available data along nine dimensions, including the form & language of the announcement, the time between announcement & departure, the official reason given for the change, the circumstances surrounding it and the nature of the succession. The model also takes into account extenuating circumstances and judgment, and assigns a score based on its assessment of the various dimensions reviewed.
As one of my law school profs was fond of saying in response to my brilliant insights – “so what?” Well, it turns out that there’s a correlation between a high Push-out Score and increased volatility (both positive & negative) in the market for the company’s stock. So the article suggests that this model may provide investors & companies with important information to assist in interpreting the market’s reaction to a CEO departure:
A positive reaction might indicate that shareholders approve of a decision to push out the CEO because of the potential for operational improvements or future sale of the company. On the other hand, a negative reaction to a high Push-out Score situation might indicate that shareholders view a forced termination as evidence of deeper operating, financial, or governance problems, or that shareholders disapprove of the decision to fire the CEO.
Keith Higgins: Back at Ropes & Gray!
After a nice healthy break, former Corp Fin Director Keith Higgins has resurfaced at his old firm – Ropes & Gray – to serve as Chair of that firm’s corporate department. Good to see Keith back in the saddle!
Yesterday, after nearly a decade since the project kicked off, the PCAOB adopted a new standard for audit reports – “AS #3101.” Weighs in at 236 pages. The SEC still needs to approve the standard.
Among other items, audit reports will need to describe the auditor’s take on “critical audit matters” that are communicated to the audit committee. These are matters that relate to material financial statement accounts or disclosures & involve especially complex judgment. Here’s the PCAOB’s press release. And see this Jack Ciesielski blog – and this WSJ article. We’ll be posting memos in our “Audit Reports” Practice Area.
This represents the first major revision to the audit report in over 50 years. It requires a major revision in how auditors think about what – and how – they communicate to boards and investors. It requires increased transparency on the part of auditors, who will need to adapt to the change – or face the consequences. This is a positive development for both investors and auditors if done right.
If approved by the SEC, parts of the rule – relating to the auditor’s tenure & role – would be effective for 2018. And the requirement to describe critical accounting matters would be effective for large accelerated filers beginning mid-2019; all other companies starting in 2021.
Here’s an excerpt from the statement by PCAOB Board Member Steven Harris:
Today’s action is a direct response to calls from investors for the Board to expand the auditor’s report to include information about the difficult parts of the audit, and information that the auditor gained from the audit that he or she would like to know as an investor – basically what “kept the auditor awake at night.”
Audit Reports: What Other Countries Already Do
For an idea of what the newly-enhanced audit report in the USA will look like, we can look to the UK & other countries that already have similar requirements. See this excerpt from Deloitte’s 2016 report on Marks and Spencer, courtesy of this SEC Institute Blog:
We performed a full scope audit on seven components representing 99% of the Group’s revenue, 90% of the Group’s profit before tax and 90% of the Group’s net assets. During our first year as auditor of the Group, we visited all significant locations. For our second year, we have implemented a rotational approach to these visits. We determined materiality for the Group to be £30 million. We reported all audit differences in excess of £1 million.
PCAOB’s Proposal: Auditor’s Specialist Use
Yesterday, in this 142-page proposing release, the PCAOB proposed to strengthen requirements that would apply when auditors use the work of specialists in an audit. Here’s the PCAOB’s press release. Comments are due by August 30th.
PCAOB’s Proposal: Auditor’s Estimates (Including Fair Value Measurements)
Yesterday, in this 152-page proposing release, the PCAOB proposed to enhance the requirements that apply when auditing accounting estimates, including fair value measurements. Here’s the PCAOB’s press release. Comments are due by August 30th.
We haven’t seen many successful climate change proposals in past years, but this year is different. Last week, Broc blogged about the proposal at Occidental Petroleum for a “2-degree scenario analysis” – notably passing with BlackRock’s support. Yesterday, ExxonMobil shareholders approved a similar proposal – with 62% supporting! – bringing the tally to three major companies this month (PPL being the third).
This Washington Post article suggests that in addition to BlackRock & State Street, Vanguard also voted in favor of the ExxonMobil proposal – which would be consistent with its recently updated E&S policies. But as noted in this article, this would be a break for Vanguard because they rarely challenge management. This new trend in institutional investor voting practices means we’ll probably see many more climate proposals in the near future.
As far as PPL, Oxy & ExxonMobil, this excerpt from Cydney Posner’s blog explains the next steps:
As is typical, these proposals are all precatory, but, as you know, companies do feel the heat when a proposal receives a majority vote in favor. According to Reuters, a PPL spokesman said that the company “is committed to sustainable energy” and that the board “‘will carefully consider the results and determine the best path forward.’”
Reuters also reported that the ExxonMobil CEO indicated that “the board would review the request.” Bloomberg BNA reported that the Chair at Occidental acknowledged shareholder support for the proposal and said that the company looked “forward to continuing our shareholder engagement on the topic and providing additional disclosure about the company’s assessment and management of climate-related risks and opportunities.” Reuters also noted that proposals have been submitted at several other companies but were withdrawn the companies conceded to take steps the proponents viewed as acceptable.
Are “Operating Metrics” the New Non-GAAP?
Earlier this month, SEC Chief Accountant Wes Bricker remarked that lessons from recent non-GAAP scrutiny also apply to disclosure of operating metrics, forecasts & other kinds of supplemental information:
I believe that much of the recent experience with non-GAAP financial metrics also provides lessons for other kinds of reporting by companies. Similar to non-GAAP financial reporting, key operating metrics and forecasts may also be distorted via bias – for example, painting a potentially misleading picture – error, or fraud, all of which undermine the credibility of the reporting. Therefore, it is important that companies proactively and thoughtfully address risks to their reporting.
Companies should first understand the other information being reported, including how operating metrics are defined.
Companies then should have adequate disclosure controls and procedures in place. In some respects, these other reporting processes may require more steps than some GAAP processes, not fewer. This is because, for example, a company’s other reporting does not have the benefit of standard-setting due process, which solicits stakeholder views on a representationally faithful manner of reporting a particular event or transaction and the types of disclosures needed by financial statement users. When a company determines a supplemental reporting framework, it does not have the benefit of a standard setter’s due process and must look to its own policies, audit committee, and other stakeholders for input.
Finally, companies should consider whether it would be beneficial to obtain insight into their other reporting processes from those outside of the finance and investor relations functions. Sometimes a fresh perspective can provide new insight into potential risks and ways to maintain the effective operation of essential controls and procedures.
This blog from Cooley’s Cydney Posner delves into more details. She notes that the SEC’s accounting staff used the big AICPA conference last year to forewarn of their impending crackdown on misleading non-GAAP practices. We’ve been talking about Corp Fin’s updated CDIs – and the related comment letters and Enforcement sweep – ever since.
Our June Eminders is Posted!
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Reportedly, SEC Chair Jay Clayton plans to tap one of his former Sullivan & Cromwell partners to lead the SEC’s Enforcement Division – Steve Peikin. Sounds like Steve will be the co-head with Stephanie Avakian, who was elevated from Deputy Director to Acting Director back in December. Here’s an excerpt from this WSJ article by Dave Michaels:
The decision to hire two top managers for the SEC’s enforcement division would ease some of the issues created by Mr. Peikin’s past work for Wall Street. Mr. Peikin has done high-profile defense work for Barclays PLC and Goldman Sachs Group Inc. Under SEC ethics rules, he would be barred for one year from supervising any cases that affect Goldman or other clients of Sullivan & Cromwell.
Mr. Peikin, a graduate of Harvard Law School, leads the criminal defense and investigations group at Sullivan & Cromwell. From 1996 to 2004 he was an assistant U.S. attorney in Manhattan, where he oversaw the Southern District of New York’s securities and commodities task force. During that era, Mr. Peikin earned headlines for his prosecution of star technology banker Frank Quattrone, who was convicted of obstructing a government investigation and witness tampering, although an appeals court later threw out the judgment.
More recently, Mr. Peikin was part of the defense team for futures trader Michael Coscia, who became the first U.S. trader criminally convicted of spoofing, a fraudulent trading strategy. Spoofing, which became illegal under the 2010 Dodd-Frank Act, involves placing orders that one doesn’t intend to fulfill, in an effort to trick other traders into altering their prices in a direction that benefits the spoofer. Mr. Coscia’s case is now pending before a federal appeals court.
This wouldn’t be the first time the Enforcement Division had Co-Directors. Broc blogged about Mary Jo White’s decision to “split the baby” back in 2013. The use of co-heads solves any conflict issues caused by bringing in someone from outside the agency to lead the Division…
D&O Insurance: Structuring Concerns
No director wants sub-par insurance coverage – and counsel is at least partially on the hook if that happens. This blog by Kevin LaCroix explains why program structure matters & how competing interests affect coverage decisions. Here’s the intro:
Most D&O insurance buyers understand the critical importance of limits selection – that is, deciding how much insurance to buy. But an equally important question involves the issue of program structure – that is, how the insurance program is put together.
Many insurance buyers understand that, in order to be able to purchase an insurance program with the desired limits of liability, their D&O insurance will be structured with a layer of primary insurance and one or more layers of excess insurance. In addition, these days many D&O insurance buyers also purchase an additional layer – usually on the top of program – of Side A Difference in Condition (DIC) insurance.
As noted in a recent post on the “Pillsbury Policyholder Pulse” blog, no coverage may be less understood than the Side A DIC policy. But even if frequently misunderstood, the coverage provides corporate directors and officers an important safety net. Moreover, there are other important D&O insurance program structure issues, beyond just the need for Side A DIC insurance.
D&O Insurance: What Startups Need To Know
D&O insurance is also important for private companies – more than 25% have had claims in the last three years & the average loss was $387,000. For early-stage ventures, it’s purchased around the time the company gets outside investors & directors, or at the time of hiring employees – but the list of potential claimants can also include customers, vendors, suppliers, creditors & others.
This Morrison & Foerster article gives tips on deciding what coverage to get – and when & how to get it (also see this blog by Kevin LaCroix). Here’s some intel on how coverage & premiums are determined:
A startup can plan on approximately $15,000 in premiums for $1 million of coverage, depending on market condition & policy wording. Specific premium amounts are largely determined by the company’s current financial statements – income statement & balance sheet. Any prior claims will also have a negative impact on pricing.
It’s critical to be able to negotiate policy wording to extract the broadest coverage grants for the business. Policy premiums may vary among insurance providers, but a startup can expect to pay higher premiums for greater coverage.
Back in March, the SEC adopted new rule & form amendments requiring that the exhibit index in registration statements & ’34 Act reports contain links to the exhibits that are listed – & that these filings be made in HTML. We’ve posted in memos in our “Exhibits” Practice Area.
The effective date is delayed for most companies until September 1st – and for smaller reporting companies and non-accelerated filers that use the ASCII format, until September 1, 2018. But companies can comply earlier of course – and some indeed have. Here’s some examples from the most recent group of Form 10-Qs – note the different approaches:
Links to Exhibits: SEC Staff Still Needs to Update Edgar Manual
Interestingly, these companies have experimented by including links to their exhibits voluntarily – without the benefit of an updated Edgar Manual. Some members told me that the updated Manual was expected in mid-May – but we haven’t seen that happen yet (nor do I think we’ll see anything soon). Without the updated Manual, companies are lacking clear instructions on how to do accomplish what the SEC will be expecting…
Per Weil Gotshal’s Howard Dicker, here are other issues that might be addressed by the Staff:
1. Amended Reg S-K Item 601(a)(2) requires an “Exhibit Index” appearing before the signatures. Current rule is immediately preceding the exhibits.
2. For exhibits that have been previously filed, what should companies do about (a) exhibits that were filed in ASCII and (b) exhibits that are not separate files (e.g., pre-2000 when the exhibits and the report were all included in one single ASCII file.
How To Fix “In Progress” Edgar Filings
In the latest issue of Edgar Filer Support’s newsletter, there’s a discussion of how to handle “in progress” Edgar filings. Here are 3 pointers:
1. If your filing shows this status for 4 hours or more, there might be a technical issue with your CIK, tax ID or filing fee.
2. If you see the “in progress” status for over 12 hours, call Edgar Filer Support at 202.551.8900.
3. Your filing will usually show up with the original filing date once the issue is resolved.
One of the more challenging aspects of this new job is learning how to blog. Luckily, I’m learning from one of the best. Here’s 5 things I’ve learned from Broc so far:
1. Write like you speak. I’m human. You’re human.
2. Get to the point. People tend to scan online rather than straight read.
3. Show a little personality.
4. But don’t show too much personality.
5. Have fun!
Annual Meetings: Another Season in the Books!
This year, the number of annual meetings peaked on May 18th. Time for your two-second break…
Last month, John blogged about disclosing material changes to ICFR that result from the new revenue recognition standard – which takes effect at the start of next year. It’s also worth noting that revenue recognition is one of the most common accounting issues that trigger a material weakness. And having a material weakness is more than just embarrassing – SEC Chief Accountant Wes Bricker cited these nasty consequences in his recent speech:
– Companies disclosing internal control deficiencies have credit spreads on loans about 28 basis points higher than that for companies without internal control deficiencies
– After disclosing an internal control deficiency for the first time, companies experience a significant increase in cost of equity, averaging about 93 basis points
According to this Deloitte memo, companies can avoid a material weakness by identifying controls necessary to make judgments under the new standard. Here’s a teaser:
The new revenue standard requires companies to apply a five-step model for recognizing revenue. As a result of the five steps, it is possible that new financial reporting risks will emerge, including new or modified fraud risks, and that new processes and internal controls will be required. Companies will therefore need to consider these new risks and how to change or modify internal controls to address the new risks.
For example, in applying the five-step model, management will need to make significant judgments and estimates (e.g., the determination of variable consideration and whether to constrain variable consideration). It is critical for management to (1) evaluate the risks of material misstatement associated with these judgments and estimates, (2) design and implement controls to address those risks, and (3) maintain documentation that supports the assumptions and judgments that underpin its estimates.
You’ll need to consider one-time controls that relate to implementing the new standard as well as ongoing controls to track information and support sound revenue recognition judgments going forward. And remember – strong controls are also a “must” for your pre-adoption transition disclosures…
Revenue Recognition: Enhance All Of Your Revenue Disclosures…
This blog from Cydney Posner digs in to the myriad of revenue recognition disclosure issues that are coming our way. I blogged last month about transition disclosures – but those are just the tip of the iceberg. In recent remarks, Sylvia Alicea of the SEC’s Office of Chief Accountant explained:
The disclosures required by the new standard are designed to allow an investor to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers.
The pertinent facts and related reasonable judgments related to a registrant’s contracts with customers, including the significant judgments made in applying the principles of the new revenue standard, should be disclosed to better inform investors’ decisions.
This disclosure will be different & more detailed than what currently exists – and it’s best to think through it before you face a looming reporting deadline.
Revenue Recognition: Impact on Contracts
Here’s a friendly reminder that you should already be incorporating the new revenue recognition concepts in your contracts. This blog by Steve Quinlivan elaborates on drafting tips that align with the 5 steps outlined in the new standard. Here are a few things to watch for:
– In some situations, you might have to combine contracts entered into around the same time with the same customer & account for them as a single contract
– If the contract involves both goods & services – and you want to separately recognize revenue for these deliverables – make sure to draft them as distinct obligations and allocate the contract price
– Variable consideration can make it tricky to estimate & recognize revenue
– Make sure your team understands that performance under the contract – not necessarily timing of payments – triggers revenue recognition
For even more detail on these points, take a look at this speech from Sylvia Alicea of the SEC’s Office of Chief Accountant.
I recommend that you watch my quasi-parody below before you watch the SEC’s video. When I fed my buddies their lines before we taped, I didn’t inform them that this was a spoof. They thought I had written the lines as a joke. After we taped – in just one take! – I showed them that the lines were actually drawn from the SEC’s real video. I call my video a “quasi-parody” because I think we showed more teamwork in creating our version. Let us know your feelings about them in the poll below…
