Yesterday, the PCAOB Staff issued implementation guidance addressing the changes in audit reports that are mandated under its new standard – AS 3101. As Liz blogged at the time of the standard’s adoption, AS 3101 requires a major revision in how auditors think about what – and how – they communicate to boards & investors.
The PCAOB Staff’s new guidance addresses both format & content and includes an annotated version of the new auditor’s report. Here’s an excerpt addressing the most controversial aspect of the new standard – the requirement that the report include a discussion of “Critical Audit Matters” (known as “CAMs”):
When the relevant requirements take effect, auditors of certain issuers will be required to include in the auditor’s report a communication regarding CAMs. CAMs are defined under AS 3101 as matters arising from the audit of the financial statements that have been communicated or were required to be communicated to the audit committee and that (1) relate to accounts or disclosures that are material to the financial statements and (2) involved especially challenging subjective, or complex auditor judgment.
The communication of CAMs is not required for audits of emerging growth companies; brokers and dealers; investment companies other than business development companies; and employee stock purchase, savings, and similar plans.
CAMs may be included voluntarily before the effective date or for entities for which the requirements do not apply. In advance of implementation, auditors may want to discuss the new CAM requirements with management and audit committees.
With the exception of the provisions relating to CAMs, the new standard goes into effect for audits of fiscal years ending on or after December 15, 2017. For large accelerated filers, the provisions relating to CAMs go into effect for audits of fiscal years ending on or after June 30, 2019. They go into effect for all other filers for audits of fiscal years ending on or after December 15, 2020.
Yesterday, PCAOB Chair Jim Doty delivered this speech entitled “The PCAOB’s Initiatives to Bolster Investor Trust in the Audit”…
Still More on “GAAP Means Nothing to Me”. . .
As another follow-up to my recent blog about institutional investors’ increasing disdain for GAAP, Broc pointed me in the direction of a series of articles in “Accounting Today” that say that it’s time for a paradigm shift in the way the accountants & standard setters approach GAAP. Why? According to the authors – two accounting profs – it’s because GAAP simply isn’t very useful:
We’re convinced that the consequence of practitioners’ inability to change is a status quo that is an unserviceable hodge-podge remnant of out-of-date practices. Specifically, we find today’s GAAP financial statements are as far removed from reports that meet the capital markets’ needs as hand-cranked telephones differ from smartphones. It follows, then, that financial accounting is stunningly ready for disruption.
Toward that end, we’re offering up paradigm-challenging truths to suggest that today’s financial accounting is bound to collapse. So, why would it?
It’s because the inability of practitioners to question their paradigm also keeps them from actually serving accounting’s ostensible information-providing purpose. Although they say they aim to present useful information, many inconsistencies between those words and their actions prove otherwise. Ultimately, their choices always favor what’s useful to themselves, not users.
Subsequent articles in the series drill down into some of the specific problems they have with the current financial reporting paradigm.
Corp Fin Updates “Financial Reporting Manual” for New Accounting Standards
On Friday, as noted in this Cooley blog, Corp Fin updated its “Financial Reporting Manual” to revise guidance on the pro forma impact of new accounting standards, address adoption of new accounting standards upon termination of EGC status, and clarify the effective date of the new revenue recognition & lease accounting standards for certain entities.
Tune in tomorrow for the CompensationStandards.com webcast — “Your Upcoming Pay Ratio Disclosures” – to hear Compensia’s Mark Borges, Gibson Dunn’s Ron Mueller, Wilson Sonsini’s Dave Thomas and Cooley’s Amy Wood discuss all the latest about how to comply with the new pay ratio rule.
PCAOB Inspections: Internal Controls #1 Concern at Companies
Recently, the PCAOB released this report about its observations of inspections of auditor clients in 2016. Deficiencies relating to internal controls continue to be the most frequently-identified deficiency. Bear in mind that only a very small portion of the total number of public company audits are actually inspected – and only a portion of the selected audits, not the entire audit, is actually inspected…
By the way, I think the PCAOB’s release of inspection reports this year is behind the schedule of past years for some auditors. That might not be good news for those auditors…
Transcript: “Evolution of the SEC’s OMA”
We have posted the transcript for our recent DealLawyers.com webcast: “Evolution of the SEC’s OMA.”
Yesterday, Corp Fin announced that its Chief Accountant Mark Kronforst will leave in about a month after serving in that role for 4 years (and in Corp Fin for 14). Kyle Moffatt will serve as Acting Chief Accountant upon Mark’s departure…
D&O Questionnaires: How to Address Board Diversity?
A few months ago, a member posted this question in our “Q&A Forum” (#9223): “We received the letter from the New York City Pension Funds requesting a director matrix that discloses gender and race/ethnicity of the directors. If companies do end up agreeing to this, are they including in the questionnaire a request for how the director self-identifies by race/ethnicity (and perhaps even LGBTQ status)?”
This was Liz’s answer:
I wouldn’t add this type of question to the D&O questionnaire without first talking to the board’s governance committee about the NYC letter and coming up with a plan. Part of that plan may be to include a matrix in the proxy statement, or at least have some general disclosure about the board’s diversity. If that’s what is agreed on, then you could include this in the questionnaire and explain the context to the board. They will also need to understand that some people may decline to answer. These issues can be complex.
And one thing to keep in mind during these discussions is that while boards may support diversity and the female and minority directors in particular may believe in its importance, no one wants to feel like they are on the board for that sole reason or that there is even any suggestion of that. The NYC Comptroller’s initiative is a new development and we’ll be watching how practices evolve…
Our December Eminders is Posted!
We have posted the December issue of our complimentary monthly email newsletter. Sign up today to receive it by simply inputting your email address!
Sorry. I couldn’t help myself. The title of this blog was the title of a fictional play mentioned in last night’s episode of “Modern Family.” Not related at all to the title of this blog comes this news about a possible new PCAOB Chair, Bill Duhnke – who’s a veteran Staffer for Senator Richard Shelby (who used to be the Senate Banking Committee Chair). Here’s the intro from this Bloomberg article:
A little-known Republican Senate aide is in line to lead the accounting industry’s watchdog, setting up an official who lacks experience in the auditing profession for one of the highest-paying jobs in financial regulation. William Duhnke, a veteran staff member for former Senate Banking Committee Chairman Richard Shelby, is on track to be selected to become chairman of the Public Company Accounting Oversight Board, according to four people familiar with the matter. An announcement by Securities and Exchange Commission Chairman Jay Clayton could be made in the coming weeks, said one of the people, who like the others asked that they not be named discussing the plan.
The job is seen as one of the most attractive regulatory roles in Washington because it pays more than $670,000 per year — well above the president’s $400,000 salary. The selection of Duhnke, whose name has been circulating as a possible pick for more than a year, would likely be controversial among investor advocates concerned that he would promote a pro-business agenda.
Do You Need a Risk Factor for the Proposed Tax Reform?
We love blogging about risk factors – they can be tough judgment calls. And we are constantly updating our “Risk Factors Handbook” as a result. Anyway, this Dorsey blog by Kimberley Anderson gives us some nice “food for thought” (don’t forget to tailor your risk factors to your own company’s circumstances):
Tax reform efforts by Congress are ongoing, and the substance of the tax bills remains fluid. However, for foreign corporations with U.S. operations, there are some specific potential risks to consider, such as additional limitations on the deductibility of interest, the migration from a “worldwide” system of taxation to a territorial system, and the use of certain border adjustments.
Foreign corporations with U.S. operations may want to consider including a risk factor in their periodic reports or offering documents regarding the potential impact of U.S. tax reform. A sample risk factor (based on the current iteration of the tax bills) is below. As the tax bills are amended during the legislative process, the language of the risk factor may need to be edited prior to use.
Possible U.S. federal income tax reform could adversely affect us.
The new U.S. administration and certain members of the U.S. House of Representatives have stated that one of their top legislative priorities is significant reform of the Internal Revenue Code. Proposals by members of Congress have included, among other things, changes to U.S. federal tax rates, imposing significant additional limitations on the deductibility of interest, allowing for the expensing of capital expenditures, the migration from a “worldwide” system of taxation to a territorial system, and the use of certain border adjustments. There is substantial uncertainty regarding both the timing and the details of any such tax reform. The impact of any potential tax reform on our business and on holders of our common shares is uncertain and could be adverse. [Prospective investors should consult their own tax advisors regarding potential changes in U.S. tax laws.]
Poll: Does the PCAOB Chair Need Deep Auditing Experience?
Please take a moment to anonymously indicate whether you think the PCAOB Chair should have extensive auditing experience:
‘Tis the season for the “Big 4” accounting firms to weigh-in on Corp Fin comment priorities. Earlier this month, we blogged about EY’s take on the topic – and now Deloitte’s weighed in with its own study on Corp Fin comments for the 2016-2017 review period. The study found that the top 10 areas for comments were:
– Non-GAAP measures
– MD&A
– Fair value
– Segment reporting
– Revenue recognition
– Intangible assets & goodwill
– Income taxes
– State sponsors of terrorism
– Signatures, exhibits & agreements
– Acquisitions, mergers & business combinations
The list includes plenty of the usual suspects, but one of these things is clearly not like the others – here’s what the study says about comments addressing state sponsors of terrorism:
This category is new to the top 10 this year. The SEC staff has increased its focus on registrants that do business with countries designated by the U.S. State Department as state sponsors of terrorism, including Iran, Sudan, and Syria. SEC staff comments focus on disclosure about (1) the nature and extent of these contacts and (2) quantitative and qualitative factors about such activities.
The study includes examples of comments that the Staff has issued to companies disclosing business in these countries.
More on “Farewell to Corp Fin Giant, Bill Morley”
Recently, I blogged that Bill Morley passed away. We now have information about his memorial: “Glory Days Restaurant” in Edgewater, Maryland – this Friday, December 1st from 6-10 pm. It’s informal in a private room. Please RSVP to Marty Dunn if you (& others you know) plan on going as they need a head count.
Here are a few more remembrances:
– Marty Dunn, who worked with Bill for several decades, notes: “From the day I arrived at the SEC in 1988, I knew what the goal was. It was to be Bill. He had the ’33 and ’34 (and ’39) Act in his being. He understood them all. Their purpose was in his soul. He taught us all so much while being so humble. He said to me ‘our job is important, we’re not.’ That always stuck with me. Mr. Carter and Mr. Morley were incredible mentors & teachers. There is an entire generation of Corp Fin lawyers who appreciate their contribution to our careers. Bless you, Bill.”
– Paul Dudek, who left Corp Fin after 22 years last year, notes: “Thanks for sharing the sad news about Bill, and the stories and the picture. He was outstanding in so many ways, as a person, as a securities lawyer, as a manager, and much more. I think at some level he was a model for me staying in Corp Fin for so long, a shining example of how to carry out the mission of investor protection through full and fair disclosure, and all the corollaries to that simple statement, through thick and thin.”
– Stan Keller notes: “Here’s one outside perspective on Bill. For so many of us practicing on the outside, Bill was for so long the face of the SEC and a good one at that. Bill treated you as a professional with respect and was always willing to listen to your position and share his vast knowledge of the law and the lore with you. You knew that you would get a fair hearing and a thoughtful, considered response. We learned a lot about securities law from Bill in this way and we learned about the agency. Bill helped instill the Corp Fin Staff ethic of the SEC as being a service agency, which continues to this day. We remember him with fondness, respect and appreciation.”
Farewell to Mort Koeppel
I’m also sad to report that Mort Koeppel also passed away recently. Mort retired in the early ’80s as an Associate Director in Corp Fin after 40 years at the SEC. He lived nearly another 40 years, passing away at 98. His son – Jeff Koeppel – who also served in Corp Fin a while back. Here’s a picture of Mort’s branch back in the day: (seated) Mort Koeppel; (standing, left to right) Bill Carter, Joe Hock, Becky Fleck, Alan Cohen, Jim McCabe, Paul Belvin, Letty Lynn, Mark Warner, Tom Klee & Laurence Lese:
As noted on their blog, Glass Lewis posted 54 pages of ’18 policy updates last week, which includes a summary of the policy changes on the first page (we’re posting memos in our “Proxy Advisors” Practice Area). As the blog notes, the updates include:
– Feature increased discussion of board gender diversity in our reports, including a phased policy that will see nomination committee chairs targeted with against/withhold recommendations if boards do not include a female director, or provide a cogent explanation for their absence, by 2019;
– Set out our phased policy on virtual-only meetings, which from 2019 will hold governance committees accountable if shareholders are not offered the same rights and opportunities to participate as at a physical meeting;
– Address the emergence of proxy access in international markets, including Canada, and explain our rationale for approaching such proposals in the context of the regulatory landscape;
– Harmonize our approach in areas such as board responsiveness and dual-class share structures, including within the context of recent IPOs and spin-offs; and
– Clarify our methodologies, including for our pay-for-performance (P4P) grades and treatment of outside commitments for NEOs, and on shareholder proposals relating to climate change and proxy access.
Whistleblowers: SEC Paid $50 Million in ’17
Recently, as noted in this memo, the SEC published its “Annual Whistleblower Report,” as fiscal ’17 saw over 4,480 tips, $50 million in payments and 700 matters under review or investigation. Which was growth by most metrics…
Cap’n Cashbags Loves Vea World Recipes Crackers!
I love the new “Vea World Recipes” crackers – particularly the flavor of “Andean Quinoa & Spices.” In this 20-second video, Cap’n Cashbags foregoes holiday bonuses for employees so he can buy Vea World Receipes for himself!
We have posted the transcript for the popular webcast – “Shareholder Proposals: Corp Fin Speaks” – during which Corp Fin Staffer Matt McNair was interviewed by Ning Chiu about Staff Legal Bulletin 14I…
Shareholder Proposals: Apple First to Seek New SLB Exclusion
Here’s the intro from this blog by Steve Quinlivan:
In the closely watch area of shareholder proposals, Apple is seeking to exclude a shareholder proposal regarding the establishment of a Human Rights Committee because it involves the company’s ordinary business operations under Rule 14a-8(i)(7). Apple is relying on newly issued Staff Legal Bulleting 14I.
Apple states SLB 14I provides that whether a policy issue is of sufficient significance to a particular company to warrant exclusion of a proposal that touches upon that issue may involve a “difficult judgment call” which the company’s board of directors “is generally in a better position to determine,” at least in the first instance. A well-informed board, according to Apple analyzing the SEC’s views, exercising its fiduciary duty to oversee management and the strategic direction of the company, “is well situated to analyze, determine and explain whether a particular issue is sufficiently significant because the matter transcends ordinary business and would be appropriate for a shareholder vote.”
ISS Releases “Preliminary” Compensation FAQs
Last week, as noted in this FW Cook blog, ISS released these “Preliminary” Compensation FAQs, which provide insight into ISS’ updated quantitative pay-for-performance screening methodology and its Equity Plan Scorecard (EPSC) evaluation for stock plan proposals. “Final” FAQs are expected in a few weeks…see this note from Ed Hauder for more…
We’ve previously blogged about FASB’s controversial proposal to conform its approach to financial statement materiality to the judicial definition of “materiality” that applies in other contexts. While that proposal is supported by business groups, most investor advocates have panned it.
After two years of back & forth, FASB has decided to throw in the towel on the new proposal – but instead of leaving things stand, it opted to return to an earlier materiality standard. This Thomson Reuters article explains what FASB has done:
A unanimous FASB agreed to return to the definition of materiality from Concepts Statement (CON) No. 2, Qualitative Characteristics of Accounting Information, which defines materiality in the context of “the magnitude of an omission or misstatement of accounting information that, in the light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement.” The FASB said the CON No. 2 definition is consistent with the definition used by the SEC, the PCAOB, and the AICPA.
The FASB’s new approach tracks a recommendation that it received this summer from the SEC’s Office of Investor Advocate – and also reflects an apparent consensus reached among participants at a roundtable meeting held by FASB last March.
More on “GAAP Means Nothing to Me”
Last month, I blogged about an investor survey that suggested that many institutional investors didn’t have a lot of use for GAAP. Here are some insightful comments on the results of that survey from Maynard Cooper’s Bob Dow:
It was suggested that GAAP is not useful because cash flow is more important. But of course there are GAAP measures for cash flow on the cash flow statement. I have always found the cash flow from operations to be an important measure. If a mature company consistently has a negative cash flow from operations, that almost always spells big trouble.
We do expect start-ups to have a negative number until they become cash flow positive, but the measure can help to indicate how far we are from that milestone. The cash flow from operations is harder to manipulate than some other measures, except maybe straight EBITDA (unadjusted). But EBITDA is a less reliable measure of cash flow because it doesn’t take into account changes in working capital. You can go all the way to bankruptcy court with a positive EBITDA.
That’s a major problem with non-GAAP measures, they are susceptible to manipulation. As a Corp Fin Staffer once said, the most prominent non-GAAP measure is EBBS – everything but the bad stuff.
Of course most non-GAAP measures themselves are built on GAAP. To have a consistent and comparable measure for EBITDA, you have to have an agreed-upon set of ground rules for, e.g., revenue recognition. GAAP provides that set of rules. If everyone starts making up their own rules for revenue recognition, how could any of the measures be comparable?
My own experience suggests that Bob’s comments about EBITDA are right on the money – forgetting that the accounting concepts of depreciation & amortization represent the reality that assets wear out is a great way to end up in over your head.
Non-Voting Common Stock: Delaware Law Overview
As I recently blogged, multi-class capital structures continue to hang around – despite the opposition of many institutional investors. This Hunton & Williams memo provides an overview of Delaware corporate law issues associated with non-voting common stock, and is a handy reference tool for companies considering such a capital structure.
1. Shareholder Rights Plans. In order to “simplify” ISS’s approach to rights plans and “to strengthen the [ISS] principle that poison pills should be approved by shareholders in a timely fashion,” ISS will now recommend voting against all directors of companies with “long-term” (greater than one year) unilaterally adopted shareholder rights plans at every annual meeting, regardless of whether the board is annually elected. Short-term rights plans will continue to be assessed on a case-by-case basis, but ISS’s analysis will focus primarily on the company’s rationale for the unilateral adoption.
2. “Excessive” Non-Employee Director Compensation. ISS will recommend voting against or withholding votes from members of board committees responsible for setting non-employee director compensation when there is a “pattern” (over two or more consecutive years) of “excessive” non-employee director pay without a compelling rationale or other mitigating factors. Because “excessive” pay would need to be flagged for at least two years under the new policy, ISS will not make negative vote recommendations on this basis until 2019.
3. Disclosure of Shareholder Engagement. In considering whether to recommend against compensation committee members of companies whose Say-on-Pay proposals received less than 70% of votes cast, ISS considers the company’s disclosure regarding shareholder engagement efforts. ISS provided guidance regarding the level of detail included in such disclosures, including whether the company disclosed the timing and frequency of engagements with major institutional investors and whether independent directors participated; disclosure of the specific concerns voiced by dissenting shareholders that led to the Say-on-Pay opposition; and disclosure of specific and meaningful actions taken to address the shareholders’ concerns.
4. Gender Pay Gap Proposals & Board Diversity. ISS will vote case-by-case on requests for reports on a company’s pay data by gender, or a report on a company’s policies and goals to reduce any gender pay gap, taking into account the company’s current policies and disclosure related to its diversity and inclusion policies and practices, its compensation philosophy and its fair and equitable compensation practices. ISS will also take into account whether the company has been the subject of recent controversy or litigation related to gender pay gap issues and whether the company’s reporting regarding gender pay gap policies or initiatives is lagging its peers. ISS also noted that it would highlight boards with no gender diversity, but would not make adverse vote recommendations due to a lack of gender diversity. In addition, ISS revised its “Fundamental Principles” to state that boards should be sufficiently diverse to ensure consideration of a wide range of perspectives.
In Canada where there are new disclosure requirements on companies’ gender diversity policies, ISS is introducing a new policy on board gender diversity that will generally recommend withhold votes for the chair of the nominating committee if a company has not adopted a formal written gender diversity policy and no female directors serve on its board.
5. Pledging of Company Stock. ISS has codified its existing practice to recommend withhold votes against the members of the relevant board committee or the entire board where a significant level of pledged company stock by executives or directors raises concerns absent mitigating factors.
6. Pay-for-Performance Analysis. In connection with its pay-for-performance analysis, ISS will consider, in addition to other alignment tests, the rankings of CEO total pay and company financial performance within a peer group measured over a three-year period.
7. Other Changes. ISS has further revised its voting recommendations on climate change shareholder proposals in order to promote greater transparency on these matters.
FCPA Disgorgement: Kokesh Decision Underlines “Need for Speed”
In a recent speech, SEC Enforcement Co-Director Steve Peikin reviewed the agency’s FCPA enforcement priorities. One of the more interesting parts of Steve’s remarks addressed the impact of the Supreme Court’s Kokesh decision on FCPA enforcement. Here’s an excerpt:
In many instances, by the time a foreign corruption matter hits our radar, the relevant conduct may already be aged. And because of their complexity and the need to collect evidence from abroad, FCPA investigations are often the cases that take the longest to develop. In contrast to the Department of Justice, the statute of limitations is not tolled for us while our foreign evidence requests are outstanding.
These limitations issues have only grown in the wake of the U.S. Supreme Court’s recent decision in Kokesh v. SEC, in which the Court held that Commission claims for disgorgement are subject to the general five-year statute of limitations. Kokesh is a very significant decision that has already had an impact across many parts of our enforcement program. I expect it will have particular significance for our FCPA matters, where disgorgement is among the remedies typically sought.
While the ultimate impact of Kokesh on SEC enforcement as a whole – and FCPA enforcement specifically – remains to be seen, we have no choice but to respond by redoubling our efforts to bring cases as quickly as possible.
Kokesh: The Bad Guys Want Their Money Back
It turns out that the need to bring FCPA cases on a more timely basis isn’t the only potential fallout from the Kokesh decision. In addition to barring claims for disgorgement beyond the limitations period, this King & Spalding memo points out that Kokesh raises the broader issue of whether the SEC has authority to seek disgorgement at all:
As it considers the impact of Kokesh, we expect that the SEC staff will be less aggressive in its disgorgement demands and more open to arguments limiting how disgorgement is calculated. At the same time, defendants and respondents who litigate will undoubtedly follow up on the Supreme Court’s apparent invitation, in a footnote, to challenge whether disgorgement is available at all as an SEC remedy in enforcement actions.
Now, this Bloomberg article says that the Supreme Court’s invitation to litigate that issue has been accepted. You know all of those guys that the SEC sought disgorgement from? Well, they want a refund:
Anyway some lawyers read the Kokesh opinion in that particular way and brought this class-action lawsuit against the SEC a couple of weeks ago. Delightfully the class of victims/plaintiffs in the lawsuit is securities fraudsters: Specifically, it’s “all persons or entities from whom the SEC has collected, during the period from October 26, 2011 to the present, purported ‘disgorgement,'” with some fairly minor-seeming exceptions. The alleged damages are “approximately but not less than $14.9 billion over the last six years.”
