The Ropes memo summarizes the complaints, which are premised on allegations of improper revenue recognition that affected financial statements used in an IPO and follow-on offering. Here’s an excerpt:
According to the complaint against the CFO and AC Chair, the CFO and AC Chair first learned that the beta tests had not been performed on the day Kubient launched the follow-on offering. The SEC alleges that on that day an employee who had discovered that KAI had not scanned the customers’ data informed the AC Chair of this discovery, while questioning whether it could be indicative of fraud and suggesting that, if the wrong data had been scanned for the beta test, the company might need to restate its earnings. The AC Chair then relayed this information to the CFO on the same day.
The complaint further alleges that, despite learning this, neither the CFO nor the AC Chair investigated the circumstances of the $1.3 million revenue recognition; instead they both furthered the CEO-initiated fraudulent scheme by failing to correct the statements in the follow-on offering documents, signing the company’s subsequent public filings including the same statements, and lying to the company’s independent auditor about the revenue and their knowledge of concerns raised internally about the transactions supporting the revenue.
The memo goes on to detail the allegations against the Audit Committee Chair specifically, which included:
– Failing to investigate the circumstances surrounding the $1.3 million revenue recognition after learning that the customers’ data were not scanned by KAI;
– Failing to inform the independent auditor of that discovery;
– Failing to correct the KAI testing and revenue statements in the follow-on offering documents;
– Excluding the independent auditor from the audit committee meeting where concerns about the KAI contract were discussed (the “KAI Audit Committee Meeting”);
– Further concealing the KAI Audit Committee Meeting from the independent auditor by signing minutes (prepared by the CFO) of the immediately following audit committee meeting that disclosed another meeting, instead of the KAI Audit Committee Meeting, as the last audit committee meeting;
– Falsely stating to the auditor, during the 2020 year-end audit interview, that she was unaware of any tips or complaints regarding the company’s financial reporting, any fraud or suspected fraud affecting the company, or any other matters relevant to the audit; and
– Signing the company’s 2020 Form 10-K that included the statements in question.
Charges against audit committee chairs are rare, but statementsfromSEC officials about the important role of gatekeepers are not. Although there appear to have been some “bad facts” here, the charges reinforce the message that gatekeepers must take their role seriously, promptly investigate red flags, and oversee steps to correct material errors.
Clean audit reports on financials that later prove inaccurate may serve as the basis for a Rule 10b5-1 securities fraud claim against a company’s independent auditor, according to an amended opinion issued last week by a Second Circuit panel. The amendment reversed course from the court’s 2023 decision to dismiss the claim. The WSJ reports:
After the [2023] ruling, a trio of former Securities and Exchange Commission officials filed a brief with the court asking it to reconsider the decision. The court then asked the SEC to submit a brief expressing its views on the subject. The SEC did so and it, too, asked the court to reconsider, writing in a brief last February that “audit certifications convey crucial information to the investing public” and “audit certifications are not too general to be material.”
The appeals court on Thursday reissued its decision with amendments and ruled the investors’ claims against BDO could proceed.
The investors had alleged that the audit report was uniquely problematic because the audit partners failed to complete the necessary checks and audit work papers before issuing the audit opinion; that they signed several audit work papers without reviewing them; and that they failed to verify that all the necessary audit work was performed before issuing the opinion. In addition, the plaintiffs alleged shortcomings under PCAOB standards that require appropriate supervision, testing of audit procedures, and quality review.
The court determined that the plaintiffs adequately alleged that the audit report contained potentially actionable misstatements, because it was plausible that the partner who signed the audit opinion disbelieved the statement that the audit was conducted in accordance with PCAOB standards. Moreover, the court found adequate allegations that the misstatements were material. Here’s an excerpt (citations omitted):
Although the challenged audit certification reflects standardized language, it is not “so general that a reasonable investor would not depend on it as a guarantee.” Instead, BDO’s certification that the audit was conducted in accordance with PCAOB standards succinctly conveyed to investors that AmTrust’s audited financial statements were reliable. The absence of BDO’s certification would have been significant, for without it, BDO could not 49 have issued an unqualified opinion, AU 508.07, which then would have alerted investors to potential problems in the company’s financial reports.
In other words, audit quality is important – and it’s been front & center in scandals & rules this year. We’ll be providing practical guidance on this topic in an upcoming webcast, “Audit Quality: Lessons from BF Borgers and Other Recent Developments.” Mark your calendars for Thursday, November 21st at 2:00 p.m. ET to hear Deloitte’s William Calder, Maynard Nexsen’s Bob Dow, and Nonlinear Analytics’ Olga Usvyatsky discuss what corporate attorneys need to know about the latest audit-quality developments to advise clients on financial reporting and corporate governance matters.
Earlier this fall, the SEC adopted a rule change that will (among other things) amend the minimum pricing increments for the quoting and trading of exchange-listed stocks. As Meredith wrote at the time, the rule is intended to address “tick-constrained stocks” – which have narrow bid-ask spreads. You may wonder, “How many stocks suffer from ‘tick constraints?'” A recent Sidley memo points out that the answer is “most of them.” Here’s an excerpt:
Once implemented, the changes to minimum tick size will cause a majority of stocks — approximately 74.3%, based on the SEC’s estimate using 2023 data — to be quoted in more granular half-penny (i.e., $0.005) increments, rather than the $0.01 minimum tick most prevalent today.
This will likely necessitate systems changes for a large number of market participants, including broker-dealers and exchanges, to allow for the submission, ranking and display of orders at more granular pricing increments.
Moreover, the applicable minimum tick sizes will vary by stock and may change for each stock on a biannual basis, which will require broker-dealer systems be able to accommodate such changes, and inform their customers.
The Sidley memo also notes that the amendments have been challenged by a retail investor advocacy group. This Bloomberg article reports that Nasdaq and Cboe have also filed a joint petition focused on challenging the “access fee” portions of the rule change.
I don’t know about you, but I can’t wait for next Wednesday when the relentless political advertising on television will cease. I much prefer the mindless advertising about bathroom renovations and big screen TV sales that dominate the airways when we are not in an election season. I also yearn for a time when politics is boring. Boring is good. We need more boring.
This week we saw the release of the 2024 CPA-Zicklin Index, a collaboration between the Center for Political Accountability (CPA) and The Carol and Lawrence Zicklin Center for Business Ethics Research. The CPA-Zicklin Index has been benchmarking political spending since the Citizens United decision in 2010. The Index highlights significant improvement in in corporate political disclosure and accountability, noting:
The 2024 CPA-Zicklin Index is published shortly before Election Day and at an unparalleled time in the nation’s political history. The Index’s data reflect leading companies holding firm overall to established norms of political disclosure and accountability, despite fierce headwinds against environmental, social, and governance (ESG) and related principles for investors and U.S. corporations.
Moreover, when the 2024 Index results are compared against the last presidential election years of 2020 and 2016, the picture is striking: Many large public companies have realized major gains in disclosure and accountability for their election-related spending from corporate funds, and the gains are permanent. Whether examining the overall number of S&P 500 companies in 2024 or the 331 companies that have been a constant in the Index since 2015, the Trump years (2017 to 2021) plus Biden years (2021 to the present) have seen solid and dramatic increases in corporate political disclosure and accountability.
Some of the highlights from this year’s Index include:
– The number of all S&P 500 companies scoring 90 percent or above for political disclosure and accountability was 103, an increase over last year’s 100, and comprising more than 20 percent of all S&P 500 companies evaluated.
– 206 companies in the overall S&P 500 (over 41 percent) placed in the first Index tier (scoring from 80 percent to 100 percent). This number was more than double the 94 top-tier companies in 2016 and well beyond the 156 companies in 2020.
– The number of core S&P 500 companies scoring lowest for disclosure and accountability – in the bottom 20 percent – has declined sharply. From 106 bottom tier companies in 2016 it has declined to 73 in 2020, 37 in 2023 and 31 this year.
– For Russell 1000 companies that do not belong to the S&P 500, the average score for political disclosure and accountability is 16.5 percent. This compares to an average score of 59.9 percent for all companies in the S&P 500.
This year’s CPA-Zicklin Index certainly highlights some considerable progress in corporate political disclosure and accountability, particularly among the largest companies. Presidential election years always put a lot of focus on political spending by public companies, and having good transparency and getting the governance right can go a long way toward dispelling concerns of investors and the public.
Yesterday, ISS-Corporate released a well-timed report on a very scary topic for many companies: shareholder proposals. The report is titled “U.S. Shareholder Proposals: A Decade in Motion,” and the press release announcing the report notes:
ISS-Corporate, a leading provider of compensation, governance, cyber risk monitoring, and sustainability offerings to help companies improve shareholder value and reduce risk, today announced the findings of an in-depth analysis of shareholder proposals submitted at U.S. public companies over a 10-year period running from July 2014 through June 2024. The analysis examines investor sentiment around assessing environmental, social, and governance (ESG) risks via the volume and support levels of different types of such proposals and looks at the underlying patterns of corporate behavior and disclosures driving shareholders’ ESG campaigns. Amid intensifying debate around the value of ESG and the emergence of shareholder campaigns that seek to counter corporate action on environmental and sustainability topics, the report investigates how the debate around ESG has impacted investor sentiment and shaped corporate practices more broadly.
Some of the key finding of the report include:
– Proposals related to E&S topics accounted for 62 percent of the total proposals submitted by shareholders in 2024, up from 44 percent a decade earlier.
– Support levels for E&S shareholder proposals have decreased since peaking in 2021, but this does not necessarily indicate a de-prioritization of sustainability factors for many investors.
– Shareholder campaigns tend to target large-cap firms, and these companies have made particularly significant strides over the last several years in the quality of their sustainability disclosures and practices and corporate governance practices.
– Anti-ESG proposals made up approximately 11 percent of the total shareholder proposals submitted in 2024 – up from around 2 percent of submitted requests from July 2014 to June 2021 – but average support levels remain in the low single digits at 1.7 percent of votes cast during the last three years.
All signs point to yet another very active proxy season for shareholder proposals, so buckle up and get ready!
Mark your calendars today for our upcoming webcast, “SEC Enforcement: Priorities and Trends,” which is coming up on Wednesday, November 13, 2024 here on TheCorporateCounsel.net. Joining us for the program are Scott Kimpel of Andrews Kurth LLP, Allison O’Neil of Locke Lord LLP and Kurt Wolfe of Quinn Emanuel Urquhart & Sullivan, LLP. They plan to address the very active SEC enforcement environment we are experiencing, including:
1. SEC Enforcement Activities in 2024 and Priorities for 2025
2. Implications of Jarkesy for SEC’s Enforcement Program
3. Monetary and Non-Monetary Penalties
4. Accounting and Disclosure Actions
5. Actions Targeting “Internal Controls”
6. Self-Reporting and Cooperation Credit
7. Coordination with DOJ Investigations
Members of TheCorporateCounsel.net are able to attend this critical webcast at no charge. If you’re not yet a member, subscribe now. The webcast cost for non-members is $595.
I kick off my Halloween-themed blogs with a scary horror story:
The opening scene is set in the 1990s, and a company has filed a registration statement with the SEC. The Staff review process is taking longer than expected, and the company desperately needs to raise money through a private placement so it can keep the lights on through the completion of the IPO. The company completes the private placement and discloses it in an amendment to its Form S-1, but then, a jump scare! The Staff raises a comment questioning whether the company has a valid exemption from registration for the private placement when it occurred while the Form S-1 was on file. Suffice it to say, this horror story does not end well – the Metaphysics monster exacts its revenge on the poor unsuspecting company.
This week, while I was teaching my exempt offerings class the concept of integration, it really hit me how the Commission’s thoughtful approach in 2020 to adopting a comprehensive integration rule really changed the landscape for public and private offerings, making the scary horror story above a relic of the past. Securities lawyers of a certain vintage will no doubt remember many stressful evenings analyzing an integration issue utilizing the unwieldy five factor test, while trying to piece together all of the random Commission and Staff integration lore to see if something could bring some level of certainty to the situation. Today, a securities lawyer need only pull up Rule 152, without being burdened with the five factor test and the numerous interpretations that made integration a pretty scary realm to navigate.
I have the advantage of being able to tell a significant piece of the story of integration’s evolution in the first person, as I worked with Marty Dunn to bring his “integration manifesto” into being (much like Frankenstein’s monster) through interpretive guidance that was included in a 2007 Regulation D proposing release. That guidance went on to serve as the foundation for the Commission’s approach in Rule 152, bringing about much needed relief to a scary part of the regulatory landscape.
If you would like to read the full story of Marty’s integration manifesto and the evolution of the integration doctrine, I encourage you to review the article “Wither the Integration Doctrine? A New Approach Dawns This Spring” in the January-February 2021 issue of The Corporate Counsel.
When I was writing the blog last year around this time, I lamented that I really miss Halloween. I noted that once my kids aged out of trick-or-treating and I moved to a scary house at the end of a long driveway in a dark forest, I was no longer able to enjoy the holiday as I once did, and I now find myself attending to professional obligations on Halloween rather than dressing up in a ridiculous costume and littering my yard with over-the-top decorations. I received some great feedback on that blog, as others in our community recounted the same estranged relationship with Halloween, or expressed the fear that their own enjoyable times during Halloween were about to come to an end.
In my ode to Halloween today, I recount my top five takeaways from the holiday that stick with me to this day:
1. Embrace the creativity – I can distinctly remember being ten years old and making a Darth Vader costume out of a football helmet and some black construction paper in the year when the first Star Wars movie premiered, and being very satisfied with my handiwork. I am sure that the adults who answered the door when I was trick-or-treating were scratching their heads, wondering what the heck my costume was supposed to be. Fast forward thirty years later, and I found myself making a very realistic R2D2 costume out of white plastic trash can for my son, who was just as fascinated with Star Wars as I was in 1977. Once again, I was very satisfied with my handiwork, although this time the adults definitely recognized the costume!
2. Trust, but verify – A lasting impression from my childhood Halloween excursions was the process of pouring all of the candy onto the floor and closely inspecting the pieces for tampering, usually looking for inserted razor blades for some reason. The message from this exercise was clear – sure, we trust you to go out and beg for candy from the neighbors, but we don’t trust them enough to let you eat uninspected candy. This bit of childhood trauma was only confirmed when I was trick-or-treating with a group of friends and we knocked on the door of a house where a 1970s-style teen party was occurring, and the person answering the door said to his friends, “there are some trick-or-treaters here, let’s give them some drugs.” Needless to say, these Halloween experiences helped formulate a worldview that not everyone out there is looking out for my best interests.
3. Have fun, but consider others – Today, the focus of Halloween festivities is on the “treat,” but not the “trick.” As a lad, I must admit that I engaged in my fair share of the “trick” part of trick-or-treating, which never involved anything particularly malicious or destructive, but was no doubt quite annoying. In today’s world of doorbell cameras and iPhones, we certainly never would have gotten away with those shenanigans. Now that I have entered what I like to call the “get off my lawn” phase of my life, I truly regret having given into the temptation and peer pressure that led to the “trick” part of “trick-or-treating.”
4. Choose your costume carefully – Several years ago, I was driving my son and his college freshmen roommates around Washington DC trying to find Halloween costumes on Halloween-eve, only to find that all of the stores were completely cleaned out. We finally found a costume store in the suburbs that was fully stocked, but the freshmen had a very hard time selecting their costumes. This was at a time (which could still be the case today) when a number of people were being called out on social media and in the news for Halloween costumes that they once wore long ago, and it had the in terrorem effect of making all Halloween costumes seem potentially problematic to somebody. We eventually got the group outfitted, but it took a while! In any event, I think it is much better to be safe than sorry, because it is really not worth offending someone when you are just wearing a silly costume as a grown adult on Halloween.
5. Enjoy the moment – While I was working in demanding jobs and had a long commute when my kids were young, I would always make it a priority to get home before the trick-or-treating commenced, because the kids would always be so excited about the holiday. While it can be stressful at times to try to make everything happen in that one evening, it was always worth the effort to see their smiles and to hear their laughter as we navigated the spooky sights around the neighborhood. It was also nice to see all of the neighbors out and about and being friendly in a way that did not usually occur on all of the other days of the year. If you are still in the mode of celebrating Halloween with your family and neighbors, I encourage you to enjoy those moments while you still can!
Yesterday, the SEC announced four new members of the Small Business Capital Formation Advisory Committee. The announcement notes:
The new Commission-appointed committee members are:
– Jennifer Newton – Managing Attorney and Founder, StartSmart Counsel; Miami
– Rose Standifer – Partner, Foley Hoag LLP; Denver
– Wendy Stevens – Partner, Forvis Mazars LLP; New York
– Emily Underwood – Clinical Professor of Law, Bluhm-Helfand Director of the Innovation Clinic, The University of Chicago Law School; Chicago
In addition to the 14 appointed members, the current committee members include the SEC’s Small Business Advocate, and three non-voting members appointed by the SEC’s Investor Advocate, the North American Securities Administrators Association, and the Small Business Administration, respectively. The committee also has an observer appointed by the Financial Industry Regulatory Authority.
The committee provides advice and recommendations to the Commission on rules, regulations, and policy matters relating to small businesses, including smaller public companies. Committee members represent a diverse spectrum of entrepreneurs, investors, and advisers who work with early-stage private companies and smaller public companies, including minority- and women-owned small businesses. Additional information about the committee, its members, and prior meeting materials is available on the committee webpage.
After having been sworn in for a second term as Chair of the PCAOB last week, PCAOB Chair Erica Williams delivered a speech outlining the PCAOB’s efforts toward meeting its strategic plan yesterday at the 2024 PCAOB International Institute on Audit Regulation. The speech outlines steps that the PCAOB has taken to meet its objectives of modernizing its standards, enhancing its inspections and strengthening enforcement.
On the topic of modernizing standards, Chair Williams notes:
Today, the PCAOB is taking unprecedented action, and our actions are necessary. Protecting investors depends on updated standards and rules—and that’s why this Board is taking great strides to meet this challenge.
While we are committed to getting this agenda done to meet the rapidly evolving capital markets, we are even more committed to making sure it’s done right.
We take public comments very seriously, reading each and every one, and ensuring that the full range of voices and feedback are taken into account. We will—and we have—reopened comment periods when necessary and have asked follow-up questions to ensure we understand the feedback received before moving forward.
Additionally, ahead of the effective dates for these standards and rules, we are committed to providing firms with resources to help them update their methodologies and train their staff on the upcoming changes.
On the topic of enhancing inspections, Chair Williams notes in her speech:
In recent years, the PCAOB has found that audit deficiencies, particularly Part I.A. deficiencies, are unacceptably high.
Part I.A findings are serious. They mean the audit firm failed to obtain sufficient appropriate evidence to support its opinion, and audit opinions were signed without completing the audit work required to verify the accuracy of the financial statements.
Part I.A deficiencies include things like failing to perform any procedures at all to test revenue or the costs of inventory, as well as instances where the auditor did not identify and test any controls over long-lived assets and depreciation expense. Simply put, these deficiencies are not just serious, but they go to the heart of the audit.
These Part I.A deficiencies are relevant when assessing the quality of work done by an audit firm. But audit quality is complex, and it escapes simplistic proxies or measures.
And on the topic of strengthening enforcement, Chair Williams states:
Enforcement has been a critical tool at our disposal, and we focus on cases that involve serious matters that put investors at risk: audit failures in cases involving financial statement fraud, taking on client work that firms can’t complete, altering work papers, and not performing sufficient work before signing audit opinions.
We examine the facts and circumstances of every case and have not hesitated to impose bars on bad actors, revoke firms’ registrations, and impose civil monetary penalties—among many other options on the table under this Board.
We have issued approximately $35 million in fines this year alone. We have also required functional changes to a firm’s supervisory structure for the very first time. And we have required firms to retain an independent monitor to drive improvements and best protect investors.
The speech wraps up by noting: “Protecting investors is a noble profession—and one that I’m proud to be part of. Trustworthy audits help give people confidence, which powers investment and capital formation to move our economies forward and improve the lives of the people we serve.”
