John recently noted that the PCAOB added a “Fraud Risk Resources” page to its website, which is intended to assist auditors in complying with their obligations to consider fraud during the course of an audit, while also providing useful information for audit committees in understanding their obligations. The Center for Audit Quality (CAQ) has also made resources available on this topic with its new publication “The Role of the Auditor: Assessing and Responding to Fraud Risk.” The CAQ notes:
Shifts in the economy, geopolitical landscape, and technological developments have created an environment in which companies are potentially more vulnerable to fraud. In recent years, as major corporate failures and scandals continue to be in the spotlight, fraud has become a growing area of focus. Regulators, investors, and other interested parties expect auditors to remain vigilant and to think critically about fraud.
The mitigation of fraud risk is most effective when all participants of the financial reporting ecosystem fulfill their roles in deterring and detecting fraud. Auditors, although often the last line of defense due to the scope and timing of their engagements, are among the many stakeholders whose influence and responsibilities have a significant impact on fraud deterrence and detection.
Auditors should continually strive to enhance their professional skepticism to effectively assess and respond to fraud risks, including considering when it may be important to elevate the basic level of skepticism that is applied throughout the process of any audit and being cognizant of biases that can impede professional skepticism.
The auditor’s fraud risk assessment is an iterative process that occurs throughout the audit and is a critical element of planning and performing an audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or by fraud. Auditors may consider the following as they plan and perform their fraud risk assessment and design procedures to address identified fraud risks…
This publication provides insights into practices, tools, and considerations that can help auditors, especially those with less experience, enhance their professional skepticism and overall approach to assessing and responding to the risks of material misstatement resulting from fraud during the audit. It also provides clarity and understanding of the auditor’s current role and responsibilities related to fraud, which may provide insights for those who are involved in evaluating and using financial reporting information as well as for policymakers and regulators.
As with the PCAOB’s resources on fraud risk, this CAQ publication can be a useful resource for counsel and the audit committee to better understand the auditor’s role in assessing and responding to fraud risk.
One of the things that I often find myself saying is that I have been very fortunate to have had several mentors over the course of my career who really helped me understand how to succeed as a lawyer, and I am eternally grateful for their guidance. I have tried to pay that forward by serving as a mentor to friends, colleagues, college students, law students and really anyone else who seeks me out to serve as a mentor. That is why I was thrilled when we relaunched The Mentor Blog here on TheCorporateCounsel.net, and our that Contributing Editor, Meaghan Nelson has been providing some great advice on the blog since its return. Some of the notable topics include:
I encourage you to check out The Mentor Blog and all of Meaghan’s insights. If you are not a member of TheCorporateCounsel.net and do not have access to all of our practical resources, email sales@ccrcorp.com or sign up online.
Nasdaq recently released its 2024 Global Governance Pulse survey, which provides insight into five key areas of focus for boards. Nasdaq notes:
A thoughtful governance model enables boards to fulfill their duties and provide effective oversight of organizations. Each board must determine the appropriate governance approach that aligns with the organization’s needs and meets prescriptive requirements imposed through relevant legal and regulatory bodies.
Nasdaq’s 2024 Global Governance Pulse survey was conducted in July, capturing information on corporate governance trends and practices and anticipated 2025 board priorities. The survey included questions that explored five key areas:
– CEO evaluations and management oversight
– Board composition and culture
– Governance practices, processes, and tools
– Board evaluations
– Strategic and risk topics on the horizon
The survey collected 872 qualified responses from board members, executives, and governance professionals across organizations and sectors. On the topic of the skills and experience that respondents thought would most enhance the board’s composition and ensure alignment to the organization’s strategy 35% of respondents specifically cited AI and machine learning. In close second was cybersecurity and data privacy, coming in at 34% and 30% noted industry experience.
In terms of the top areas that will impact an organization’s success in the next 12 months, 44% of respondents cited access to capital, resource allocation, and cost controls, 43% cited economic conditions, and 39% identified clearly defined and articulated strategy and goals.
Yesterday, the SEC posted a new “Office Hours” video with SEC Chair Gary Gensler, this time on the topic of systemic risk in artificial intelligence. Drawing a comparison to the disturbing 2013 romantic comedy Her, starring Scarlett Johansson and Joaquin Phoenix, Gensler discusses how AI may pose risks to financial stability in the future, given the potential dependency on a small number of AI base models. The main concern is that the base model – or data aggregator – may send a similar signal to many individual actors, leading many of them to make similar decisions. This network interconnectedness could lead a significant number of financial institutions to all head off the proverbial cliff simultaneously, leading us to the next financial crisis.
I must admit that this is an AI nightmare that I had not really considered until Chair Gensler brought it up. The fact that one or a few AI models could have such an impact on the financial markets is pretty terrifying. Thank you, Chair Gensler, for giving me another reason to not go to sleep at night.
I have always been fascinated with systemic risks in the financial system. Even before I became a lawyer, I wrote a Comment titled “Enforceability of Over-the-Counter Financial Derivatives,” which was published in the ABA Business Law Section publication, The Business Lawyer (see Vol. 50, No. 1 (November 1994)). My Comment explored concerns with enforceability in the then-nascent financial derivatives market, following a decision of the British House of Lords that derivative agreements involving certain municipalities were unenforceable. I like to think of that Comment as the starting point of my illustrious publishing career!
Tune in later today – Tuesday, October 29th – at 2:00 pm Eastern for our webcast, “Surviving Say-On-Pay: A Roadmap for Winning the Vote in Challenging Situations.” Get practical tips for scenarios that companies frequently encounter – from D.F. King’s Zally Ahmadi, Compensia and CompensationStandards.com’s Mark Borges, Orrick’s JT Ho, Foot Locker’s Jenn Kraft, and Tesla’s Derek Windham.
Members of this site are able to attend this critical webcast at no charge. The webcast cost for non-members is $595. If you’re not yet a member, subscribe now by emailing sales@ccrcorp.com – or call us at 800.737.1271.
We will apply for CLE credit in all applicable states (with the exception of SC and NE, which require advance notice) for this 60-minute webcast. You must submit your state and license number prior to or during the program using this form. Attendees must participate in the live webcast and fully complete all the CLE credit survey links during the program. You will receive a CLE certificate from our CLE provider when your state issues approval, typically within 30 days of the webcast. All credits are pending state approval.
On Friday, the SEC’s Small Business Capital Formation Advisory Committeereleased the agenda for its meeting on Wednesday, November 13, 2024. The meeting will include a discussion of how venture capital fund managers are raising capital, including the limits of arm’s length fundraising and challenges facing emerging fund managers. The Committee’s meeting will be open to the public via webcast on www.sec.gov. The press release announcing the meeting notes:
The committee, which provides advice and recommendations to the Commission on rules, regulations, and policy matters relating to small businesses, will continue its exploration of ways to expand early-stage capital raising by focusing on how certain fund managers, including emerging fund managers and diverse fund managers, are accessing capital. Committee members will hear from Professor Sabrina Howell, from the New York University Stern School of Business, who will present her upcoming academic paper that examines venture capital fund manager use of relationship-based versus arm’s length public advertising approaches to fund-raising. Professor Howell will discuss the advantages and challenges of public advertising for traditionally underrepresented managers.
Staff members from the SEC’s Division of Investment Management will provide a brief overview of the registration framework applicable to private fund advisers and their funds, including those exemptions from the registration requirements of the Investment Advisers Act of 1940 and the Investment Company Act of 1940, which may be relied upon by emerging fund managers.
The committee will discuss the challenges that emerging fund managers report facing when seeking to raise investment funds and will hear from Karen Kerr, PhD, Board Member and Charter Class, Kauffman Fellows and Managing Director, Exposition Ventures, about how new fund managers can be supported and promoted through fellowship programs. As part of this discussion, the committee will explore ways to address some of the challenges facing emerging fund managers and consider whether regulatory or other solutions could be undertaken to further support these fund managers and the early-stage companies in which these managers invest.
The agenda for this meeting, meeting materials and information about the webcast are available on the Committee’s webpage.
I am now past the middle of the semester for the course that I co-teach at Georgetown Law called “Beyond the IPO: Exempt Securities Offerings,” and one of the topics that we spend a good deal of time on in class is the topic of what constitutes a “general solicitation” and how to avoid it when conducting a private placement offering (relying on, e.g., Section 4(a)(2) or Rule 506(b) of Regulation D). With the SEC Staff paying close attention to private placements in recent years, avoiding general solicitation problems has become even more important for companies seeking angel and venture capital. This is an area where companies are not always following the counsel’s guidance, or they are not running communications by their counsel, or counsel is just letting things go that seem to clearly be a general solicitation in connection with private placement transactions.
The consequences of getting a general solicitation issue wrong are what I always tell my class are the reasons why securities lawyers do not sleep well at night. Under Section 12(a)(1) of the Securities Act, if an offering is not registered or exempt from registration, it is illegal and private placement investors could recover their investment in full through a recission right. At the same time, the SEC could bring an action against the company for violating Section 5 of the Securities Act, and against individuals for causing the violation. A company can be disqualified from conducting private placements under Regulation D and relying on other exemptions with bad actor disqualification provisions as a result of an SEC enforcement action.
To make things more challenging, the SEC has never explicitly defined the terms “general solicitation” or “general advertising” in its rules, but we typically think of these terms as relating to communications seeking to generate interest in an offering which is inconsistent with the notion of a private placement. Generally, you look at the medium of dissemination and the number of recipients, as well as the type of information contained in the communication, to determine if it is a general solicitation.
What can issuers seeking angel and venture capital do to avoid having a general solicitation take place in connection with a private placement? Here are my top five suggestions:
1. Do not speak to the press, grant interviews or otherwise provide media with materials relating to the offering, replying with “no comment” if someone form the media asks about the offering;
2. Do not discuss the fact that the company is offering securities at a conference, seminar, or forum where the attendees were invited through a general solicitation;
3. Do not discuss the company’s performance in a public setting in a manner that could be viewed as conditioning the market or hyping up the company for the offering;
4. Do not put out press releases about the offering while it is ongoing, and do not post information about the offering on social media or on a website that is generally available; and
5. Do not contact prospective investors unless the company or its financial intermediary has a substantive, pre-existing relationship with those investors.
It is important to keep in mind that companies can continue to publish regularly released factual business information that would not be deemed an offer of securities during the course of an exempt offering. Perhaps most importantly, communications with prospective investors with which a company (or the company’s financial intermediary) has a substantive pre-existing relationship would not be deemed a general solicitation.
If you have ever tried to communicate these principles to an entrepreneur that is seeking to raise capital for a start-up, you have no doubt received a considerable amount of pushback. I encourage you to stick to your guns, because this is not an area today where you want to blow up a private placement based on a general solicitation issue.
In the latest “Understanding Activism with John & J.T.” podcast, John and Orrick’s J.T. Ho were joined by David Farkas, Head of Shareholder Intelligence in the US for Georgeson, to discuss Schedule 13F filings & stock surveillance services. Topics covered during this 18-minute podcast include:
– Overview of Schedule 13F and why 13F filings aren’t reliable indicators of activity in a company’s stock
– Strategies activists use to avoid tipping their hands through a 13F filing
– The role 13F filings can play in a company’s efforts to identify an activist building a position in its stock
– Additional actions a company can take to determine if an activist is building a position
– The role of stock surveillance services
– Implications of rulemaking petition to amend 13F rules
Our objective with this podcast series is to share perspectives on key issues and developments in shareholder activism from representatives of both public companies and activists. We’re continuing to record new podcasts, and we think you’ll find them filled with practical and engaging insights from true experts – so stay tuned!
Over five years into the requirement to communicate Critical Audit Matters (CAMs) in audit reports (where has the time gone?!?), the Center for Audit Quality sought to better understand how institutional investors use CAMs and how well they understand them. Dan Goelzer’s Audit Update blog on this topic gives this explanation of CAMs as a reminder:
Under the PCAOB’s auditing standards, a CAM is any matter arising from the audit of the financial statements that was communicated or required to be communicated to the audit committee and that: relates to accounts or disclosures that are material to the financial statements and involved especially challenging, subjective, or complex auditor judgment. The audit report must include a description of any CAMs and how the auditor addressed them in the audit.
CAQ engaged KRC Research to run an online survey in July of 100 US institutional investors. All survey respondents were at the director level or higher with at least 5 years of experience and employed at companies with a minimum of $500M in assets under management. The feedback was resoundingly positive.
– Nearly all (93%) investors surveyed indicated that they read the CAMs section in 10-Ks of companies they invest in or are researching, and 78% indicated that they do so often.
– 92% of respondents indicated that they use CAMs in their investment decision-making process.
– 93% said that, considering all the sources of information available to them, CAMs play a very important (53%) or somewhat important (40%) role in their analysis of potential investments.
– Additionally, nine in ten investors stated that they are very satisfied (48%) or somewhat satisfied (42%) with the quality and clarity of CAMs disclosed in most audit reports, with only 2% of respondents expressing dissatisfaction.
The few critics focused on the quality and clarity of CAMs — specifically that the language used to describe CAMs could be clearer. Despite the generally positive feedback, respondents did identify a number of other areas that could be improved:
– More than half (58%) of investors surveyed indicated that they prefer to see more CAMs identified in an auditor’s report; and when asked what changes to CAMs would benefit their investment decisions, approximately half of respondents shared that both increasing the number of CAMs (52%) and increasing the detail provided in CAMs (51%) would be beneficial.
– Twenty-five percent of respondents also felt that requiring CAMs related to specific audit areas would be advantageous, but there was no consensus regarding the specific areas in which required subject matter specific CAMs were desired.
The Wall Street Journal reported this week on a proposed Senate bill that would allow any investor capable of passing an exam to more easily invest in private companies. The legislation from Senate Banking Committee Republicans would allow the SEC or another regulator to write an exam to test “financial sophistication,” with the specifics of the exam left open for the agency to decide. Critics argue that only financial resources protect investors from the losses of risky investments.
The article reviews other attempts to change the rules to focus on knowledge and investing acumen but says this latest proposal is unlikely to get very far unless Republicans win more seats in November. But politicians aren’t the only group that’s pitched this concept in recent months. As a reminder, the Small Business Capital Formation Advisory Committee met to discuss the accredited investor definition (again) last March and voted to approve three recommendations to present to the SEC. One of those recommendations suggested that non-accredited investors be permitted to invest up to 5% of their income or net worth in private offerings annually if they meet certain sophistication criteria or pass a certification exam.
