Yesterday, Corp Fin posted CF Disclosure Guidance: Topic No. 10, Disclosure Considerations for China-Based Issuers, which provides guidance regarding disclosure considerations for companies based in or with the majority of their operations in the People’s Republic of China (China-based Issuers). You might recall that, in August, the President’s Working Group on Financial Markets, which includes Treasury Secretary Steven T. Mnuchin, Fed Chair Jerome H. Powell, SEC Chair Jay Clayton and CFTC Chair Heath P. Tarbert, issued a Report on Protecting United States Investors from Significant Risks from Chinese Companies, which made a number of recommendations, among them that regulators should require enhanced and prominent issuer disclosures of the risks of investing in China-based Issuers and should issue interpretive guidance to clarify these disclosure requirements and increase awareness of the risks of investing in these companies. (See this PubCo post.) This guidance appears designed to implement that recommendation. The clear implication of the guidance is that China-based Issuers need to consider beefing up their risk factor and related disclosures; in outlining risks and posing questions to consider, the guidance provides a great starting point.
In October 2017, the SEC approved the PCAOB’s proposed new auditing standard for the auditor’s report, which requires auditors to include a discussion of “critical audit matters,” know colloquially as “CAMs.” CAMs are “matters communicated or 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.” Essentially, the concept is intended to capture the matters that kept the auditor up at night. As former Commissioner Kara Stein observed in her statement, the new “standard marks the first significant change to the auditor’s report in more than 70 years.” Changes related to CAMs became applicable to audits of large accelerated filers beginning with June 30, 2019 fiscal years and will apply to audits of all other companies to which the requirements apply for fiscal years ending on or after December 15, 2020. (See this PubCo post.) As a first step in analyzing the impact of CAM implementation before the requirement becomes more broadly applicable, the PCAOB undertook an interim analysis of the effect on key stakeholders in the audit process, including preparers (e.g., CFOs) at large accelerated filers, their audit firms, audit partners, audit committees and investors. That report is now available.
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According to Protiviti, in 2019, 90% of companies in the S&P 500 issued separate sustainability reports—not part of SEC filings—and, as of February 2020, over 1,000 companies with an aggregate market cap of $12 trillion have endorsed the Task Force on Climate-related Financial Disclosures (TCFD) recommendations for sustainability disclosure (see this PubCo post and this PubCo post). Similarly, use of the Sustainability Accounting Standards Board (SASB) framework has increased by 180% over the last two years (see this PubCo post). With this heightened focus on sustainability, how can boards best oversee ESG? To that end, in this article, consultant Protiviti offers ten questions about ESG reporting that boards should consider with their management teams.
For over a year, the SEC, credit rating agencies, investors, the Big Four accounting firms and other interested parties have been sounding the alarm about a popular financing technique called “supply chain financing”—not that there’s anything wrong with it, inherently at least. It can be a perfectly useful financing tool in the right hands—companies with healthy balance sheets. But it can also disguise shaky credit situations and allow companies to go deeper into debt, often unbeknownst to investors and analysts, with sometimes disastrous ends. This week, the FASB voted to add to its agenda a project to address the lack of transparency associated with the use of supplier finance programs.
On Friday, the SEC announced adoption of final amendments to the auditor independence rules, largely as proposed at the end of 2019 (see this PubCo post). The changes to the rules make adjustments to address certain recurring fact patterns that came to light in the course of myriad staff consultations in which “certain relationships and services triggered technical independence rule violations without necessarily impairing an auditor’s objectivity and impartiality. These relationships either triggered non-substantive rule breaches or required potentially time-consuming audit committee review of non-substantive matters, thereby diverting time, attention, and other resources of audit clients, auditors, and audit committees from other investor protection efforts.” According to SEC Chair Jay Clayton, although “far-reaching and restrictive” auditor independence rules are necessary to maintain market confidence—as “even the appearance of inappropriate influence can undermine confidence”—they can still have “unintended, negative consequences” as markets evolve. The changes are designed to address these issues by “more effectively focus[ing] the analysis on relationships and services that may pose threats to an auditor’s objectivity and impartiality.” As noted in the adopting release, both auditors and audit clients “have a shared responsibility to monitor independence,” and it is important to keep in mind that violations of the auditor independence rules can have serious consequences not only for the audit firm, but also for the audit client. For example, an independence violation may cause the auditor to withdraw the firm’s audit report, requiring the audit client to have a re-audit by another audit firm. As a result, in most cases, inquiry into the topic of auditor independence should be a menu item on the audit committee’s plate. The amendments will be effective 180 days after publication in the Federal Register.
Enforcement has certainly been busy at the end of the SEC’s fiscal year, with disclosure violations receiving their fair of attention. In this action against HP Inc., the company was charged with failing to disclose known trends and uncertainties regarding the impact of sales and inventory practices, as well as failure to maintain adequate disclosure controls and procedures. HP was ordered to pay a penalty of $6 million.
With the SEC presumably about to adopt enhanced disclosure requirements for human capital next week (see this PubCo post), this new report from the World Economic Forum in Davos, prepared in collaboration with consultant Willis Towers Watson, offers a timely new framework for valuing human capital. While the COVID-19 pandemic has increased our focus on the value of the workforce as an asset, this shift in perspective is not entirely new: SEC Chair Jay Clayton has long recognized that, while, historically, companies’ most valuable assets were plant, property and equipment, and human capital was primarily a cost, now, human capital often represents “an essential resource and driver of performance for many companies. This is a shift from human capital being viewed, at least from an income statement perspective, as a cost.” But he also recognized that developing a metric around this issue was not so easy. (See this PubCo post.) The pandemic, however, serves as a springboard: the new WEF report contends that, as “companies look to reset for the new world of work that emerges from the pandemic, they would benefit from an approach that values talent as a key asset that contributes to an organization’s sustained value creation. This calls for the development of a new human capital accounting framework, which would enable a company’s board and management to track how their investment in people is augmenting the firm’s human capital, and support the delivery of better outcomes for the business, the workforce and the wider community.” The report seeks to offer that framework. Whether it actually catches on is another question.
For over a decade, the PCAOB has been unable to fulfill its SOX mandate to inspect audit firms in “Non-Cooperating Jurisdictions,” or “NCJs,” including China. To address this issue, in May, the Senate passed the Holding Foreign Companies Accountable Act, which would amend SOX to impose certain requirements on public companies that are audited by a registered public accounting firm that the PCAOB is unable to inspect, and a version was subsequently passed by the House as an amendment to a defense funding bill. Around the same time, Nasdaq also proposed rule changes aimed at addressing similar issues in restricted markets, including new initial and continued listing standards. (See this PubCo post.) Now, the President’s Working Group on Financial Markets, which includes Treasury Secretary Steven T. Mnuchin, Fed Chair Jerome H. Powell, SEC Chair Jay Clayton and CFTC Chair Heath P. Tarbert, has issued a Report on Protecting United States Investors from Significant Risks from Chinese Companies. The Report makes five recommendations “designed to address risks to investors in U.S. financial markets posed by the Chinese government’s failure to allow audit firms that are registered with the Public Company Accounting Oversight Board (PCAOB) to comply with U.S. securities laws and investor protection requirements.” In this Statement, the SEC Chair Jay Clayton, Chief Accountant Sagar Teotia and the Directors of various SEC Divisions responded to the Report, indicating that Clayton had already “directed the SEC staff to prepare proposals in response to the report’s recommendations for consideration by the Commission and to provide assistance and guidance to investors and other market participants as may be necessary or appropriate. The SEC staff also stands ready to assist Congress with technical assistance in connection with any potential legislation regarding these matters.”
In December 2019, as part of its strategy of enhancing transparency and accessibility through proactive stakeholder engagement, the PCAOB conducted conversations with almost 400 audit committee chairs, focused on audit committee perspectives on topics such as audit quality assessment and improvement and auditor communications, and reported on those conversations. (See this PubCo post.) As noted by PCAOB Chair William Duhnke in this PCAOB webinar for audit committees, the PCAOB prioritized this engagement, viewing informed and engaged audit committees as “force multipliers.” In addition, he noted, the PCAOB had heard criticism early in the process that the PCAOB did not play well with others and was not receptive to feedback—the conversations also represented an effort to address that problem. The PCAOB has continued this same outreach to audit committee chairs during 2020, focused this time on the unprecedented challenges created by COVID-19 and its effect on the chairs’ oversight of financial reporting and the audit. The responses regarding the impact of the pandemic varied widely, depending on the industry and company. The chairs identified a number of new or increased risks, including cybersecurity, employee safety and mental health, going concern, accounting estimates, impairments, international operations and accounting implications of the CARES Act. The PCAOB’s recent report summarizes two of the common themes the PCAOB regularly heard from audit committee chairs across industries and highlights some of the helpful questions and considerations that the chairs identified.