Category: Accounting and Auditing
Be on the alert for California’s Climate Corporate Data Accountability bill
If you’re waiting with bated breath to find out what the SEC has in store for public companies in its final version of its climate disclosure regulations (see this PubCo post, this PubCo post and this PubCo post), you might also want to take a look at this California bill—the Climate Corporate Data Accountability Act (SB 253)—previously known as the Climate Corporate Accountability Act when it went belly up last year after sailing through one chamber of the legislature but coming up shy in the second (see this PubCo post). In fact, this year, the press release announces, the bill is part of California’s Climate Accountability Package, a “suite of bills that work together to improve transparency, standardize disclosures, align public investments with climate goals, and raise the bar on corporate action to address the climate crisis. At a time when rising anti-science sentiment is driving strong pushback against responsible business practices like risk disclosure and ESG investing,” the press release continues, “these bills leverage the power of California’s market to continue the state’s long tradition of setting the gold standard on environmental protection for the nation and the world.” If signed into law this time, the bill, which was introduced at the end of January and has a hearing scheduled in March, would mandate disclosure of GHG emissions data—Scopes 1, 2 and 3—by all U.S. business entities with total annual revenues in excess of a billion dollars that “do business in California.” The bill’s mandate would exceed, in several key respects, the requirements in the current SEC climate proposal. Whether this new bill will face the same fate as its predecessor remains to be seen.
SEC brings settled charges against Roadrunner—no, not the cartoon character—for accounting fraud
Here’s another earnings management case from SEC Enforcement, this time against Roadrunner Transportation Systems, Inc., a shipping and logistics company formerly traded on the NYSE, involving a veritable pu pu platter of alleged financial manipulations. As charged in the SEC’s Order, from July 2013 through January 2017, the company engaged in an “accounting fraud scheme by manipulating its financial reports to hit prior earnings guidance and analyst projections.” Among other things, Roadrunner was alleged to have improperly deferred and stretched out expenses over multiple quarters to minimize their impact on earnings, failed to write down worthless assets and uncollectable receivables, and manipulated earnout liabilities related to its numerous acquisitions. The company agreed to pay disgorgement of just over $7 million, with prejudgment interest of approximately $2.5 million—except that the company paid nothing additional: the penalties were deemed satisfied by the settlement payment the company made in connection with prior private securities litigation.
SEC Enforcement’s “EPS Initiative” chalks up another one
Last week, the SEC announced settled charges against Gentex Corporation, a manufacturer of digital vision, connected car, dimmable glass and fire protection products, and its former Chief Accounting Officer and current CFO, Kevin Nash, related to financial reporting, books-and-records and internal accounting controls violations. Allegedly, these violations were the consequence of deficiencies in the company’s accounting practices for its bonus programs, which practices allowed the company to manage its earnings by adjusting its accruals for bonuses to ensure that publicly reported EPS was in line with consensus EPS estimates—without the required accounting analysis or adequate supporting documentation. According to the SEC, had the company not reduced the accrual for bonuses, it “would have missed consensus EPS estimates by one penny.” Gentex was ordered to pay a civil money penalty of $4 million and Nash to pay $75,000. These charges represent yet another case resulting from SEC Enforcement’s “Earnings-Per-Share Initiative,” which applies risk-based data analytics to detect potential violations from earnings management, among other things.
Corp Fin issues new CDIs regarding the clawback rules
In October last year, the SEC adopted a new clawback rule, Exchange Act Rule 10D-1, which directed the national securities exchanges to establish listing standards requiring listed issuers to adopt and comply with a clawback policy and to provide disclosure about the policy and its implementation. The clawback policy must provide that, in the event the listed issuer is required to prepare an accounting restatement—including not only a “reissuance,” or “Big R,” restatement (which involves a material error and an 8-K), but also a “revision” or “little r” restatement—the issuer must recover the incentive-based compensation that was erroneously paid to its current or former executive officers based on the misstated financial reporting measure. (See this PubCo post.) Now, the Corp Fin staff has issued some new CDIs, summarized below, providing guidance about the timing of the new required disclosure, which officers of foreign private issuers are subject to the disclosure rule and plans subject to the clawback.
Will companies need to provide more detailed country-by-country tax disclosure?
The topic of taxes—corporate, presidential and otherwise—seems to be trending these days, with calls for greater transparency coming from investors, analysts and others, including speakers at the SEC’s Investor Advisory Committee. They contend that some corporate tax practices may give rise to financial, legal and reputational risks that would be material for investors to understand. Currently, however, financial statements are required to include disclosure of the total taxes paid, but are not required to break out the amounts by country or state. Consequently, investors and analysts say that they do not have sufficient visibility to understand the impact on companies of changes in tax laws or the tax environment in different jurisdictions or to otherwise evaluate companies’ exposure to tax risks.
PCAOB gains “unprecedented access” to inspect audit firms in China
You might recall that, for well over a decade, the PCAOB has been unable to fulfill its SOX mandate to inspect audit firms in “Non-Cooperating Jurisdictions,” including China. Years of negotiation failed to resolve the deadlock over audit inspections and, in 2020, the Holding Foreign Companies Accountable Act amended SOX to prohibit trading on U.S. exchanges of public reporting companies audited by audit firms located in foreign jurisdictions that the PCAOB has been unable to inspect for three sequential years. (See this PubCo post.) According to the U.S.-China Economic and Security Review Commission, as of March 31, 2022, Chinese companies listed on the three largest U.S. exchanges had a total market capitalization of $1.4 trillion. (See this PubCo post.) As a result, the trading prohibitions of the HFCAA were poised to have a substantial impact. After passage of the HFCAA, more negotiations ensued, and, in August, the PCAOB took an initial step by signing a Statement of Protocol with the China Securities Regulatory Commission and the Ministry of Finance of the People’s Republic of China governing inspections and investigations of audit firms based in China and Hong Kong. (See this PubCo post.) But that was viewed as just an opening; as SEC Chair Gary Gensler phrased it, the “proof will be in the pudding. While important, this framework is merely a step in the process. This agreement will be meaningful only if the PCAOB actually can inspect and investigate completely audit firms in China. If it cannot, roughly 200 China-based issuers will face prohibitions on trading of their securities in the U.S. if they continue to use those audit firms.” To the surprise of many, last week, the PCAOB announced that it had secured unprecedented access to conduct these inspections. According to PCAOB Chair Erica Williams, for “the first time in history, the PCAOB has secured complete access to inspect and investigate registered public accounting firms headquartered in mainland China and Hong Kong. And this morning the Board voted to vacate the previous determinations to the contrary. This historic and unprecedented access was only possible because of the leverage Congress created by passing the Holding Foreign Companies Accountable Act. Congress sent a clear message with that legislation that access to U.S. capital markets is a privilege and not a right, and China received that message loud and clear. Investors are more protected today because of Congress’ leadership….” However, she added, she wanted “to be clear: this is the beginning of our work to inspect and investigate firms in China, not the end. The PCAOB is continuing to demand complete access in mainland China and Hong Kong moving forward. Our teams are already making plans to resume regular inspections in early 2023 and beyond, as well as continuing to pursue investigations.” What is the impact? To remove, at least for now, the immediate peril of delisting from U.S. exchanges that was threatening many U.S.-listed China-based companies.
Happy Holidays!
Corp Fin posts revised and new non-GAAP CDIs
The Corp Fin staff has issued a group of revised and new compliance & disclosure interpretations on the use of non-GAAP financial measures. The CDIs are more detailed and expansive in describing disclosure that the staff considers to be misleading as well as presentations that the staff believes reflect excessive non-GAAP prominence over the comparable GAAP number under Reg S-K Item 10(e). Summaries are below.
Happy Holidays!
Will climate disclosures translate into climate action?
In light of the billions that even the SEC’s economic analysis estimates would be spent complying with its proposed climate disclosure regulations (see this PubCo post, this PubCo post and this PubCo post), will those disclosures catalyze real climate action? In this recent EY Global Climate Risk Barometer, accounting firm EY analyzed why, notwithstanding the vast amounts spent on climate disclosures, they “are still not translating into practical strategies to accelerate decarbonization.” In fact, EY pointed out, “global energy-related carbon dioxide emissions rose by 6% in 2021 to 36.3 billion tonnes [a metric unit of mass equal to 2,240 lbs], their highest-ever level, according to the International Energy Agency.” Will companies be able to “close the major disconnect between the disclosures they are making” and “their own transformation journeys”? Is integrating climate risk into the financial statements the key? Is climate risk disclosure just a “box-ticking exercise” or, by enabling accountability, can climate disclosures help to accelerate “the decarbonization process”?
FASB issues proposed ASU on segment reporting
Last month, the FASB issued a proposed ASU on segment reporting. In its announcement, the FASB explained that investors find segment information to be critically important to understanding a company’s different business activities, as well as its overall performance and potential future cash flows. Although financial statements do provide information about segment revenue and a measure of profit or loss, not much information is disclosed about segment expenses. According to FASB Chair Richard Jones, the “proposed ASU would represent the FASB’s most significant change to segment reporting since 1997….On the basis of our extensive stakeholder outreach, the proposed ASU would provide investors and other allocators of capital with valuable insights into significant segment expenses, expand segment disclosures reported in interim periods, and require disclosures for single-segment entities.”
SEC adopts final rules on compensation clawbacks in the event of financial restatements—“Big R” and “little r” [UPDATED]
[This post revises and updates my earlier post primarily to reflect in greater detail the contents of the adopting release. For a discussion of the comments and criticisms of the SEC Commissioners at the open meeting at which the rules were adopted, see my earlier post.]
At an open meeting last week, the SEC adopted, by a vote of—surprise—3 to 2, rules to implement Section 954 of Dodd-Frank, the clawback provision. Clawback rules were initially proposed by the SEC back in 2015, but were relegated to the long-term agenda, until they suddenly reemerged on the SEC’s short-term agenda in 2021 (see this PubCo post) with a target date for a re-proposal of April 2022. Instead of a re-proposal, however, a year ago, the SEC simply posted a notice announcing that it was re-opening the comment period and posing a number of questions for public comment. (See this PubCo post.) One possible change suggested by the SEC’s questions was a potential expansion of the concept of “restatement” to include not only “reissuance,” or “Big R,” restatements (which involve a material error and an 8-K), but also “revision” or “little r” restatements. Then, in June of this year, DERA issued a new staff memorandum addressing in part the restatement question, which led the SEC to once again re-open the comment period. Finally, the SEC concluded that, after more than seven years, the proposal had marinated long enough. Time to serve it up. The new rules direct the national securities exchanges to establish listing standards requiring listed issuers to adopt and comply with a clawback policy and to provide disclosure about the policy and its implementation. The clawback policy must provide that, in the event the listed issuer is required to prepare an accounting restatement—including a “little r” restatement—the issuer must recover the incentive-based compensation that was erroneously paid to its current or former executive officers based on the misstated financial reporting measure. Commissioners Hester Peirce and Mark Uyeda dissented, contending that, among other problems, the rule was too broad and too prescriptive. According to SEC Chair Gary Gensler, the key word here is “erroneously,” that is, the rule requires recovery of compensation to which the officers were never entitled in the first place. In his statement at the meeting, Gensler indicated that he believes “that these rules will strengthen the transparency and quality of corporate financial statements, investor confidence in those statements, and the accountability of corporate executives to investors….Through today’s action and working with the exchanges, we have the opportunity to fulfill Dodd-Frank’s mandate and Congress’s intention to prevent executives from keeping compensation received based on misstated financials.”
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