Category: Accounting and Auditing
Is it Groundhog Day? SEC reopens comment period for clawback proposal
Yesterday, the SEC announced that it is reopening the comment period for its 2015 proposal for listing standards for recovery of erroneously awarded compensation. Wait—didn’t they just do that? Yes, in October 2021. (See this PubCo post.) But no, that’s not Sonny and Cher on the radio. The SEC has decided to reopen the comment period AGAIN to allow further public comment in light of a new, just released DERA staff memorandum containing “additional analysis and data on compensation recovery policies and accounting restatements.” The new comment period will be open until 30 days after publication of the reopening notice in the Federal Register.
Is time running out under the HFCAA?
In December 2020, the Holding Foreign Companies Accountable Act, co-sponsored by Senators John Kennedy, a Republican from Louisiana, and Chris Van Hollen, a Democrat from Maryland, was signed into law. The HFCAA 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.) The U.S.-China Economic and Security Review Commission reports that, as of March 31, 2022, Chinese companies listed on the three largest U.S. exchanges had a total market capitalization of $1.4 trillion. As a result, the trading prohibitions of the HFCAA, which could kick in in just a couple of years—or perhaps even sooner, if Congress speeds up the timeline—could have a substantial impact. According to SEC Chair Gary Gensler, “[w]e have a basic bargain in our securities regime, which came out of Congress on a bipartisan basis under the Sarbanes-Oxley Act of 2002. If you want to issue public securities in the U.S., the firms that audit your books have to be subject to inspection by the [PCAOB]….The Commission and the PCAOB will continue to work together to ensure that the auditors of foreign companies accessing U.S. capital markets play by our rules. We hope foreign governments will, working with the PCAOB, take action to make that possible.” But China and Hong Kong have not permitted PCAOB inspections, largely because of purported security concerns. Last week, in remarks to International Council of Securities Associations, YJ Fischer, Director of the SEC’s Office of International Affairs, addressed “recent regulatory developments related to the lack of US inspections of audits and investigations in China and Hong Kong, and the implications for continued trading of China-based issuers on US exchanges.” The main message: although there has been progress, “significant issues remain,” and reaching an agreement would be only “a first step.” In other words, there is still “a long way to go.”
What happened with financial restatements in 2021?
Audit Analytics has just posted its 2021 annual review of financial restatements, which this year covered a 21-year period. The review showed a 289% increase in the number of restatements to 1470, the highest level of restatements since 2006. You may have guessed that the increase was attributable to restatements by SPACs. Excluding SPACs, the numbers actually reflected a 10% decrease in the number of restatements year over year. SPACs also account—largely but not entirely—for a large increase in the proportion of reissuance (“Big R”) restatements. Audit Analytics found that 62% of restatements were reissuance restatements, the biggest proportion since 2005. But even excluding SPAC restatements, 24% of 2021 restatements were reissuances, an increase from 2020 of three percentage points.
SEC staff takes issue with widely used pharma non-GAAP financial measure
Pharmas, biotechs and others may want to take notice—if they haven’t already—of a series of SEC comment letters to global biopharmaceutical company, Biogen, about one of the company’s non-GAAP financial measures. More specifically, in 2021, the SEC staff objected to the company’s exclusion from non-GAAP R&D and non-GAAP net income of material upfront and premium payments made in connection with collaboration agreements. In the end, Biogen agreed to discontinue these adjustments going forward and to recast prior period information. As reported in this article in MarketWatch, this year a number of biopharmas have taken a lesson from the exchange between Biogen and the SEC staff and have included language in their earnings releases explaining similar changes in practice, following guidance from the SEC staff, regarding exclusion of upfront payments from non-GAAP R&D. Moreover, the article indicated, the impact of the changes was “not insignificant,” leading, in one example, to a change of $0.15 in EPS for a single quarter.
After dam collapse, SEC alleges false safety claims in sustainability reports and SEC filings
As described in this press release, the SEC has filed a complaint against Vale S.A., a publicly traded (NYSE) Brazilian mining company and one of the world’s largest iron ore producers, charging that it made “false and misleading claims about the safety of its dams prior to the January 2019 collapse of its Brumadinho dam. The collapse killed 270 people, caused immeasurable environmental and social harm, and led to a loss of more than $4 billion in Vale’s market capitalization.” The SEC alleged that Vale “fraudulently assured investors that the company adhered to the ‘strictest international practices’ in evaluating dam safety and that 100 percent of its dams were certified to be in stable condition.” Significantly, these statements were contained, not just in Vale’s SEC filings, but also, in large part, in its sustainability reports. According to Gurbir Grewal, Director of Enforcement, “[m]any investors rely on ESG disclosures like those contained in Vale’s annual Sustainability Reports and other public filings to make informed investment decisions….By allegedly manipulating those disclosures, Vale compounded the social and environmental harm caused by the Brumadinho dam’s tragic collapse and undermined investors’ ability to evaluate the risks posed by Vale’s securities.” Notably, the press release refers to the SEC’s Climate and ESG Task Force formed last year in the Division of Enforcement “with a mandate to identify material gaps or misstatements in issuers’ ESG disclosures, like the false and misleading claims made by Vale.” The SEC’s charges arising out of this horrific accident are a version of “event-driven” securities litigation—brought this time, not by shareholders, but by the SEC.
Raiding the cookie jar—“part of the art of the close”?
In this Order, the SEC brought settled charges against Rollins, Inc., a termite and pest control company—think “Orkin”—and its former CFO for earnings management. In essence, the SEC alleged that the company adjusted the amounts in several of its corporate reserves, without support or documentation, to bump up its EPS so that its EPS would meet analysts’ consensus EPS estimates for two quarters. The company would otherwise have missed those consensus estimates by a penny in each quarter. The SEC charged the company with securities fraud under the Securities Act, financial reporting violations under the Exchange Act and failure to maintain adequate internal accounting controls and imposed a civil penalty of $8 million. The CFO was also charged with similar violations and ordered to pay a civil penalty of $100,000. According to Gurbir Grewal, Director of Enforcement, “[t]his is the fourth action and the highest penalty to date against an issuer in connection with the Division of Enforcement’s highly successful and continuing EPS Initiative, which uses data analytics to uncover hard-to-detect accounting and disclosure violations by public companies….The SEC staff’s ever-increasing sophistication with data made today’s action possible and underscores that we will continue to pursue public companies that lack adequate accounting controls and engage in improper earnings management practices.”
PCAOB talks to audit committee chairs about auditor oversight in 2021
Since 2019, as part of its strategy of enhancing transparency and accessibility through proactive stakeholder engagement, the PCAOB has been engaging with audit committee chairs at U.S. public companies that have had audits inspected by the PCAOB during the year. The PCAOB staff continued this outreach to audit committee chairs during 2021, engaging in conversations with over 240 audit committee chairs. The results are discussed in this new report. The discussions involved required communications between the auditor with the audit committee and discussions outside of required communications, auditor strengths and weaknesses, PCAOB inspection reports, quality control, use of technology and matters outside of the financial statements. The PCAOB believes that the audit committee’s oversight of the auditor and the audit process is a critical job. Accordingly, “engaged and informed audit committees can be a force for elevating audit quality to the benefit of investors and our capital markets broadly.”
SEC proposes new rules on climate disclosure [UPDATED—PART II—GHG emissions]
[This post is Part II of a revision and update of my earlier post that primarily reflects the contents of the proposing release. Part I (here) covered the background of the proposal and described the SEC’s proposed climate disclosure framework, including disclosure of climate-related risks, governance, risk management, targets and goals, financial statement metrics and general aspects of the proposal. This post covers GHG emissions disclosure and attestation.]
So, what are the GHG emissions for a mega roll of Charmin Ultra Soft toilet paper? That was the question I asked to open this PubCo post. According to this article in the WSJ, the answer was 771 grams, a calculation performed by the Natural Resources Defense Council. But how did they figure that out? How public companies could be required to calculate and report on their GHG emissions is one of the major issues addressed by the SEC in its proposal on climate-related disclosure regulation issued last week. The proposal was designed to require disclosure of “consistent, comparable, and reliable—and therefore decision-useful—information to investors to enable them to make informed judgments about the impact of climate-related risks on current and potential investments.” Drawing on the Greenhouse Gas Protocol, the proposal would, in addition to the disclosure mandate discussed in Part I of this Update, require disclosure of a company’s Scopes 1 and 2 greenhouse gas emissions, and, for larger companies, Scope 3 GHG emissions if material (or included in the company’s emissions reduction target), with a phased-in attestation requirement for Scopes 1 and 2 data for large accelerated filers and accelerated filers. The disclosure would be included in registration statements and periodic reports in the section captioned “Climate-Related Disclosure.” At 510 pages, the proposal is certainly thoughtful, comprehensive and stunningly detailed—some might say overwhelmingly so. If adopted, it would certainly require a substantial undertaking for many companies to get their arms around the extensive and granular requirements and comply with the proposal’s mandates. How companies would manage this enormous effort remains to be seen.
SEC (finally) proposes new rules on climate disclosure [UPDATED—PART I]
[This post is Part I of a revision and update of my earlier post primarily reflecting the contents of the proposing release. This post covers background and describes various aspects of the proposal other than the sections on GHG emissions disclosure and attestation, which will be covered in a separate post early next week.]
The SEC describes it modestly as a proposal to “enhance and standardize registrants’ climate-related disclosures for investors.” The WSJ called it “the biggest potential expansion in corporate disclosure since the creation of the Depression-era rules over financial disclosures that underpin modern corporate statements,” and Fortune said it “could be the biggest change to corporate disclosures in the U.S. in decades.” But now you can judge for yourself, after the SEC voted earlier this week, three to one, to propose new rules on climate disclosure regulation. The proposal was designed to require disclosure of “consistent, comparable, and reliable—and therefore decision-useful—information to investors to enable them to make informed judgments about the impact of climate-related risks on current and potential investments.” The proposal would require public companies to disclose information about climate-related risks that are reasonably likely to have a material impact on their businesses, results of operations or financial condition, as well as information about the effect of climate risk on companies’ governance, risk management and strategy. The disclosure, which would be included in registration statements and periodic reports, would draw, in part, on disclosures provided for under the Task Force on Climate-Related Financial Disclosures and the Greenhouse Gas Protocol. Compliance would be phased in, with reporting for large accelerated filers due in 2024 (assuming an—optimistic—effective date at the end of this year). The proposal would also mandate disclosure of a company’s Scopes 1 and 2 greenhouse gas emissions, and, for larger companies, Scope 3 GHG emissions if material (or included in the company’s emissions reduction target), with a phased-in attestation requirement for Scopes 1 and 2 data for large accelerated filers and accelerated filers. The proposal would also require disclosure of certain climate-related financial metrics in a note to the audited financial statements. At 510 pages, the proposal is certainly thoughtful, comprehensive and stunningly detailed—some might say overwhelmingly so. If adopted, it would surely require a substantial undertaking for many companies to get their arms around the extensive and granular requirements and comply with the proposal’s mandates. How companies would manage this enormous effort remains to be seen.
Corp Fin posts sample comments related to Ukraine disclosure
Corp Fin has posted a sample comment letter to companies about potential disclosure obligations arising out of the Russian invasion of Ukraine, the international response to it and related supply chain issues. Corp Fin wants companies to provide more “detailed disclosure, to the extent material or otherwise required,” about the direct or indirect impact on their businesses of their exposure to or business relationships with Russia, Belarus or Ukraine, any goods or services sourced in those countries and supply chain disruption. The letter provides a useful resource to help companies think through how their businesses have been or may be affectedCorp Fin has posted a sample comment letter to companies about potential disclosure obligations arising out of the Russian invasion of Ukraine, the international response to it and related supply chain issues. Corp Fin wants companies to provide more “detailed disclosure, to the extent material or otherwise required,” about the direct or indirect impact on their businesses of their exposure to or business relationships with Russia, Belarus or Ukraine, any goods or services sourced in those countries and supply chain disruption. The letter provides a useful resource to help companies think through how their businesses have been or may be affected, even if they don’t have operations in Russia or Ukraine.