Category: Securities
Auditor problems are not just auditor problems
On Friday, SEC Enforcement charged audit firm BF Borgers CPA PC and its owner, Benjamin F. Borgers, with “massive fraud” involving “deliberate and systemic failures” to comply with PCAOB standards in auditing and reviewing financial statements incorporated into more than 1,500 SEC filings from January 2021 through June 2023. The charges also included “falsely representing to their clients that the firm’s work would comply with PCAOB standards; fabricating audit documentation to make it appear that the firm’s work did comply with PCAOB standards; and falsely stating in audit reports included in more than 500 public company SEC filings that the firm’s audits complied with PCAOB standards.” In settlement, the audit firm agreed to pay a $12 million civil penalty, and Benjamin Borgers agreed to pay a $2 million civil penalty, along with censures, cease-and-desists and permanent suspensions from appearing and practicing before the SEC as accountants. According to SEC Enforcement Director Gurbir S. Grewal,
“Ben Borgers and his audit firm, BF Borgers, were responsible for one of the largest wholesale failures by gatekeepers in our financial markets….As a result of their fraudulent conduct, they not only put investors and markets at risk by causing public companies to incorporate noncompliant audits and reviews into more than 1,500 filings with the Commission, but also undermined trust and confidence in our markets. Because investors rely on the audited financial statements of public companies when making their investment decisions, the accountants and accounting firms that audit those statements play a critical role in our financial markets. Borgers and his firm completely abandoned that role, but thanks to the painstaking work of the SEC staff, Borgers and his sham audit mill have been permanently shut down.”
This case has received an unusual amount of press—for an audit firm that many have never even heard of before—because Borgers was the auditor for the social media company of a certain former president. (See, e.g., the NYT, CNBC, CBS News) But, as we’ve often seen in other contexts, such as auditor independence (see, e.g., this PubCo post), this case also illustrates the importance for companies to keep in mind that these types of violations may have serious consequences not only for the audit firm, but also for the audit clients. In fact, in this case, the staff of Corp Fin and the Office of Chief Accountant issued this Staff Statement on Issuer Disclosure and Reporting Obligations in Light of Rule 102(e) Order against BF Borgers CPA PC.
Cooley Alert: Proposed Regulations on Stock Buyback Excise Tax
In April, the Treasury Department and the IRS published proposed regs on the 1% excise tax on stock buybacks imposed under the Inflation Reduction Act. As discussed in this comprehensive Cooley Alert, IRS Publishes Proposed Regulations on Stock Buyback Excise Tax, from our Comp & Benefits and Tax groups, the proposed regs take an expansive approach, applying the excise tax to transactions not typically considered stock buybacks, including redemptions and transactions that are economically similar to redemptions, such as exchanges of target stock in acquisitive reorganizations and other economically similar transactions. The Alert cautions that “companies may have excise tax liability or tax return filing obligations in myriad circumstances.”
Is the proxy advisory industry a net benefit or cost to shareholders?
In Seven Questions About Proxy Advisors, from the Rock Center for Corporate Governance at Stanford, the authors, David Larcker and Brian Tayan, examine the proxy advisory firm industry—all two of them. Well, actually, as the paper observes, there are a large number of small players, but Institutional Shareholder Services and Glass Lewis “control[] almost the entire market.” It’s well-known that recommendations from ISS and GL are considered important—sometimes even a major aspect of the battle—especially in contests for corporate control and director elections. But, the authors point out, the extent of their influence on “voting outcomes and corporate choices is not established, nor is the role they play in the market. Are proxy advisory firms information intermediaries (that digest and distill proxy data), issue spotters (that highlight matters deserving closer scrutiny), or standard setters (that influence corporate choices through their guidelines and models)? Because of the uncertainty around these questions, disagreement exists whether their influence is beneficial, benign, or harmful. Defenders of proxy advisors tout them as advocates for shareholder democracy, while detractors fashion them as unaccountable standard setters.” The paper examines “seven important questions about the role, influence and effectiveness of proxy advisory firms.” The authors explore why there is so much controversy about the purpose, role and contribution of proxy advisory firms, asking whether “the proxy advisory industry—as currently structured—[is] a net benefit or cost to shareholders?”
SEC and NAM appeal decision holding 2020 proxy advisor rule amendments unlawful
You probably remember the saga about the SEC’s rules regarding proxy advisory firms? Back in 2019, the SEC issued interpretive guidance that proxy advisory firms’ vote recommendations were, in the view of the SEC, “solicitations” under the proxy rules and subject to the anti-fraud provisions of Rule 14a-9. (See this PubCo post.) That guidance led ISS to sue the SEC and then-SEC Chair Jay Clayton. SEC rules codifying that interpretation were adopted in 2020. ISS amended its complaint, contending that the interpretation in the release and the subsequent rules were unlawful for a number of reasons, including that the SEC’s determination that providing proxy advice is a “solicitation” was contrary to law, that the SEC failed to comply with the Administrative Procedure Act and that the views expressed in the release were arbitrary and capricious. The National Association of Manufacturers, which favored the 2020 amendments, intervened on the side of the SEC (and also became a defendant). Over four years later, in February 2024, the DC District Court held that the SEC’s rules regarding proxy advisory firms were invalid, stating that the “SEC acted contrary to law and in excess of statutory authority when it amended the proxy rules’ definition of ‘solicit’ and ‘solicitation’ to include proxy voting advice for a fee.” (See this PubCo post.) Now, both NAM and the SEC have filed notices of appeal with the DC Circuit.
Change primary business focus? NYSE proposes to allow immediate delisting
The NYSE has filed a proposed rule change with the SEC that would allow the NYSE to commence immediate suspension and delisting procedures for a listed company if that company has “changed its primary business focus to a new area of business that is substantially different from the business it was engaged in at the time of its original listing or which was immaterial to its operations at the time of its original listing.” Comments on the proposal are due 21 days after publication in the Federal Register.
Cooley Alert—US Supreme Court: Pure Omissions Not Actionable Under Rule 10b-5(b)
Earlier this month, SCOTUS unanimously decided Macquarie Infrastructure Corp v. Moab Partners, holding that a pure omission of information required to be disclosed—in this case required in MD&A under Item 303—cannot form the basis of a private securities fraud action under Rule 10b-5(b). The Court was clear: “Pure omissions are not actionable under Rule 10b–5(b).” To be actionable under Rule 10b-5(b), the Court said, the omission must render an affirmative statement materially misleading. According to the Court, a “pure omission occurs when a speaker says nothing, in circumstances that do not give any particular meaning to that silence.” Actionable “[h]alf-truths, on the other hand, are ‘representations that state the truth only so far as it goes, while omitting critical qualifying information’…….In other words, the difference between a pure omission and a half-truth is the difference between a child not telling his parents he ate a whole cake and telling them he had dessert.” As discussed in this new Cooley Alert, US Supreme Court: Pure Omissions Not Actionable Under Rule 10b-5(b), from our Securities Litigation + Enforcement and Public Companies groups, the “decision emphasizes the importance of assessing whether statements could be construed as being misleading by omission.”
Is the SEC’s case against SolarWinds counterproductive?
You remember the 2020 SolarWinds hack, perhaps one of the worst cyberattacks in history? As described by NPR in 2021, the hack was “believed to be directed by the Russian intelligence service, the SVR,” which used a “routine software update to slip malicious code into Orion’s software and then used it as a vehicle for a massive cyberattack against America.” It was estimated that 18,000 customers were affected, including some very well-known companies and about a dozen government agencies including the Treasury, Justice and Energy departments, the Pentagon and, ironically, the Cybersecurity and Infrastructure Security Agency, part of the Department of Homeland Security. The SEC filed a complaint against SolarWinds and its Chief Information Security Officer, Timothy G. Brown, charging ‘fraud and internal control failures relating to allegedly known cybersecurity risks and vulnerabilities.” The gist of the complaint, as alleged by the SEC, is that many red flags emerged and incidents occurred, well known among company employees, that should have spurred the company and its CISO to take action to address serious cyber vulnerabilities, including vulnerabilities related to the company’s “crown jewel” assets. Instead, the SEC charged, the CISO “failed to resolve the issues or, at times, sufficiently raise them further within the company.” (See this PubCo post.) As discussed in this blogpost, Fatal Flaws in SEC’s Amended Complaint Against SolarWinds, from our White Collar Defense and Investigations group, this case has developed into a very high-stakes contest.
CAQ’s 2024 audit committee practices report discusses priorities and practices
The Center for Audit Quality has released its 2024 “Audit Committee Practices Report: Common Threads Across Audit Committees.” The report highlights the top five audit committee priorities identified by committee members in a survey from CAQ and discusses practices to improve effectiveness and other observations. Interspersed throughout the report are recommendations and advice from the CAQ. What was identified by respondents as the “most important topic, risk, or issue” for their audit committees in the next 12 months? Not financial reporting or financial audits—core responsibilities for the audit committee—as you might expect. Nope, it was cybersecurity. According to the CAQ report, the scope of audit committee responsibilities “continues to expand beyond the traditional remit of financial reporting and internal controls, internal and external audit, and ethics and compliance programs. Topics like cybersecurity, artificial intelligence (AI), and climate are now regularly showing up on many audit committee agendas, especially when it’s a matter of complying with regulatory disclosure requirements.” Audit committee members and their advisors may want to check out the report.
Chamber seeks to intervene in environmental group challenges to SEC climate disclosure rules
As you probably remember, the SEC’s climate disclosure rules were challenged not only by those contending that the rules went too far and that the SEC had no authority—think, for example, Liberty Energy, the State of Iowa and the Chamber of Commerce—but also by the Sierra Club and the Natural Resources Defense Council, which claimed that the SEC did have the legal authority to adopt the rules but did not go far enough and left out some important information. All those cases have recently been consolidated in the Eighth Circuit. Now, the Chamber of Commerce has moved for leave to intervene in the cases brought by the Sierra Club and the NRDC “to defend those portions of the final rule that refrained from imposing the additional disclosure requirements the environmental groups would have this Court require the SEC to impose.” The Sierra Club, the motion contends, “intends to argue that the SEC should have required public companies to disclose not only their own greenhouse-gas emissions, but also the emissions from the ‘use of [their] products’ and across their ‘supply chains’”; that is, that the SEC failed to impose a requirement to disclose Scope 3 GHG emissions.
Another House hearing on climate disclosure rules?
Yesterday, the House Financial Services Committee held a hearing entitled “Beyond Scope: How the SEC’s Climate Rule Threatens American Markets.” Since, as one of the committee members observed, this is their sixth hearing on the SEC and twelfth on climate change, there was a lot of the same old, same old—just from different witnesses. (One Committee member called this topic a “manufactured culture war” that the Committee is relitigating; why was the Committee wasting time on this topic when they should be dealing with the problems in housing?) At the hearing, we heard familiar statements to the effect of: the SEC is just pandering to political interest groups; the rules require “extensive and granular” disclosure of information that many do not view to be material; the rules are outside the SEC’s authority and an instance of “mission creep”; this is an attempt by the Biden administration to use regulation to force on the public the climate agenda that it was unable to get through Congress; the costs will be burdensome especially for smaller companies and will result in higher costs and fewer public companies. Or: investors have been demanding this information; voluntary disclosure is inconsistent, unreliable and not comparable; and many companies will already need to comply with the more rigorous rules of the EU and California anyway, so the cost will not be as great as some fear; the SEC acted completely within its wheelhouse. Sound familiar? But there were some highlights, so let’s hit those.
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