Category: Securities
Corp Fin Director discusses changes to guidance on shareholder proposals
In remarks earlier this month to the Council of Institutional Investors, Corp Fin director Renee Jones discussed Corp Fin’s reevaluation of the no-action process for shareholder proposals under Rule 14a-8. In particular, she provided some insight into the staff’s issuance, in November 2021, of new Staff Legal Bulletin No. 14L, which outlined Corp Fin’s most recent interpretations of Rule 14a-8(i)(7), the ordinary business exception, and Rule 14a-8(i)(5), the economic relevance exception, and rescinded three earlier SLBs—SLBs 14I, 14J and 14K—following a “review of staff experience applying the guidance in them.” Generally, new SLB 14L presented its approach as a return to the perspective that historically prevailed prior to the issuance of the three rescinded SLBs. (See this PubCo post.) The effect of SLB 14L was to make exclusion of shareholder proposals—particularly proposals related to environmental and social issues—more of a challenge for companies, smoothing the glide path for inclusion of proposals submitted by climate and other activists. Jones explains why Corp Fin believed that SLB 14L was advisable. She also shares some statistics about the current proxy season.
Lee to leave SEC
SEC Commissioner Allison Herren Lee has announced her intention not to seek another term on the Commission when her current term ends in June. Here is Chair Gary Gensler’s statement on her departure.
SEC’s Acting Chief Accountant discusses materiality assessments in connection with restatements
In this statement from the SEC’s Office of the Chief Accountant, Acting Chief Accountant Paul Munter discusses materiality assessments in the context of errors in financial statements. As he summarizes the issue, the “determination of whether an error is material is an objective assessment focused on whether there is a substantial likelihood it is important to the reasonable investor.” And when an error in historical financial statements is determined to be material, a “Big R” restatement of the prior period financial statements is required. On the other hand, if the error is not material, “but either correcting the error or leaving the error uncorrected would be material to the current period financial statements, a registrant must still correct the error, but is not precluded from doing so in the current period comparative financial statements by restating the prior period information and disclosing the error,” known as a revision or “little r” restatement. In either case, Munter observes, “both of these methods—reissuance and revision, or ‘Big R’ and ‘little r’—constitute restatements to correct errors in previously-issued financial statements as those terms are defined in U.S. GAAP.” According to a review by Audit Analytics, “while the total number of restatements by registrants declined each year from 2013 to 2020, ‘little r’ restatements as a percentage of total restatements rose to nearly 76% in 2020, up from approximately 35% in 2005.” Should we attribute this change to improvements in audit quality or internal control over financial reporting, or could it be that some companies are not being entirely objective in making their materiality determinations? In the event of error in the financial statements, Munter emphasizes, companies, auditors and audit committees must “carefully assess whether the error is material by applying a well-reasoned, holistic, objective approach from a reasonable investor’s perspective based on the total mix of information.”
SEC votes to propose new rules for cybersecurity disclosure and incident reporting [UPDATED]
[This post revises and updates my earlier post primarily to reflect the contents of the proposing release.]
At an open meeting last week, the SEC voted, three to one, to propose regulations “to enhance and standardize disclosures regarding cybersecurity risk management, strategy, governance, and incident reporting by public companies.” At the meeting, SEC Corp Fin Director Renee Jones said that, in today’s digitally connected world, cyber threats and incidents pose an ongoing and escalating threat to public companies and their shareholders. In light of the pandemic-driven trend to work from home and, even more seriously, the potential impact of horrific global events, cybersecurity risk is affecting just about all reporting companies, she continued. While threats have increased in number and complexity, Jones said, currently, company disclosure about cybersecurity is not always decision-useful and is often inconsistent, not timely and sometimes hard for investors to locate. What’s more, some material incidents may not be reported at all. The SEC’s proposal is intended to provide meaningful and decision-useful information to help shareholders better understand cybersecurity risks and how companies are managing and responding to them. As described by Jones, the SEC approached the rulemaking from two perspectives: first, incident reporting and second, periodic disclosure regarding cybersecurity risk management, strategy and governance. According to SEC Chair Gary Gensler, “[o]ver the years, our disclosure regime has evolved to reflect evolving risks and investor needs….Today, cybersecurity is an emerging risk with which public issuers increasingly must contend. Investors want to know more about how issuers are managing those growing risks….I am pleased to support this proposal because, if adopted, it would strengthen investors’ ability to evaluate public companies’ cybersecurity practices and incident reporting.” Notably, the proposal is quite prescriptive, with a number of multi-part bullet point disclosure requirements, just the sort of thing to elicit a dissent from Commissioner Hester Peirce. The public comment period will be open for 60 days following publication of the proposing release on the SEC’s website or 30 days following publication of the proposing release in the Federal Register, whichever period is longer.
SEC votes to propose new rules for cybersecurity disclosure and incident reporting
In remarks in January before the Northwestern Pritzker School of Law’s Annual Securities Regulation Institute, SEC Chair Gary Gensler addressed cybersecurity under the securities laws. (See this PubCo post.) Gensler suggested that the economic cost of cyberattacks could possibly be in the trillions of dollars, taking many forms, including denials-of-service, malware and ransomware. In addition, he said, it’s a national security issue. Gensler reminded us that “cybersecurity is a team sport,” and that the private sector is often on the front lines. (As reported by the NYT, that has been especially true in recent weeks, where “the war in Ukraine is stress-testing the system.”) And today, according to Corp Fin Director Renee Jones, in light of the pandemic-driven trend to work from home and, even more seriously, the potential impact of horrific global events, that’s more true than ever, with escalating cybersecurity risk affecting just about all reporting companies. Given the recent consternation over hacks and ransomware, as well as the rising potential for cyberattacks worldwide, it should come as no surprise that the SEC voted today, by a vote of three to one, to propose regulations “to enhance and standardize disclosures regarding cybersecurity risk management, strategy, governance, and incident reporting by public companies.” While threats have increased in number and complexity, Jones said, currently, company disclosure is not always decision-useful and is often inconsistent, not timely and hard for investors to find. What’s more, some material incidents may not be reported at all. As described by Jones, the SEC approached the rulemaking from two perspectives: first, incident reporting and second, periodic disclosure regarding cybersecurity risk management, strategy and governance. According to SEC Chair Gary Gensler, “[o]ver the years, our disclosure regime has evolved to reflect evolving risks and investor needs….Today, cybersecurity is an emerging risk with which public issuers increasingly must contend. Investors want to know more about how issuers are managing those growing risks….I am pleased to support this proposal because, if adopted, it would strengthen investors’ ability to evaluate public companies’ cybersecurity practices and incident reporting.” The public comment period will be open for 60 days following publication of the proposing release on the SEC’s website or 30 days following publication of the proposing release in the Federal Register, whichever period is longer.
SEC Commissioner Lee advocates new gatekeeper regulations for attorneys
In remarks at PLI’s Corporate Governance webcast last week, SEC Commissioner Allison Herren Lee advocated that, after 20 years, it’s time for the SEC to fulfill the mandate of SOX 307 by adopting rules to set minimum standards of professional conduct for attorneys appearing and practicing before the SEC in the representation of issuers. But didn’t the SEC adopt up-the-ladder attorney reporting provisions under SOX 307 many years ago? Yes, but, she contended, the SEC “did not adopt a broader set of rules as Congress directed, and quite significantly, even this single standard has not been enforced in the nearly 20 years since it was adopted.” Her suggestions for standards are sure to trigger some controversy. Will the SEC up the ante on regulations for attorneys as gatekeepers?
In most recent comments on climate disclosure, SEC drills down on materiality
In September last year, Corp Fin posted a sample letter to companies containing illustrative comments regarding climate change disclosures, presumably designed to help companies think about and craft their climate-related disclosure. (See this PubCo post.) Corp Fin began by noting that, under its 2010 guidance (see this PubCo post), depending on the facts and circumstances, climate change disclosure could be elicited in a company’s SEC filings in connection with the description of business, legal proceedings, risk factors and MD&A. Still, right now, there is little in the way of prescriptive climate disclosure requirements, although a proposal for climate disclosure regulation is high on the SEC’s agenda. (See this PubCo post.) Instead, companies have instead looked largely to standards of materiality to determine whether climate disclosure is required in their SEC filings. However, many companies provide climate disclosure in corporate social responsibility reports that are not filed with the SEC, but instead typically posted on company websites. As reported in a recent analysis by Audit Analytics, in the SEC’s most recent round of comment letters about climate last month, the climate disclosure on which the SEC is commenting is primarily contained in these CSR reports. And the SEC wants companies to justify—in some detail—why that disclosure isn’t also in companies’ SEC filings.
Company charged for improper intra-company foreign exchange transactions
On Tuesday, the SEC announced settled charges against Baxter International Inc., its former Treasurer and Assistant Treasurer, for misconduct related to improper intra-company foreign exchange transactions that resulted in the misstatement of the company’s net income. From at least 1995 to 2019, the SEC alleged, Baxter converted foreign-currency-denominated transactions and assets and liabilities on its financial statements using its own “convention”—not in accordance with U.S. GAAP. Then, beginning around 2009, the SEC charged, Baxter leveraged the convention to devise a series of non-operating intra-company foreign exchange transactions “for the sole purpose of generating foreign exchange accounting gains or avoiding foreign exchange accounting losses.” In the order against Baxter, the SEC found that the company violated the negligence-based anti-fraud, public reporting, books and records, and internal accounting controls provisions of the federal securities laws and imposed an $18 million penalty. In this order and this order, the SEC found that the company’s Treasurer “did not take any steps to investigate how Baxter’s treasury department generated consistent gains or whether the transactions that generated the gains were permissible,” and that the Assistant Treasurer, working with others at his direction, was “primarily responsible for executing the transactions.” The Treasurer and Assistant Treasurer were determined to have violated the negligence-based anti-fraud provisions of the federal securities laws and to have caused Baxter’s public reporting and books and records violations.
Are staggered boards ever good for shareholders?
In the folklore of corporate governance, is there a governance structure that is more anathema to corporate governance mavens and shareholder democracy activists than the staggered board? (Ok, that’s an exaggeration, but you get my point.) Proxy advisory firms and activists oppose them, institutional investors vote against them and shareholders proposals to eliminate them are unusually successful. Staggered boards, where subsets of board members are elected in separate classes every three years—and therefore cannot be easily or quickly voted out—are often viewed as the archetypal technique to prevent hostile takeovers. Opponents also argue that staggered boards entrench boards and managements by insulating them from the shareholders and making it tough for shareholders to dethrone the CEO. That has to be bad for the company, right? Not so fast, says this study co-authored by a professor at Stanford Graduate School of Business and Stanford Law School. According to the author, quoted in Insights by Stanford Business, “[f]rom Adam Smith on, the concern of corporate governance has been how to mind the managers….Corporate governance has been about building up checks and monitors on the managers. The idea is that if we can fire them, and they know we can fire them, then maybe they will do the right thing.” But for some companies—in this case, early-life-cycle technology companies facing more Wall Street scrutiny—the evidence showed that, by allowing managers to focus on long-term—perhaps bolder and riskier—investments and innovations, staggered boards can actually be a benefit.
What about disclosure regarding gig workers?
When, in August 2020, the SEC adopted a new requirement to discuss human capital as part of an overhaul of Reg S-K, the SEC applied a “principles-based” approach, limiting the requirement to a “description of the registrant’s human capital resources, including the number of persons employed by the registrant, and any human capital measures or objectives that the registrant focuses on in managing the business (such as, depending on the nature of the registrant’s business and workforce, measures or objectives that address the development, attraction and retention of personnel).” At the time, SEC Commissioner Allison Herren Lee argued for a more balanced approach that would have included some prescriptive line-item disclosure requirements and provided more certainty in eliciting the type of disclosure that investors were seeking. (See this PubCo post.) Subsequent reporting has suggested that companies “capitalized on the fact that the new rule does not call for specific metrics,” as “[r]elatively few issuers provided meaningful numbers about their human capital, even when they had those numbers at hand.” (See this PubCo post.) Accordingly, Corp Fin is reportedly working on a proposal to enhance company disclosures regarding human capital management. Now, Senators Sherrod Brown and Mark Warner, the Chair and a member, respectively, of the Senate Committee on Banking, Housing, and Urban Affairs, have written a letter to SEC Chair Gary Gensler, calling on the SEC to include in its proposal a requirement that companies report about—not just employees—but also the number of workers who are not classified as full-time employees, including independent contractors. It may be a topic to keep in mind as companies prepare the disclosures for this proxy season.
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