Does appointment of a former partner of the client’s audit firm to the client’s audit committee impair audit quality?
Studies of former partners of audit firms that have assumed management positions at audit clients have raised concerns, at least pre-SOX, about potentially lower audit quality, perhaps reflecting hesitation by the audit firm to “challenge aggressive accounting decisions” made by former partners of their firms. But what happens when a former partner joins the audit client’s audit committee? Does the former partner feel pressured not to question the audit firm’s decisions or lose objectivity about the quality of the work of the audit firm? Does the audit firm feel pressured to accept the company’s more aggressive accounting decisions when a former partner sits on the audit committee? In this study, published in Auditing: a Journal of Practice & Theory, a group of academics looked at that question. Their conclusion was that affiliated former partners on audit committees actually led to improved audit processes and outcomes. Why? Applying psychology’s “social identity theory,” the authors posit that the former partners continued to identify with their former firms, but instead of losing their objectivity, the former audit partners “use their knowledge of, and identification with, the audit firm to improve the audit process and the communication between the two parties,” leading to improvement in audit quality.
ISS sues the SEC—what will it mean for regulation of proxy advisory firms?
Today, ISS filed suit against the SEC and its Chair, Jay Clayton (or Walter Clayton III, as he is called in the complaint) in connection with the interpretation and guidance directed at proxy advisory firms issued by the SEC in August. (See this PubCo post.) That interpretation and guidance (referred to as the “Proxy Adviser Release” in the complaint) confirmed that proxy advisory firms’ vote recommendations are, in the view of the SEC, “solicitations” under the proxy rules and subject to the anti-fraud provisions of Rule 14a-9. In its complaint, ISS contends that the Proxy Adviser Release is unlawful and its application should be enjoined for a number of reasons, including that the SEC’s determination that providing proxy advice is a “solicitation” is contrary to law, that the SEC failed to comply with the Administrative Procedures Act and that the views expressed in the Release were arbitrary and capricious.
Interestingly, the litigation comes right before the SEC is scheduled to consider and vote (on November 5) on a proposal to amend certain exemptions from the proxy solicitation rules to provide for disclosure, primarily by proxy advisory firms such as ISS and Glass Lewis, of material conflicts of interest and to set forth procedures to facilitate issuer and shareholder engagement and otherwise improve information provided. There are various rumors circulating about the details of the proposal, including this Reuters article stating that the proposal would require proxy advisory firms to “give companies two chances to review proxy materials before they are sent to shareholders.” (Note that also on the agenda is a proposal to “modernize” the shareholder proposal rules by changing the submission and resubmission requirements.) Whether the firms’ advice is a “solicitation” takes on particular significance given that the SEC’s anticipated proposal appears to be predicated on the firms’ reliance on the exemptions from the proxy solicitation rules.
Are companies that follow a stakeholder model more “effective”?
New research from the Drucker Institute, published in the WSJ, applied the Institute’s analytical framework to assess companies’ “effectiveness,” defined for this purpose as “doing the right things well.” Notably, the authors of the article find a harmonious congruence—or is it a “harmonic convergence”?—between the “indicators” of effectiveness that make up their model and the various commitments for the benefit of all stakeholders in the Business Roundtable’s new “Statement on the Purpose of a Corporation.” What’s more, the authors suggest that their own framework was created to promote exactly “the kind of stakeholder mind-set that the Business Roundtable has now endorsed.” With that in mind, the authors highlight the group of companies led by CEOs who signed the BRT Statement to see how well these companies fared. While some have viewed the BRT Statement as mere “virtue signaling” (see the SideBar below), the article sets out to measure the extent to which the signatories put their money where their mouths are. How did they do? “Quite well,” but with “notable room for improvement.”
What is going on at the PCAOB?
Yikes! What is going on at the PCAOB? You may recall that, back in 2018, former staffers at the PCAOB and former partners of KPMG were charged by the SEC in connection with “their participation in a scheme to misappropriate and use confidential information relating to the PCAOB’s planned inspections of KPMG.” You know, that case where the former PCAOB staffers were accused of leaking to KPMG the plans for PCAOB inspections of KPMG—“literally stealing the exam.” (See this PubCo post.) The same scheme led the U.S. Attorney’s Office for the SDNY to file criminal charges against the former staffers, and some have actually been sentenced to prison. But that’s not even the half of it.
New SEC proposal to modernize filing fee disclosure and payment methods
The SEC today slipped a new proposal in on us, without an open meeting or even so much as a press release. Could they perhaps have had a premonition that we might not be spellbound in reading it? The proposal is intended to modernize filing fee disclosure and payment methods, which are currently manual and labor-intensive. The proposal would amend almost everything—“most fee-bearing forms, schedules, statements, and related rules”—to require each fee table and accompanying explanatory notes (which would be expanded by the proposal) to include “all required information for fee calculation in a structured format.” You know what that means—more inline XBRL. The proposed amendments would add an option for fee payment using Automated Clearing House (“ACH”) and retain the current option for payment by wire transfer, but eliminate fee payment with paper checks and money orders. According to the proposing release, the proposed amendments “are intended to improve filing fee preparation and payment processing by facilitating both enhanced validation through fee structuring and lower-cost, easily routable payments through the ACH payment option.”
EY analyzes cybersecurity risk disclosure
What are companies disclosing about their efforts to oversee cybersecurity risk? In this article, Ernst & Young analyzes cybersecurity-related disclosures in the proxy statements and Forms 10-K of Fortune 100 companies from 2018 to 2019, focusing on disclosure regarding board oversight, cybersecurity risk and risk management. Building on its similar analysis conducted for 2018 (see this PubCo post), EY detected “modest” enhancements in disclosures compared to the prior year—most significantly regarding board oversight practices—although the depth, detail and company-specificity of the disclosures continued to vary widely. Nevertheless, based on its observations of companies’ activities in the market, EY found that even these enhanced disclosures sometimes failed to capture all of a company’s oversight activities, such as third-party independent assessments or tabletop exercises designed to enhance preparedness. Given that many stakeholders have interests in cybersecurity risk preparedness and board oversight, EY advises, enhanced disclosure can serve to build “stakeholder confidence and trust as the cybersecurity risk landscape evolves and as technological innovations raise the stakes for data privacy and protections.”
How are companies approaching the new requirement for hedging policy disclosure?
At the end of 2018, the SEC dredged up its 2015 rule proposal regarding hedging disclosure (required by Dodd-Frank) and voted to adopt final rule amendments. The amendments mandate disclosure about the ability of a company’s employees or directors to hedge or offset any decrease in the market value of equity securities granted as compensation to, or held directly or indirectly by, an employee or director. As described in the legislative history of the related Dodd-Frank provision, the purpose of the requirement was to “allow shareholders to know if executives are allowed to purchase financial instruments to effectively avoid compensation restrictions that they hold stock long-term, so that they will receive their compensation even in the case that their firm does not perform.” As required, companies have now begun to include the new hedging disclosure in their proxy statements. To see how companies were approaching their responses to the new rule, comp consultant F.W. Cook examined the first 40 proxies that contained the new disclosure (covering the period from August 23, 2019 to October 4, 2019) and provides us with a number of observations that may well be helpful as we head into the new proxy season.
Are we misunderstanding the elements that lead to good governance?
What does good governance really mean? What does it mean to follow best practices? Are there really best practices that make sense for all companies? Do we tend to latch onto easily identified and measured structural features that may not really be effective for good governance and ignore qualities that may be more effective but are not as easily identified or measured? Do we even have a common understanding of the meaning of concepts central to governance? These are some of the questions addressed in an interesting paper, “Loosey-Goosey Governance Four Misunderstood Terms in Corporate Governance,” from the Rock Center for Corporate Governance at Stanford.
Corp Fin issues SLB 14K—it’s “ordinary business” again
Just in time for proxy season, the Corp Fin staff has issued a new Staff Legal Bulletin 14K on—what else—shareholder proposals and the “ordinary business” exclusion. The SLB attempts, once again, to provide some insight—following SLB 14I (see this PubCo post) and SLB 14J (see this PubCo post) which also address the “ordinary business” exclusion— regarding the staff’s interpretation of Rule 14a-8(i)(7), including:
company-specific significance of policy issues;
board analyses submitted in no-action requests to demonstrate that a policy issue raised by the proposal is not significant to the company; and
the application of “micromanagement” as a basis to exclude a proposal under Rule 14a-8(i)(7). Notably here, the staff attempts to explain the thinking behind its treatment of various climate change proposals submitted last proxy season.
In addition the SLB addresses “proof-of-ownership” letters.
GAO issues annual report on conflict minerals filings
Under Dodd-Frank, the GAO is required to assess annually the effectiveness of the SEC’s conflict minerals rules in promoting peace and security and to report on the rate of sexual violence in the DRC and adjoining countries. Recently, the GAO released its annual report submitted to Congress on conflict mineral disclosures filed with the SEC in 2018. The report is based on a random sample of 100 Forms SD, interviews with company representatives, DRC officials and other stakeholders, as well as reviews of government reports and fieldwork conducted at an industry conference. Any big changes? Not really. But, interestingly, in the GAO sample, only two companies indicated that they relied on Corp Fin’s 2017 guidance (discussed below) to avoid filing a conflict minerals report or providing an independent private-sector audit. With the 2017 guidance apparently not having much impact, is a revision of the conflict minerals rules to address the impact of the litigation (which held that the requirements violated the First Amendment) even a twinkle in the staff’s eye at this point?
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