Category Archives: Hot Topic

A Busy Holiday Season at the SEC

The SEC was busy in the weeks before the holiday season, taking several significant actions.  Here is a summary you can use to explore each development.

Latest Reg Flex Agenda

The SEC published its latest regulatory agenda, which you can review here.  Key issues to be addressed in the near-term include climate change and human capital resources disclosures.  Cybersecurity risk governance is also on the agenda.

Proposed New Rules for 10b5-1 Plans

On December 15, 2021, the SEC proposed amendments to Rule 10b5-1 to “strengthen the affirmative defense to insider trading” provided by the rule.  Details are in this related Fact Sheet and the Proposed Rule.  One significant change would be a 120-day cooling-off period before trading could begin under a plan.

Proposed New Rules and Disclosures for Stock Buybacks

On December 15, 2021, the SEC proposed amendments to its rules requiring disclosure about repurchases of equity securities.  You can read more in this Fact Sheet and the Proposed Rule.  Companies would be required to provide a new Form SR before the end of the first business day following a buyback.  In addition, periodic disclosures would include disclosure of the objective of share repurchases and any related process.

CorpFin Announcement Personally Identifiable Information in Rule 14a-8 Submissions

On December 17, 2021, CorpFin issued this Announcement requiring companies to redact all personally identifiable and any other related sensitive information from Rule 14a-8 submissions related to shareholder proposals.  The announcement also addresses how shareholder proponents should limit the amount of personally identifiable and sensitive information they include in correspondence to only information required to establish their eligibility to submit a proposal.

As always, your thoughts and comments are welcome!

Cybersecurity Insights from Commissioner Roisman

On October 29, 2021, SEC Commissioner Elad L. Roisman delivered a speech to the Los Angeles County Bar titled “Cybersecurity: Meeting the Emerging Challenge.”  In this speech he addresses important cybersecurity matters, beginning with this introductory section – “Understanding that You May be a Victim.”

“Before I go further, it’s important to acknowledge a point that is sometimes overlooked in discussions about cybersecurity.  In the case of cyber-crimes, companies are the targets and victims.  The last thing a company wants is to suffer this kind of criminal and illegal attack.  But, today, the threat of a cyber-attack is so constant and significant for every market participant that it should be viewed as a substantial likelihood.

The SEC has imposed specific obligations on particular registrants relating to certain cybersecurity risks.  But it’s undeniable that our registrants, who have more general obligations under the securities laws—such as to serve the best interests of clients or to shareholders—also are accountable for taking measures to prevent and mitigate damage from these threats as part of their broader responsibilities.

Accordingly, it has become increasingly important for market participants to work with counsel and other experts on preparing for potential cyber-attacks before they happen—that is, devising a plan for monitoring for cyber threats, responding to potential breaches, and understanding when information must be reported outside the company and to whom.”

After this assertion that cyber-attack should be viewed as a risk with a “substantial likelihood” and that companies should take measures to address this risk, he discusses cybersecurity risk for a variety of entities that the SEC regulates, including exchanges, SRO’s, advisors, broker dealers and others.

In the section addressing public issuers, he reviews the SEC’s 2018 Release “Commission Statement and Guidance on Public Company Cybersecurity Disclosures.”  In a related footnote he mentions that the Division of Corporation Finance “blazed trail” for this release with Disclosure Guidance Topic 2.  He reminds issuers that disclosure requirements in areas including risk factors, description of the business and MD&A may create obligations to disclose cybersecurity-related matters.  He also mentions that the 2018 Release focuses on  the importance of disclosure controls and procedures.  (See this post for an enforcement case about cybersecurity-related disclosure controls and procedures.)

Commissioner Roisman also discusses internal accounting controls over cybersecurity risk, mentioning the SEC’s 2018 “21(a) Report” that focused on cases where companies had been victimized in cybersecurity-related fraud.  That report, which did not enforce against the victim companies, reminded companies that internal accounting controls should address these kinds of risks.

Commissioner Roisman notes that the SEC’s rulemaking agenda includes issuer cybersecurity matters, but that no formal rulemaking has taken place yet.  He provides these thoughts about possible rulemaking:

“But I will let you know some of the things that I would be looking for as I consider any additional rules in this area.  First, we need to define any new legal obligations clearly.  Second, we need to make sure that these obligations do not create inconsistencies with requirements established by our sister government agencies.  Third, we should recognize that some registrants have greater resources than others, and we should not try to set the resource requirements for an entity.  And finally, because issuers’ businesses vary, the cybersecurity-related risks they face also will vary, and therefore a principles-based rule would likely work best.”

Commissioner Roisman’s thoughts provide helpful insights that can lead to action steps as we address cybersecurity risk going forward.

As always, your thoughts and comments are welcome!

PLI’s InSecurities Podcast Explores 2021 SEC Enforcement Results

On November 18, 2021, the SEC issued a detailed Press Release reviewing Enforcement Division activity for 2021.  This Press Release, while a departure from the “glossy” annual report in previous years, provides significant information about the types of enforcement cases, sanctions and focus areas of the Division.  If you would like more insight into the Division’s activities, PLI’s InSecurities podcast, hosted by Chris Ekimoff and Kurt Wolfe, provides a deep dive discussion in this “Special Episode: The 2021 SEC Enforcement ‘Report,’” featuring Sarah Heaton Concannon, who recently left the Enforcement Division.

As always, your thoughts and comments are welcome!

Yet Another Perks Enforcement Case!

As we have blogged about on previous occasions, the SEC Enforcement Division is actively watching for companies that fail to adequately disclose executive perks.  In a recent case against ProPetro Holding Corp., an oilfield services company, and its former CEO, the SEC underscored this point in their enforcement agenda.

The Press Release announcing this case states:

“The SEC’s order finds that Redman (the former CEO) caused ProPetro to incur $380,594 worth of personal and travel expenses unrelated to the performance of his duties as CEO. He also failed to disclose to company personnel that he had pledged all of his ProPetro stock in two private real estate transactions. During the same period, ProPetro failed to properly disclose $47,591 in additional, authorized perks it paid to Redman.”

As you can read in the related AAER, use of a company aircraft for personal trips and use of a company credit card for personal expenses were major parts of this case.

As is typical in these cases, ProPetro and Redman agreed to cease and desist from further violations, and the former CEO agreed to pay a $195,046 penalty. The order notes ProPetro’s significant cooperation with the agency’s investigation as well as its very extensive remedial efforts, including “hiring an entirely new management team with significant public company experience, hiring additional finance department personnel, installing several new directors, and developing new controls, policies, and procedures concerning perks.”  The company did not pay a penalty.

These steps go well beyond company actions and SEC’s sanctions in other cases, such as when Dow Chemical was required to hire an independent consultant to conduct a review of its policies, procedures, controls, and training relating to perks.

As always, your thoughts and comments are welcome!

SEC Adopts Universal Proxy Rules and Proposes Proxy Advisor Changes

On November 17, 2021, the SEC took two proxy-related actions.  The Commission:

  1. Adopted a Final Rule that requires the use of universal proxy cards in contested director elections.
  2. Proposed rules that would rescind two 2020 rules applicable to proxy voting advice.

Universal Proxy Final Rule

In a 4 to 1 vote the Commission adopted a Final Rule that requires all parties in a contested director election to use a universal proxy card, that is, a card that includes all director nominees.  In the related Press ReleaseChair Gensler said:

“These amendments address concerns that shareholders voting by proxy cannot vote for a mix of dissident and registrant nominees in an election contest, as they could if voted in person SEC.  Today’s amendments will put these candidates on the same ballot. They will put investors voting in person and by proxy on equal footing. This is an important aspect of shareholder democracy.”

You can read more about the requirements for universal proxy cards and related procedural changes in this Fact Sheet and the related Final Rule.  The rules will be effective for contested director elections held after August 31, 2022.

Proxy Voting Advice Rules

The Commission voted to propose rules that would rescind two 2020 rules related to proxy voting advice.  The proposed rules would rescind, for proxy advisory firms, conditions to the availability of two exemptions from informational and filing requirements in the proxy rules.

According to the related Press Release:

“Investors and others have expressed concerns that these conditions will impose increased compliance costs on proxy voting advice businesses and impair the independence and timeliness of their proxy voting advice.”

You can read more in this Fact Sheet and the related Proposed Rule.

As always, your thoughts and comments are welcome!

Shareholder Proposals – CorpFin Issues Staff Legal Bulletin 14L

On November 3, 2021, CorpFin issued Shareholder Proposals: Staff Legal Bulletin No. 14L to provide information about Rule 14a-8 – Shareholder Proposals.  The new Staff Legal Bulletin, or SLB, rescinds old SLBs 14I, 14J and 14K.

The first section of the new SLB:

“outlines the Division’s views on Rule 14a-8(I)(7), the ordinary business exception, and Rule 14a-8(i)(5), the economic relevance exception.”

The discussion of these issues surrounds the significant social policy exception and micromanagement.

The SLB also republishes with some “primarily technical, conforming changes,” earlier SLB guidance about using graphics and images, and proof of ownership letters.

Lastly, the new SLB includes new guidance about using email for submission of proposals, delivery of notice of defects, and responses to those notices.

You can gain perspective about the changes in the SLB in this Statement from Chair Gary Gensler and this Statement from Commissioners Peirce and Roisman.

As always, your thoughts and comments are welcome.

IFRS Foundation Creates International Sustainability Standards Board and Announces Consolidation with the CDSB and VRF

While the SEC has been working on its climate change and ESG rule proposal (see more below), the IFRS Foundation has been actively considering the need for a new sustainability standards board.  This September 2020 “Consultation Paper” provided background and sought input about creating a separate sustainability standards board.  In February 2021, the Foundation announced their intention to formally consider establishing a new board.  One month later, this March 2021 statement set out the strategic direction for the proposed new board.

The Foundation’s work came to fruition quickly.  On November 3, 2021, at the 26th UN Climate Change Conference of the Parties (COP26) in Glasgow, the IFRS Foundation Trustees announced that they have formed the International Sustainability Standards Board or ISSB.  This Board will focus on building a “global baseline of high-quality sustainability standards to meet investors information needs.”

In addition to the creation of the ISSB, the Foundation also announced that the Climate Disclosure Standards Board and the Value Reporting Foundation will consolidate with the ISSB.  The Climate Disclosure Standards Board is an initiative of the Carbon Disclosure Project (CDP).  The Value Reporting Foundation was formed via the recent consolidation of the Sustainability Accounting Standards Board and the International Integrated Reporting Council.

The IFRS Foundation has already begun foundational work on standard setting, forming a Technical Readiness Working Group to develop prototype climate and general disclosure requirements.  You can review progress so far in this “Summary of the Technical Readiness Working Group’s Programme of Work.”

While all this is happening in the international realm, the SEC is continuing to work on its approach to climate change and ESG reporting.  Chair Gary Gensler made this clear in his speech “Prepared Remarks Before the Principles for Responsible Investment ‘Climate and Global Financial Markets’ Webinar”:

“Companies and investors alike would benefit from clear rules of the road. I believe the SEC should step in when there’s this level of demand for information relevant to investors’ decisions.

Thus, I have asked SEC staff to develop a mandatory climate risk disclosure rule proposal for the Commission’s consideration by the end of the year.

I think we can bring greater clarity to climate risk disclosures.

I believe, though, we should move forward to write rules and establish the appropriate climate risk disclosure regime for our markets, as we have in prior generations for other disclosure regimes.”

While it now appears that this proposal may happen in early 2022, the SEC is clearly working to establish its own reporting standards.

As always, your thoughts and comments are welcome!

Check Out “Office Hours with Gary Gensler” Video Series

As part of his commitment to investor education, SEC Chair Gary Gensler (who was a professor at MIT) has launched “Office Hours with Gary Gensler,” a series of short videos about topics ranging from climate change to cryptocurrency.  You can find the current videos and future releases at the SEC’s YouTube channelChair Gensler’s Twitter account (an interesting follow!) also announces new videos.

As always, your thoughts and comments are welcome!

Whistleblowing – Compliance and Reporting Systems

The unparalleled success of the SEC’s Whistleblower Program in uncovering hidden financial crimes and achieving successful enforcement has been well publicized.  In this September 21, 2021, blog post we highlight that the program has paid out over $1 billion in awards to whistleblowers.

In this related Press Release Chair Gary Gensler emphasized the importance of the program:

 “Today’s announcement underscores the important role that whistleblowers play in helping the SEC detect, investigate, and prosecute potential violations of the securities laws.  The assistance that whistleblowers provide is crucial to the SEC’s ability to enforce the rules of the road for our capital markets.”

One frequently overlooked aspect of the program’s success is how companies may need to adjust governance and policy related to whistleblower activity.

In this environment that provides such strong incentives for whistleblowers to come forward, companies need to build appropriate governance and policies.  To help companies in this process, PLI’s InSecurities podcast, in Episode 47 – Whistleblower Tips: Advice From a Former Chief of the SEC’s Whistleblower Office, provides crucial information about developing policies and governance surrounding whistleblower processes.  Included are suggestions about how to develop parallel internal reporting systems and encourage, triage and investigate whistleblower tips.

As always, your thoughts and comments are welcome!

The SEC’s Focus on Accounting for Contingencies – Comments and Enforcement

The SEC reinforced its focus on accounting for contingencies in an August 24, 2021 enforcement case against Health Care Services Group, Inc.  Accounting Standards Codification Topic 450 requires that loss contingencies be recorded when it is probable that a loss will be incurred, and the amount can be reasonably estimated.  Contingencies frequently involve high stakes and appropriate accounting requires complex and subjective judgments.  Contingencies are lightning rods for SEC review and enforcement.

In the Health Care Services Group case the SEC found that the company failed to record loss contingencies surrounding private litigation against the company in the proper periods.  The Enforcement Division found that the company, by failing to record loss contingencies in the appropriate period, managed its earnings to meet analyst’s estimates for several quarters.

A fascinating aspect of this case is that, according to Enforcement Division Director Gurbir Grewal, the company “reported EPS that met analyst estimates for multiple quarters as a result of accounting violations that were uncovered by the Division of Enforcement’s ongoing EPS Initiative,” Mr. Grewal also said:

“As today’s actions demonstrate, we will continue to leverage our in-house data analytic capabilities to identify improper accounting and disclosure practices that mask volatility in financial performance, and continue to hold public companies and their executives accountable for their violations.”

Accounting for contingencies is not a new theme in SEC enforcement.  In 2007 the SEC fined Cardinal Health $35 million for engaging in a four-year long accounting fraud that, among other misstatements, involved manipulation of a number of reserve and contingency accounts creating misstatements of over $65 million.  The company also accrued $22 million of expected proceeds from a litigation settlement before recognition under GAAP was appropriate.  As you would suspect, these steps helped Cardinal meet earnings estimates.

BorgWarner provided another example of the SEC’s ongoing focus on accounting for contingencies.  This case is more complex.  It is based on ASC 450’s guidance about when to record a contingent liability.  It started with this comment the company received on its December 31, 2016 Form 10-K in a May 11, 2017 comment letter:

Note 14: Contingencies

Asbestos-related Liability, page 95

  1. We note your disclosure that you have made enhancements to the management and analysis of asbestos-related claims, including the engagement of new national coordinating council and new local counsel panels, outsourcing administration and claims handling, implementing improvements in processing, and increasing audits and compliance reviews of counsel handling asbestos-related claims. You state that this has resulted in improvements in both the quantity and quality of information available and an increased ability to reasonable forecast the number of potential future claims that may be asserted.

You also state that you hired a third party consultant in the third quarter of 2016 to further assist you in the analysis of potential future asbestos-related claims. It appears that with the assistance of this external consultant and the updated data and analysis resulting from your claims review process, you determined that your best estimate of the aggregate liability both for asbestos-related claims asserted but not yet resolved and potential asbestos-related claims not yet asserted, including an estimate for defense costs, is $879.3 million as of December 31, 2016, which is $770.8 million higher than the prior year.

Please tell us your consideration of accounting for this as a correction of an error in previously issued financial statements rather than as a change in estimate. Refer to ASC 250- 10-20.

The key issue in this comment is the timing of recording the contingent liability related to potential asbestos claims.  Given the material increase in the accrual in 2016, it is logical to ask if the amount was “probable” and capable of reasonable estimation in an earlier period.  In its lengthy response, the company included this language:

In connection with the preparation of its annual financial statements for 2016, the Company was able to determine for the first time that its potential liability for asbestos-related claims not yet asserted was capable of reasonable estimation. That determination became possible at such time for several reasons:

  • during 2016, the Company was able to identify and verify trends in the Company’s claims data which indicated that the Company’s claims experience was stabilizing, becoming less volatile, and becoming consistently related to industry trends in the tort system generally, which led to the Company’s belief that extrapolation from its past claims experience could, for the first time, form the basis for a reasonable estimate of potential future claims,
  • the Company’s handling and processing of asbestos-related claims (as noted by the Staff in the May 11 letter) collectively improved the quantity and quality of information available to the Company respecting those claims, which in turn increased the real-time visibility to the Company and its senior professionals regarding the handling and resolution of individual asbestos-related claims. This information has been used by the Company in its litigation and settlement efforts to determine better how to resolve individual claims, resulting in more consistent litigation and settlement efforts respecting asbestos claims as a whole and more stable settlement and defense costs,
  • changes implemented by courts in certain jurisdictions in which the Company is most often named as a defendant in asbestos-related litigation, which were incorporated into the Company’s litigation and settlement efforts, allowing for greater litigation and settlement consistency and predictability in the Company’s claims projections,
  • co-defendant bankruptcies and the magnitude and timing of bankruptcy trust payments to claimants became more consistent, and information as to both was increasingly required to be made available by claimants, which affected the value of claims asserted against the Company, and
  • the number of asbestos-related claims faced by the Company was significantly reduced as a result of the Company’s ongoing efforts to eliminate many claims that had become dormant as a result of the passage of time or otherwise capable of being dismissed, which allowed the Company greater ability to forecast outcomes respecting potential claims not yet asserted.

The culmination of all of the foregoing factors in 2016 led the Company to consider, as part of its ongoing review process, that it had become possible to make a reasonable estimate of its potential liability for asbestos-related claims not yet asserted. The Company engaged a third-party consultant in the third quarter of 2016, as the Staff notes in the May 11 letter, to assist the Company with its evaluation of such potential liability. The consultant prepared its analysis during the third and fourth quarters of 2016, and presented its final analysis to the Company in the first quarter of 2017. The Company reviewed the analysis and made its own assessment in connection with the Company’s preparation of its annual financial statements for 2016 that the best estimate of the aggregate liability both for asbestos-related claims asserted but not yet resolved and potential asbestos-related claims not yet asserted, including an estimate for defense costs, was $879.3 million, and adjusted its liability on its consolidated balance sheet in accordance with ASC 450-20-25-2.

The Company does not consider this additional reserve to be a correction of an error in prior financial statements because no error was made. There were no mistakes in the application of GAAP, mathematical errors or oversight or misuse of facts in previously issued financial statements. The Company was diligent in its efforts to monitor and track available information to measure the potential liability for future asbestos-related claims, and appropriately recorded a reserve when information sufficient to support a reasonable estimate became available. The Company followed generally accepted accounting principles – specifically, ASC 450-20-25-2 – in only accruing a liability once such amount was capable of being reasonably estimated.

After this response by BorgWarner, the SEC issued this follow-up comment:

  1. We note your response that you concluded your revised estimate for asbestos-related claims is a change in accounting estimate rather than a correction of an error in previously issued financial statements because the quarter ending December 31, 2016 is the first time that the liability attributable to potential asbestos-related claims not yet asserted could be reasonably estimated. You state that prior to the quarter ending December 31, 2016, you concluded claims data was too volatile, and the circumstances in which future asbestos-related claims would be resolved too uncertain, to support a reasonable estimate of the liability for potential claims not yet asserted.

Based on your response, it appears you believed a liability for potential claims not asserted was probable prior to the quarter ending December 31, 2016, but that such liability was not recognized because it could not be reasonably estimated. Please confirm whether our understanding is correct.

Regarding periods prior to the quarter ending December 31, 2016, please tell us whether you (1) attempted to estimate a liability for potential claims but concluded the resulting estimate of loss (or range) was not reasonable or (2) did not attempt to estimate a liability because you believed you could not develop a reasonable estimate. If the former, please tell us the results of your estimation including your estimated liability (or range thereof) as of December 31, 2015 and why you did not believe the estimate(s) to be reasonable.

The back and forth continued and ultimately resulted in a restatement by BorgWarner to record the contingent liability for the asbestos-related claims in earlier years, as you can see in this
Form 10-K/A.

As each of these three cases demonstrates, the SEC carefully scrutinizes the accounting, disclosures and judgments surrounding contingencies.  This is a reminder that we should carefully make and document judgments surrounding contingent liabilities.

As always, your thoughts and comments are welcome!