All posts by George Wilson

When Is a 10b5-1 Trading Plan Not a 10b5-1 Trading Plan?

Hot Topic

How company executives and others use Rule 10b5-1 trading plans has created controversy and in fact been the subject of SEC rule making.  A recent indication that the SEC Enforcement Division is scrutinizing these plans is this September 21, 2022, Press Release announcing an enforcement action against two executives of Cheetah Mobil related to the use of a 10b5-1 plan.

The case centers on this provision of Rule 10b5-1:

Affirmative defenses.

(1)

(i) Subject to paragraph (c)(1)(ii) of this section, a person’s purchase or sale is not “on the basis of” material nonpublic information if the person making the purchase or sale demonstrates that:

(A) Before becoming aware of the information, the person had:

(1) Entered into a binding contract to purchase or sell the security,

(2) Instructed another person to purchase or sell the security for the instructing person’s account, or

(3) Adopted a written plan for trading securities;

According to the SEC Order:

“At both the time they established the March Trading Plan and when they sold Cheetah Mobile securities pursuant to it, Sheng Fu and Ming Xu knew about the material negative trend in revenues from the Advertising Partner relationship. Sheng Fu and Ming Xu knew or recklessly disregarded that this information was material and nonpublic. Moreover, because both Sheng Fu and Ming Xu were aware of this material nonpublic information when they created the March Trading Plan, the March Trading Plan did not comport with the requirements of Exchange Act Rule 10b5-1.”

Both officers paid civil money penalties and agreed to several conditions to trading in Cheetah Mobile’s securities, including requirements that they provide notice to an independent third party about any trading activity and any new 10b5-1 plans, to observe a 120-day “cooling off” period before trading under any new 10b5-1 plan, and to only have one such plan at any time.  These requirements will sound familiar if you have read the SEC’s proposed rule.

As always, your thoughts and comments are welcome!

FASB Moves Its Crypto Asset Project Forward

Hot Topic

When the FASB added Accounting for and Disclosure of Crypto Assets to its technical agenda, investors, auditors, preparers, regulators and other constituents were glad that the Board would address the complex and challenging accounting issues presented by crypto assets.  At its October 12, 2022 meeting, as you can read in this Tentative Board Decisions report, the FASB addressed perhaps the most complex issue surrounding crypto assets, measurement basis. 

Most believe that crypto assets fall into the current accounting framework for indefinite-lived intangible assets.  Many of the FASB’s constituents believe the historical cost with impairment testing approach provided in this model does not communicate the most relevant information about crypto assets.  It would appear that the FASB agrees.  The Board reached a tentative conclusion that crypto assets should be carried at fair value with gains and losses included in comprehensive income.  Many would agree that this is a much more reasonable and relevant approach for these kinds of volatile assets.

As always, your thoughts and comments are welcome!

SEC Extends Several Rulemaking Comment Periods

Reporting, SEC Hot Topic

On October 7, 2022, the SEC announced that it was extending the comment periods for eleven rulemaking releases and one request for comment.  The affected rulemakings include the SEC’s proposed rules for disclosures related to climate matters, stock repurchases and cybersecurity.  It also applies to the SEC’s SPAC proposal.

The extensions were made because of a technical problem in the Commission’s internet comment form.  The affected comment periods will be open until 14 days after the publication of the related release in the Federal Register.

As you can read in the related Press Release and Reopening Release, anyone who submitted a public comment related to the proposed rulemakings between June 2021 and August 2022 should check to see that their comment is included in the comment file at sec.gov.  If it is not included, it should be resubmitted.

As always, your thoughts and comments are welcome.

SEC Releases Draft Strategic Plan for Fiscal Years 2022-2026

Reporting

On August 24, 2022, the SEC released its Draft Strategic Plan for Fiscal Years 2022-2026.  The plan is based on the three-part mission of the SEC:

The mission of the SEC is to protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation.

The draft plan begins with three goals to work towards accomplishing this mission:

  1. Protect working families against fraud, manipulation, and misconduct; 
  2. Develop and implement a robust regulatory framework that keeps pace with evolving markets, business models, and technologies; and 
  3. Support a skilled workforce that is diverse, equitable, and inclusive and is fully equipped to advance agency objectives. 

The plan describes the SEC’s vision and values along with the steps the organization will take to accomplish each goal.  Included in the planned steps are:

For Goal 1:

Pursue enforcement and examination initiatives focused on identifying and addressing risks and misconduct that affects individual investors.

For Goal 2:

Update existing SEC rules and approaches to reflect evolving technologies, business models, and capital markets

A review of all the steps included in the plan provides many insights into the future direction of the SEC.

The related request for comments on the draft strategic plan can be found here.

As always, your thoughts and comments are welcome!

The PCAOB in Motion

Reporting

Since the SEC’s appointment of an essentially entirely new board on November 8, 2021, the Public Company Accounting Oversight Board (PCAOB) has taken several steps that help auditors and companies begin to understand the future directions of audit oversight and standard setting.

In early 2022, the Board established two new advisory groups, the Investor Advisory Group and the Standards and Emerging Issues Advisory Group.  It approved charters for the groups on March 29, 2022, and on May 9, 2022, announced the members of each group and set dates for their first meetings.   The meeting summaries for the advisory groups can provide insight into areas the PCAOB may address in the future.

On June 7, 2022, the Board hired its first ever Investor Advocate.  This new role is expected to enhance engagement with investors and “amplify investor voices” in the activities of the PCAOB.

The Board also established new Standard-Setting and Research Agendas on May 4, 2022.  Included are several projects to update and modernize the “interim standards” adopted shortly after the PCAOB’s formation.

On June 21, 2022, the Board adopted amendments to its auditing standards designed to “strengthen requirements that apply to audits involving multiple audit firms.”  The amendments were developed after three comment solicitations and were formally approved by the SEC on August 12, 2022.  They will be effective for audits of financial statements for fiscal years ending on or after December 15, 2024.

On August 17, 2022 the Board released its latest Audit Committee Resource.  This PCAOB Spotlight document is designed to offer “questions that audit committees of public companies might want to consider as part of their ongoing engagement and discussion with their auditors, including how the auditors are responding to the financial reporting and audit risks posed by the current economic environment.”

In June 2022, the Inspections Division published its “Staff Overview for Planned 2022 Inspections.”  This document, which is relevant not just for auditors but for audit committees and investors, “highlights selected areas of planned 2022 inspection focus.”

On August 26, 2022, the PCAOB announced the signing of a “Statement of Protocol” with the China Securities Regulatory Commission and the Ministry of Finance of the People’s Republic of China.  This document is a significant step in providing a process for the PCAOB to conduct inspections of Chinese audit firms and, if necessary, pursue investigations. 

Lastly, in a process that builds on these steps and provides insight into the overall direction of the PCAOB, on August 16, 2022, the Board published for comment a draft “Five-Year Strategic Plan for Protecting Investors.”  The plan sets out four goals which are consistent with its actions in recent months:

  • Goal 1:  Modernize Standards
  • Goal 2:  Enhance Inspections
  • Goal 3:  Strengthen Enforcement
  • Goal 4:  Improve Organizational Effectiveness

The momentum and direction of the PCAOB is becoming clear with its actions and Spotlight statements.  Each of these developments clearly fits with the elements of the draft Five-Year Strategic Plan.  This information can help auditors and companies as they plan and execute audits.

As always, your thoughts and comments are welcome.

SEC Adjusts JOBS Act Revenue Threshold for Inflation

Reporting

The 2012 JOBS Act requires the SEC to adjust the Emerging Growth Company (EGC) revenue threshold for inflation every five years.  (If you would like a quick refresher about the “IPO On-Ramp” created by the JOBS Act, check out this summary at SEC.gov.)  In 2017, the first inflation adjustment increased the revenue threshold from $1,000,000,000 to $1,070,000,000.  On September 9, 2022, the SEC announced the second inflation adjustment, increasing the threshold to $1,235,000,000.  You can read more in this Press Release, which includes links to the Final Rule and Fact Sheet.

As always, your thoughts and comments are welcome!

SEC Charges VMware in “Reverse” Channel Stuffing Case

Hot Topic, Reporting

We have blogged about many SEC “pull forward” enforcement cases.  They all involve companies that “pull forward” orders scheduled for future periods to the current period to meet sales forecasts and expectations. (Check out this post for several example cases).  As the volume of these cases shows, “pull forwards” are a common way companies can try to mask revenue shortfalls.  Interestingly, in almost all these cases, there is no financial statement revenue recognition misstatement.  Goods are shipped and revenue is recognized in the proper period.  Most of these cases focus on companies not disclosing the impact of related management practices, including price reductions, extended payment terms and the potential impact on future period revenues.

In an interesting twist on this practice, on September 12, 2022, the SEC charged VMware with “managing” its backlog to move orders from current quarters to future quarters, the mirror image of a “pull forward.”  According to the SEC’s Accounting and Auditing Enforcement Release, this allowed VMware to meet revenue forecasts and related analysts’ expectations during a period where its business slowed relative to projections and its sales mix was shifting from a point in time license model to a revenue recognition over time subscription model.

The basis for this case is failing to disclose to investors how VMware “managed” its backlog.  Revenue was not misstated.  The case includes disclosures in Exchange Act reports, earnings calls and earnings releases. According to the AAER:

“Beginning with its Form 10-Q filed for Q1 FY19, VMware began disclosing in its filings that ‘[t]he amount and composition of [VMware’s] backlog will fluctuate period to period, and backlog is managed based upon multiple considerations, including product and geography,’ but the disclosure omitted material information regarding the discretionary nature of VMware’s backlog, the extent to which VMware controlled the amount of its backlog, and how backlog was used to manage the timing of the company’s recognition of total and license revenue. In actuality, VMware’s backlog practices during the relevant period were controlled for the purpose of determining in which quarters revenue would be recognized and had the effect of obscuring the company’s financial results and avoiding revenue shortfalls versus company financial guidance and analysts’ estimates in at least three quarters during FY20, as well as full-year FY20.”

The AAER focuses on disclosure:

“In making public statements regarding its backlog, VMware omitted material information regarding the extent to which the company controlled its quarter-end total and license backlog numbers through its use of discretionary holds, and the extent to which it used backlog to control the timing of revenue recognition generally. The managed backlog disclosure did not convey to investors the material information that backlog was used by VMware to manage the timing of revenue recognition based upon factors such as the company’s financial guidance and  analysts’ estimates. This information was necessary in order to make VMware’s statements regarding its backlog, in light of the circumstances under which they were made, not misleading.”

In key parts of the AAER, the SEC addresses materiality:

“VMware’s statements and omissions regarding its quarterly revenue and revenue growth, without disclosing the impact that the company’s discretionary backlog practices and revenue management had on reported revenue, materially concealed a substantial FY20 slowing in the company’s recognized revenue growth versus expectations. Reasonable investors would have considered the foregoing information to have been important in deciding whether to purchase VMware securities during the relevant period.”

“In addition, this was important information to analysts, who began questioning VMware’s backlog ‘drawdown’ following the company’s Q1 earnings call and continued to question the continual reductions in quarter-end backlog numbers throughout the remainder of the fiscal year. VMware recognized the materiality of the issue when preparing its Q&A scripts.”

VMware paid an $8,000,000 fine.  The company did not admit or deny the SEC’s findings.

As always, your thoughts and comments are welcome.

CorpFin Adds New Offices for Crypto Assets and Industrial Applications and Services

SEC Hot Topic

On September 9, 2022, CorpFin added two new offices to its Disclosure Review Program (DRP), the Office of Crypto Assets and the Office of Industrial Applications.  This brings the total number of DRP offices to nine.

The Office of Crypto Assets will consolidate the review of filings involving crypto assets into one group.  This will “enable the DRP to better focus its resources and expertise to address the unique and evolving filing review issues related to crypto assets.”

The Office of Industrial Applications and Services will review non-pharma, non-biotech, and non-medicinal products companies currently being reviewed in the Office of Life Sciences.

You can read more in this Press Release.

As always, your thoughts and comments are welcome!

SEC Institute’s 18th Annual SEC Reporting & FASB Forum for Mid-sized & Smaller Companies* – Register Now!

About SECI

On September 22-23, 2022, SEC Institute will present the 18th Annual SEC Reporting & FASB Forum for Mid-sized & Smaller Companies.  Participants can attend in-person at PLI’s New York Conference Center or via Live Webcast.  The program will include our top-notch speakers addressing relevant and important topics which will help you:

  • Understand the details of the SEC’s proposed rules on climate change and cybersecurity disclosure requirements
  • Explore updates on other rulemaking and interpretive guidance in the SEC’s Division of Corporation Finance, plus hot topics in their comment process
  • Evaluate the latest on FASB’s projects, including Segment Reporting and Disaggregation of Income Statement Expenses
  • Review the status of the changes from reference rate reform and other financial instruments hot topics
  • Discuss MD&A hot topics, including inflation, reference rate reform, cybersecurity, ESG matters and progress on implementing the 2020 rules
  • Hear a lively SEC reporting roundtable discussion of current events, including discussion of the SEC’s proposed rules and other accounting and reporting issues
  • Review recent SEC enforcement actions, whistleblowing developments and ethical challenges
  • Recall tips for staying out of trouble with a focus on audit quality, enforcement and other PCAOB matters

You can learn more and register here. 

*Forums are included with Privileged Membership.

A Frequent SEC Comment – “Can You Prove it?”

Comment of the Week, Reporting

In both offering documents and periodic reports companies frequently make assertions like the following, which appears in a Form S-1 Registration Statement for Doximity:

Overview

We are the leading digital platform for medical professionals, with over____ million members as of March 31, 2021, including more than ____% of physicians across all 50 states and every medical specialty.

(Note:  The numbers were left blank in the first draft registration statement submitted to the SEC.)

When companies make these sorts of assertions, the SEC will invariably ask for support, as the staff did in this comment:

Draft Registration Statement on Form S-1 submitted March 5, 2021

Prospectus Summary Overview, page 1

  1. You describe yourself as the “leading digital platform for U.S. medical professionals.” Please provide the basis for your characterization that you have a leading software platform and describe how this leadership is defined and/or determined. For example, it is not clear whether you are basing this on objective criteria such as market share based on revenues for competing software platforms in your industry.

As long as the company can support their assertion, these types of statements are acceptable disclosures.  In this case Doximity supported their assertion with this response and clarified disclosure:

Prospectus Summary

Overview, page 1

1.You describe yourself as the “leading digital platform for U.S. medical professionals.” Please provide the basis for your characterization that you have a leading software platform and describe how this leadership is defined and/or determined. For example, it is not clear whether you are basing this on objective criteria such as market share based on revenues for competing software platforms in your industry.

RESPONSE: The Company respectfully acknowledges the Staff’s comment, and advises the Staff that it has revised the disclosure on pages 1, 63, and 91 of the Amended Draft Registration Statement to address the Staff’s comment. The Company also advises the Staff that the Company is basing this on the number of U.S. physicians utilizing its platform compared to competing software platforms in its industry.

The clarified disclosure, which was included in an amended Form S-1, appropriately describes the measure the company uses to support its “leading” status:

Overview

We are the leading digital platform for U.S. medical professionals, as measured by the number of U.S. physician members, with over 1.8 million medical professional members as of March 31, 2021. Our members include more than 80% of physicians across all 50 states and every medical specialty.

As always, your thoughts and comments are welcome!