The role of proxy advisory firms has been hotly and extensively debated over the years.  In August 2019 the SEC issued guidance that:

 Addressed the ability of investment advisers to establish a variety of different voting arrangements with their clients,

Discussed matters investment advisers should consider when they use the services of a proxy advisory firm,

Included an interpretation that proxy voting advice provided by proxy advisory firms generally constitutes a “solicitation” under the federal proxy rules, and

Provided related guidance about the application of the proxy antifraud rule to proxy voting advice.

The discussion about proxy advisory firms continues, and as part of this evolution ISS has released their annual Global Policy Survey.  For an interesting number of comments and perspectives on the survey, including discussion of ESG issues, you can read this post on the soundboard governance blog.  This blog is authored by Doug Chia, a Fellow at the Rutgers Center for Corporate Law and Governance.

Lastly, as a next step in this area, on November 5, 2019 the SEC proposed a rule to “improve accuracy and transparency of proxy voting advice”.

As always, your thoughts and comments are welcome!

On November 19, 2019 the SEC issued SAB 119 to align its guidance with the FASB’s Current Expected Credit Loss Standard, ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.  The new SAB  updates existing guidance dealing with what the staff expects of companies as they develop methodologies and supporting documentation for measuring credit losses.

The SAB addresses areas that will sound very familiar to professionals who have been dealing with the new, subjective estimates required to implement the new standard, including:

1. Measuring current expected credit losses

2. Development, governance, and documentation of a systematic methodology

3. Documenting the results of a systematic methodology

4. Validating a systematic methodology

The SAB will be most relevant for financial institutions but could be helpful for all entities.  As of the date of this writing there is one formal detail still in process for the SAB, publication in the Federal Register.

As always, your thoughts and comments are welcome!

As we mentioned in our quarterly Newsletter, during the late summer the FASB had decided to defer the implementation date for its CECL, Leases, Hedging and Long Duration Insurance Contracts standards for certain types of entities.  On November 15, 2019 the final standard for this change was issued.  You can find a press release and links to the final ASU here.  The press release includes this table summarizing the changes:

As always, your thoughts and comments of celebration are welcome!

After making changes for mining and oil and gas companies the SEC has proposed changes in the statistical disclosures for banks and bank holding companies.  You can read the details of the proposed rule here.  The proposal has a 60-day comment period from the date it is published in the Federal Register.

The proposed rule would eliminate Guide 3 (which has been essentially the same for 30 years) and provide new disclosures in Regulation S-K.  According to the press release announcing the new rule it will require disclosure about:

Distribution of assets, liabilities and stockholders’ equity, the related interest income and expense, and interest rates and interest differential;

Weighted average yield of investments in debt securities by maturity;

Maturity analysis of the loan portfolio including the amounts that have predetermined interest rates and floating or adjustable interest rates;

An allocation of the allowance for credit losses and certain credit ratios; and

Information about bank deposits including amounts that are uninsured.

As always, your thoughts and comments are welcome!

SEC Reporting this year-end presents several challenges, including:

Form 10-K updates from the SEC’s March 2019 Disclosure Modernization rule,

Implementation of Critical Audit Matters, and

New accounting standards including CECL.

Our 35^Th Annual SEC Reporting and FASB Forums in New York and San Francisco (and also via webcast) will provide you all the practical knowledge and useful tools you need to successfully navigate this complexity.  You will also earn an hour of regulatory ethics CPE.  (Note that some state boards of accountancy do not accept regulatory ethics towards their ethics CPE requirements ).  You can find all the details and register here.

As always your thoughts and comments are welcome!

As we move towards the end of the third-quarter and begin preparations for year-end reporting we are presenting a series of blog posts focused on common questions and problems in quarterly and annual reports.

This blog post explores some complexities of Item 9 in Form 10-K and the reporting requirements for auditor changes.  To illustrate this point, Workshop Instructors Reed Wilson and Rich Alven, who lead SECI’s Form 10-K In-Depth Workshop and who review each Workshop participant’s Form 10-K as part of their Workshop preparations, noted that many of the participants’ company filings do not use Form 10-K Item 9 properly.  In a recent Workshop, two out of five companies who had auditor changes misused Item 9.

Clearly, this is a confusing disclosure requirement!

Overview and Summary

The explanation behind this confusion is long and detailed.  To help, here is a summary of how this disclosure requirement works.  You will get all the details as you read the rest of this blog post:

1. Form 10-K Item 9 CANNOT be used to report auditor changes.
2. ALL auditor changes MUST be reported on Form 8-K Item 4.01.
3. Form 10-K Item 9 is only used to report certain information when there has been an auditor change previously reported on Form 8-K and the auditor change involved “disagreements or reportable events”.
4. Auditor changes previously reported on Form 8-K where there were no “disagreements or reportable events” should not be disclosed in Form 10-K Item 9.
5. Form 10-K Item 9 disclosure is only required when there was an auditor change that involved “disagreements or reportable events” that was previously reported on Form 8-K, the accounting issue that was the subject of the “disagreements or reportable events” continues to affect the company’s financial statements, AND the company’s new auditor does not require the company to account for these matters in the way the former auditor thought was in accordance with GAAP.
6. In the event Item 9 disclosure is required, the company must disclose what the financial statements would have looked like had it followed the treatment the former auditor thought was GAAP.

The Details

One reason for this confusion is the Item 9 title in Form 10-K: “Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.”

From simply reading this description it might seem that auditor changes and /or disagreements with the former auditor should be reported here.

That is not the case.

Another issue that creates confusion in this area is the articulation of Form 10-K and 8-K.  Form 10-K  Item 9B can (generally!) be used to report information that would normally be reported on Form 8-K if the deadline for a Form 10-K falls in the period that an 8-K would be required.

However, a change in auditor cannot be reported on Form 10-K Item 9B.  Because auditor changes are such an important watch area for the SEC they issued this Compliance and Disclosure Interpretation.  Confusingly perhaps, the C&DI is not in the 8-K section, but in the overall General Guidance section:

Section 101. Form 8-K — General Guidance

Question 101.01

Question: If a triggering event specified in one of the items of Form 8-K occurs within four business days before a registrant’s filing of a periodic report, may the registrant disclose the event in its periodic report rather than a separate Form 8-K? If so, under what item of the periodic report should the event be disclosed? Item 5 of Part II of Form 10-Q and Item 9B of Form 10-K appear to be limited to events that were required to be disclosed during the period covered by those reports.

Answer: Yes, a triggering event occurring within four business days before the registrant’s filing of a periodic report may be disclosed in that periodic report, except for filings required to be made under Item 4.01 of Form 8-K, Changes in Registrant’s Certifying Accountant and Item 4.02 of Form 8-K, Non-Reliance on Previously Issued Financial Statements or a Related Audit Report or Completed Interim Review. The registrant may disclose triggering events, other than Items 4.01 and 4.02 events, on the periodic report under Item 5 of Part II of Form 10-Q or Item 9B of Form 10-K, as applicable. All Item 4.01 and Item 4.02 events must be reported on Form 8-K. Of course, amendments to previously filed Forms 8-K must be filed on a Form 8-K/A. See also Exchange Act Form 8-K Question 106.04 regarding the ability to rely on Item 2.02 of Form 8-K. [April 2, 2008]

So, it is clear that neither Item 9B nor Item 9 in Form 10-K should be used to report auditor changes.  All changes in auditors must be reported on Form 8-K because this is such a sensitive issue given the risk of opinion shopping.

So, what exactly is supposed to be reported in Item 9?  The S-K reference in Item 9 is to S-K Item 304(b).  This part of S-K requires the following disclosures:

(b) If: (1) In connection with a change in accountants subject to paragraph (a) of this Item 304, there was any disagreement of the type described in paragraph (a)(1)(iv) or any reportable event as described in paragraph (a)(1)(v) of this Item;

(2) During the fiscal year in which the change in accountants took place or during the subsequent fiscal year, there have been any transactions or events similar to those which involved such disagreement or reportable event; and

(3) Such transactions or events were material and were accounted for or disclosed in a manner different from that which the former accountants apparently would have concluded was required, the registrant shall state the existence and nature of the disagreement or reportable event and also state the effect on the financial statements if the method had been followed which the former accountants apparently would have concluded was required.

These disclosures need not be made if the method asserted by the former accountants ceases to be generally accepted because of authoritative standards or interpretations subsequently issued.

This disclosure requirement begins to unravel the mystery, but to fully understand Item 9 we need to review exactly what “a change in accountants subject to paragraph (a) of this Item 304” is about, and understand what the disclosures about a “disagreement of the type described in paragraph (a)(1)(iv) or any reportable event as described in paragraph (a)(1)(v) of this Item” are about.

It turns out these are the normal requirements for disclosures about a change in auditors required in Form 8-K.  The instructions for Item 4.01 in Form 8-K state:

Item 4.01 Changes in Registrant’s Certifying Accountant.

(a) If an independent accountant who was previously engaged as the principal accountant to audit the registrant’s financial statements, or an independent accountant upon whom the principal accountant expressed reliance in its report regarding a significant subsidiary, resigns (or indicates that it declines to stand for re-appointment after completion of the current audit) or is dismissed, disclose the information required by Item 304(a)(1) of Regulation S-K (17 CFR 229.304(a)(1) of this chapter), including compliance with Item 304(a)(3) of Regulation S-K (17 CFR 229.304(a)(3) of this chapter) .

So, any change in auditors will be covered by S-K Item 304(a).  However not all auditor changes will include the disclosures about a “disagreement of the type described in paragraph (a)(1)(iv) or any reportable event as described in paragraph (a)(1)(v) of this Item”.

These disclosures will only be required when there has been an auditor change where there were reportable events or disagreements.

(As a side note, don’t forget that retaining a new auditor also requires an Item 4.01 8-K.)

So, this means that disclosure in Form 10-K Item 9 is only required if there has been an auditor change that was previously reported on Form 8-K and as part of the change the company disclosed disagreements with the auditor or reportable events.

But the decision process does not end here.  As the instructions to Item 9 refer to S-K Item 304(b) this item provides that disclosure has to be made when the company’s new auditor agrees with the company’s position and does not make the company account for the transactions or other matters involved in the disagreement the way the former auditors thought was appropriate.

Conclusion and Summary

1. Form 10-K Item 9 CANNOT be used to report auditor changes.
2. ALL auditor changes MUST be reported on Form 8-K Item 4.01.
3. Form 10-K Item 9 is only used to report certain information when there has been an auditor change previously reported on Form 8-K and the auditor change involved “disagreements or reportable events”.
4. Auditor changes previously reported on Form 8-K where there were no “disagreements or reportable events” should not be disclosed in Form 10-K Item 9.
5. Form 10-K Item 9 disclosure is only required when there was an auditor change that involved “disagreements or reportable events” that was previously reported on Form 8-K, the accounting issue that was the subject of the “disagreements or reportable events” continues to affect the company’s financial statements, AND the company’s new auditor does not require the company to account for these matters in the way the former auditor thought was in accordance with GAAP.
6. In the event Item 9 disclosure is required, the company must disclose what the financial statements would have looked like had it followed the treatment the former auditor thought was GAAP.

Given the complexity of this decision process, it is not surprising that this disclosure requirement creates confusion.  That said, given the more or less “confessing to opinion shopping” orientation of this disclosure, it is really best to not use Item 9 unless it is really required!

As always, your thoughts and opinions are welcome, and if you know of a particularly interesting auditor change please put it in a comment to this post!

The CorpFin staff has provided two incremental sources of information and guidance dealing with shareholder proposals in the proxy process.  On September 6, 2019, CorpFin published an “Announcement Regarding Rule 14a-8 No Action Requests.”  In this Announcement, CorpFin staff says:

The staff will continue to actively monitor correspondence and provide informal guidance to companies and proponents as appropriate. In cases where a company seeks to exclude a proposal, the staff will inform the proponent and the company of its position, which may be that the staff concurs, disagrees or declines to state a view, with respect to the company’s asserted basis for exclusion. Starting with the 2019-2020 shareholder proposal season, however, the staff may respond orally instead of in writing to some no-action requests.

 The second development is Staff Legal Bulletin 14K issued on October 16, 2019. In the SLB CorpFin states:

 The Purpose of this bulletin

This bulletin is part of a continuing effort by the Division to provide guidance on important issues arising under Exchange Act Rule 14a-8. Specifically, this bulletin contains information regarding:

• the analytical framework of Rule 14a-8(i)(7);
• board analyses provided in no-action requests to demonstrate that the policy issue raised by the proposal is not significant to the company;
• the scope and application of micromanagement as a basis to exclude a proposal under Rule 14a-8(i)(7); and
• proof of ownership letters.

Rule 14a-8 addresses shareholder proposals and paragraph (7) provides one of the ways that a shareholder’s proposal can be excluded by the company from its proxy statement:

(7) Management functions: If the proposal deals with a matter relating to the company’s ordinary business operations

How to interpret this language and how much guidance the SEC staff will provide in this process has been evolving over time, and the announcement and SLB are the latest step in this process.  It will likely continue to be a difficult process!

As always, your thoughts and comments are welcome!

As you may have heard, Virgin Galactic, Richard Branson’s space tourism company, began trading on the NYSE on October 28, 2019.  There was not a lot of press leading up to this listing as the company did not purse a traditional IPO.  The company achieved its NYSE listing by merging with a special purpose acquisition company or “SPAC”.  A SPAC is a company that raises capital through an IPO and lists on an exchange with the intention of finding another company to acquire.  Virgin Galactic merged with a SPAC named Social Capital Hedosophia Holdings Corp.  This interesting transaction is very similar to a reverse merger.  In the combination of Virgin Galactic with Social Capital Hedosophia Holdings Corp. the accounting acquirer is Virgin Galactic and the legal acquirer is Social Capital Hedosophia Holdings Corp.  This in essence results in a NYSE traded company with the historical financial statements of Virgin Galactic, but with the equity section replaced by that of Social Capital Hedosophia Holdings Corp.  If you would like to read more check out this definitive proxy statement.

As always, your thoughts and comments are welcome!

The SEC has made some technical corrections to its March 2019 Final Rule for Disclosure Modernization and Simplification.  These corrections were made in an August 6, 2019 Final Rule to make technical corrections to the March 20, 2019 original Final Rule.

First, in several registration statement forms (S-1, S-3, S-4, F-1, F-3, and F-4) the Item 3 section header should now read as:

            Item 3. Summary Information and Risk Factors

As of September 5, 2019, versions of these forms on the SEC’s web page still had the now obsolete heading of:

            Item 3. Summary Information, Risk Factors and Ratio of Earnings to Fixed Charges.

Second, to address some confusion caused by the original Modernization and Simplification Rule, the August 6 Final Rule made a technical correction to the Electronic Code of Federal Regulations (or “e-CFR”) on-line version of the Exhibit Table in S-K Item 601(a).  The e-CFR version of the Exhibit Table was updated to make it clear that the new Exhibit 4 “Description of Registrants Securities” is required in Form 10-K.  (This is the information in S-K Item 202.) There was a similar update for Exhibit 104 “Cover Page Interactive Data” to clarify that it is required for Forms 10-K and 10-Q as well as Form 8-K.

You can review a few other detailed changes, primarily to the “N” forms, in the Final Rule.

As always, your thoughts and comments are welcome!

It is always a good to remember that auditor independence is not just an issue for auditors but also for audit committees and management.  With the recent auditor independence enforcement actions against RSM and PwC as reminders, all companies, and in particular multinational companies, should review their own processes to assure no company personnel act in a way which could impact on auditor independence.  Particularly, offices outside the United States, where financial and other personnel may not be aware of the more restrictive SEC independence requirements, should be trained about the restrictions in non-audit services and related issues.

As an additional resource in this process, earlier this year the Office of the Chief Accountant updated its auditor independence FAQs, which could be a helpful resource in policy development and training.

As always, your thoughts and comments are welcome!