As we enter financial reporting periods beginning on or after April 1, 2023, here is a hopefully helpful reminder to include the new Rule 10b5-1 plan disclosures in your next quarterly report.  As a reminder, the SEC’s December 2022 Final Rule implementing changes to how individuals use 10b5-1 plans, also requires new disclosures about:

• • Officer and director plans, and
  • Company insider trading policies.

The rule became effective on February 27, 2023.

The new officer and director plan disclosures are required quarterly in both the 10-Q and 10-K.  The mechanics of this process is that S-K Item 408(a) disclosure requirements have been added to the Form 10-K Instructions in Item 9B and the Form 10-Q Instructions in Part II – Item 5.  These disclosures include details of adoption, modification and termination and material terms (other than pricing) of both 10b5-1 plans and “non 10b5-1 trading arrangements.”  You can find all the details in S-K Item 408.

For non-Smaller Reporting Companies, the new officer and director plan disclosures are required for fiscal periods, including quarters, that begin on or after April 1, 2023.  The transition date for Smaller Reporting Companies is periods that begin on or after October 1, 2023 .

These disclosures must be tagged with iXBRL.

The new annual requirements include disclosure of insider trading policies and procedures and disclosures surrounding option awards made to executives where the timing of the award is close in time to the release of material non-public information.

The timing for the new annual disclosures is a bit uncertain.  The Final Rule states that non-Smaller Reporting Companies:

“…will be required to comply with the new disclosure and tagging requirements in Exchange Act periodic reports on Forms 10-Q, 10-K and 20-F and in any proxy or information statements that are required to include the Item 408, Item 402(x), and/or Item 16J disclosures in the first filing that covers the first full fiscal period that begins on or after April 1, 2023.”

While this is clear for quarterly fiscal periods, it could be read to mean that the annual disclosures would not be required for years that end on December 31, 2023, but rather the year after that.  If this was indeed the intent of the rule, that will hopefully be clarified at some point by the staff.

As always, your thoughts and comments are welcome!

Almost two years ago, on July 15, 2021, the SEC charged the former CEO and CFO of FTE Networks, Inc. with perpetrating a multi-year accounting fraud.  The allegations included multiple misstatements, including overstating revenues and concealing the existence of conversion features in notes payable.  The SEC also alleged that the former officers stole money from the company.  The Department of Justice brought criminal charges.

In cases like this, the question of where were the auditors invariably arises.  In many cases the auditors were as much victims of the fraud as any other parties.  Audit procedures designed to find fraud provide “reasonable” rather than “absolute” assurance that fraud will be detected.  When the PCAOB and the SEC Enforcement Division investigate these kinds of situations and find that audits were conducted in accordance with Generally Accepted Auditing Standards (GAAS), no action is brought against the auditors and there is no public announcement of any kind.

In other cases, auditors may not have appropriately designed their audit to detect material fraud or not followed GAAS in other ways.  In these cases, there will be public announcements by the PCAOB or the SEC Enforcement Division.

The FTE case falls into the second of these categories and is an example of how separate cases against companies and their auditors move at different rates.  On February 28, 2023, almost two years after the original charges, the SEC instituted public administrative and cease-and-desist proceedings against the company’s auditor.  As you can read in the related Accounting and Auditing Enforcement Release, the proceedings allege several audit failures.

This auditor focused enforcement is particularly important as it fits together with the Chief Accountant’s October 2022 Statement about the auditors’ responsibilities for fraud detection.  You can read more in this blog post.

As always, your thoughts and comments are welcome!

On March 14, 2023, the SEC announced a settled enforcement action against DXC Technology Company (DXC) based on misleading non-GAAP measures and related ineffective disclosure controls and procedures.  The company disclosed non-GAAP net income and non-GAAP diluted EPS measures that were adjusted for “transaction, separation and integration-related costs (TSI costs),” which were described as costs related to the merger that formed the company.  DXC’s disclosures, as required by regulation S-K Item 10(e), about why the measures provided useful information to investors stated:

“We present these non-GAAP financial measures to provide investors with meaningful supplemental financial information, in addition to the financial information presented on a GAAP basis. Non-GAAP financial measures exclude certain items from GAAP results which DXC management believes are not indicative of core operating performance. DXC management believes these non-GAAP measures allow investors to better understand the financial performance of DXC exclusive of the impacts of corporate wide strategic decisions. DXC management believes that adjusting for these items provides investors with additional measures to evaluate the financial performance of our core business operations on a comparable basis from period to period.”

However, according to the SEC’s order:

“DXC materially increased its non-GAAP earnings by negligently misclassifying tens of millions of dollars of expenses as TSI costs and improperly excluding them in its reporting of non-GAAP measures.”

The SEC’s order goes on to state that the company’s disclosure controls and procedures were inadequate to assure that “the company’s expense classifications were consistent with its own public description of TSI costs.”  As a result, non-GAAP net income and non-GAAP diluted EPS were materially overstated in several quarters.  The order contains a very revealing look into discussions about this issue between the company’s controllership group and its former Assistant Corporate Controller for External Reporting.

DXC consented to a cease-and-desist order and will pay an $8 million penalty.  In addition, the company entered into undertakings to design and implement appropriate non-GAAP measure policies and disclosure controls and procedures.

The use of non-GAAP measures has consistently been at or near the top of frequent SEC comment areas, and this case is a clear indicator that the Enforcement Division is also focused on misuse of non-GAAP measures.

As always, your thoughts and comments are welcome.

We have blogged several times about the SEC Enforcement Division’s frequent perks enforcement actions and the messages they send.  Among the companies where the SEC has found problems identifying and disclosing perks are:

• • Gulfport – February 2021
  • ProPetro Holding Corp – November 2021
  • National Beverage – August 2021
  • Hilton – September 2020
  • ARGO Group Holdings – June 2020
  • Sito Mobile –August 2019
  • Dow – July 2018
  • Energy XXI – July 2018
  • Provectus – December 2017
  • MusclePharm – September 2015
  • Tyson Foods – April 2005
  • GE ­– September 2004

On March 2, 2023, the Division announced its latest perks-related cases against The Greenbrier Companiesand its founder and former CEO, William A. Furman.  Both cases dealt with failure to disclose perks of approximately $329,000 and failure to disclose related-party transactions in which Greenbrier paid Furman for the use of his private airplane.  According to the Greenbrier Order, the company lacked appropriate internal controls to identify and record perks and related-party transactions.  As a result, both the company’s proxy statements and Form 10-K reports contained material misstatements.

In the Greenbrier Order, the SEC noted that the company undertook significant remedial actions.  Greenbrier and Furman both entered into cease-and-desist orders.  The company paid a $1,000,000 penalty and Furman paid a $100,000 penalty.

Perks identification and disclosure are clearly areas where financial reporting management and disclosure committees should review company policies, ensure that appropriate controls are designed and operating effectively, and carefully review related disclosures.

As always, your thoughts and comments are welcome!

On February 3, 2023, the SEC announced a settled enforcement action against Activision Blizzard, Inc. that involved two issues:

• • Provisions in separation agreements that violated whistleblower protection rules, and
  • Ineffective disclosure controls and procedures for human capital resources disclosures.

Activision agreed to pay a $35 million fine and entered into a cease and desist order.

Separation agreement and employment contract provisions that try and limit whistleblowing are not a new enforcement topic.  Over the years the SEC has brought cases against a number of companies, including Brinks, KBR, Blackrock and Homestreet, for provisions in agreements that attempt to limit whistleblowing.

Section 21F of the Dodd-Frank Act, “Whistleblower Incentives and Protection”, includes provisions to protect whistleblowers.  Pursuant to this section of the Act, the SEC adopted Rule 21F-17, which includes this language:

 (a) No person may take any action to impede an individual from communicating directly with the Commission staff about a possible securities law violation, including enforcing, or threatening to enforce, a confidentiality agreement . . . with respect to such communications.

Activision Blizzard routinely included provisions in separation agreements that required departed employees to notify Activision Blizzard if the SEC sent them a request for information, in violation of these rules.

The second issue in this case, inadequate disclosure controls and procedures, relates to Activision Blizzard not having processes and controls to accumulate and communicate information concerning employee complaints about workforce misconduct.  The company was aware that its ability to attract, retain, and motivate employees was a particularly important risk in its business.  It included this language as a risk factor heading in 10-Ks for 2017, 2018, 2019 and 2020:

“If we do not continue to attract, retain, and motivate skilled personnel, we will be unable to effectively conduct our business.”

According to the SEC’s Order, the company:

“lacked controls and procedures designed to ensure that it captured and assessed – from a disclosure perspective – certain information related to these risk factors.”

The SEC specifically focused on information about workplace misconduct.  As a result, according to the SEC’s Press Release, the company

“lacked sufficient information to understand the volume and substance of employee complaints about workplace misconduct and did not assess whether any material issues existed that would have required public disclosure.”

You can read more details in the SEC’s Order.

As always, your thoughts and comments are welcome!

As we discussed in this earlier post, the SEC’s October 2022 “Listing Standards for Recovery of Erroneously Awarded Compensation” rules will require companies whose securities are listed on national securities exchanges to develop and adopt  policies for the recovery or “clawback” of incentive compensation that has been “erroneously awarded” when a company restates its financial statements. The Dodd-Frank Act required the SEC to implement these requirements through listing standards that national securities exchanges will soon be required to adopt.   

Based on the final rules’ January 27, 2023, effective date, the timetable for implementation of the clawback rules, including the adoption of a clawback policy by exchange-listed companies, will be:

• • February 26, 2023 – last day by which national securities exchanges are to file proposed clawback listing standards;
  • November 28, 2023 – last day by which clawback listing standards must become effective; and
  • January 27, 2024 – last day by which listed companies must adopt and comply with an appropriate clawback policy.

Of course, if the exchange listing standards become effective earlier than the November 28, 2023 deadline, companies will have to adopt policies before January 27, 2024.

This earlier post discusses the implementation process in more detail and includes a policy template to help companies get a head start in this process.

This current post reviews the rules’ new disclosures:

• • First, if during or after the last completed fiscal year, a company is required to prepare an accounting restatement that requires recovery of “erroneously awarded” compensation, or, as of the last completed fiscal year, there was an outstanding balance of “erroneously awarded compensation” still to be recovered from a prior restatement, the required disclosures include:
  • The date of the restatement;
  • The dollar amount of compensation required to be clawed back;
  • Details of the calculation of compensation subject to clawback;
  • If the financial reporting measure in a compensation plan subject to clawback related to a stock price or total shareholder return, details of the estimates used in determining clawback amounts and the methodology used for these estimates;
  • The dollar amount of any “erroneously awarded compensation” outstanding at the end of the last completed fiscal year; and
  • If the dollar amount of compensation subject to clawback has not yet been determined, disclose this information, including an explanation of why the amount could not be determined. The required information should then be disclosed in the next report requiring compensation disclosure pursuant to Item 402 of Regulation S-K.
  • Second, when a company determines, based on the limited practicability exceptions in the rules, that clawback would be impracticable, it must disclose the amount of the compensation recovery not pursued for each executive officer and all executive officers as a group, along with a description of why recovery was not pursued.
  • Third, disclosure must include amounts that, as of the end of the most recently completed fiscal year, have been outstanding for 180 days or more from any current or former named executive officer.
  • Fourth, if a company has a restatement and concludes that clawback of compensation is not required for that restatement, it must disclose how it arrived at that conclusion.

In addition to the disclosures described above, each listed company must file its clawback policy as Exhibit 97 to Form 10-K.  These new disclosures are to be tagged with Inline XBRL and will also be required in Forms 20-F and 40-F.  Note that this will not be required until after the company is required to adopt a clawback policy, which could be as late as January 27, 2024.

Furthermore, the rules add two new checkboxes to the cover pages of Form 10-K, Form 20-F and Form 40-F.  These forms were updated on January 27, 2023, the effective date of the new rules.  Below is the revised section of the cover page of Form 10-K from the SEC’s webpage:

Also, on January 31, 2023, the staff issued several new C&DIs addressing these new disclosures.  One of the C&DIs addresses the form amendments:

Question 104.19

Question: The form amendments adding check boxes to the cover page of Form 10-K, Form 20-F, and Form 40-F indicating whether the form includes the correction of an error in previously issued financial statements and a related recovery analysis are effective January 27, 2023. However, the listing standards are not required to be effective until November 28, 2023 and issuers subject to such listing standards will not be required to adopt a recovery policy for 60 days following the date on which the applicable listing standards become effective. Will issuers be required to mark the check boxes in 2023 before an issuer is required to adopt a recovery policy and comply with the applicable listing standards?

Answer: In the adopting release, the Commission indicated that it does not expect compliance with the disclosure requirements until issuers are required to have a recovery policy under the applicable exchange listing standard. While the check boxes and other disclosure requirements will be in the rules and forms in 2023, we do not expect issuers to provide such disclosure until they are required to have a recovery policy under the applicable listing standard. [January 31, 2023]

Because disclosure is not required until after a listed company is required to adopt a clawback policy, whether to add the new checkboxes on the cover page of your annual report is essentially an “it depends” decision.  We believe that the better practice is to include the new checkboxes as they are now on the official form.  Some companies, however, may decide not to include them since the underlying disclosure requirement is not effective until after the company is required to adopt a clawback policy.  Assuming that the EDGAR system allowed such a submission, that would, in essence, make both answers allowable.

Non-listed companies have similar considerations about inclusion of the checkboxes on the form cover but they will not have to check either of the boxes. The first box would not apply – they do not have “Section 12(b)” (i.e., listed) securities.  Then, even if they had a restatement, the second box would not apply because it would not be “required.”   Should non-listed companies not have a clawback policy – we’re not saying that adoption of a clawback policy might not be a wise move as a matter of good governance practices.  But even if they do – these rules will not apply to them.

As always, your thoughts and comments are welcome!

On February 14, 2023, SEC Chief Accountant Paul Munter again addressed the FASB’s standard-setting process in a Statement titled “Accounting Standard Setting in a Rapidly Evolving Business Environment: A Focus on the Timely Delivery of Investor Priorities.”  This Statement continues discussion of several issues mentioned in Mr. Munter’s February 22, 2022, “Statement on the FASB’s Agenda Consultation: Engagement with Investors and Other Stakeholders Vital to Development of High Quality Accounting Standards.”

In the 2022 Statement, Mr. Munter discussed several aspects of the FASB’s agenda consultation project, particularly the importance of investor and other stakeholder input.  He also highlighted the importance to investors of several standard-setting areas including disaggregating financial statement information, accounting for digital assets, and climate-related transactions and disclosures.

Mr. Munter’s 2023 Statement continues this focus on the FASB’s standard-setting process.  In the introduction to his Statement, he acknowledges that the FASB’s standard-setting project agenda has been reprioritized, “largely to focus on investor and other stakeholder priorities identified through the agenda consultation process.”  He also mentions the Board’s focus on various projects, including:

Disaggregation – Income Statement Expenses;

Accounting for and Disclosure of Crypto Assets;

Improvements to Income Tax Disclosures; and

Segment Reporting.

He then writes:

“Completion of these and other reprioritized projects in a timely manner is critical to the quality of accounting standards and the resulting quality of financial reporting. As FASB standard-setting projects move forward, we believe there are continued opportunities for improvement to the standard-setting process, and that constructive collaboration by preparers, investors, auditors, and other stakeholders, with a focus on timely solutions that meet investor financial reporting needs, is key to the development of high-quality accounting standards for the benefit of the financial reporting system, investors, and issuers.”

The next section in the Statement, titled “Enhancing the Accounting Standard-Setting Process,” includes this observation:

“The rapid pace of change in today’s business and economic environment requires a thoughtful, yet timely, response by standard setters to improve the quality of financial accounting and reporting standards, thereby enhancing the usefulness of the financial information provided to investors. The FASB’s recent agenda reprioritization, however, is just one step in addressing such needs in a rapidly changing environment. Consistent with many projects on its reprioritized agenda, the FASB should continue to scope its standard-setting projects to allow for achievable standards updates to be finalized in the near term on topics that are of the highest priority to investors. The FASB, with the support of its stakeholders, should act with a renewed sense of focus and urgency in order to enhance its standard-setting process and produce timely, meaningful improvements to its standards.”

 In this section Mr. Munter also states:

“However, more work remains to be done—including improved collaboration across the FAF and the FASB regarding additional process improvements needed to accomplish more timely standard setting in response to investor needs. To accomplish its mission of establishing and improving standards that foster decision-useful financial reporting for investors, it is critically important that the FASB, and the FAF Trustees in their oversight role, continue to enhance its process to improve standard-setting efficiency, effectiveness, and transparency.”

The Statement then discusses projects which are top priorities for investors and how the FASB’s agenda “now better reflects a focus on investor and other stakeholder priorities in meaningful and achievable standard-setting projects.”  Mr. Munter then notes:

“However, the proof is in the doing. The FASB should now execute on those stated priorities in an effective, efficient manner to produce timely, high-quality standards updates. As noted above, this will require the FASB to carefully design and execute on the scope of its projects. It is also of critical importance that preparers, auditors, and other stakeholders focus on providing collaborative feedback to the FASB on cost-effective solutions that meet investors’ needs for improved financial information.”

As always, your thoughts and comments are welcome!