Category Archives: Reporting

Three Tips to Avoid Low-Hanging Fruit on the MD&A SEC Comment Tree

10-K/10-Q Tips, Reporting

As we discussed in this blog post, creating change in MD&A is a complex process.  The number of stakeholders involved in drafting and reviewing MD&A creates logistical and tactical challenges.  Old and obsolete beliefs that disclosure changes will attract negative attention from the SEC create resistance that is difficult to overcome.  This is true even when the changes are to implement new requirements that will help companies avoid comments.

There are three areas of change from the SEC’s 2020 MD&A update that have become frequent comment areas, likely because companies have not changed their MD&A to implement these rule changes:

    • Critical accounting estimate disclosures
    • Quantitative and qualitative disclosures about material changes
    • Meaningfully addressing liquidity and capital resources

To help understand the issues in these disclosures, below are links to blog posts with example disclosures and related SEC comments.

This post presents an example comment and company response for critical accounting estimate disclosures.  While the example, particularly the revised disclosure, is lengthy, the lesson is simple.  Critical accounting estimates are not the same thing as accounting policies.  This is a simple comment to avoid.

This post presents an example comment and company response about providing quantitative and qualitative disclosures about material financial statement changes.  The Regulation S-K Item 303 guidance for this disclosure is very direct:

“Where the financial statements reflect material changes from period-to-period in one or more line items, including where material changes within a line item offset one another, describe the underlying reasons for these material changes in quantitative and qualitative terms.”

This post examines an example comment and company response focused on meaningfully addressing liquidity and capital resources disclosures.

Given the complexity and challenges in improving MD&A, one strategy companies can adopt is to make incremental change as they work on quarterly reports during the year.  This could help in working toward a reasonable implementation of these rule changes in their next year-end MD&A.

As always, your thoughts and comments are welcome!

SEC Finalizes New Share Repurchase Rule

Hot Topic, Reporting, SEC News

On May 3, 2023, the SEC adopted a Final Rule requiring new disclosures about share repurchases.  The new rule includes quantitative disclosures such as daily repurchases and qualitative disclosures such as the objectives or rationales behind repurchases.  The new rule is intended to “enhance information to assess the purposes and effects” of share repurchases.

Companies that file Forms 10-Q and 10-K will be required to provide these new disclosures beginning with the first filing that covers the first full fiscal quarter that begins on or after October 1, 2023.  Foreign private issuers that file Form 20-F will be required to provide this information via a new Form F-SR beginning with the first full fiscal quarter that begins on or after April 1, 2024.  Form F-SR will be due within 45 days after the end of each fiscal quarter.

The new rule requires companies that file Forms 10-K and 10-Q to:

    • Disclose share repurchases on a daily basis in each Form 10-Q and in Form 10-K for their fourth quarter
    • Include this information in new exhibit 26
    • Provide details using a format for exhibit 26 such as the table below from S-K Item 601, which will also be tagged using iXBRL:

This new exhibit will include language disclosing whether officers or directors subject to Section 16 reporting traded within four business days of certain company announcements about a repurchase plan:

Use the checkbox to indicate if any officer or director reporting pursuant to Section 16(a) of the Exchange Act (15 U.S.C. 78p(a)), or for foreign private issuers as defined by Rule 3b-4(c) (§ 240.3b-4(c) of this chapter), any director or member of senior management who would be identified pursuant to Item 1 of Form 20-F (§ 249.220f of this chapter), purchased or sold shares or other units of the class of the issuer’s equity securities that are registered pursuant to section 12 of the Exchange Act and subject of a publicly announced plan or program within four (4) business days before or after the issuer’s announcement of such repurchase plan or program or the announcement of an increase of an existing share repurchase plan or program. □

The amendments also add this language to S-K Item 703 to require disclosure in Forms 10-Q and 10-K of:

“(1) The objectives or rationales for each repurchase plan or program and the process or criteria used to determine the amount of repurchases;

(2) The number of shares (or units) purchased other than through a publicly announced plan or program, and the nature of the transaction (e.g., whether the purchases were made in open-market transactions, tender offers, in satisfaction of the issuer’s obligations upon exercise of outstanding put options issued by the issuer, or other transactions);

(3) For publicly announced repurchase plans or programs:

(i) The date each plan or program was announced;
(ii) The dollar amount (or share or unit amount) approved;
(iii) The expiration date (if any) of each plan or program;
(iv) Each plan or program that has expired during the period covered by the table in § 229.601(b)(26) (Item 601(b)(26) of Regulation S-K); and
(v) Each plan or program the issuer has determined to terminate prior to expiration, or under which the issuer does not intend to make further purchases.

(4) Any policies and procedures relating to purchases and sales of the issuer’s securities by its officers and directors during a repurchase program, including any restrictions on such transactions.”

As mentioned above, Foreign Private Issuers that file Form 20-F will provide this same information each quarter on Form F-SR.

The new rule adds a requirement to S-K Item 408 for quarterly disclosure in Forms 10-K and 10-Q regarding company adoption and termination of 10b5-1 trading arrangements.

The new rule eliminates the existing share repurchase disclosure requirements in Regulation S-K Item 703.

Listed Closed-End Funds will include this repurchase data in their annual and semi-annual reports on Form N-CSR.

You can learn more in the related Final Rule and Fact Sheet.

As always, your thoughts and comments are welcome.

Don’t Forget the New Rule 10b5-1 Plan Quarterly Disclosures!

Hot Topic, Reporting

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!

Company and Auditor Investigations Each Have Their Own Pace

Hot Topic, Reporting

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!

Clawback Rulemaking Process Moves Forward with Proposed Listing Standards

Reporting

The SEC’s October 2022 Listing Standards for Recovery of Erroneously Awarded Compensation Final Rule requires national securities exchanges to propose and adopt requirements that listed companies have an appropriate “clawback policy.”  The NYSE and NASDAQ recently issued proposed listing standards.  You can find the proposals for the NYSE here and for the NASDAQ here.

You can read this post for more information about the clawback rulemaking process and deadlines.  The post also includes a clawback policy template from Gary Brown, Partner at Nelson Mullins Riley & Scarborough LLP, and SEC Institute workshop leader and PLI author.

You can read this post for information about the new clawback Form 10-K cover page checkboxes and other disclosures. 

As always, your thoughts and comments are welcome!

SEC Updates Tender Offer Compliance and Disclosure Interpretations

Reporting

On March 17, 2023, CorpFin updated several Compliance and Disclosure Interpretations (C&DIs) related to tender offers.  The updates address a wide range of questions.  For example, one of the C&DIs clarifies that a tender offer may be subject to conditions only when the conditions are based on objective criteria.  Other examples discuss who is a bidder in the tender offer process.  You can find the updated C&DIs here.

Chief Accountant Address Responsibilities of Lead Auditors

Reporting, Role of the Audit Committee

On March 17, 2023, Chief Accountant Paul Munter issued a Statement titled “Responsibilities of Lead Auditors to Conduct High-Quality Audits When Involving Other Auditors.”  In the Statement, Mr. Munter notes that:

“In 2021, for example, 26 percent of all issuer audit engagements and 57 percent of large accelerated filer audits involved the use of other auditors by the lead auditor.”

The Statement begins with a summary of shortcomings the Office of the Chief Accountant has observed in audit engagements where another auditor is involved.  These include using other auditors who are not registered with the PCAOB, failure to communicate the correct legal entity name of other firms, and providing audit committees incomplete information about network firms.  The Statement then addresses:

    • The importance of quality control processes when other auditors play a role in an engagement,
    • Roles of network firms,
    • Independence considerations, and
    • Good practices for audit committees and issuers.

In his conclusion, Mr. Munter states:

“The relevant risks should be considered and the appropriate PCAOB standards must be applied in order to strengthen lead auditors’ supervision over the work of other auditors, within and outside of network firms, to help enhance audit quality.”

As always, your thoughts and comments are welcome!

SEC Enforces for Misleading Non-GAAP Measures and Deficient Disclosure Controls and Procedures

Hot Topic, Reporting

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.

A Proxy Area for Care – Perks Reporting!

Hot Topic, Reporting

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!

A Two for One Enforcement – Whistleblower Restrictions and Human Capital Resources Disclosure Controls

Hot Topic, Reporting

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!