Category Archives: SEC Hot Topic

inSecurities Podcast Explores Recent U.S. Supreme Court Decisions

Recent U.S Supreme Court decisions have addressed how the SEC can use its administrative court processes for fraud cases and ended the Chevron doctrine, which had created a presumption that courts must rely on an agency’s interpretations of ambiguous statutes.  In this episode of the inSecurities podcast, hosts Chris Ekimoff and Kurt Wolfe provide an understandable, inciteful and thorough discussion of the issues in both these areas and how the Court’s decisions may affect practice.

As always, your thoughts and comments are welcome!

SEC Adopts Final Rules for Climate-Related Disclosures

In a long-anticipated development, on March 6, 2024, the SEC adopted final rules requiring climate-related disclosures.  The rules add:

    • Non-financial disclosures about climate-related risks, how such risks are managed and related board oversight;
    • Scope 1 and Scope 2 greenhouse gas (GHG) emission disclosures along with phased-in attestation requirements for large-accelerated and accelerated filers;
    • Financial statement disclosures about “capitalized costs, expenditures expensed, and losses incurred as a result of severe weather events and other natural conditions, such as hurricanes, tornadoes, flooding, drought, wildfires, extreme temperatures, and sea level rise, subject to applicable one percent and de minimis disclosure thresholds”;
    • Disclosures about carbon offsets and renewable energy credits or certificates (RECs) if material; and
    • Information about the impact on the estimates and assumptions used to produce the financialstatements from risks and uncertainties associated with severe weather events and other natural conditions and other related issues, if material.

To help companies and advisors implement these new requirements, PLI’s SEC Institute will offer several programs.

We will present two One-Hour Briefings delving into the final rules at 1 p.m. and 3 p.m. on April 18, 2024.  The first briefing will focus on governance related disclosures and the second briefing will focus on GHG emission and financial statement disclosures.  We will put links to the briefings in this blog as soon as they are available.

Our Midyear Forums will include in-depth discussion of the details of the rules.

We will also have a special conference in the early fall focused on understanding and implementing these extensive new disclosures.  We will put a link to this conference in this blog as soon as it is available.

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

As always, your thoughts and comments are welcome.

Chief Accountant Statement on Investor Protection and Auditors

On February 5, 2024, SEC Chief Accountant Dr. Paul Munter issued a Statement titled “An Investor Protection Call for a Commitment to Professional Skepticism and Audit Quality.”  The Statement reminds auditors and audit committees that their ultimate responsibility is to investors.

In the introduction to the Statement Dr. Munter notes that the PCAOB inspection process has found an increase in audit deficiencies over the last several years:

“The Public Company Accounting Oversight Board (“PCAOB”) reported a troubling increase in deficiency rates found in its recent inspections.  In its 2022 inspections of audits performed in 2021, the PCAOB inspections program found that insufficient audit evidence was obtained to support the auditor’s opinion in 40% of inspected audits. In its 2021 inspections, this same deficiency rate was 34%, up from 29% in its 2020 inspections. This is a troubling trendline in PCAOB inspections results.”

He then goes on to state:

“While we believe strongly that most auditors are talented professionals, dedicated to performing high-quality audits, the issues and trends identified in PCAOB inspections in recent years demand the attention and renewed commitment of the entire profession to deliver on its mission of protecting investors.”

The Statement then focuses on two principal areas:

Management’s Role and Auditors’ Exercise of Professional Skepticism in Response to Changing Conditions 

After a discussion focused on several audit issues, including frequent inspection findings and the importance of professional skepticism, the Statement emphasizes that audits are not like other business services:

“Applying professional skepticism can sometimes come at a cost, whether it is budget overruns, conflicts with management, or pressure from within the audit firm to maintain client relationships. But the audit engagement is not a standard business relationship between service provider and client, with profit as the primary goal and indicator of success. Instead, as the Supreme Court recognized, the auditor’s ultimate responsibility is to the investing public.”

The Importance of the Audit Committee in Prioritizing and Promoting Audit Quality

In this section of the Statement Dr. Munter focuses on important aspects of audit committee oversight of the audit process:

“Academic studies highlight the risk that, in some cases, in executing their mandate, audit committees may look to protect the interests of the issuer and its management over the interests of investors.  This risk can arise out of an audit committee’s association or coziness with the issuer or its management or through management’s influence over the audit committee’s supervision of the auditor. We remind audit committees of their role as critical gatekeepers for investor protection through oversight of a high-quality audit and the benefit of having an audit committee that is independent of management.”

As always, your thoughts and comments are welcome.

SEC Adopts SPAC Rules and Adds an Enforcement Exclamation Point!

On January 24, 2024, the SEC adopted final rules that create substantial reporting and process changes for SPACs.  The rules were originally proposed on March 30, 2022.  The new rules affect both SPAC IPO and de-SPAC  transactions.  (A de-SPAC transaction occurs when a SPAC merges with an operating company.)  In his Statement on the final rules, Chair Gary Gensler said that the new rules would “better align the protections investors receive when investing in SPACs with those provided to them when investing in traditional IPOs.”

You can find an overview of the voluminous new rules, which create a new Subpart 1600 in Regulation S-K, in this Press Release and the related Fact Sheet.  Highlights of the changes for SPAC IPOs include additional disclosures about SPAC sponsors, SPAC sponsor compensation, conflicts of interest and dilution.  For de-SPAC transactions, new disclosures include additional details about the target company and information about whether the board of the SPAC determined the transaction was advisable for the company and shareholders.  The new rules provide that the 1995 Private Securities Litigation Reform Act safe harbors for forward-looking statements will not be available for SPACs and also change underwriter liability in de-SPAC transactions.

The rules will be effective 125 days after publication in the Federal Register.  Certain information will be tagged with Inline XBRL, but this requirement is not effective until 490 days after publication in the Federal Register.

On January 25, 2024, the day after adopting the new rules, the SEC announced settled charges against Northern Star Investment Corp II, a SPAC, for failing to disclose discussions with a potential acquisition target in its IPO registration statement and de-SPAC transaction Form S-4.  As you can read in the SEC’s Order, the company entered into a cease and desist order and paid a fine of $1.5 million.

You can learn more about the new rules and SPACs in general at two upcoming programs:

A One-Hour Briefing about the final rules on February 14, 2024 – SPAC Developments: SEC Amendments to SPAC IPO and de-SPAC Related Rules, and

Our SPAC Life Cycle: Business, Legal, and Accounting Considerations Forum on April 15, 2024, will discuss the new rules in depth.

As always, your thoughts and comments are welcome.

SEC’s Fall Regulatory Agenda

On December 6, 2023, SEC Chair Gary Gensler published a Statement noting that the SEC’s Fall Regulatory Agenda has been published.  His Statement does not mention any specific projects.  As you can read in the Agenda, the Climate Change Disclosure and Special Purpose Acquisition Company projects are both in the final rule stage, with expected final rules by April 2024.  Human Capital Management disclosures are in the proposed rule stage.

As always, your thoughts and comments are welcome!

Reporting Implications of the Share Repurchase Rule Postponement

As we discussed in this post, on November 22, 2023, the SEC postponed the effective date of its Share Repurchase Disclosure Modernization rule.  The postponement was in the wake of an opinion by the U.S. Court of Appeals for the Fifth District in Chamber of Com. of the USA v SEC.  Gary Brown of Nelson Mullins has written this Securities Alert exploring how companies should deal with the postponement, including the implications for issuer 10b5-1 plans.

As always, your thoughts and comments are welcome.

Another 12b-25 Enforcement Sweep

We’d like to again remind our readers that Form 12b-25 is not an automatic extension for quarterly and annual reports.  In a prior blog post, we discussed an enforcement sweep in which eight companies paid fines for failing to disclose “anticipated restatements” in Form 12b-25.

On August 22, 2023, the SEC announced another sweep that caught five companies for exactly the same issue, failing to disclose “anticipated restatements.”  These companies restated their financial statements within three to twenty-one days after filing Form 12b-25.

As a reminder, Part III of Form 12b-25 includes this instruction:

State below in reasonable detail why Forms 10-K, 20-F, 11-K, 10-Q, 10-D, N-CEN, N-CSR, or the transition report or portion thereof, could not be filed within the prescribed time period.

(Attach extra Sheets if Needed)

As always, your thoughts and comments are welcome!

Getting Ahead of the MD&A Update Curve – Critical Accounting Estimates

As we discussed in this post, three parts of the SEC’s 2020 MD&A modernization have become focus areas in the comment process:

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

We also explored how one of the reasons behind this increase in MD&A comments could be that companies are reluctant to change MD&A, even when the change is to comply with a new rule or to improve MD&A!

This post presents an example comment and company response for the first of these three areas, 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 very simple comment to avoid.

The Regulation S-K Item 303 guidance for critical accounting estimate disclosures, which was in FR 72 prior to the 2020 rule modernization, requires companies to go beyond accounting policy disclosure in the financial statements:

Critical accounting estimates. Critical accounting estimates are those estimates made in accordance with generally accepted accounting principles that involve a significant level of estimation uncertainty and have had or are reasonably likely to have a material impact on the financial condition or results of operations of the registrant. Provide qualitative and quantitative information necessary to understand the estimation uncertainty and the impact the critical accounting estimate has had or is reasonably likely to have on financial condition or results of operations to the extent the information is material and reasonably available. This information should include why each critical accounting estimate is subject to uncertainty and, to the extent the information is material and reasonably available, how much each estimate and/or assumption has changed over a relevant period, and the sensitivity of the reported amount to the methods, assumptions and estimates underlying its calculation.

Here is an example disclosure from a company’s Form 10-K that became the source of a critical accounting estimate comment. (Note that the title in this example is out of date.  It should, as stated in S-K Item 303, be Critical Accounting Estimates.)

Critical Accounting Policies and Estimates

The preparation of financial statements in accordance with GAAP requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses, and the disclosure of contingent assets and liabilities at the date of the financial statements. We believe our estimates and assumptions are reasonable; however, actual results could differ from those estimates.

Our most significant accounting policies are described in Note 2 of the Notes to Consolidated Financial Statements. Some of those significant accounting policies require us to make difficult, subjective, or complex judgments, or estimates. An accounting estimate is considered to be critical if it meets both of the following criteria:

(1) the estimate requires assumptions about matters that are highly uncertain at the time the accounting estimate is made, and

(2) different estimates reasonably could have been used, or changes in the estimate that are reasonably

We have identified the following critical accounting policies:

      • Revenue Recognition
      • Loyalty Program Accounting
      • Asset Impairment Analysis
      • Valuation of the TRA Liability

(Note: For the sake of illustration only the Loyalty Program Accounting disclosure is included here.  You can find the entire disclosure by the company here.)

Loyalty Program Accounting – The Company records a liability for loyalty points earned by passengers under its Sun Country Rewards program using two methods: (1) a liability for points that are earned by passengers on purchases of the Company’s services is established by deferring revenue based on the redemption value net of breakage; and (2) a liability for points attributed to loyalty points issued to the Company’s Visa card holders is established by deferring a portion of payments received from the Company’s co-branded agreement. The Company’s Sun Country Rewards program allows for the redemption of points to include payment towards air travel, land travel, taxes, and other ancillary purchases. The Company estimates breakage for loyalty points that are not likely to be redeemed. These estimates are based on historical experience of loyalty point redemption activity and other factors, such as program changes and modifications that could affect the ultimate usage pattern of loyalty points.

While this seems like a fairly robust accounting policy disclosure, as a critical accounting estimate disclosure it generated this comment:

Management’s Discussion and of Financial Condition and Results of Operations Critical Accounting Policies and Estimates, page 4

    1. The disclosures of your critical accounting policies and estimates appear to be a
      repetition of certain of your significant accounting policies. Please revise your disclosures to address the material implications of the uncertainties that are associated with the methods, assumptions and estimates underlying your critical accounting estimates. Your expanded disclosure should address the risk related to using different assumptions and analyze their sensitivity to change based on outcomes that are deemed reasonably likely to occur. For additional guidance, refer to Item 303(b)(3) of Regulation S-K and the related Instruction 3 to paragraph (b) of Item 303.

The essence of this comment is a frequent theme, that simply repeating an accounting policy is not a critical accounting estimate disclosure.  Here is the company’s response, which, as you can read, significantly expands the disclosure (note, it’s ok to skim this lengthy disclosure!):

The Company respectfully acknowledges the Staff’s comment and will revise future filings in response to the Staff’s comment. Utilizing the disclosure from the most recent annual report on Form 10-K, the following reflects our proposed updated disclosures to be included in future filings. The Company notes there have been no changes to the selection and application of its critical accounting policies and estimates. The Company will continue to evaluate any reasonably likely changes that could impact its critical accounting estimates and provide updated disclosure in future filings as necessary. All numbers below are presented in thousands consistent with the disclosure approach used in the Company’s most recent annual report on Form 10-K.

Critical Accounting Policies and Estimates

……..

Loyalty Program Accounting

The Sun Country Rewards program provides loyalty awards to program members based on accumulated loyalty points. The Company records a liability for loyalty points earned by passengers under the Sun Country Rewards program using two methods: (1) a liability for points that are earned by passengers on purchases of the Company’s services is established by deferring revenue based on the redemption value, net of breakage; and (2) a liability for points attributed to loyalty points issued to the Company’s Visa card holders is established by deferring a portion of payments received from the Company’s co-branded agreement. The Company’s Sun Country Rewards program allows for the redemption of points to include payment towards air travel, land travel, taxes, and other ancillary purchases. The balance of the Loyalty Program Liabilities fluctuates based on seasonal patterns, which impact the volume of loyalty points awarded through travel or issued to co-branded credit card and other partners (deferral of revenue) and loyalty points redeemed (recognition of revenue). The Company records an estimate for loyalty points breakage in Passenger Revenue upon issuance of the loyalty points. Loyalty points held by co-branded credit card members do not expire. All other loyalty points expire if unused after three years.

Points Earned Through Travel Purchases. Passenger sales that earn Sun Country Rewards provide customers with travel services and loyalty points, which are each considered distinct performance obligations. The Company values each performance obligation on a standalone basis. The Company determines the standalone selling price of loyalty points issued using a redemption value approach which considers the value a passenger will receive upon redemption of the loyalty points. Consideration allocated to loyalty points is deferred, net of estimated breakage, and recognized as Passenger Revenue when both the loyalty points have been redeemed and the passenger travel occurs.

Points Earned through the Co-Branded Credit Card Program. Under the Company’s co-branded credit card program, funds received for the marketing of a co-branded credit card and delivery of loyalty points are accounted for as a multiple-deliverable arrangement. The Company determined the arrangement has two distinct performance obligations: loyalty points to be awarded; and use of our brand and access to our customer lists, and certain other advertising and marketing elements (collectively, the marketing performance obligation). Funds received from the co-branded credit card program are allocated to the two performance obligations based on relative standalone selling price. The assumptions used to allocate the funds received are not considered critical to the application of the accounting model for the Company’s loyalty program. Consideration allocated to loyalty points is deferred, net of estimated breakage, and recognized as Passenger Revenue when both the loyalty points have been redeemed and the passenger travel occurs. Consideration allocated to the marketing performance obligation is recognized as revenue as the spend occurs and is recorded in Other Revenue.

The Company estimates breakage for loyalty points that are not likely to be redeemed. Loyalty points are combined in one homogenous pool, that includes both air and non-air travel awards, and are not separately identifiable. The estimated breakage rate is primarily based on historical experience of loyalty point redemption activity and other factors that may not be indicative of future trends, such as the COVID-19 pandemic, program changes or modifications that could affect the ultimate usage pattern of loyalty points. The Company continuously monitors its breakage rate assumptions and may adjust its estimated breakage rate for loyalty points in the future. Changes in the Company’s estimated breakage rate assumptions impact revenue recognition prospectively.

During the year ended 2021, the Company recognized $852 of loyalty points breakage within Passenger Revenue. A 10% change in the Company’s loyalty point estimated breakage rate would have resulted in a change to Passenger Revenue of approximately $170.

Our next post will explore another frequent comment area, providing both quantitative and qualitative explanations for material changes.

As always, your thoughts and comments are welcome!

SEC Extends Several Rulemaking Comment Periods

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.

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

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!