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From Securities Regulation Daily, January 28, 2014
By Amy Leisinger, J.D., and Anne Sherry, J.D.
The Securities Regulation Institute continued in Coronado, California, today with a group of speakers including many current and former SEC staff. Two panels consisting entirely of SEC staff and/or alumni discussed updates in the Division of Corporation Finance and answered frequently asked securities questions. Other sessions touched on accounting and auditing developments; corporate governance and shareholder activism; and enforcement and criminal investigations.
Disclosure. The previous day closed with a disclosure panel chaired by former Director of the Division of Corporation Finance Meredith B. Cross and including Mark Kronforst, currently Associate Director and Chief Accountant at the Division. Ms. Cross continued the day’s theme of adaptation, observing that companies have new ways to communicate, and that younger investors and analysts do not use information the same way as earlier generations. In addition, she said, “companies are facing incredible pressures to satisfy the wants and demands of an ever-increasing population of stakeholders,” including regular investors, socially motivated investors, governance advocates, activist investors, proxy advisory firms, Congress, and now non-governmental organizations (NGOs).
Associate Director Kronforst discussed areas of staff focus for 2014 disclosure reviews. Turning again to the topic of metrics, he said he agreed with Director Higgins’ earlier remarks that the Division would not object to the use of a metric if its relevance is explained. But sometimes filings do not tie the metrics in to the result, he said, and that’s when CorpFin will start asking questions. Associate Director Kronforst also discussed the Accounting Quality Model from the Division of Economic and Risk Analysis. This data-driven tool is early in development, but CorpFin anticipates using the model to help it identify areas of focus or rules to prioritize.
Ms. Cross led a discussion of disclosure issues for social media. She observed that the SEC’s Netflix release did not really change the regulatory framework and that the rules for disclosure broadly, including Regulation FD, apply equally to social media. The two in-house attorneys on the panel, Stephanie D. Marks and Christopher Walther, discussed their respective companies’ social media policies and other practical disclosure issues.
David M. Lynn remarked on compensation- and governance-related disclosures. He noted that change in this area is driven in large part by the market — it is not necessarily the SEC demanding that proxies become more readable and accessible, but proxy advisory firms or institutional investors calling for particular disclosures and explanations. Mr. Lynn also cited a survey finding that 6 percent of institutional investors review a proxy statement in its entirety. He advised registrants to use a proxy summary to make the information more accessible.
Finally, the panel took up specialized disclosure, in particular the conflicts mineral disclosure. Ms. Cross characterized this rule as a difficult, but important, disclosure. There is no de minimis threshold, Mr. Lynn noted, and he advised companies that believe they have nothing to disclose to research each product line and supply chain to make sure of this, then document that analysis. Ms. Cross agreed, but speculated that this is not an area the SEC will be able to focus on, at least at first. She believes that the comments will come from NGOs, and if the NGOs find something, there may be follow-up from the SEC.
CorpFin update. Tuesday, the conference reopened with a panel comprising senior staff members of the Division of Corporation Finance: Director Keith F. Higgins, Deputy Director Shelley E. Parratt, Acting Chief Counsel Jonathan A. Ingram, and Associate Director and Chief Accountant Mark Kronforst. The panelists discussed recent and ongoing CorpFin initiatives, including pay-ratio regulations, crowdfunding implementation, and Reg. A+ development. Director Higgins noted the main issues highlighted by commenters on the items: (1) the alleged impropriety of applying the pay-ratio standards to “all” employees and the potential for over-complication for small companies; (2) the terms of a follow-up rulemaking to develop a registration regime for funding portals in connection with crowdfunding; and (3) the controversial use of the “qualified purchaser” standard in the proposed amendments to Regulation A. In addition to considering comments on pending matters, the Division continues to evaluate and prepare for not-yet-complete Dodd-Frank regulations that were not subjected to deadlines.
Next, Acting Chief Counsel Ingram noted that it is the season for requests to exclude shareholder proposals and that this year’s most prominent subject matters include executive compensation, lobbying and contributions, environmental issues, and independent-chair requirements. He stated that this season has proven to be quite litigious, citing three lawsuits filed seeking declaratory judgments to exclude proposals; an SEC staff position on exclusion is only an informal view, and a final decision does lie with the court, Acting Chief Counsel Ingram explained. Most proposals never even come before Commission staff or a court because many companies just include them in proxies without objection, he concluded.
The panelists also discussed “disclosure overload,” that is, the addition of new disclosure items without corresponding removal of other items. According to Deputy Director Parratt, people use this term in reference to disclosures that they do not personally find useful, but what is “useful” may well be in the “eye of the beholder,” including CorpFin staff. The panelists acknowledged the potential role the Division may have played in creating the overload, noting that companies often add disclosure in response to staff comments (including comments made to other companies) and that the staff does not go back and ask companies to remove extraneous items. The panelists recommended that, when reviewing comments on others’ disclosures, a company learn about the underlying circumstances to determine whether disclosure is truly necessary in its case. In addition, when disclosures become outmoded or irrelevant, a company should consider removing them to increase disclosure quality; removal of items will not directly result in a review, the panelist explained.
Accounting and auditing. A session chaired by John W. White focused on what a fellow panelist termed “daunting” accounting and auditing changes facing the industry and the interrelation of FASB accounting standards, PCAOB auditing standards and alerts, and SEC staff accounting bulletins. The panelists considered the financial reporting trends affecting emerging growth companies, non-GAAP measures, and contingencies disclosures. Deputy Chief Accountant Daniel Murdock from the SEC’s Office of the Chief Accountant discussed the placement and roles of accountants within the Commission and the foci of accounting reviews, including proper identification of segments and the existence of conflicting information. The panelists agreed that it is important to consider what kind of disclosure is appropriate in light of all circumstances, but, in response to the CorpFin panel’s statements regarding omitting outmoded disclosures, Michele J. Hooper, audit committee chair of PPG Industries, Inc., suggested that the perceived threat of such a decision coming back to “bite” the audit committee may make this action impractical.
The panelists also discussed upcoming changes to the auditor’s reporting model and other auditing developments, including the enhanced focus on and testing of internal controls. According to Jeanette M. Franzel of the PCAOB, reviews and inspections are “drilling down” to find out whether proper controls are being implemented and whether auditors are observing these controls. As to the auditor’s reporting model, she said, the PCAOB has proposed to require inclusion of critical audit matters in reports and evaluation of whether information included is materially inconsistent with financial statements or materially misleading. The panelists agreed with the goal of moving reporting beyond “pass/fail” but suggested further consideration of the additional burdens that will be imposed in relation to these requirements.
Shareholder activism. The last morning panel took up corporate governance issues, specifically shareholder activism. The panelists, led by David A. Katz, defined the differences among social, economic, and governance activism. The panelists agreed that there is more money in activism than previously, and this has led to a “settlement fever” and increased activity. As the stigma against activism has subsided, governance activists have been able to attract higher-profile director candidates and mutual funds are beginning to “get their hands dirty,” identifying underperforming companies in their portfolios and suggesting to activists that they get involved.
“Invulnerable is not a word you hear a lot in the boardroom,” according to Thomas A. Cole, who emphasized that good performance does not insulate against activism. Companies should prepare to be activist targets before that threat arises, the panelists agreed. Joele Frank stressed the importance of preparation, all-hands conference calls to ensure consistency across disciplines, and investor relations.
With respect to governance activism, the panelists discussed the difficulty of splitting the vote across multiple director ballots. Daniel H. Burch of MacKenzie Partners, Inc., pointed out that SEC rules make it difficult to solicit a proxy card with dissident candidates. He believes that the universal proxy will eventually make this easier, but will also be a precursor in many respects to shareholder activism. Robert McCormick represented Glass Lewis & Co. on the panel. He said that the perception that the proxy advisory firm always recommends dissident candidates does not coincide with the firm’s goal, and pointed out that in the Target board contest, the firm recommended in favor of all the incumbents.
SEC staff Q&A. After lunch, SEC alumni Martin P. Dunn, Brian V. Breheny, and Keir D. Gumbs joined current Deputy Director Shelley E. Parratt to answer common questions regarding Exchange Act reporting and other SEC filings; the reach of SEC staff no-action positions, interpretations, and guidance; and issues surrounding capital raising and integration, shareholder proposals and proxy materials, and executive compensation and corporate governance filings.
Of note, the panelists pointed out that there is no requirement to provide interim vote results when requested in connection with a proxy contest. In addition, when filing a post-effective amendment, a filer may continue to offer securities under Form S-1, depending on why the amendment is being filed and where the filer is in terms of the fiscal year. However, the panelists noted, if the amendment is made to correct a deficiency, the offering process should cease. According to Deputy Director Parratt, when commenting on filings, the staff intends to encourage quality disclosure from the start, for the benefit of both investors and Commission staff members.
In debunking myths about Commission practices, Deputy Director Parratt noted that the staff will ask for written “test the waters” materials in reviewing the registration statement of an emerging growth company and that, if a publicly filed registration statement is withdrawn before effectiveness, it will not be published on EDGAR but will still be subject to a FOIA request.
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