The SEC’s Disclosure Modernization Proposals

Recent proposed rules to modernize and simplify SEC disclosure requirements have gotten a lot of attention. You may recall that the Fixing America’s Surface Transportation (FAST) Act of 2015  directed the SEC to issue a report recommending amendments to Regulation S-K to accomplish those goals. The SEC issued its report in November 2016. The proposals are the next step in the process. The proposed changes, while helpful, are perhaps only marginally so. The most significant proposal would modify MD&A by allowing companies to forgo discussion of the oldest period being presented if (1) it has been previously reported and (2) the disclosure is no longer material. Although this is not an earth shattering development, eliminating the redundancy of the year-two to year-three comparison would be nice. The materiality qualifier may, however, limit the proposal’s practical effect if companies take a conservative approach to determining materiality. Also helpful would be the proposal to streamline the process for obtaining confidential treatment for commercially sensitive information. The proposed change would permit companies to omit from exhibits confidential information that is not material and would cause competitive harm without having to first request confidential treatment from the SEC staff. Companies also would be permitted to omit “personally identifiable information” in all cases without submitting a request. Exhibits would remain subject to review by the staff, which could issue comments if it determines that redactions were not appropriate. Several other proposed changes are even more minor, mostly just simplifying the forms themselves, tweaking certain disclosure provisions, or clarifying regulation instructions. They include updates and clarifications to: the scope of the property description, the placement...

The New Auditor Reporting Standards

Late last month, the SEC approved the new auditing standards adopted by the PCAOB back in June, which substantially modify the content of the auditor’s report. They also raise various concerns that public companies and the SEC will need to closely monitor going forward. Critical audit matters disclosure. By far the biggest and most controversial change to the old standards is the requirement that the auditors include in a separate section of their report “critical audit matters” applicable to the current period covered by the report. CAMs are defined as: “any matter … that was communicated or required to be communicated to the audit committee and that relates to accounts or disclosures that are material to the financial statements and involved especially challenging, subjective, or complex auditor judgment.” The auditor must identify the CAM, describe the principal considerations that led the auditor to determine it was a CAM, describe how the CAM was addressed in the audit, and reference the accounts or disclosures related to the CAM. In the unlikely event that a report contains no CAMs, it must affirmatively so state. Though the determination of a CAM is supposed to be principles-based, the new rules provide a nonexclusive list of factors for the auditor to consider in its determination. Even so, the standards emphasize that disclosure must be tailored to the particular company and audit, meaning that it should not be boilerplate. Emerging growth companies and employee stock purchase plans, savings plans and similar plans are excluded from the CAM disclosure requirements. Additional changes. The modified auditor’s report also must: State the year the auditor began serving as...

The NYC Comptroller and Pension Funds Boardroom Accountability Project 2.0

Board composition is increasingly at the forefront of governance activists’ focus and initiatives. A recent, high-profile example of this comes from New York City Comptroller Scott M. Stringer and the New York City Pension Funds via their Boardroom Accountability Project 2.0. This initiative builds on their 2014 initiative and, according to their press release, is intended to “ratchet up the pressure on some of the biggest companies in the world to make their boards more diverse, independent, and climate-competent, so that they are in a position to deliver better long-term returns for investors.” The campaign directly targets the boards of 151 U.S. companies, calling on them to “disclose the race and gender of their directors, along with board members’ skills, in a standardized ‘matrix’ format and to enter into a dialogue regarding their board’s ‘refreshment’ process.” They believe this will push boards to be more diverse and independent. The targeted companies include “139 that enacted proxy access after receiving a proposal from the New York City Pension Funds, and 12 at which the pension funds’ proposal received majority shareowner support in 2017, but have yet to enact the reform.” Comptroller Stringer and the Funds blame the “persistent lack of diversity on corporate boards” on a nomination and election process “that is effectively controlled by the existing board — and as a result, more akin to a coronation.” They cite PwC’s 2016 Annual Corporate Directors Survey as reporting that 87% of directors rely on board member recommendations to recruit new directors, while only 18% consider investor recommendations. Fundamentally, they believe that shareowners “need to know the race and gender of...

An Exhibit Hyperlink Reminder

This past spring, the SEC issued final rules designed to make it easier to access and retrieve exhibits to company filings through the use of hyperlinks. For most companies, this new requirement becomes effective for filings made on or after September 1, 2017, which means it’s time to be sure you are ready. (Smaller reporting companies and non-accelerated filers using ASCII format have until September 1, 2018 to comply.) Item 601 of Regulation S-K, which requires companies to include an exhibit index that lists each exhibit included with the filing, now requires that each exhibit to Forms S-1, S-3, S-4 and S-8 (among others) under the Securities Act and Forms 10, 10-K, 10-Q and 8-K (among others) under the Exchange Act include an active hyperlink to the particular document on EDGAR. This applies whether or not the exhibit is incorporated by reference. For periodic reports, an active hyperlink must be included for each exhibit listed when the report is filed. For registration statements, a hyperlink must be included in the initial filing and in each amendment (pre-effective and post-effective) thereafter. The new rules exclude a short list of filings, including among others: XBRL exhibits, and exhibits that were filed on paper before EDGAR filings became mandatory, have not been re-filed electronically and are incorporated by reference. Companies must submit all affected registration statements and reports in HyperText Markup Language (HTML) format, which is not generally a problem since that is the format already used by almost everyone. One potential glitch arises, however, if your exhibit list includes an old document that was filed in American Standard Code for Information...

An Unexpected Free Cash Flow Comment from the SEC Staff

It is surprising how much attention free cash flow continues to generate in SEC disclosures. After all, it’s been used for decades as a non-GAAP financial measure. In fact, back in 2003, the SEC’s non-GAAP financial measure FAQs stated that companies should be “cautious” when using it, noting that it does not have a uniform definition and might inappropriately imply that it represents residual cash flow available for discretionary expenditures. Fast forward to the much-scrutinized 2016 non-GAAP financial measures C&DIs, which essentially repeated the old free cash flow FAQ, though now companies need only be “aware” of, rather than “cautious” about, the absence of a uniform definition. This softer language presumably reflects the staff’s general softening toward non-GAAP measures, which it now sees as helpful disclosure so long as it’s done properly. Then unexpectedly (at least to me), Monsanto Company received the following comment in a February letter that appears to have resulted from the staff’s routine review of Monsanto’s Form 10-K: “We note you define free cash flow as the total of net cash provided or required by operating activities and net cash provided or required by investing activities. Pursuant to Question No. 102.07 of the Staff’s Compliance & Disclosure Interpretations (“C&DIs”) on Non-GAAP Financial Measures, issued May 17, 2016, please advise of your consideration given to redefining this measure or its computation as the typical calculation of free cash flow (i.e., cash flows from operating activities less capital expenditures). Please provide us with any proposed revisions to your disclosure of free cash flow to be included in future filings.” The comment seems inconsistent with the staff’s position...

Sustainability Reporting After the Paris Climate Accord

It’s fair to say that President Trump’s June 1 announcement that the U.S. will withdraw from the Paris climate accord has been widely reported. It’s also fair to say that the announcement triggered a host of passionate reactions, positive and negative, around the world. Within corporate America, a number of high-profile corporations (for example, Apple, Disney, Facebook, General Electric, Google, Salesforce, Tesla and Twitter) pledged to continue their efforts to cut greenhouse gas emissions and adhere to the spirit of the accord. This leads one to wonder whether withdrawal from the Paris climate accord might, per the law of unintended consequences, actually increase investor emphasis on corporate social responsibility (CSR) and the number of companies that voluntarily report their sustainability initiatives. It’s an intriguing possibility. Momentum for sustainability reporting has been building for years. In fact, the vast majority of S&P 500 companies now publish some type of sustainability or CSR report, and disclosures have begun to appear in SEC filings, particularly proxy statements. Mid-size and smaller companies, lacking the resources of their larger brethren, have been slower to do so, though some have begun and others are giving it serious consideration. Increased pressure from institutional investors, employees and other stakeholders, now coupled with widespread concern over withdrawal from the accord, could tip the reporting balance, especially for companies in sustainability-sensitive industries or companies that otherwise want to send a certain message. One challenge for all companies is to make sense out of the CSR reporting landscape. First of all, the terminology itself—sustainability, CSR, environmental, social and governance (ESG), and triple bottom line, to name a few—is confusingly ambiguous...