According to attorneys, CFOs can expect the Securities and Exchange Commission (SEC) under the Biden administration to further scrutinize their company’s financial disclosure and control processes.
COVID-19-related reporting and environmental, social and governance (ESG) performance are expected to be in the spotlight as well as highly lucrative Special Purpose Acquisition Companies (SPACs).
“We expect an increase in enforcement,” said John Nowak, a Paul Hastings attorney, on a webcast hosted by the law firm last week.
To identify problems in traditional areas of disclosure of financial and accounting principles, the SEC is increasingly using three tools: Whistleblower, a new EPS (earnings per share) initiative that uses AI-based data analysis to identify financial inconsistencies. and short seller monitoring.
With these tools, and given an assertive SEC chief expected to be named, reporting issues like accounting, over-sales, channel stuffing, and non-GAAP financial metrics will come to the fore, he said.
“The SEC will use all of these new tools to evaluate company information,” Nowak said.
The Whistle Blower Program, established under the Dodd-Frank Act in 2010 to provide a financial incentive for people to come forward if they think a company is not doing its finances properly managed, exploded. Last year, the SEC received nearly 7,000 tips and paid out $ 155 million in rewards to 39 people.
“The program seems to be getting bigger every year,” said Paul Hastings partner Nick Morgan.
The EPS initiative, first used late last year when the SEC brought charges against a carpet maker and financial services company, uses data processing software to run companies’ financial records to see if they could tamper with their numbers, to meet analysts. Expectations.
A few months later, a handful of other companies were caught under the initiative.
The SEC is likely to expand its use to reporting areas outside of the EPS, Nowak said. “I think the SEC will take full advantage of risk-based data analysis to identify and potentially overcome problems,” he said.
More monitoring of short sellers is also expected as comments on the business performance of these market participants can put the spotlight on numbers that don’t make sense on closer inspection, he said.
“We have already seen … short sellers commenting and giving opinions on public companies,” he said.
Should it be confirmed, Gary Gensler, Biden’s SEC chief candidate, is expected to draw on all of these tools and other increased efforts as he focused on enforcement about a decade ago as head of the Commodity Futures Trading Commission, Morgan Miller said by Paul Hastings.
“I expect Gensler to have a similarly strict enforcement stance as the CFTC,” he said.
Corporations’ handling of material non-public information (MNPI) is another area of enforcement that is expected to increase, but in a different context than the typical insider trading case, Morgan said.
Insider trading fees have been falling for a decade, partly because judges have significant leeway in their decisions, creating a muddy picture that is difficult for the SEC to navigate, he said.
Perhaps to get around this, the SEC has stepped up cases involving the processes companies have put in place to control how they handle information, including MNPI, that can affect market prices.
In a recent case, the SEC fined a public company $ 20 million for repurchasing shares while it was on the verge of acquiring another company without disclosing it. The pending M&A deal was material information that was withheld from the public at a time when the company went onto the public market to buy shares.
“The allegation was that the company did not have adequate accounting controls for handling this MNPI and could not judge whether or not the company owned MNPI,” he said. “A $ 20 million fine is an uncommon scenario for an accounting control regime to resolve what is essentially an MNPI problem.”
In another control case, a private equity firm that had an employee on the board of a public company bought a large number of shares, raising the question of whether it owned MNPI at the time of the transaction.
The case was not about insider trading, but about controlling the handling of information that Morgan said could be a way for the SEC to address an insider trading case.
Morgan said more cases like this are expected. “We will see more scenarios like this without asking for inside information as there is ambiguity in this area of law,” he said.
On COVID-19 late last year, the SEC announced how it plans to deal with disclosure issues after bringing charges against chain restaurant The Cheesecake Factory.
The company was fined $ 125,000 for claiming in its financial reports at the end of the first quarter that it was operating “sustainably” when in fact it was consuming $ 6 million a week and quickly running out of cash .
Nowak described the SEC action as overly aggressive as it appeared to regard the word “sustainable” and some other information as material misrepresentation. However, it can be argued that the disclosures were appropriate in a broader context.
Regardless, the case shows the aggressiveness with which the SEC wants to pursue COVID-19 disclosures, Nowak said.
“I definitely view this as a news case that certainly underscores the need to be objective when evaluating public disclosures and to ensure that you have qualifying language to accompany your disclosures,” he said. “I expect these types of cases will continue.”
While ESG performance is not a mandatory reporting issue, the SEC is expected to establish guidelines that reflect the Biden government’s focus on climate change and diversity, said Hastings partner Tara Giunta.
“The Biden administration and Biden himself really made ESG a focus,” she said. “It’s a pretty dramatic shift forward from the Trump administration. At the SEC, we expect improved ESG disclosures and a focus on climate change and diversity,” including board diversity.
Giunta said she expects the SEC to collect public disclosures on board diversity with metrics.
“The Commission will look at metrics. How do we rate what we mean by diversity, how do you measure it?”
A rule Nasdaq proposed last month will help the SEC take a position on at least the diversity part of ESG disclosures. The SEC has until mid-March to comment on Nasdaq’s plan that all companies listed on it must disclose diversity statistics and have at least two different board members or an explanation of why not.
“It’s really going to be a focus of this SEC,” she said.
Special-purpose acquisition firms are also being scrutinized just because so much money is being thrown on them now, Nowak said.
According to SPACInsider, 270 SPACs were launched last year, up from 59 in 2019.
It is only because of its growth that the SEC will be forced to review it to ensure that it is properly structured and managed.
“It’s about so much money,” he said. “I can definitely see the SEC looking under the hood and kicking the tires to see if there are any problems or not.”
These topics include: party disclosure of interests, party incentives, and IPO stock trading. “There is just too much money involved,” he said.