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Financial Reporting and Regulatory Update

First Quarter 2021

From the SEC

Environmental, social, and governance (ESG) focus

Directive on review of climate-related disclosure and public comments request

Public company audit committees and preparers should be aware in preparing their disclosure documents that on Feb. 24, 2021, acting SEC Chair Allison Herren Lee announced she was directing Division of Corporation Finance (Corp Fin) staff to enhance its focus on climate-related disclosures in public company filings. She said Corp Fin staff should “review the extent to which public companies address the topics identified in the 2010 guidance, assess compliance with disclosure obligations under the federal securities laws, engage with public companies on these issues, and absorb critical lessons on how the market is currently managing climate-related risks.” Insights learned from this review process will be used by Corp Fin to update the 2010 guidance.

On March 15, 2021, Lee announced a request for public comment on climate change disclosures to further inform the SEC’s policymaking. The SEC is posing 15 questions. Comments are due June 13, 2021.

Commissioners on ESG enhanced focus

SEC commissioners Hester M. Peirce and Elad L. Roisman issued, on March 4, 2021, a public statement addressing the recently issued statements and press releases on ESG matters. In their statement, Peirce and Roisman contemplate the meaning of the enhanced focus on climate and ESG-related matters and provide some thoughts.

Regarding the statements from acting Chair Lee in her directive to Corp Fin, the commissioners say they believe that – given the focus of Corp Fin on reviewing companies’ disclosures, assessing their compliance with disclosure requirements under the federal securities laws, and engaging with issuers on climate change and ESG issues – the initiative is a continuation of the work already being conducted and not a plan to assess disclosures against any new standards or expectations. With regard to updating the SEC’s 2010 guidance, Peirce and Roisman say they do not believe that a plan exists to issue guidance establishing more specific line items or changing the SEC’s principles-based approach to a prescriptive one.

The announcement of the 2021 examination priorities highlights that the SEC will enhance its focus on climate and ESG-related risks; however, the identified areas do not specifically include a climate or ESG focus. The commissioners note that the risk-based reviews of compliance with existing statutes and regulations will touch on climate and ESG-related risks given the current environment; however, the review will have a broader focus.

The commissioners also said that the purpose of the newly created Climate and ESG Task Force is not clear, as currently the Division of Enforcement identifies, investigates, and brings actions against those who violate the SEC’s laws and rules and no new standards related to climate and ESG have been introduced.

On March 19, 2021, Peirce and Roisman provided additional perspectives on ESG matters in prepared statements at the SEC’s Asset Management Advisory Committee.

Climate and ESG enforcement task force

The SEC announced, on March 4, 2021, the creation of a Climate and ESG Task Force in the Division of Enforcement. The task force, led by Kelly L. Gibson, the acting deputy director of enforcement, will develop initiatives to identify misconduct related to ESG issues. Initially, the task force will focus on identifying material gaps or misstatements in issuers’ disclosure of climate and ESG risks under existing rules and will coordinate with other SEC resources to identify potential violations. In addition, the task force will assess and pursue tips, referrals, and whistleblower complaints on issues related to ESG, and it will provide expertise to teams working on ESG-related matters.

Remarks on ESG disclosures

Acting Corp Fin Director John Coates shared observations on ESG disclosures at the 33rd annual Tulane Corporate Law Institute on March 11, 2021. He remarked on issues including:

  • Considerations for an effective ESG disclosure system
  • Costs of not having ESG disclosure requirements
  • Mandatory versus voluntary disclosure
  • Benefits of having a global ESG reporting framework

Coates said he believes policymakers, including the SEC, should consider these issues when debating ESG disclosures, and he remarked the SEC’s approach to ESG disclosures should be both “adaptive and innovative.”

Crowe ESG resource

As investors and other stakeholders increasingly focus on ESG factors as part of their investment decisions, some entities are seeking a greater understanding of ESG disclosures. Crowe published an article, “Got ESG? Current developments in ESG disclosure,” with information about ESG disclosure developments.

Rules and guidance

Confidential treatment orders updated guidance

On March 9, 2021, Corp Fin updated its previously issued guidance in CF Disclosure Guidance Topic No. 7, “Confidential Treatment Applications Submitted Pursuant to Rules 406 and 24b-2.” This guidance addresses how and what to submit when filing an application objecting to public release of information otherwise required to be filed under the Securities Act and the Securities Exchange Act.

Corp Fin updated the guidance on options for when a confidential treatment order is about to expire. Under the guidance, companies that previously have obtained a confidential treatment order have three choices of what to do when the order is about to expire. The options include refiling the unredacted information, extending the confidential period, and transitioning to compliance with the requirements under Regulation S-K Item 601(b)(10) and other parallel rules.

Securities offerings during extreme price volatility

While acknowledging the importance of capital formation, Corp Fin believes companies and investors should consider specific risks during periods of extreme market volatility and when a company’s own securities exhibit extreme volatility. The impact of such risks can be more pronounced when a company seeks to raise capital during periods with:

  • Significant stock price increases or recent divergences in valuation ratios
  • High short interest or reported short squeezes
  • Reports of strong and unusual retail investor interest

Such risks also might have a more significant impact on companies experiencing financial distress, liquidity challenges, or smaller public floats. Corp Fin believes that in these circumstances, explicit, tailored disclosures about market events and conditions, the company’s situation, and the potential effect on investors are necessary to provide sufficient information for an investment decision.

To help address disclosures that might be necessary in such circumstances, Corp Fin released, on Feb. 8, 2021, an example letter containing comments that, depending on the particular facts and circumstances, Corp Fin may issue to companies that are seeking to raise capital in a volatile market. The sample comments in the letter do not represent a comprehensive list of the issues that companies should consider, and companies should appropriately tailor any disclosures to the entity’s specific facts and circumstances. In addition, Corp Fin encourages companies to consider these comments in preparing disclosure documents that typically might not be subject to review by Corp Fin (for example, automatically effective registration statements or prospectus supplements for shelf takedowns from an already effective registration statement). Corp Fin indicates any company with questions on proposed disclosures should consider contacting the industry office responsible for the company’s filings.

Effective date for Regulation S-K amendments

The SEC, on Nov. 19, 2020, adopted amendments that simplify and enhance certain Regulation S-K disclosure requirements. The amendments eliminate duplicative disclosures and modernize and improve management’s discussion and analysis (MD&A) for the benefit of investors while simplifying compliance efforts for registrants. Specifically, the requirement for selected financial data (Item 301) has been eliminated, the requirement to disclose supplementary financial information (Item 302) has been streamlined to replace the current requirement of quarterly tabular disclosure with a principles-based requirement for material retrospective changes, and MD&A (Item 303) requirements have been amended.

Among other changes to Item 303, changes to MD&A include clarifying disclosure requirements for liquidity and capital resources, streamlining disclosure requirements for results of operations, adding a new item for critical accounting estimates, replacing off balance sheet arrangements with a requirement to discuss such obligations in a broader context, eliminating tabular disclosure of contractual obligations, and streamlining required information regarding interim periods.

The rule is effective Feb. 10, 2021. Registrants are required to comply with the rule beginning with the first fiscal year ending on or after Aug. 9, 2021.

For filings after Feb. 10, 2021, registrants may choose to early adopt the final amendments as long as the amended item is adopted in its entirety. The final rule provides the following: “For example, upon effectiveness of the final amendments, a registrant may immediately cease providing disclosure pursuant to former Item 301, and may voluntarily provide disclosure pursuant to amended Item 303 before its mandatory compliance date. In this case, the registrant must provide disclosure pursuant to each provision of amended Item 303 in its entirety, and must begin providing such disclosure in any applicable filings going forward.”

The SEC staff has shared it has been receiving numerous questions regarding whether the effective date of the final rule “Management’s Discussion and Analysis, Selected Financial Data, and Supplementary Financial Information” will be delayed in light of the Biden administration’s memo ordering a 60-day freeze of pending regulations. The amendments, which were adopted on Nov. 19, 2020, were done by SEC action, and the staff’s understanding is the effective date of the amendments can be delayed only by SEC action. As the staff understands, there are no such plans for SEC action. As a result, the effective date of the amendments has remained unchanged at Feb. 10, 2021.

Auditor independence rules

The SEC issued an order on Jan. 14, 2021, to approve the PCAOB-adopted amendments to the PCAOB interim independence standards and PCAOB rules to align with the changes recently made by the SEC to its auditor independence rules. The rules will be effective June 9, 2021, 180 days after the date of the publication of the SEC’s Oct. 16, 2020, amendments to Rule 2-01 in the Federal Register.

Securities Act amendments

The SEC, on Dec. 22, 2020, proposed an amendment to Rule 144 under the Securities Act of 1933. The proposed amendment would revise the holding period determination for securities acquired upon the conversion or exchange of market-adjustable securities that meet certain criteria as defined in the amendment. The proposal is designed to reduce the risk of unregistered distributions in connection with sales of those securities. Related to this amendment, the SEC also proposed amendments to update and simplify the Form 144 filing requirements.

Under the current Rule 144, securities acquired solely in exchange for other securities of the same issuer are deemed to have been acquired at the same time as the securities surrendered for conversion or exchange. Under the proposed amendments, the holding period for the underlying securities acquired upon conversion or exchange of certain market-adjustable securities would not begin until conversion or exchange, thereby requiring that a purchaser would need to hold the underlying securities for the applicable Rule 144 holding period before reselling them under Rule 144.

The proposed amendments to Form 144 would mandate electronic filing of the form, remove the requirement to file a Form 144 with respect to sales of securities issued by companies that are not subject to Exchange Act reporting, and revise the filing deadline to match the Form 4 filing deadline.

Comments were due March 22, 2021.

Proposal for board diversity

On Dec. 4, 2020, Nasdaq filed with the SEC a proposal to adopt new listing rules related to board diversity and disclosure to address findings that a link exists between diverse boards and better financial performance and corporate governance. These proposed standards focus on clearer disclosures of a company’s board composition and increased information provided to investors that listed companies are considering diversity when selecting directors.

Under the proposal, most Nasdaq-listed companies would be required to have, or explain why they do not have, at least two directors from diverse backgrounds. In accordance with the proposal, boards should include at least one woman and one LGBTQ person or person who is an underrepresented minority. All listed companies also will be required to disclose consistent and clear diversity statistics regarding their board of directors.

If the proposal is approved by the SEC, Nasdaq would become the first major U.S. stock exchange to require boardroom diversity. Companies would have up to one year to disclose board diversity statistics, and the board composition diversity requirement would need to be met within five years, depending on the size of the company.

Nasdaq’s proposed changes to exchange listing rules are subject to SEC review and a public comment period. Comments were due Jan. 4, 2021. On Feb. 26, 2021, Nasdaq filed an amended rule proposal, and on March 10, 2021, the SEC published a notice seeking further public comment on the amendment. Comments on the amended rule proposal are due April 6, 2021, with any rebuttal comments due April 20, 2021.

Examination priorities

On March 3, 2021, the SEC’s Division of Examinations announced its 2021 examination priorities. Per the announcement, the 2021 examinations will include a greater focus on climate and ESG-related risks and will also focus on, among other topics, these areas:

  • Compliance with Regulation Best Interest, Form CRS, and whether registered investment advisers have fulfilled their fiduciary duties of care and loyalty
  • Information security and operational resiliency, including review of entities’ business continuity and disaster recovery plans to confirm that they are accounting for the increasing physical and other relevant climate change and related risks
  • Financial technology and innovation, including digital assets
  • Anti-money laundering programs’ compliance with requirements
  • London Interbank Offered Rate (LIBOR) transition

The listing of 2021 priorities is not meant to be comprehensive and will not be the only areas the SEC will focus on in its examinations, risk alerts, and outreach.

Staffing updates

On March 2, 2021, Gary Gensler, President Joseph Biden’s nominee to be the next SEC chair, appeared before the Senate banking committee for a hearing on his nomination. On March 10, 2021, the committee voted 14-10 to approve Gensler both for the remainder of the term of retired Chair Jay Clayton ending on June 5, 2021, and for a full term ending on June 5, 2026. The Senate confirmed Gensler as SEC chair on April 14, 2021, and he was sworn in on April 17.

On Feb. 1, 2021, the SEC announced that Satyam Khanna will serve as senior policy adviser for climate and ESG issues to acting Chair Allison Herren Lee, and said he will guide SEC initiatives on climate risk and ESG developments. Most recently, Khanna was a resident fellow at New York University School of Law’s Institute for Corporate Governance and Finance, and he served on the Biden-Harris presidential transition team for financial regulation.

On Feb. 1, 2021, the SEC announced that John Coates will serve as acting director of Corp Fin. Prior to this appointment, Coates was a professor of law and economics at Harvard University, where he also served as vice dean for finance and strategic initiatives and taught courses on corporate law and governance, securities regulation, and finance. He also served on the SEC’s Investor Advisory Committee.

The SEC announced, on Jan. 22, 2021, that Paul Munter will be acting chief accountant upon Sagar Teotia’s departure in February 2021. Since 2019, Munter has served as deputy chief accountant, where he led the Office of the Chief Accountant’s international work. As acting chief accountant, Munter will serve as the primary adviser to the SEC on accounting and auditing matters and be responsible for assisting the SEC in its oversight of the FASB and the PCAOB.

Allison Herren Lee was named acting chair of the SEC on Jan. 21, 2021. Lee has served on the staff of the SEC for more than a decade in various roles and as a commissioner since 2019. Upon her appointment Lee said, “During my time as Commissioner, I have focused on climate and sustainability, and those issues will continue to be a priority for me.”

On Jan. 13, 2021, the SEC announced that Sagar Teotia will conclude his tenure at the SEC by the end of February. Teotia was named as the chief accountant in July 2019 after previously serving as acting chief accountant since May 2019 and deputy chief accountant since March 2017. He also previously served as a professional accounting fellow in the Office of the Chief Accountant.

On Jan. 12, 2021, the SEC announced the conclusion of Marc Berger’s tenure. Berger joined the agency as director of the New York regional office in December 2017 and was named deputy director of the Division of Enforcement in August 2020. Berger replaced Stephanie Avakian, Division of Enforcement director, who departed after the SEC’s announcement on Dec. 10, 2020. Avakian led the division as co-director and then director for the past four years.