Financial Reporting and Regulatory Update

Third Quarter 2021

From the SEC

Environmental, social, and governance (ESG) focus

Sustainability of ESG rules

On June 22, 2021, SEC Commissioner Elad L. Roisman spoke at the National Investor Relations Institute’s virtual conference. He focused on three questions, including:

  1. “What precise items of ‘E,’ ‘S,’ and ‘G’ information are investors not getting that are material to making informed investment decisions?
  2. “If we were able to identify the information investors need, how would the SEC come up with ‘E’ and ‘S’ disclosure requirements – now, and on an ongoing basis? What expertise do we need?
  3. “If the SEC were to incorporate the work of external standard-setters with respect to new ESG disclosure requirements: how would the agency oversee them – in terms of governance, funding, and substantive work product – on an ongoing basis? And what kind of new infrastructure would be required inside the SEC and at the standard-setters themselves?”

In addressing these questions, Roisman noted that determining who the investors are and understanding from those investors what ESG information is missing from the markets is vital. He also asked how the SEC would provide one list of ESG disclosures for companies that could satisfy the differing and evolving demands for ESG information. Roisman noted that any new disclosure requirements should focus on what information is material to an investment decision. He also raised questions about how the SEC will acquire and maintain expertise over environmental and social areas to develop and oversee disclosure requirements when information in these areas quickly changes. He noted concerns over how the standards would be updated over time. Roisman said that considering these questions will help the SEC meet the challenging task of creating ESG rules that are sustainable.

Remarks from the chair on ESG

On June 23, 2021, at London City Week, SEC Chair Gary Gensler presented prepared remarks on public company disclosure, market structure, and transparency resulting from ESG initiatives. His remarks on public company disclosure focused on his requests that SEC staff consider and make recommendations on:

  • Mandatory company disclosures on climate risk and human capital to address the need for consistent, comparable, and useful investment decision-making information
  • Climate risk governance, strategy, and risk management, including specific metrics that might be relevant
  • Potential requirements for companies that make forward-looking climate commitments
  • Ways that funds are marketing themselves to investors as sustainable, green, and focused on ESG matters, and what factors support those claims
  • Human capital disclosures that might include metrics such as workforce turnover, skills and development training, compensation, benefits, workforce demographics including diversity, and health and safety

Climate, ESG matters, and the board of directors discussion

SEC Commissioner Allison Herren Lee presented the keynote address at the 2021 Society for Corporate Governance conference on June 28, 2021. She addressed the important role corporate directors play in overseeing climate and ESG issues. Lee discussed:

  • Putting ESG matters in context in the recent proxy season. Lee described actions taken during the most recent proxy season and highlighted shareholder proposals related to climate and racial equity and how the increase in such activity shows the importance of addressing and integrating climate and ESG issues into decision-making, risk management, and corporate initiatives.
  • Understanding ESG and board obligations. Lee noted that “boards increasingly have oversight obligations related to climate and ESG risks – identification, assessment, decision-making, and disclosure of such risks.”
  • Mitigating ESG risks and maximizing ESG opportunities. Lee identified physical, transition, regulatory, reputational, and human capital risks and said enhancing board diversity, increasing board expertise, and inspiring management success present opportunities for boards to position themselves as ESG leaders.

IFRS sustainability standards

SEC Commissioner Hester M. Peirce issued a statement, on July 1, 2021, highlighting her comment letter responding to the International Financial Reporting Standards (IFRS) Foundation’s proposal to amend its constitution to make possible the creation of an International Sustainability Standards Board to set sustainability standards. In her comment letter, she urges “the IFRS Foundation not to wade into sustainability standard-setting because doing so would (i) improperly equate sustainability standards with financial reporting standards, (ii) undermine the Foundation’s current important, investor-centered work, and (iii) raise serious governance concerns.” Peirce warns, “We must be careful not to compromise accounting standard-setting in an effort to achieve objectives other than high-quality financial reporting,” as accounting and sustainability standards are fundamentally different from one another.

Fund and diversity disclosures

On July 7, 2021, before the Asset Management Advisory Committee, Chair Gensler and Commissioners Peirce and Caroline Crenshaw presented remarks covering ESG, diversity and inclusion, private investments, and technology.

Gensler shared his thoughts on sustainability related to fund disclosures and fund names. He questioned how funds that market themselves using sustainability-related terms support those claims when often the information underlying those claims is not objective, a large range of criteria and sources are used, and no standardized meanings of the sustainability-related terms exist. Gensler said he has asked SEC staff to consider recommendations about whether fund managers should disclose the criteria and underlying data they use. He added that updates to fund disclosures and to naming conventions could bring needed transparency to the asset management industry. He concluded with comments on diversity and inclusion and noted that the asset management industry has a lot of work to do to increase racial and gender diversity; therefore, he has asked SEC staff to consider ways that the SEC can enhance transparency to improve diversity and inclusion practices.

Peirce commented on the pitfalls of ESG standard-setting before addressing diversity and inclusion in U.S. capital markets and her concerns about the committee’s draft recommendations. She said that adding government-mandated diversity classifications for the asset management industry might not promote unity and empower people but rather have the opposite effect. Peirce questioned how the SEC would define diversity, how to categorize people with diverse backgrounds, and what do to with those who prefer not to identify, among others. Finally, she said that these recommendations should be open to further debate.

Crenshaw said she agrees that the SEC has a role to play in promoting diversity and inclusion in the asset management industry and she is interested in potential guidance or recommendations that would discourage discrimination by fiduciaries. She mentioned ESG disclosures and the importance that they be consistent, comparable, high quality, and decision useful. She raised concerns about lack of visibility into the private markets and the need to understand the benefits, risks, and costs of investing in the private markets. She also discussed technology-enabled personalization and how technology can be used to both benefit and harm investors.

10 theses for ESG stakeholder discussion

On July 20, 2021, SEC Commissioner Peirce spoke before the Brookings Institution on the SEC’s role in ESG disclosures and the complexities and consequences of potential rulemaking. She presented 10 theses to encourage further discussion.

As an alternative to prescriptive ESG rules, Peirce suggested that the SEC could work within its existing regulatory framework to release updated guidance to help issuers consider how the existing disclosure framework elicits ESG disclosure and to address frequently asked questions that arise in connection with the application of the existing disclosure framework. She also suggested working with investment advisers to help investors better understand each adviser’s ESG branding and investment practices.

Stakeholder calls for climate risk disclosures

At the Principles for Responsible Investment “Climate and Global Financial Markets” webinar on July 28, 2021, Chair Gensler addressed the need for climate-related disclosures for public companies and funds to bring transparency to the capital markets.

Gensler said that investors want to understand the climate risks of the companies they invest in or are considering investing in and these investors are looking for consistent, comparable, and decision-useful disclosures on climate risks. He shared that in response to the SEC’s March 2021 statement on climate disclosures, more than 550 unique comment letters were submitted and 75% of these responses supported mandatory climate disclosure rules.

Gensler noted that while companies already are trying to meet the demand for climate risk information, many use generic or boilerplate language that is not decision-useful for investors. Gensler said that both investors and companies would benefit from greater clarity over climate risk disclosures, which is why he has asked SEC staff to develop a mandatory climate risk disclosure rule proposal for consideration by the end of the year. He said that the proposal should consider consistency, comparability, the need for sufficient detail, and both quantitative and qualitative aspects of climate risk. Additionally, he asked SEC staff to consider whether certain metrics for specific industries such as banking should be included.

Additionally, Gensler noted an increase in funds marketing themselves as “green,” “sustainable,” “low-carbon,” and similar but said little information exists to support those claims. He has directed staff to consider whether fund managers should disclose the criteria and underlying data they use in making those claims, including looking at how funds are named.

Sample comment letter on climate change disclosure

On Sept. 22, 2021, the Division of Corporation Finance issued a sample comment letter addressing the types of comments staff might consider related to an issuer’s climate-related disclosures, or lack thereof. While it does not provide an exhaustive list, the letter assists registrants in considering how current disclosure rules apply to climate-related disclosure.

Public statements and announcements

Remarks on digital engagement practices, crypto assets, and disclosures

On Sept. 1, 2021, Chair Gensler provided remarks on digital engagement practices, crypto assets, and disclosures before the European Parliament Committee on Economic and Monetary Affairs, the financial advisory body of the European Union.

In the evolving area of technology and finance, Gensler discussed the use of predictive data analytics underlying the trading and wealth management apps flooding the market. The apps use individualized marketing and behavioral prompts, which encourage users to engage with a digital platform. These tools are designed to increase platform revenues, data collection, and customer engagement, leading to potential conflicts between the platform and investors. Use of digital enhancements raises questions about investor protection, securities laws implications, and how these tools and models ensure access and pricing fairness. He highlighted the SEC’s request for information and comment on digital engagement practices issued on Aug. 27 and warned of his concern that the broad adoption of deep learning models could contribute to a future crisis.

In his remarks about crypto assets, Gensler reiterated his position that the SEC needs to ensure it is achieving its public policy goals: protecting investors and consumers, guarding against illicit activity, and ensuring financial stability. He noted that most crypto platforms provide direct access for investors with no broker between the public and the platform, which creates vulnerability as these platforms do not have clear obligations to protect investors. Gensler said the use of stablecoins on these platforms might help those looking to avoid many of the public policies – such as anti-money laundering policies – in the traditional banking and financial system.

Lastly, recognizing investors’ increased demand for additional disclosures to understand climate risks, workforces, and cybersecurity risks of the companies they invest in, Gensler shared that he asked the SEC staff to develop a proposal for climate risk disclosure requirements and to examine information that can be learned from other frameworks and standards. He said he directed staff to review current fund branding practices and make recommendations about whether fund managers should disclose the criteria and underlying data they use to market themselves, and to consider disclosure requirements about human capital and board diversity.

Deficient cybersecurity procedures

On Aug. 30, 2021, the SEC announced the sanctioning of eight firms in three actions for failures in their cybersecurity policies and procedures that resulted in cloud-based email account takeovers exposing personally identifying information of thousands of customers and clients at each firm. The firms are SEC-registered broker-dealers, investment advisory firms, or both. Specifically, the SEC noted that the affected accounts were not protected consistent with firm policies, breach notifications to clients included misleading language, and some of the firms failed to adopt and implement firmwide enhanced security policies and procedures after initial discovery of email account takeovers

The SEC’s orders against each of the firms found that they violated Rule 30(a) of Regulation S-P, known as the Safeguards Rule, which is aimed at protecting confidential customer information. For two of the firms, the orders also found that they violated Section 206(4) of the Investment Advisers Act and Rule 206(4)-7 in connection with their breach notifications to clients. Although the firms did not admit to or deny the SEC’s findings, each agreed to cease and desist from future violations of the charged provisions, to be censured, and to pay a penalty.

Digital practices of broker-dealers and investment advisers

The SEC, on Aug. 27, 2021, issued a request for information and public comment on broker-dealers’ and investment advisers’ use of digital engagement practices (DEPs). These DEPs include behavioral prompts, differential marketing, gamelike features, other design elements aimed at engaging with retail investors on digital platforms, and the analytical and technological tools and methods used. Investment advisers use DEPs to learn more about their clients in order to develop investment advice based on that information.

The SEC issued the request primarily to:

  • Develop a better understanding of the market practices associated with the use of DEPs and the related analytical and technological tools and methods
  • Learn what conflicts of interest may arise from optimization practices and whether those practices affect the determination of whether DEPs are making a recommendation or providing investment advice
  • Provide market participants and other interested parties an avenue to share their perspectives on the use of DEPs and the related tools and methods
  • Facilitate the SEC’s assessment of existing regulations and consideration of whether regulatory action may be needed, including additional investor protections

Comments were due Oct. 1, 2021.

Remarks on stronger investor protections for crypto assets

On Aug. 3, 2021, before the Aspen Security Forum, SEC Chair Gensler discussed the current environment for crypto asset investing and trading and identified the need for greater investor protections. Gensler said that the crypto asset class is currently worth approximately $1.6 trillion without enough investor protections over crypto assets. He warned about scams and frauds across the asset class and said no structure is in place to provide comprehensive information to investors as these assets often trade and move outside of established regulatory frameworks, platforms, and regulations.

Gensler said that trading platforms where crypto assets are being bought, sold, and traded might include unregistered securities. Therefore, these are not being regulated as other registered securities are, and they are missing required disclosures and market oversight. This creates significant gaps in investor protections. Further, Gensler said he believes these trading platforms are potentially skirting securities, commodities, and banking laws. He also touched on custody of crypto assets and noted that custody protections are important to preventing theft and protecting investors.

To address the regulatory gaps, Gensler called on Congress to act on crypto asset legislation. He noted that the SEC is ready to work with Congress, the administration, and other regulators and partners to address regulatory gaps and focus on trading and lending platforms.

Lack of guidance on digital asset trading

On July 14, 2021, SEC Commissioners Peirce and Elad Roisman released a public statement addressing the lack of clarity for market participants around the application of the securities laws to digital assets and their trading. Referring to the recent Coinschedule Ltd. SEC order, which found that a publicized token offering included investment contracts, which are securities and therefore subject to securities laws, the commissioners expressed their disappointment that the order did not explain which digital assets in the offering were securities or how that was determined, which would have provided additional guidance.

Peirce and Roisman noted that although the SEC has provided some guidance and people can use and analogize settled SEC enforcement actions to determine if the tokens are securities, not enough clear guidance exists for the large number of factors to consider. Clues can be gathered from enforcement actions to make determinations; however, applying those clues to the facts of a completely different token offering does not necessarily produce clear answers. Peirce and Roisman both conclude that the SEC needs to prepare better guidance with clear and timely answers, as providing guidance piecemeal through enforcement actions is not the best way to move forward in this complex and evolving marketplace.

Competition and regulatory reform at the PCAOB

On Sept. 9, 2021, the SEC’s Investor Advisory Committee (IAC) met to discuss various matters including consideration of audit firm competition and regulatory reform at the Public Company Accounting Oversight Board (PCAOB). The discussion of competition and regulatory reform included panelists representing various stakeholders in the financial reporting ecosystem. Panelists debated how audit opinion customers (that is, audit committees) and consumers (that is, investors) receive and use information about audit quality as well as how communication of that information could be changed or improved to meet various stakeholder objectives. The discussion also focused on the PCAOB’s current role in fostering audit quality and how that role might evolve in the ever-changing landscape of stakeholder needs and technology. Jurisdictional differences in audit regulatory regimes also arose as a topic.

The IAC meeting also included a panel discussion of investor protection in light of the behavioral design of certain online trading platforms, and the IAC also voted to provide the SEC with certain recommendations regarding special purpose acquisition companies and Rule 10b5-1 trading plans.

SEC Chair Gensler, Commissioners Peirce and Roisman, and some panelists offered prepared remarks.

Statement on investor protection related to developments in China

On July 31, 2021, SEC Chair Gensler released a public statement addressing actions he directed the staff to take in response to recent regulatory developments in China.

Rules and guidance

Nasdaq board diversity rule

On Aug. 6, 2021, the SEC approved Nasdaq’s new board diversity rule, which requires Nasdaq-listed entities to:

  • Provide standardized annual public disclosure of board-level diversity statistics
  • Maintain two directors, one female and the other of an under-represented minority or LGBTQ, or explain why it does not

The rule provides additional flexibility for smaller reporting companies, foreign issuers, and entities with five or fewer directors. It also specifies Nasdaq will provide one year of complimentary board recruiting services to eligible companies, which will facilitate identifying and evaluating diverse board candidates.

An entity must comply with the annual board-level diversity disclosure requirements by the later of Aug. 8, 2022, or the date the entity files its proxy or information statement for its annual shareholder meeting during 2022. The entity may provide the disclosure either in its SEC filings or on its website.

Entities must meet the requirement to have two diverse directors or explain why not, using a phased-in approach based on the Nasdaq tier on which the entity’s securities trade. Nasdaq has provided a summary of the rule and transition requirements.

Rulemaking agenda

On Sept. 14, 2021, SEC Chair Gensler testified before the Senate Committee on Banking, Housing, and Urban Affairs. His testimony focused on current work of SEC staff on areas identified in the most recent SEC rulemaking agenda, including:

  • Market structure (Treasury, non-Treasury fixed income, equity, security-based swaps, and crypto asset markets)
  • Predictive data analytics
  • Issuers and issuer disclosure (including climate risk, human capital, cybersecurity, special purpose acquisition companies, China, and 10b5-1 plans)
  • Funds and investment management

Gensler concluded his remarks with observations about the SEC’s enforcement and examinations activities.

Staffing updates

The SEC announced, on Aug. 25, 2021, the appointment of Barbara Roper as senior adviser to Chair Gensler. Roper’s focus will be on retail investor protections, broker-dealer and investment adviser oversight, and examinations. She joins the SEC after 35 years at the Consumer Federation of America, most recently as director of investor protection, and is a leading consumer spokesperson on investor protection issues, specifically the standards that apply to investment professionals that investors rely on for advice and recommendations. Roper said she plans to bring that focus to her new position.

On June 29, 2021, the SEC announced that Gurbir S. Grewal has been named director of the Division of Enforcement, effective July 26, 2021. Grewal has served as the New Jersey attorney general since January 2018.