SPEAKERS:
MELINDA BRUNGER
GEORGE VLAHAKOS
PHILIP PEACOCK
ANNUAL
DISCLOSURES:
ANTICIPATING QUESTIONS
FROM THE BOARD
JANUARY 13, 2015
Attorney Advertising
SPEAKERS
MELINDA BRUNGER
GEORGE VLAHAKOS
PHILIP PEACOCK
Partner
Andrews Kurth LLP
+1.713.220.4305 (Houston)
mbrunger@andrewskurth.com
Partner
Andrews Kurth LLP
+1.713.220.4351 (Houston)
gvlahakos@andrewskurth.com
Vice President, General Counsel
and Corporate Secretary
Western Gas Partners, LP
+1.832.636.2439 (The Woodlands)
philip.peacock@anadarko.com
January 13, 2015
2
IMPACT OF SEC’S “BROKEN WINDOWS” ENFORCEMENT ON
DISCLOSURE
Broken windows enforcement
SEC Commissioners and Enforcement Staff have announced a new focus on “broken
windows,” or non-fraudulent violations. Late filings and disclosure omissions receive new
scrutiny with a view to potential enforcement.
•
Compliance. SEC Enforcement Staff seek to have a “presence” in all areas of
disclosure compliance, including timeliness of filing.
•
Form checks. Failure to meet SEC form disclosure requirements may rise to the level
of enforcement. In short, there is no technical or de minimis disclosure failure that is
immune from enforcement.
•
Disclosure controls. Risk of enforcement places additional pressure on an issuer’s
disclosure controls and CEO/CFO certifications.
•
Operation Broken Gate. Announced by SEC in September 2013, charging three
auditors with violating federal securities laws or failing to comply with US auditing
standards. Part of effort to identify auditors, Audit Committees and other gatekeepers
who fail to carry out duties consistent with industry standards.
January 13, 2015
3
IMPACT OF SEC’S “BROKEN WINDOWS” ENFORCEMENT ON
DISCLOSURE
Broken windows enforcement trends
Enforcement example (Form 8-K). In November 2014, SEC announced separate
enforcement actions against 10 issuers for failing to make required Form 8-K disclosures
about financing deals and other unregistered sales that diluted their stock.
Enforcement example (Section 13 & 16 beneficial ownership). In September 2014,
SEC charged 28 officers, directors or major shareholders with failing to promptly report
information about their stock holdings and transactions.
Don’t assume a low probability of enforcement action on any disclosure rule. DoddFrank has given the SEC increased authority to bring administrative proceedings “in
house” with a greater probability of winning settlements and penalties.
SEC technology. New data-mining technology enables the SEC to bring cases more
quickly and cost-effectively by processing massive amounts of data every day. Technology
can identify both suspicious activity and instances of noncompliance with disclosure
requirements.
January 13, 2015
4
SOME THINGS TO KEEP AN EYE ON…
Regulatory and governance perspectives
• Regulatory issues
 State/local initiatives
 E.g., Colorado “setback” ballot initiative
 FERC regulation of liquids lines
 No gathering exception
 Jurisdiction depends on the intent of the shipper
 No federal power of eminent domain
 Ability to provide true “firm” transportation service is very limited
• Enhanced Audit Committee independence standards
• Delaware corporate/MLP fiduciary duty decisions
January 13, 2015
5
DON’T IGNORE XBRL!
SEC Staff focused on XBRL disclosures
“Dear CFO” letter (July 2014). Sent to certain issuers regarding their Form 10-Qs,
reminding them to include all required calculation relationships for contributing line item
elements for the financial statements and related footnotes.
SEC Staff observations of custom tag rates (July 2014)
•
Custom tag usage. Steady decline in custom tag use by large accelerated filers, but
continued high custom tag rates among other issuers.
•
Management’s responsibility for vendors. Issuers relying on a vendor “to create
their XBRL exhibits are responsible for the exhibits’ accuracy and compliance with the
filing requirements.”
•
Continued monitoring of custom tag use. SEC Staff may issue further guidance or
pursue “other action.”
SEC Staff comment trends. SEC Staff continue to point out basic errors, including (1)
incorrect use of negative values, (2) incomplete tagging and (3) inappropriate use of
custom tags.
January 13, 2015
6
DON’T IGNORE XBRL!
XBRL reminders
Limited liability phase-in has ended. All issuers, including newly-public issuers, are
subject to anti-fraud, Securities Act Section 11 and 12 and Exchange Act Section 18
liability for any material errors or omissions in XBRL files.
Review disclosure controls. In light of SEC observations and expiration of the limited
liability period, ensure disclosure controls adequately address XBRL filing matters.
Review exhibit index reference to XBRL exhibits. As XBRL exhibits are now “filed,”
ensure any reference to “furnished” or “furnished, not filed” is removed.
Exchange Act Rule 12b-25 is not available to extend the due date of an XBRL file.
Instead, must comply with the temporary or continuing hardship exemption requirements
of Regulation S-T.
January 13, 2015
7
INCREASED FOCUS ON CYBERSECURITY DISCLOSURE
Board oversight
SEC and other government agencies have noted their expectation that Boards oversee
cyber risk, along with other risk oversight responsibilities.
•
Cyber risk. SEC Commissioner Aguilar expressed “little doubt that cyber-risk also must
be considered as part of [the] board’s overall risk oversight.” (June 2014 speech).
Cybersecurity has moved from the IT department to the Boardroom.
•
Rule. Regulation S-K Item 407(h) requires disclosure of the extent of the Board’s role in
the issuer’s risk oversight and the effect on the Board’s leadership structure.
•
Litigation. Lawsuits were filed against directors and officers at Target and Wyndham
following cyber incidents, alleging failure to formulate adequate policies and responses.
•
ISS. ISS recommended removal of Target’s incumbent Board following its cyber
incident.
January 13, 2015
8
INCREASED FOCUS ON CYBERSECURITY DISCLOSURE
Disclosure considerations
•
Risk disclosure needed despite defenses. Disclose material cyber risks regardless
of perceived strength/effectiveness of cyber defenses.
•
Update cautionary statements regarding forward-looking statements in SEC
filings and press releases. Address actual cyber risks then affecting the issuer or its
industry.
•
Consider controls. Ensure disclosure controls cover cyber disclosure. Consider
impact on disclosure controls and internal control over financial reporting (ICFR),
including audit of ICFR, if a breach occurs and is not detected and reported timely.
•
Pre-clear or coordinate disclosures. Coordinate if governmental agencies conduct a
parallel investigation and ensure consistent disclosure with public statements by the
government (e.g., see FBI press release about Sony Pictures in Appendix A).
•
Consider Form 8-K disclosure. Although not required by Form 8-K, consider whether
to provide Form 8-K disclosure following an incident if material.
January 13, 2015
9
SOCIAL MEDIA DISCLOSURE TRENDS
Post-Netflix disclosures: establishing social media channels
•
Press release disclosure example.
•
Website disclosure example (cited in press release).
•
Traditional channels. Issuers continue to rely on traditional channels for marketmoving disclosures.
January 13, 2015
10
SOCIAL MEDIA DISCLOSURE TRENDS
“Solicitations”
•
Commencement. SEC Staff interprets “solicitation” broadly; any social media or other
communication with an activist may constitute a solicitation and commence a
solicitation period.
•
Same-day filing. Written solicitation materials, including social media posts (and
emails), are subject to same-day filing with the SEC (before a proxy statement is filed
or as a proxy supplement).
•
Example: mergers. Social media posts require filing after announcement of a merger
or otherwise in the lead-up to a stockholder vote.
January 13, 2015
11
SOCIAL MEDIA DISCLOSURE TRENDS
Hyperlinks to required securities legends
In April 2014, the SEC Staff provided guidance that hyperlinks may be used to add
required legends to character-limited social media posts.
•
Guidance—limited use. Guidance permits hyperlinks to legends upon compliance with
certain conditions in social media posts involving tender offers, business combinations,
proxy solicitations and registered securities offerings.
•
Other contexts. Although hyperlinks are sometimes used in other contexts, guidance
does not extend to those situations or rules (e.g., tweeting during earnings releases or
providing GAAP number with link to Reg. G reconciliation). Consult with SEC Staff in
other contexts.
•
Safe harbor. Risks can arise when safe harbor cautionary statement does not
“accompany” forward-looking statements (e.g., class action brought after CEO blog).
January 13, 2015
12
SOCIAL MEDIA DISCLOSURE TRENDS
Social media channels can leak
Avoid discussing material, non-public information on social media to prevent
inadvertent disclosure, such as the public tweet by Twitter’s CFO.
January 13, 2015
13
INTERNAL CONTROL OVER FINANCIAL REPORTING
Lessons from recent SEC enforcement actions
•
Enforcement without allegations of fraud or intentional wrongdoing. For example,
action against an issuer alleging that its internal accounting controls kept it from
adhering to accounting rules.
•
Weak internal controls can result in accounting fraud. For example, actions against
a Dallas-based jewelry issuer and its CFO for allegedly inflating inventory values and
misleading auditors, and a Silicon Valley software issuer and two VPs for alleged
improper revenue recognition scheme by VPs.
•
CEOs & CFOs face personal liability for ICFR disclosure and SOX 404
certification violations. Control failures can assign individual responsibility for
restatements or material misstatements (e.g., action against CEO & CFO for internal
control deficiencies and certification violations).
•
Inadequate controls around revenue recognition are ripe for enforcement. For
example, action against Arizona-based software issuer for allegedly failing to properly
recognize and report revenue from software licenses.
•
Ensure proper controls exist and operate for foreign operations. For example,
action against Smith & Wesson related to FCPA violations.
January 13, 2015
14
INTERNAL CONTROL OVER FINANCIAL REPORTING
SEC Staff comment trends
•
Failure to identify COSO framework used. In both management’s report and the
auditor’s report. (Area for scrutiny by Office of Chief Accountant)
•
Inquiries when multiple control deficiencies exist. Including how management
evaluated severity of deficiencies when a material weakness is not reported, and if
management evaluated whether deficiencies existed in other COSO components.
•
Whether management evaluated the severity of deficiencies related to immaterial
restatements. A deficiency’s severity does not depend upon a misstatement, but on
whether a reasonable possibility exists that the deficiency could result in a
misstatement.
•
Challenging ICFR effectiveness. Especially if there are changes in ICFR and
corrections of previous errors (e.g., where an issuer discloses a charge due to historical
accounting inconsistent with GAAP).
•
Questioning lack of disclosure of material changes in ICFR. Especially during
periods when certain events occur with the potential to affect controls adversely (e.g.,
employee layoffs or changes in accounting policies or outsourcing arrangements).
January 13, 2015
15
INTERNAL CONTROL OVER FINANCIAL REPORTING
Disclosure considerations in the event of a control deficiency
Disclose cause. Allow investors to understand the cause of any control deficiency.
Disclose the accounting error and also the deficiency:
• Cause. What is its cause?
• Nature of the deficiency. For example, is it a design or operating effectiveness issue?
Is the issue narrow or could the deficiency be broader than what has been observed?
• Impact. What is its impact on financial reporting and ICFR? Careful consideration is
required when considering the “could factor” - do not equate the actual error identified
with the reasonably possible potential misstatement.
• Identification. How was it discovered (e.g., by management or the auditor)? If by
management, was it identified “accidentally” or as part of the normal operation of
controls?
• Remediation. What measures are likely necessary to rectify the deficiency?
January 13, 2015
16
PCAOB IMPOSES NEW BURDENS
New Auditing Standard 18 focuses on related party and significant
transactions
New audit procedures will be required in the upcoming year for audits of related party
transactions (RPTs), significant unusual transactions (SUTs) and financial relationships
with executive officers.
•
More extensive diligence by auditors. Focus on proper authorization and business
purpose of transactions will assess risks of material misstatements.
•
Auditors must discuss RPTs with the Audit Committee. Auditors expected to probe
Audit Committee about their concerns with RPTs and to discuss RPTs they identify.
•
New management representations regarding RPTs and SUTs. Management will
face additional inquiries during the audit.
•
Review accounting policies and controls. Accounting policies and procedures,
disclosure controls and ICFR must properly address RPTs, SUTs and executive
compensation in light of AS18.
•
SEC enforcement action may intensify auditor scrutiny. SEC recently pursued
action against an auditor regarding an audit failure relating to RPTs.
January 13, 2015
17
PCAOB IMPOSES NEW BURDENS
Other PCAOB developments
PCAOB evaluating standards for auditing accounting estimates and fair value
measurements
•
Changes increase the potential for auditor/issuer disputes. Disputes over
accounting estimates and fair value determinations with related risks of restatements
and compensation clawbacks.
PCAOB’s Audit Practice Alert on auditing revenue. Alert issued in September 2014
after audit inspections identified numerous audit failures relating to revenues. Auditors
expected to step up audit review of revenues.
January 13, 2015
18
MD&A CONSIDERATIONS
Known trends and uncertainties disclosure
Recent Facebook IPO litigation
Allegations. Failure to adequately disclose (1) whether increasing mobile usage had or
was reasonably expected to have a material unfavorable impact on revenues, and (2) the
extent these trends had or were reasonably expected to impact revenues. Plaintiffs alleged
issuer had a duty to disclose its knowledge of these known trends.
Decision. Court found the allegations stated a claim for omissions of material information
required by Regulation S-K Item 303, noting that an issuer has a duty to disclose
•
“any trend, event or uncertainty that is ‘known and existing at the time of the IPO’” that
‘was reasonably likely to have a material impact’ on the issuer’s financial condition,”
and
•
“‘whether, and to what extent’ that known trend, event or uncertainty ‘might reasonably
be expected to materially impact … future revenues.’”
Awareness of trend. Court also found that the issuer’s notice to underwriters when it
changed its own internal guidance and projections demonstrated that the issuer was aware
the trend was material.
January 13, 2015
19
MD&A CONSIDERATIONS
2014 10-K and 2015 focus for current macro trends
Commodity price sensitivity
•
Known impacts and trends of lower crude oil prices
Impairments, contingencies and volatility
•
Estimates of oil and gas reserves
•
Goodwill from recent acquisitions
•
Potential trends as long-term contracts with existing cash flows expire
•
Impairment “cushion” and forward-looking disclosures
Political risks and effects of sanctions
•
Know where your company and your material customers do business
Effects on liquidity
•
Known or anticipated effects of the foregoing, if applicable
 Borrowing base redeterminations
 Repatriation of cash from foreign jurisdictions and related tax liabilities
January 13, 2015
20
ENHANCING AUDIT COMMITTEE DISCLOSURE
Calls for increased transparency
Expanded Audit Committee responsibilities have increased regulators’ and investors’
interest in the committee’s roles, responsibilities and activities.
•
SEC scrutiny. Chair White has asked the SEC Staff to consider improvements to the
Audit Committee report to make it more useful to investors, in part because investors
“have expressed interest in increased transparency into the audit committee’s
activities.” (May 2014 speech). SEC expects to issue a concept release on enhancing
Audit Committee work in 2015.
•
Investors. Some investors and policy groups are seeking greater disclosure. (See
Appendix A for United Brotherhood of Carpenters letter and Council for Institutional
Investors Policies on Corporate Governance.)
January 13, 2015
21
ENHANCING AUDIT COMMITTEE DISCLOSURE
Audit Committee disclosure enhancement considerations
Enhanced disclosure is voluntary, but may help with shareholder votes on Audit Committee
members and auditor ratification.
•
Centralize audit-related disclosures. Either in Audit Committee report or “auditrelated” section of proxy statement.
•
Scope of responsibilities. Especially responsibility for appointment, compensation,
retention and oversight of external and internal auditors and areas of risk oversight
(especially those areas beyond financial reporting).
•
Processes or specific activities undertaken for external auditor oversight.
Discussion could include the degree of interaction with the auditor (e.g., nature or
number of meetings without management), issues/topics discussed with auditor and
factors used to assess qualifications and work quality (e.g., PCAOB reports on auditor).
•
Auditor compensation. Responsibility for fee negotiations, factors considered when
determining compensation, and explanation of reasons for changes in fees from prior
years.
January 13, 2015
22
ENHANCING AUDIT COMMITTEE DISCLOSURE
Audit Committee disclosure enhancement considerations
•
Auditor independence. Discussion of processes for conducting periodic independence
evaluation, including consideration of non-audit fees/services and auditor rotation, and
enhanced discussion of approval/pre-approval of audit and non-audit services/fees.
•
Rationale for selecting or reappointing an auditor. For example, qualifications (e.g.,
industry expertise and geographical reach), impact of changing auditors, relevant
information from the annual auditor evaluation, and statement that selection is in best
interest of issuer and shareholders.
•
Involvement in selecting lead audit engagement partner. Including disclosure of
year current lead engagement partner was appointed.
•
Auditor tenure. Number of years or year auditor was initially engaged.
•
Committee composition. Not only independence, financial literacy, and identity of
Audit Committee financial experts, but also clearly describe members’ qualifications.
January 13, 2015
23
REVISITING AUDITOR INDEPENDENCE
Audit Committee shares responsibility and risk of auditor non-independence
•
Drill down into nature and scope of proposed services. Consider “appearance
issues” in addition to any prohibited services.
•
Preview fees in proxy table. Disproportionate fees for non-audit and tax services can
highlight independence questions.
•
Monitor shifts in scope. Changing transactions and relationships (e.g., business
combinations) can result in “scope creep,” which could result in prohibited non-audit
services identified after the fact, forcing the auditor to resign.
Disclosure impact
•
Reporting violations resulting from non-independence. If a non-independent audit
report is filed with a Form 10-K, the issuer would violate fundamental reporting
obligations under Exchange Act Section 13(a) (that financial statements in annual
reports must be audited by an independent accountant).
•
Risk of losing access to capital markets. Lack of audited financial statements would
foreclose public offerings.
•
SEC Staff encouraging fee disclosures. In the proxy statement audit fee table, SEC
Staff is seeking and reviewing details about significant non-audit services.
January 13, 2015
24
REVISITING AUDITOR INDEPENDENCE
Lessons from recent SEC enforcement actions
•
Permissible non-audit services (e.g., tax) are prohibited if otherwise inconsistent
with rules (e.g., prohibition against acting as an employee). Scrutinize both the
nature of the proposed non-audit services and how the services will be delivered.
•
“Loaned staff” arrangements are prohibited. Auditor may not perform any decisionmaking, supervisory, or monitoring functions for the issuer.
•
Acting as an employee is prohibited, even if temporary. A key inquiry is the degree
of control that the issuer exercises over auditor personnel.
•
Advocacy on behalf of audit clients is prohibited. Advocacy can take many forms
(e.g., not only “lobbying”).
•
Former lead partner must step out after rotation. Observe roles of new and former
engagement partner post-rotation.
•
SEC Staff will respond to independence questions. SEC Staff encourage Audit
Committee members to contact the Office of the Chief Accountant in advance with any
independence questions, including the permissibility of a contemplated service.
January 13, 2015
25
NEW REVENUE RECOGNITION STANDARD
New standard on accounting for revenues from contracts with customers
FASB’s new ASC Topic 606 will supersede current Topic 605, effective as to public
companies for fiscal years beginning after December 15, 2016, including interim periods.
•
Every contract for the transfer of goods and services and certain nonfinancial
assets. Applies across industries and types of transactions.
•
Judgments. Requires new types of accounting judgments, estimates and
determinations and increased disclosure.
•
Impact on contracts. New rules for recognizing revenues from contracts with variable
consideration.

Indexed pricing. Will affect E&P and midstream issuers that are parties to, e.g.,
gas purchase/sale contracts with pricing varying over contract term based on
changes in an index.

Estimates. Will require significant judgments regarding such contracts, including
estimates of amounts probable of being received under the contracts.

Drafting impact. Consider writing contract terms to make the timing of revenue
recognition and amount of revenues to be recognized under the new rules more
certain.
January 13, 2015
26
NEW REVENUE RECOGNITION STANDARD
New standard on accounting for revenues from contracts with customers
Lead time to review contracts. Issuers may have to review each customer contract and
make major changes to accounting systems and procedures and internal controls to
ensure compliance with the new standard.
•
Systems. Full retrospective adoption requires accounting systems to be upgraded
soon.
•
Covenants. New standard may affect compliance with financial covenants and other
provisions tied to revenues, operating income, net income, EBITDA and other liquidity
measures in credit and other agreements, and achievement of executive compensation
performance targets.
•
Risks. New standard may increase risks of financial restatements and compensation
clawbacks.
Other revenue recognition standards to be amended. FASB is also amending its
standard for recognition of gains and losses on transfer of PPE and intangibles.
January 13, 2015
27
SEC STAFF’S FOCUS ON DISCLOSURE EFFECTIVENESS:
BEYOND PLAIN ENGLISH
SEC positions
SEC Staff report released in late 2013 with recommendations for next steps.
•
Avoid information overload. SEC Chair White is speaking out on how “information is
presented, where and how that information is disclosed, and how we can take
advantage of technology to facilitate investors’ access to information and make it more
meaningful.”
•
Initial SEC Staff focus. SEC is encouraging comments.
•

Business and financial disclosures required by periodic and current reports, Forms
10-K, 10-Q and 8-K (and impact on Securities Act disclosures).

Whether to update and codify Industry Guides and form-specific disclosure
requirements.

Whether disclosure requirements should be based on issuer size.
Subsequent phases. SEC also plans to focus on compensation and governance
information in proxy statements.
January 13, 2015
28
SEC STAFF’S FOCUS ON DISCLOSURE EFFECTIVENESS:
BEYOND PLAIN ENGLISH
Impact on current disclosure
•
Reduce repetition. Consolidate Regulation S-K with financial disclosure requirements
and use cross-references where appropriate.
•
Use executive summaries. Introduce and organize other disclosures.
•
Eliminate outdated information. Focus on current information and delete older
information if no longer relevant or material.
What to expect?
•
Comments on information overloads. Length, redundancies and information
overload may trigger SEC Staff scrutiny, especially in risk factor disclosure.
•
New round of “disclosure effectiveness” comments?
•
Return of plain English comment letters?
January 13, 2015
29
CONFLICT MINERALS RULE: FIRST YEAR PROBLEMS / SECOND
YEAR CHALLENGES
Conflict minerals rule compliance
First year’s compliance marked by uncertainty and uneven efforts. Many issuers may
not have made significant improvements to their compliance programs for 2014, which is
the last year in the rule’s transition period.
Limited information available for compliance and disclosure
•
Supplier responses. Some conflict mineral suppliers did not respond to information
requests for 2013, while others responded with form letters or inadequate information.
•
Inadequate information. Available marketplace information appeared to be inadequate
to allow issuers to identify country of origin for much of conflict mineral supply.
Responses to the filed Form SDs and conflict minerals reports
•
Social activists. Criticized issuers for inadequate compliance and disclosures.
•
No SEC Staff comments. Staff does not appear to be commenting on specific filings.
•
Full compliance advantages. Some issuers said to seek a competitive and
reputational advantage from full compliance and disclosure.
January 13, 2015
30
CONFLICT MINERALS RULE: FIRST YEAR PROBLEMS / SECOND
YEAR CHALLENGES
Conflict minerals rule compliance
SEC Staff views. SEC Staff’s review of first year filings led the SEC Staff to note that:
•
Distinction should be made between reasonable country of origin inquiries and due
diligence regarding the country of origin of conflict minerals for larger issuers.
•
Implications of products being “DRC conflict free” should be avoided if that
determination has not been made.
•
Issuers failed to disclose known countries of origin, smelters and refiners in sufficient
detail.
Challenges for second year compliance. Many compliance challenges in 2013 are likely
to remain for the 2014 reporting year.
•
Problems with information availability will likely persist for compliance as to 2014 and
perhaps into the future; many suppliers likely unmotivated to improve.
•
Some issuers may be unaware of their obligations to file, or changes in business and
contracts may capture new issuers.
January 13, 2015
31
ACTIVISM TRENDS AND FOCUS ON ENERGY
Activist positions
Whether taking profits at a high point in the market, or seeking better returns when oil
prices fall and market values of energy issuers decline, activist positions influence
governance and disclosure. Activists may work in parallel, creating “wolf packs” of
dissident investors who may control the vote for directors and other proposals at the
annual meeting.
Activist objectives differ
Activists have differing objectives and playbooks, and require targeted responses from
management and the Board. Proxy solicitors may be able to advise on changes in investor
base and activist strategies pursued by large investors. Activists may pursue:
•
Governance reform. Governance changes that affect the Board and governance
policies, such as proxy access or changes in executive compensation to “pay for
performance.”
•
Corporate social responsibility (CSR). CSR goals, such as changes in investments
and sustainability planning, with potential shareholder proposals for the annual meeting.
•
Value. Strategic changes advanced by value-oriented funds, who may press for a
transaction in the near term, whether a sale of the issuer or specific transactions to
“unlock” value for the benefit of investors (and the fund’s portfolio).
January 13, 2015
32
ACTIVISM TRENDS AND FOCUS ON ENERGY
Impact of activism on disclosure
While meeting disclosure requirements, an issuer may also highlight information that is
followed by activist investors. For example:
•
Proxy statement—directors. Governance-oriented activists (such as pension funds)
look for disclosures of director qualifications to see whether investor experience and
viewpoints are represented on the Board.
•
Proxy statement—compensation. All activists track executive compensation and
specific disclosure of “pay for performance” and equity dilution, especially when trading
prices are falling or the issuer proposes a new equity plan.
•
Business description. Social responsibility activists look for descriptions of business
activity, including geographical locations (for example, Myanmar/Burma, Sudan and
Syria), human rights policies and practices, environmental impact, and sustainability
planning. Specific proactive disclosures can head off shareholder proposals.
•
Strategic focus. Value funds look for disclosures in MD&A regarding known trends and
uncertainties and the issuer’s planned response, such as capital expenditures, margins,
overhead, use of cash, and investment in core businesses.
January 13, 2015
33
CURRENT STATE OF CLAWBACKS
Regulatory status
Dodd-Frank Section 954. Requires SEC to adopt rules (yet to be proposed) prohibiting
the listing of any issuer without a clawback policy to recoup incentive-based compensation
from current and former executives based on specified triggers.
•
Broader than SOX. Extends further than clawback provisions in SOX Section 304.
SOX enforcement actions. SEC Enforcement Chief recently stated that since SOX, SEC
has obtained clawbacks from 52 people related to activity at 32 issuers, and six
enforcement actions sought clawbacks from executives without citing any misconduct.
•
Saba Software (September 2014). CEO repaid $2.57 million of bonuses, incentive pay
and profit from stock sales to issuer despite no allegation of CEO misconduct related to
alleged improper revenue recognition scheme perpetrated by two VPs.
Open questions
•
State employment law
•
Variable accounting
•
Practicalities of recoupment
•
Uncertainty over future SEC rules
•
Desire of Board and Committees to retain discretion
January 13, 2015
34
EXECUTIVE COMPENSATION
Litigation-resistant compensation disclosure
Drafting notes. Boilerplate in the proxy statement can be subject to third party litigation as
well as SEC Staff comments.
•
Pay for performance. Avoid overstating pay-for-performance policies when payouts
are discretionary or performance goals are easy to achieve.
•
Tax deductions. Comply with terms of the plan and avoid general statements about
qualifying compensation for deductibility under Section 162(m).
Legal privilege. Communications involving the compensation consultant are not subject to
legal privilege. Compensation Committee deliberations can be protected by holding
executive sessions without the consultant, which can serve as a privileged forum for legal
advice and sensitive discussions.
Use of discretion if metrics are not met. In a market downturn, the Compensation
Committee may use discretion to exceed target payouts.
•
Bonus column. If Committee discretion is used after the fact, or performance criteria
are not satisfied, compensation is more prominently reported in the bonus column of
the summary compensation table (whether or not the award was originally intended to
be an incentive award).
January 13, 2015
35
APPENDIX A
January 13, 2015
36
BIBLIOGRAPHY
SEC “Broken Windows” Enforcement
•
Speech, SEC Chair Mary Jo White, Remarks at the Securities Enforcement Forum (October 9, 2013), available at
http://www.sec.gov/News/Speech/Detail/Speech/1370539872100#.VJe2JZ1DDs.
•
SEC, Press Release, SEC Announces Charges Against Corporate Insiders for Violating Laws Requiring Prompt
Reporting of Transactions and Holdings (September 10, 2014), available at
http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370542904678#.VJsXp-AABh.
•
SEC, Press Release, SEC Announces Fraud Charges Against Biotech Company and Former Executive Who Failed
to Report Insider Stock Sales (September 10, 2014), available at
http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370542903208#.VJsXveAABh.
•
SEC, Press Release, SEC Sanctions 10 Companies for Disclosure Failures Surrounding Financing Deals and Stock
Dilution (November 5, 2014), available at
http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370543368026#.VJsXweAABh.
XBRL
•
SEC, Sample Letter Sent to Public Companies Regarding XBRL Requirement to Include Calculation Relationships
(July 2014), available at http://www.sec.gov/divisions/corpfin/guidance/xbrl-calculation-0714.htm.
•
SEC Division of Economic and Risk Analysis, Staff Observations of Custom Tag Rates (July 7, 2014), available at
http://www.sec.gov/dera/reportspubs/assessment-custom-tag-rates-xbrl.html#.VJg9EOAABg.
•
SEC Office of Interactive Disclosure, Staff Observations From Review of Interactive Data Financial Statements
(various dates), available at http://www.sec.gov/spotlight/xbrl/staff-review-observations.shtml.
•
SEC Division of Corporation Finance, Interactive Data Compliance & Disclosure Interpretations (last updated May
16, 2013), available at http://www.sec.gov/divisions/corpfin/guidance/interactivedatainterp.htm.
January 13, 2015
37
BIBLIOGRAPHY
Cybersecurity Disclosure
•
SEC Division of Corporation Finance’s Disclosure Guidance Topic No. 2, Cybersecurity, available at
http://www.sec.gov/divisions/corpfin/guidance/cfguidance-topic2.htm.
•
SEC Cybersecurity Roundtable Webcast (March 26, 2014), available at
http://www.sec.gov/news/otherwebcasts/2014/cybersecurity-roundtable-032614.shtml.
•
Speech, SEC Commissioner Aguilar, Boards of Directors, Corporate Governance and Cyber-Risks: Sharpening the
Focus (June 10, 2014), available at http://www.sec.gov/News/Speech/Detail/Speech/1370542057946#.VJghMsALA.
•
FBI, Press Release, Update on Sony Investigation (December 19, 2014), available at
http://www.fbi.gov/news/pressrel/press-releases/update-on-sony-investigation.
Social Media
•
SEC Division of Corporation Finance, Securities Act Rules Compliance & Disclosure Interpretations regarding use of
hyperlinks in compliance with Securities Act Rule 134 (April 21, 2014), available at
http://www.sec.gov/divisions/corpfin/guidance/securitiesactrules-interps.htm#110-01.
•
SEC Division of Corporation Finance, Securities Act Rules Compliance & Disclosure Interpretations regarding use of
hyperlinks in compliance with Securities Act Rule 165 (April 21, 2014), available at
http://www.sec.gov/divisions/corpfin/guidance/securitiesactrules-interps.htm#164-02.
•
SEC Division of Corporation Finance, Securities Act Rules Compliance & Disclosure Interpretations regarding use of
hyperlinks in compliance with Securities Act Rule 433 (April 21, 2014), available at
http://www.sec.gov/divisions/corpfin/guidance/securitiesactrules-interps.htm#232-15.
January 13, 2015
38
BIBLIOGRAPHY
Internal Control Over Financial Reporting
•
SEC, Commission Guidance Regarding Management’s Report on Internal Control Over Financial Reporting Under
Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (June 27, 2007), available at
http://www.sec.gov/rules/interp/2007/33-8810.pdf.
•
SEC, Definition of the Term Significant Deficiency, Release Nos. 33-8829; 34-56203 (August 3, 2007), available at
http://www.sec.gov/rules/final/2007/33-8829.pdf.
•
SEC Office of the Chief Accountant and Division of Corporation Finance, Management's Report on Internal Control
Over Financial Reporting and Certification of Disclosure in Exchange Act Periodic Reports FAQs (revised September
24, 2007), available at http://www.sec.gov/info/accountants/controlfaq.htm.
•
Speech, SEC Deputy Chief Accountant Brian T. Croteau, Remarks Before the 2014 AICPA National Conference on
Current SEC and PCAOB Developments (December 8, 2014), available at
http://www.sec.gov/News/Speech/Detail/Speech/1370543616539#.VJtH2sALA.
•
Speech, SEC Senior Associate Chief Accountant Kevin M. Stout, Remarks before the 2014 AICPA Conference on
Current SEC and PCAOB Developments (December 8, 2014), available at
http://www.sec.gov/News/Speech/Detail/Speech/1370543613733#.VJtIWsALA.
•
SEC, Press Release, SEC Charges Fortune 200 Company for Accounting Deficiencies (June 3, 2013), available at
http://www.sec.gov/News/PressRelease/Detail/PressRelease/1365171575142#.VKs1xtLF-y4.
•
SEC, Press Release, SEC Charges Former CFO of Dallas-Based Jewelry and Collectibles Company With
Accounting Fraud (May 27, 2014), available at
http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370541917817#.VJtMSsALA.
•
SEC, Press Release, SEC Charges Software Company in Silicon Valley and Two Former Executives Behind
Fraudulent Accounting Scheme; CEO Agrees to Return $2.5 Million Under Clawback Provision (September 24,
2014), available at http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370543035992#.VJsWh-AABh.
January 13, 2015
39
BIBLIOGRAPHY
Internal Control Over Financial Reporting, cont.
•
SEC, Press Release, SEC Charges Company CEO and Former CFO With Hiding Internal Controls Deficiencies and
Violating Sarbanes-Oxley Requirements (July 30, 2014), available at
http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370542561150#.VJtOAsALA.
•
SEC, Press Release, SEC Charges Arizona-Based Software Company for Inadequate Internal Accounting Controls
Over Its Financial Reporting (September 25, 2014), available at
http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370543042731#.VJtTz-AABh.
•
SEC, Press Release, SEC Charges Smith & Wesson With FCPA Violations (July 28, 2014), available at
http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370542384677#.VJtuGsALA.
Developments in PCAOB Auditing Standards
•
PCAOB, Auditing Standard No. 18: Related Parties, Amendments to Certain PCAOB Auditing Standards Regarding
Significant Unusual Transactions and Other Amendments to PCAOB Auditing Standards (June 10, 2014), available at
http://pcaobus.org/Rules/Rulemaking/Docket038/Release_2014_002_Related_Parties.pdf.
•
PCAOB, Staff Consultation Paper: Auditing Accounting Estimates and Fair Value Measurements (August 19, 2014),
available at
http://pcaobus.org/Standards/Documents/SCP_Auditing_Accounting_Estimates_Fair_Value_Measurements.pdf.
•
PCAOB, Staff Audit Practice Alert No. 12: Matters Related to Auditing Revenue in an Audit of Financial Statements
(September 9, 2014), available at http://pcaobus.org/Standards/QandA/9-9-14_SAPA_12.pdf.
•
PCAOB Investor Advisory Group, Report from the Working Group on The Relationship and Role of the Auditor with
the Audit Committee, available at
http://pcaobus.org/News/Events/Documents/10202014_IAG/Auditor_and_Audit_Committee_Relationship.pdf.
January 13, 2015
40
BIBLIOGRAPHY
Developments in PCAOB Auditing Standards, cont.
•
SEC, Press Release, SEC Imposes Sanctions Against Hong Kong-Based Firm and Two Accountants for Audit
Failures (December 17, 2014), available at http://www.sec.gov/news/pressrelease/2014-284.html#.VKc-0dLF-y4.
MD&A
•
In re Facebook, Inc., IPO Sec. and Derivative Litig., 986 F. Supp. 2d 487 (S.D.N.Y. 2013), available at
http://scholar.google.com/scholar_case?case=7947374115702520923&q=In+re+Facebook,+Inc.,+IPO+Sec.+and+D
erivative+Litig.,+986+F.+Supp.+2d+487+&hl=en&as_sdt=6,48.
•
In re Facebook, Inc., IPO Sec. and Derivative Litig., 986 F. Supp. 2d 544 (S.D.N.Y. 2014), available at
http://scholar.google.com/scholar_case?case=18433700731972701561&q=In+re+Facebook,+Inc.,+IPO+Sec.+and+
Derivative+Litig.,+986+F.+Supp.+2d+487+&hl=en&as_sdt=6,48 (subsequent Section 16(b) litigation).
•
Deloitte, SEC Comment Letters – Including Industry Insights: A Recap of Recent Trends (November 20, 2014),
available at http://www2.deloitte.com/content/dam/Deloitte/us/Documents/audit/us-sec-comment-letters-includingindustry-insights-a-recap-of-recent-trends-12112014.pdf.
Audit Committee Disclosures
•
Center for Audit Quality, Enhancing the Audit Committee Report: A Call to Action (November 20, 2013), available at
http://www.thecaq.org/docs/audit-committees/enhancing-the-audit-committee-report-a-call-to-action.pdf?sfvrsn=2.
•
Slide Presentation, SEC Chief Accountant Paul Beswick, Regarding Audit Committees at SEC Speaks 2014
(February 22, 2014), available at http://www.sec.gov/News/Speech/Detail/Speech/1370540846980#.VJtousALA.
•
Deloitte, Audit Committee Brief: A new era in audit committee reporting (February 2014), available at
http://www2.deloitte.com/content/dam/Deloitte/be/Documents/risk/Directorsdesk/ACBrief_February2014.pdf.
January 13, 2015
41
BIBLIOGRAPHY
Audit Committee Disclosures, cont.
•
Speech, SEC Chair White, Remarks at the Financial Accounting Foundation Trustees Dinner (May 20, 2014),
available at http://www.sec.gov/News/Speech/Detail/Speech/1370541872065#.VKHOzuAABg.
•
EY, Audit committee reporting to shareholders 2014 proxy season update (August 2014), available at
http://www.ey.com/Publication/vwLUAssets/ey-lets-talk-governance-august-2014/$FILE/ey-lets-talk-governanceaugust-2014.pdf.
•
United Brotherhood of Carpenters, Carpenter Funds’ 2014 Proxy Season Report, available at
https://www.carpenters.org/Todays_UBC_Top_Nav/CorporateGovernance/NewCGDhome/NewActRes/2014Report.a
spx.

•
Under “Auditor Independence Issue” lists six specific disclosures requested and large-cap issuers targeted.
Requested disclosures include (1) responsibility for auditor appointment, compensation, retention and oversight,
(2) auditor tenure, (3) responsibility for auditor fee negotiations, (4) consideration of regular auditor rotation, (5)
involvement in the selection of a new lead engagement partner, and (6) retention of the auditor is in the best
interests of the issuer and its investors.
Council of Institutional Investors, Policies on Corporate Governance (last updated October 1, 2014), available at
http://www.cii.org/corp_gov_policies.

Section 2.13a notes that the Audit Committee report should include (1) “meaningful information” about how
responsibilities are carried out, including how carried out in consideration of audit quality objectives, and (2) a
“fact specific” explanation for not changing an auditor with more than 10 consecutive years of service, or if the
auditor is retained despite knowledge of substantive deficiencies.
January 13, 2015
42
BIBLIOGRAPHY
Auditor Independence
•
SEC, Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: KPMG, LLP (January
24, 2014), available at http://www.sec.gov/litigation/investreport/34-71390.pdf.
•
SEC, Press Release, SEC Charges KPMG With Violating Auditor Independence Rules (January 24, 2014), available
at
http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370540667080?utm_source=feedburner&utm_mediu
m=feed&utm_campaign=Feed%253A+sec%252FlgHO+(SEC.gov+Updates%253A+Press+Releases)#.VKH8Y-AABi.
•
Slide Presentation, SEC Chief Accountant Paul Beswick, Regarding Audit Committees at SEC Speaks 2014
(February 22, 2014), available at http://www.sec.gov/News/Speech/Detail/Speech/1370540846980#.VJtousALA.
•
SEC, Press Release, SEC Charges Ernst & Young With Violating Auditor Independence Rules in Lobbying Activities
(July 14, 2014), available at
http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370542298984#.VKIBBuAABg.
•
SEC, Press Release, SEC Sanctions Florida-Based Auditor for Circumventing Rules (October 24, 2014), available at
http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370543281121#.VKIBE-AABi.
•
Speech, SEC Deputy Chief Accountant Brian T. Croteau, Remarks Before the 2014 AICPA National Conference on
Current SEC and PCAOB Developments (December 8, 2014), available at
http://www.sec.gov/News/Speech/Detail/Speech/1370543616539#.VJtH2sALA.
•
SEC, Guidance for Consulting with the Office of the Chief Accountant, available at
http://www.sec.gov/info/accountants/ocasubguidance.htm.
January 13, 2015
43
BIBLIOGRAPHY
Revenue Recognition
•
FASB, Accounting Standards Update: Revenue from Contracts with Customers (Topic 606) (May 2014), available at
http://www.fasb.org/jsp/FASB/Document_C/DocumentPage?cid=1176164076069&acceptedDisclaimer=true.
•
SEC, Press Release, California-Based Telecommunications Equipment Firm and Two Former Executives Charged in
Revenue Recognition Scheme (August 22, 2014), available at
http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370542732440#.VKs6b9LF-y4.
•
SEC Administrative Proceeding, SEC Charges Two Information Technology Executives With Mischaracterizing
Resale Transactions to Increase Revenue (August 28, 2014), available at
http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370542786775#.VKs7DNLF-y4.
Disclosure Effectiveness
•
Speech, SEC Chair White, The Path Forward on Disclosure (October 15, 2013), available at
http://www.sec.gov/News/Speech/Detail/Speech/1370539878806#.VKLF_uAABg.
•
SEC, Report on Review of Disclosure Requirements in Regulation S-K (December 2013), available at
http://www.sec.gov/news/studies/2013/reg-sk-disclosure-requirements-review.pdf.
•
Speech, SEC Chair White, The SEC in 2014 (January 27, 2014), available at
http://www.sec.gov/News/Speech/Detail/Speech/1370540677500#.VKs8c9LF-y4.
•
Speech, SEC Commissioner Daniel M. Gallagher, Remarks to the Forum for Corporate Directors, Orange County,
California (January 24, 2014), available at http://www.sec.gov/News/Speech/Detail/Speech/1370540680363#.VKLFAAABh.
•
Speech, SEC Director of Division of Corporation Finance Keith F. Higgins, Disclosure Effectiveness: Remarks Before
the American Bar Association Business Law Section Spring Meeting (April 11, 2014), available at
http://www.sec.gov/News/Speech/Detail/Speech/1370541479332#.VKLFRuAABg.
January 13, 2015
44
BIBLIOGRAPHY
Disclosure Effectiveness, cont.
•
Speech, SEC Director of Division of Corporation Finance Keith F. Higgins, Shaping Company Disclosure: Remarks
before the George A. Leet Business Law Conference (October 3, 2014), available at
http://www.sec.gov/News/Speech/Detail/Speech/1370543104412#.VKLFUsALA.
•
SEC Disclosure Effectiveness website, available at http://www.sec.gov/spotlight/disclosure-effectiveness.shtml.
•
FASB, Proposed Statement of Financial Accounting Concepts - Conceptual Framework for Financial Reporting:
Chapter 8: Notes to Financial Statements (March 4, 2014), available at
http://www.fasb.org/jsp/FASB/Document_C/DocumentPage?cid=1176163868268&acceptedDisclaimer=true.
Clawbacks
•
PWC, Executive Compensation: Clawbacks (2013 Proxy Disclosure Study) (April 2014), available at
http://www.pwc.com/en_US/us/hr-management/publications/assets/pwc-clawbacks-2013-proxy-disclosure-study.pdf.
 Events triggering clawbacks.

Restatement. 92% have policies to recoup compensation upon a restatement; of those 92%, 73% (i.e,
68% of total) require evidence that the employee caused or contributed to false or incorrect financial
reporting, while 27% (i.e., 25% of total) require repayment in the event of a restatement without personal
accountability. In many cases, the clawback is only triggered for a material restatement or the amount of
the clawback is only the excess of the amount paid over the corrected payments after applying the
restatement.

Misconduct. Misconduct is another prevalent reason (84%) for recoupment of incentives (100% of energy
sector survey). Includes breaking an issuer’s code of conduct or ethics policies, being convicted of a
criminal offense, or other transgressions and often overlaps at times of a restatement.
January 13, 2015
45
BIBLIOGRAPHY
Clawbacks, cont.


Minority clawback events. Committing fraud (44%)(71% of energy sector survey); competition breaching non-compete agreements (22%); misrepresentation of performance results to purposely attain
higher incentive payments (24%); negligence or general lack of supervision/ oversight of subordinates
(16%); violating non-solicitation agreements during or just after the employment period (15%);
misstatement of financial or performance results without any intentions (14%); breaking a covenant other
than non-solicit, non-compete, etc. (10%); financials impacted but through no fault of the employee (9%);
performance targets/thresholds not met by the issuer or division (8%); and issuer standards for compliance
(continuing education, certifications, credential criteria) are not met (3%).
Discretion.

Discretion on trigger events. PWC found that in almost all cases, discretionary features are not included
in the events that trigger a clawback. (e.g., generally do not see provisions that provide blanket discretion
for the Board or Compensation Committee to determine whether a clawback event has occurred).

Discretion on scope. PWC found many examples of discretion in determining the extent of recovery of
compensation in cases where the triggering event has occurred. Many policies reserved the right to apply
the recoupment policies on a case-by-case basis (“discretionary”), while others do not allow for discretion
or judgment (“mandatory”). And some issuers use both, depending on the clawback trigger (“both”).


Discretion on enforcement. Of the 100 issuers studied, 79% reserved discretion to determine whether or
not to enforce their clawback policies on a case-by-case basis (86% in energy sector), 14% mandated the
recovery of awards at the discovery of any clawback triggering behaviors or actions, and 7% reserved
discretion to determine whether or not to enforce their clawback policies for certain clawback triggers or
awards and mandated the recovery of awards for others.
Dodd-Frank reference. Only a combined 33% of the study population mentioned Dodd-Frank in relation to
clawback policies. With Dodd- Frank affecting issuers listed on a securities exchange, expect that percentage to
increase once the SEC issues final rulemaking.
January 13, 2015
46
BIBLIOGRAPHY
Clawbacks, cont.
•
Equilar, Clawback Policy Report (2013), available at http://info.equilar.com/rs/equilar/images/equilar-2013-clawbackspolicyreport.pdf?mkt_tok=3RkMMJWWfF9wsRoisqjPZKXonjHpfsX54%2BgtW6C%2FlMI%2F0ER3fOvrPUfGjI4FScpjI%2B
SLDwEYGJlv6SgFS7fFMalt0LgFXBY%3D.
 Key findings.

Clawback policy disclosure continues to grow. From 2006 to 2013, the number of Fortune 100 issuers
with publicly-disclosed clawback policies increased from 17.6% to 89.4%. Many policies allow issuers to
recover compensation in the event of a financial restatement or ethical misconduct.

Most clawback policies focus on multiple triggers. Of the Fortune 100 issuers that disclosed clawback
policies as grounds for recoupment of compensation, 85.4% included materially inaccurate financial
statements and 81.6% included ethical misconduct. Of Fortune 100 clawback policies, 71.8% included
provisions containing both financial restatement and ethical misconduct triggers. In addition, 29.1% of the
policies included non-compete violations as triggers and 27.2% had other forms of triggers.

Continuing focus on top executives. Of clawback policies included in the analysis, 68.0% applied to key
executives and employees including NEOs in 2013, up slightly from 67.4% in 2012. Percentage of
clawback policies that cover all employees dropped to 14.6% in 2013 from 15.6% in 2012, while policies
that exclusively cover CEOs and/or CFOs rose to 7.8% in 2013 from 6.3% in 2012.

•
Recoupment policies expand to cover more pay. From 2012 to 2013, the percentage of policies
covering types of compensation such as deferred compensation, sales commissions, flexible perquisite
accounts and/or supplemental retirement plans increased from 25.1% to 35.9%.
SEC, Press Release, SEC Charges Software Company in Silicon Valley and Two Former Executives Behind
Fraudulent Accounting Scheme; CEO Agrees to Return $2.5 Million Under Clawback Provision (September 24,
2014), available at http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370543035992#.VJsWh-AABh.
January 13, 2015
47
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