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Report on SEC Comment Letter Trends Highlight Issues for 10-K Disclosure

Deloitte recently published a 127-page report on SEC comment letter trends that companies may find useful as they prepare their annual 10-K disclosures.

Recognizing that Keith Higgins and other SEC staff members have admonished companies not to provide disclosure merely because it is known to be a “hot button” that may generate an SEC comment, with similar advice from the staff that even the receipt of an SEC letter with specific comments is supposed to be the beginning of a discussion rather than a set of demands, companies should still be aware of the topics that generate the strongest staff focus.
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Top Five Considerations for Improved Proxy Disclosure from Investors’ Perspectives

RR Donnelley’s survey from last year on how investors view proxy statements continues to be worth considering now, as companies begin preparing their public disclosure documents for the 2015 proxy season. The survey results show that a mix of presentation and substantive issues are compelling for investors, and boil down to five key points.

Impressive online appearance.  A key consideration, often overlooked, is to recognize that major institutional investors are using online platforms to review proxy statements. Many companies have spent vast amounts of resources to make their documents more readable, but the focus has continued to be on the visual effect of hard copies.
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Oil and Gas Companies Agree to Disclose Hydraulic Fracturing Risks in SEC and Other Public Documents

Anadarko Petroleum Corporation and EOG Resources, Inc. agreed with the New York State Attorney General earlier this month to provide additional disclosure regarding hydraulic fracturing risks in, and outside of, their SEC filings. These agreements, available here and here, effectively set forth disclosure checklists for the companies’ annual reports on Form 10-K for any material financial effects of current and future hydraulic fracturing regulation, litigation and impacts to drinking water, air and the environment resulting from hydraulic fracturing, including disclosure of each company’s management of these matters. In addition, Anadarko and EOG agreed to publicly disclose (outside of their SEC filings) detailed information regarding hydraulic fracturing risk mitigation techniques, chemical and greenhouse gas information and injury rate and spill statistics.
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Large European Companies Now Required to Provide Mandatory Environmental, Social and Governance (ESG) Disclosure

The European Council adopted on September 29, 2014, a Directive requiring large public interest entities with more than 500 employees to disclose in their annual reports “relevant, useful information” necessary for an understanding of such companies’ environmental, social, employee, human rights, anti-corruption and bribery matters. These companies will also be required to disclose board diversity matters. The disclosure would focus on the companies’ governing policies, related risks and the management of such risks. The Directive will become law 20 days after it is published in the European Union Official Journal (which is expected in due course). Member states will have two years to transpose the Directive into national legislation.
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Study Reflects Key Trends in Governance and Executive Compensation Practices at the Largest Companies

91% of big companies disclose the existence of anti-hedging policies and 66% mention anti-pledging policies, according to the Meridian 2014 Governance and Design Survey, which examined the 250 largest public companies by revenue and market capitalization.  Anti-pledging policies generally prohibit all pledging of company shares, although 18% allow some pledging with approval by the board or management.

Other notable governance structure developments include:

  • Majority voting and classified boards.  89% use majority voting standards for director elections, but only 79% of those companies accompany that with  mandatory resignation policies.  While there has been a movement toward annual elections,  21% continue to have a classified board. 

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Twelve Senators Urge SEC Not to Delay Conflict Mineral Disclosure

Senate Assistant Majority Leader Dick Durbin (D. Illinois) and a group of 11 other senators are urging the SEC to move forward with the initial deadline of May 31 (or June 2, 2014 for this year) for public company due diligence and reporting of conflict minerals.  The letter stated that the SEC rule was “drafted in a balanced and thoughtful way that followed Congressional intent,” and given what the Senators view to be “strong court decisions” affirming major portions of the rule, a delay in implementation is not necessary while the free speech issues cited by the recent appeals court decision are resolved.
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SEC Cybersecurity Roundtable Panel Debate Public Disclosure and Board Roles

The need for disclosure about cybersecurity breaches must be balanced against other factors, urged some of the panelists at the SEC’s roundtable on cybersecurity when the discussion focused on this topic.

While the SEC in its own 2011 guidance for companies questioned whether disclosure of historical attacks would make companies more vulnerable to future breaches, at least one panelist was equally concerned that the disclosure was more likely, based on historical examples, to bring about a rash of litigation. That creates a strong disincentive to disclose breaches, especially if a company can conclude that it does not otherwise have a disclosure obligation. 
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SEC Warns Against Agreements Restricting Whistleblowers and Continues to Discuss Reforms Focused Proxy Advisers and Disclosure Requirements

Sean McKessy, the Chief of the SEC’s whistleblower office, recently warned companies not to be “creative” in trying “get people out of our programs.” He was referring to concerns regarding confidentiality, separation or employee agreements that require employees to agree that they will not report issues to a regulator in order to obtain the benefits under the contracts. His admonishment went so far as to indicate that the Commission will examine not only the companies that may have these types of agreements but will also “go after” the lawyers who prepared them, reminding people that the SEC has the power to revoke attorneys’ ability to appear before the Commission and indicating that the SEC is actively looking for these types of situations.
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SEC Pay Ratio Rule: Davis Polk Comment Letter

As discussed previously here, the SEC solicited comments on its proposed “pay ratio” rule, as mandated by Section 953(b) of the Dodd-Frank Act, that requires companies to disclose the median annual total compensation of all employees, as well as the ratio of that median to the annual total compensation of the company’s chief executive officer. Davis Polk has submitted a comment letter with the following recommendations, which are focused on easing companies’ compliance burdens:

  • More flexible timing for determining the “median employee”: providing companies with the option to select a date prior to the company’s fiscal year end as the calculation date for purposes of determining the median employee, so as to allow companies to perform the median employee analysis outside of the crush of the busy fiscal year end.

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Joe Hall Discusses PCAOB’s Audit Report Proposals on Spreecast

TheCorporateCounsel.net hosted a Spreecast with Davis Polk’s Joe Hall and re: The Auditors’ Francine McKenna focused on the PCAOB’s new audit report proposal, which we address in this memo

On the Spreecast, Joe summarized the proposals’ main requirements, and focused on a few key points that companies may want to think about. One proposal would require the auditor to discuss “critical audit matters” in the audit report. Joe questioned whether this would result in much new information for investors beyond what a company already discloses in its “critical accounting policies” discussion, and was skeptical that it would produce anything like a robust and individualized discussion about the company’s financials.
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Initial Reactions to the SEC Pay Ratio Rule Proposal

By now, the governance community is well aware that the SEC proposed the pay ratio rules yesterday at an open meeting, which we discussed here. The initial reaction has demonstrated the divisive nature of the disclosure.

The AFL-CIO lauded the SEC for finally passing the proposal three years after passage of the Dodd-Frank Act. While the SEC release is clear that the Commission is uncertain about the exact benefits of the pay ratio disclosure, the AFL-CIO, a persistent advocate of the pay ratio disclosure, believes that the information will “help investors evaluate CEO pay levels in a broader context.” According to their calculations, the ratio of the S&P 500 CEOs was “354 times more pay than rank-and-file workers” in 2012.
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SEC Approves Proposing Pay Ratio Rules for Public Comment

At the SEC’s open meeting today, the Commissioners approved in a 3 to 2 vote (Commissioners Gallagher and Piwowar dissenting) the proposed so-called “pay ratio” rules, mandated by Section 953(b) of the Dodd-Frank Act, that require companies to disclose the median annual total compensation of all employees and the ratio of that median to the annual total compensation of the company’s chief executive officer. 

Based on the summary read at the meeting, the proposed rules will provide companies with “significant flexibility” to determine the median total compensation for their employees. Companies will be allowed to use any “consistently applied compensation measure” (for example, wages recorded for tax filing purposes), including the use of reasonable estimates.
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Studies Reveal Companies Disclosing Cybersecurity Risks, to a Degree

22% of the Fortune 501 to 1000 companies remain silent about their cybersecurity risks, compared to 12% of the larger Fortune 500 companies, according to a September report released by the Willis Group. Other than this key difference, the report found that the public disclosures by smaller companies were similar to the findings in the Willis Group’s prior study published in June, which focused solely on the Fortune 500. In both cases, the primary risks identified included: loss or theft of confidential information, reputational harm, direct loss from malicious acts caused by hackers or viruses, and liability concerns from system breaches or failures.
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PCAOB Proposes Framework to Reorganize Auditing Standards

The PCAOB has proposed a framework for reorganizing existing auditing standards based on topics. Currently, existing standards consist of “AS Standards,” which are new or amended standards adopted by the PCAOB, or “AU Sections,” which are interim auditing standards originally from the American Institute of Certified Public Accountants that the PCAOB adopted in April 2003. Over time, some AU sections became superseded and replaced by PCAOB rules.

The topics will be grouped into the following categories: general auditing standards for broad principles and activities; audit procedures; auditor reporting; matters relating to SEC filings; and other matters. Certain interim standards will also be replaced in the process, but the changes are not expected to impose new requirements on auditors.
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Concerns Regarding New Auditing Standard 16, Communications with Audit Committees

As we discussed here, the PCAOB recently approved Auditing Standard No. 16, Communications with Audit Committees. While the bulk of the new standard concerns communications that the auditors are required to provide to the audit committee, one notable provision relates to inquiries required to be made of the audit committee by the independent auditor. Under the new standard, auditors are required to inquire whether the audit committee “is aware of matters relevant to the audit, including, but not limited to, violations or possible violations of laws or regulations.” This expands the inquiries of the audit committee required by previous auditing standards, which required the auditor to inquire of the audit committee regarding the matters important to the identification and assessment of risks of material misstatement and fraud risks.
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SEC Staff Continues to Focus on Loss Contingency Disclosures

In recent months, the SEC staff has increasingly raised the disclosure of loss contingencies required by FASB ASC 450-20-50 (formerly known as FAS 5) in comment letters and as a discussion point at conferences and meetings.

In particular, the staff is focusing on whether and when a company discloses an estimate of the “possible loss or range of loss” associated with unaccrued loss contingencies. Prodded by the staff, several large financial institutions (American Express Company, Bank of America Corporation, Citigroup Inc., The Goldman Sachs Group Inc., JPMorgan Chase & Co., Morgan Stanley and Wells Fargo & Company) gave an estimate of possible loss or range of loss above their existing reserves for the first time in their Form 10-Ks for the 2010 fiscal year and updated those estimates in their 2011 first quarter Form 10-Qs.
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Environmental Disclosure in SEC Filings – 2011 Update

This memorandum, which updates our January 2009 and February 2010 memoranda on this topic, summarizes the key developments in the past year relating to environmental disclosure and provides practical guidance on how to comply with the complex SEC rules relevant to environmental matters. In particular, the memorandum discusses (i) updates regarding SEC climate change disclosure; (ii) potential revisions to the SEC’s risk factor disclosure standards; (iii) an update on the New York Attorney General’s climate risk disclosure subpoenas; and (iv) FASB’s ongoing efforts to expand its requirements governing loss contingency disclosures.
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