Photo of David C. Scileppi

David is a Gunster Shareholder and Co-Chair of its Securities and Corporate Governance Practice.  His principal areas of practice are securities, corporate governance, mergers and acquisitions, and general corporate law.  He has extensive experience in securities matters, including advising clients with regard to private and public offerings of securities (including initial public offerings) and ongoing disclosure obligations.  David has taken companies public as an attorney and, while an auditor with KPMG LLP, as an accountant.

PCAOB creates yet another dumpster fire  (Photo by Toms River FD)
PCAOB creates yet another dumpster fire
(Photo by Toms River FD)

Earlier this month, after seven years of threats, the PCAOB adopted rules to drastically change the standard auditor’s report. In adopting the rules, the PCAOB noted that the standard auditor’s report had largely remained unchanged since the 1940s. I believe there was good reason for this: the current auditor’s report works well (or at least well enough). It is simple and, therefore, easy to interpret. Either a company receives an unqualified opinion or it doesn’t. The current report is generally referred to as a pass/fail model. But, the simple and straightforward approach is about to change.

Enter the CAMs

The PCAOB has introduced a new acronym for us to learn, CAM, which stands for Critical Audit Matter. Under the new rules, a CAM is any matter communicated or required to be communicated to the audit committee that: (i) relates to material accounts or disclosures that are material to the financial statements and (ii) involves especially challenging, subjective, or complex auditor judgment. Each and every CAM, as determined by an issuer’s auditor, will then be identified and described in the audit report and the auditor will explain how the CAMs were addressed in the audit. Simple enough, right? Don’t worry, if you are confused – the rules contain a flow chart!

The whole idea behind the CAMs concept is that it is designed to reduce the information asymmetry that exists between investors and auditors. The PCAOB is concerned that investors are unable to adequately assess the risk that underlies the estimates and judgments made by management in preparing the financial statements. That’s probably a fair assessment, but changing the auditor’s report won’t address information asymmetry. And here’s why:

First, critical audit matters are already identified in the MD&A and the financial statements. The PCAOB claims that the auditor should not be limited to discussing the estimates that management discloses. While that may be a good point, most sophisticated users of financial statements should be able to identify the significant estimates an issuer would make. Generally, these estimates are consistent from company to company based on their industry. Is it a revelation that a commercial bank’s most significant estimate is its allowance for loan losses? Or that the valuation of inventory would be important to an issuer with a large inventory balance (especially if the inventory can quickly become obsolete)?

Second, the PCAOB notes that if there aren’t any identified CAMs then the auditor will need to state that fact. What’s the likelihood that any of the larger accounting firms will go on record to state that there was very little judgment used in compiling a set of financial statements? I think the likelihood is next to zero. Also, what is the likelihood that each auditor will craft a custom disclosure each year Continue Reading The CAMs are coming and other enlightened enhancements courtesy of the PCAOB

William Hinman, the new Corp Fin director
William Hinman, the new Corp Fin director

As has been rumored, the SEC announced today that William H. Hinman will be the new director for the SEC’s Division of Corporation Finance.

Mr. Hinman, who recently retired as a securities and corporate finance partner from the Silicon Valley office of Simpson Thacher & Bartlett LLP, has advised in some of the larger IPOs in the technology section in recent history such as Alibaba, Google and Facebook. Mr. Hinman replaces Keith Higgins, the former director of Corp Fin who left in January.

Given newly appointed SEC Chair Clayton’s stated desire to substantially reduce regulation and burdens to increase the IPO market, hiring Mr. Hinman seems to align with Chair Clayton’s vision. The number of public companies has decreased 37% since the high water mark set in 1997. While there may be many reasons for the decrease in IPOs and in the number of public companies, overly burdensome disclosure obligations certainly ranks among the top reasons (see conflict minerals, pay ratio, CD&A, XBRL . . . ).

While I doubt we will be going back to 20 page Form 10-Ks, let’s hope that the new Chair and Corp Fin director can jettison some of the most burdensome and least effective disclosure, that they can help make the public capital markets for potential small- and mid-cap issuers more robust, and that the SEC can move forward with other important initiatives.

Bob Lamm wins Lifetime Achievement AwardCongratulations to our esteemed colleague, Bob Lamm, for winning this prestigious award! While we all know that Bob is the guru in the governance space, it’s great that he was recognized for all of his achievements (to date!). Well deserved!

WEST PALM BEACH, Fla. (Nov. 29, 2016) – Gunster, one of Florida’s oldest and largest full-service business law firms, is pleased to announce that Bob Lamm received the Lifetime Achievement award at the ninth annual Corporate Secretary Corporate Governance Awards.

Lamm serves as co-chair of Gunster’s securities & corporate governance practice. He has devoted his career to governance in his prior positions with companies such as Pfizer; CA, Inc.; and W.R. Grace & Co. In addition to his role at Gunster, Lamm acts as an independent senior advisor to the Deloitte Center for Board Effectiveness and as an advisory director of Argyle, and he has actively been involved as a long-term member of the Society for Corporate Governance. In addition, Lamm serves as a senior fellow of the Conference Board Center for Corporate Governance, as well as a director for the Junior Achievement of South Florida.

“As an independent senior advisor, Bob has made an indelible mark. His dedication shows his deep passion for investing in the next generation of independent directors,” said Deb DeHaas, vice chair and managing partner at the Deloitte Center for Board Effectiveness. “Throughout my career, it has been my experience that truly brilliant people are also kind and generous of spirit. In this respect, Bob is a special treasure; an expert lawyer with a big heart and the soul of a teacher, who shares his knowledge without pretension, and always praises the qualities he sees in others,” added Iain Poole, managing director at Argyle. Bill Perry, Gunster’s CEO and managing shareholder stated that “Bob’s commitment to excellence in corporate governance and securities law is exceptional. We are fortunate to call Bob a colleague and as Florida’s law firm for business, we are honored to have him among our ranks.”

On Thursday, Nov. 3, more than 400 industry professionals in the governance, risk and compliance world gathered together in New York to celebrate the best of the best in the industry and celebrate the lifelong accomplishments of all the evening’s honorees. There were over 300 nominations received in 14 different categories.

 

Photo by Chad Cooper
Photo by Chad Cooper

Good, but not surprising, news for issuers considering a Regulation A+ offering. Back in May 2015, Massachusetts and Montana sued the SEC in an attempt to invalidate the Regulation A+ rules.  Montana had attempted to obtain an injunction to prevent the Regulation A+ rules from going into effect last June, but was denied.  Now, the DC Circuit has officially rejected the lawsuit brought by the two states.

As we have discussed, Regulation A+ is a vast improvement over the previous version of Regulation A.  The biggest improvement, state pre-emption, was the most controversial (from the states’ perspectives).  Because Regulation A is already a more burdensome exemption than Regulation D (private offerings) due to the need for SEC review and qualification, pre-empting state securities laws for Tier II offerings was a welcome improvement.  The North American Securities Administrators Association (NASAA), which represents the state securities regulators, was strongly against pre-emption.  NASAA is largely seen as the force behind the lawsuits by Montana and Massachusetts.

I will boil down the details of the lawsuit into a sound bite. The states argued that the SEC acted beyond its authority in enacting rules that pre-empted state securities laws.  The court disagreed and said that Congress, in passing the JOBS Act, pre-empted the state laws.

Massachusetts and Montana could appeal, but I doubt that they will. The validity of the states’ argument was not well grounded because the JOBS Act clearly states that the new Regulation A+ exemption would be a “covered security” – which means state law is pre-empted by federal law.

In any event, the conclusion of the lawsuit provides additional clarity for Regulation A+ offerings. We expect that Regulation A+ will become more widely used as bankers and issuers become more comfortable with the exemption.

ASU 2016-09 - Share-Based Accounting
Photo by David Fulmer

Over the past couple of months, the FASB has been busy. I wanted to point out one recent change and my thoughts on its impact.

FASB has “simplified” share-based compensation accounting. I will always have a special place in my heart for old FAS123 since it was on my CPA exam a couple of decades ago.  Nevertheless, much has changed since then (APB No. 25 anyone?), including most recently:

  • No more APIC pools. Currently, tax benefits in excess of compensation cost are recorded in equity (specifically, Additional Paid In Capital or APIC). The accumulation of excess benefits has been known as an APIC pool. Tax deficiencies decrease the APIC pool. Under the new accounting rules, excess benefits and deficiencies are recognized in the period in which they occur.

My Take – Expect more income tax expense volatility from period to period. If the changes impact tax expense significantly, we could see more non-GAAP financial measures develop. Just be careful of the renewed focus on non-GAAP financial measures from the SEC.

  • No longer need to estimate forfeitures. GAAP currently requires you to estimate the number of awards that will be forfeited to calculate a more accurate amount of compensation cost each period. Under the new rules, you can continue to estimate or you can just reverse the compensation previously expensed when the forfeiture occurs. If you choose the new route, then you will have to hit retained earnings for the cumulative-effect adjustment incurred as a result of the change as of the beginning of the year the change is applied.

My Take – Again, there could be potentially more volatility if you elect to apply the new “actual” forfeiture approach.   A good example of volatility would be if a company had a significant layoff of employees. The increase in forfeitures during the layoff period would significantly Continue Reading Impact of accounting literature: Time to get out of the pool and other changes

Pay ratio disclosures
Photo by Brian Talbot

After much foot dragging, I have finished reading the adopting release for the new pay ratio disclosure rules.  Yes, the release is long (300 pages or so), but adopting releases are always long.  The real reason why it took so long is that the whole concept of pay ratio disclosure just seems silly to me (and apparently to Bob Lamm as well) so I just hoped it would go away.

I am not against finding ways to strengthen the middle class.  Just like I am not against ending the sale of certain minerals in Central Africa that end up funding deadly conflict.  The problem I have is that public companies should not have to bear the complete burden of fixing social ills.  Less than 1% of the 27 million companies in the United States are publicly traded.  And there are plenty of private companies that are larger than most publicly traded companies.  Thus, while we may not agree whether the social goals are worth achieving, I think we can all agree that there are better ways to achieve them than selective enforcement (particularly since the SEC itself has said that the pay ratio will not be comparable from one company to another).  The Securities Edge  has been criticizing the social disclosure movement for some time, but we haven’t yet seemed to have stopped Congress from continuing to go down that path.

So, unless Congress acts to reverse its mandate for public companies to disclose their pay ratios before 2018 (the first year of required disclosure), I suppose we should all start learning how to comply.  Leading practices for calculating the ratio and providing narrative disclosure will develop over the next couple of years, but I have summarized the important parts of the rules in this post:

What is the required disclosure?

Registrants must disclose:

  • The median of the annual total compensation of all employees of the registrant (excluding the CEO)
  • The annual total compensation of the CEO; and
  • The ratio of the median to the CEO’s compensation.

The ratio needs to be expressed as X:1 or X to 1 where “X” represents the CEO’s total compensation and “1” represents the median employee’s salary.  The ratio can also be expressed in narrative form such as: “The CEO’s annual total compensation is X times the median employee’s annual total compensation.”  You can’t Continue Reading Pay ratio (unfortunately) coming to public company filings soon

Reg A+ is now effective!
Photo by Lisandro M. Enrique © 2015 All rights reserved

Today is June 19th.  It is an exciting day for companies that need to raise capital because Reg A+ finally goes into effect.

As a reminder, Reg A+ is a nickname for SEC Regulation A, as amended by the SEC.  Reg A has been around for many years but was rarely used because it was available only to very small financings, had too many limitations, and was costly.  As part of the JOBS (Jumpstart Our Business Startups) Act enacted in 2012, the SEC was instructed to update Reg A to make it more useful as a capital-raising tool.  Reg A+ is the result.

The main benefits of Reg A+ include the following:

  • Companies can raise up to $50 million every 12 months.
  • Insiders can sell their shares in a Reg A+ offering.
  • Investors in a Reg A+ offering have immediate liquidity – they can sell their shares once the offering is completed and don’t have to hold them for a period of time.
  • Some Reg A+ offerings are exempt from state securities or “blue sky” laws.
  • Some Reg A+ offerings are easier to list on an exchange.

We think Reg A+ provides a great opportunity to raise capital and can be looked at as an alternative to either a private placement or an IPO.  But, don’t take our word for it.  Here is what others are saying about Reg A+.  If you have any questions about Reg A+, please feel free to reach out to any of the Gunster attorneys in the Securities and Corporate Governance Practice.

Long Delay for JOBS Act Changes
Photo by Omar Parada

On January 14th, the House passed H.R. 37 “Promoting Job Creation and Reducing Small Business Burdens Act.”  Although passed with some support from the Democrats (29 votes, which in these days of hyper-partisanship is practically a bipartisan bill), the White House issued a veto threat on January 12th because the bill also delays part of the Volker Rule effectiveness until July 21, 2019.  Thus, in its current form, it looks dead on arrival, but there are some interesting ideas that I support and will hopefully make it in a revised bill later in the term:

  • Delays the requirement for savings and loan holding companies to register under the Securities Exchange Act of 1934 to the same extent as bank holding companies (assets of $10 million and class of equity securities held of record by 2,000 or more persons).  Also allows deregistration for savings and loan holding companies when they have fewer than 1200 shareholders of record.  This seems fair and was likely an unintended distinction made when the JOBS Act passed.  Unfortunately, this innocuous bill was grouped with the Volker delay. 
  • Provides for an exemption from the Securities Exchange Act of 1934 for certain business brokers.  The bill provides for some restrictions such as Continue Reading Update to the JOBS Act? Probably not…

 

Florida corporation pushing the envelope with restrictive bylaws?
Photo by Stuart Rankin

How to stop frivolous plaintiff lawsuits?  Since 2010, when Vice Chancellor Laster of the Delaware Court of Chancery noted that “if boards of directors and stockholders believe that a particular forum would prove an efficient and value promoting locus for dispute resolution, then corporations are free to respond with charter provisions selecting an exclusive forum for intra-entity disputes,” many public companies have adopted bylaws provisions restricting frivolous derivative lawsuits.  As the ABA notes, these so called “forum selection bylaws” are extensions of the forum selection clauses that have long been upheld in contracts.

As anyone who has ever worked on a public merger well knows, within hours after a merger is announced, several plaintiff firms will announce an “investigation” and then file a derivative lawsuit (presumably based on the findings of their thorough “investigation”).  Of course, frivolous lawsuits aren’t limited to M&A transactions, but many of these lawsuits follow the same pattern.  As a result, public companies have had continued interest in restricting such lawsuits.  Forcing plaintiffs to sue in Delaware with a forum selection bylaw is one way to help restrict lawsuits.  But, more recently, some companies have become even more creative.  Here is a quick chronological summary of the movement to adopt restrictive bylaws:

Bob's Upticks added to The Securities Edge
Photo by Austin Kleon

To our readers:

As you may have noticed, this week we launched a new feature for The Securities Edge.  We call our new feature “Bob’s Upticks,” which will be authored by our very own Bob Lamm.  We are excited to add this new “blog within a blog” and to share Bob’s extensive and deep securities and corporate governance knowledge with you!

While The Securities Edge has always strived to provide deeper analysis on some of the most important issues of the day, Bob’s Upticks will use shorter posts and will focus on keeping you up to speed on the weekly changes in the securities and corporate governance world.  When Bob was the Chairman of the Securities Law Committee for the Society of Corporate Secretaries and Governance Professionals, we all looked forward to receiving Bob’s weekly updates.  With Bob’s Upticks, our readers get the same opportunity! You can even subscribe separately to the RSS feed for Bob’s Upticks 

Please drop us a note to let us know what you think.