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SEC Issues More COVID-19 Disclosure Guidance as Quarter End Approaches

On June 23, 2019, both the Division of Corporation Finance and the Office of the Chief Accountant issued additional statements to public companies and their stakeholders about the importance of “high-quality” financial reporting and the need for focused analysis and disclosures in the context of the principles-based disclosure system.

The Division of Corporation Finance issued CF Disclosure Guidance Topic No. 9A, a supplement to Topic No. 9 issued near the close of the first quarter of this year (see our prior blog post on Topic No. 9 here).  The new guidance states that the Division is monitoring how companies are addressing COVID-19 related disclosures and encourages public companies to provide meaningful disclosures of the current and expected impact of COVID-19 through the eyes of management.  The key topics covered by the guidance are the effects of the pandemic on a company’s operations, liquidity and capital resources; the short and long-term impact of any federal relief received under the CARES Act; and the company’s ability to continue as a going concern.

The staff acknowledges that companies are making many operational changes as a result of the pandemic – from converting to telework to modifying supply chain and customer contracts, and now converting to the return to the workplace and business reopenings.  The guidance says that companies need to consider whether any or all of those changes “would be material to an investment or voting decision” and disclose accordingly.  The staff takes a similar tack with respect to the

Public Companies Beware of SEC’s Continuing Interest in Accounting and Disclosure Cases

As the end of the quarter approaches for most public companies, it is important to keep in mind that the SEC’s Enforcement Division has brought numerous cases alleging financial and disclosure fraud in the past year.  Many of the cases stem from efforts to meet analysts’ earnings expectations by recognizing revenue prematurely or underreporting expenses and reserves.  Some of the notable matters include:

  • a case against a technology company alleging that it accelerated sales originally scheduled for future quarters, thereby masking declining market conditions,
  • a case against a large insurance company alleging that it underreported reserves, and
  • a case against a publicly traded REIT, alleging that it improperly adjusted “same property net operating income,” a non-GAAP metric.

Allegations in some of the other cases involved:

  • recognizing revenue when there were undisclosed side agreements enabling distributors to return product, or when getting paid was conditioned on the distributor’s sale to an end user,
  • inflating the value of a portfolio of complex reverse mortgage bonds, and
  • failing to correct an error in accounting for FX losses.

The cases are usually accompanied by allegations of books and records violations and significant deficiencies in internal controls.  The SEC almost always imposes multi-million dollar penalties on the companies and brings charges against the individuals the SEC deems responsible for the misstatements, which usually includes CEOs, CFOs and Controllers.

Financial reporting involves judgment calls that can be difficult to make.  It is important that the company’s motivation is accuracy and transparency in

COVID-19 Business Risk Management: Addressing Counter-Party Risk

June 11, 2020

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As public companies continue to manage vulnerabilities attendant to the global pandemic and its widespread economic consequences, counter-party risk assessments and careful management of those risks can be critical.  In a series of ongoing posts to our Retail Law blog, our restructuring and special situations team provides a useful paradigm for analysis and action.  The points made in this series are equally applicable to companies in many other industries.

Our special situations team discusses the importance of getting the finance and legal functions of the business on the same page as the sourcing and sales functions.  As they point out, to be effective with mitigation, all parts of the business need to quickly align in terms of identifying the level of risk each counterparty poses to the business (and how that counterparty’s inability to pay or deliver goods/services will impact the overall business).  In doing so, companies will be better able to allocate scarce resources to counterparties that pose the greatest degree of near-term risk while carefully watching future performance through the same filtered lens.  To help think about the analysis, the team has created a Heat Grid for Triaging Counter-Party Risk that can serve as a one-page resource.

Companies should look both at their customers and their suppliers in assessing risk and addressing mitigation measures.  The point is to be intentional about better assessing particular customer or supplier risk, putting processes in place

U.S. – Significant Increase in Complaints Brings Potential for Increased SEC Whistleblowing Activity

Among the myriad quarantine pursuits undertaken by the work-from-home crowd, whistleblowing appears to be proving popular. Recent reports indicate that the SEC received more than 4,000 Tips, Complaints, and Referrals (“TCRs”) regarding possible corporate malfeasance between mid-March and mid-May.  As noted by Division of Enforcement Co-Director Steve Peikin in a recent speech, that represents an approximate 35% increase over the same period last year.  This surge in TCRs has resulted in the SEC initiating hundreds of new investigations of alleged misconduct in the contexts both of COVID-19 and many other traditional areas.  After already facing challenges from the coronavirus pandemic, many employers may be surprised by this new COVID-19 side-effect.

Under the SEC’s Whistleblower Program, individuals who report TCRs containing high-quality original information that results in financial relief exceeding $1 million may be eligible for monetary awards ranging from 10% to 30% of that relief.  Since the Program’s inception, tips have resulted in more than $2 billion in financial relief, and more than $500 million in related whistleblower awards.  These figures include the recent record award of nearly $50 million to a single whistleblower on June 4, 2020.  Some have attributed the surge in TCRs to a combination of increasingly rich award sums, potential TCR filers’ being emboldened by their remote work environments and/or harboring increasing frustration over their job or financial situations, and enmity by furloughed or terminated employees.

Regardless of its cause, the increase in TCRs means that issuers and regulated entities should evaluate their

U.S. SEC Enforcement Division Pursues Coronavirus-Related Fraud Claims

June 5, 2020

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Federal, state and local law enforcement and consumer protection agencies have been issuing alerts and investigating cases regarding efforts by fraudsters to exploit the coronavirus crisis for profit.  The SEC is taking similar action, focused on the use of public securities markets to carry out fraud.

Since the onset of coronavirus, or COVID-19, the SEC has suspended  trading in the stock of more than 30 companies in connection with coronavirus-related fraud, pursuant to its authority to suspend trading temporarily where it believes that information about a company is unreliable or inaccurate.

And the SEC’s Enforcement Division in recent weeks has brought enforcement  actions in several cases alleging fraudulent statements regarding coronavirus products designed to boost a company’s share price.  The actions were brought against smaller companies issuing releases with false claims about products and services likely to be in high demand because of the pandemic, such as virus tests, hand sanitizer and masks.  The statements are alleged to cause rapid increases in stock price and volume, and are alleged to violate section 10(b) of the Securities Exchange Act of 1934 and rule 10b-5.

The SEC’s latest coronavirus-related complaint, filed this week in the Southern District of Florida, involved a different fact pattern. It charged an investment adviser, E*Hedge Securities, Inc., and its CEO with violations of the Investment Advisers Act of 1940 for failure to produce books and records in the course of an SEC investment-adviser examination, and for failure to properly register under the Act.  E*Hedge on March 22,

Frustrations Emerge Over Lack of Clear ESG Disclosure Standards Among Patchwork of Providers

Fallout from the COVID-19 pandemic appears to be sharpening some investors’ focus on ESG (Environmental, Social or Governance) matters, as evidenced by the SEC Investor Advisory Committee’s recent recommendation that the SEC mandate disclosure of “material, decision-useful, ESG factors” as relevant to each company.

The desire for more clarity around ESG disclosure is understandable.  More than a dozen non-profit and for-profit ESG data providers have emerged in this complex, booming market, according to a May 28, 2020 webinar of the Sustainability Accounting Standards Board and the Society for Corporate Governance.  The data providers generally fall into four distinct groups:  (1) providers who publish guidance for voluntary ESG disclosure, often with company feedback; (2) providers who request data from companies using questionnaires and then based on the answers issue reports or ESG ratings; (3) providers who compile publicly available ESG data about companies and issue ESG ratings based only on that publicly available information; and (4) providers who create assessments of companies based on public and/or private information to sell to investors.

Under the current patchwork, a public company can be the subject of an ESG assessment without knowledge that it occurred or an opportunity to give input or correct misperceptions, particularly in situations where the company has very limited ESG disclosures because ESG issues were not deemed material and not required to be disclosed under SEC rules.  For public companies trying to navigate the maze of ESG issues and disclosures, frustration can easily emerge.  The different ESG assessment

SEC Amends Acquired Business Financial Statement Requirements

On May 21, 2020 the Securities and Exchange Commission adopted a number of amendments intended to reduce the complexity of financial disclosures required for business acquisitions and dispositions by U.S. public companies. These amendments will, among other things, (i) revise the requirements for financial statements and pro forma financial information for acquired businesses, (ii) revise the tests used to determine significance of acquisitions and dispositions, and (iii) for certain acquisitions of a component of a business, allow financial statements to omit certain expenses. The amendments are effective January 1, 2021, but registrants may voluntarily comply with the rules as amended prior to the effective date.

When a registrant acquires a business that is “significant,” other than a real estate operation, Rule 3-05 of Regulation S-X generally requires a registrant to provide separate audited financial statements of that business and pro forma financial information under Article 11 of Regulation S-X. The number of years of financial information that must be provided depends on the relative significance of the acquisition to the registrant. Similarly, Rule 3-14 of Regulation S-X addresses the unique nature of real estate operations and requires a registrant that has acquired a significant real estate operation to file financial statements with respect to such acquired operation.

The significance of an acquisition or disposition is based on an Investment Test, an Asset Test, and an Income Test. The amendments revise the Investment Test to compare a registrant’s investments in and advances to the acquired or disposed business to the

Registered U.S. Securities Offerings in the COVID-19 Pandemic

Despite the ongoing COVID-19 pandemic, companies continue to access the capital markets.  In fact, liquidity concerns have put even greater emphasis on securities offerings for some companies.  But there can be no question that COVID-19 has affected capital market transactions and companies should be mindful of the new environment.

Companies should consider a variety of offering issues that have been affected by the ongoing health crisis.  These include:

Access to the market.  Companies should consult with financial advisors as to the feasibility of offerings during this turbulent time.  Companies may need to be much more flexible in timing and pricing their offerings.

Disclosure.  As always, companies must evaluate the sufficiency of their disclosures.  The difference now is that there may be a higher risk than usual as to whether all material nonpublic information has been disclosed.  The SEC staff has encouraged disclosure to be as timely, accurate and as robust as practicable under the circumstances created by the COVID-19 pandemic.  The Chairman of the SEC and the Director of the Division of Corporation Finance have pressed publicly for these robust disclosures to include management’s expectations about the effects of the pandemic going forward as well as the effects thus far.  They suggested that detailed discussions of current liquidity positions and expected financial resource needs, as well as company actions to protect worker health and well-being and customer safety, could all be material to investors and encouraged disclosure.  As we have previously discussed, companies need to give special

Temporary SEC rules ease Regulation Crowdfunding to address urgent COVID-19 capital needs

The Securities and Exchange Commission (the “SEC”) recently adopted temporary final rules to Regulation Crowdfunding to address companies’ urgent COVID-19 capital needs.  The temporary rules provide tailored, conditional relief to established smaller companies from certain Regulation Crowdfunding requirements relating to the timing of the offering and the availability of financial statements required to be included in issuers’ offering materials.  For example, the temporary rules provide an exemption from certain financial statement review requirements for issuers offering $250,000 or less in securities in reliance on Regulation Crowdfunding within a 12-month period.

The SEC included the following table summarizing the existing Regulation Crowdfunding and changes resulting from the temporary rules:

  Regulation Crowdfunding Temporary Rule Amendments Eligibility The offering exemption is not available to:

·       Non-U.S. issuers;

·       Issuers that are required to file reports under Section 13(a) or 15(d) of the Securities Exchange Act of 1934;

·       Investment companies;

·       Blank check companies;

·       Issuers that are disqualified under Regulation Crowdfunding’s

disqualification rules;

·       Issuers that have failed to

file the annual reports

required under Regulation Crowdfunding during the

two years immediately

preceding the filing of the offering statement In addition to the existing eligibility criteria, issuers wishing to rely on the temporary rule amendments must also meeting the following criteria:

·       The issuer cannot have been organized and cannot have been operating less than six  months prior to the

commencement of the offering; and

·       An issuer that has sold

securities in a Regulation

Crowdfunding offering in the past,

U.S. SEC staff issues FAQs relating to extension of filing deadlines due to COVID-19

May 5, 2020

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Late Monday, the SEC Staff published FAQs addressing several questions relating to the SEC’s March 25th Order extending filing relief for public companies unable to meet a filing deadline because of circumstances related to COVID-19 and previously discussed in our April 1 blog post.

  • Disclosure Required to Utilize Filing Extension (FAQ 1). To utilize the filing extension, a reporting company must disclose in the Form 8-K (or 6-K):
    • that it is relying on the Order;
    • a brief description of the reasons why the company could not make the filing on a timely basis;
    • the estimated filing date;
    • a company-specific risk factor or factors explaining the impact, if material, of COVID-19 on its business; and
    • if the reason the report cannot be timely filed relates to the inability of a third party to provide any required opinion, report or certification, the filing should include as an exhibit a statement signed by the third party specifying the reasons they were unable to provide the document by the original due date.

When the delayed report is eventually filed, the company must disclose that it is relying on the Order and state the reasons why it could not file the report on a timely basis.

  • Shelf-Takedowns Permitted If Required Information Included in Prospectus (FAQ 2). A company that has utilized the Order to delay filing current or periodic reports can continue to complete shelf-takedowns from an effective shelf registration statement if it determines
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