As we noted last year in our memorandum focused on 2013 developments, Securities and Exchange Commission Chair Mary Jo White has called for the SEC to be more aggressive in its enforcement program. By all accounts, the Enforcement Division has responded to that call. The past year saw the SEC continue the trend, started under Enforcement Director Robert Khuzami in 2009, of transforming the SEC’s civil enforcement arm into an aggressive law enforcement agency modeled on a federal prosecutor’s office. This should not come as a surprise since both Andrew Ceresney, the current Director, and George Cannellos, Ceresney’s Co-Director for a brief period of time, like Khuzami, spent many years as federal prosecutors in the Southern District of New York. And the Commission itself is now led for the first time by a former federal prosecutor, Mary Jo White, the US Attorney for the Southern District of New York from 1993 to 2002. Given the events of the past decade involving the Madoff fraud and the fallout from the 2008 financial crisis, we believe both the aggressive tone and positions the SEC has taken in recent years will continue.
Posts Tagged ‘Financial reporting’
The recent financial crisis has generated fundamental reforms in the financial regulatory system in the U.S. and internationally. In our paper, Enhancing Prudential Standards in Financial Regulations, which was recently made publicly available on SSRN, we discuss academic research and expert opinions on this vital subject of financial stability and regulatory reforms.
Despite the extensive regulation and supervision of U.S. banking organizations, the U.S. and the world financial systems were shaken by the largest financial crisis since the Great Depression, largely precipitated by events within the U.S. financial system. The new “macroprudential” approach to financial regulations focuses on both the risks arising in financial markets broadly and those risks arising from financial distress at individual financial institutions.
In our paper, The Impact of Whistleblowers on Financial Misrepresentation Enforcement Actions, which was recently made available on SSRN, we investigate the effect of employee whistleblowers on the consequences of financial misrepresentation enforcement actions by the Securities and Exchange Commission (SEC) and Department of Justice (DOJ). Whistleblowers are ostensibly a valuable resource to regulators investigating securities violations, but whether whistleblowers have any measurable impact on the outcomes of enforcement actions is unclear. Using the universe of SEC and DOJ enforcement actions for financial misrepresentation between 1978 and 2012 (Karpoff et al., 2008, 2014), we investigate whether whistleblower involvement is associated with more severe enforcement outcomes. Specifically, we examine the effects of whistleblower involvement on: (1) monetary penalties against targeted firms; (2) monetary penalties against culpable employees; and (3) the length of incarceration (prison sentences) imposed against employee respondents. In addition, we investigate the effect of whistleblowers on the duration of the violation, regulatory proceedings, and total enforcement periods. We examine the effects of whistleblowers conditional on the existence of a regulatory enforcement action. This distinction is important because our tests exploit variation in consequences to SEC or DOJ enforcement with and without whistleblower involvement; we do not measure the effects of whistleblower allegations for which there are no regulatory enforcement actions.
In our paper, Not Clawing the Hand that Feeds You: The Case of Co-opted Boards and Clawbacks, which was recently made publicly available on SSRN, we examine the impact of beholdenness of the directors to the CEO on the adoption and enforcement of clawbacks.
Clawbacks have been increasingly prevalent in recent years, and the aim of such provisions is to provide a punishment mechanism that links an executive’s compensation more closely to his or her financial reporting behavior. Clawbacks typically allow firms to recoup compensation from executives upon the occurrence of accounting restatements. Perhaps not surprisingly, the implementation and enforcement of clawbacks by companies is likely to create tensions between boards and executives because executives are unlikely to want to have a “Sword of Damocles” hanging over the compensation that is already in their pocket and are likely to resist attempts by boards to claw at this compensation when accounting restatements trigger a clawback. Hence, to better understand the use of clawbacks by firms, it is important to understand the type of boards that are more likely to implement clawbacks.
As calendar-year reporting companies close the books on fiscal 2014, begin to tackle their annual reports on Form 10-K and think ahead to reporting for the first quarter of 2015, a number of issues warrant particularly close board and management attention. In highlighting these key issues, we include guidance gleaned from the late Fall 2014 programs during which members of the staff of the Securities and Exchange Commission (SEC) and other regulators delivered important messages for companies and their outside auditors to consider. Throughout this post, we offer practical suggestions on “what to do now.”
While there are no major changes in the financial reporting and disclosure rules and standards applicable to the 2014 Form 10-K, companies can expect heightened scrutiny from regulators, and heightened professional skepticism from outside auditors, regarding compliance with existing rules and standards. Companies can also expect shareholders to have heightened expectations of transparency fostered by notable 2014 events such as major corporate cyber-attacks. Looking forward into 2015, companies will need to prepare for a number of significant changes, including a new auditing standard for related party transactions, a new revenue recognition standard and, for the many companies that have deferred its adoption, a new framework for evaluating internal control over financial reporting (ICFR). The role of the audit committee in helping the company meet these challenges is undiminished—and perhaps, in regulators’ eyes, more important than ever.
The changing business landscape, technological advances, and significant risks such as cybersecurity continue to present opportunities and challenges for companies today. Directors will want to take a fresh and critical look at their boardroom agenda to ensure it is meeting today’s needs.
PwC’s 2014-2015 edition of Key considerations for board and audit committee members, an annual publication from PwC’s Center for Board Governance, can help enhance the quality of board and management discussions in the coming year.
Here are some highlights:
On January 12, 2015, the United States Court of Appeals for the Second Circuit issued an unprecedented decision holding that a company’s failure to disclose a known trend or uncertainty in its Form 10-Q filings, as required by Item 303 of SEC Regulation S-K, can give rise to liability under Section 10(b) of the Securities Exchange Act of 1934. Stratte-McClure v. Morgan Stanley, 2015 WL 136312 (2d Cir. Jan 12, 2015). The decision in Stratte-McClure is in direct conflict with the Ninth Circuit’s recent ruling in In re NVIDIA Corp. Securities Litigation, 768 F.3d 1046 (9th Cir. 2014) (“NVIDIA“), the only other court of appeals decision to squarely address this issue. The Second Circuit’s decision, while affirming the dismissal of the case against Morgan Stanley, potentially exposes issuers to greater liability under Section 10(b) for alleged failures to disclose known adverse trends and uncertainties as required by Item 303, in addition to the already existing exposure to regulatory claims arising out of such alleged disclosure violations. In light of Stratte-McClure, issuers should proceed with even greater care in crafting their MD&A disclosures, and in particular their disclosures related to known trends and uncertainties.
In our paper, Financial Disclosure and Market Transparency with Costly Information Processing, which was recently made publicly available on SSRN, we provide new insights about the effects of financial disclosure and market transparency. Specifically, we address the following question: can the disclosure of financial information and the transparency of security markets be detrimental to issuers? On the one hand, there is an increasing concern that, in John Kay’s words, “there is such a thing as too much transparency. The imposition of quarterly reporting of listed European companies five years ago has done little but confuse and distract management and investors.” On the other, insofar as disclosure reduces adverse selection and thus increases assets’ issue prices, it should be in the best interest of asset issuers: these should spontaneously commit to high disclosure and list their securities in transparent markets. This is hard to reconcile with the need for regulation aimed at augmenting issuers’ disclosure and improving transparency in off-exchange markets. Yet, this is the purpose of much financial regulation such as the 1964 Securities Acts Amendments, the 2002 Sarbanes-Oxley Act, and the 2010 Dodd-Frank Act.
The close of 2014 saw the SEC’s Division of Enforcement take a victory lap. Following the release of the statistics for the fiscal year ended September 30, Division Director Andrew Ceresney touted a few records—the largest number of enforcement actions brought in a single year (755); the largest total value of monetary sanctions awarded to the agency (over $4 billion); the largest number of cases taken to trial in recent history (30). As Ceresney noted, numbers alone don’t tell the whole story. And it is in the details that one sees just how aggressive the Division has become, and how difficult the terrain is for individuals and entities caught in the crosshairs of an SEC investigation under the current administration.
Today [January 14, 2015], the Commission considers rules that are designed to address the lack of transparency in the security-based swaps (SBS) market that substantially contributed to the 2008 financial crisis. These rules are the result of the Congressional mandate in the Dodd-Frank Act, which directed the SEC and the CFTC to create a regulatory framework to oversee this market.
The global derivatives market is huge, at an amount estimated to exceed $692 trillion worldwide—and more than $14 trillion represents transactions in SBS regulated by the SEC. The continuing lack of transparency and meaningful pricing information in the SBS market puts many investors at distinct disadvantages in negotiating transactions and understanding their risk exposures. In addition, as trillions of dollars have continued to trade in the OTC market, there is still no mandatory mechanism for regulators to obtain complete data about the potential exposure of individual financial institutions and the SBS market, in general.