Financial Reporting and Regulatory Update

Second Quarter 2022

From the SEC

Public statements and announcements

Investor Advisory Committee meeting

The SEC Investor Advisory Committee held a meeting on June 9, 2022, that included two panel discussions – one regarding accounting of nontraditional financial information and one addressing climate disclosures. The panel discussion on accounting of nontraditional financial information began with a general overview of the U.S. accounting and auditing infrastructure presented by speakers from the SEC and the PCAOB. Three experts discussed whether the accounting and auditing infrastructure is providing investors with the information they need to make informed decisions and provided their suggestions and strategies to make sure the U.S. capital markets remain the most competitive in the world. The panel discussion on climate disclosures focused on the SEC’s March 2022 proposed rules to enhance and standardize climate-related disclosures.

Statement on importance of independence

On June 8, 2022, SEC acting Chief Accountant Paul Munter issued a statement on the importance of auditor independence and an ethical culture for the accounting profession. He identifies the SEC’s auditor independence rule, Rule 2-01 of Regulation S-X, as integral to the SEC’s mandate to protect investors and notes it is fundamental for promoting investor confidence in the quality of financial disclosures. In addition, Munter discusses:

  • The importance of the auditor independence framework under Rule 2-01(b) of Regulation S-X. Munter says not to overlook the importance of Rule 2-01(b) when determining whether an accountant is independent and that all relevant circumstances should be considered. The independence evaluation is not just a checklist exercise under Rule 2-01(c), and the general standard requires an evaluation of auditor independence, including an assessment of independence both in fact and appearance from the perspective of a reasonable investor.
  • The Office of the Chief Accountant’s (OCA) approach to auditor independence consultations. Munter notes that an important part of consultations is that all relevant circumstances and facts for the specific question are provided to the OCA. Also, Munter warns that relying on previous staff positions might not be appropriate as specific risks, facts, and circumstances might be different even if they appear similar and the OCA will independently access all circumstances.
  • Recurring issues on auditor independence consultations. Munter identifies recurring issues in recent independence consultations, including treating independence considerations as a checklist in place of a careful analysis, providing nonaudit services without considering the extent and magnitude of the nonaudit services and business relationships, and initiating complex business arrangements through restructurings and the use of alternative practice structures.

Finally, Munter notes the importance of accounting firms fostering an ethical culture with respect to auditor independence and leading by example.

Remarks on market structure

In his speech on June 8, 2022, before the Piper Sandler Global Exchange Conference, SEC Chair Gary Gensler discussed market structure and how the playing field is not level across different parts of the market. He concentrated on trading in dark pools and through wholesalers, noting that key aspects of the U.S. national market system rules, including rules related to order handling and execution, have not been updated in almost seven years. Gensler described the requests he has made of staff for recommendations on how to update the rules, specifically in the following six areas:

  • Minimum pricing increment
  • National best bid and offer
  • Disclosure of order execution quality
  • Best execution
  • Order-by-order competition
  • Payment for order flow, exchange rebates, and related access fees

Discussion of key matters

On June 2, 2022, the 40th Annual SEC and Financial Reporting Institute Conference was held and included speakers and presentations from the SEC, the FASB, and the PCAOB among others. The opening keynote session with representatives from the FASB and the SEC OCA focused primarily on the FASB agenda consultation and highlighted the 500-plus letters written by investors and stakeholders to the FASB with feedback on recent standards updates. Some of the key areas of feedback centered around the need for further disaggregation of the income statement (additional information about expenses), disclosures on climate regulations and environmental credits, policies related to digital assets, and a review of the income tax provision disclosure requirements (better understanding of complex tax positions). The session also touched on what projects the FASB, the SEC, and the PCAOB are planning to work on in the coming year including standardizing key performance indicators (KPIs), reorganizing consolidation guidance, and the climate disclosure proposal.

Speakers also discussed ESG matters throughout the conference, including implementation of new ESG policies and regulations and what the future holds for companies disclosing information related to ESG policies. One presenter emphasized that while ESG disclosure requirements are not fully instituted yet, companies need to be proactive about instituting policies and controls related to ESG disclosures now. Management should consider using the help of specialists, regulators, auditors, and researchers to identify how the ESG disclosure requirements will affect companies.

Other sessions focused on the remote work environment, high employee turnover and the labor shortage and its effect on auditing and accounting, the Russia-Ukraine war and how it is affecting the agencies, the recent increase in the use of non-GAAP adjustments and a plan to release further guidance about when a company can and can’t use them, and PCAOB inspection focus areas.

Testimony before Congress

On May 17, 2022, Chair Gensler provided testimony before the Subcommittee on Financial Services and General Government of the U.S. House Appropriations Committee on necessary increases in SEC resources.

Gensler noted that it takes constant vigilance to protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation, and he said U.S. securities laws are the gold standard for capital markets around the world. He said that we cannot take U.S. leadership in capital markets for granted as new financial technologies and business models continue to change the face of finance for investors and issuers, more retail investors than ever are accessing our markets, and other countries are developing competitive capital markets. To meet the challenges of maintaining these high standards, the SEC needs to be adequately resourced. Market participation, responsibilities, technologies, and competition have increased, the funding for the SEC has not, and the agency has shrunk in size.

Gensler detailed his budget request for enforcement and examinations, corporate finance, trading and markets, and investment management, among other areas. He shared that the expansive growth and added complexity in the capital markets continue to necessitate increased resources for the SEC. He said, “Markets don’t stand still. The world isn’t standing still. Our resources can’t stand still, either.”

Remarks on enforcement landscape

Gurbir Grewal, director of the SEC Division of Enforcement, presented a speech on May 12, 2022, at the Securities Enforcement Forum West 2022. Grewal said a goal of enforcement is to increase public confidence in the U.S. markets and government and to offset the waning trust in institutions. Grewal noted that it is in everyone’s collective interest to ensure that investigations move quickly and efficiently. He discussed the perception of delayed accountability as investigations seem to take a very long time and examined obstacles that are encountered throughout the enforcement process including document production issues; reputational, financial, psychological, and emotional costs; trust between staff and counsel and staff and witnesses; and questionable privilege claims.

With regard to document production, he noted there are problems with delayed or slow production, too many documents being provided, or too few being provided in response to requests. Highlighting the importance of documents, Grewal described them as “the lifeblood of many investigations.” He ended his speech with thoughts on the way forward including discussing cooperation, the ways to cooperate, and the benefits of cooperating.

Remarks on swaps

On May 11, 2022, Chair Gensler delivered prepared remarks before the International Swaps and Derivatives Association Annual Meeting. Gensler noted that the U.S. economy benefits from a well-functioning swaps market as it is important that companies have the ability to manage their risks. He addressed security-based swaps, which are under the SEC’s jurisdiction. Related to the security-based swap markets, he concentrated his remarks on reducing risk, increasing transparency, and enhancing market integrity. He described recent actions taken by the SEC including rule implementations and proposals to reduce risk, enhance pre-trade and post-trade transparency, and improve market integrity. He added that there is still more work to do.

Gensler closed his speech by discussing crypto assets with derivatives and the use of derivatives within structured and so-called complex products. He described actions that can be taken to improve guidance and regulations over these products.

Discussion on climate disclosures and SPACs proposals

On May 6, 2022, the SEC’s Small Business Capital Formation Advisory Committee met to examine the SEC’s proposed rules on climate-related disclosures and proposed rules on special purpose acquisition companies (SPACs), shell companies, and projections.

Chair Gensler provided remarks to the committee on both proposals. He said he believes the climate-related disclosures proposal will help ensure that investors receive consistent, comparable, and decision-useful information and will establish clear and consistent reporting obligations for issuers. Gensler said that the SPACs proposal would strengthen the disclosures, marketing practices, and gatekeeper and issuer obligations for SPACs.

Commissioner Hester Peirce also provided remarks on the proposals’ potential effects on small businesses. She noted that the climate change proposal would vastly expand the disclosure requirements and compliance burdens for all public companies, and she shared concerns that she provided when the rules were proposed. She posed several questions about the unique challenges that small companies might face. She also noted that the SPAC proposal would require significant changes to the operations, economics, and timeline of SPACs.

Remarks on financial markets

Recently, both Chair Gensler and Commissioner Caroline Crenshaw spoke about regulating various aspects of the financial markets:

  • On May 6, 2022, Gensler presented a speech on enhancing the efficiency, resiliency, and transparency of the U.S. markets, including consideration of disclosures. He highlighted the importance of new rules to meet the needs of the current and future markets and to help the U.S. maintain its competitiveness in the world market.
  • On April 26, 2022, Gensler spoke virtually about the fixed income markets, noting their importance to individuals, companies, and governments in the U.S. and around the world. He discussed some of the policy work at the SEC with respect to strengthening and increasing transparency, modernizing rule sets for electronic platforms, and enhancing financial resiliency.
  • On April 28, 2022, Crenshaw presented a speech discussing SPACs and SPAC IPOs. She noted that the SEC has identified several areas of concern with SPACs, including misaligned incentives, several points of dilution that might disproportionately affect retail investors, and a lack of liability that could create an unjustified advantage in this path to the public markets over the traditional IPO. She encouraged all “to think about the ever-growing divide between the public and private markets and how the paths to public markets can be improved and made more efficient while preserving key investor and market integrity protections.”
  • On April 14, 2022, Crenshaw presented a speech addressing private markets and their important role in the economy. She said that private markets are growing at record rates and companies are staying private for longer periods of time, and she discussed whether adequate protection exists for investors in private markets. She noted the debate on the balance between public and private markets and posed multiple questions to help define recommendations from the SEC.

Remarks on cybersecurity

Chair Gensler on April 14, 2022, gave a speech before the joint meeting of the Financial and Banking Information Infrastructure Committee and the Financial Services Sector Coordinating Council, addressing the SEC’s important roles as part of “Team Cyber” and as a regulator.

Gensler said he thinks about the evolving cybersecurity risk landscape in three ways: cyberhygiene and preparedness, cyber incident reporting to the government, and disclosure to the public. He discussed the SEC’s cybersecurity policy work related to financial sector registrants, public companies, service providers, and the SEC itself.

Related to financial sector SEC registrants, Gensler discussed proposed changes to and expansion of Regulation Systems Compliance and Integrity (Reg SCI) and said that he believes additional opportunities exist to expand Reg SCI to further strengthen the cyberhygiene of important financial entities, including and beyond the Treasury market. He highlighted the rules proposed in February 2022 that would require registered investment advisers, registered investment companies, and business development companies to bolster their cybersecurity practices focusing on adopting written plans to address cybersecurity risks, disclosing certain cybersecurity incidents to the public, reporting certain cybersecurity incidents to the SEC, and meeting specific recordkeeping obligations. He said such reforms could reduce the risk that these registrants would not be able to maintain critical operational capability during a significant cybersecurity incident.

For public companies, Gensler discussed the March 2022 proposal to enhance cybersecurity disclosures, which would require ongoing disclosures on companies’ governance, risk management, and strategy with respect to cybersecurity risks and would mandate material cybersecurity incident reporting.

Gensler noted that the SEC is not immune to cyberattacks and said the staff continues to work to protect SEC data and information technology. He concluded with a reminder that cyber risks have implications across the financial sector, investors, issuers, and the economy and the SEC has a role to play, along with the rest of Team Cyber.

Remarks on climate-related disclosures proposal

On April 12, 2022, at the Ceres investor briefing, Chair Gensler delivered remarks on the recently proposed climate-related disclosure rules. He began with some background on the tradition of disclosures, noting that the SEC has provided guidance and requirements when needed for disclosure of information relevant to investors and has played a role in standardizing disclosures. He said that the proposed climate-related disclosures would provide investors with consistent, comparable, and decision-useful information and would provide consistent and clear reporting obligations for issuers.

Gensler added that climate-related disclosures already are being made by hundreds of companies and that investors already are making decisions based on climate risks, which can create significant financial risks to companies. He said, “It makes sense to build on what so many companies are already doing to enhance the consistency, comparability, and decision-usefulness of these disclosures for investors.” He described the importance of including the disclosures in filings, specifically Form 10-K, so that investors can find useful information in one place rather than having to piece together information from different locations.

Gensler encouraged issuers and investors of all sizes to comment, noting that the SEC will benefit from wide and diverse input, including how the proposal approaches disclosure of strategy, governance, risk management, targets, financial statement metrics, and greenhouse gas emissions.

Proposals and guidance

Reopening of comment period on recovery of erroneously awarded compensation

The SEC on June 8, 2022, reopened the comment period on proposed rules for listing standards for recovery of erroneously awarded compensation. In conjunction with reopening the comment period, the SEC staff released a memo providing supplemental data and analysis on the voluntary adoption of compensation recovery provisions by issuers and the impact of including “little r” restatements as triggers for a compensation recovery analysis.

The SEC initially proposed the rules in July 2015 to implement Section 954 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). The comment period for the proposal was first reopened for 30 days in October 2021.

Comments were due July 14, 2022.

Proposed ESG disclosures for certain investment advisers and investment companies

On May 25, 2022, the SEC proposed amendments to rules and reporting forms to promote consistent and reliable information for investors about funds’ and advisers’ incorporation of ESG factors. Those affected by the changes would include certain registered investment advisers, advisers exempt from registration, registered investment companies, and business development companies.

Funds and advisers would be required to provide more specific disclosures in prospectuses, annual reports, and brochures based on the ESG strategies they pursue. Funds that focus on the environmental factors generally would be required to disclose the greenhouse gas emissions associated with their portfolio investments. Funds that claim to achieve specific ESG impacts would have to describe the specific impacts and summarize their progress on achieving those impacts. Funds that use proxy voting or other engagement with issuers as a significant means of implementing their ESG strategy would be required to disclose information about their voting of proxies on particular ESG-related voting matters and information concerning their ESG engagement meetings. The proposed amendments also include implementing a layered, tabular disclosure approach for ESG funds to allow investors to compare ESG funds at a glance. Additionally, the proposal would require certain ESG reporting on Forms N-CEN and ADV Part 1A.

Comments are due Aug. 16, 2022.

Also on May 25, Chair Gensler issued a statement in support of the proposal, and Commissioners Allison Herren Lee, Crenshaw, and Peirce all issued statements sharing their positions on the proposed amendments.

Proposed changes to funds’ Names Rule

To address changes in the fund industry and compliance practices that have developed since the rule was adopted almost 20 years ago, the SEC, on May 25, 2022, proposed amendments to improve and modernize the Investment Company Act “Names Rule” to prevent misleading and deceptive fund names. This proposal addresses public feedback on potential rule reforms received as part of a March 2020 request for comment.

Under the current Names Rule, registered investment companies whose fund names suggest a focus in a particular type of investment (among other areas) must adopt a policy to invest at least 80% of the value of their assets in those investments. The proposed amendments would require more funds to adopt an 80% investment policy by extending the requirement to any fund name with terms suggesting that the fund focuses on investments that have (or whose issuers have) particular characteristics including fund names with terms such as “growth” or “value” or terms indicating that the fund’s investment decisions include one or more environmental, social, or governance factors. The proposed amendments would limit temporary departures from the 80% investment requirement and clarify the rule’s treatment of derivative investments. The proposal also provides new enhanced disclosure and reporting requirements, updates notice requirements, and establishes recordkeeping requirements.

Comments are due Aug. 16, 2022.

Chair Gensler and Commissioners Peirce, Lee, and Crenshaw issued statements on the proposed amendments.

Geopolitical risk considerations

The staff in the SEC’s Division of Corporation Finance (Corp Fin) in May published “Sample Letter to Companies Regarding Disclosures Pertaining to Russia’s Invasion of Ukraine and Related Supply Chain Issues” to provide guidance on disclosures. While the letter was created to specifically address the current conflict, the comments could be applied more broadly across similar situations. The letter indicates that Corp Fin believes that companies should provide detailed disclosure, to the extent material or otherwise required, regarding:

  • “Direct or indirect exposure to Russia, Belarus, or Ukraine through their operations, employee base, investments in Russia, Belarus, or Ukraine, securities traded in Russia, sanctions against Russian or Belarusian individuals or entities, or legal or regulatory uncertainty associated with operating in or exiting Russia or Belarus
  • “Direct or indirect reliance on goods or services sourced in Russia or Ukraine or, in some cases, in countries supportive of Russia
  • “Actual or potential disruptions in the company’s supply chain
  • “Business relationships, connections to, or assets in, Russia, Belarus, or Ukraine”

The financial statements also might need to reflect and disclose:

  • Impairment of assets
  • Changes in inventory valuation
  • Deferred tax asset valuation allowance
  • Disposal or exiting of a business
  • Deconsolidation
  • Changes in exchange rates
  • Changes in contracts with customers or the ability to collect contract considerations

Additionally, Corp Fin notes that “many companies have experienced heightened cybersecurity risks, increased or ongoing supply chain challenges, and volatility related to the trading prices of commodities regardless of whether they have operations in Russia, Belarus, or Ukraine that warrant disclosure.” Also, Corp Fin requests that companies should “consider how these matters affect management’s evaluation of disclosure controls and procedures, management’s assessment of the effectiveness of internal control over financial reporting, and the role of the board of directors in risk oversight of any action or inaction related to Russia’s invasion of Ukraine, including consideration of whether to continue or to halt operations or investments in Russia and/or Belarus.”

Extended comment period on climate-related disclosures and reopened comment period for private fund advisers and Regulation ATS proposals

On May 9, 2022, the SEC announced that it has extended the public comment period from May 20, 2022, until June 17, 2022, on the proposed rulemaking to enhance and standardize climate-related disclosures for investors.

A recent report from Crowe, “SEC Proposes Climate-Related Disclosures: A Closer Look,” provides considerations for management and boards.

Additionally, the SEC announced the reopening of the comment periods for 30 days on the proposed rulemaking to enhance private fund investor protection and on the proposed rulemaking to include significant Treasury markets platforms within Regulation ATS. The reopened comment periods ended on June 13, 2022.

Proposed security-based swap execution facilities rules

On April 6, 2022, the SEC proposed new Regulation SE under the Securities Exchange Act of 1934 (Exchange Act) to create a framework for the registration and regulation of security-based swap execution facilities (SBSEFs), as mandated under the Dodd-Frank Act.

The proposal would implement the Exchange Act’s trade execution requirement for security-based swaps and address the cross-border application of that requirement, implement Section 765 of the Dodd-Frank Act to mitigate conflicts of interest at security-based swap execution facilities and national securities exchanges that trade security-based swaps, and promote consistency between the proposed Regulation SE and the existing rules under the Exchange Act. Among other requirements, the proposed rules would require an entity meeting the definition of an SBSEF to register with the SEC as an SBSEF on Form SBSEF or register as a national securities exchange.

Comments were due June 10, 2022.

Crypto assets guidance

On March 31, 2022, the SEC issued Staff Accounting Bulletin (SAB) 121, providing guidance for entities filing financial statements with the SEC that provide crypto asset custody services for platform users. It answers three questions:

  • How should an entity account for its obligations to safeguard crypto assets held for platform users?
  • What disclosure would the staff expect an entity to provide regarding its safeguarding obligations for crypto assets held for its platform users?
  • How and when should an entity initially apply the guidance in this topic in its financial statements?

Crowe released on April 22, 2022, an article taking an in-depth look at SAB 121. As significant judgment might be required to determine the applicability of SAB 121, the article provides a decision tree to help entities decide if the SAB’s accounting and disclosure guidance applies to them.

Regulatory agenda

On June 22, 2022, the SEC released its Spring 2022 regulatory agenda, which lists short- and long-term regulatory actions that the SEC plans to take. This recent release lists 27 rules in proposal stage and 26 rules in the final stage. These rulemakings address each part of the SEC’s three-part mission of protecting investors; maintaining fair, orderly, and efficient markets; and facilitating capital formation.

Examination priorities

On March 30, 2022, the SEC’s Division of Examinations announced its 2022 examination priorities, including several significant areas of focus and many perennial risk areas. Annually, the division publishes its examination priorities to provide transparency into its examination program and insights into its risk-based approach, including the areas that might present risks to investors and U.S. capital market integrity.

The 2022 examination priorities are categorized as follows:

  • Private funds
  • ESG investing
  • Retail investor protections
  • Information security and operational resiliency
  • Emerging technologies
  • Crypto assets

New commissioners

On June 16, 2022, the U.S. Senate confirmed Jaime Lizarraga and Mark Uyeda to serve as SEC commissioners. Uyeda will serve until June 5, 2023, replacing Elad Roisman, who recently resigned. Lizarraga’s term will run through June 5, 2027, as he replaces Allison Herren Lee, who left the SEC in June 2022.

Crypto Assets and Cyber Unit expansion

On May 3, 2022, the SEC announced the addition of 20 positions to the newly renamed Crypto Assets and Cyber Unit in the Division of Enforcement, which will increase the unit to 50 positions. The Crypto Assets and Cyber Unit is responsible for protecting investors in crypto markets and from cyber-related threats.

Since 2017, when it was created, “the unit has brought more than 80 enforcement actions related to fraudulent and unregistered crypto asset offerings and platforms, resulting in monetary relief totaling more than $2 billion.” The unit has brought numerous actions against SEC registrants and public companies for failing to maintain adequate cybersecurity controls and for failing to appropriately disclose cyber-related risks and incidents. To continue to address the ever-growing crypto markets and ensure investors are protected, the expanded unit will focus on investigating securities law violations related to:

  • Crypto asset offerings
  • Crypto asset exchanges
  • Crypto asset lending and staking products
  • Decentralized finance platforms
  • Nonfungible tokens
  • Stablecoins