Month-In-Brief: Securities Law

CURRENT MONTH (March 2021)

Securities Regulation 

SEC Doubles Down on Climate and ESG Issues 

By Alan J. Wilson, WilmerHale  

The Securities and Exchange Commission has announced in recent weeks multiple efforts across the agency to highlight climate change in corporate disclosures and to increase scrutiny and, potentially, enforcement focus on company disclosure efforts on climate and other ESG (Environmental, Social, Governance) matters. 

In regard to disclosure, on February 24, SEC Acting Chair Lee issued a statement directing the Division of Corporation Finance “to enhance its focus on climate-related disclosure in public company filings.”  President Biden’s nominee for Chair of the SEC is also focused on climate risk disclosures.  In a March 2 confirmation hearing before the Senate Banking Committee, Gary Gensler stated that, under his leadership, the SEC would issue new guidance for climate risk disclosures.  During the hearing, Mr. Gensler indicated that disclosure requirements should be grounded in traditional concepts of materiality.  He also repeatedly emphasized that investors want to see climate risk disclosures and suggested that investor demands are relevant to understanding what is material.  On March 11, Acting Director of the SEC Division of Corporation Finance, John Coates, published a statement in connection with remarks he delivered at the 33rd Annual Tulane Corporate Law Institute, expressing a belief that “SEC policy on ESG disclosures will need to be both adaptive and innovative.”  To develop such standards, Mr. Coates offered a list of significant questions that “the SEC should be a key part of answering,” which likely will be featured in future SEC efforts to update its approach to climate and other ESG disclosures.  On March 15, Acting Chair Lee invited public comment on whether and how the SEC’s rules and guidance concerning climate change disclosures should be modified. 

Beyond disclosure, the SEC also made clear that it is prepared to initiate enforcement action on the basis of companies’ inadequate climate risk disclosures.  On March 4, the SEC issued a press release announcing the deployment of a 22-member task force to examine “misconduct” in the ESG disclosure area, “[c]onsistent with increasing investor focus and reliance on climate and ESG-related disclosure and investment.”  The Climate and ESG Task Force will begin by analyzing material gaps or misstatements in public companies’ climate change statements under existing disclosure rules and will pursue tips, referrals, and whistleblower complaints on ESG-related issues.  Companies should be prepared to defend their climate-related disclosures and differences between those filed disclosures and the company’s voluntary climate statements. 

The recent efforts announced by the Acting Chair have been met with some skepticism by the two Republican members of the Commission, who released a public statement on March 4, in response.  Their pushback puts down a marker that the announced shifts in priorities cannot themselves create new reporting obligations and suggests that, in fact, the announcements amount to little more than “continuing ongoing efforts with a little extra fanfare.”  Their public statement also seeks to contextualize calls for new guidance, making clear the Republican Commissioners’ view that such guidance cannot “elicit more specific line items or otherwise convert the Commission’s general principles-based approach to a prescriptive one.” 

There is surely much more to come on ESG disclosures.  A new Commission release refreshing the existing climate change disclosure guidance is highly likely, and new rulemaking efforts aimed at requiring more specific disclosures in that area are also likely.  Although climate change is the current focus, investors and the Commission could soon turn to disclosures about other ESG concepts, such as racial equity, environmental justice, human capital, and political contributions.Page Break 

Accounting Organizations Issue Roadmap for ESG Reporting and Attestation 

By Thomas W. White, Retired Partner, WilmerHale 

ESG reporting continues to develop rapidly as a “hot-button” issue for investor organizations, public companies and the SEC.  In February, two accounting organizations, the Association of International Certified Professional Accountants and the Center for Audit Quality, issued a “roadmap” for ESG reporting and attestation.  Although the roadmap is aimed principally at auditors, its discussion may also be useful for public companies that are considering including ESG disclosures in their SEC reports and/or whether to obtain external assurance about those disclosures. 

The roadmap notes that “[i]n the relatively new landscape of ESG reporting, companies are wrestling with what ESG information to report and how to communicate it to stakeholders.”  In particular, the roadmap states, “Third-party assurance from an independent accounting firm can enhance the reliability of ESG information by companies, in a manner similar to the process that occurs with audits of financial statements and internal control over financial reporting.”  

The roadmap discusses three general areas in which auditors can support companies with ESG reporting: 

• Where and how to report ESG information (e.g., in an SEC submission), 
• Whether to engage an independent accounting firm to perform an attestation engagement on the ESG information, and 
• Where to include the attestation report or reference such report. 

According to the roadmap, in 2019, 90 percent of S&P 500 companies voluntarily published sustainability reports, which are designed to communicate performance on ESG matters.  The roadmap reports that 29 percent of S&P 500 companies subjected some or all of the sustainability information to some sort of third-party assurance.  This assurance ranged from attestation by an independent accounting firm based on a review or examination pursuant to professional standards, to verification or certification services from engineering and consulting firms.  The roadmap describes ESG attestations included by, or referred to, in the SEC submissions of two domestic registrants (Vornado Realty Trust and Etsy).  It also notes that several foreign private issuers have done the same and describes an independent assurance report included by UBS in a recent Form 6-K. 

SEC Issues Interim Final Amendments and Requests Public Comment on Holding Foreign Companies Accountable Act 

By Alan J. Wilson, WilmerHale  

On March 24, the SEC (a) adopted interim final amendments to implement congressionally mandated submission and disclosure requirements under the Holding Foreign Companies Accountable Act (HFCAA) and (b) requested comment on the interim amendments and how the SEC should implement a process for identifying “Commission-Identified Issuers” subject to the submission and disclosure requirements.  The interim amendments take effect 30 days after publication in the Federal Register, and comments are due the same day.  

Under the HFCAA, the SEC is directed to prohibit trading in the securities of any company that has been a Commission-Identified Issuer for three consecutive years.  The interim amendments implement one of several logistical components that need to be in place for the SEC to identify Commission-Identified Issuers and carry out the HFCAA directives.  Commission-Identified Issuers are companies that have filed an annual report on Forms 10-K, 20-F, 40-F or N-CSR with an audit report issued by a registered public accounting firm that is located in a foreign jurisdiction and that the PCAOB has determined it is unable to inspect or investigate completely because of a position taken by an authority in that jurisdiction. 

Practically speaking, the interim amendments will not impose any immediate obligation on companies when they take effect.  The process for identifying Commission-Identified Issuers that are subject to the interim amendments first requires the PCAOB to identify the audit firms it is unable to inspect or investigate completely because of a position taken by an authority in a foreign jurisdiction.  That has not happened yet, and any rulemaking required by the PCAOB to implement its HFCAA obligations will be subject to SEC review and approval.  The SEC indicated that it understands the PCAOB is evaluating its obligations under the HFCAA and that it encourages the PCAOB to “act quickly.” 

Notably, the interim amendments and Request for Comment do not address the more complex issue of how the SEC will comply with the HFCAA’s directive to prohibit trading in securities of Commission-Identified Issuers.  The SEC will address this implementation issue in a future notice and comment rulemaking process, but the SEC has not signaled when to expect rules in that regard.    

SEC Announces Examination Priorities for 2021 

By Bella Zaslavsky, K&L Gates 

On March 3, the Division of Examinations of the SEC announced its 2021 initiatives and examination priorities. At a high level, many of the Division’s priorities emphasize a greater focus on (a) climate and other ESG related risks, (b) conflicts of interest for brokers and investment advisors, and (c) FinTech associated risks. 

The SEC’s 2021 priorities, as summarized in the announcement, include: 

• Retail Investors, Including Seniors and Those Saving for Retirement. The Division intends to concentrate on Regulation Best Interest, with a particular focus on fiduciary duties of care and loyalty and proper disclosure and mitigation of conflicts of interest, prioritizing products heavily used by retail investors such as mutual funds. 

• Information Security and Operational Resiliency. In reviewing business continuity and disaster recovery plans, the Division intends to shift its focus on how plans account for risks associated with climate change, and measures taken to safeguard customer accounts and prevent account intrusions, particularly in light of increases in remote operations. 
• Financial Technology (FinTech) and Innovation, Including Digital Assets. Examinations within FinTech will focus on, among other things, whether registrants are operating consistently with their representations and whether customer orders are handled in accordance with customer instructions. Consistent with the Division’s February 2021 Risk Alert, the focus around digital assets will continue to include (1) whether investments are in the best interests of investors, (2) portfolio management and trading practices, (3) safety of client funds and assets, (4) pricing and valuation, (5) effectiveness of compliance programs and controls, and (6) supervision of representatives’ outside business activities. 
• Anti-Money Laundering (AML) Programs. The Division intends to continue to evaluate the adequacy of and compliance with applicable AML requirements and whether policies are reasonably designed to identify suspicious and illegal money-laundering activities.  
• The London Inter-Bank Offered Rate (LIBOR) Transition. The discontinuation of LIBOR continues to be a focus for the Division, which intends to assess registrant’s understanding of their own exposure to LIBOR and their preparations for a transition to an alternative rate, both with respect to registrants as well as their clients. 
• Focus Areas Involving Registered Investment Advisers (RIAs) and Investment Companies: 

• RIA Compliance Programs. The Division’s review of RIA compliance programs will continue to assess whether programs, policies and procedures are reasonably designed, implemented and maintained, with a heightened focus on ESG factors and consistency and adequacy of disclosure around these matters. 
• Registered Funds, Including Mutual Funds and Exchange Traded Funds (ETFs). The Division has indicated it intends to prioritize examinations of mutual funds or ETFs that have not previously been examined or have not been examined in a number of years. Examinations of registered funds will focus on disclosures, valuation filings, personal trading activities, as well as a review of fund governance practices and compliance programs. 
• RIAs to Private Funds. Review of advisers to private funds will focus on liquidity and disclosure around investment risks and conflicts of interest.  

• Focus Areas Involving Broker-Dealers and Municipal Advisors. 

• Broker-Dealers. Examination of broker-dealers will continue to focus on the Customer Protection Rule and Net Capital Rule, including review of internal processes, procedures, controls, and compliance with requirements for borrowing securities from customers. 

• Municipal Advisors. The review of municipal advisors will look at how municipal advisors have adjusted their practices in light of the COVID-19 pandemic and its impact, as well as whether municipal advisors have met their fiduciary duty obligations to clients, particularly with respect to conflicts of interest. 

• Market Infrastructure. 

• Clearing Agencies. Examination will focus on, among other things, compliance, legal, recovery and wind down, margin, back-testing, settlement and operations, liquidity risk management, LIBOR transition and cybersecurity. 
• National Securities Exchanges. The Division will focus on operations to monitor, investigate and enforce compliance with exchange rules and federal securities laws. 
• Regulation Systems Compliance and Integrity (SCI). Evaluations by the Division will look at SCI establishment, maintenance and enforcement of written policies, focusing on IT, cybersecurity, business continuity planning and third party vendor management. 

• Transfer Agents (TAs). The Division will focus on core functions of TAs, such as turnaround timings, recordkeeping and retention on and safeguarding of funds and securities. 
• Oversight of Financial Industry Regulatory Authority (FINRA) and Municipal Securities Rulemaking Board (MSRB). Oversight of FINRA will continue to focus on the quality of its operations and regulatory programs, including its examinations. MSRB evaluations will look at policies, procedures and controls. 

The list of the SEC’s 2021 priorities is not exhaustive and reflects what Division of Examinations Director Pete Driscoll describes as “the complicated, diverse, and evolving nature of the risks to investors and the markets, including climate and ESG.” Even this list, as seen in the past, is subject to change based on developments during 2021.