May 2022 in Brief: Securities Law

Securities Regulation

PCAOB Expands Standard-Setting and Research Agendas

By Thomas W. White, Retired Partner, WilmerHale

In another expected initiative, the reconstituted Public Company Accounting Oversight Board recently posted revised agendas describing its current plans for standard-setting and research regarding auditing and related professional practice standards for audits of public companies and broker-dealers. According to the Board’s release, the agendas “are the result of the new Board’s assessment of priorities that advance audit quality to protect the interest of investors” and “represent the Board’s focus to modernize, simplify, and enhance our professional standards.”

Based on the standard-setting agenda, the PCAOB contemplates proposal or adoption within the next twelve months of standards in the following areas:

• Audit firm use and oversight of other auditors (adoption in 2022)
• Audit firm quality control systems (proposal in 2022)
• Noncompliance with laws and regulations (proposal in 2022)
• “Interim” attestation standards adopted upon establishment of the Board (proposal in 2022)
• Company’s ability to continue as a going concern (proposal in 2023)
• Audit confirmation process (proposal in 2023)

The standard-setting agenda also includes active projects where Board action is not contemplated in the next twelve months. These projects cover substantive analytical procedures, fraud, interim ethics and independence standards, and other interim standards. The research agenda has two projects: data and technology, and audit evidence.

The Board’s revised agendas follow a controversy about its 2020 action, under former Chairman William Duhnke, to remove several items from the standard-setting agenda. Investor advocates criticized these deletions, which included projects on noncompliance with laws and regulations and going concern. Those two projects have now been added back to the agenda.

SEC Posts Sample Comment Letter to Companies Regarding Disclosures Pertaining to Russia’s Invasion of Ukraine and Related Supply Chain Issues

By Alan J. Wilson, WilmerHale

Consistent with its recent practice regarding emerging developments, on May 3, the Securities and Exchange Commission (“SEC”) Division of Corporation Finance posted a sample comment letter regarding applicable disclosure considerations resulting from Russia’s invasion of Ukraine and the impact on an issuer’s business. The sample comments include general comments about the impact of Russia’s invasion of Ukraine on an issuer’s business, particularly its operations in the affected regions, as well as comments on risks relating to cybersecurity, known trends and uncertainties bearing on MD&A disclosure, non-GAAP measures, disclosure controls and procedures, and internal control over financial reporting.

The sample comment makes clear that the SEC Division of Corporation Finance “believes that companies should provide detailed disclosure, to the extent material or otherwise required” that relates to:

1. 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,
2. direct or indirect reliance on goods or services sourced in Russia or Ukraine or, in some cases, in countries supportive of Russia,
3. actual or potential disruptions in the company’s supply chain, or
4. business relationships, connections to, or assets in, Russia, Belarus, or Ukraine.

The SEC Division of Corporation Finance also noted that “financial statements may also need to reflect and disclose the impairment of assets, changes in inventory valuation, deferred tax asset valuation allowance, disposal or exiting of a business, de-consolidation, changes in exchange rates, and changes in contracts with customers or the ability to collect contract considerations.”

SEC Ramps Up Enforcement Focus on Crypto and Cyber

By Alan J. Wilson, WilmerHale

In May, the SEC announced that it had nearly doubled the size of the Division of Enforcement’s Crypto Assets and Cyber Unit (formerly the Cyber Unit), increasing the unit to fifty dedicated positions. “By nearly doubling the size of this key unit, the SEC will be better equipped to police wrongdoing in the crypto markets while continuing to identify disclosure and controls issues with respect to cybersecurity,” said SEC Chair Gary Gensler. Since its formation in 2017, the unit has brought over eighty enforcement actions and obtained over $2 billion in monetary relief.

Fifth Circuit Deems SEC’s In-House Court Unconstitutional

By Alan J. Wilson, WilmerHale

In May, the Fifth Circuit held in Jarkesy v. Sec. & Exch. Comm’n that (1) the SEC’s in-house adjudication of a securities fraud case violated the Seventh Amendment right to a jury trial of the hedge fund manager and his investment adviser company, which were defendants in that fraud case; (2) Congress unconstitutionally delegated legislative power to the SEC by failing to provide an intelligible principle by which the SEC would exercise the delegated power, in violation of Article I’s vesting of “all” legislative power in Congress; and (3) statutory removal restrictions on SEC administrative law judges (ALJs) violate the Take Care Clause of Article II. 34 F.4th 446 (5th Cir. 2022). In his dissenting opinion, Judge W. Eugene Davis disagreed with all three of the majority’s holdings, finding “no constitutional violations or any other errors with the administrative proceedings below.” This latest challenge to the SEC’s use of ALJs could raise questions as to the SEC Division of Enforcement’s future reliance on administrative proceedings to pursue claims as opposed to litigating in federal courts.

SEC Weighs in on Lack of Audit Transparency in China and Hong Kong

By Alan J. Wilson, WilmerHale

In a May 24 speech, YJ Fischer, Director, SEC Office of International Affairs, addressed recent regulatory developments regarding the lack of PCAOB inspections of audits and investigations in China and Hong Kong and the related implications on the continued trading of China-based issuers on U.S. exchanges. Against the backdrop of the Holding Foreign Companies Accountable Act (the “HFCAA”) (see our prior post), Fischer discussed four key points:

1. Claims of national security concerns to justify a refusal to provide the PCAOB with audit work papers should be viewed with skepticism.
2. Time is running out for resolving audit issues involving China and Hong Kong. With both houses of Congress having passed legislation to accelerate the HFCAA’s trading prohibition from three consecutive non-inspection years to two, China-based issuers could begin to see trading prohibitions beginning as early as 2023 if prompt action is not taken.
3. An agreement between the PCAOB and Chinese authorities is not all that is required. Assuming an agreement is reached, which Fischer acknowledged remains “uncertain,” the PCAOB would also need to determine that it could complete inspections and investigations before modifying its determinations, which would all need to happen before the end of 2022, likely by early November 2022.
4. Chinese-based issuers could opt to delist preemptively from U.S. exchanges. As a potential path forward, Chinese authorities could choose to designate a subset of China-based issuers that are “too sensitive to comply” with U.S. listing requirements, thereby delisting those companies, while managing to navigate a path forward for other China-based issuers to enable them to remain listed on U.S. exchanges.

Ms. Fischer’s remarks concluded by emphasizing the following takeaways:

[E]ven if an agreement is signed between the PCAOB and Chinese authorities, it will only be a first step. The PCAOB must be able to obtain sufficient cooperation and agreement from Chinese authorities so that the PCAOB Board can make a determination that it can inspect and investigate completely in China and Hong Kong.

It is also important to note that the PCAOB’s determination and identification of audit firms under the HFCAA was a jurisdiction-wide determination, and not a firm-specific determination. This means that the PCAOB must be able to access audit work papers from all, not some, China-based issuers and their registered public accounting firms, as well as conduct complete inspections and investigations in China and Hong Kong.