Accounting guidance
Accounting guidance issued in first quarter 2022
ASU 2022-02, Financial Instruments — Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures, provides updated guidance for accounting for troubled debt restructurings (TDRs) by creditors and vintage disclosures for entities applying the guidance in ASU 2016-13. The new ASU eliminates the specific accounting guidance for TDRs by creditors while enhancing the disclosure requirements for loan refinancings/restructurings by creditors when the borrower is experiencing financial difficulty. The ASU also updates the vintage disclosure requirements to require disclosure of current period gross write-offs by year of origination. The new ASU is effective for years beginning after Dec. 15, 2022, for entities that have adopted ASU 2016-13. For all other entities, the amendments are effective when the entity adopts ASU 2016-13.
ASU 2022-01, Derivatives and Hedging (Topic 815) — Fair Value Hedging — Portfolio Layer Method, makes it easier for entities to apply the portfolio layer method to qualify for hedge accounting. The amendments include the following main provisions:
- Allows multiple hedged layers of a single closed portfolio. This expansion resulted in the last-of-layer method being renamed the portfolio layer method.
- Expands the types of financial instruments that can be hedged using the portfolio layer method by allowing nonprepayable financial assets to be included within the closed portfolio being hedged. Previously only nonprepayable financial assets or beneficial interests secured by prepayable financial instruments to be included in the closed portfolio being hedged using the portfolio layer method.
- Specifies that eligible hedging instruments in a single-layer hedge may include spot-starting or forward-starting constant-notional swaps, or spot or forward-starting amortizing-notional swaps, and that the number of hedged layers (that is, single or multiple) corresponds with the number of hedges designated.
- Provides additional guidance on accounting for and disclosure of hedge-basis adjustments.
- Specifies how hedge-basis adjustments should be considered when determining credit losses for the assets included in the closed portfolio.
This new guidance is effective for public business entities for fiscal years beginning after Dec. 15, 2022. For all other entities the new guidance is effective for fiscal years beginning after Dec. 15, 2023.
Regulatory update
Materiality assessment of errors
On March 9, 2022, Paul Munter, acting chief accountant, issued a statement regarding assessing the materiality of errors in financial statements. Mr. Munter and other SEC staff previously addressed this topic at the 2021 AICPA and CIMA Conference on Current SEC and PCAOB Developments. He noted that whenever a material error is identified in previously issued financial statements, investors must be notified promptly and the error must be corrected. Management’s determination of whether an error is material is an objective assessment focused on whether there is a substantial likelihood it is important to the reasonable investor as discussed in Staff Accounting Bulletin (SAB) No. 99, Materiality and SAB No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements.
Mr. Munter indicated it is “important for registrants, auditors, and audit committees to carefully assess whether the error is material by applying a well-reasoned, holistic, objective approach from a reasonable investor’s perspective based on the total mix of information. To be objective, those involved in the process must eliminate from the analysis their own biases, including those related to potential negative impacts of a restatement, that would be inconsistent with a reasonable investor’s view. Additionally, the objective analysis should consider all relevant facts and circumstances including both quantitative and qualitative factors.”
Mr. Munter discussed the following topics with key takeaways noted:
Concept of materiality and the correction of material errors
- The Supreme Court has held that a fact is “material” if there is “a substantial likelihood that the ... fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.”
- When an error is determined to be material to previously issued financial statements, the error must be corrected by restating the prior-period financial statements, which is sometimes referred to as a “Big R” restatement.
- When an error is not material to previously issued financial statements, but either correcting the error or leaving the error uncorrected would be material to the current period financial statements, the error must be corrected, but it can be corrected in the current period comparative financial statements by restating the prior period information and disclosing the error. This type of restatement is sometimes referred to as a “little r” restatement.
Objective assessment of materiality
- Companies, auditors, and audit committees need to thoroughly and objectively evaluate the total mix of information considering all relevant facts and circumstances surrounding the error, including both quantitative and qualitative factors, to determine whether an error is material to investors.
- There is an increased need for objectivity in the assessment of qualitative factors. Mr. Munter noted that “as the quantitative magnitude of the error increases, it becomes increasingly difficult for qualitative factors to overcome the quantitative significance of the error.”
Observations from recent interactions with registrants and auditors on materiality
The following arguments were not found to be persuasive.
- Financial statements or specific line items in financial statements are irrelevant to investors’ investment decisions. For example, some have argued that certain elements of financial statements prepared in accordance with U.S. GAAP or International Financial Reporting Standards (IFRS) do not provide useful information to investors, so an error in those elements can’t be material or that historical financial statements, or specific line items in those financial statements, are irrelevant to investors’ current investment decisions. It was noted that the effects of errors on certain key non-GAAP measures that are important to users of the registrant’s financial statements should be performed in addition to, but not as a substitute for, the analysis of materiality to the financial statements.
- An error is not material to previously issued financial statements because the error was also made by other registrants, and therefore reflects a widely held view rather than an intention to misstate. This type of argument has been raised by registrants in various industries and with various structures, including special purpose acquisition companies.
- An error is not material because its effect is offset by other errors. SAB 99 provides direction that, each misstatement must be assessed to determine if it is material, without consideration of its effect when combined with other misstatements.
Identification of an accounting error also impacts management’s assessment of the effectiveness of ICFR, and the statement provides considerations for this assessment.
Compliance and disclosure interpretations updated for business combinations
Division of Corporation Finance (Corp Fin) updated the following Compliance and Disclosure Interpretations (C&DIs):
- Exchange Act Form 8-K (Question 102.04-102.05)
- Proxy Rules and Schedules 14A/14C (101.02, 132.01-132.02)
- Tender Offers and Schedules (166.01)
These updated C&DIs provide additional guidance on disclosures associated with entering into a business combination agreement. This updated guidance includes discussion of when a company must disclose material terms and conditions when entering into a business combination agreement that is reportable under Item 1.01 of Form 8-K. The updated guidance also discusses certain proxy disclosure rules related to whether public communications represent solicitations subject to such rules. Finally, the updated guidance discusses Corp Fin’s views on whether SEC Rule 14e-5 on the prohibition of purchases outside of a tender offer applies to transactions involving special purpose acquisition companies.
SAB 121
On March 31, 2022, the SEC issued Staff Accounting Bulletin (SAB) No. 121, which updates SAB Codification Topic 15, Miscellaneous Accounting, adding interpretive guidance for companies to consider when they have obligations to safeguard crypto-assets held for their platform users. The SAB notes that, “In recent years, the staff has observed an increase in the number of entities that provide platform users with the ability to transact in crypto-assets. In connection with these services, these entities and/or their agents may safeguard the platform user’s crypto-asset(s) and also maintain the cryptographic key information necessary to access the crypto-asset. The obligations associated with these arrangements involve unique risks and uncertainties not present in arrangements to safeguard assets that are not crypto-assets, including technological, legal, and regulatory risks and uncertainties.”
The SAB provides recognition, measurement, and disclosure guidance for obligations to safeguard crypto-assets that an entity holds for platform users. It also addresses how and when a company should initially apply the guidance in its financial statements.
Cybersecurity-related proposals
SEC proposes rules on cybersecurity disclosures for public companies
On March 9, 2022, the SEC proposed amendments to its rules to enhance and standardize disclosures regarding cybersecurity risk management, strategy, governance, and incident reporting by public companies. The proposed amendments are intended to better inform investors about a registrant’s risk management, strategy, and governance and to provide timely notification to investors of material cybersecurity incidents.
The proposed amendments would require current reporting about material cybersecurity incidents and periodic reporting of, among other things:
- Registrant’s policies and procedures to identify and manage cybersecurity risks
- Registrant’s board of directors’ oversight of cybersecurity risk
- Management’s role and expertise in assessing and managing cybersecurity risk and implementing cybersecurity policies and procedures
The proposal would also require annual reporting or certain proxy disclosure about the board of directors’ cybersecurity expertise, if any.
SEC proposes cybersecurity risk management rules and amendments for registered investment advisers and funds
On Feb. 9, 2022, the SEC proposed rules related to cybersecurity risk management for registered investment advisers, and registered investment companies and business development companies (funds), as well as amendments to certain rules that govern investment adviser and fund disclosures. SEC Chair Gary Gensler stated: “The proposed rules and amendments are designed to enhance cybersecurity preparedness and could improve investor confidence in the resiliency of advisers and funds against cybersecurity threats and attacks.”
The proposal would require advisers and funds to:
- Adopt and implement written cybersecurity policies and procedures designed to address cybersecurity risks that could harm advisory clients and fund investors.
- Publicly disclose cybersecurity risks and significant cybersecurity incidents that occurred in the last two fiscal years in their brochures and registration statements.
- Meet new recordkeeping requirements that are designed to improve the availability of cybersecurity-related information and help facilitate the SEC’s inspection and enforcement capabilities.
The proposed rules also would require advisers to report significant cybersecurity incidents affecting the adviser or its fund or private fund clients to the SEC on a new confidential form.
SEC proposes rules to enhance and standardize climate-related disclosures
As discussed in previous quarterly updates, climate change disclosures have been a concern of the SEC as evidenced in various statements and comments letters. In September 2021, the staff in the Division of Corporation Finance (Corp Fin) published an illustrative letter containing sample comments that it may issue to companies regarding their climate-related disclosure or the absence of such disclosure. As stated in the sample comment letter, depending on the particular facts and circumstances, these disclosures may be required as part of a company’s description of business, legal proceedings, risk factors, and management’s discussion and analysis of financial condition and results of operations.
On March 21, 2022, the SEC proposed rule changes that would require registrants to include certain climate-related disclosures in their registration statements and periodic reports, including information about climate-related risks that are reasonably likely to have a material impact on their business, results of operations, or financial condition, and certain climate-related financial statement metrics in a note to their audited financial statements. The required information about climate-related risks also would include disclosure of a registrant’s greenhouse gas emissions, which have become a commonly used metric to assess a registrant’s exposure to such risks.
The proposed rule changes would require a registrant to disclose information about (1) its governance of climate-related risks and relevant risk management processes; (2) how any identified climate-related risks have had or are likely to have a material impact on its business and consolidated financial statements, which may manifest over the short-, medium-, or long-term; (3) how any identified climate-related risks have affected or are likely to affect the registrant’s strategy, business model, and outlook; and (4) the impact of climate-related events (severe weather events and other natural conditions) and transition activities on the line items of a registrant’s consolidated financial statements, as well as on the financial estimates and assumptions used in the financial statements.
The proposed rules would also require a registrant to disclose information about its direct greenhouse gas (GHG) emissions (Scope 1) and indirect emissions from purchased electricity or other forms of energy (Scope 2). In addition, a registrant would be required to disclose GHG emissions from upstream and downstream activities in its value chain (Scope 3), if material, or if the registrant has set a GHG emissions target or goal that includes Scope 3 emissions. The proposed rules would provide a safe harbor for liability from Scope 3 emissions disclosure and an exemption from the Scope 3 emissions disclosure requirement for smaller reporting companies.
Under the proposed rule changes, accelerated filers and large accelerated filers would be required to include an attestation report from an independent attestation service provider covering Scopes 1 and 2 emissions disclosures, with a phase-in over time, to promote the reliability of GHG emissions disclosures for investors.
The proposed rules would include a phase-in period for all registrants, with the compliance date dependent on the registrant’s filer status, and an additional phase-in period for Scope 3 emissions disclosure.
SEC proposes rules to enhance disclosure and investor protection relating to special purpose acquisition companies, shell companies, and projections
On March 30, 2022, the SEC proposed new rules and amendments to enhance disclosure and investor protection in initial public offerings by special purpose acquisition companies (SPACs) and in business combination transactions involving shell companies, such as SPACs, and privately operating companies.
The proposed new rules and amendments, among other things are to:
- Require additional disclosures about SPAC sponsors, conflicts of interest, and sources of dilution.
- Require additional disclosures regarding business combination transactions between SPACs and privately operating companies, including disclosures relating to the fairness of these transactions.
- Address issues relating to projections made by SPACs and their target companies, including the Private Securities Litigation Reform Act safe harbor for forward-looking statements and the use of projections in Commission filings and in business combination transactions.
- Address the status of SPACs under the Investment Company Act of 1940, which is designed to increase attention among SPACs about this important assessment. Under the proposed rule, SPACs that satisfy certain conditions that limit their duration, asset composition, business purpose, and activities would not be required to register under the Investment Company Act.
If adopted, the proposed rules would more closely align the required financial statements of privately operating companies in transactions involving shell companies with those required in registration statements for an initial public offering.
SEC issues proposal to reduce risks in clearance and settlement of securities
On Feb. 9, 2022, the SEC proposed rule changes to reduce risks in the clearance and settlement of securities, including by shortening the standard settlement cycle for most broker-dealer transactions in securities from two business days after the trade date (T+2) to one business day after the trade date (T+1). The proposed changes are designed to reduce the credit, market, and liquidity risks in securities transactions faced by market participants and U.S. investors.
In addition to shortening the standard settlement cycle, the proposal includes rules directed at broker-dealers and registered investment advisers to shorten the process of confirming and affirming the trade information necessary to prepare a transaction for settlement so that it can be completed by the end of the trade date. Further, the proposal includes a new requirement to facilitate straight-through processing, which would apply to certain types of clearing agencies that provide central matching services. Central matching service providers help facilitate the processing of institutional trades between broker-dealers and their institutional customers. The proposed rule would require new policies and procedures directed to straight-through processing and require an annual report on progress with the process.
With the goal of shortening the settlement cycle further, the proposal solicits comments on challenges associated with and potential paths to achieving a same-day settlement cycle.
The SEC’s published fact sheet notes that “reducing time between the execution of a securities transaction and its settlement reduces risk. Two recent episodes of increased market volatility — in March 2020 following the outbreak of the COVID-19 pandemic, and in January 2021 following heightened interest in certain “meme” stocks — highlighted potential vulnerabilities in the U.S. securities market that shortening the standard settlement cycle and improving institutional trade processing can mitigate. In the future, it may be beneficial to further shorten the standard settlement cycle beyond T+1. The proposal solicits comments on potential paths to and challenges associated with achieving a same-day settlement cycle.”
Other SEC proposals
Whistleblower program rules
On Feb. 10, 2022, the SEC proposed two amendments to the rules governing its whistleblower program. The first proposed amendment concerns award claims for related actions that would be otherwise covered by an alternative whistleblower program and the second affirms the SEC’s authority to consider the dollar amount of a potential award for the limited purpose of increasing an award but not to lower an award.
Modernize beneficial ownership reporting
On Feb. 10, 2022, the SEC proposed rule amendments governing beneficial ownership reporting under Exchange Act Sections 13(d) and 13(g) to provide more timely information to meet the needs of today’s financial markets.
The proposed amendments to Regulation 13D-G would accelerate the filing deadlines for Schedules 13D beneficial ownership reports from 10 days to five days and require that amendments be filed within one business day; generally accelerate the filing deadlines for Schedule 13G beneficial ownership reports (which differ based on the type of filer); expand the application of Regulation 13D-G to certain derivative securities; clarify the circumstances under which two or more persons have formed a “group” that would be subject to beneficial ownership reporting obligations; provide new exemptions to permit certain persons to communicate and consult with one another, jointly engage issuers, and execute certain transactions without being subject to regulation as a “group;” and require that Schedules 13D and 13G be filed using a structured, machine-readable data language.
Short sale disclosure rule, order marking requirement, and CAT amendments
On Feb. 25, 2022, the SEC proposed changes that would provide greater transparency to investors and regulators by increasing the public availability of short sale-related data.
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