May One-Minute Reads

SEC enforcement director speaks on AI ‘washing’

In our April 2024 One-Minute Reads, we covered the concept of artificial intelligence (AI) “washing.” Gurbir Grewal, director of the Securities and Exchange Commission (SEC) Division of Enforcement, has now provided guidance on the enforcement perspective. The key takeaway from his comments is that companies must ensure that “representations regarding [their] use of AI are not materially false or misleading.”

To do this, Grewal recommends that companies rely on “proactive compliance,” which requires education, engagement and execution. In his speech, Grewal made three points:

1. Companies should educate themselves about “emerging and heightened AI risk areas” related to their business, including “reviewing any future enforcement actions that may follow in this space.”
2. Companies also should take what they have “learned from [the SEC’s] orders and public pronouncements,” along with doing their own research, and “engage with personnel inside the company’s different business units to learn how AI intersects with their activities, strategies, risks, financial incentives, and so on.”
3. Companies should execute on what they know, asking if their “use of AI requires updating policies and procedures and internal controls,” and if so, “are those policies and procedures bespoke to your company?”

With respect to the third point on updating and adopting AI policies and procedures, it is important to remember that the SEC is bringing enforcement actions against companies that fail to implement or follow the policies and procedures that they have drafted and adopted. Due to this, any AI policy or procedure should be tailored to the company’s specific business and use of AI, with processes put in place to support compliance.

SEC appeals decision on proxy adviser rule amendments

On April 23, 2024, both the SEC and the National Association of Manufacturers (NAM) appealed the US District Court for the District of Columbia’s ruling that the SEC’s rules regarding proxy advisory firms were invalid. The court had previously ruled that the SEC’s amended rules were invalid on the basis that the SEC acted contrary to law and against its statutory authority when it amended the proxy rules regarding solicitation.

The case started back in 2019 when the SEC issued interpretive guidance asserting that proxy advisory firms’ vote recommendations were “solicitations” under the proxy rules – and therefore subject to the anti-fraud provisions of Rule 14a-9. This April 29 PubCo blog post provides background on the case, which includes Institutional Shareholder Services (ISS) suing the SEC and then-SEC Chair Jay Clayton over the 2019 interpretive guidance, the SEC codifying the interpretive guidance as a rule in 2020, and the continued litigation that followed.

NYSE proposes amendments that would permit it to delist companies that change primary business focus

The New York Stock Exchange (NYSE) has proposed amendments to Section 802.01D of the NYSE Listed Company Manual. The proposed amendments would “provide the [NYSE] with discretion to commence suspension and delisting proceedings with respect to a listed company that has changed its primary business focus to a new area of business that it was not engaged in at the time of its original listing, or which was immaterial to its operations at the time of its original listing.”

The proposal would allow the NYSE, after a company changes its business focus, to reanalyze the company’s suitability for listing, and to consider whether it would have accepted the company for initial listing based on the revised business focus. The exchange is concerned that “investors who acquired the company’s stock prior to this change in operations (including, in many cases, in connection with the company’s initial public offering) may have made their investment decision based on the company’s disclosure about its original business and might not have made their investment if they had been aware of how the company would change.” For further reading, see this April 25 PubCo post.

NYSE amends trading halt requirements for reverse stock splits

On May 11, 2024, the NYSE adopted its proposed amendments to Rule 123D, which establish specific requirements for halting and resuming trading in securities subject to a reverse stock split. The NYSE’s proposal was modeled on the Nasdaq proposal that was approved by the SEC in March 2024. Under the newly adopted amendment, the NYSE will be able to institute a regulatory halt, prohibiting “pre-market trading immediately after a reverse stock split, and to re-open trading in such securities using a Trading Halt Auction.” The NYSE believes that these changes will allow it “to better detect any errors or problems with orders for the security resulting from the reverse stock split” – and thus avoid any “material effect” on the market.

Nasdaq proposes changes to phase-in schedules for corporate governance requirements

Nasdaq has proposed amendments to Rules 5606, 5615 and 5810 to clarify and modify phase-in schedules for certain corporate governance requirements – including director independence and committee requirements for initial public offering (IPO) companies, companies emerging from bankruptcy, companies transferring from other exchanges, companies listing securities previously registered under Section 12(g), companies listing in connection with a carve out or spinoff transaction, companies ceasing to be a smaller reporting company, and companies ceasing to qualify as a foreign private issuer. The amendments largely align Nasdaq’s phase-in requirements with the SEC’s and NYSE’s rules governing the same subject matter. For more information, see this May 28 PubCo post.

EU delays CSRD implementation for certain companies

The European Union (EU) member states in the European Council approved a directive that will delay the requirement for companies outside of the EU to provide sector-specific sustainability disclosures and sustainability reporting under the Corporate Sustainability Reporting Directive (CSRD) until June 2026. For more information on the approved delay, refer to this April 30 ESG Today article.

BF Borgers charged with massive fraud

On May 3, 2024, the SEC charged audit firm BF Borgers and its owner Benjamin Borgers with massive fraud involving “deliberate and systemic failures” to comply with Public Company Accounting Oversight Board (PCAOB) standards in auditing and reviewing financial statements. The failures encompass more than 1,500 SEC filings filed between January 2021 and June 2023. The audit firm agreed to pay a $12 million civil penalty, and Benjamin Borgers agreed to pay a $2 million civil penalty, along with cease and desists and permanent suspension from appearing and practicing before the SEC as accountants in order to settle the SEC’s charges, which included “falsely representing to their clients that the firm’s work would comply with PCAOB standards; fabricating audit documentation to make it appear that the firm’s work did comply with PCAOB standards; and falsely stating in audit reports included in more than 500 public company SEC filings that the firm’s audits complied with PCAOB standards.” For further reading, see this May 6 PubCo post.

EY releases report on disclosure committees

EY’s recent report on disclosure committees set out to learn whether and how public companies have been leveraging disclosure committees to meet disclosure requirements. In its report, EY found that:

1. Nearly all respondents to the survey have a formal disclosure committee (or comparable body with similar responsibilities).
2. Committee members are generally appointed by senior executive management – chief financial officer (CFO), general counsel or chief accounting officer, for example.
3. Committee members represent a broad, cross-functional group necessary to fulfil the duties of the committee.
4. Committees are generally chaired and coordinated by different roles (typically, a combination of controller/chief accountant and head of SEC reporting).
5. Committees regularly review a variety of disclosure channels.
6. Committees continue to focus on financial and technical disclosures but increasingly review other types of disclosures.
7. Committees generally have documented processes and procedures.
8. CEOs and CFOs regularly approve disclosure committee charters.
9. Committees generally meet at least quarterly.
10. Management commonly reports to the audit committee about the disclosure committee’s activities.

In a similar vein, Deloitte released a new report on aligning disclosure committees in the era of disclosure, which looks at the disclosure committee through the lens of the audit committee.

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