Weinberg & Company

Best Practice Newsletter – September 2022

By September 21, 2022 No Comments

Deal or No Deal?

China Company Audit Inspections Begin-

Inspectors from the PCAOB will be on the ground in Hong Kong on September 26 to begin reviewing audit documents of China-based companies that are listed on US exchanges.

For two decades Chinese authorities have refused to allow audit reviews of its nearly 200 companies that trade on US exchanges, citing national security concerns. Under US pressure and the threat of delistings, a deal was brokered to allow PCAOB inspections.

In spite of receiving assurances of cooperation from both the Chinese Ministry of Finance and the China Securities Regulatory Commission, SEC Chair Gary Gensler, told the Senate Banking Committee on September 14 that he remains cautious over whether full access to inspections will actually occur. “I don’t know if the Chinese are going to comply,” he said.

“It’s pretty clear: no redactions in the work papers, take testimony from whomever the PCAOB needs to take testimony from, they can onward share the information with us and they can pick which ever companies they want to look at,” he continued.

The United States’ frustration over non-compliance, combined with a series of accounting scandals at Chinese companies, triggered Congress in 2020 to pass the Holding Foreign Companies Accountable Act which bans the trading of securities on US exchanges of companies whose auditors can’t be inspected by the PCAOB for three consecutive years. Under that law, which was signed in 2021, Chinese companies have until Spring 2024 to comply, or be delisted.

As China continued its refusal to comply, US lawmakers introduced another bill earlier this year that would shorten the deadline for delisting non-compliant Chinese companies as early as March 2023.

In his Senate testimony, Gensler said he supports the shortened deadline for non-compliant Chinese companies explaining, “I do think it will continue to have the right leverage. Even if the Chinese authorities and Chinese regulators allow for compliance this year, what about next year, and what about the next year?”

Perhaps in anticipation of PCAOB inspections, five of China’s largest state-owned enterprises on August 12 announced they had started the delisting process from US Exchanges. The five companies had a combined market cap of US $348.5 billion.

Until now, China and Hong Kong were the only two jurisdictions worldwide that didn’t allow the PCAOB to inspect audits of US exchange-listed companies. The US works with 50 jurisdictions worldwide in inspecting audit documents of US-listed companies.

Dodd-Frank lives

Executive Pay vs Performance Disclosures Adopted

Public companies are now required to disclose how compensation paid to its executives relates to their companies’ financial performance. Additionally, companies will be required to compare its executive compensation to executives at other companies in their selected peer group.

The SEC’s newly adopted amendments on “pay vs. performance” requires public companies to provide a table disclosing specified executive compensation and detailed financial performance measures for their five most recently completed fiscal years.

With respect to the measures of performance, a registrant will be required to report its total shareholder return (TSR), the TSR of companies in the registrant’s peer group, its net income, and a financial performance measure chosen by the registrant.

Using the information presented in the table, registrants will be required to describe the relationships between the executive compensation actually paid and each of the performance measures, as well as the relationship between the registrant’s TSR and the TSR of its selected peer group.

Registrants also will be required to provide a list of three to seven financial performance measures that it determines are its most important performance measures for linking executive compensation actually paid to company performance.

Smaller reporting companies will be subject to scaled disclosure requirements under the rules. For example, smaller reporting companies must report their three most recent years and aren’t required to report the TSR of peer groups.

The “pay vs. performance” disclosure rules were first proposed in 2015 to fulfill a requirement of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act. The SEC reopened the comment period on the proposal in January of this year.

Public companies must begin to comply in proxy and information statements that are required to include Item 402 executive compensation disclosure for fiscal years ending on or after Dec. 16, 2022.

A Compass Without Direction

Study Finds ESG Ratings Firms Fall Short

As the October deadline for the SEC’s adoption of US ESG standards draws near, a Stanford University study of ESG ratings firms said that these new businesses are flawed by inadequate standardization, and incomplete and inconsistent data.

ESG ratings firms are supposed to provide information to investors, analysts and corporate managers about the relation between corporations and non-investor stakeholder interests, notes the study entitled ESG Ratings: A Compass Without Direction.

Recently, ESG ratings providers have come under scrutiny over concerns of the reliability of their assessments. The study found that inconsistency in methodology provided different ratings for the same company.

Demand for ESG information has exploded in recent years. “While ESG ratings providers may convey important insights into the nonfinancial impact of companies, significant shortcomings exist in their objectives, methodologies and incentives which detract from the informativeness of their assessments,” the study said.

The study also said that rating firms often don’t substantiate findings and methodologies noting “It is rare for ratings providers to offer concrete, systematic evidence to back up claims about their ratings.”

And while the goal of rating agencies is to determine a company’s ESG program and risks from social or environmental issues, Stanford said “current evidence is mixed” on whether ratings actually predict risk or return on investment. “It is also increasingly unclear whether they capture or predict improvement in stakeholder outcomes.”

In assessing environmental and social impact, the report says “Studies find that ESG ratings have low associations with environmental and social outcomes.”

As the burgeoning ESG ratings industry grows, the study questions whether these new agencies should be subject to the same regulations imposed by the SEC on rating agencies such as Moody’s, Standard & Poor’s and Fitch. The SEC currently requires these firms to adhere to certain policies, procedures, and protections to reduce conflicts of interest and improve market confidence in their quality.

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