At a conference, senior Securities and Exchange Commission (SEC) officials said that the staff will closely review several areas, including certain financial reporting topics, China, artificial intelligence (AI), and commercial real estate (CRE) disclosures, in company filings in 2024.
Financial Reporting
The staff will especially focus on accounting areas that involve judgment or new standards that were issued by the FASB or the IASB, said Erik Gerding, director of the SEC’s Division of Corporation Finance (CorpFin) at the 2024 SEC Speaks conference hosted by the Practising Law Institute on April 2 in Washington.
For example, he cited segment reporting, including compliance with new US GAAP disclosures, which is effective for annual periods beginning after December 15, 2023; compliance with non-GAAP regulations and rules; critical accounting estimates disclosure in management’s discussion & analysis (MD&A); and disclosures related to supplier finance programs in the notes to financial statements and any related information in MD&A.
For segment reporting, the FASB is requiring companies to disclose significant segment expenses that are regularly provided to the chief operating decision maker and included within each reported measure of segment profit or loss, among other requirements.
The Sarbanes-Oxley Act of 2002 requires the SEC to review each reporting company at least once every three years.
Gerding said, however, that a significant number of companies are reviewed more frequently. And in fiscal 2023, CorpFin reviewed about 3,300 companies as part of the division’s annual review program.
This is intended to make sure that companies are complying with disclosure rules and accounting standards. When CorpFin staff find insufficient or misleading disclosures, a staff comment letter is sent to the company to fix the deficient areas.
China-Based Companies
In addition to the financial reporting topics mentioned, Gerding said that disclosure review priorities from 2023 will continue this year, including a scrutiny of disclosures made by China-based companies.
In particular, the staff want to see robust disclosures about material risks companies face when the Chinese government intervenes or exercises control over their operations.
In addition, Lilyanna Peyser, legal branch chief of CorpFin’s Office of Mergers and Acquisitions, said companies with operations in China should enhance disclosures about Chinese government permissions and approvals to which they are subject.
Some companies disclosed the permissions and approvals they are required to obtain to offer securities but not to operate their business and vice versa. But both need to be disclosed.
Inflation
CorpFin Director Gerding said that the disclosure review program will also continue to look at information related to inflation.
“While it appears that inflation is beginning to come down, this is not the time for issuers to revert to boilerplate disclosures,” Gerding said. “Any material ongoing impacts from inflation should be disclosed, and we ask companies cannot just note high-level trends but discuss the more particularized risks and impacts on their specific company.”
Banking Turmoil From Spring 2023
Early last year, the banking system experienced disruptions with Silicon Valley Bank and others that have failed almost overnight because of poor risk management practices during skyrocketing inflationary and high interest rate periods.
And Gerding said CorpFin will continue to take a close look at updated disclosures related to interest rates and liquidity risks.
New Priorities for Review
Gerding said the division is adding new areas for review priorities, such as AI and CRE.
While companies have been using AI for years, the use of sophisticated technology to improve its operations has gone up significantly with the advent of generative AI in recent years.
There are many benefits, such as higher efficiency, but there are also risks with AI creating security, regulatory, and data privacy risks, raising ethical questions, and introducing errors.
Johnny Gharib, deputy chief risk officer of CorpFin’s Office of Risk and Strategy, said that the number of large accelerated filers discussing AI in their annual reports significantly increased to 59%, compared to 27% in prior year. These companies have public floats of more than $700 million.
“Although existing disclosure requirements do not explicitly refer to AI, a number of rules may require disclosure describing how a company uses AI and the risks related to its use,” he said.
The rules in question require disclosure in the business section, MD&A, risk factors section, financial statements, disclosure controls and procedures, board’s role in risk oversight.
As for CRE, the market has been hit hard in the past few years. Even though more companies today are now requiring hybrid work or in-office only work following the COVID-19 pandemic, there are still companies that allow much of the work to be done remotely. Hybrid work also means that companies do not need much office space with hot desking arrangements.
Bobby Klein, accounting branch chief of CorpFin’s Office of Finance, said that investors and regulators have been closely examining CRE and asset quality over the past year. The challenges the market experienced last year include decreased values, elevated interest rates, inflation, and property operations costs, and an increase in CRE loan delinquencies.
“The level of investor attention around CRE is indicative of their interest to understand at a more disaggregated level, about those concentrations, credit risks and exposure that may exist within a particular CRE loan portfolio,” Klein said.
While disclosures related to material concentrations in a loan category is not a new topic or issue, this will continue to be an area of review priority, he said, and asked companies to provide more granular data so investors can better understand the risk and exposure.
For example, he said companies should write clearly about movements or changes in the balance with other quantitative information related to past-due statistics of non-performing loans or classified assets.
Companies should also disclose critical accounting estimates and assumptions that underlie the allowance for credit losses calculation and how much each estimated input in assumption has changed from period to period. This should include a discussion of the factors that are driving the change.
This article originally appeared in the April 15, 2024, edition of Accounting & Compliance Alert, available on Checkpoint.
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