Q1 Meeting: A Q&A on SEC Rulemaking and Enforcement with David Peavler

The SEC under Chair Gary Gensler has been more aggressive in its rulemaking and use of enforcement actions than commissions of the past, former SEC Regional Director David Peavler said at the Q1 SEC Pro Group national meeting in March.

"Even in the wake of Sarbanes-Oxley, even in the wake of Dodd-Frank, this volume of rulemaking is, to me at least, unprecedented," said David, now a partner at the law firm Jones Day after spending 19 years with the SEC.

The commission has also pushed envelopes in its enforcement activity, David said. Rules and charges have been used in ways they hadn't before, as in the recent DCP (disclosure controls and procedures) case against Activision, and the SEC has been getting tougher with sanctions.

Pro Group Executive Advisor Steve Soter's Q&A with David at the Q1 meeting sparked more conversation at in-person chapter meetings around the country. (More on that in a moment!) Here's a look at David's thoughts on other hot topics:

On the use of non-GAAP measures as financial metrics under the new pay-for-performance rule

David didn't comment on the spot about whether a non-GAAP measure would have to be connected to a GAAP measure in your proxy but suggested that using non-GAAP metrics could introduce an area for the SEC to review. "Have you defined it in a way that is clear and consistent over time? And have you made changes to it that have the effect of benefitting the executives?" he asked.

"The one common theme that you see running through the SEC's enforcement and rulemaking is when information is reaching shareholders, the SEC is going to expect that there is the process behind it, that there is good disclosure around it," David said.

He expects more enforcement cases around gaps in processes and internal controls as the SEC tries to prevent material misrepresentations.

On the proposed cybersecurity rule

Steve mentioned the proposed cyber rule would require companies to alert the public of a cybersecurity event or breach within a certain timeframe, even if law enforcement has asked not to disclose anything because of an ongoing investigation into the breach.

David noted the time the SEC is taking to adopt a final rule. "I think ultimately the rule is going to run headlong into reality," he said. However, if a company discloses information early after a cybersecurity event that it later learns is false or misleading, recent SEC actions have shown the SEC expects companies to correct those misrepresentations, David said.

On the climate rule

David predicts opponents will challenge the SEC's climate rule in court, whenever it becomes final. It's possible courts could decide the issue needs to be addressed by Congress not regulators, he said.

"I think the other question is whether it would be better to let the market kind of solve itself," he said. "Do you need to force disclosure if the market is moving in that direction?"

On the SEC's enforcement priorities

David said the SEC has been putting its resources in:

• Cybersecurity
• Crypto
• Earnings diclosures and earnings management (the SEC is using technology to detect anomalies, revenue smoothing, and earnings smoothing)
• Ponzi schemes, broker-dealers, investment advisors

On red flags auditors tend to watch to catch fraud

• The "diving catch", or the late quarter heroics to meet the numbers that go beyond the typical late-quarter sales surge
• Fortuitous changes to reserves that happen to move in a direction that you need them to move
• Top down adjustments

All companies should have internal processes, hotlines, or outlines for associates to resolve questions about red flags.

Reflections on a career with the SEC

One of David's takeaways was that most instances of fraud that he saw didn't start out with ill intent but as a misguided effort to cover up or make up for a mistake.

"At some point, it crosses the line from mistake into fraud," David said. "When you find yourself having to justify a mistake, just admit the mistake. It's the old line, "The cover-up is worse than the crime.' That really is true."

What conversations did David's comments spark at your chapter meeting?

Those of you who attended in-person chapter meetings know part of the fun is talking about what you just heard with your peers.

In Dallas (thanks to Vaco for supporting and sponsoring the event!), chapter chairs Mallory King of Match Group, Mark Abbott of Peraton, and Denyse Lessard of Cinemark led a follow-up Q&A session with attendees. Over lunch, the group chatted about:

• The psychology of people who commit fraud (David mentioned the book Why They Do It: Inside the Mind of the White-Collar Criminal by Eugene Soltes)
• The right spot for ESG disclosures (the SEC is figuring that out, but it's possible those could be spread through a 10-K in addition to having its own section)
• How far do companies go with calculating Scope 3 emissions? (Would an app maker, for example, be forced to calculate the emissions tied to someone using their smart phone to access the app?)
• Should COVID-19 still make an appearance in 10-Ks? (Consider whether it's still affecting your business or if it's been normalized)
• Crypto (David raised the question of whether it's a topic that Congress, rather than regulators, will ultimately take on)

Get ready for your local Q2 chapter meeting!

Look for information soon on your local Q2 SEC Pro Group chapter meeting taking place in the second half of June to further discuss how SEC reporting teams are working with ESG teams to prepare for and respond to the upcoming final climate rule.

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