February 2023 financial reporting, governance, and risk management

| 2/15/2023
February 2023 financial reporting, governance, and risk management

Message from John Epperson, Managing Principal, Financial Services

Dear FIEB readers,

Many of our readers are well into year-end financial reporting season, which means 2022 is quickly moving stage left while all eyes focus on interest rates and the next move of the Board of Governors of the Federal Reserve.

As we consider what 2023 holds, the federal financial institution regulators issued a crypto asset policy statement, provided details of upcoming climate scenario pilot exercises, and revised fair lending guidance, among other activities. The Financial Accounting Standards Board finalized decisions on an upcoming crypto asset accounting proposal. The Securities and Exchange Commission (SEC) updated its financial reporting manual; published new interpretations on pay-versus-performance disclosures, erroneously awarded compensation, and glossy annual reports; proposed securitization conflict of interest rules; and held a forum on small-business capital matters. The SEC chief accountant released a statement on accounting standard-setting, and we also note recent commissioner remarks on environmental, social, and governance investing and crypto assets. Finally, the Center for Audit Quality published an alert to assist stakeholders’ understanding of the SEC’s recent non-GAAP interpretive updates.

We look forward to keeping you informed throughout 2023.

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Matters of importance from the federal financial institution regulators

Fed levels playing field for crypto asset keepers without FDIC insurance

The Federal Reserve (Fed) on Jan. 27, 2023, released a policy statement clarifying how it will evaluate requests from state-chartered entities that are not insured by the Federal Deposit Insurance Corp. (FDIC) but are seeking to engage in novel activities, such as those involving crypto assets. The policy seeks to create a level playing field and limit regulatory arbitrage for state banks with deposit insurance, state banks without deposit insurance, and national banks, which are overseen by the Office of the Comptroller of the Currency (OCC). The Fed reiterated that such novel activities must be conducted in “a safe and sound manner.”

In response to inquiries from banks over the years about engaging in crypto asset activities, the Fed statement specifies it will evaluate such requests “consistent with longstanding practice.” In the statement the Fed notes, “Today's action would not prohibit a state member bank, or prospective applicant, from providing safekeeping services, in a custodial capacity, for crypto-assets if conducted in a safe and sound manner and in compliance with consumer, anti-money laundering, and anti-terrorist financing laws.”

The Fed policy statement follows a Jan. 3 interagency joint statement in which the federal banking regulators issued a warning on crypto asset risks and said that they had significant concerns about the safety and soundness of business models that are concentrated in activities related to crypto assets or have concentrated exposures to the crypto asset sector.

Fed offers details on climate scenario pilot exercise

The Fed on Jan. 17, 2023, provided additional details on how its upcoming pilot climate scenario analysis exercise will be conducted and what information on risk management practices will be gathered from the program. The six largest banks in the U.S. will participate in the exercise, starting in the first quarter of this year.

Over the course of the pilot, the Fed will collect qualitative and quantitative information. Areas of interest include governance and risk management practices, measurement methodologies, risk metrics, data challenges, and lessons learned. The exercise will include physical risk scenarios with different levels of severity affecting residential and commercial real estate portfolios in the northeastern U.S., with each bank also asked to consider the impact of additional physical risk shocks for their real estate portfolios in another region of the country. In addition, the banks will be asked to consider the effect on corporate loans and commercial real estate portfolios using a scenario based on current climate policies and one based on reaching net-zero greenhouse gas emissions by 2050.

Without releasing firm-specific information, the Fed plans to publish results of the pilot reflecting what it has learned about climate risk management practices and how insights from scenario analysis will help identify potential risks and promote effective risk management practices. As reported in the January 2023 Financial Institutions Executive Briefing, Fed Chair Jerome Powell recently said that while the Fed has important supervisory responsibilities to ensure banks appropriately manage climate-related financial risk, it is not and will not be a “climate policymaker” and that it should be careful not to pursue perceived social benefits that are not tightly linked to the Fed’s statutory goals and authorities.

OCC revises fair lending booklet

The OCC on Jan. 12, 2023, issued a revised version of the “Fair Lending” booklet of the Comptroller’s Handbook. The booklet outlines information and examination procedures to help OCC examiners assess fair lending risk and evaluate compliance with the Fair Housing Act, the Equal Credit Opportunity Act (EOCA), and Regulation B of the ECOA. The revisions reflect changes to laws and regulations that have occurred since the previous booklet was published in 2010. The revised booklet includes new and clarified details and risk factors for a variety of examination scenarios, and it updates references to supervisory guidance, sound risk management practices, and applicable legal standards. In addition, it details the OCC's current approach to fair lending examinations.

OCC holds bank mergers symposium

The OCC on Feb. 10, 2023, held its 2023 Symposium on Bank Mergers at its Washington, D.C., headquarters with the objective of providing a forum for healthy debate on the future direction of bank mergers policy. Numerous panel discussions throughout the all-day program included representatives largely from academia and economic professionals from federal banking agencies. The conference focused on evaluating the impact of bank mergers on competition, financial stability, and the convenience and needs of the community served – three of the more significant factors the agencies are required to address as part of the merger review and approval process.

Benjamin McDonough, OCC senior deputy comptroller and chief counsel, opened the program with some brief remarks and read a prepared statement from acting Comptroller Michael Hsu that said “the framework for analyzing bank mergers needs updating.” A consistent theme of the symposium was that clear and concise guidance is needed along with a consistent approach across all agencies when reviewing competitive impacts on local markets from mergers while considering the effects on the communities affected by the mergers and access to fair financial products by all consumers in those markets.

Panelists presented competing arguments on whether mergers are good for U.S. financial stability and competition in general. Some panelists cautioned against regulatory policies potentially rejecting healthy mergers, which might restrict innovation of financial products and push banking activities outside of insured depository institutions and into uninsured shadow banking entities that are not subject to strict regulatory standards. Other panelists advocated for a much stricter merger approval process, largely claiming that existing lax merger approval processes have produced institutions that are “too big to fail,” that present challenges with resolution efforts in the event of failure, and that increase overall risk to financial stability.

Several panelists highlighted the continuing multidecade trend of industry consolidation and concentration of assets and deposits in larger institutions. They pointed to higher barriers of entry in more recent years preventing new market entrants, as evidenced by negligible de novo bank formation since 2008. Some said that the agencies should focus on reducing the costs, initial capital, and time needed to form a new bank in order to help reduce potential negative competitive impact of mergers while also enabling new smaller banks to meet the convenience and needs of communities. Continued dialogue on the merger review process among the federal banking regulators and legislators is expected through the remainder of 2023.

FHFA issues guidance on MSRs for managing counterparty credit risk

The Federal Housing Finance Agency (FHFA) on Jan. 12, 2023, released an advisory bulletin on the valuation of mortgage servicing rights (MSRs) for managing counterparty credit risk. The notice is intended to communicate the FHFA’s supervisory expectations for Fannie Mae and Freddie Mac “to establish and implement risk management policies and procedures for monitoring and valuing seller/servicers’ mortgage servicing rights.”

In the bulletin the FHFA states, “Enterprise-wide risk management policies and procedures should be commensurate with [Fannie and Freddie]’s risk appetite, and based on an assessment of seller/servicer financial strength and MSR risk exposure levels.” The FHFA also notes that although seller/servicers assign values to their MSRs, Fannie Mae and Freddie Mac should have their own processes to evaluate the reasonableness of seller/servicer MSR values.

The advisory outlines risk management expectations to ensure MSR values are reasonable, objective, and transparent. Specific guidance is included on objective evaluation of MSR values, MSR valuations for mortgage loans owned or guaranteed by Fannie and Freddie and stress testing, MSR valuations for mortgage loans not owned or guaranteed by Fannie and Freddie, market data input, use of third-party providers, frequency of evaluations, and discount to MSR values when servicing rights are terminated. The bulletin only applies to MSRs for single-family mortgage loans and is effective April 1, 2023.

FinCEN solicits comments on proposed beneficial ownership reporting process

The Financial Crimes Enforcement Network (FinCEN) on Jan. 17, 2023, issued a notice and request for comments on the reporting process that the agency plans to use to collect beneficial ownership data from reporting companies.

The beneficial ownership information reporting requirements final rule issued on Sept. 30, 2022, requires reporting companies to provide FinCEN with information about the reporting company, the individual beneficial owners of the reporting company, and individuals who have filed an application with specified governmental authorities to create a domestic reporting company or register a foreign reporting company to do business in the U.S. The notice gives the public an opportunity to comment on the proposed reporting process as well as on the agency’s estimate of the burden resulting from preparing and submitting the report.

FinCEN said the report will be filed electronically through an online interface and must identify the reporting entity. The reporting company must certify that the report is true, correct, and complete. In addition, companies would be required to update the information in these reports as needed and correct any incorrect information within specific time frames. The collected information will be maintained by FinCEN and made accessible to authorized users.

Comments are due March 20, 2023.

CFPB proposal would remove credit card late fee safe harbor

The Consumer Financial Protection Bureau (CFPB) on Feb. 1, 2023, issued a proposed rule that would eliminate a longstanding safe harbor that banks of all sizes rely on when setting late fees on credit card payments. Citing “excessive credit card late fees,” the CFPB proposal would reduce the safe harbor dollar amount for late fees from $30 to $8 and eliminate a higher safe harbor dollar amount for late fees for subsequent violations of the same type, eliminate the annual inflation adjustment for the safe harbor amount, and mandate that late fees must not exceed 25% of the required minimum payment.

With the proposed rule, the CFPB looks to amend Regulation Z and the Fed provisions approved in 2010 that implemented the Credit Card Accountability Responsibility and Disclosure Act, which included a Fed provision that allowed credit card issuers to set fees at a particular level as a safe harbor.

Comments are due April 3, 2023.

From the Financial Accounting Standards Board (FASB)

FASB addresses crypto assets

At its meeting on Feb. 1, 2023, the FASB finalized its decisions on a forthcoming proposal that would require entities to account for holdings of certain crypto assets at fair value.

Under the proposal, holdings of crypto assets would be measured at fair value at each reporting date with changes in fair value recorded through earnings. Also, the proposal would require entities to provide extensive disclosure about crypto assets measured at fair value, including an annual rollforward of an entity’s crypto asset holdings. Entities would adopt using a modified retrospective approach, recording a cumulative effect adjustment to equity (or net assets) as of the beginning of the year of adoption. Early adoption would be permitted. The board directed the staff to draft a proposed Accounting Standards Update for vote by written ballot. More details can be found in the Crowe article “Proposal on Accounting for Crypto Assets Coming Shortly.”

From the Securities and Exchange Commission (SEC)

SEC chief accountant makes accounting standard-setting observations

On Feb. 14, 2023, SEC Chief Accountant Paul Munter released current observations on the state of accounting standard-setting in today’s ever-evolving business environment. The release focuses on key considerations for meeting investor information needs in a timely manner.

SEC commissioner remarks on ESG investing

SEC Commissioner Mark Uyeda on Jan. 27, 2023, spoke before the California ’40 Acts Group. His speech focused on issues related to asset managers’ use of environmental, social, and governance (ESG) investment strategies. He said that “ESG investing has taken the asset management industry by storm.” Uyeda noted that describing products as ESG is good for business, but it is difficult to determine exactly what ESG means. It is challenging to identify when an ESG investment strategy is properly labeled as such.

Uyeda said the regulatory issues presented by ESG investing are nothing new, but ESG investing is complicated by three factors that make it difficult to establish ESG-specific frameworks:

  • “[T]he inability to objectively define ‘ESG’ or any of its components”
  • “[T]he temptation to place the regulators’ fingers on the scale in favor of specific ESG goals or objectives”
  • “[T]he desire of certain asset managers to use client assets to pursue ESG-related goals without obtaining a mandate from clients”

In recognition that ESG is difficult to define, the SEC’s own ESG proposed rule for investment advisers and investment companies recognizes a “variety of perspectives concerning what ESG investing means, the issues or objectives it encompasses, and the ways to implement an ESG strategy.” Further, Uyeda said that ESG measures often are used to advance social or political causes, and the goal of ESG investing is something other than financial performance. He shared that there is not consistency among ESG rating agencies, which calls into question how investment advisers are using ESG ratings to make decisions. He warned that the lack of a universal ESG definition creates the potential for abuses that can steer assets to particular companies based on social or political agendas.

Uyeda concluded with a caution that “ESG” can have different meanings, so to comply with federal securities laws, asset managers should describe precisely what they mean when they use the term to describe an ESG fund or product. He said the existing regulatory framework is well suited to guide the conduct of investment advisers, but “[a]ny emerging regulations should be careful not to tip the scale in favor of any particular political or social cause, and adherence to the established framework of focusing on financial materiality will continue to serve investors well.”

SEC publishes interpretations on new compensation rules

The SEC updated its Regulation S-K Compliance and Disclosure Interpretations (C&DIs) on Feb. 10, 2023, to include a series of implementation questions on the new pay-versus-performance disclosure rules.

 On Jan. 27, 2023, the SEC updated its Exchange Act Rules and Exchange Act Forms C&DIs related to the recently finalized erroneously awarded compensation rules.

SEC removes “glossy” annual report EDGAR submissions

Finally, on Jan. 11, 2023, the SEC updated its Proxy Rules and Schedule 14A C&DIs to withdraw the requirement to submit “glossy” annual reports to shareholders electronically on EDGAR.

SEC proposes rule on conflict of interest in securitizations

On Jan. 25, 2023, the SEC proposed a rule prohibiting conflicts of interest in certain securitization transactions. The proposed rule:

  • Prohibits, generally from the date the participation begins until one year after the sale of the asset-backed security (ABS), a securitization participant (underwriters, placement agents, initial purchasers, or sponsors) from engaging in any transaction that would result in a conflict of interest with an investor in the ABS
  • Identifies prohibited participant transactions, when material to an investor’s ABS investment decision, as:
    • ABS short sales
    • Purchase of certain credit derivatives or other financial instruments that protect against certain ABS-adverse events
  • Provides certain exceptions to the prohibited transactions including risk-mitigating hedging activities, bona fide market-making activities, and liquidity commitments
  • Requires certain compliance activities if the participant relies on exceptions

Comments are due 60 days following publication of the proposal on the SEC’s website or 30 days following publication in the Federal Register, whichever is longer.

SEC commissioner remarks on digital assets

On Jan. 20, 2023, SEC Commissioner Hester Peirce spoke before the Digital Assets at Duke Conference. Peirce said that crypto assets’ value proposition depends primarily on the builders of the technology and not on regulators. She offered some lessons for the crypto asset industry:

  • Do not wait for regulators to fix the problems that became evident in 2022. Root out harmful practices and encourage good behavior. Regulatory solutions, which often are inflexible, should be a last resort.
  • Digital assets need to trade; therefore, centralized venues or decentralized exchange protocols are necessary. But trading markets are not the end point. Technologies like cryptography, blockchain, and zero-knowledge proofs offer new solutions.
  • Each crypto asset, blockchain, and project needs to be assessed on its own merits.
  • Problems in protocol design or at a centralized infrastructure provider can have far-reaching and disastrous consequences. Testing protocols and carefully analyzing the incentives can prevent problems.
  • As long as a company is actively involved in crypto assets, investors should take the same precautions as they would when dealing with any other company.
  • Risks, counterparties, counterparties’ counterparties, collateral, leverage, conflicts of interest, motives for buying, risk controls, and concentration matter.

Peirce also advised that one of the most important things in the crypto asset industry is to listen to the critics inside and outside the industry. Peirce said that the SEC wants to regulate crypto assets but needs to conduct better, more precise, and more transparent legal analysis to develop a coherent and consistent legal framework that works across all asset classes. She noted that the SEC’s approach of regulation by enforcement actions is the opposite of a rational regulatory framework. However, a notice-and-comment process allows broad public and internal participation in developing a sound and reasonable regulatory system. Peirce described five guiding principles that should be considered in developing such a regulatory framework:

  • Take a nuanced approach that recognizes differences across blockchains and applications built on top of them, and differences among crypto assets.
  • Carefully decide what areas of crypto assets to regulate on a federal level, along with when and how to do so.
  • Be clear that government regulation is not the same as government endorsement.
  • Understand that scaring traditional entities away from crypto is not realistic and does not protect investors.
  • Preserve decentralization.

SEC addresses small-business capital matters

On Feb. 7, 2023, the SEC Small Business Capital Formation Advisory Committee held a meeting to discuss challenges and opportunities for small businesses raising capital in 2023, alternatives to traditional financing for smaller private companies, the SEC’s proposal on private fund reforms, and the role of equity research for smaller public companies.

On Jan. 20, 2023, the SEC announced that it is seeking nominees for appointment to the Small Business Capital Formation Advisory Committee. The members of the committee provide advice and recommendations on SEC rules, regulations, and policy matters relating to small businesses, including smaller public companies.

At the 50th Annual Securities Regulation Institute on Jan. 30, 2023, SEC Commissioner Caroline Crenshaw presented the keynote address on issues with the small-business safe harbor. She discussed the origins of and the current state of Rule 506 of Regulation D, which is the primary exemption that large private issuers rely on to raise “essentially unlimited capital from an unlimited number of accredited investors.” Crenshaw next noted some of the consequences of allowing limitless capital to flow into the private markets. Finally, she suggested two potential reforms:

  • Revise Form D to provide essential information to all private investors, to the public markets, and to the regulators.
  • Impose increased obligations on large private issuers and large capital raises.

Crenshaw said that increasing obligations on large private issuers and large capital raises is a tailored solution that helps the SEC fulfill its mandates as it both acknowledges Regulation D’s purpose in allowing reprieve to smaller businesses and also helps eliminate the benefits and effective subsidies being given to large private issuers at the expense of small businesses. Additionally, such reform would provide better disclosures to investors. She said that the proposed reforms to Regulation D are incremental but essential to ensure that the private markets operate as originally intended.

SEC releases 2023 examination priorities

On Feb. 7, 2023, the SEC’s Division of Examinations announced its 2023 risk-based examination priorities. Annually, the division publishes examination priorities to provide transparency into its approach, including areas in a changing landscape that might present risks to investors and U.S. capital market integrity.

The 2023 examination priorities include:

  • Compliance with new rules:
  • Private funds
  • Retail investor protections
  • ESG investing
  • Information security and operational resiliency
  • Emerging technologies and crypto assets
  • LIBOR transition

Corp Fin updates Financial Reporting Manual

In January 2023, SEC’s Division of Corporation Finance (Corp Fin) staff released updates to its Financial Reporting Manual, which provides nonauthoritative guidance based on staff interpretations. Among other changes, the following updates identified with the tag “Last updated: 12/31/2022” are included:

  • Revisions for amendments to Rules 3-10 and 3-16 of Regulation S-X in SEC Release No. 33-10763, “Financial Disclosures About Guarantors and Issuers of Guaranteed Securities and Affiliates Whose Securities Collateralize a Registrant’s Securities”
  • Removal of outdated information including information related to the adoption of Accounting Standards Codification 606

SEC names new director of Corp Fin

On Jan. 13, 2023, the SEC announced Erik Gerding’s appointment as director of the Division of Corporation Finance, effective on Feb. 3, 2023. Gerding has served as deputy director and replaces Renee Jones, who returns to the faculty of Boston College Law School. Gerding, who has degrees from Duke University and Harvard Law School, joined the SEC in October 2021 and leads Legal and Regulatory Policy in Corp Fin. Prior to joining the SEC, he was professor of law at the University of Colorado Law School and the University of New Mexico School of Law. He also practiced in the New York and Washington, D.C., offices of Cleary Gottlieb Steen & Hamilton LLP.

From the Center for Audit Quality (CAQ)

CAQ addresses updates to SEC non-GAAP financial measures guidance

On Jan. 25, 2023, the CAQ issued “Alert 2023-1: Updates to SEC Non-GAAP Financial Measures Compliance and Disclosure Interpretations (C&DIs)” to provide an overview of the updates posted by the SEC on Dec. 13, 2022, and a comparison between the old C&DIs and the updated ones. The updates to the C&DIs encompass the SEC staff’s views that have been communicated in comment letters over the past several years.  


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