November 2021 financial reporting, governance, and risk management

| 11/17/2021
November 2021 financial reporting, governance, and risk management

Message from John Epperson, Managing Principal, Financial Services

Dear FIEB readers,

Where has the time gone? I find it hard to believe Thanksgiving is next week.

Third quarter financial reporting results are now largely complete for the roughly 400 banks filing with the SEC. For the approximately 170 banks on CECL, allowances continue to decrease for the vast majority. For the remaining banks filing with the SEC, allowances remain relatively steady. Credit quality continues to improve overall, with the vast majority of issuers reporting a decline in nonperforming loans.

I invite our readers join our 2021 Crowe Financial Services Conferences. We will cover the latest accounting and financial reporting changes, federal tax proposals, and critical economic and technology trends – information that can help you navigate this time of rapid transformation. Registration is available for various two-day in-person locations or our one-day virtual event on Friday, Nov. 19.

As we move through the fourth quarter, I wish you, your family, and your friends a delightful Thanksgiving, whether it’s in person or virtually.

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Takeaways from the 2021 AICPA online conference on credit unions

AICPA holds online credit union conference

The American Institute of Certified Public Accountants (AICPA) and Chartered Institute of Management Accountants Conference on Credit Unions was held virtually Oct. 18-20, 2021, and covered accounting and auditing topics relevant to credit unions. Conference topics focused on the current economic environment and emerging from the pandemic into a “new normal”; digital transformation and fintech companies; diversity, equity, and inclusion in the workplace; and regulatory and compliance updates. Crowe has issued a comprehensive report covering key takeaways from the conference and insights on economic, accounting, and regulatory updates, as well as other industry hot topics.

Matters of importance from the federal financial institution regulators

Fed board member remarks on potential guidance on climate scenario analysis

The Federal Reserve Board (Fed) has provided information in previous public speeches on the Fed’s early efforts to develop a framework for evaluating how banks are taking into account climate-related risk in the management of credit, market, liquidity, and operational risks. At an industry stress-testing conference on Oct. 7, 2021, Lael Brainard, a Fed governor, provided an update and noted that the Fed “is carefully considering the potential implications of climate-related risks for financial institutions and the financial system, with scenario analysis emerging as a potential key analytical tool for that purpose.”

Acknowledging the challenges of conducting such an analysis, Brainard provided her view that it would be “helpful to provide supervisory guidance for large banking institutions in their efforts to appropriately measure, monitor, and manage material climate-related risks.”

Brainard added that “the Federal Reserve’s Financial Stability Climate Committee is assessing climate-related risks to financial stability from a macroprudential perspective – that is, one that considers the potential for complex interactions across the financial system. Both the prudential and macroprudential work programs will benefit from the development of climate scenario analysis.”

In related news, the U.S. Department of the Treasury released its initial Climate Action Plan as directed by President Joe Biden’s “Executive Order on Tackling the Climate Crisis at Home and Abroad,” which charges Treasury bureaus and agencies to integrate climate change adaptation planning and actions into their programs, policies, and operations.

FSOC reports on climate-related financial risk

The Financial Stability Oversight Council (FSOC), whose members include the Treasury secretary as chair, and chairs of the Fed, the Federal Deposit Insurance Corp. (FDIC), the Commodity Futures Trading Commission (CFTC), the National Credit Union Administration (NCUA), the Office of the Comptroller of the Currency (OCC), and the Securities and Exchange Commission (SEC) as well as directors of the Consumer Financial Protection Bureau (CFPB) and the Federal Housing Finance Agency (FHFA), released on Oct. 21, 2021, its “Report on Climate-Related Financial Risk” in response to the president’s “Executive Order on Climate-Related Financial Risk.” As part of the announcement, the FSOC has identified climate change as an “emerging and increasing threat to U.S. financial stability.”

The comprehensive report and accompanying recommendations will guide the FSOC to build on and accelerate efforts on climate change through concrete recommendations for member agencies to take these steps:

  • “Assess climate-related financial risks to financial stability, including through scenario analysis, and evaluate the need for new or revised regulations or supervisory guidance to account for climate-related financial risks;
  • “Enhance climate-related disclosures to give investors and market participants the information they need to make informed decisions, which will also help regulators and financial institutions assess and manage climate-related risks;
  • “Enhance actionable climate-related data to allow better risk measurement by regulators and in the private sector; and
  • “Build capacity and expertise to ensure that climate-related financial risks are identified and managed.”

The report also calls for the use of enhanced climate-related risk disclosures. Specifically, the FSOC recommends that regulators review existing public disclosure requirements and consider updates that would build on the work of the Task Force on Climate-Related Financial Disclosures. Regulators also should consider whether such disclosures should include disclosures of greenhouse gases produced and financed by financial firms.

Additionally, the report calls for the establishment of a dedicated FSOC committee to assess climate-related financial risks as well as an advisory committee that would include representatives from industry stakeholders. The report also directs the regulatory agencies to increase their internal capacity to identify, measure, assess, and report on climate-related financial risks and their effects on financial stability and to address any gaps that hinder the gathering and analysis of reliable data.

While the report recommends that FSOC regulators take new actions on climate change data, disclosure, and scenario analysis, it also discusses how individual members such as the Fed and the SEC have climate risk and environmental, social, and governance initiatives underway.

Agencies release statement on transition from LIBOR

In a joint statement on Oct. 20, 2021, the federal and state financial institution regulators emphasize that supervised institutions are expected to continue to progress toward an orderly transition away from the London Interbank Offered Rate (LIBOR) ahead of the scheduled Dec. 31, 2021, deadline. “Failure to adequately prepare for LIBOR’s discontinuance could undermine financial stability and institutions’ safety and soundness and create litigation, operational, and consumer protection risks,” according to the statement.

The OCC, Fed, FDIC, and NCUA previously communicated that supervised institutions should stop entering into new contracts that use LIBOR as a reference rate “as soon as practicable,” but no later than Dec. 31. The CFPB and state bank and credit union regulators joined the Oct. 20 joint statement.

The statement includes a number of considerations that banks should take into account when selecting a reference rate, such as understanding how the chosen reference rate is constructed and being aware of any fragilities associated with it and the markets that underlie it. The agencies remind institutions to develop and implement a transition plan for communicating with consumers, clients, and counterparties and to ensure that systems and operational capabilities will be ready for transition to a replacement reference rate after LIBOR’s discontinuation.

In related news, the OCC on Oct. 18, 2021, updated its self-assessment tool for banks to evaluate their preparedness for transitioning from LIBOR to an alternative reference rate, replacing one issued in February 2021.

The tool can be used to determine the appropriateness of a bank’s transition plan and risk management process for identifying and mitigating LIBOR transition risks. LIBOR transition plans should be risk-based and may not need to include all points included in the self-assessment. The OCC encouraged banks to work toward resolving replacement rate issues while communicating with affected customers and third parties.

OCC releases bank supervision operating plan for 2022

The OCC, on Oct. 15, 2021, released its bank supervision operating plan for fiscal year 2022, providing the foundation for OCC policy initiatives and supervisory strategies for the new federal fiscal year that started Oct. 1. The OCC said supervision efforts will continue to focus on the impacts of the pandemic and the resulting economic, financial, operational, and compliance implications.

In addition, OCC examiners will focus on the safety and soundness of strategic and operational planning in a number of areas including:

  • Credit risk management, allowances for loan and lease losses, and allowances for credit losses
  • Cybersecurity and operational resilience
  • Oversight of third parties and related concentrations
  • Bank Secrecy Act/anti-money laundering (BSA/AML) compliance management
  • Consumer compliance management systems and fair lending risk
  • The impact of a low-rate environment and the transition from LIBOR to alternative reference rates
  • Payment systems products and services
  • Fintech partnerships for potential crypto asset-related activities and other services
  • Climate change risk management

FinCEN finds ransomware reports in first half of 2021 exceed 2020 total

The Financial Crimes Enforcement Network (FinCEN) issued a ransomware trends report on Oct. 15, 2021, in response to the increase in number and severity of ransomware attacks in the U.S. since late 2020. The report highlights that in the first six months of 2021, FinCEN identified $590 million in ransomware-related suspicious activity reports (SARs), a 42% increase compared to the 2020 total of $416 million. The report also notes that if current trends continue, SARs filed in 2021 are projected to have a higher ransomware-related transaction value than SARs filed in the previous 10 years combined. This increase would represent a continuing trend of substantial increases in reported year-over-year ransomware activity.

The median average payment amount for ransomware-related transactions in the first half of the year was $102,273, a slight increase from the same period last year. FinCEN notes that the majority of ransomware-related payments were for less than $250,000. The report also identifies 68 ransomware variants.

Given ransomware payments are often paid using a virtual currency, Treasury’s Office of Foreign Assets Control (OFAC) released guidance to accompany the FinCEN report. The guidance is intended to help financial institutions incorporate virtual currencies in their sanctions compliance programs and to assist the virtual currency industry in mitigating risks of sanctioned persons from exploiting virtual currencies to evade sanctions. The OFAC guidance includes case studies, best practices, OFAC requirements, and information about enforcement procedures.

President’s working group issues report on stablecoin regulations

In a much-anticipated report released on Nov. 1, 2021, the President’s Working Group on Financial Markets, working in conjunction with the FDIC and the OCC, examines potential risks and regulatory gaps related to stablecoins, cryptocurrencies that are valued by a specified reserve asset, and offers recommendations for mitigating these risks. The report outlines some background on the growing use of stablecoins in the U.S. digital asset markets and describes a range of risks associated with increased stablecoin-related activities including risk of fraud, misappropriation, conflict of interest, market manipulation, money-laundering, and terrorist financing, among others.

The report highlights that too many regulatory gaps exist related to stablecoins, which could lead to vulnerabilities. Thus, the report cites an urgent need for a “consistent and comprehensive regulatory framework” to “increase transparency into key aspects of stablecoin arrangements and to ensure that stablecoins function in both normal times and in stressed market conditions.” Specifically, the report calls for legislation that would require stablecoins to be issued only by insured depository institutions and for providers of custodial wallets to be subject to “appropriate federal oversight,” including compliance with risk management, liquidity, and capital requirements.

The report further recommends that while Congress considers stablecoin legislation, the FSOC should take actions within its jurisdiction to address risks, such as designating certain activities conducted within stablecoin arrangements as systemically significant payment, clearing, and settlement activities. This designation would permit federal regulatory agencies to promptly establish risk management requirements for the institutions that engage in those activities and subject them to an examination and enforcement framework.

In response, SEC Chair Gary Gensler issued, on Nov. 1, 2021, a statement describing the report as thoughtful. He said the use of stablecoins presents many public policy challenges, and the SEC and the CFTC will deploy, as applicable, the full protections of the federal securities laws and the Commodity Exchange Act to stablecoin arrangements.

From the Financial Accounting Standards Board (FASB)

FASB issues discount rate guidance for lessees

On Nov. 11, 2021, the FASB issued Accounting Standards Update (ASU) 2021-09, “Leases (Topic 842): Discount Rate for Lessees That Are Not Public Business Entities,” to provide entities that are not public business entities (PBEs) with more flexibility in how they determine the discount rate and make the risk-free rate election to reduce implementation costs. Prior to this update, Topic 842 provided lessees that are not PBEs with a practical expedient to elect an accounting policy to use a risk-free rate as the discount rate for all leases. The amendments allow those lessees to make the risk-free rate election by class of underlying asset rather than at the entitywide level. In making the risk-free rate election, entities are required to disclose to which asset classes it has elected to apply the risk-free rate. Under the ASU, when the rate implicit in the lease is readily determinable for any individual lease, the lessee would use that rate regardless of whether it has made a risk-free rate election.

For entities that have not adopted Topic 842, the amendments are effective when they adopt Topic 842. For entities that already have adopted Topic 842, the amendments are effective for fiscal years beginning after Dec. 15, 2021, and interim periods within fiscal years beginning after Dec. 15, 2022. Early adoption is permitted.

FASB proposes changes to interim disclosures

The FASB issued, on Nov. 1, 2021, a proposed ASU, “Interim Reporting (Topic 270): Disclosure Framework – Changes to Interim Disclosure Requirements,” that introduces a disclosure principle for interim reporting. Specifically, the proposed ASU removes the phrase “at a minimum” and encourages assessing materiality when entities evaluate interim disclosure requirements. The principle is designed to require event- or transaction-specific disclosure when there is a material effect on an entity. The proposed guidance provides clarification to presentation and disclosure alternatives for interim financial statements and consolidates all interim reporting requirements under one topic.

Comments are due Jan. 31, 2022.

FASB issues guidance on accounting for acquired revenue contracts in a business combination

The FASB issued, on Oct. 28, 2021, ASU 2021-08, “Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities From Contracts With Customers,” to address diversity in practice. At the acquisition date, an acquirer should account for the related revenue contracts in accordance with Topic 606 as if it had originated the contracts instead of at fair value. The ASU also provides certain practical expedients and applies to contract assets and liabilities from other contracts to which the provisions of Topic 606 apply.

For public business entities, the amendments are effective for fiscal years beginning after Dec. 15, 2022, including interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after Dec. 15, 2023, including interim periods within those fiscal years. The amendments should be applied prospectively to business combinations occurring on or after the effective date of the amendments. Early adoption is permitted.

FASB issues private company practical expedient for equity-classified share-based awards

On Oct. 25, 2021, the FASB issued ASU 2021-07, “Compensation – Stock Compensation (Topic 718): Determining the Current Price of an Underlying Share for Equity-Classified Share-Based Awards,” for nonpublic business entities that issue equity-classified share-based awards as compensation to employees and nonemployees. The ASU provides an option to elect a practical expedient to determine the current price input of equity-classified share-based awards issued as compensation using the reasonable application of a reasonable valuation method, consistent with Treasury regulations related to Section 409A of the U.S. Internal Revenue Code. In addition to complying with its financial reporting requirements, an entity that grants equity-classified share-based awards must also comply with requirements in Section 409A of the U.S. Internal Revenue Code. The practical expedient can be elected for equity-classified share-based awards within the scope of ASC Topic 718, “Stock Compensation.”

The ASU is effective on a prospective basis for fiscal years beginning after Dec. 15, 2021, and interim periods within fiscal years beginning after Dec. 15, 2022. Early application is permitted.

For more information, read the Crowe article “ASU 2021-07: Equity-Classified Share-Based Award Measurement.”

From the Securities and Exchange Commission (SEC)

SEC appoints new PCAOB chair and board members

The SEC, on Nov. 8, 2021, announced the appointments of Erica Y. Williams as the new chair of the Public Company Accounting Oversight Board (PCAOB) and Christina Ho, Kara M. Stein, and Anthony C. Thompson as new board members. Duane DesParte, current acting chair, will continue to serve in that role until Williams is sworn in. On Nov. 9, 2021, the PCAOB announced that Ho was sworn in as a board member.

Most recently a litigation partner at Kirkland & Ellis LLP, Williams previously spent more than a decade in various roles at the SEC and served as special assistant and associate counsel to President Barack Obama. Ho, who will join the PCAOB from her position as vice president of government analytics and innovation at Elder Research, has 28 years of broad experience in public finance, policy development, accounting and auditing, disclosure modernization, data analytics, and technology innovation. Stein previously served as a commissioner of the SEC from 2013 to 2019 and currently serves as a distinguished policy fellow and lecturer-in-law at the University of Pennsylvania Carey Law School and is director of the AI, Data, and Capital Markets Initiative at the Center for Innovation, University of California Hastings Law. Currently serving as the executive director and chief administrative officer of the CFTC, Thompson previously held senior positions at the U.S. Department of Agriculture and served in the United States Air Force for 32 years.

SEC issues shareholder proposal guidance

The SEC’s Division of Corporation Finance (Corp Fin), on Nov. 3, 2021, issued Staff Legal Bulletin (SLB) No. 14L, “Shareholder Proposals,” to provide information for companies and shareholders regarding Rule 14a of the Securities Exchange Act of 1934, which allows companies to exclude shareholder proposals from their proxy statements in certain circumstances.

Companies regularly request assurance that the SEC staff will not recommend enforcement action if they omit a proposal based on one of the exclusions (“no-action relief”) set forth in Rule 14a-8. Accordingly, Corp Fin has issued this bulletin to streamline and simplify the process of reviewing no-action relief requests and to provide clarification of the standards applied to evaluate such requests. Upon issuance, this SLB replaces previously issued SLBs 14I, 14J, and 14K and provides guidance relating to proof of ownership letters and the use of graphics and images. The bulletin also provides new guidance on the use of email for submission of proposals, delivery of notice of defects, and responses to those notices.

This bulletin is not an SEC rule, regulation, or statement and does not alter or amend applicable law, and it creates no new or additional obligations.

In response the issuance of the bulletin, SEC Chair Gensler issued a statement, on Nov. 3, 2021, saying that the bulletin is consistent with the SEC’s original intent under Rule 14a-8 and will provide greater clarity to companies and shareholders on understanding when exclusions may or may not apply.

Offering alternative views on the shareholder proposal guidance, Commissioners Hester M. Peirce and Elad L. Roisman also issued a statement on Nov. 3. 2021. Peirce and Roisman note that the new guidance fails to address the issues that the three rescinded bulletins were trying to resolve.

SEC acting chief accountant releases statement on independent audits and effective audit committee oversight

On Oct. 26, 2021, SEC acting Chief Accountant Paul Munter issued a statement addressing the importance of high-quality independent audits and effective audit committee oversight to high-quality financial reporting to investors. He noted the upcoming 20th anniversary of the Sarbanes-Oxley Act (SOX) and said that “it is critical for all gatekeepers in the financial reporting ecosystem (auditors, management, and their audit committees) to maintain constant vigilance in the faithful implementation of the requirements of SOX by fulfilling their shared responsibilities to continue to produce high quality financial disclosures that are decision-useful to investors and maintain the public trust in our capital markets. An integral part of the faithful implementation of SOX is for audit firms to remain independent of their audit clients and for audit committees to take ownership of their oversight responsibilities with respect to the independent auditor.”

While emphasizing the importance of understanding and applying the general standard of independence, Munter identified auditor independence as “foundational to the credibility of financial statements.” He went on to discuss the responsibilities of audit committees, management, and audit firms in considering independence. He warned that as companies pursue access to public markets through new and innovative transactions, and audit firms continue to expand business relationships and nonaudit services, independence must always be considered. Further, Munter highlighted the importance of audit committee oversight of the independent auditor. He stressed that audit committees play a key role in the external independent audit process and that an effective audit committee enhances the auditor’s independence. In his closing, he shared that the gatekeepers should work together and that an effective audit committee overseeing the independent audit is critical to providing high-quality financial information to the capital markets.

SEC staff releases report on market volatility

The SEC staff issued, on Oct. 18, 2021, a report titled, “Staff Report on Equity and Options Market Structure Conditions in Early 2021.” The report provides a description of the U.S. market structure and securities regulatory framework and examines what happened with GameStop Corp. stock, a “meme stock,” which experienced dramatic increases in its share price in January 2021. The report examines trading activity of GameStop stock, increasing individual investor participation, short selling, and trading restrictions, among other topics.

The report proposes that “meme stock” events present an opportunity to reflect on the market structure and regulatory framework and identifies the following areas for potential study in the interests of protecting investors; maintaining fair, orderly, and efficient markets; and facilitating capital formation:

  • Forces that might cause a brokerage to restrict trading
  • Digital engagement practices and payment for order flow
  • Trading in dark pools and through wholesalers
  • Short selling and market dynamics

Also on Oct. 18, Gensler released a statement on the staff report, and Peirce and Roisman released a separate statement. Gensler highlighted the importance of furthering efforts to make equity markets as fair, orderly, and efficient as possible. Saying they “looking forward to a robust policy discussion,” Peirce and Roisman stated, “We always should be on the lookout for ways to improve our rules and our markets.” However, they noted that “it does not appear that many conclusions can be drawn from the data [in the report].”

From the Public Company Accounting Oversight Board (PCAOB)

PCAOB releases preview of 2020 inspection observations

The PCAOB issued, on Oct. 18, 2021, a publication, “Spotlight: Staff Update and Preview of 2020 Inspection Observations,” that provides observations from the 2020 inspections of audits of issuers prior to issuance of the inspection reports, which audit committees might find useful when engaging with their auditors. The report highlights changes in the PCAOB inspection approach, common deficiencies, observations related to quality control, observations on good practices, and responses to technology developments including cybersecurity, distributed ledger technologies, and digital assets. While recurring deficiencies are similar to those in prior years, the PCAOB did observe improvements in auditing accounting estimates. The publication notes, however, that deficiencies continue to occur, particularly in auditing the allowance for loan losses.

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