November 2022 financial reporting, governance, and risk management

| 11/16/2022
November 2022 financial reporting, governance, and risk management

Message from John Epperson, Managing Principal, Financial Services

Dear FIEB readers,

I thought I would lead off the month with a piece of personal risk management advice: Don’t take that backyard Thanksgiving football game too seriously!

Personal risk management aside, stakeholders in the world of financial reporting, governance, and risk management have their eyes on the Federal Reserve, interest rates, and inflation. Uncertainty still exists in how high interest will rates go and when inflation will ease. As that panorama unfolds, we keep you informed on the annual American Institute of Certified Public Accountants and Chartered Institute of Management Accountants credit union conference and developments from the federal financial institution regulators, the Securities and Exchange Commission, and the Public Company Accounting Oversight Board.

As of this week, our slate of 2022 Crowe Financial Services Conferences is just getting underway. Registration is still available for various in-person locations, all including CPE credit. Also, in early December, we present the first of a two-part, CPE-eligible webinar series on commercial lending transformation that will cover enhancing efficiency and decreasing risk.

I wish you and yours a very happy Thanksgiving.

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Takeaways from the 2022 AICPA & CIMA credit union conference

AICPA and CIMA hold credit union conference

The annual American Institute of Certified Public Accountants (AICPA) and Chartered Institute of Management Accountants (CIMA) Conference on Credit Unions was held Oct. 24-26, 2022, focusing on the economic outlook and risks in the credit union system. Adoption of the current expected credit loss (CECL) standard was a focal point of the conference. Of note, digital assets and the acceleration in technology were emerging topics.

The conference included sessions presented by the National Credit Union Administration (NCUA) and the Financial Accounting Standards Board (FASB). Other topics included attracting and retaining leading talent, liquidity concerns, and hot topics in regulatory compliance.

As in prior years, Crowe will issue a comprehensive report covering key takeaways from the conference with insights on economic, accounting, and regulatory updates.

Matters of importance from the federal financial institution regulators

FFIEC issues updated cybersecurity resource guide

On Oct. 3, 2022, the Federal Financial Institutions Examination Council (FFIEC) posted an update to its 2018 Cybersecurity Resource Guide for Financial Institutions. The new guide includes updated references and ransomware-specific resources for financial institutions to use in meeting security control objectives and preparing to respond to cyber incidents. It was released during Cybersecurity Awareness Month, which highlights the importance of safeguarding the nation’s critical infrastructure from malicious cyber activity and protecting citizens and businesses from ransomware and other cyberattacks.

In addition to the new ransomware resources in the guide, the FFIEC also updated the resource links for the assessment, exercise, information-sharing, and response and reporting categories. The agencies also reminded financial institutions and their service providers to remain vigilant in addressing cyber risk. The guide is designed for use by institutions of all asset sizes and charters.

OCC announces 2023 symposium on bank mergers

The Office of the Comptroller of the Currency (OCC) will host a symposium on bank mergers at its headquarters in Washington, D.C., on Feb. 10, 2023, the agency announced on Oct. 26, 2022. The symposium is designed to facilitate public input and discussion regarding the framework for analyzing bank mergers under federal law, including topics such as competition, financial stability, and convenience and needs. The event will be open to the public and viewable by livestream. The symposium’s agenda and registration instructions will be posted on the OCC website.

FDIC adopts TDR replacement for insurance assessments

The Federal Deposit Insurance Corp. (FDIC) on Oct.18, 2022, issued a final rule to revise the assessment scorecards for banks with at least $10 billion in assets for institutions that have adopted Accounting Standards Update (ASU) No. 2022-02. That ASU eliminates the accounting for troubled debt restructurings (TDRs) and replaces with new financial statement disclosures on modifications to borrowers experiencing financial difficulty. In order to capture the risk posed by restructured loans, the final rule includes modifications to borrowers experiencing financial difficulty in the underperforming assets ratio and higher-risk assets ratio for purposes of deposit insurance assessments. The revised rule will go into effect on Jan. 1, 2023, and will be applicable for the first quarterly assessment period ending March 31, 2023. FFIEC agencies are planning to revise the call report form and instructions for the first quarter of 2023 to replace the TDR terminology with the updated language from ASU 2022-02.

The final rule, which does not affect the small-banks deposit insurance assessment system, is adopted without changes from the proposed rule issued on July 27, 2022.

FDIC issues request for comment on ombudsman’s role in supervisory appeals process

In conjunction with its restoration of the Supervision Appeals Review Committee (SARC) earlier in 2022, the FDIC on Oct. 18, 2022, issued a notice requesting feedback on its proposed amendments that would clarify and expand the role of the FDIC ombudsman in the supervisory appeals process..

The notice proposes that the FDIC ombudsman serve as a nonvoting member of the SARC to monitor the supervision process following an institution’s appeal. The proposal also would require that materials considered by the SARC be shared with both parties to the appeal and allow institutions to request a stay of a supervisory action or determination while an appeal is pending.

Comments are due Nov. 21, 2022.

CFPB issues circular on fees for overdraft protection, depositors

The Consumer Financial Protection Bureau (CFPB) on Oct. 26, 2022, issued Circular 2022-06 regarding unanticipated or surprise overdraft fee assessment practices. On the same day, President Joe Biden announced the White House was directing federal agencies to take action against “junk fees” and “surprise billing” such as surprise banking overdraft fees, cable and internet termination charges, and airline and concert ticket processing fees.

The CFPB stated that a financial institution might engage in an unlawful practice when it authorizes a transaction on sufficient funds in the customer’s account but charges an overdraft fee when the transaction posts against insufficient funds in the account, known as “authorized positive, settled negative” (APSN) transactions.

In terms of depositor fees, financial institutions “can generally stay on the right side of the law when they employ more tailored fee policies that charge depositor fees only in situations where a depositor could have avoided the fee,” according to the news release. The CFPB more broadly has been reviewing overdraft fee practices, issuing two research papers in 2021 and several blog posts in 2022 indicating supervision teams are closely reviewing how institutions are assessing their fees and providing updates on their analyses of these practices.

Circuit court rules CFPB’s funding structure unconstitutional

The 5th U.S. Circuit Court of Appeals, on Oct. 19, 2022, ruled that the CFPB’s funding structure violates the separation of powers clause of the Constitution. Currently, pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), the CFPB receives its funding directly from the Federal Reserve System based on a request by the bureau’s director and is not subject to the Congressional appropriations process.

In the court case, the Community Financial Services Association of America and the Consumer Service Alliance of Texas challenged the bureau’s 2017 small-dollar lending rule on several constitutional grounds. The court agreed with the plaintiffs on the CFPB’s “unique, double-insulated funding mechanism” and also vacated the CFPB’s small-dollar lending rule. The CFPB is expected to appeal the ruling.

This decision by the 5th Circuit is binding only in Texas, Louisiana, and Mississippi. Similar challenges may be brought in other circuit courts, and the issue could go to the Supreme Court.

From the Securities and Exchange Commission (SEC)

SEC enhances transparency of proxy voting records

On Nov. 2, 2022, the SEC adopted amendments to Form N-PX to enhance the information that mutual funds, exchange-traded funds, and certain other registered funds report about their proxy votes. The amendments will make these funds’ proxy voting records easier to analyze, improving investors’ ability to monitor and compare different funds’ voting records. Additionally, the adopted rule will require institutional investment managers to disclose how they voted on executive compensation, or “say-on-pay” matters, meeting one of the rulemaking mandates of Dodd-Frank.

SEC Chair Gary Gensler said, “I am pleased to support these amendments because they will allow investors to better understand and analyze how their funds and managers are voting on shares held on their behalf.”

The new rules and form amendments will be effective for votes occurring on or after July 1, 2023, with the first filings subject to the amendments due in 2024.

SEC adopts compensation recovery listing standards and disclosure rules

The SEC on Oct. 26, 2022, adopted rules requiring securities exchanges to adopt listing standards that make issuers develop and implement a policy providing for the recovery of incentive-based compensation that was erroneously awarded to current or former executive officers. In accordance with the final rules, a listed issuer must file the policy as an exhibit to its annual report and include disclosures related to its recovery policy and recovery analysis where a recovery is triggered.

Implementing Section 10D of the Securities Exchange Act of 1934, a provision added by Dodd-Frank, new Exchange Act Rule 10D-1 also requires national securities exchanges and associations to establish listing standards that require disclosure of those compensation recovery policies in accordance with SEC rules, including providing the information in tagged data format.

Additionally, the new rules require specific disclosure of information about actions taken pursuant to the issuer’s recovery policy.

The final rules will be effective 60 days after publication in the Federal Register. Securities exchanges will be required to file proposed listing standards no later than 90 days following publication in the Federal Register, and the listing standards must be effective no later than one year following such publication. Issuers subject to such listing standards will be required to adopt a recovery policy no later than 60 days following the effective date.

SEC modernizes fund shareholder report and advertising rules

On Oct. 26, 2022, the SEC adopted rule and form amendments requiring mutual funds and exchange-traded funds to transmit concise and visually engaging shareholder reports. In addition, the amendments promote transparent and balanced presentations of fees and expenses in investment company advertisements.

Regarding fund shareholder reports, the amendments require funds to highlight key information, such as fund expenses, performance, and portfolio holdings. The use of graphic and text features is encouraged to make reports more effective. Also, funds will be required to tag the information in their reports in a structured data format and to make certain more in-depth information available online and available for delivery free of charge to investors on request.

The advertising rules require fee and expense presentations in registered investment company and business development company advertisements and sales literature to be consistent with relevant prospectus fee table presentations and to be reasonably current.

The amendments will be effective 60 days after publication in the Federal Register. The SEC is providing an 18-month transition period to adjust shareholder reports and transmission practices and to comply with the advertising amendments. The amendments addressing representations of fees and expenses that could be materially misleading apply on the effective date.

SEC approves final broker-dealer rule on securities-based swaps

On Oct. 12, 2022, the SEC adopted amendments to the requirements for electronic recordkeeping, prompt production of records, and third-party recordkeeping service applicable to broker-dealers, security-based swap dealers (SBSDs), and major security-based swap participants (MSBSPs). These amendments are intended to modernize recordkeeping requirements in light of new technologies in electronic recordkeeping.

The current broker-dealer electronic recordkeeping rule requires firms to preserve electronic records solely in a nonrewritable, nonerasable format. Among other requirements, the amendments add an audit trail alternative under which electronic records can be preserved in a manner that permits the re-creation of an original record if it is altered, overwritten, or erased; requires broker-dealers and all types of SBSDs and MSBSPs to produce electronic records to securities regulators in a reasonably usable electronic format; and eliminates the requirement that a broker-dealer notify its designated examining authority before employing an electronic recordkeeping system.

The amendments will be effective Jan. 3, 2023. Broker-dealers must comply with the new requirements six months after the effective date. SBSDs and MSBSPs must comply 12 months after the effective date.

SEC proposes changes to open-end fund liquidity framework

On Nov. 2, 2022, the SEC proposed rule and form amendments to better prepare open-end funds for stressed conditions and to mitigate dilution of shareholders’ interests. The amendments would change the existing framework by:

  • Enhancing how open-end funds other than money market funds (MMFs) and certain exchange-traded funds (ETFs) classify the liquidity of their investments and requiring a minimum of at least 10% of net assets be highly liquid assets
  • Requiring any open-end fund, other than a MMF or ETF, to use swing pricing and implementing a “hard close” to operationalize this pricing and to improve order processing
  • Providing for more frequent, timelier, and more detailed public reporting of fund information, including information about funds’ liquidity and use of swing pricing

Comments are due 60 days after publication in the Federal Register.

SEC proposes new oversight requirements for outsourced services by investment advisers

The SEC on Oct. 26, 2022, proposed a new rule and rule amendments under the Investment Advisers Act of 1940 to prohibit registered investment advisers from outsourcing certain services and functions without meeting certain minimum requirements such as conducting due diligence and monitoring the service providers.

The proposal includes requirements for advisers:

  • To conduct due diligence before outsourcing and to periodically monitor service providers’ performance and reassess whether to retain them
  • To make and/or keep books and records related to the due diligence and monitoring requirements
  • To conduct due diligence and monitoring for third-party recordkeepers and to obtain reasonable assurances that the third party will meet certain standards

Comments are due Dec. 27, 2022.

SEC commissioners address demand for quality ESG and climate-related data

SEC Commissioner Jaime Lizárraga spoke on Oct. 17, 2022, at the Future of ESG Data conference in London, on the demand for high-quality ESG data and actions of the SEC. Lizárraga highlighted the following three SEC rule proposals designed to facilitate comparable environmental, social, and governance (ESG) disclosures and focus on ensuring statements made to investors are not false or misleading:

  • Enhanced climate risk disclosures by issuers
  • Enhanced ESG disclosures by registered funds and investment advisers
  • Modernized rules governing ESG-related fund names

Noting that the underlying principle to these proposals is ensuring investors receive the information they need to make the most informed investment decisions, Lizárraga said, “the SEC’s disclosure framework is most effective when investors benefit from objective, quantitative metrics that provide the highest degree of comparability. I believe the proposed rules are a significant step forward in getting investors this information. I look forward to working to ensure that the final rules are as robust as possible.”

He said that the data that investors want, and that is available, is always evolving and as a result of advances in technology such as emissions modeling, artificial intelligence, and big data analytics, this information is now both in demand and available. Therefore, the timing is right for the SEC to step in to ensure that investors have the most relevant information for their investment decisions.

He added that markets change, driven by technology or other factors, and investor needs and practices evolve. Challenges exist in keeping up with rapid change and updating the SEC regulatory framework so that it continues to meet investor needs without compromising protections and in ensuring that claims made to investors are supported by verifiable information and disclosures are not misleading. He concluded by noting, “The best way to get there is with meaningful disclosures that incorporate the highest quality, reliable, and verifiable data in a standardized and investor-useful format.”

On Oct. 21, 2022, at the inaugural European Corporate Governance Institute (ECGI) Responsible Capitalism Summit in Brussels, SEC Commissioner Caroline Crenshaw gave a speech discussing the SEC’s proposed climate-related disclosure rule. She highlighted that the proposal includes both qualitative and quantitative disclosure about climate-related risks and disaggregated climate-related risk impacts to existing line items in audited financial statements. She noted that investors are demanding and using climate-related information, which emphasizes the importance of reliable and comparable data. She said that markets already have evolved and are disclosing this climate-related information; however, the disclosures are made with varying degrees of specificity, standardization, and, sometimes, unreliability, which must be addressed to protect investors and help provide decision-useful information.

SEC commissioners comment on DE&I

In response to the 2021 Asset Management Advisory Committee’s (AMAC) report and recommendations to the SEC on diversity, equity, and inclusion (DE&I) and the lack of gender and racial diversity in the asset management industry, on Oct. 13, 2022, the SEC issued a staff FAQ addressing an adviser’s fiduciary duty when considering factors relating to DE&I in the selection or recommendation of other investment advisers. Commissioners Crenshaw and Lizárraga issued a statement supporting the FAQ, saying they believe all of the recommendations in the AMAC report warrant timely consideration. Both commissioners noted that they are committed to working with the chair and other commissioners in considering ideas or actions that would help provide transparency on diversity practices, potential biases, and other DE&I matters that are important to investors.

Related to DE&I, on Oct. 13, 2022, Lizárraga gave a speech at the Investment Company Institute Securities Development Conference on raising the bar on DE&I. He highlighted some startling statistics from the AMAC report on the lack of diversity in the asset management industry and said that DE&I can be challenging and controversial. He noted that progress can take time and that meaningful advances in DE&I require a combination of commitment, leadership, and constructive engagement. Lizárraga described the recommendations to the SEC from the AMAC and noted that the SEC’s spring rulemaking agenda includes planned rules relating to enhanced board diversity and human capital management disclosures. In closing, he stated, “There are many benefits that result from a long-term commitment to advancing diversity, equity, and inclusion.”

SEC chair speaks on enforcement

Chair Gensler on Nov. 2, 2022, spoke before the Practising Law Institute’s 54th Annual Institute on Securities Regulation. His speech focused on enforcement as part of effective administration. For the fiscal year ended Sept. 30, 2022, the SEC filed more than 700 actions and obtained judgments and orders totaling $6.4 billion, including $4 billion in civil penalties. He identified and explored five themes of effective administration of enforcement: economic realities, accountability, high-impact cases, process, and positions of trust.

SEC chair remarks on competition

Chair Gensler on Oct. 24, 2022, presented remarks on competition to the annual meeting of the Securities Industry and Financial Markets Association. He noted how competition runs through each part of the SEC’s mission to protect investors, facilitate capital formation, and maintain fair, orderly, and efficient markets. Gensler said that the whole economy benefits when competition is greater among investors, issuers, and intermediaries. He explained that competition increases returns for investors, lowers the cost of capital for issuers, promotes innovation and efficiency in the middle of the markets, and helps capital markets more effectively price and allocate money and risk. His remarks focused on how to promote greater competition among the intermediaries in the middle of the U.S. markets while concentrating on the themes of centralization and concentration. To address competition, Gensler identified three tools – transparency, access, and fair dealing – and how to apply these tools across the fixed income, equity, and private markets. Further, he identified several SEC projects that are designed to lower the cost to issuers and raise the returns for investors, using transparency, access, and fair dealing to promote greater competition. He concluded, “I hope that competition is something we all can stand behind.”

From the Public Company Accounting Oversight Board (PCAOB)

PCAOB holds advisory group meetings

The PCAOB’s two advisory groups, the Investor Advisory Group (IAG) and the Standards and Emerging Issues Advisory Group (SEIAG), met on Oct. 12 and Nov. 2, 2022, respectively. Discussion topics included a new PCAOB research project on firm and engagement performance metrics as well as auditing considerations and attestation standards related to ESG. The research project on firm and engagement performance metrics focuses on firm- and engagement-level metrics that may be indicative of audit quality. The objective of the project is to assess whether there is a need for guidance, changes to PCAOB standards, or other regulatory actions considering the increased disclosure and demand for firm and engagement metrics. Discussion topics related to ESG included the auditor’s consideration of climate-related risks in performance of public company audits and potential updates to the PCAOB’s attestation standards to address the requirements within the SEC’s proposal on climate-related disclosures.
From the Center for Audit Quality (CAQ)

CAQ analyzes S&P 500 ESG reporting

On Oct. 18, 2022, the CAQ issued an analysis of 2020 ESG reports and Carbon Disclosure Project (CDP) Climate Change Questionnaires for S&P 500 companies. The purpose of this analysis was to understand what the companies disclosed about reporting standards and frameworks used, greenhouse gas emissions, assurance or verification of ESG information, and net-zero and carbon neutral commitments. Among other findings, the CAQ highlighted that of the S&P 500 companies, 464 issued a stand-alone ESG report and 313 responded to the CDP Climate Change Questionnaire for the 2020 period. Of the 464 ESG reports issued, 43 obtained some type of assurance from public company auditors. Most companies (93%) issued an ESG report using at least one framework or standard, and more than 230 companies used three or more standards and frameworks to help develop their reports.

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