Multiple lawyers said that under the Biden administration, chief financial officers (CFOs) can expect their companies' financial disclosures and internal control processes to face more rigorous scrutiny from the U.S. Securities and Exchange Commission (SEC).

COVID-19-related reporting, environmental, social, and governance (ESG) performance, and highly profitable special purpose acquisition companies (SPACs) are also expected to become regulatory priorities.

"We expect enforcement actions to increase," said John Nowak, a lawyer at Paul Hastings, during a webinar hosted by the firm last week.

He noted that the SEC is increasing its use of three tools to identify problems in traditional financial and accounting disclosure areas: the whistleblower program, a new earnings per share (EPS) initiative that uses AI-assisted data analysis to detect financial inconsistencies, and monitoring of short sellers.

With these tools, combined with the expected appointment of an enforcement-minded SEC chair, reporting issues such as bill-and-hold accounting, inflated sales, channel stuffing, and non-GAAP financial metrics will be key areas of focus, he said.

"The SEC will use all these new tools to evaluate corporate disclosures," Nowak said.

The whistleblower program, established as part of the 2010 Dodd-Frank Act, was designed to provide financial incentives for those who believe corporate financial mismanagement has occurred to come forward. Its use has expanded dramatically. Last year, the SEC received nearly 7,000 tips and paid $155 million in awards to 39 individuals, both records.

"The program seems to expand year after year," said Nick Morgan, a partner at Paul Hastings.

The EPS initiative was first deployed late last year, when the SEC brought settled charges against a carpet manufacturer and a financial services provider. The initiative runs corporate financial data through data-parsing software to determine whether numbers may have been manipulated to meet analyst expectations.

Several other companies have been caught under the initiative in the months since.

Nowak said the SEC may expand its use beyond EPS-related reporting areas. "I think the SEC will fully embrace risk-based data analytics to try to identify issues and potentially address them early," he said.

He also expects increased monitoring of short sellers, as these market participants' commentary on company performance can bring numbers that do not withstand scrutiny into the spotlight.

"We have seen... short sellers step out and make comments, offering views on public companies," he said.

Morgan Miller of Paul Hastings said that if Biden's SEC chair nominee Gary Gensler is confirmed, given his enforcement style when he led the Commodity Futures Trading Commission (CFTC) about a decade ago, he is expected to embrace all these tools and other enhancements.

"I expect Gensler to take the same tough enforcement stance he took at the CFTC," he said.

Internal control cases

Morgan said companies' handling of material nonpublic information (MNPI) is another enforcement area expected to increase, but its context differs from typical insider trading cases.

He noted that insider trading charges have trended downward over the past decade, partly because judges have considerable discretion in their rulings, creating an ambiguous landscape that makes it difficult for the SEC to pursue cases.

Perhaps to circumvent this, the SEC has been strengthening cases involving companies' processes for controlling information handling, including MNPI that could affect market pricing.

In a recent case, the SEC fined a public company $20 million for executing a stock buyback while about to acquire another company without disclosing the acquisition. The pending merger was material information, and the company did not disclose it to the public while purchasing shares in the open market.

"The allegation was that the company failed to establish adequate accounting controls around the handling of MNPI and failed to assess whether the company possessed MNPI," he said. "The $20 million fine is an unusual instance of using the accounting controls provision to address what is essentially an MNPI issue."

In another controls-related case, a private equity firm purchased a large number of shares while its employees served on the board of a public company, raising questions about whether it possessed MNPI when trading.

That case was not about insider trading but about controls over information handling. Morgan said this could be an indirect path for the SEC to address what are essentially insider trading cases.

Morgan expects such cases to increase. "Given the ambiguity in this area of law, we will see more of these factual scenarios without actually charging insider trading," he said.

COVID-19-related cases

On COVID-19, the SEC signaled late last year how it plans to handle disclosure issues by settling charges against restaurant chain The Cheesecake Factory.

The company was fined $125,000 for stating in its first-quarter-end financial report that its operations were "sustainable" when it was actually burning through $6 million per week and rapidly depleting cash.

Nowak called the SEC's action overly aggressive because it seemed to treat the word "sustainable" and some other disclosures as material misstatements, though it could be argued that, in a broader context, the disclosures were appropriate.

Either way, the case shows the SEC's aggressive approach to pursuing COVID-19-related disclosure issues, Nowak said.

"I do view this as a cautionary case, and it certainly underscores the need to be objective when evaluating public disclosures and to ensure that disclosures include qualifying language," he said. "I do expect such cases to continue to emerge."

ESG performance

Although ESG performance is not a mandatory reporting matter, the SEC is expected to develop policies reflecting the Biden administration's focus on climate change and diversity, said Hastings partner Tara Giunta.

"The Biden administration and Biden himself have indeed made ESG a focal point," she said. "This is a fairly significant shift compared to the Trump administration. At the SEC, we expect to see more enhanced ESG disclosures and attention to climate change and diversity," including board diversity.

Giunta said she expects the SEC to seek public disclosures on board diversity, accompanied by metrics.

"The commission will focus on metrics—how do we define diversity, how do we measure it?"

A rule proposed by Nasdaq last month will help push the SEC to take a position on at least the diversity component of ESG disclosures. The SEC must comment by mid-March on Nasdaq's plan, which would require all companies listed on its exchange to disclose diversity statistics and have at least two diverse board members, or explain why not.

"This will indeed become a focus of this SEC," she said.

SPAC regulation

Special purpose acquisition companies will also come under scrutiny, simply because too much money is flowing into them right now, Nowak said.

According to SPACInsider data, 270 SPACs went public last year, up from 59 in 2019.

By sheer scale of growth, the SEC will be compelled to review them to ensure the soundness of their structure and management.

"There is too much money involved," he said. "I can fully foresee the SEC digging in and scrutinizing to determine whether there are problems."

These issues include: disclosure of parties' interests, incentives of the parties, and trading of IPO shares. "There is simply too much money involved," he said.