Category: Accounting and Auditing
McMahon takes a bump
On Friday, the SEC announced settled charges against Vince McMahon, founder, controlling shareholder and former Executive Chair and CEO of World Wrestling Entertainment, for “knowingly circumventing WWE’s internal accounting controls,” making false or misleading statements to WWE’s auditor, and causing “WWE’s violations of the reporting and books and records provisions of the Exchange Act.” The SEC alleged that McMahon signed two settlement agreements relating to claims of sexual misconduct (as the WSJ framed it), one in 2019 and one in 2022, on behalf of himself and WWE but failed to disclose the existence of the agreements to “WWE’s Board of Directors, legal department, accountants, financial reporting personnel, or auditor.” Oops. The SEC charged that this omission “circumvented WWE’s system of internal accounting controls and caused material misstatements in WWE’s 2018 and 2021 financial statements,” leading WWE ultimately to issue financial restatements. McMahon agreed to pay a $400,000 civil penalty and to reimburse WWE just over $1.3 million pursuant to SOX 304(a), the SOX clawback provision. According to the Associate Regional Director in the SEC’s New York Regional Office, “[c]ompany executives cannot enter into material agreements on behalf of the company they serve and withhold that information from the company’s control functions and auditor.” (Even if—or maybe especially if—it involves hush money.)
SEC charges Entergy with violation of internal accounting controls requirements
At the end of last year, the SEC announced settled charges against Entergy Corporation, a Louisiana-based utility company with shares traded on the NYSE, for failure to maintain internal accounting controls adequate to ensure that its surplus materials and supplies were accurately recorded on its books and financial statements in accordance with GAAP. The case represents yet another example where the charged misconduct related only to ineffective controls, without any associated charges of fraud. According to Sanjay Wadhwa, Acting SEC Enforcement Director, “internal accounting controls serve as a front-line defense in ensuring the accuracy and reliability of financial statements….Investors rely on public companies, such as Entergy, to ensure that adequate internal accounting controls are in place. We allege that Entergy failed to fulfill its obligation in this regard.” Entergy agreed to pay a civil penalty of $12 million. Rumor has it that we’re likely not going to see a lot more of these “controls-only” types of Enforcement actions once the SEC comes under new management.
SEC charges Becton Dickinson with misleading investors about regulatory risks and product sales
The SEC has announced settled charges against Becton, Dickinson and Company, a medical device manufacturer known as BD listed on the NYSE, for “repeatedly misleading investors about risks associated with its continued sales of its Alaris infusion pump and for overstating its income by failing to record the costs of fixing multiple software flaws with the pump.” In essence, the company failed to disclose that it needed, but did not have, FDA clearance for certain changes to the software for its Alaris product, sales of which contributed about 10% of BD’s profits. Without those changes, the product was potentially harmful to patients. “Rather than inform investors that these issues heightened the risk that the FDA would limit BD’s ability to continue selling Alaris,” the SEC charged, “BD made misleading statements in its periodic reports about its regulatory risks.” BD agreed to pay a $175 million civil penalty. Companies in the life sciences should take note that this is yet another recent Enforcement action aimed at a life science company’s alleged misleading statements, including hypothetical or generic risks, regarding regulatory (FDA) status; in charges announced earlier this month against Kiromic BioPharma, the SEC alleged that Kiromic had failed to disclose that the FDA had placed both of its INDs on clinical hold. (See this PubCo post.) According to Sanjay Wadhwa, Acting Director of SEC Enforcement, “BD repeatedly painted a misleading picture of its Alaris infusion pump for investors and then doubled down by keeping them in the dark when the device’s issues came to a head with the FDA in late 2019….Public companies have a fundamental duty to accurately disclose material business risks and should expect to be held accountable when they fall short in that regard.”
Happy Holidays!
SEC charges UPS with failure to take goodwill impairment charge require by GAAP
Last week, the SEC announced settled charges against United Parcel Service Inc. for failing to take an appropriate goodwill impairment charge for a poorly performing business unit, thus materially misrepresenting its earnings. As alleged by the SEC, instead of calculating the write-down based on the price UPS expected to receive to sell its Freight business unit—as required under GAAP—UPS relied on a valuation prepared by an outside consultant, but “without giving the consultant information necessary to conduct a fair valuation of the business.” According to the Associate Director of Enforcement, “[g]oodwill balances provide investors with valuable insight into whether companies are successfully operating the businesses they own….Therefore, it is essential for companies to prepare reliable fair value estimates and impair goodwill when required. UPS fell short of these obligations, repeatedly ignoring its own well-founded sale price estimates for Freight in favor of unreliable third-party valuations.” UPS was charged with making material representations in its reporting, as well as violations of the book and records, internal accounting controls, and disclosure controls provisions of the Exchange Act and related rules. UPS agreed to adopt training requirements for certain officers, directors and employees, retain an independent compliance consultant and pay a $45 million civil penalty.
Happy Thanksgiving!
PLI panel offers hot tips on accounting and auditing issues
At the PLI Securities Regulation Institute last week, the accounting and auditing update panel provided some useful insights—especially for non-accountants. The panel covered the new requirements for segment reporting, the intensified focus on controls, PCAOB activities (including NOCLAR) and errors and materiality. Below are some takeaways.
FASB adopts new ASU requiring disaggregation of expenses
Currently, companies typically include in their income statements expense captions for selling, general and administrative expenses, cost of services and other cost of revenues, and cost of tangible goods sold. But, as reported by Bloomberg, there has been a push for disaggregation of expenses on the income statement since at least 2016. As this piece in Bloomberg explained, investors complained that “companies lump expenses into catch-all financial statement categories like ‘selling, general, and administrative,’ without explaining the biggest cost drivers inside them.” But in 2019, the FASB voted (5 to 2) “to put its once-high priority financial reporting project on pause.” It was quite a lengthy pause, but, in February 2022—hearing the call again from investors and others in response to the FASB’s 2021 Invitation to Comment—the FASB decided to restart work on the project to “improve the decision usefulness of business entities’ income statements through the disaggregation of certain expense captions.” And, in 2023, FASB published a proposed Accounting Standards Update intended to provide investors with more decision-useful information about expenses on the income statement. (See this PubCo post and this PubCo post.) As reported, businesses “bristled against the plan,” contending that it was too expensive and time-consuming, with many raising, in particular, issues regarding the difficulty of providing more detailed inventory and manufacturing expense disclosures required in each relevant expense category. Companies also asked for specific industry carve-outs or exemptions for smaller reporting companies. But the FASB rejected that that request. Last week, the FASB announced that it had adopted a new Accounting Standards Update—ASU 2024-03—that will require “public companies to disclose, in interim and annual reporting periods, additional information about certain expenses in the notes to financial statements.” According to FASB Chair Richard Jones, the “project was one of the highest priority projects cited by investors in our extensive outreach with them as part of our 2021 agenda consultation initiative….We heard time and again from investors that additional expense detail is fundamental to understanding the performance of an entity and we believe that this standard is a practical way of providing that detail.”
PCAOB spotlight on auditor independence outlines considerations for audit committees
The PCAOB has released a new Spotlight on auditor independence, which provides observations from PCAOB inspections regarding independence issues and identifies considerations for both auditors and audit committees. Auditor independence has, for years, been a major focus of the SEC’s Office of the Chief Accountant, and current Chief Accountant Paul Munter has addressed the issue in a number of statements, characterizing auditor independence as a concept that is “foundational to the credibility of the financial statements.” (See, for example, this PubCo post and this PubCo post.) But auditor independence is not just an issue for auditors. It’s important for companies to keep in mind that violations of the auditor independence rules can have serious consequences not only for the audit firm, but also for the company as the audit client. For example, an independence violation may cause the auditor to withdraw the firm’s audit report, requiring the audit client to have a re-audit by another audit firm. What’s more, auditor independence violations can sometimes even result in charges against the company; for example, Lordstown Motors was charged with several Exchange Act violations in connection with misrepresentations and failures to include financial statements audited by independent auditors required in current and periodic reports. Munter has long recognized that the responsibility to monitor independence is a shared one: “[w]hile sourcing a high quality independent auditor is a key responsibility of the audit committee, compliance with auditor independence rules is a shared responsibility of the issuer, its audit committee, and the auditor.” As a result, in most cases, inquiry into the topic of auditor independence should certainly be a recurring menu item on the audit committee’s plate. Fortunately, the Spotlight offers advice, not only for auditors, but fortunately, also for audit committee members.
SEC charges Zymergen for “unsupported hype” in its IPO
The SEC has announced settled charges against Zymergen, which, prior to its recent bankruptcy and ultimate liquidation, was a biotech “focused on the manufacture of novel materials, including optical films used in electronic screens.” The SEC charged that, in its $530 million IPO in 2021, Zymergen misled “IPO investors about its overall market potential, revenue prospects, and customer pipeline for its only commercially available product, an electronics film named Hyaline.” According to the Director of the SEC’s San Francisco Regional Office, “[p]re-revenue and early-stage companies that seek to tap the capital markets must do so with reasonable estimates of their market potential….Today’s order finds that Zymergen failed to satisfy this obligation when it misled investors with what amounted to unsupported hype.” The company agreed to pay a civil penalty of $30 million. In the meantime, Bloomberg reports that a federal district court has recently allowed claims by Zymergen investors to proceed against several VC funds (along with the company, the board, the underwriters, etc). The investors contended that, among other things, the levers provided in the company’s governing documents allowed the VC funds to “control[] the company in the lead-up to its initial public offering” and claimed that they were “responsible for misleading IPO papers before the biological manufacturing company imploded.”
At open meeting, SEC approves new PCAOB quality control standard
Yesterday, the SEC approved, by a vote of three to two, a new PCAOB quality control standard, QC 1000, A Firm’s System of Quality Control, and related amendments to its standards, rules and forms. According to the press release, the new standard
“establishes an integrated, risk-based quality control standard that will require all registered public accounting firms to identify specific risks to their practice and design a quality control system that includes appropriate responses to guard against those risks. Registered firms that perform engagements under PCAOB standards will be required to implement and operate the QC system. The new quality control standard focuses on an audit firm’s accountability and continuous improvement of its audit practice and will require an annual evaluation of the firm’s QC system and related reporting to the PCAOB, certified by key firm personnel. In addition, firms that annually issue audit reports for more than 100 issuers will be required to establish an external quality control function (EQCF) composed of one or more persons who can exercise independent judgment related to the firm’s QC system.”
According to SEC Chief Accountant, Paul Munter, “[e]ffective QC systems provide critical investor protections by driving continuous improvement in firms’ audit quality in support of the issuance of informative, accurate, and independent audit reports….QC 1000 is an integrated risk-based QC standard that strikes an appropriate balance that can be applied by firms of varying sizes and complexities along with a set of mandates tailored to the size of the firms’ audit practices, which should assure that QC systems are designed, implemented, and operated with an appropriate level of rigor.” SEC Chair Gary Gensler pointed out that the “auditing profession has changed in the 21st century, and the Amendments we are considering today are long overdue. To put in context how important it is to update the quality control standards, the PCAOB found that 46 percent—nearly half—of the auditing engagements it reviewed in 2023 fell short of obtaining sufficient appropriate audit evidence.” The two dissenters primarily took issue with, in their view, the too-brief time allotted by the SEC to the process of refining the standard, the requirement that every PCAOB-registered firm design a compliant QC system—even if they are not required to implement it—and the failure to address adequately commenters’ concerns about the new EQCF. QC 1000 and related amendments will take effect on December 15, 2025.
What might the FASB be looking at for 2025?
In the last couple of months of 2024, the FASB issued some “invitations to comment” intended to allow FASB stakeholders to express their views on whether or not the FASB should pursue the projects identified. It could well turn out that these ITCs offer a preview of topics that the FASB might be taking up in 2025. What’s more, two of these projects have the potential to be somewhat contentious: accounting for intangibles, such as brand recognition, copyrights, patents, trademarks, trade names, customer relationships and customer lists, and key performance indicators. In an interview with the WSJ, FASB Chair Rich Jones observed that “[y]ou’re seeing us really explore what, depending on the direction those projects take, could be a very significant shift in financial reporting.”