Category: Accounting and Auditing

More SPAC restatements on the way?

It’s been weeks since the SEC last took SPACs to task!  According to Bloomberg, the SEC is now requiring many SPACs to “Big R” restate their financial statements because they tripped over the classification of certain shares they offered to investors.  Auditors with whom Bloomberg spoke said that the latest SPAC accounting snafu relates to incorrect categorization of Class A shares—which are typically redeemable—as “permanent equity instead of temporary equity.”  One auditor described the issue as “pervasive[:] everyone’s dealing with it because everyone did it wrong.”

Is your audit committee climate literate?

According to audit firm Deloitte, “[i]nformative climate reporting requires a complex transformation of reporting processes, of data collection, education of the finance function, and in many cases, of the audit committee itself. Yet, despite the urgency and magnitude of the task, many boards are hesitating in the face of inconsistent standards, fragmented global standard-setting, and myriad expectations from investors.”  Just how prepared are companies, their boards and especially their audit committees to deal with climate risk and climate reporting?  That’s the big question that Deloitte asked 353 audit committee members globally (56% of whom were chairs) in September 2021. The answer? Not so much. According to Deloitte’s new report, 42% of respondents indicated that their company’s “climate response is not as swift and robust as they would like” and almost half “do not believe that they are well-equipped to fulfil their climate regulatory responsibilities.”  Deloitte called the responses “sobering.”

Commissioner Roisman talks cybersecurity

On Friday, in remarks before the L.A. County Bar Association, SEC Commissioner Elad Roisman addressed some of the challenges associated with cybersecurity and cyber breaches and similar events. In his presentation, Roisman considers cybersecurity in a variety of contexts, such as the exchanges, investment advisers and broker-dealers, but his discussion of cybersecurity in the context of public companies is of most interest here. Although the SEC has imposed some principles-based requirements and issued guidance about cybersecurity disclosure, Roisman believes that there is more in the way of guidance and even rulemaking that the SEC should consider “to ensure that companies understand [the SEC’s] expectations and investors get the benefit of increased disclosure and protections by companies.”

SEC Acting Chief Accountant urges scrutiny of auditor independence in current environment

This week, Acting Chief Accountant Paul Munter issued a statement regarding the importance of auditor independence—a concept that is “foundational to the credibility of the financial statements.”  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.”  That has long been the case.  But what is happening in the current setting to prompt this statement?  It is the recent trend toward the use of “new and innovative transactions” to access the public markets, such as SPACs, together with the continued expansion by audit firms of business relationships with non-audit clients. That is, gatekeepers must be especially vigilant to prevent an audit firm from unwittingly losing its independence in the event of a transaction by an audit client with a non-audit client, a risk that is enhanced as audit firms engage in consulting relationships with more non-audit clients. This environment, Munter cautions, requires audit committees to be especially attentive in considering “the sufficiency of the auditor’s and the issuer’s monitoring processes, including those that address corporate changes or other events that potentially affect auditor independence.” And it requires audit firms to consider “the impact of business relationships and non-audit services on existing and prospective audit relationships.”  It is 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 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. 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.

SEC revisits 2015 Dodd-Frank clawback proposal—opens public comment period

It’s time to dig back into your mental archives for 2015.  That’s when the SEC, by a vote of three to two, initially proposed rules to implement Section 954 of Dodd-Frank, the clawback provision. But the proposal was relegated to the SEC’s long-term agenda and never heard from again.  Until, that is, the topic found a spot on the SEC’s short-term agenda this spring (see this PubCo post) with a target date for a re-proposal of April 2022.  The SEC had scheduled an open meeting for Wednesday to consider re-opening the comment period, but instead cancelled the meeting and, on Thursday, simply posted a notice.  Here is the original 2015 Proposing Release and here is the new fact sheet. SEC Chair Gary Gensler said that, with re-opening of the comment period, he believed “we have an opportunity to strengthen the transparency and quality of corporate financial statements as well as the accountability of corporate executives to their investors.” The questions posed by the SEC in the notice (discussed below) give us some insight into where the SEC may be headed with the proposal. It’s worth noting that one possible change suggested by the questions is a potential expansion of the concept of “restatement” to include not only “reissuance” restatements (which involve a material error and an 8-K), but also “revision” restatements (or some version thereof).  The public comment period will remain open for 30 days following publication of the release in the Federal Register.

Do companies time changes in accounting estimates to meet analyst forecasts?

In this new paper by a group of academics from the University of Richmond (and elsewhere), the authors explore whether companies might be timing when they record changes in their accounting estimates (CAEs) to meet earnings benchmarks.  Because accounting estimates are “by their nature forward-looking, often subjective and difficult to quantify with precision,” they would seem to offer an excellent “opportunity for management to misrepresent the firm’s financial performance.” CAEs, the authors suggest, may be used to meet or beat earnings benchmarks or, alternatively, to smooth earnings or take a “big bath” when the current period’s earnings are particularly low.  For purposes of the study, the authors assumed that “most CAEs are fully justified and reasonable, and the ‘manipulation’ stems primarily from their timing, not the nature or appropriateness of the CAEs themselves.”  The study concludes, particularly with respect to analyst forecast earnings, that companies do indeed “appear to time CAEs to meet earnings benchmarks or achieve other reporting objectives.”  It’s worth noting that the SEC has recently brought charges in a couple of cases involving earnings or expense management (see this PubCo post and this PubCo post), so violations resulting from earnings management practices appear to be a focus for Enforcement.

Climate risk disclosure “glaringly absent” in financial statements? Will regulators act to require more?

In one of the illustrative comments in Corp Fin’s just published sample comment letter on climate issues, Corp Fin asks companies to explain what consideration they may have given to providing in their SEC filings the same type of expansive climate-related disclosure that’s in their corporate social responsibility reports. One place in companies’ SEC filings where climate-related disclosure is “glaringly absent,” according to this report from the Carbon Tracker Initiative, is in the financial statements.  Although many companies face serious climate risk, and many have even made net-zero pledges, the report “found little evidence that companies or their auditors considered climate-related matters in the 2020 financial statements.”  According to the lead author of the report, “[b]ased on the significant exposure these companies have to transition risks, and with many announcing emissions targets, we expected substantially more consideration of climate matters in the financials than we found. Without this information there is little way of knowing the extent of capital at risk, or if funds are being allocated to unsustainable businesses….” Financial statement disclosure was so deficient, the report concluded, investors were essentially “flying blind.”

How reliable is your company’s carbon footprint?

Just how reliable are those carbon footprints that many large companies have been publishing in their sustainability reports?  Even putting aside concerns about greenwashing, what about those nebulous Scope 3 GHG emissions?  As we all know, the SEC is now is the midst of developing a proposal for mandatory climate-related disclosure.  (See, e.g., this PubCo post and this PubCo post.)  The WSJ reports that “[o]ne problem facing regulators and companies: Some of the most important and widely used data is hard to both measure and verify.” According to an academic cited in the article, the “measurement, target-setting, and management of Scope 3 is a mess….There is a wide range of uncertainty in Scope 3 emissions measurement…to the point that numbers can be absurdly off.”

SEC charges Kraft Heinz with improper expense management scheme

On Friday, the SEC announced settled charges against Kraft Heinz Company, its Chief Operating Officer and Chief Procurement Officer for “engaging in a long-running expense management scheme that resulted in the restatement of several years of financial reporting.” According to the SEC’s Order regarding the company and the COO, as well as the SEC’s complaint against the CPO, the company employed a number of expense management strategies that “misrepresented the true nature of transactions,” including recognizing unearned discounts from suppliers, maintaining false and misleading supplier contracts and engaging in other accounting misconduct, all of which resulted in accounting errors and misstatements. The misconduct, the SEC contended, was designed to allow the company to report sham cost savings consistent with the operational efficiencies it had touted would result from the 2015 merger of Kraft and Heinz, as well as to inflate EBITDA—a critical earnings measure for the market—and to achieve certain performance targets. And, once again, charges of failure to design and implement effective internal controls played a prominent role. After the SEC began its investigation, KHC restated its financials, reversing “$208 million in improperly-recognized cost savings arising out of nearly 300 transactions.” According to Anita B. Bandy, Associate Director of Enforcement, “Kraft and its former executives are charged with engaging in improper expense management practices that spanned many years and involved numerous misleading transactions, millions in bogus cost savings, and a pervasive breakdown in accounting controls. The violations harmed investors who ultimately bore the costs and burdens of a restatement and delayed financial reporting….Kraft and its former executives are being held accountable for placing the pursuit of cost savings above compliance with the law.” KHC agreed to pay a civil penalty of $62 million. Interestingly, this case comes on the heels of an earnings management case brought by the SEC against Healthcare Services Group, Inc. for alleged failures to properly accrue and disclose litigation loss contingencies. 

How did COVID-19 affect financial reporting and financial health?

Audit Analytics has just released a deep dive into the impact of COVID-19 on financial reporting and financial wellbeing. To assess the effect of the pandemic, the report looked at going-concern audit opinions, impairment charges, late filings and changes in the control environment, as well as restatements. Some of the results might be surprising.  For example, the pandemic had a significant impact on impairment charges, but the number of going-concern qualifications in audit opinions?  Not so much.