Category: Accounting and Auditing
What happened at the meeting of the SEC’s Small Business Capital Formation Committee?
At yesterday’s meeting of the SEC’s Small Business Capital Formation Committee, the Committee discussed three topics: the SEC’s Harmonization Concept Release, the proposal to amend financial disclosure requirements relating to acquisitions and dispositions of businesses, and the proposal to amend the accelerated and large accelerated filer definitions. SEC Chair Jay Clayton emphasized that his goal was to find the right balance between making sure that investors receive the information they need and eliminating unnecessary costs and burdens. Several of the presentations to the Committee can be found here.
Secret sauce, sausages and cookie jars…
No, it’s not an episode of Top Chef, but it is about “cooking the books.” And those are just some of the ingredients and tools used by Brixmor Property Group, a publicly traded REIT, and four of its executives to do the cooking: manipulation of a key non-GAAP financial measure, according to this SEC complaint and order and, even more to the point, this SDNY criminal indictment of the executives. As alleged, management sought to create the impression that a static pool of its existing properties showed steady and predictable income growth across a number of quarters. In contrast, however, Brixmor’s actual income growth rate was “volatile and frequently fell above or below the company’s publically issued guidance range” for the period. So, according to the order, the company architected the desired illusion—touted as its “secret sauce”—by engaging in some “sausage-making” with regular hits to the “cookie jar.” While it doesn’t sound very appetizing, it did create the desired deception—until, of course, it didn’t. The lesson is that manipulation of a non-GAAP measure, together with violations of GAAP, to mislead the public can be trouble—and perhaps even criminal. Although cases of accounting fraud may not be as common as they once were, this case should serve as a reminder that the SEC and the Justice Department are still on the lookout for it.
What happened at the Corp Fin roundtable on short-termism?
Corp Fin has recently focused on the issue of corporate reporting and short-termism. At the end of last year, the SEC posted a “request for comment soliciting input on the nature, content, and timing of earnings releases and quarterly reports made by reporting companies.” (See this PubCo post.) Following up, Corp Fin then organized a roundtable, held last week, to discuss the issues surrounding short-termism. The roundtable consisted of two panels: the first explored “the causes and impact of a short-term focus on our capital markets,” with the goal of identifying potential market practices and regulatory changes that could promote long-term thinking and investment. In part, this panel developed into a debate about whether short-termism was actually creating a problem for the economy at all. In that regard, several of these panelists were quick to cite the oft-cited academic study revealing that “three quarters of senior American corporate officials would not make an investment that would benefit a company over the long run if it would derail even one quarterly earnings report.” (See this PubCo post and this article in The Atlantic.) Could the reason be a misalignment of incentives? The second panel was centered on the periodic reporting system and potential regulatory changes that might encourage a longer-term focus in that system. Does the current periodic reporting system, along with the practice of issuing quarterly earnings releases and, in some cases, quarterly earnings guidance contribute to or encourage an overly short-term focus by managers and other market participants? On this panel, the headline topic notwithstanding, the discussion barely touched on short-termism; rather, the focus was almost entirely on regulatory burden. At the end of the day, is the SEC seriously considering making changes to periodic reporting?
FASB tentatively decides on new staggered approach to effective dates for major standards
As anticipated in this PubCo post, at its July 17 meeting, the FASB Board signaled its intent to adopt a new “two-bucket” approach that would stagger the effective dates for new major accounting standards. Under the new approach, the effective dates of major new standards would be delayed for entities in “Bucket Two”—smaller reporting companies, private companies, employee benefit plans and not-for-profit organizations— for at least two years after the effective dates for entities in “Bucket One”—other SEC filers. The determination of whether an entity is an SRC will be based on the entity’s most recent assessment in accordance with SEC regulations. (See this PubCo post and this Cooley Alert.)
SEC staff encourages attention to LIBOR transition
You may recall that, at the end of last year, SEC Chair Jay Clayton and Corp Fin Chief Accountant Kyle Moffatt were warning at various conferences about some of the risks the SEC was monitoring, among them the LIBOR phase-out, which is expected to occur in 2021. LIBOR, the London Interbank Offered Rate, is calculated based on estimates submitted by banks of their own borrowing costs. In 2012, the revelation of LIBOR rigging scandals made clear that the benchmark was susceptible to manipulation, and British regulators decided to phase it out. In one speech, Clayton reported that, according to the Fed, “in the cash and derivatives markets, there are approximately $200 trillion in notional transactions referencing U.S. Dollar LIBOR and… more than $35 trillion will not mature by the end of 2021.” Clayton indicated that an alternative reference rate, the Secured Overnight Financing Rate, or “SOFR,” has been proposed by the Alternative Reference Rates Committee; nevertheless, there remain significant uncertainties surrounding the transition. (See this PubCo post.) And those uncertainties surrounding LIBOR and SOFR may be leading companies and others to delay addressing the issue until everything is finally settled. Perhaps with that in mind, on Friday evening, the SEC staff published a Statement that “encourages market participants to proactively manage their transition away from LIBOR.” And, in the press release announcing the publication, Clayton drew “particular attention to the staff’s observation: ‘For many market participants, waiting until all open questions have been answered to begin this important work likely could prove to be too late to accomplish the challenging task required.’”
PCAOB offers help for audit committees about CAMs
The PCAOB has just released a new resource for audit committees about critical audit matters, designed to “inform audit committees as they engage with their auditors on the new CAM requirements.” The new auditing standard for the auditor’s report (AS 3101), which requires CAM disclosure, will be effective for audits of large accelerated filers for fiscal years ending on or after June 30, 2019. For audits of all other companies to which they apply (e.g., not EGCs), CAM requirements will be effective for fiscal years ending on or after December 15, 2020. The resource document provides information about CAM basics, as well as PCAOB staff guidance through responses to FAQs and, importantly, questions audit committees could consider asking their auditors. At the same time, the PCAOB also issued a new resource about CAMs for investors.
Tips on CAMs at PLI panel
An article in the Federal Securities Law Reporter reports on some tips gleaned from a discussion of, what else, “critical audit matters” on a PCAOB panel at PLI’s 34th Midyear SEC Reporting and FASB Forum. The new auditing standard for the auditor’s report (AS 3101), which requires CAM disclosure, will be effective for audits of large accelerated filers for fiscal years ending on or after June 30, 2019.
FASB to consider delaying required adoption dates of new standards for some companies
As reported in Bloomberg, FASB will soon be considering whether the mandatory adoption dates for major new accounting standards should be delayed for small public companies and privately held businesses. According to the article, testimony from some small business finance professionals at a recent meeting of the Financial Accounting Standards Advisory Council indicated that, while they may be comfortable following the same rules as bigger companies, smaller companies “don’t have the same resources as large public companies so they need extra time to implement significant new accounting rules.” However, there seemed to be a fair amount of pushback from some commentators at the meeting, which could impact FASB’s decision.
Use of non-GAAP financial metrics increases in executive comp—will the SEC increase its scrutiny?
You might recall that, in April of this year, SEC Commissioner Robert Jackson co-authored an op-ed (with Robert Pozen, MIT senior lecturer and former president of Fidelity) that lambasted the use of non-GAAP financial metrics in determining executive pay, absent more transparent disclosure. The pair argued that, although historically, performance targets were based on GAAP, in recent years, there has been a shift to using non-GAAP pay targets, sometimes involving significant adjustments that can “be used to justify outsize compensation for disappointing results.” On the heels of that op-ed came a rulemaking petition submitted by the Council of Institutional Investors requesting, in light of this increased prevalence, that the SEC amend the rules and guidance to provide that all non-GAAP financial measures (NGFMs) used in the CD&A of proxy statements be subject to the reconciliation and other requirements of Reg G and Item 10(e) of Reg S-K. But how pervasive is the use of NGFMs in executive comp? This article from Audit Analytics puts some additional data behind the brewing controversy about the use of non-GAAP financial measures in executive comp—and the level of increase is substantial.
SEC modifies auditor independence rule regarding lending relationships with audit clients
The SEC has adopted final amendments to the auditor independence rules relating to lending relationships between the auditor and an audit client or certain shareholders of the audit client. As noted in the press release, the SEC had become aware of circumstances where the existing rules captured attenuated “relationships that otherwise do not bear on the impartiality or objectivity of the auditor. The amendments are intended to focus the rules on those lending relationships that reasonably may bear on external auditors’ impartiality or objectivity and, in so doing, improve the application of the Loan Provision for the benefit of investors while reducing compliance burdens.” Although the issues associated with this independence rule have created the severest compliance challenges for companies in the investment management industry, the final amendments will apply to entities beyond that industry, including operating companies and registered broker-dealers. The final amendments will become effective 90 days after publication in the Federal Register.
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