Category: Accounting and Auditing

The CAQ has some ideas for improving audit committee disclosure

The Center for Audit Quality, working with Ideagen Audit Analytics, has just released a new edition of its annual Audit Committee Transparency Barometer, which, over the past ten years, has measured the robustness of audit committee disclosures in proxy statements among companies in the S&P Composite 1500. Why is that important? According to the CAQ, “numerous studies have identified a positive correlation between increased communication of audit committee oversight through disclosures in the proxy statement and increased audit quality.” Not to mention the interest of investors and other stakeholders in better disclosure. The bottom line, according to the CAQ, is that the level of voluntary transparency has continued to increase steadily in most core areas of audit committee responsibility, such as oversight of the external auditor, as well as in evolving areas, such as cybersecurity risk and ESG. But it could still stand some improvement. In light of the “current environment of economic uncertainty, geopolitical crises, and new ways of working,” the CAQ encourages audit committees to jettison boilerplate and “tell their story through tailored disclosures in the proxy statement…. For audit committees to enhance their disclosures, they should provide further discussion not just of what they do in their oversight of the external auditor but also how they do it.” In the Barometer, the CAQ offers some specific ideas on just how audit committees can improve their disclosure and enhance its utility.

FASB issues final ASU requiring enhanced disclosure of segment expenses

The FASB has announced a final Accounting Standards Update designed to improve disclosures about public companies’ reportable segments, particularly disclosures about significant segment expenses—information that the FASB says investors frequently request. The ASU indicates that investors and others view segment information as “critically important in understanding a public entity’s different business activities. That information enables investors to better understand an entity’s overall performance and assists in assessing potential future cash flows.”  According to FASB Chair Richard R. Jones, the “new segment reporting guidance is based on the FASB’s extensive outreach with stakeholders, including investors, who indicated that enhanced disclosures about a public company’s segment expenses would enable them to develop more decision-useful financial analyses….It will improve financial reporting by providing additional information about a public company’s significant segment expenses and more timely and detailed segment information reporting throughout the fiscal period.” Previously, at the proposal stage, Jones had referred to the ASU as the “FASB’s most significant change to segment reporting since 1997.” While the extent of new information will vary among entities, the FASB “expects that nearly all public entities will disclose new segment information under the amendments.” It’s worth pointing out here that the financial reporting changes could well lead to changes in MD&A disclosure. The ASU will apply to all public entities required to report segment information (under Topic 280).  Compliance with the new guidance will be required starting in annual periods beginning after December 15, 2023.

SEC Chief Accountant has some thoughts about the statement of cash flows

The SEC’s Office of Chief Accountant appears to be taking a hard look these days at statements of cash flows. In “The Statement of Cash Flows: Improving the Quality of Cash Flow Information Provided to Investors,” SEC Chief Accountant Paul Munter discusses the importance of the statement of cash flows, the failure of companies and auditors to prepare and review cash flows statements with an appropriate level of care and the mischaracterization of classification errors on the cash flows statement as immaterial, resulting in questionable “little r” restatements. Munter cautions that “preparers and auditors may not always apply the same rigor and attention to the statement of cash flows as they do to other financial statements, which may impede high quality financial reporting for the benefit of investors.”  According to Munter, that conclusion is evidenced by both the prevalence of restatements associated with the statement of cash flows as well as by the staff’s “observations of material weaknesses in internal control over financial reporting…around the preparation and presentation of the statement of cash flows.” It’s worth noting here that, as reported by the WSJ, other SEC representatives have also been raising these same issues at conferences regarding inadequate attention to the statement of cash flows and lack of objectivity in assessing the materiality of cash flow errors. Statements like this one from the Chief Accountant and others at OCA usually warrant close attention because they signal topics on which the staff is focused and often presage Enforcement activity on these same subjects.

SEC reports Enforcement stats for fiscal 2023 —with big contributions from whistleblowers

The SEC has announced its Enforcement stats for fiscal 2023, which revealed that the SEC filed 784 total enforcement actions, up 3% from the 760 filed in fiscal 2022.  However, the level of financial remedies declined in fiscal 2023 to $4.9 billion from a record $6.4 billion last year. Nevertheless, it was still the second highest amount in SEC history. (Of course, you might recall that Gurbir S. Grewal, Director of the Division of Enforcement, said last year that the SEC didn’t expect to break last year’s records and set new ones every year because they “expect behaviors to change. We expect compliance.”)  Of those financial recoveries, in fiscal 2023, the SEC distributed $930 million to harmed investors, representing the second consecutive year of distributions in excess of $900 million. But the standout statistics this year related to the SEC’s whistleblower program, where new records were set with whistleblower awards totaling almost $600 million, and 18,000 whistleblower tips in fiscal 2023, about 50% more tips than were received in fiscal 2022. A new record was also set with a $279 million award to one whistleblower. Overall, in fiscal 2023, the SEC received over “40,000 tips, complaints, and referrals in total,” a 13% increase over last year. According to SEC Chair Gary Gensler, the “investing public benefits from the Division of Enforcement’s work as a cop on the beat….Last fiscal year’s results demonstrate yet again the Division’s effectiveness—working alongside colleagues throughout the agency—in following the facts and the law wherever they lead to hold wrongdoers accountable.” Grewal added that “[i]nvestor protection and enhancing public trust in our markets requires that we work with a sense of urgency, using all the tools in our toolkit. As today’s results make clear, that’s precisely what the Enforcement Division did in fiscal year 2023….Whether it was by leveraging risk-based initiatives, seeking robust remedies, rewarding cooperation, protecting whistleblowers, or returning nearly a billion dollars to harmed investors, the Enforcement Division stood up for the investing public.”

SEC charges Charter Communications with controls violation related to 10b5-1 plans for company buybacks

Yesterday, the SEC announced a settled action against Charter Communications for “violating internal accounting controls requirements when it engaged in stock buybacks not authorized by its board of directors.” More specifically, the Board had authorized the company to conduct stock buybacks using Rule 10b5-1 plans, but the SEC contended that Charter’s plans contained a provision that permitted too much discretion—allowing Charter to “change the total dollar amounts available to buy back stock and to change the timing of buybacks after the plans took effect.”  As a result, the SEC concluded, the plans did not satisfy Rule 10b5-1. But this was not a case about insider trading. Rather, the SEC charged, because the plans did not satisfy Rule 10b5-1, the buybacks were effectively unauthorized. And that was a problem of ineffective internal accounting controls (which, the SEC maintained, aren’t necessarily just about accounting). According to Melissa Hodgman, Associate Director of Enforcement, “[c]ompanies whose boards authorize buybacks using Rule 10b5-1 plans must have controls that reasonably assure that their trading plans meet all of the rule’s conditions….This includes the fundamental requirement that, to benefit from the protection of Rule 10b5-1, traders have to relinquish their ability to influence the amount or timing of trades after their trading plans go into effect.” Charter agreed to pay a civil penalty of $25 million. Commissioners Hester Peirce and Mark Uyeda dissented.  

The PCAOB suggests some questions for audit committee members

The PCAOB has posted a 2023 audit committee resource that identifies a number of questions that audit committees may want “to consider amongst themselves or in discussions with their independent auditors, particularly given today’s economic and geopolitical landscape.”  The topics include the risk of fraud, risk assessment and internal controls, auditing and accounting risks, digital assets, M&A activities, use of the work of other auditors, talent and its impact on audit quality, independence, critical audit matters and cybersecurity. Audit committee members will certainly want to review the resource in its entirety, but, to give you a flavor, summarized below are some of the questions.

Some highlights of the 2023 PLI Securities Regulation Institute

This year’s PLI Securities Regulation Institute was a source for a lot of useful information and interesting perspectives. Panelists discussed a variety of topics, including climate disclosure (although no one shared any insights into the timing of the SEC’s final rules), proxy season issues, accounting issues, ESG and anti-ESG, and some of the most recent SEC rulemakings, such as pay versus performance, cybersecurity, buybacks and 10b5-1 plans. Some of the panels focused on these recent rulemakings echoed concerns expressed last year about the difficulty and complexity of implementation of these new rules, only this time, we also heard a few panelists questioning the rationale and effectiveness of these new mandates. What was the purpose of all this complication? Was it addressing real problems or just theoretical ones? Are investors really taking the disclosure into account? Is it all for naught?  Pay versus performance, for example, was described as “a lot of work,” but, according to one of the program co-chairs, in terms of its impact, a “nothingburger.”  (Was “nothingburger” the word of the week?) Aside from the agita over the need to implement the volume of complex rules, a key theme seemed to be the importance of controls and process—the need to have them, follow them and document that you followed them—as well as an intensified focus on cross-functional teams and avoiding silos. In addition, geopolitical uncertainty seems to be affecting just about everything. (For Commissioner Mark Uyeda’s perspective on the rulemaking process presented in his remarks before the Institute, see this PubCo post.) Below are just some of the takeaways, in no particular order.

Is there an alternative to Scope 3?

As you know, the SEC has proposed a sweeping set of regulations for disclosure on climate (see this PubCo post, this PubCo post and this PubCo post), and we anxiously wait to see what the final rules have in store (obviously not happening in October as the SEC had previously targeted). One controversial part of that proposal draws on the Greenhouse Gas Protocol, requiring disclosure of a company’s Scopes 1 and 2 greenhouse gas emissions, and, for larger companies, Scope 3 GHG emissions if material (or included in the company’s emissions reduction target), with a phased-in attestation requirement for Scopes 1 and 2 data for large accelerated filers and accelerated filers. There haven’t been many complaints about the Scope 1 and Scope 2 requirements, but Scope 3 is another matter. According to the SEC, some commenters indicated that, for many companies, Scope 3 emissions represent a large proportion of overall GHG emissions, and therefore, could be material. However, those emissions result from the activities of third parties in the company’s “value chain,” making collection of the data much more difficult and much less reliable. In two articles published in the Harvard Business Review—“Accounting for Climate Change” and “We Need Better Carbon Accounting. Here’s How to Get There”—Robert Kaplan and Karthik Ramanna from Harvard Business School and the University of Oxford, respectively, propose another idea—the E-liability accounting system. The GHG protocol is, at this point, deeply embedded. Would the E-liability system work? Should the SEC or other regulators make room for a different concept?

Is political corruption securities fraud?

You remember Matt Levine’s mantra in his “Money Stuff” column on Bloomberg: “everything is securities fraud”? “You know the basic idea,” he says, a

“company does something bad, or something bad happens to it. Its stock price goes down, because of the bad thing. Shareholders sue: Doing the bad thing and not immediately telling shareholders about it, the shareholders say, is securities fraud. Even if the company does immediately tell shareholders about the bad thing, which is not particularly common, the shareholders might sue, claiming that the company failed to disclose the conditions and vulnerabilities that allowed the bad thing to happen. And so contributing to global warming is securities fraud, and sexual harassment by executives is securities fraud, and customer data breaches are securities fraud, and mistreating killer whales is securities fraud, and whatever else you’ve got. Securities fraud is a universal regulatory regime; anything bad that is done by or happens to a public company is also securities fraud, and it is often easier to punish the bad thing as securities fraud than it is to regulate it directly.” (Money Stuff, 6/26/19)  

(See this PubCo post.) But here’s a new one—bribery and political corruption as securities fraud. As described in this press release, in the fiscal-year-end enforcement crush, the SEC brought settled charges against Exelon Corporation, a utility services holding company, and its subsidiary, electric utility company Commonwealth Edison Company (ComEd), and filed a complaint against ComEd’s former CEO alleging “fraud in connection with a multi-year scheme to corruptly influence and reward the then-Speaker of the Illinois House of Representatives.” Exelon and ComEd agreed to settle the charges, with Exelon paying a civil penalty of $46.2 million.  The charges against the CEO are headed for trial.  So how is this securities fraud? According to the Chief of the SEC Enforcement Division’s Public Finance Abuse Unit, the CEO’s “remarks to investors about ComEd’s lobbying efforts hid the reality of the long-running political corruption scheme in which they were engaged….When corporate executives speak to investors, they must not mislead by omission.”

SEC charges executives with fraudulent revenue recognition practices

As part of its fiscal-year-end enforcement surge, the SEC filed charges against three former executives of Pareteum Corporation, a telecommunications and cloud software company, for fraudulent revenue recognition practices—a settled action against the former controller and a complaint against the former CFO and former Chief Commercial Officer (also, formerly CEO).  As described in the complaint, the SEC charged the former executives with orchestrating a fraudulent scheme to overstate revenue by recording revenue from non-binding purchase orders and concealing the practice from the company’s auditors. From 2018 through mid-2019, the SEC alleged, the defendants’ improper revenue recognition practices resulted in the company’s overstating revenue by “approximately $12 million for fiscal year 2018 (60% of the ultimately restated revenue), and by approximately $30 million for the first and second quarters of 2019 (91% of the ultimately restated revenue).” In addition, the former CFO, the SEC charged, did not establish sufficient internal accounting controls to assess whether revenue should be recognized under GAAP. According to the press release, Pareteum previously settled with the SEC on accounting and disclosure fraud charges in 2021 and filed for bankruptcy in 2022. Notably, the U.S. Attorney’s Office for the SDNY has announced parallel criminal charges against the former CFO and CCO. According to the Associate Director of Enforcement for the SEC’s Philadelphia Regional Office, as the SEC alleged in its complaint, “Pareteum’s executives artificially inflated Pareteum’s revenue numbers to create the illusion of robust revenue growth….Investors should be able to trust public companies to issue truthful and accurate financial statements, and we will hold accountable any executives who abuse that trust and defraud investors.”