Last week, the SEC announced settled charges against PwC and one of its audit partners for violations of the auditor independence rules. As described in the Order, the violations included “performing prohibited non-audit services during an audit engagement, including exercising decision-making authority in the design and implementation of software relating to an audit client’s financial reporting, and engaging in management functions.” PwC was also charged with “improper professional conduct” in connection with 19 engagements by failing to comply with PCAOB rules requiring an auditor to “describe in writing to the audit committee the scope of work, discuss with the audit committee the potential effects of the work on independence, and document the substance of the independence discussion.” According to the Order, the failure to properly advise these audit committees prevented them from examining whether the non-audit services affected PwC’s independence. Notably, because it issued an audit report stating that it was independent when it was not, PwC was also charged with having caused its audit client to violate the Exchange Act by filing with the SEC an annual report that contained materially false or misleading information and that failed to include financial statements audited by an independent public accountant, as required. The SEC concluded that these violations reflected “breakdowns in [PwC’s] system of quality control to provide reasonable assurance that PwC maintained independence.” In addition to requiring PwC to pay disgorgement and penalties, the SEC censured PwC. For companies, it is important to keep in mind that the consequences of violations of the auditor independence rules apply not just to the audit firm, but also to the audit client. An independence violation may cause the audit client to violate the Exchange Act, as in this case, and/or lead the auditor to withdraw its audit report, requiring the audit client to have a re-audit by another audit firm. Audit committees need to be on the alert for the possibility of auditor independence violations and be vigilant regarding the performance of non-audit services.
You may recall that, for a while now, the SEC has been actively warning about risks associated with the LIBOR phase-out, which is expected to occur in 2021. LIBOR, the London Interbank Offered Rate, is a widely used reference rate 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. SEC Chair Jay Clayton has advised 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.” In July, the SEC staff published a Statement that “encourages market participants to proactively manage their transition away from LIBOR.” (See this PubCo post.) However, the substantial uncertainties and challenges associated with implementing the transition have led to delays and triggered a high level of anxiety among companies faced with addressing the issue. (See this PubCo post.) As reported in Bloomberg BNA, to ease the strain of the transition, FASB has jumped in with some proposed temporary financial reporting relief.
The SEC’s Office of Chief Accountant has updated its FAQs regarding auditor independence. The new and revised questions relate to the general standard for independence, prohibited non-audit services, partner rotation, definitions and miscellaneous other independence issues. It is important 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 its 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 be another menu item on the audit committee’s plate.
By now, we all know that, sooner or later, audit reports for most public companies will be required to disclose critical audit matters, which are intended to make the audit report more informative for investors. (See this PubCo post.) But, as this article from the EY Center for Board Matters reports, over the last several years, companies and their audit committees have gone a long way toward increasing the amount of audit-related information they provide to investors voluntarily. To carry out its assessment, EY reviewed audit-related disclosures in the proxy statements of Fortune 100 companies over the period from 2012 to 2019. While year to year, the changes appear largely incremental, the change over the entire period is considerable.
AS 3101, the new auditing standard for the auditor’s report that requires disclosure of critical audit matters, is effective for audits of large accelerated filers for fiscal years ending on or after June 30, 2019. And that means that audit reports communicating the first round of CAMs have now been filed for the pioneers—large accelerated filers with fiscal years ended June 30, 2019. In this Deloitte Heads Up, the audit firm takes a look at all 52 of them. Deloitte reports that an average of 1.8 CAMs were disclosed per audit report, and the most commonly disclosed CAMs related to goodwill and intangible assets. Other companies may want to listen up because CAM requirements will be upon them soon—for companies other than large accelerated filers (excluding EGCs), CAMs will be required for fiscal years ending on or after December 15, 2020.
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.
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.
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?
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.)
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.’”