Monthly Archives: April 2015

The Whistleblower’s Saga

Whistleblowers are much in the news. With stories ranging from Jim Marchese of “Real Housewives of New Jersey” fame collecting his second whistleblower legal settlement, to the SEC announcing a $1 million dollar whistleblower payout to a compliance officer, the volume of whistleblower activity is clearly increasing.

(The SEC Release is at:

www.sec.gov/news/pressrelease/2015-73.html )

Whistleblowers clearly play a key role in the detection of fraud. The SEC’s Office of the Whistleblower says: “Assistance and information from a whistleblower who knows of possible securities law violations can be among the most powerful weapons in the law enforcement arsenal of the Securities and Exchange Commission”.

If you would like to get to the story of how blowing the whistle affected one person’s life and career, skip to the links at the end of this entry. But first, here is some background about how regulators have tried to create paths for whistleblowers.

Congress has built ways for whistleblowers to do what their label says, blow the whistle when they find something that is wrong, a major focus in the efforts to combat fraud.

The Sarbanes-Oxley act created a whistleblower’s hotline to the audit committee and required that whistleblowers be able to blow the whistle anonymously. The Dodd-Frank Act created a separate incentivized hotline directly to the SEC. A whistleblower using the Dodd-Frank hotline can also remain anonymous and may even be entitled to cash rewards if the matter about which they blow the whistle results in penalties against the company.

Importantly, companies are not allowed to try and restrict employees in blowing the whistle. This is an important enough issue that the SEC has enforced against companies and levied fines when companies try to limit how employees can contact the SEC. A very recent example is against KBR’s use of a confidentiality agreement containing overly restrictive language, summarized at:

www.sec.gov/news/pressrelease/2015-54.html#.VRw2AzbD_cs

You can learn more about the Dodd-Frank hotline and the SEC’s Office of the Whistleblower at:

www.sec.gov/whistleblower

One would think with all this legislative and SEC support being a whistleblower is becoming an easier path to walk. However, it is still true that few events in a persons professional career are more stressful and disruptive than blowing the whistle.

Marketplace and Propublica have put together an interesting study of how one whistleblower’s path unfolded. It is a great example with lots of gray issues, a prolonged period of uncertainty, and many other complications. You can read and hear about it at:

www.marketplace.org/topics/business/whistleblowers-tale-how-accountant-took-halliburton

www.propublica.org/article/the-whistleblowers-tale-how-an-accountant-took-on-halliburton

 

Comment of the Week – Its all About the Future!

One of the most challenging disclosures we discuss in our workshops is the required forward-looking MD&A requirement to disclose “known trends”. (As a heads-up, this post contains some pretty long comments, but they raise some very important issues!)

This forward-looking information requirement is rooted in the overall objective of MD&A as articulated in FR 72. The relevant section of the release states that part of the objective of MD&A is:

“to provide information about the quality of, and potential variability of, a company’s earnings and cash flow, so that investors can ascertain the likelihood that past performance is indicative of future performance” (emphasis added)

And, of course, this is done “through the eyes of management”.

You can find the whole release at:

www.sec.gov/rules/interp/33-8350.htm

From this objective it is clear that if management knows about something that means past performance is not going to be predictive of future performance and the information is material, it should be disclosed in MD&A. This is made clear in S-K Item 303(a) (3) (ii):

“Describe any known trends or uncertainties that have had or that the registrant reasonably expects will have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations. (emphasis added)

The SEC is watchful for companies that surprise the markets with disclosure of bad news, potentially driving down their stock price, where the companies have not said anything about the bad news issue in previous filings.

In many cases the Staff’s presumption is that the bad news did not surprise management, and that in fact they knew about the problem well before they disclosed it to investors. In that situation, management likely failed to meet the disclosure requirements in MD&A and S-K Item 303(a) (3) (ii) specifically.

In our workshops we discuss some of the classic enforcement actions where this has happened, including the “groundbreaking” cases against Caterpillar and Sony. The staff continues to search for problems in this area, and frequently starts with the comment letter process.

Here are example comments that were written to a grocery store chain that had decided to exit one of its “banners”. In this industry a “banner” is a brand name for the supermarket chain. Notice the subtle interaction of these comments from the initial letter:

  1. We note that you announced the sale and/or closure of all of your (name omitted) stores in May 2014. We further note that in the related press release, filed as Exhibit 99.2 to your March 29, 2014 Form 10-Q, your Chief Executive Officer stated, “The economic downturn over the last few years, coupled with an increased competitive footprint in the Minneapolis/St. Paul Market, has made it difficult for (the company) to keep the (name omitted) banner competitive.” We further note that the disclosures regarding negative factors impacting your business within this Form 10-K appear to broadly apply to your business and do not specifically refer to the (name omitted) banner. Please tell us how you determined additional disclosures were not required in this Form 10-K as it relates to your (name omitted) banner. In your response, specifically explain how you considered whether these stores were disproportionately impacted by any of the negative factors described in your disclosures, either in the periods of historical financial statements included in this Form 10-K or in your analysis of trends and uncertainties that you reasonably expected would have a material impact on your future results. If the decision to sell this banner was influenced by worse than expected results for this banner during the first quarter of 2014, then also apply this comment to your MD&A disclosures within your March 29, 2014 Form 10-Q. (emphasis added)

The first comment above puts the trend disclosure on the table. This next comment goes a bit further, clearly articulating the “does the past predicts the future?” requirement:

  1. We note your disclosures under the heading “Goodwill Impairment Charge.” Please tell us, and disclose in future filings, why your fair value declined such that you recorded this impairment charge. We remind you that one of the principle objectives of MD&A is to provide your investors with enough insight into the underlying factors that drove your historical results [so] that they can assess the likelihood that past results are indicative of future results. We also remind you of your obligation to describe known trends and uncertainties that have had or you reasonably expect will have a material impact on your results. (emphasis added)

The following comment directly quotes S-K 303(a)(3)(ii), asking some very challenging questions:

  1. We note you recorded $280.0 million of pretax goodwill impairment charges in the quarter ended September 27, 2014. Please tell us what consideration you gave to updating your goodwill critical accounting estimate disclosures in your September 27, 2014 Form 10-Q. In this regard, you refer your investors to the critical accounting estimates on goodwill contained in your annual report. Given the charge you recorded in the most recent quarter it would appear the assumptions used to assess goodwill for impairment have significantly changed. Further, you now have two reporting units as opposed to one reporting unit at December 28, 2013. Please advise. Additionally, given the significance of the impairment charges and the material amount of goodwill remaining on your balance sheet, please show us what critical accounting estimate disclosures you anticipate making in your upcoming Form 10-K filing. Please ensure your disclosures provide investors with sufficient information to assess the material implications of uncertainties associated with the methods, assumptions and estimates underlying this critical accounting estimate. Refer to Item 303(a)(3)(ii) of Regulation S- K, which requires a description of a known uncertainty and Section V of SEC Release No. 33-8350. (emphasis added)

After the company’s responses to the above comments, the staff wrote this follow-on comment in the second round of comments. Note the depth of the analysis asked for in the comment and the depth of the SEC’s review into material that was not even included in a 10-K or 10-Q!

 We have read your November 2014 “Company’s Investor Presentation” and note the strong growth in the Chicago Market with the ChicagoBanner’s format. Further, you highlight several differences between your Wisconsin and Illinois markets. For example, on slide five you point out the Chicago market has “2x the productivity of your Wisconsin stores.” The information presented on slide six indicates that your ChicagoBanner’s banner is a “highly differentiated food shopping experience.” You further indicate on slide seven the ChicagoBanner’s banner has 1) two times the average Wisconsin retail sales volume, 2) lower EBITDA margin and higher gross profit dollars, and 3) strong store-level ROIC. We also note on slide sixteen that ChicagoBanner’s represents a significant growth opportunity for the Company. It also appears from the disclosures in your filings and your response to our comments that your Wisconsin and Illinois markets were behaving differently during 2013 and 2014, leading you to “[shift] focus to stabilizing [your] Wisconsin market” in contrast to “growing [your] ChicagoBanner’s banner.” We further note a general trend of highly differentiated grocery stores having higher profit margins than value-oriented grocery stores. Based on this information, we continue to believe that your Wisconsin and Illinois markets likely have different current or future trends in per-store revenue and per-store profitability, and that the mix of stores between these two markets will therefore impact your consolidated results. Please explain to us in significantly more detail why the apparent differences between these types of stores were not addressed in your most recent Form 10-Q, either as part of your analysis of results of operations or as part of your discussion of trends and uncertainties, and also tell us how these matters will be addressed in your upcoming Form 10-K. 


So, the moral of this story, if you know of something that is reasonably likely to have a material impact on future results, don’t keep it secret! Even if you hope it will not be a problem, these MD&A requirements need to be carefully reviewed to determine when to share the information with investors!

As always, your thoughts and comments are welcome!

Audit Committee Challenges and Changes on the Horizon

The role of the Audit Committee in corporate governance is continuously developing, expanding and becoming more complex. Even before the dramatic events at Enron and Worldcom (without going too much into history!) regulators and governance experts focused on clarifying and enhancing audit committee functions. After Enron, Worldcom and the rest of the wave of governance breakdowns in the early 2000’s the SEC began to require even more significant disclosures about audit committee function.

This process has continued. At the 2014 PLI SEC Speaks conference the Chief Accountant of the SEC delivered a speech entitled “Audit Committee – Back to Basics”. You can find the presentation materials at:

www.sec.gov/News/Files/1371146714240

Even matters as foundational as auditor independence have been issues for the SEC. Deputy Chief Accountant Brian Croteau focused on such areas in this December 2014 speech:

www.sec.gov/News/Speech/Detail/Speech/1370543616539

As Audit Committees deal with these challenges, PLI will have a great program on June 23, 2015 titled “Audit Committees and Financial Reporting 2015 – Recent Developments and Current issues”. Included will be the latest news on potential expanded audit committee reporting. You can learn more about the program at:

www.pli.edu/Content/Seminar/Audit_Committees_and_Financial_Reporting/_/N-4kZ1z129aq?fromsearch=false&ID=221246

As always your comments, thoughts and ideas are welcome!

Watch Out – Instructions to Form 10-K Typo’s?

In all our workshops we always advise everyone to check the SEC’s webpage for the latest version of the instructions whenever it is 10-K or 10-Q time. And, recently, the SEC put updated instructions for Form 10-K on their webpage.

But this update has an interesting twist!

The updated instructions do not have any major changes. The only really new instructions relate to asset-backed issuers.

That said, there is something really strange about the new instructions. Check them out at:

www.sec.gov/about/forms/form10-k.pdf

Now, as you read them check out the cover page and as you look at the second line it says:

“For the fiscal yar ended”

While this looks like it might be a typo, we know the SEC is always VERY CAREFUL when they make these changes, and we think in all likelihood there has been some sort of a technical problem in the process of converting the instructions to PDF form and uploading them to the webpage.

So, how should we react? Should we literally follow these instructions? Include the likely technical issue errors?

Obviously NOT!

In fact, don’t forget what General Instruction C(1) says:

This form is not to be used as a blank form to be filled in, but only as a guide in the preparation of the report on paper meeting the requirements of Rule 12b-12. Except as provided in General Instruction G, the answers to the items shall be prepared in the manner specified in Rule 12b-13.

So, do it right!

As a last note, the 10-Q instructions have not been changed, but as we approach the First Quarter Form 10-Q, watch for updates!

As always, your thoughts and comments are welcome!

Foreign Corrupt Practices Act – Yikes?

FCPA enforcement has become more and more of a priority for the SEC and a bigger and bigger issue for public companies in recent years. The SEC actually has a special section of its webpage devoted to FCPA Enforcement Actions!

www.sec.gov/spotlight/fcpa/fcpa-cases.shtml

Any business with foreign operations, or thinking of establishing one, even if they are modest, needs to pay attention to the challenges of FCPA compliance. Lawyers, accountants and professionals working in almost any aspect of a company with foreign operations need to understand this complex law.

To manage FCPA risks it is crucial to understand issues such as:

What are the Act’s anti-bribery provisions?

What are the Act’s “accounting and recordkeeping” (internal control) provisions?

What are the traps and major issues in the “accounting and recordkeeping” provisions?

How payments that may be immaterial for financial reporting still matter for FCPA compliance.

How internal audits and FCPA compliance audits differ.

What is the difference between a bribe and a “facilitating payment”, and does it matter for FCPA compliance?

What are the civil and criminal consequences of violating the Act?

What are the major parts of a compliance program?

How does a company build an effective compliance program?

If you need a good place to start understanding what is required to deal with FCPA issues, PLI’s One-Hour Briefing, Basics of the U.S. Foreign Corrupt Practices Act (FCPA) 2015, on April 17, 2015, is a great resource for understanding the issues and complying with the Act.