Tag Archives: PLI Securities Regulation

Are There Consequences for Reporting ICFR Problems? – The Chief Accountant Speaks!

By: George M. Wilson & Carol A. Stacey

In a recent speech SEC Chief Accountant Wesley Bricker, towards the end of his remarks, made some interesting overall comments about the evaluation of ICFR. These comments are an interesting step in the ongoing conversation about whether the SOX 404 evaluation of ICFR makes any difference in investor behavior. There has been a lot of anecdotal evidence and much discussion about this question. Mr. Bricker’s comments are not based on supposition, inference or piecemeal observation. His comments have their roots in articles from various academic journals, including the Accounting Review and The Journal of Accounting Research. Research in these peer-reviewed journals is based on statistical analysis of quantitative data. (If you have never heard of these journals, they are very prestigious academic journals, so if you decide to read any of the articles grab a cup of coffee and a calculator!)

Here are some excerpts from his remarks. The footnote numbers are references to the academic papers which support his points. We left them in so you could follow-up if you would like to review the quantitative research underlying his comments.

 

Recent experience with disclosures 

Another point related to ICFR is consideration of disclosures.  Investors tend to incorporate disclosure of ICFR deficiencies in the price they are willing to pay for a stock.  For example, companies disclosing material weaknesses are more likely to experience increased cost of capital, and to face more frequent auditor resignations and restatements.[11]

 

Recent academic research suggests:

 

Companies disclosing internal control deficiencies have credit spreads on loans about 28 basis points higher than that for companies without internal control deficiencies; [12] and

 

After disclosing an internal control deficiency for the first time, companies experience a significant increase in cost of equity, averaging about 93 basis points. [13]

 

Remediation of ineffective ICFR tends to be followed by improved financial reporting quality, reduced cost of capital, and improved operating performance.[14]   For example,

 

Companies that have remediated their prior disclosed internal control deficiencies exhibit an average decrease in market-adjusted cost of equity of 151 basis points; [15]  and

 

Remediating companies also experience increases in investment efficiency and in operating performance, suggesting that accounting information generated by effective ICFR is more useful for managerial decision-making. [16]

 

A disclosure of material weaknesses, combined with demonstrating progress toward remediation, can provide investors with information about the company’s ability to function as a public company.  Some companies, for example, voluntarily disclose material weaknesses in their registration statements along with their plans for remediating those weaknesses. [17]

 

You can find citations in to the relevant articles in the text of the speech.

As always, your thoughts and comments are welcome!

Master SEC Reporting and Prepare to Tackle New Challenges

 

The complicated world of SEC reporting has now gotten even more challenging! Be sure you are prepared to comply with the recently enacted changes and have a plan in place to deal with the SEC staff “hot buttons”.  Attend SECI’s live workshop SEC Reporting Skills Workshop 2017 being held April 24-25 in Chicago, May 8-9 in McLean, Va., May 16-17 in Dallas and May 24-25 in San Francisco with additional dates and locations listed on the SECI website.

http://www.pli.edu/Content/SEC_Reporting_Skills_Workshop_2017/_/N-1z10od0Z4k?ID=290559

Hope you Don’t Need This One!

As we discuss in all our programs, litigation is one of the issues and risks in the public company world. Our program “Securities Litigation 2017: From Investigation to Trial” on April 5, 2017 includes an expert faculty of practitioners and government officials. Included on the agenda are:

The steps involved in a securities case

The initial government investigation

Filing of the civil case, and

Settlement or the trial

 

Again, hope this is not one you need!

 

As always, your thoughts and comments are welcome!

 

Things are Changing More!

By: George M. Wilson & Carol A. Stacey

 

On February 6, 2017, Acting Chairman Michael Piwowar announced that the SEC will be reconsidering implementation of the Pay Ratio Rule required by the Dodd Frank Act. Chairman Piwowar’s announcement said in part:

“I am seeking public input on any unexpected challenges that issuers have experienced as they prepare for compliance with the rule and whether relief is needed. I welcome and encourage the submission of detailed comments, and request that any comments be submitted within the next 45 days.

I have also directed the staff to reconsider the implementation of the rule based on any comments submitted and to determine as promptly as possible whether additional guidance or relief may be appropriate.”

As you know this new disclosure, unless changed, applies for years beginning on or after January 1, 2017.

 

As always, your thoughts and comments are welcome.

Revenue Recognition –Some Example Implementation Judgements and an Update on the AICPA’s Industry Task Forces

By: George M. Wilson & Carol A. Stacey

Some of the New Revenue Recognition Judgments

If you have begun your implementation work for the new revenue recognition standard you know that this one-size-fits-all, principles based model will require many new judgments for most of us. Among the challenging questions are:

  1. When does an agreement with a customer become legally enforceable and include the five elements that bring it in scope for revenue recognition?
  2. How do we properly account on the balance sheet for transactions with customers before there is an in-scope, legally enforceable contract?
  3. When does a product or service we deliver to a customer meet the new criteria of “distinct” and become a performance obligation, the unit of account for revenue recognition?
  4. How do we make the now required estimate of variable consideration and apply the new constraint?
  5. What will be the best method to make the required estimate of stand-alone selling price when it is not directly observable?
  6. When does control transfer to a customer now that delivery, ownership and risk of loss are no longer the points in time when revenue is recognized?

 

This list is, of course, in no way complete. Individual companies may find their judgments more or less extensive and complex.

While the FASB has produced all of these new principles and the related judgments, it has also included a fair amount of implementation guidance in the new standard and clarified several issues in updates to the ASU. There are a few more soon to be final technical corrections in another ASU that you can read about here.

 

AICPA Help for Specialized Industries

 

Since this new standard is a “one-size-fits-all” approach to revenue recognition and it supersedes all industry specific guidance we have today, industries like oil and gas, airlines and others face unique challenges. In addition to the FASB’s efforts to assist us in this process you may have heard that the AICPA has also formed special task forces to deal with industry specific challenges in implementing the new standard.

You can learn about the AICPA’s efforts surrounding the new revenue recognition task force here.

The industry groups are:

 

There are over 100 specific position papers that have been put in process for the working groups and task forces which will ultimately be reviewed by FINREC. If you work in one of these industries, the links above will help you find the related working papers and their status.

 

As always, your thoughts and comments are welcome!

A Control Environment and History Follow-Up

By: George M. Wilson & Carol A. Stacey

 

This famous quote has been in our thoughts over the last several months:
“Those who cannot remember the past are condemned to repeat it.”

George Santayana, the poet and essayist, wrote these famous words in his book The Life of Reason. Many other people including Winston Churchill have thoughtfully incorporated this fundamental principle of life in speeches and remarks.

Another favorite variation of the idea comes from Mark Twain:
“History doesn’t repeat itself, but it does rhyme.”

The lesson here is that if we learn history we can hopefully avoid making the same or similar mistakes in the future. As we discussed a couple of posts back, recent public company news shows that many organizations have not been learning from the past.

 

One person who can help us learn about history we do not want to repeat is Cynthia Cooper. She was the WorldCom head of internal audit who built and lead the team that worked almost “under cover” to find the largest fraud ever discovered. This was a tone at the top fraud, involving the CEO, CFO and CAO. Her book is a sometimes-chilling story of how bad tone at the top results in fraud.

 

Sharron Watkins is another person who can help us learn how to not repeat history. She was the Enron Vice President, a direct report to Andy Fastow, who blew the whistle about Enron’s accounting irregularities. And we all know perhaps too much about that fraud which was even the subject of a book and related movie “Enron: The Smartest Guys in the Room”.

 

Corporate ethics will never be easy, but as history and current events show, it does matter. If leadership of an organization sends the message that making money is the most important thing an organization does, if it sends the message that if you don’t make money you will be fired, if it sends the message that other values can be sacrificed if you make money, the ultimate result is inevitable. In countless frauds over centuries, from Ivar Kreuger, the match king in the early 1900s, to Equity Funding in the 1970s, to Madoff, to Enron, to the companies we are talking about today, this lesson has been proven time and time again.

 

These stories can help us learn and avoid the mistakes others have made. They can be the focus of training and learning. They can be the foundation for building awareness and support for these issues in organizations large and small.

 

As always, your thoughts and comments are welcome.

Disclosure Effectiveness – The Saga Continues

By: George M. Wilson & Carol A. Stacey

A not so long, long time ago (OK, sorry Arlo Guthrie), and over a very reasonable period, the SEC began its Disclosure Effectiveness initiative. As you have likely heard (and can read about here), the Staff has sought comment and feedback about a variety of issues, including a lengthy release dealing with Regulation S-K and another dealing with various “financial statements of others” requirements in Regulation S-X.

The latest disclosure simplification development is a 26-page Staff report required by the FAST Act titled “Report on Modernization and Simplification of Regulation S-K”. It addresses a variety of areas ranging from properties to risk factors. Included are several interesting ideas such as requiring year-to-year comparisons in MD&A for only the current year and prior year and including hyperlinks to prior filings for prior comparisons.

The report is a thoughtful and interesting step in this challenging process.

As always, your thoughts and comments are welcome!

Tone at the Top, History and COSO

By: George M. Wilson & Carol A. Stacey

 

First, a quick warning before you read this post. One of the authors of this post spent nine years teaching at a university which had one of the few undergraduate business programs in the country with a required course in business ethics. This post is perhaps a bit preachy!

We have seen some distressing examples in the news lately of organizations acting unethically. If you were around during the early 2000s these events evoke a strong feeling of déjà vu. The similarities in the “tone at the top” of the organizations in the news today compared to the tone at the top in the companies involved in the pre-SOX waves of fraud (such as WorldCom and Enron) is eerie!

In all of these frauds, the roots of unethical conduct which harmed shareholders were at the top of the organizations.

History, as it always seems to do, is repeating itself. Eventually defective tone at the top will always result in trouble and distress for the organization and investors. (Yes, that was one of the preachy parts!)

All this makes it seem like a great time to review a key element in the foundations of internal control, the control environment. Here is an excerpt from the Executive Summary of the 2013 COSO Framework:

 

“Control Environment

The control environment is the set of standards, processes, and structures that provide the basis for carrying out internal control across the organization. The board of directors and senior management establish the tone at the top regarding the importance of internal control including expected standards of conduct. Management reinforces expectations at the various levels of the organization. The control environment comprises the integrity and ethical values of the organization; the parameters enabling the board of directors to carry out its governance oversight responsibilities; the organizational structure and assignment of authority and responsibility; the process for attracting, developing, and retaining competent individuals; and the rigor around performance measures, incentives, and rewards to drive accountability for performance. The resulting control environment has a pervasive impact on the overall system of internal control. “

Building an effective control environment starts at the top of an organization with the executive leadership, board and Audit Committee. If the people in these roles place financial performance before integrity, if their attitude is about accomplishing objectives at whatever the cost, that is poison in the control environment.

Understanding, assessing and evaluating tone at the top and the other elements of the control environment is not easy.

In a telecom company where the message from the CEO is to make the numbers at any cost is there any surprise that the end result is one of the largest financial reporting frauds ever? Or that the fraud was carefully crafted to avoid detection by the auditors? And, when the perpetrators of the fraud are the leaders of the organization, who have the power to punish anyone who might call out the tone at the top issues, is it any wonder that it is easy for them to conceal the corruption in the control environment? Is it any surprise that the courageous internal auditors who eventually called out the fraud actually had to conduct their investigation in secret and at times wondered if they should be afraid for their lives?

 

In an energy trading company where the CFO was behind hidden issues involving off-balance sheet arrangements that were not on the up-and-up, is it any wonder that the first person to really escalate the issue did so in an anonymous letter?

 

In a bank where not making sales goals resulted in your termination, is there any surprise when rules are bent? Is there any surprise when people are fired when they attempt to raise the issue to their managers?

 

As another example, check out this 10-K for Hertz which includes a major restatement. In the “Explanatory Note” at the beginning of the document you will find this language:

 

As of December 31, 2014, we did not maintain an effective control environment primarily attributable to the following identified material weaknesses:

Our investigation found that an inconsistent and sometimes inappropriate tone at the top was present under the then existing senior management that did not in certain instances result in adherence to accounting principles generally accepted in the United States of America (“GAAP”) and Company accounting policies and procedures. In particular, our former Chief Executive Officer’s management style and temperament created a pressurized operating environment at the Company, where challenging targets were set and achieving those targets was a key performance expectation. There was in certain instances an inappropriate emphasis on meeting internal budgets, business plans, and current estimates. Our former Chief Executive Officer further encouraged employees to focus on potential business risks and opportunities, and on potential financial or operating performance gaps, as well as ways of ameliorating potential risks or gaps, including through accounting reviews. This resulted in an environment which in some instances may have led to inappropriate accounting decisions and the failure to disclose information critical to an effective review of transactions and accounting entries, such as certain changes in accounting methodologies, to the appropriate finance and accounting personnel or our Board, Audit Committee, or independent registered public accounting firm.

 

This is another example of a fraud with its roots in tone at the top.

When frauds escalate to a material level there is a reasonable likelihood that it started with a problem with tone at the top, with the control environment.

So, where does all this lead? Assessing tone at the top is not easy. And a poisoned control environment will do everything it can to protect itself. The leaders of an organization with a defective control environment will use the power they wield to keep others from exposing the problem. Perhaps more protections for whistleblowers are a good thing in this regard. Tools to measure ethical behavior in an organization are difficult to find, subjective and imprecise. Enron in fact had a model code of ethics, but having something on paper does not mean that people will live by the code of ethics. The one thing that is clear is that this continues to be a complex area and continues to be at the root of many financial reporting frauds. We all need to focus on this area and work to develop a better understanding and better tools to assess the control environment.

We all need to focus on tone at the top and ethical behavior. Yes, it is not easy to measure, it is not easy for an outsider to observe, but it is clearly crucial to effective ICFR!

 

As always, your thoughts and comments are welcome!

 

 

Year-End Planning – More or Less Concluded – Keeping Up with SEC Focus Areas

By George M. Wilson & Carol A. Stacey

In recent weeks we have been posting about areas to deal with in advance of year-end. So far we have addressed:

Issues in the Statement of Cash Flows

Evaluating and Auditing ICFR

The New Item 16 Form 10-K Summary

Recently Issued Accounting Standards and a Few Example Comments

SAB 74/Topic 11-M – News from the SEC at the September EITF Meeting

Disclosure Effectiveness

Should You Consider Any Issues for OCA Consultation?

A Year End Planning Detail – No More Mailing the ARS to the SEC!

Three Years of Fun – Planning the “Big Three” New FASB Statement Transitions

 

As we are getting ever closer to year-end this is also a good time to proactively review areas where financial reporting problems frequently occur and take steps to assure we have all the “i’s” dotted and “t’s” crossed in these areas.

Unusually complex accounting issues, difficult estimates and sensitive disclosures all become the focus of SEC comments. This is not because the Staff thinks they are important in and of themselves, but rather because these are areas where the Staff frequently uncovers problems in the comment process. Clearly if we do not deal with them appropriately, they involve risk of restatement and amendment.

There are a variety of ways you can keep up with the CorpFin Staff’s frequent comment areas. Every year at our Annual Reporting Forums in November and December, our Conference for Mid-Size and Smaller Companies in September and our Mid-Year Programs in May and June current and former Staffers discuss the areas where they have concerns.

Here is the list from our most recent programs:

  • Segments
  • Statement of Cash Flows
  • Income Taxes
  • Consolidation
  • Business Combinations
  • Fair Value
  • Goodwill
  • Revenue Recognition
  • Non-GAAP Measures & Metrics
  • Internal Control over Financial Reporting

Beyond hearing from the Staff and those in the know, many organizations research comment letters and summarize the areas and frequency of comments within these areas.   You can find these summaries on the web pages for most of the national CPA firms. Here are links to some of them:

EY SEC Comments and Trends

Deloitte’s SEC Comment Letter Series

PWC’s SEC Comment Letter Trends

Other companies build databases of comments which can be researched by comment area, CorpFin Office and even by reviewer. Two companies who sell these kinds of tools are Audit Analytics and Intelligize. However, remember the Staff’s caution that their comments are fact-specific to each registrant and you should never cut and paste from another letter.

If you have any other good sources of information about these issues, please leave them in a comment to this post, and, as usual, your thoughts and comments are welcome!

 

 

 

Hot Topic Update – FASB’s Dramatic New Lease Accounting Standard

 

The FASB’s new lease accounting standard presents complex accounting, internal control, system and implementation challenges. Learn the conceptual underpinnings, overall structure and details of the standard as it applies to both lessees and lessors. Register now for our live half-day seminar December 15th in New York City, Implementing the FASB’s New Lease Accounting Standard Workshop 2016. Discussion includes implementation steps and system and ICFR issues.

http://www.pli.edu/Content/Seminar/Implementing_the_FASB_s_New_Lease_Accounting/_/N-4kZ1z10l1v?fromsearch=false&ID=300755