Tag Archives: sec trends

How Has the “Salman” Decision Changed Insider Trading Law?

Insider Trading Law 2017

Chair: David I. Miller – Morgan, Lewis & Bockius LLP

In recent years, insider trading has been a critical area of criminal and civil enforcement, and it will likely remain so for some time to come. The Supreme Court issued its first insider trading opinion in nearly twenty years in the Salman appeal. Salman is significant and may assist the government in its ongoing insider trading enforcement efforts. Don’t miss out on this highly topical program where our experienced faculty will address the change in law, current and future areas of enforcement, and best compliance practices to prevent insider trading.

New York City and Live Webcast – July 21, 2017, 9:00 a.m. – 12:30 p.m. ET

Groupcast Locations: Atlanta, Boston, Cleveland, Indianapolis, Philadelphia, Pittsburgh and Mechanicsburg – July 21, 2017, 9:00 a.m. – 12:30 p.m. ET

Nashville – July 21, 2017, 8:00 – 11:30 a.m. CT

Key Topics Will Include:

  • The law of insider trading
  • Implications of Salman, Newman, and other recent decisions
  • The re-argument of the Martoma case
  • Best compliance practices and avoiding enforcement actions
  • Key strategies in defending criminal and civil insider trading actions
  • Current and future criminal and civil enforcement priorities for insider trading cases

Credit Information: CLE, CPE, CFE Fraud and CPD

Register Today!

Whither the Auditor’s Report?

By: George M. Wilson & Carol A. Stacey

 

Would you expect to find this language in an auditor’s report?

“We performed a full scope audit on seven components representing 99% of the Group’s revenue, 90% of the Group’s profit before tax and 90% of the Group’s net assets.

 

During our first year as auditor of the Group, we visited all significant locations. For our second year, we have implemented a rotational approach to these visits.”

Or how about a discussion of materiality such as this?

“We determined materiality for the Group to be £30 million.

We reported all audit differences in excess of £1 million.

 

We define materiality as the magnitude of misstatement in the financial statements that makes it probable that the economic decisions of a reasonably knowledgeable person would be changed or influenced.”

This language may sound like it is from the auditor’s internal conclusion memoranda, but in fact it is from the Deloitte report on the 2016 financial statements of an English company, Marks and Spencer.

Their annual report contains the expanded auditor’s report now required by UK Auditing Standards. The report is on pages 78 to 85 (Yes, it is that long!). It also enumerates several “Key Audit Matters”, describing how each such issue was dealt with in the audit.

While this might seem like an extreme example, there has been movement in international audit standard setting towards more tailored, descriptive audit reports. Here in the US the PCAOB began consideration of changes to the auditor’s report over 7 years ago.

In a May 24, 2017 news release the PCAOB announced that on June 1, 2017 they will consider adopting a new Standard on the auditor’s report. The proposal would eliminate the existing standardized form auditor’s report and replace it with a more tailored report which would include discussion of audit specific issues such as “Critical Audit Matters”. Also to be considered at the meeting are new standards about auditing estimates and using the work of specialists.

You can read about the auditor’s report project and review the most recent proposed version of the standard here.

 

As always, your thoughts and comments are welcome!

Challenging Accounting Judgments, Principles Based Standards and ICFR

By: George M. Wilson & Carol A. Stacey

As you have undoubtedly heard from a variety of sources (including this post we made last December), the new revenue recognition, financial instruments impairment and lease standards all involve many new and sometimes complex accounting judgments and estimates.

 

Issues ranging from how to estimate current expected credit losses to what is stand-alone selling price confront us with new, difficult, and subjective judgment calls.

 

Even the Chief Accountant has discussed this issue in a recent speech, which we discussed in our blog. In his remarks, the Chief Accountant focused on ICFR, specifically mentioning:

 

“Having the requisite skills in the accounting and financial reporting area to make the many new, complex judgements required by these standards, and

 

Setting an appropriate tone at the top to assure these judgments are made in a reasonable, consistent and appropriate manner.”

 

To help us all deal with these challenges the Anti-Fraud Collaboration, a group made up of the Center For Audit Quality, FEI, NACD and IIA, has issued a report titled “Addressing Challenges for Highly Subjective and Complex Accounting Areas”.

 

This report is built on a foundation of detailed analysis of several SEC and PCAOB enforcement cases, a webcast and two workshops. The report has a robust discussion of several of the issues underlying these enforcement cases. One important conclusion drawn from this work is that a lack of controls surrounding subjective and complex accounting judgments is frequently a root cause underlying reporting problems. Based on this conclusion, the report includes a discussion of ways to help establish appropriate controls for such estimates and judgments. In fact, one of the enumerated objectives of the report is to:

 

“Facilitate a robust discussion about accounting policy, centering on highly subjective and complex accounting areas, and the design and operating effectiveness of ICFR”

In the report, there are several insights into ICFR issues surrounding complex judgments. For example:

 

Difficult Accounting Issues

 

Three accounting issues were problematic for companies under investigation: revenue recognition, loan impairment, and valuation. Both highly subjective and complex, these three areas were under stress during the financial crisis and therefore more prone to manipulation or error. The analysis of the AAERs also highlighted issues with the accounting policies pertaining to these areas. In the enforcement actions studied, the SEC cited that the companies either did not have an adequate accounting policy or procedure for the issue being investigated; the company was non-compliant with their existing policy or procedure; or that management acted to override the company’s accounting policy.

 

 

The report goes on to state:

 

For all members of the financial reporting supply chain, the importance of tone at the top cannot be overstated. In most cases of alleged financial fraud, the SEC names the CEO and/or the CFO in the complaint. Commission staff noted that the driver of earnings management—the catalyst for most fraud cases—is often top management, such that the focus on the CEO and CFO is not surprising. In cases the PCAOB has brought against individual auditors, it is usually the lead audit engagement partner or other senior members of an audit engagement team who are disciplined.

 

 

Hopefully, as you think about the design of ICFR over the new estimates and judgments required to implement the revenue recognition, lease and financial instrument impairment standards, you will find some helpful ideas in this report.

 

As always, your thoughts and comments are welcome!

 

 

The Move to The New Revenue Recognition Standard – Is the Pressure On?

By: George M. Wilson & Carol A. Stacey

 

Now that year-end is over for most calendar-year companies the transition to the new revenue recognition standard is a major focus area. In recent weeks there have been two interesting sources of comment and information about this transition.

 

First, on March 21, 2017 Chief Accountant Wesley Bricker spoke before the Annual Life Sciences Accounting & Reporting Congress in Philadelphia. (If you are thinking “that sounds familiar”, it was at this same conference a year ago that former Chief Accountant Jim Schnurr made some serious comments about the use of non-GAAP measures that previewed the May C&DI’s!).

 

In his remarks, Mr. Bricker focused on the transition to the new revenue recognition standard, saying:

 

“Let me now turn to implementation of the new revenue standard.  This area deserves close attention, both to make sure that the standard is implemented appropriately and timely and to ask whether the appropriate transition disclosures are being made so that investors and other market participants have sufficient time to absorb the anticipated effects of the new standard.

 

…………………………..

 

In the worrisome column, however, some companies need to make significant progress this year in their implementations.  In a survey of public companies released in October 2016, eight percent of respondents at that time had not started an initial assessment of the new revenue recognition standard, while an overwhelming majority of the others were still assessing the impact.

Particularly for companies where implementation is lagging, preparers, their audit committees and auditors should discuss the reasons why and provide informative disclosures to investors about the status so that investors can assess the implications of the information. Successful implementation requires companies to allocate sufficient resources and develop or engage appropriate financial reporting competencies.”

 

The second recent development is the release by Deloitte in a “Heads Up” newsletter in April 2017 of their most recent updated survey “Adopting the New Revenue Standard — Where Do Companies Stand?”

 

In the survey, Deloitte found that many companies that had originally contemplated using a full retrospective have moved more towards the modified retrospective method. And, along with the worries of the Chief Accountant above, they also found:

 

“Slightly more than half of respondents had started to implement the new standard, but most were in the very early phases of adoption.”

 

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

Jeepers – More Whistleblower Enforcement Cases? – Do We Have the Message Yet?

By: George M. Wilson & Carol A. Stacey

Just a few weeks ago we did the latest in a series of posts about the SEC’s Whistleblower program. That post focused on two significant enforcement cases where companies attempted to impede whistleblowers. For other posts in our whistleblower series, see:

Our post discussing the background of the SOX and Dodd/Frank whistleblower programs

Our post about the total amount being paid-out to whistleblowers exceeding $100,000,000 (It is even more today!)

Our post discussing a company having to pay a $500,000 fine for firing a whistleblower

SEEMS LIKE THE MESSAGE SHOULD BE CLEAR BY NOW! Don’t try to limit how employees can blow the whistle.

But, the Enforcement Division is not done!

In a case announced on January 17 a company paid a $650,000 fine for including language trying to restrict whistleblower rights in over 1,000 severance arrangements. After removing the language the company also voluntarily agreed to conduct annual training for employees about their whistleblowing rights.

In a case announced on January 21 the SEC found a company that actively searched for a whistleblower, to the point of essentially threatening employees. The reason for the hunt was clear, the treasurer and the company had manipulated information related to hedge accounting and was actively trying to hide the fact that certain hedging relationships were not effective. When the SEC began to ask questions about the issue, the company suspected someone had blown the whistle. The company tried to ferret out the whistleblower, compounding their offenses. The company and the treasurer both paid fines.

There is a very important reason for these cases. In many situations a fraud would go undetected if it were not for the conscience and courage of whistleblowers.

It would seem that the SEC is actively searching for more enforcement cases to make the point that it is illegal for a company to try and prevent or impede employees from blowing the whistle.

Not to be too preachy, and hopefully to be a bit practical, here are two thoughts:

For all of us who may see a need to blow the whistle, know that this is never easy, and know that you have rights and protections.

For companies, don’t try to hide problems and make sure any agreements surrounding employee departures don’t have these kinds of restrictions!

 

As always, your thoughts and comments are welcome!

Message From Enforcement: Metrics Matter!

Metrics, measures of performance drivers outside the financial statements, have become a larger part of how companies communicate with investors in recent years. As with all communication tools, a carefully planned, balanced presentation is important. Well-designed metrics can provide greater insight into the fundamentals of a company’s operations.

As with other elements of financial reporting, metrics can be misused. A metric could be poorly designed and not really correlate with financial performance. A metric could also be misstated or manipulated.

Poorly Designed Metrics

Many tech companies have complex and hard to understand revenue models. Measures such as “daily active users” and “monthly active users” can help users understand a company’s performance. That said, the link between the metric and performance needs to be clear. The CorpFin Staff has written many comments about this issue. Here are a couple of examples:

  1. In your various quarterly earnings calls, we note your discussion of the performance of your business in terms of the “add/quit metric” and “uniform wearer losses” (based upon changes in the number of uniform wearers within particular sectors of your customer base). We further note this is your fourth consecutive quarter of negative uniform wearer losses. Please expand your MD&A to include this information as well as a discussion of any trends or uncertainties. Additionally, the add/stop metric appears to have a meaningful impact on operating margins and growth rate. Please expand your disclosure to provide a complete picture of the relationship between the add/quit metric, operating margins, and growth rate for each material sector of your customer base. Please refer to Item 303(a)(3) of Regulation S-K and Section III.B.1. of SEC Release 33-8350.

 

  1. We note your statement that your results are highly dependent on comparable store sales. We further note that your comparable store sales have declined over the last three years and within each year have generally declined each quarter. We also note your statements that your comparable store sales are difficult to predict in the current competitive landscape and may get marginally worse before they get better. Given the importance of this metric to your results and its significant decline over the last three fiscal years, please tell us and disclose in more detail the factors that contributed to this decline, such as any significant declines in prices, including significant increases in your promotional activity, any significant declines in the volume of items sold, any change in the mix of products being sold or any other material factors that had a significant impact on the decline in your comparable store sales. While this decline in comparable store sales may ultimately be driven by your competitive environment, we believe a more detailed discussion of changes in intermediate factors such as price and volume will provide more transparency to your investors as to how you are affected by this competition, any steps management has taken to mitigate the impact of this competition and the success of management’s strategies. Refer to Item 303(a)(3)(iii) of Regulation S-K and SEC Release No. 33-8350.

 

Misstated Metrics and Enforcement

When companies present metrics, they should be very careful to use a balanced approach to the information and use the metric consistently to avoid presenting potentially misleading information. We discussed many of these issues in our One-Hour Briefing about Non-GAAP Measures and Metrics. You can find the briefing at:

 

www.pli.edu/Content/Non_GAAP_Measures_and_Metrics_Getting_it/_/N-1z10vnyZ4n?ID=282910

 

One really “old school” example metric would be the financial ratio gross margin. It is not a non-GAAP measure so long as it is computed using the revenues, cost of sales and gross margin lines on a company’s income statement. For retailers, it is a crucial measure of performance. Gross margin trend over time can have a significant impact on how investors view a retailer.

In a recent enforcement case the SEC fined a large outdoor products retailer and its CFO for manipulating their gross margin and then misstating why gross margin changed. The source of the issue was a fee the company charged to its wholly owned banking subsidiary. In the retailer’s financial statements the fee was used to reduce cost of sales and thus increase gross margin. Such a fee would normally be eliminated in consolidation. Here though, the company failed to eliminate this intercompany transaction. As a result, in the consolidated financial statements the net income of the financing part of the business was understated and the gross margin of the retailing part of the business was overstated. Additionally, the company did not disclose that this intercompany fee had increased their gross margin and actually attributed the increase to other causes.

 

Here is a quote from the enforcement order:

This in turn increased ——– merchandise gross margin percentage, a key company-specific financial metric that signaled the profitability of the company and was referenced by the company in earnings releases and analysts calls.

 

The end result: Enforcement!

And, a clear message, manipulating metrics can get a company into just as much trouble as manipulating the financial statements!

You can read the enforcement release at:

www.sec.gov/litigation/admin/2016/34-77717.pdf

 

As always, your thoughts and comments are welcome!

Known Trends and Self-Fulfilling Prophecies

Forewarning disclosures, the “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” are one of the topics we discuss occasionally in our blog posts. This MD&A disclosure can be very problematic because the information disclosed may alarm investors or make management nervous about creating a “self-fulfilling prophecy”.

We are always watching how companies deal with these issues, and here are two examples from both ends of the potential disclosure spectrum.

The first example, dealing with goodwill impairment, is from a company that has been in the news a lot lately, Yahoo. Along with all the issues they have dealt with involving their investment in Alibaba, Yahoo continues to work on building their core business. As part of this process in June of 2013 they acquired Tumblr, the blog-hosting website. The purchase price was $990 million and in connection with the acquisition Yahoo recorded $749 million in goodwill. (See note 4 about acquisitions in the consolidated F/S in the 2015 10-K)

Fast forward the acquisition to December 31, 2015 and in note 5 to the consolidated F/S dealing with impairments Yahoo says:

As identified above, in step one, in 2015, the carrying value of the U.S. & Canada, Europe, Tumblr and Latin America reporting units exceeded the estimated fair value. The Company completed an assessment of the implied fair value of these reporting units, which resulted in an impairment of all goodwill for the U.S. & Canada, Europe, and Latin America reporting units and a partial impairment for the Tumblr reporting unit. The Company recorded goodwill impairment charges of $3,692 million, $531 million, $230 million and $8 million, associated with the U.S. & Canada, Europe, Tumblr, and Latin America reporting units, respectively, for the year ended December 31, 2015. The impairments were a result of a combination of factors, including a sustained decrease in our market capitalization in fourth quarter of 2015 and lower estimated projected revenue and profitability in the near term.

 

So, from June 2013 to December 31, 2015 the $749 million in Tumblr related goodwill was reduced by $230 million. In the tech world, these things happen.

But what about the future? In an interesting spot, Critical Accounting Estimates in their 2015 10-K MD&A Yahoo included this statement:

Given the partial impairment recorded in our Tumblr reporting unit in 2015, it is reasonably possible that changes in judgments, assumptions and estimates we made in assessing the fair value of goodwill could cause us to consider some portion or all of the remaining goodwill of the Tumblr reporting unit to become impaired, which comprised $519 million of our remaining $808 million goodwill balance as of December 31, 2015. In addition, a future decline in market conditions and/or changes in our market share could negatively impact the estimated future cash flows and discount rates used in the income approach to determine the fair value of the reporting unit and could result in an impairment charge in the foreseeable future.

 

This is a direct warning, using the S-K words “reasonably possible”.

 

Here is the second example. These comments are from a letter to a retailing company, and you can see the SEC is asking whether the company effectively dealt with an uncertainty in their future:

  1. Please expand this section to discuss any known material trends, events or uncertainties that have had or are reasonably expected to have a material impact on your liquidity or revenues or income from continuing operations. In this regard, we note (i) persistent comparable store sales decreases in fiscal year 2014 and through the first three quarterly periods of 2015 and (ii) that the company has scaled back its previously planned strategic retail expansion for fiscal year 2016 and beyond.

We also note management’s concern, as expressed in recent earnings calls, regarding the cannibalization effect from new retail stores, coupled with softer than expected new store performances. Please discuss whether you expect comparable store sales to continue to decrease, due to continued cannibalization or otherwise, and the short and long-term actions that you are taking to address any perceived trends. In this regard, your discussion should address your past and future financial condition and results of operation, with particular emphasis on the prospects for the future. See Item 303(a) of Regulation S-K and SEC Release No. 33- 8350.

 

One really interesting part of this comment is how the staff went well beyond the company’s filings to information disclosed in earnings calls.

 

 

As always, your thoughts and comments are appreciated!