All posts by George Wilson

CorpFin Addresses Universal Proxy Questions

The SEC’s November 2021 adoption of universal proxy rules was expected to create detailed questions related to their use.  As a reminder, universal proxy cards allow shareholders to vote in the same way they could if they voted in person at a meeting.  To make this possible, a universal proxy includes all duly nominated persons from all parties on the same card.  This allows shareholders to select candidates from different slates as they vote on the universal proxy card.

On December 6, 2022, CorpFin issued three Compliance and Disclosure Interpretations (C&DIs) addressing questions concerning dissident shareholder nominations and universal proxy cards.  You can find the three new C&DIs here.

As always, your thoughts and comments are welcome!

Fraud – A Forewarning Message from the Chief Accountant?

Financial reporting frauds have historically occurred in waves and sometimes in tidal waves as in the period of Enron, Worldcom, Tyco, Adelphia, Quest, etc.  When economic times turn challenging or become uncertain, fraud frequently increases.

Given the time since a major wave of financial reporting frauds and the current economic environment, it may not be a coincidence that Paul Munter, the SEC’s Chief Accountant, released a Statement titled “The Auditor’s Responsibility for Fraud Detection” on October 11, 2022.  (At that time Mr. Munter was Acting Chief Accountant.)

In the Statement, Mr. Munter focuses on the auditor’s gatekeeper responsibilities as they relate to financial statement fraud.  The Statement discusses detailed considerations in a number of areas, including the auditor’s role and responsibilities; the importance of a strong system of quality controls, risk assessment and responses; and good practices.

Mr. Munter’s Statement begins with an important reminder about the nature of the auditor’s role:

“Auditors must plan and perform an audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud.”

In addition, the Statement highlights that:

“The PCAOB auditing standards further require auditors to exercise due professional care, which requires the auditor to exercise appropriate levels of professional skepticism [emphasis added] throughout the audit.”

With respect to the auditor’s responsibility, after noting several auditing standards that include fraud considerations, Mr. Munter goes on to say:

“We emphasize that the auditor’s risk assessment and use of the fraud lens is a continual and iterative process that continues until the issuance of the audit report.”

The Statement includes an important point concerning an auditor’s quality control system, which is that budget, time, and other kinds of pressure could distract an auditor from appropriately identifying fraud risk.

In his discussion of risk assessment and responses, Mr. Munter emphasizes the importance of professional skepticism, noting:

“For instance, the mindset of ‘trust but verify’ may represent potential bias if it is anchored in the belief that management is honest and has integrity. Such a mindset may interfere with an auditor’s ability to effectively evaluate signs of fraud when evaluating misstatements or to objectively challenge evidence provided by management.”

With respect to appropriate “good practices,” the Statement notes that examples of fraud risk factors in the auditing literature should not be considered a checklist.  Rather, they should inform the process of building a tailored list of fraud risk factors for each engagement.

This “early warning” Statement, which addresses many other important fraud related issues, is likely based on a desire to get out in front of any incentives that could result in increases in fraud in coming periods.  It may also inform parts of the PCAOB inspection process.  Auditors and companies should begin incorporating its points in their year-end planning now.

As always, your thoughts and comments are welcome!

More About CorpFin’s Updated Non-GAAP Measures

As we mentioned in this post, on December 13, 2022, the SEC updated several non-GAAP Compliance and Disclosure Interpretations.  One of the updates relates to a frequent comment area, the use of “tailored accounting principles.”  This can be a complex issue:

Question 100.04

Question: Can a non-GAAP measure violate Rule 100(b) of Regulation G if the recognition and measurement principles used to calculate the measure are inconsistent with GAAP?

Answer: Yes. By definition, a non-GAAP measure excludes or includes amounts from the most directly comparable GAAP measure. However, non-GAAP adjustments that have the effect of changing the recognition and measurement principles required to be applied in accordance with GAAP would be considered individually tailored and may cause the presentation of a non-GAAP measure to be misleading. Examples the staff may consider to be misleading include, but are not limited to:

  • changing the pattern of recognition, such as including an adjustment in a non-GAAP performance measure to accelerate revenue recognized ratably over time in accordance with GAAP as though revenue was earned when customers were billed;
  • presenting a non-GAAP measure of revenue that deducts transaction costs as if the company acted as an agent in the transaction, when gross presentation as a principal is required by GAAP, or the inverse, presenting a measure of revenue on a gross basis when net presentation is required by GAAP; and
  • changing the basis of accounting for revenue or expenses in a non-GAAP performance measure from an accrual basis in accordance with GAAP to a cash basis. [December 13, 2022]

As an example, consider this disclosure in an S-4 by Bowlero Corp. that reconciles from net income to adjusted EBITDA.  In particular, look at the adjustment to rent expense.

In its description of the “Contra rent expense” adjustment, the company said:

Represents Net income (Loss) before Interest, Income Taxes, Depreciation and Amortization, …… with Contra Rent Expense accounting for Rent on a cash basis (Cash Rent Expense).

This generated the following SEC comment:

    1. We note the adjustment Contra Rent Expense which you state is accounting for rent on a cash basis. Please further clarify for us in further detail how this adjustment is calculated. Additionally, please tell us how this adjustment complies with Question 100.04 of the Staff’s Compliance and Disclosure Interpretations on Non-GAAP Financial Measures.

After an initial response and this follow-up comment, the company removed the “Contra rent expense adjustment” from adjusted EBITDA:

  1. We note your response to our prior comment number 22. You state that “Contra rent expense is an adjustment to report rent expense on a cash basis.” By making this adjustment you are substituting an individually tailored recognition and measurement method to record rent expense instead of GAAP rent expense which is prohibited by Question 100.04 of the Staff’s Compliance and Disclosure Interpretations on Non- GAAP Financial Measures. Accordingly, please revise to remove this adjustment.

As always, your thoughts and comments are welcome!

Check Out the SEC’s Fall 2022 Reg Flex Agenda

On January 4, 2023, the U.S. Office of Information and Regulatory Affairs released the SEC’s Fall Reg Flex Agenda.  The agenda addresses many issues, including Human Capital Management Disclosures (Proposed Rule Stage), Cybersecurity Risk Governance (Final Rule Stage), and Climate Change Disclosure (Final Rule Stage).

In a Statement on the agenda, Chair Gary Gensler said:

“I support this agenda as it reflects the need to modernize our ruleset, moving deliberately to update our rules in light of ever-changing technologies and business models in the securities markets. Our ability to meet our mission depends on having an up-to-date rulebook—consistent with our mandate from Congress, guided by economic analysis, and shaped by public input.”

As always, your thoughts and comments are welcome!

A Pay Versus Performance Template from Gary M. Brown of Nelson Mullins

The SEC’s Dodd-Frank “pay versus performance” final rule raised a number of overall and detailed implementation questions.  To help companies as they build these disclosures, Gary M. Brown of Nelson Mullins Riley & Scarborough LLP, and a frequent SEC Institute workshop leader, has built a very helpful implementation template.  You can find the template here.

In addition, on January 5, 2023, Mr. Brown and SEC Institute Director George M. Wilson will present a One-Hour Briefing,  Finished Business – The SEC’s New Pay Versus Performance and Clawback Rules, to provide insights and guidance for companies as they implement these complex new requirements.

As always, your thoughts and comments are welcome!

PCAOB Previews 2021 Inspection Observations

On December 8, 2022, the PCAOB issued a report titled “Staff Update and Preview of 2021 Inspection Observations”.  The report shows an increase in the number of audits with deficiencies at audit firms inspected in 2021.  The report indicates that many of the areas that have historically been the source of audit deficiencies continue to be problematic.  These include ICFR audit areas such as testing controls with a review element and identifying controls to test, and financial statement audit areas such as revenue recognition and inventory.  In addition, deficiencies related to the reporting of critical audit matters increased in 2021 inspections.

You can read more in this News Release and the staff report.

As always, your thoughts and comments are welcome!

CorpFin Updates Non-GAAP Compliance and Disclosure Interpretations

On December 13, 2022, just in time for the holidays, CorpFin updated several non-GAAP measure Compliance and Disclosure Interpretations.  You can find the CorpFin announcement here and the updated C&DIs here.  C&DI Questions 100.01, 100.04 – 100.06, and 102.10(a)(b)(c) were updated.  All companies that use non-GAAP measures should review these updates.

As an example, the old language of C&DI 100.01 read:

Question 100.01

Question: Can certain adjustments, although not explicitly prohibited, result in a non-GAAP measure that is misleading?

Answer: Yes. Certain adjustments may violate Rule 100(b) of Regulation G because they cause the presentation of the non-GAAP measure to be misleading. For example, presenting a performance measure that excludes normal, recurring, cash operating expenses necessary to operate a registrant’s business could be misleading. [May 17, 2016]

The update expands the discussion of what might make an adjustment misleading.  The changed language is in bold below:

Question 100.01

Question: Can certain adjustments, although not explicitly prohibited, result in a non-GAAP measure that is misleading?

Answer: Yes. Certain adjustments may violate Rule 100(b) of Regulation G because they cause the presentation of the non-GAAP measure to be misleading. Whether or not an adjustment results in a misleading non-GAAP measure depends on a company’s individual facts and circumstances.

Presenting a non-GAAP performance measure that excludes normal, recurring, cash operating expenses necessary to operate a registrant’s business is one example of a measure that could be misleading.

When evaluating what is a normal, operating expense, the staff considers the nature and effect of the non-GAAP adjustment and how it relates to the company’s operations, revenue generating activities, business strategy, industry and regulatory environment.

The staff would view an operating expense that occurs repeatedly or occasionally, including at irregular intervals, as recurring. [December 13, 2022]

As always, your thoughts and comments are welcome!

SEC Enforcement Division Announces Fiscal Year 2022 Results

On November 15, 2022, the SEC Enforcement Division issued a press release announcing its fiscal year 2022 results.  As it did last year, the Commission again used this simpler release rather than a glossy annual report.  Highlights for the year include:

    • Money ordered in SEC actions in f/y 2022 actions totaled $6.439 billion, a significant increase over $3.852 billion for f/y 2021,
    • The Division filed 760 enforcement actions in 2022, an increase of 9 percent over the prior year, and
    • Actions included 169 “follow-on” cases to bar or suspend individuals.

You can read more details, including the SEC’s focus on individual accountability, along with commentary by SEC Chair Gary Gensler in this Press Release and accompanying addendum.

If you would like to hear a deeper discussion of the Enforcement Division’s report, you can check out this episode of our inSecurities Podcast where co-hosts Chris Ekimoff and Kurt Wolfe delve into the report with a number of experts and former inSecurities guests.  And, if you would like a deeper dive into accounting-related enforcement issues and the role of the Enforcement Division’s Chief Accountant, check out this episode of inSecurities where Chris and Kurt discuss these issues along with the auditor’s responsibility for identifying fraud with Matt Jacques, a former Chief Accountant for the SEC’s Enforcement Division.

As always, your thoughts and comments are welcome!

PCAOB Proposes New Audit Firm Quality Control Standards

On November 18, 2022, the PCAOB issued a proposed auditing standard designed to modernize and improve audit firm quality control standards.  The current standards were developed by the AICPA and were part of the interim standards adopted at the time the PCAOB was originally formed in 2002.

The proposed standards incorporate feedback from advisory groups and a 2019 concept release.   According to the PCAOB’s News Release, the proposed quality control standards are “grounded in proactively identifying and managing risks to quality, with a feedback loop from ongoing monitoring and remediation designed to drive continuous improvement.”  In addition, the proposed standards would require that firms annually evaluate their quality control system and report the results on a new Form QC.

The Board has asked for comments by February 1, 2023.

As always, your thoughts and comments are welcome!