On December 6, 2023, SEC Chair Gary Gensler published a Statement noting that the SEC’s Fall Regulatory Agenda has been published. His Statement does not mention any specific projects. As you can read in the Agenda, the Climate Change Disclosure and Special Purpose Acquisition Company projects are both in the final rule stage, with expected final rules by April 2024. Human Capital Management disclosures are in the proposed rule stage.
As always, your thoughts and comments are welcome!
On December 4, 2023, SEC Chief Accountant Dr. Paul Munter issued a Statement titled “The Statement of Cash Flows: Improving the Quality of Cash Flow Information Provided to Investors.” In his introduction Dr. Munter notes:
“Unfortunately, we have observed that preparers and auditors may not always apply the same rigor and attention to the statement of cash flows as they do to other financial statements, which may impede high quality financial reporting for the benefit of investors.”
He also discusses the importance of cash flow information to investors and that the statement of cash flows has consistently been one of the higher frequency areas of restatements.
The statement addresses several statement of cash flow considerations including:
Dr. Munter’s conclusion makes the point:
“The statement of cash flows represents a critical piece of a complete picture of an issuer’s financial health and operations. Issuers and auditors have a responsibility, under securities laws and professional standards, to apply the same high level of care and professionalism to the preparation, review, and audit of the statement of cash flows as is required for the other financial statements.”
As always, your thoughts and comments are welcome!
As we discussed in this post, on November 22, 2023, the SEC postponed the effective date of its Share Repurchase Disclosure Modernization rule. The postponement was in the wake of an opinion by the U.S. Court of Appeals for the Fifth District in Chamber of Com. of the USA v SEC. Gary Brown of Nelson Mullins has written this Securities Alert exploring how companies should deal with the postponement, including the implications for issuer 10b5-1 plans.
As always, your thoughts and comments are welcome.
On November 22, 2023, the SEC postponed the effective date of its Share Repurchase Disclosure Modernization rule. The postponement was in the wake of an opinion by the U.S. Court of Appeals for the Fifth District in Chamber of Com. of the USA v SEC. You can read more in the SEC’s Announcement. The rule has been stayed pending further Commission action. Companies do not need to comply with the new rule at this time. It would have required daily share repurchase disclosures for the first full fiscal quarter that began on or after October 1, 2023.
As always, your thoughts and comments are welcome.
On September 25, 2023, the SEC announced a settled enforcement action against GTT Communications, Inc. GTT grew rapidly, primarily through acquisitions. This growth created challenges and disruption that eventually resulted in material problems in two of GTT’s key operational and reporting systems. The two systems were used to track elements of expenses, and over time they began reporting diverging amounts. Though the company tried, the systems could not be reconciled. As a result, the company could not reasonably determine amounts to record for certain expenses, including its cost of revenue (COR). Without solving this identified problem, company personnel made large, unsupported adjustments to its accounting records. When this situation came to light, the company commenced an internal investigation and ultimately filed this Item 4.02 Form 8-K to inform investors that its previously issued financial statements should not be relied upon.
It is difficult to appreciate the magnitude of GTT’s reporting problems. The company spent more than a year and tens of millions of dollars trying to build the information required to restate its financial statements. Ultimately, the company abandoned these efforts. It eventually filed for bankruptcy, emerging as a privately-owned company. Because the company’s historical records could not be reconstructed, upon emerging from bankruptcy, the company used fresh-start accounting.
Early in its process the company self-reported its problems to the SEC. It also “cooperated extensively with the SEC staff during its investigation.” The company’s remedial measures included “attempting to rebuild its COR accounts, replacing certain members of management, its board of directors, and its auditor, and overhauling its accounting function, including its policies and procedures relating to COR.”
The company entered into a cease-and-desist order, but as a result of self-reporting, cooperating and taking strong remedial steps, there was no monetary penalty against the company. You can read more in this Press Release and the related SEC Order.
This case presents a favorable outcome, but self-reporting and cooperation present several complex questions. When companies find a problem, they must consider whether to self-report, when to self-report, how to approach the staff, and what information to share. For an in-depth discussion of these and a number of related issues, you can listen to this episode of PLI’s inSecurities podcast. Host Kurt Wolf and Miller & Chevalier Partner Sandra Hanna discuss a variety of issues including considerations for self-reporting.
As always, your thoughts and comments are welcome.
On August 28, 2023, the SEC announced an Order of Suspension Pursuant to Rule 102(e) barring Peter Armbruster, CPA, former CFO of Roadrunner Transportation Systems, Inc. (“Roadrunner”), from appearing or practicing before the Commission. The bar was based on Armbruster’s 2021 conviction for committing:
He was sentenced to 24 months imprisonment in a federal penitentiary to be followed by one year of supervised release and ordered to pay restitution of $1,142,597.50. All of this, of course, in addition to his permanent bar from appearing before the SEC.
While this announcement about a single individual seems like a discrete event, a deeper look into the events at Roadrunner leading up to Armbruster’s bar provides insight into the dramatic costs and consequences of manipulating financial statements and reporting fraudulent information.
Roadrunner, a trucking and transportation company, had grown dramatically between 2010 and 2017, largely through acquisitions. As a NYSE listed company, there was pressure to show successful results from this strategy. Unfortunately, Roadrunner’s results were falling short of expectations, and this pressure caused people and the company to break financial reporting rules. The chronology of events and related consequences in this case are long and complicated.
January 30, 2017 – First Public Announcement
The first publicly disclosed information about financial reporting problems was this January 30, 2017 Form 8-K. In the Form 8-K, the company stated:
Item 4.02(a). Non-Reliance on Previously Issued Financial Statements or a Related Audit Report or Completed Interim Review
In November 2016, we were made aware of various potential accounting discrepancies at our Morgan Southern and Bruenger operating subsidiaries. In response, our Board of Directors immediately commenced an investigation of the discrepancies with the assistance of Greenberg Traurig, LLP, as outside counsel, and RubinBrown LLP, as forensic accountants. Our investigation into these discrepancies is still ongoing; however, based on the investigation to date, and as described in further detail below, we have identified various accounting errors that we currently estimate will require prior period adjustments to our results of operations of between $20 million and $25 million. These errors principally relate to unrecorded expenses from unreconciled balance sheet accounts including cash, driver and other receivables, and linehaul and other driver payables. As the investigation is ongoing, the estimated amount is preliminary and could change materially.
The Form 8-K also included details indicating that several years of financial statements would likely be restated.
March 29, 2017 – Termination of CFO
In this Form 8-K, filed on April 3, 2017, Roadrunner announced:
Item 5.02. Departure of Directors or Certain Officers; Election of Directors; Appointment of Certain Officers; Compensatory Arrangements of Certain Officers.
On March 29, 2017, Mr. Peter Armbruster was terminated from his positions as the Company’s principal financial officer and principal accounting officer.
Interestingly, just a few weeks earlier, on February 28, 2017, the CFO was included in the company’s incentive compensation plans announced in this Form 8-K.
January 31, 2018 – Form 10-K/A Filing
A year after the initial announcement Roadrunner filed a Form 10-K/A to restate several years of financial statements. In the Form 10-K/A, the company stated:
Restatement Background
In November 2016, we commenced an internal investigation into certain accounting discrepancies at our Morgan Southern and Bruenger operating companies. Subsequently, an independent internal investigation was undertaken by the Audit Committee of our Board of Directors (the “Audit Committee”), with assistance from outside counsel and outside consultants to provide forensic and investigative support (the “Audit Committee Investigation”). The expanded Audit Committee Investigation included detailed reviews of financial records at other operating companies and at our corporate headquarters. The Audit Committee Investigation identified material accounting errors that impacted substantially all financial statement line items and disclosures.
……
Based on the Audit Committee Investigation, current management determined that there were deficiencies in the design and/or execution of internal controls that constituted material weaknesses. Current management determined that structural and environmental factors, including the increased size and complexity arising from the acquisition of 25 non-public companies between February 2011 and September 2015, the inconsistency of our accounting systems, policies and procedures, and management override of internal controls contributed to the material weaknesses and resulting material accounting errors. Our internal controls failed to prevent or were overridden by management in certain instances to allow recording accounting entries without appropriate support, recording accounting entries that were inconsistent with information known by management at the time, not communicating relevant information within our organization and, in some cases, withholding information from our independent directors, our Audit Committee, and our independent auditors, which resulted in material accounting errors.
March 12, 2018 – Consolidated Amended Class Action Complaint Filed
As expected in cases like this, class action litigation resulted. You can find a detailed list of developments at Roadrunner and related assertions by the plaintiffs in this Consolidated Amended Class Action Complaint. The time and costs involved in this kind of litigation are substantial.
April 1, 2019 – Stipulation and Agreement of Settlement Filed for Class Action Litigation
In a step towards ending the class action litigation, plaintiffs and defendants entered into this Stipulation and Agreement of Settlement. As you review the details you will find the amount of the Settlement was $20 Million. There were several steps in the process to have the agreement approved by the court. The company announced preliminary approval on this June 26, 2019 Form 8-K.
April 6, 2020 – Roadrunner Delists from the NYSE and Withdraws its 1934 Act Registration
On April 6, 2020, Roadrunner filed a Form 25 to end its listing on the NYSE, and on April 17, 2020, the company filed a Form 15-12B to terminate its 1934 Act registration.
February 14, 2023 – SEC Announces Cease and Desist Order Against Roadrunner
As you can read in this AAER, the company entered into a Cease and Desist Order with the SEC in February 2023, well after the end of its 1934 Act registration. The Order includes a summary of the various accounting misstatements that impacted the company’s reported results. Interestingly, the settlement that Roadrunner paid in the related class action litigation was deemed to satisfy the SEC’s disgorgement principles.
August 28, 2023 – Former CFO Is Barred by the SEC
As described above and as you can read in this AAER, the former CFO, based on his conviction, was barred from SEC practice.
September 7, 2023 – Former Segment Controller and Director of Accounting Barred by the SEC
As you can read in this AAER, a former controller of the Truckload Logistics segment of Roadrunner was also barred by the SEC.
In addition, as you can read in this AAER, the Director of Accounting for Truckload was also barred.
These cases, if we are drawn into them, have a long and complex path with dramatic costs, financial and otherwise, for individuals and companies. The above summary does not include several officer and director changes, including two CFO changes. Nor does it include the details of how the company ended up delisting and going dark, or a settled action against a former officer for insider trading charges during the period of the financial reporting fraud.
As always, your thoughts and comments are welcome.
On August 25, 2023, Chief Accountant Dr. Paul Munter issued a Statement titled “The Importance of a Comprehensive Risk Assessment by Auditors and Management.” The Statement begins:
“Management’s and auditors’ risk assessment processes are critical to the decisions regarding financial reporting and the effectiveness of internal control over financial reporting (ICFR). Accordingly, we are troubled by instances in which management and auditors appear too narrowly focused on information and risks that directly impact financial reporting, while disregarding broader, entity-level issues that may also impact financial reporting and internal controls.”
Dr. Munter’s Statement addresses several risk assessment issues, including changing business risks, the importance of professional skepticism for auditors, and internal control issues that may be outside of direct financial reporting objectives. These issues in many ways involve entity-level controls and dovetail nicely with a culture assessment tool from the Anti-Fraud Collaboration titled “Assessing Corporate Culture: A Proactive Approach to Deter Misconduct.” The Anti-Fraud Collaboration is comprised of The Center for Audit Quality, Financial Executives International, The Institute of Internal Auditors, and the National Association of Corporate Directors.
In the executive summary of the assessment tool, the group makes this important point:
“When a corporate scandal occurs and stakeholders seek reasons and root causes, the trail often leads back to problems with the organization’s culture. Financial statement fraud is one extreme example of a consequence of a weak ethical culture, while a strong ethical culture can mitigate the risks of fraud…”
When a material financial reporting fraud occurs, very rarely is it the result of only a process level control problem. More often it is the result of material weaknesses in entity-level controls within the control environment that allow process level and other controls to be overridden or otherwise circumvented by persons who can abuse authority within a culture.
A real-world example of this type of weakness is discussed in Roadrunner Transportation Systems’ Form 10-K for 2017, which was issued shortly after a material restatement. These excerpts from Roadrunner’s ICFR report focus on entity-level control weaknesses:
Management’s Report on Internal Control Over Financial Reporting
Management, including our CEO and CFO, is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act and based upon the criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO framework”)). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of our financial statements for external purposes in accordance with GAAP.
……..
Based on evaluation under these criteria, management determined, based upon the existence of the material weaknesses described below, that we did not maintain effective internal control over financial reporting as of the Evaluation Date.
Control Environment
We did not maintain an effective control environment based on the criteria established in the COSO framework. We have identified deficiencies in the principles associated with the control environment of the COSO framework. Specifically, these control deficiencies constitute material weaknesses, either individually or in the aggregate, relating to: (i) our commitment to integrity and ethical values, (ii) the ability of our board of directors to effectively exercise oversight of the development and performance of internal control, as a result of failure to communicate relevant information within our organization and, in some cases, withholding information, (iii) appropriate organizational structure, reporting lines, and authority and responsibilities in pursuit of objectives, (iv) our commitment to attract, develop, and retain competent individuals, and (v) holding individuals accountable for their internal control related responsibilities.
We did not maintain an effective control environment to enable the identification and mitigation of risks of material accounting errors as result of the contributing factors to the material weaknesses in the control environment, including:
| • | The tone from former executive management was insufficient to create the proper environment for effective internal control over financial reporting and to ensure that (i) there were adequate processes for oversight, (ii) there was accountability for the performance of internal control over financial reporting responsibilities, (iii) identified issues and concerns were raised to appropriate levels within our organization, (iv) corrective activities were appropriately applied, prioritized, and implemented in a timely manner, and (v) relevant information was communicated within our organization and not withheld from our independent directors, our Audit Committee, and our independent auditors. |
| • | Our oversight processes and procedures that guide individuals in applying internal control over financial reporting were not adequate in preventing or detecting material accounting errors, or omissions due to inadequate information and, in certain instances, management override of internal controls, including recording improper accounting entries, recording accounting entries that were inconsistent with information known by management at the time, not communicating relevant information within our organization and, in some cases, withholding information from our independent directors, our Audit Committee, and our independent auditors. |
Risk Assessment
We did not design and implement an effective risk assessment based on the criteria established in the COSO framework. We have identified deficiencies in the principles associated with the risk assessment component of the COSO framework. Specifically, these control deficiencies constitute material weaknesses, either individually or in the aggregate, relating to: (i) identifying, assessing, and communicating appropriate objectives, (ii) identifying and analyzing risks to achieve these objectives, (iii) contemplating fraud risks, and (iv) identifying and assessing changes in the business that could impact our system of internal controls.
For auditors, it is particularly important to remember that evaluating entity-level controls is required as part of an audit of ICFR. AS 2201 paragraph 25 states:
Control Environment. Because of its importance to effective internal control over financial reporting, the auditor must evaluate the control environment at the company. As part of evaluating the control environment, the auditor should assess –
The points made in the Anti-Fraud Collaboration document, the example above from Roadrunner Transportation and the guidance from AS 2201 dovetail with the points made in Dr. Munter’s Statement. In his conclusion, he makes this point:
“When business risks change, a robust, iterative risk assessment process and strong entity and process-level controls are essential to transparent and high-quality financial reporting. Auditors in their public gatekeeper role serve as an independent check on management’s performance of these critical functions and should transparently communicate with investors in accordance with PCAOB standards.”
As always, your thoughts and comments are welcome.
On September 27, 2023, CorpFin issued ten new Compliance and Disclosure Interpretations (C&DIs) addressing questions about Pay versus Performance (PvP) disclosures and the use of non-GAAP measures in executive compensation disclosures.
The nine new PvP C&DIs address a number of technical issues such as the treatment of pre-IPO equity awards in periods after a company’s IPO, vesting considerations for awards with market conditions, and how to treat awards that vest because the holder becomes retirement eligible.
The one new executive compensation C&DI addresses an exception to non-GAAP measure disclosure requirements when a non-GAAP measure is included as a target in S-K Item 402 disclosures. It clarifies that a non-GAAP measure disclosed in executive compensation disclosures that does not relate to target levels is subject to the non-GAAP disclosure requirements in Regulation G and S-K Item 10(e).
As always, your thoughts and comments are welcome.
We’d like to again remind our readers that Form 12b-25 is not an automatic extension for quarterly and annual reports. In a prior blog post, we discussed an enforcement sweep in which eight companies paid fines for failing to disclose “anticipated restatements” in Form 12b-25.
On August 22, 2023, the SEC announced another sweep that caught five companies for exactly the same issue, failing to disclose “anticipated restatements.” These companies restated their financial statements within three to twenty-one days after filing Form 12b-25.
As a reminder, Part III of Form 12b-25 includes this instruction:
State below in reasonable detail why Forms 10-K, 20-F, 11-K, 10-Q, 10-D, N-CEN, N-CSR, or the transition report or portion thereof, could not be filed within the prescribed time period.
(Attach extra Sheets if Needed)
As always, your thoughts and comments are welcome!
We’d like to again remind our readers that Form 12b-25 is not an automatic extension for quarterly and annual reports. In a prior blog post, we discussed an enforcement sweep in which eight companies paid fines for failing to disclose “anticipated restatements” in Form 12b-25.
On August 22, 2023, the SEC announced another sweep that caught five companies for exactly the same issue, failing to disclose “anticipated restatements.” These companies restated their financial statements within three to twenty-one days after filing Form 12b-25.
As a reminder, Part III of Form 12b-25 includes this instruction:
State below in reasonable detail why Forms 10-K, 20-F, 11-K, 10-Q, 10-D, N-CEN, N-CSR, or the transition report or portion thereof, could not be filed within the prescribed time period.
(Attach extra Sheets if Needed)
As always, your thoughts and comments are welcome!