Category Archives: Uncategorized

About That “In Like a Lion” Thing…

In an earlier post Carol and George talked about the SEC Enforcement Division ramping up its activities and focusing on financial reporting fraud.  And, sure enough, on March 11, 2014 the SEC announced their latest financial reporting fraud enforcement.  We could make a bad joke about the SEC going “hog wild” with this one, but we won’t!  The company involved, AgFeed, which is a hog raising and selling company, committed what the SEC calls a “massive accounting fraud”.  The areas where fraud was found were the “usual suspects”, primarily revenue recognition.  (Being and agricultural company, the fraud areas were really interesting, including things like saying hogs for sale were fatter than they really were.)  And, adding a bit of intrigue to the fraud and the related enforcement, the bulk of the company’s operations are in China.

So, you might be tempted to say, well, this is just another typical fraud, similar to the accounting fraud cases we have seen historically.

But, when you read into the case, there turns out to be a lot more going on, and a lot more to learn.  While the company’s operations were primarily in China, they also had US operations, and the Chair of the audit committee and CFO were in the US.

One of the key aspects of this enforcement action is that the audit committee chair and the CFO became aware of several “red flags” about the company’s reporting in China, including the classic “we keep two sets of books” situation.  When they became aware of the “red flags”, as “gatekeepers”, they have a serious responsibility, which is where they fell down and where the SEC makes one of the key point in the enforcement action.

The real lesson of this case is seeing what the US based audit committee chair and CFO did.  What they did was essentially try to keep it all internal.  As gatekeepers, they failed in their responsibility.  According to the enforcement press release, the audit committee chair actually consulted with others who told him that there was “not just smoke but fire” and instead of taking action, “ignored the recommendation and internalized the situation while false financial reporting continued”.

In the words of Andrew J. Ceresney, director of the SEC’s Division of Enforcement,  “This is a cautionary tale of what happens when an audit committee chair fails to perform his gatekeeper function in the face of massive red flags.”

This is the lesson.  We are all gatekeepers.  And, as the SEC’s Enforcement Division ramps up its focus on financial reporting fraud, starts to use “Robocop” and charters its special task force for financial reporting fraud, we all need to remember our roles as gatekeepers.

Even accountants in staff rolls have this responsibility.  The Mckesson case, where a revenue recognition director of contract accounting was enforced against and lost her license for not challenging her supervisors clearly inappropriate instructions to record revenue is another clear example of the responsibility we all have.  For the lesson check out:

http://www.sec.gov/litigation/admin/34-45588.htm

and

http://www.sec.gov/litigation/litreleases/lr17189.htm

According to the enforcement division, the analyst, “a former Certified Public Accountant and former Manager of Contract Accounting at HBOC, also participated in the fraud by abdicating her gatekeeper role over the recording of software revenue when she repeatedly booked revenue on contracts where she knew it was improper to do so.”

So, lets stay away from the lion!

In Like a Lion, Out Like a…?

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Are you tired of the winter weather we have been dealing with?  New Hampshire, where Carol resides, and Minnesota, where George resides, have not had so much snow in years, and the cold has been relentless.   Even Atlanta has had its share of crazy winter weather, although as Northerners, we are amazed to see what snow does to that city.

Now that we are finally done with January and into mid-February, perhaps we can begin to believe that winter will eventually end.  As we go from February to March, hopefully into the last phases of this extreme winter, we are thinking about an old saying about March – “In like a lion, out like a lamb.”  With luck this old saw will be true this year and a wintery early March might give way to a warmer, almost spring like late March.

How does all this relate to SEC reporting?  Well, the SEC Enforcement Division has definitely come in this year like a lion.  There have been several high-profile cases and campaigns in the enforcement division.

One of our favorite programs even has a cool name, “Operation Shell-Expel.”  This program suspended trading in 255 dormant shell companies.  We are often asked about the viability of using shell company reverse mergers as a means of becoming a public company and our advice is – beware, shell companies are easy tools of market fraud, and their registrations are not often clean.  The SEC’s press release calls them “ripe for abuse in the over-the-counter markets.”  You can read all about it at:

http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370540714936

In another action earlier this February the enforcement staff moved against 20 “purported” mining companies, all alleged to be including false information in registration statements.  Interestingly, all of them were also apparently connected to an individual who had been the subject of an earlier enforcement action and who is suspended from practice before the SEC.  You can read about this one at:

http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370540716442

In January the SEC settled a case with KPMG involving auditor independence and other issues, a lesson for registrants and their audit committees, in addition to audit firms.  The settlement involved a large fine, and details are at:

http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370540667080

And, of course, insider trading cases continue to be a major focus of the enforcement division, with several big wins in recent years.  The latest is the conviction of Mathew Martoma, the eighth win by the SEC and DOJ against former SAC Capital employees.  Mr. Martoma faces prison for his actions.

As a last “in like a lion” thought, and as a cheap tie to a new movie, don’t forget the SEC’s new Financial Reporting and Audit Task Force.  This group, one of the prime users of the technology-based tools such as the “Accounting Quality Model,” or the SEC’s RoboCop tool, is already watching reporting carefully.

You can read about the Accounting Quality Model at:

http://www.sec.gov/News/Speech/Detail/Speech/1365171491988

So, while hopefully March comes in like a lion and goes out like a lamb, I suspect this year the enforcement division which has already come in like a lion, will also go out like a lion!

Carol Stacey and George Wilson,

Directors of The SEC Institute, a Division of Practising Law Institute®

 

‘Round and ‘Round the Auditor Rotation Circle

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Do you ever feel like our profession goes around in circles with the issues we face?  We talk about a major issue, it creates all kinds of sound and fury, it goes away for a while and then returns?  The SEC’s consideration of IFRS for domestic issuers is an issue that has been “going around” for years.    The FASB’s projects on leases, financial instruments, and revenue recognition are not the first time the board has addressed these areas.

I think one of the theme songs of our profession could be Joni Mitchell’s “Circle Game”:

“We can’t return, we can only look behind from where we came, and go round and round and round in the circle game”

(BTW, here is a great youtube video of her performing the song live: http://www.youtube.com/watch?v=AbIuC9hTY9Y&feature=kp )

I think the number of times an issue goes around this circle is directly related to complexity and the level of controversy it creates.

One hugely controversial and complex issue which many hope will move to the low end of the cycle is mandatory auditor rotation.

The PCAOB moved auditor rotation to the high end of the cycle back in August of 2011 with its Concept Release on Auditor Independence and Audit Firm Rotation.  While it was only a concept release it stirred enormous discussion and controversy.  Congress even got involved with the House passing a bill, although no Senate action occurred.

We have all been going round and round the auditor rotation circle.

As we come around the circle this month, the latest news on this front is that in the SEC’s hearings about the PCAOB’s budget last Thursday, in response to a question from Commissioner Gallagher, PCAOB chairman James Doty told the SEC:

“We don’t have an active project or work going on within the board to move forward on a term limit for auditors or mandatory rotation project.  It is not part of the budget – not budgeted in what you are approving today.”

However, Doty added, the PCAOB would “continue to think about what impacts independence.”

(BTW, you can listen to the recorded video webcast at: http://www.sec.gov/news/openmeetings/2014/020514openmeeting.shtml It is entertaining and suspenseful as, …, well, I am not sure what, but you should try it once!)

Perhaps this means that for the time being we will not be seeing any action on this front, at least for a while!

I suppose that this is not the last time this issue will come around.  As you may have heard, the EU is moving forward with a rotation proposal.

Considering how all this works, maybe the theme song should be “The Wheels on the Bus go Round and Round….”

Where Is My Flying Car and My New Revenue Recognition Standard? A Few Heads-Up Issues

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Many years ago, when I was a young boy (and yes, this was MANY years ago), I watched a TV show called The Jetsons.  The show featured a family in the future, and one of the coolest things about them was that their car flew!  I assumed that by the time the 21st Century started, we would all have flying cars!  Well, I am still waiting, and kind of disappointed. Seriously, every time I am stuck in traffic I ask, “Where is my flying car?”

As challenging as the flying car wait has been, I am not sure if the wait for the FASB and IASB’s new revenue recognition standard has been any easier!  We have seen this project on the FASB’s agenda for over a decade, and I have to say, as an accounting geek, I am not sure which I am really more excited about, this new standard, or my flying car…

It is understandable why this new standard is taking so long.  The scope of the project is immense and the challenge of finding a model that applies to all types and forms of revenue is enormous.  And in the end, we will all likely be very glad that this project has been done without undue rush and with due care.

Thankfully, with the effective date of periods beginning after December 15, 2016 for public companies (periods beginning after December 15, 2017 for private companies), we will have time to plan and implement the new standard.

So, here are a few heads-up issues to think about as we wait for the final standard to be issued sometime soon!

1.  A key point to see is that this guidance supersedes virtually all existing revenue recognition guidance, including software and percentage of completion revenue recognition standards in effect today.  The new five-step contract-based model will require all companies to analyze whether and how the new standard will affect your revenue recognition.

2.  Even if the new standard does not change much about the way you recognize revenue, it will affect you.  Implementing the new disclosures will require significant work, and given the SEC’s focus on revenue disclosures, disaggregation of revenues and MD&A disclosures about revenues, both the notes to the financial statements and MD&A will be affected.

3.  For counsel, the form of revenue related contracts might need to be revised to better fit into the five-step contact based mode in the standard.

4.  We will all be learning a lot as discussion of the new standard evolves, and the FASB/IASB task force to deal with implementation issues will be a process to watch.

So, watch for the excitement of the new standard.  Our workshops and conferences to help you deal with it will be announced soon.  And, let’s hope for news on the flying car front soon also!