Pictured, left to right: Charles Wright, Norman Strauss, Wesley Bricker, and Kyle Moffatt

Photos by E. Lee White

Bricker began the panel by showing the audience an introductory video on the role of the various organizations that make up the U.S. financial reporting structure. He then moved on to current topics within the Office of the Chief Accountant (OCA), beginning with the effects of the Tax Cuts and Jobs Act of 2017 (TCJA) on financial reporting. The new tax laws will lead to disclosure changes, he said, and guidance (such as Staff Accounting Bulletin 118) has been published to help companies organize their efforts. “Our expectation is that companies continue to apply a good faith effort in resolving the uncertainty associated with preparing disclosures associated with income tax effects,” he said. “We would anticipate disclosure changes from quarter to quarter as management continues to make progress.”

Bricker then moved on to revenue recognition, where he urged companies to pay particular attention to their disclosure packages. “The disclosures should identify both the accounting policies as well as the critical judgments and assumptions that went into applying the standard and the effect on contracts with customers,” he said, adding that consultation with the SEC is available for companies with unresolved questions. He also noted that the same is true for the leasing standard, which “should be front and center for companies as well as audit firms.”

Regarding these standards and the new credit losses standard, Bricker emphasized that “it’s important to describe what the company knows about the anticipated effect of adoption. Don’t say more than you know, don’t say less than you know, but the guidance expectations around SAB 74 are applicable.” Moffatt added that the disclosures should be updated as companies’ expectations change.

Moving on to audit topics, Bricker touched on the PCAOB’s new auditor reporting model, which expands the disclosures required of auditors as part of their attestation to the accuracy of financial statements. “This is a year for dry runs,” Bricker said, highlighting the opportunity for audit committees to test their approaches to the new model before implementation. He also addressed audit committee oversight, saying that committee members need to have the proper training to understand and make judgments on the material being reported on, especially in smaller companies.

Bricker also said that users should keep in mind that “audit tenure is simply a reference point. It doesn’t convey whether in a short-tenured relationship you’re getting a quality audit. It also doesn’t convey in a long-tenured relationship that you’re getting a good audit. It’s just a reference point for the audit committee, ultimately, in exercising their oversight of the selection, the retention and ultimately the compensation of the auditor.”

Bricker also stressed the importance of internal controls. “I’m very pleased the amount of dialogue among companies about what good controls look like,” he said. “It enhances the quality of understanding of what good controls look like, and ultimately lowers the cost associated with maintaining internal controls.” He also briefly discussed technology and cybersecurity, noting that “our expectations for quality are not varied, even when the terminology of capital raising changes.” Moffatt added that the SEC has issued recent guidance on cybersecurity disclosure.

Finally, Bricker briefly spoke about the existing guidance on mutual fund reporting, saying, “There’s an opportunity to take a fresh look at our rules to make sure that they incorporate our best and latest thinking.” He also urged audience members to share their input on the SEC’s rulemaking proposal on auditor independence, which had been issued the day before.

Revenue Recognition and Corporate Reporting

Moffatt then shared the perspective of the Division of Corporation Finance (DCF) on these and other financial reporting matters. He began with saying that DCF has received numerous questions about adjustments for the impact of the TCJA. “Primarily questions asking if certain things can be done to adjust for the impact of the act. Certainly we’d expect that companies are going to show the impact,” he said, adding, “I’m not sure it will result in a lot of comments unless there was something that we viewed to be misleading or would run afoul of our guidance.” One area of concern, he noted, would be instances where companies adjust for one impact of the TCJA, but not others. He also cautioned against applying to the new 21% corporate tax rate to prior period results in a non-GAAP or pro forma assessment, a question both he and Bricker have actually received. “We’d have significant concerns with that approach,” Moffatt said.

Turning to the revenue recognition standard, Moffatt acknowledged that the transition was causing “a lot of frustration” among corporate directors. “The implementation of a new standard to them was really a pain and it was a significant cost burden, not just all the time it took, the cost, the systems to put in place, the man-hours.” In spite of the standard’s stated goal of providing a single framework for revenue recognition, he said, many are pushing back, asking for industry-specific guidance.

Bricker defended the revenue recognition standard. “In terms of the cost of change against the benefits, how does that balance really tilt? I believe it tilts in favor of the change that we’ve just gone through. But I say that with full appreciation, that change, especially affecting the topline, is substantial. It’s significant but manageable. It was a fairly extraordinary thing for the FASB,” Bricker noted, “to provide an extra year so that that change could be appropriately and responsibly incorporated into our system. In working through that, I think it’s right to acknowledge the magnitude of effort that went into implementing a new standard.”

Bricker continued, “Some companies point out, rightly, that the impact in the primary financial statements was not all that significant, and therefore they say the cost of implementation doesn’t match our perception of the benefit.” While he understood this point, “that argument tends to minimize, I think, the greater benefit of the standard, which is the disclosure package and the quantitative as well as the qualitative disclosure elements that now are provided to investors about contracts with customers.”

In addition, Bricker said, the new disclosures regarding contracts could not have been accomplished so easily as a simple add-on to existing frameworks. “I think it was right to take a fresh, principles-based approach,” he said. “We now have a comprehensive framework that is focused on communicating to investors in an enforceable way what the economics of contracts with customers are. I think we’re on much better footing across the system for having done that.” Bricker and Moffatt both also emphasized how the standard enables financial statement users to better compare companies across industries.

Moving on, Moffatt discussed the DCF’s approach to reviewing filings under the new standard. “We are not planning to beat up companies,” he said, noting that, as usual, comments will only be issued when disclosures are problematic or unclear. “We’re not going to use a checklist; we’re going to think about the totality of the information that’s being presented.” Moffatt also said that the early disclosures so far have highlighted areas of disclosure that companies have found challenging, but not to the level where the SEC needs to take action.

Bricker added that accountants can be invaluable in helping companies make the right judgment call regarding their new revenue disclosures. “It occurs in the judgments around selection of accounting policies routinely,” he said, “and this is an area that benefits from that same discipline. Investors will count on the good work that you do.”

Finally, Moffatt gave the DCF’s perspective on non-GAAP measures, which has not changed much from previous years. “We encourage you to reach out to us,” he said. “We really want to help folks get the right disclosures in place.” Questionable presentations of non-GAAP information do still happen, he said, but less than in the past two years. For the DCF, key questions companies should ask themselves about their non-GAAP disclosures revolve around transparency, risks associated with presenting the information, and not confusing investors and other financial statement users. “When people take a step back and think about the ‘why’ [of the disclosure],” Moffatt said, “they do a much better job of understanding what they should present.”

Enforcement Cases

For the last part of the SEC’s presentation, Wright discussed some recent enforcement cases, highlighting the issues that the SEC is paying close attention to. He began by highlighting the sources of SEC investigations. Traditional sources (e.g., restatements and other filings by registrants, self-reporting by registrants, whistleblowing and other tips and complaints, internal and external referrals) represent the majority of leads for new cases. Wright noted that the SEC’s whistleblower program recently made its highest ever awards: nearly $50 million to two whistleblowers and more than $33 million to another.

The first cases Wright discussed revolved around revenue recognition, which he noted was becoming a big theme for the panel. A quintessential case was Maxwell Technologies, a California-based energy and power storage company that had prematurely recognized more than $19 million in revenue in order to meet analysts’ expectations. The company settled the case and paid a $2.8 million penalty, and is now required to report insufficiencies in its controls and compliance directly to the SEC. Other revenue cases included medical device company Orthofix and Mexican-based homebuilder Homex, the latter of which was charged with $3.3 billion in fraud.

In the area of expense recognition, Wright highlighted the cases of Overseas Shipholding Group and Penn West. The former understated its income tax liability by more than $500 million by leaving out a debt guaranteed by a foreign subsidiary, eventually paying a $5 million penalty. This case was noteworthy because a member of the company’s board, upon learning of the unrecorded liability, pushed for disclosure and an investigation and resigned when he was ignored. The Penn West case, still in litigation, involved the Canadian oil giant improperly capitalizing its operating expenses by manipulating a key metric regarding its cost of extracting oil.

Wright spoke briefly on Altaba’s (formerly Yahoo Inc.) failure to disclose a massive cybersecurity breach in December 2014 that exposed the user-names, email addresses, passwords, and sensitive personal information of hundreds of millions of its users. The breach was not publicly disclosed until 2016, of which Wright, quoting SEC Division of Enforcement codirector Steve Peikin, said, “We do not second-guess good faith exercises of judgment about cybersecurity incident disclosure, but we have also cautioned that a company’s response to such an event could be so lacking that an enforcement action would be warranted, and this case was such a case.” He also stressed the importance of disclosure controls for cyber breaches to determine whether the event is material to investors, and also noted that the division would be taking a close look at controls surrounding recognizing revenue under the new standard once cases begin coming in.

Finally, Wright discussed audit failures, including the SEC’s enforcement case against KPMG for its failed audit of Miller Energy. That case involved inflation of the value of properties by over 100 times their actual value, among other red flags KPMG either ignored or failed to notice. “We settled with KPMG and the firm agreed to certain undertakings, he said. “We will sometimes seek those against firms. They’re remedial, they’re supposed to address the issues that gave rise to the audit failure, and they may sometimes include an independent consultant.” In a separate matter, KPMG failed to retain proper documentation and work-papers for another client for the required seven years. Both cases resulted in severe penalties for the Big Four firm. Wright stressed that “auditors are important gatekeepers,” and that maintaining independence in engagements is critical.

Audience Q&A

Strauss then opened the floor to questions from the audience. The first question came from a member of the technical staff at FASB, who wanted to know the SEC’s view on adopting international financial reporting standards (IFRS) into the U.S. reporting system, and specifically on any possible future convergence project between FASB and the IASB. Bricker replied that “for domestic companies, U.S. GAAP best serves their reporting,” and he therefore does not see any traction for IFRS in the United States for the foreseeable future. He also noted that the two frameworks have come much closer together in recent years, and therefore the impact of such a switch would not be as significant. He also stressed that compliance with IFRS remains important for multinational companies.

Another audience member asked Wright whether companies are more willing to cooperate with the SEC in recent years to avoid prosecution. Wright replied that cooperation is always welcome, but that whether or not it occurs depends on several factors, including the position of defense counsel. “I think our cooperation statement bears close reading by all members of the defense bar, as well as preparers,” he said.

The final question was about the enhanced auditor’s report and whether the SEC would coordinate its response to new reports with the PCAOB, particularly with regard to critical audit matters (CAM). Moffatt did not speak as to the PCAOB’s intentions, but did state that the DCF staff is currently undergoing training and working out its approach to what are, essentially, communications between auditors and the audit committee. “That will be a challenge, but we’re well aware of it,” he said.

Norman Strauss is distinguished lecturer of accountancy at Baruch College, moderated the panel.
Wesley Bricker is chief accountant at the SEC’s Office of the Chief Accountant.
Kyle Moffatt is chief accountant at the SEC’s Division of Corporation Finance.
Charles Wright is the senior legal advisor at the SEC’s Division of Enforcement.