About the Panelists
The final session of the first day of the conference was focused on current developments at the SEC. Lindsay McCord, chief accountant, SEC Division of Corporation Finance, served as moderator and discussion leader. Jonathan Wiggins, senior associate chief accountant, SEC Office of the Chief Accountant (OCA), and Charles Wright, senior legal and policy advisor, SEC Division of Enforcement, also participated on the panel. This article presents an edited summary of that panel discussion. The comments made by the panelists represent their own thoughts and views, and are not necessarily representative of the SEC, the Commissioners, or other members of the SEC staff.
Lindsay McCord, Chief Accountant at the SEC’s Division of Corporation Finance, said that the panel would begin with an overview of each individual’s respective division or office, followed by a discussion of trends in accounting and financial reporting, and conclude with an overview of enforcement.
Charles Wright, Senior Legal and Policy Advisor at the SEC’s Division of Enforcement, began by describing the background of the Division of Enforcement. It is the largest division at the SEC and brings hundreds of civil enforcement actions administrative actions each year.
“The division obtains evidence of possible violations of securities laws from many sources, including market surveillance activities, investor tips, and complaints,” Wright noted. “Following an investigation, the staff can present their findings to the Commission for review, and the Commission can authorize the staff to file a case in Federal Court or bring an administrative action. In many cases, the Commission or the party charged decides to settle a matter without trial.”
Jonathan Wiggins, Senior Associate Chief Accountant in the SEC’s Office of the Chief Accountant, said of OCA’s accounting group, “we work directly with registrants through accounting consultations, where we provide staff views on any complex or unique technical accounting issues. And we also work closely with you all in court, then with enforcement, and others at the SEC and oversee and monitor accounting standard setting.”
Lindsay McCord said that the Division of Corporation Finance (CorFin) “supports the commission’s mission by seeking to ensure that investors are provided with material information in order to make informed investment decisions.” She discussed recent leadership changes at CorpFin and credited the division’s Disclosure Review Program with doing the work to ascertain current accounting and financial reporting trends.
Revenue Recognition and Digital Assets
Prompted to discuss the accounting consultation trends that OCA has observed recently, Wiggins said he would focus on revenue recognition and digital assets. There has been “a lot of volume in revenue and that has continued since the adoption of [FASB Accounting Standards Codification] 606,” he noted. “There’s a lot of judgment involved; it’s a very important line item in the financial statements for investors and companies.” He explained that “many of the questions that we get on revenue are related to the identification of performance obligations, and that would include the guidance on principal-agent analyses. Those issues can require a lot of judgment and can also be very material to registrants’ financial statements, in that they can affect either the timing of revenue recognition or revenue, whether revenue should be recognized on a gross or net basis, or sometimes both.” He noted that such questions tend to be highly unique and often pertain to making distinctions in arrangements where a company promises to provide a customer with a good or service up front, and also promises to provide a related service over time.
As for principal versus agent questions, Wiggins said, “we’ve seen those issues from registrants like platform companies. There are a lot of platform companies today that connect users with a service provider or other vendor, like delivery services or other gig economy–type of platforms.”
“In those types of assessments, I think it’s really helpful to determine whether the company is actually performing an integration service—and, if so, the exact nature of that integration service and how significant that service is.” Wiggins explained that “it’s also really helpful to assess whether the company controls the good or service from that third-party vendor since, in my view, it would be unclear how a company could integrate that good or service into their own offering if they didn’t have control over that good as an input in the first place.” He added that “I would caution folks from simply concluding a certain party is the company’s customer without digging really into the contracts and the facts and circumstances.”
The discussion then shifted to digital assets. “Generally,” Wiggins said, “I would put a digital asset or crypto asset issues into two different buckets. The first bucket would include questions that really aren’t unique to the crypto space, but are informed by the specific facts and circumstances of the transaction or the business model. While we may talk about certain issues as being digital asset or crypto asset issues, oftentimes they are the same types of questions that we’ve seen for many years … Just because those are showing up in an emerging industry or new business model focused on crypto assets doesn’t mean that they’re new questions; they’re just questions in that specific fact pattern. We do see a lot of those types of questions arise in these new crypto asset type transactions or businesses. The second bucket would include questions that are more specific to the crypto assets space, and the interpretive staff guidance in SAB [Staff Accounting Bulletin] 121 is just one example of our communication of staff views on this type of issue.”
“We have really observed an increase in the number of entities that provide users with the ability to hold and transact in crypto assets,” Wiggins continued. “And as part of the services, some entities have taken on safeguarding obligations that really involve unique risks and uncertainties that aren’t present in arrangements to safeguard assets that aren’t crypto assets. These risks include a number of technological, legal, or regulatory risks that are further discussed in the SAB. Because of these risks, the staff believes that it was necessary to provide recognition, measurement, and disclosure guidance specific to these fact patterns.”
“The scope of the SAB is specific to entities that provide a service to safeguard crypto assets that are not the entities’ crypto assets,” Wiggins explained. “And as part of this safeguarding service, the entity or its agent has taken on either a contractual or a constructive obligation to maintain the cryptographic key that is necessary to access those crypto assets for the platform users and protect them from loss or theft, even if the company doesn’t consider itself to be a platform—and I know that term isn’t defined in the SAB, even though it’s used in the SAB. But a company that doesn’t consider itself to be a platform would still consider whether their safeguarding activities give rise to other types of risks or uncertainties that may be unique to digital assets before reaching a conclusion that they don’t have a safeguarding obligation.”
“In applying the guidance in the SAB, an entity would recognize a liability on their balance sheet that would reflect its obligation to safeguard the crypto assets under the arrangement, with a corresponding indemnification-like asset, and notably that is not the crypto asset itself,” Wiggins continued. “This liability would be measured at the fair value of the crypto assets that the entity is responsible for holding for users, and the corresponding asset would be measured at the fair value of the crypto assets held for users.”
“The guidance also includes specific disclosures that would be required under either U.S. GAAP or IFRS in light of the unique risks involved. These include disclosures of significant risks and uncertainties, disaggre-gated disclosures of significant crypto assets held for users, and disclosures related to the fair value measurements, including disclosure considerations outside the financial statements, like the description of business or risk factors,” Wiggins said, repeating that OCA is available for consultation on conclusions issuers have reached based on their specific fact pattern.
“While we may talk about certain issues as being digital asset or crypto asset issues, oftentimes they are the same types of questions that we’ve seen for many years.”
“Yesterday, CorpFin issued a sample letter to companies regarding disclosures pertaining to Russia’s invasion of Ukraine and related supply chain issues,” McCord announced, highlighting the broad scope of the statement. “The letter provides sample comments related to disclosures covering all the sections in a normal 10 K or 10-Q filing for, for example, risk factors, management discussion analysis (MD&A), critical accounting estimates, internal controls, and non-GAAP measures.”
McCord moved on to the perennial trending topic of non-GAAP measurements. “How does the staff in CorpFin look at non-GAAP measures? We look at it the same way the audit firms or the law firms do, through the lens of rules and guidance, such as the non-GAAP compliance and disclosure interpretations or the Commission’s guidance on MD&A issued in 2020. We start there, we read why the company is providing the measure, the usefulness of it, and then we just compare it to the rules and guidance to understand, or does anything feel inconsistent with the rules, regulations, or guidance provided? … I would focus on why management believes the presentation of the non-GAAP measure provides useful information to investors regarding the company’s financial condition and results of operations.”
McCord addressed a few comment letter themes on non-GAAP. “We do continue to see companies disclose non-GAAP measures more prominently than their GAAP results in both their earnings release and, in some cases, in their periodic reports,” she began. “For example, if there’s a profit measure, we often have seen and commented on the fact that profit measure is being reconciled to revenue, not net income, or not even a fully loaded GAAP gross profit, to revenue, and we would say that’s not the most comparable GAAP measure in most cases. Non-GAAP adjustments continue to evolve, and there often is not consistent presentation of similarly titled measures across registrants and even peers, or the title of a measure may not match the description.”
Mislabeling was the next comment trend. “An example of where a measure may be mislabeled is when someone presents a measure as net revenue when actually the measure is meant to be contribution margin or non-GAAP gross margin,” McCord said. “Again, it’s normally through the comment process where we inquire further about that net revenue measure that we learn that the company was actually trying to present more of a non-GAAP gross margin or contribution margin.”
“Another is referring to something as non-GAAP core earnings, but then excluding cost of revenue line items for other expenses that are material and directly tied to the business,” she explained. “The term ‘core’ here is important when you think about what that measure represents and what is core to your business.”
“As it relates to labeling of non-GAAP adjustments, due to the number of adjustments we see and the lack of consistency across registrants, we believe this is of equal importance as labeling of the measure itself,” continued McCord. “The disclosure should be in sufficient detail for an investor to understand all material components of the measure and any adjustment to a GAAP disclosure should be in sufficient detail.” She also asked for sympathy and patience for the staff tasked with understanding often complex measures.
Materiality of Errors
The discussion turned to the materiality of accounting errors, where there is overlap between CorpFin and OCA. “I would encourage you all to read the statements that we issued in March on this issue,” began Wiggins. He emphasized that the materiality evaluation needs to be an objective assessment. “And an impartial evaluation that takes into consideration all facts and circumstances with respect to the error. … However, I think it’s critical that that we all remember that the concept of materiality is focused on the total mix of information from the perspective of a reasonable investor, so all those experts really need to assess the materiality of errors through the lens of the reasonable investor and eliminate any of their own biases or perspectives.”
McCord then examined two specific examples of accounting errors in depth, explaining the thought process behind CorpFin’s determination that these represented “Big R” restatements.
“Rulemaking is a very public process and must follow the requirements of the administrative procedures act,” McCord explained. The SEC’s Fall 2021 agenda included disclosures related to climate risk, human capital, cybersecurity risks, and Dodd-Frank related rulemaking. “All rulemaking may begin either with a request for comment concept release, or proposed release,” she said. Once comments are received, the staff considers them in making recommendations for the final rules. Sometimes, comment periods are reopened for the SEC to ask new questions.
McCord then turned to the CorpFin “Dear Issuer” letter that was published last fall on climate disclosures. “It provides companies with some examples of the type of climate-related comments we may issue in the course of filing reviews under existing requirements, not under the proposing release.” She explained that “as companies craft their disclosures in this area, they should consider carefully the commission’s existing rules, regulations, and guidance; that includes the 2010 guidance on climate change. It also suggests that, on this issue and others, companies provide a robust analysis when the staff is asking questions and the company asserts that additional disclosures are not material. Companies are best positioned to make these assessments … so, please make sure to kind of ‘show your work,’ and provide us with the analysis underlining the conclusion.”
“At OCA, we do work on rulemaking projects that intersect with many accounting and auditing issues,” Wiggins said. He gave the example of the staff guidance in SAB 120: “It conformed the existing SAB series for recent changes to share-based payment accounting guidance issued by the FASB, and it provided interpretive guidance on the accounting for certain share-based compensation arrangements commonly referred to as ‘spring loaded awards.’” Wiggins described how such awards are intended to “spring load” the value to the executive or other recipient. “SAB 120 notes that a company should carefully consider whether, in determining the grant date fair value of such awards, an adjustment to the observable market price of the company shares is required to meet the objective in the accounting guidance. It also notes the staff’s belief that non-routine spring-loaded grants merit particular scrutiny.”
Wiggins also mentioned the recently proposed amendments to Rule 10b-51 under the 34 Act, which would “enhance disclosure requirements and certain investor protections against insider trading. I mention it here today because the that proposal would also amend the compensation discussion and analysis, or CDA, requirements that are in item 402 of [SEC Regulation] S-K to really enhance the transparency regarding the company’s granted stock options or any other similar instruments either before or after the release of material nonpublic information in a periodic report or in an 8K.”
Charles Wright provided an overview of Division of Enforcement efforts. “The division has several specialized units, including FCPA [Foreign Corrupt Practices Act], municipal securities, market abuse, complex financial instruments, and a crypto assets and cyber unit. … In March 2021, the Commission announced the formation of an Enforcement Task Force focused on climate and ESG issues.” He explained that “the initial focus of the task force was to identify material gaps or misstatements in issuers’ disclosures of climate risks under existing rules.” Wright then detailed the recent complaint against a mining company for making false and misleading statements about the safety of its dams.
“Enforcement continues to use data analytics and other tools to uncover potential violations of law,” Wright continued. He then described actions brought against companies based on the division’s use of analytics. “Our market abuse unit’s analytics and detection centered uses data analytics to detect suspicious patterns, such as improbably successful trading across different securities over time.”
Wright also touched upon the SEC’s whistleblower program and the significant monetary awards available to eligible individuals who come forward with high-quality information that leads to an enforcement action. “The Commission made more whistleblower awards in fiscal year 2021 than all prior years combined. … The Commission is committed to protecting whistleblowers from retaliation. We’ve brought several enforcement actions addressing whistleblower protections.”
McCord concluded the panel by answering a couple of questions from the audience, including one on the Russia-Ukraine conflict. She noted that issuers’ financial exposure to the conflict may be broad or indirect, and disclosures should be tailored to a company’s individual facts and circumstances.