The first panel was focused on current developments at the SEC. Jonathan Wiggins, deputy chief accountant, Office of the Chief Accountant (OCA), SEC, served as moderator and discussion leader. Lindsay McCord, chief accountant, Division of Corporation Finance, SEC, returned to the panel, joining first-time participant Ryan Wolfe, chief accountant, Division of Enforcement, SEC. The following is an edited and condensed report of the panel’s discussion along with conference chair Norman Strauss. 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.
Jonathan Wiggins began by asking the panelists to describe their respective offices’ mission. “Our mission is quite broad,” replied Ryan Wolfe, chief accountant, Division of Enforcement, SEC. “We’re looking at things like insider trading. We’re looking at market manipulation. We’re looking at offering frauds. But I think probably what most people are interested in are the accounting cases, the application of GAAP, the financial reporting, and the issues of auditors.”
“Our investigations come from a multitude of places,” he continued. “They might come from tips, self-reporting. Sometimes they come from the news, and then there are also analytics that we do and initiatives that we have. … Once we take all of that information and develop the record, we try to see if there have been any violations.”
“Once we establish that we think that there is a violation, the next phase is: What’s the appropriate remedy?” said Wolfe. He described the first two steps in remediation as getting parties to obey the law and then imposing monetary sanctions; lastly, the SEC can suspend accounts from appearing and practicing before it. “It’s a privilege to be in our space and do the work that we do, so that can be taken away if you have conduct that demonstrates you’re a threat.”
Lindsay McCord, chief accountant, Division of Corporation Finance, described the division as charged with “the mission of making sure that investors have material information to make informed investment decisions.” McCord noted that “we just look at the same thing investors are looking at. What are the public documents that the company has prepared? News articles? And then what is actually within the SEC filing? We’re just trying to understand and make sure all the material information is in there.”
She believes what makes the Division of Corporation Finance special is, “not only do we get to work on GAAP information, financial reporting, and all the exciting things that the SEC rules have, but we get to help develop some of the rules, and we get to then help with the interpretation.” With regard to changes in the past year, McCord noted that the office of crypto review was established to consolidate this specialized knowledge into one office.
Wiggins noted that the SEC Office of the Chief Accountant, with Paul Munter as its chief, serves as the principal advisor for the commission on any accounting or auditing issues that arise in the administration of the federal securities laws.
Norman Strauss asked Wolfe how the SEC decides, when there are corporations that have allegedly violated GAAP, to bring actions against their audit firm and individual auditors.
Wolfe replied that “our federal securities laws really rely on auditors and professionals who provide assurance in so many ways, … Individual accountability is such an important part of our Enforcement program. … There’s a lot of things we think about in terms of who we loop in on the engagement team, and that goes to responsibility and culpability. Those sometimes make the job difficult, but obviously we are always focused on that individual accountability.”
The conversation then turned to the use of non-GAAP measures. “I appreciate the value that non-GAAP has for investors,” McCord said. “However, there are guidelines. There are rules over what could mislead an investor, and I think we spend most of our time on that line, on those judgment areas of what is misleading, or on things like prominence.”
McCord then described a project her office took on, looking at non-GAAP comments and trends, and trying to identify what preparers are struggling with when they present non-GAAP information. This led to updates to the three existing interpretations aimed at providing clearer guidance on identified issues like, for example, the definition of recurring expenses and the use of tailored accounting principles.
McCord emphasized that “you can’t cure a misleading non-GAAP measure with more disclosure. All the disclosure in the world cannot change that measure from being misleading. This is a long-standing interpretation of the division.”
“We in the division are very focused on non-GAAP, and we’re very focused on it because investors are focused on non-GAAP metrics,” Wolfe added. He described a recent case where a company was presenting information in a non-GAAP metric, removing expenses purportedly related to a merger, but without a policy in place, which led to misclassification of expenses and an overstated metric. Wolfe summarized: “For a company to say, ‘We think that this measure is so important that we’re going to include it in our filing and reconcile to GAAP,’ and then not have the diligence and the rigor to make sure what they’re putting out there was correct and reasonable in accordance with Regulation G—that is a problem for investors, and that is why this is a Division of Enforcement case.”
From an OCA perspective, we’re very focused on the impacts and potential impacts to the financial statements on our current environment, said Wiggins. “There are a wide variety of current events and conditions with geopolitical and macroeconomic impacts globally that can then impact the risks and uncertainties of an issuer in their financial reporting. We’re very focused on those types of conditions. I’m not a prognosticator. … It’s more about the risk of what could come next and the uncertainty embedded in financial reporting today.”
Wiggins continued by providing examples such supply chain challenges, the ongoing impact of COVID-19, the conflict in Ukraine, labor shortages, inflationary pressures, rising interest rates, volatility and foreign exchange rates. “We’re focused on that throughout financial reporting and through the GAAP financial statements, but that that plays out throughout a filing, including MD&A [management discussion and analysis] and risk factors.”
McCord added that there are common themes in how the division thinks about emerging issues with respect to disclosure, whether that issue is COVID-19 or something else that impacts operations, borrowing, or liquidity. “I always tell people, no matter where your business is with the pandemic and whether the pandemic’s over or not, go back and replace COVID-19 with whatever else is top of mind or in the news, and see if you are developing new disclosures, because I think you may be,” she said. “Other places that aren’t readily available in a disclosure guidance topic or dear issuer letter are those items like supply chain issues or maybe inflation. … I hope preparers are looking at their market risk disclosures under Item 305 of Regulation SK, and asking themselves, ‘Are these sufficient in these times?’”
“We really emphasize the importance of the auditor as a gatekeeper,” Wiggins added.
“With rising interest rates, what is the impact to your investment strategy as a company?” McCord continued. “Valuations are changing because of interest rates, inflation. That links back to the critical accounting estimate disclosures in 2020. When we did MD&A updates, we actually codified our critical accounting estimates guidance that it’s a required disclosure. But there are parts where sometimes we see companies fall flat, and that’s not enough quantification about critical accounting estimates.”
“We really emphasize the importance of the auditor as a gatekeeper,” Wiggins added. “We want management to go first to assess GAAP, fulfill their responsibility, and then the auditor to fulfill their responsibility before something comes to us for us to weigh in on it.” He noted that an increase in global integration and multinational corporations has led lead auditors to rely more upon component auditors, whether from an affiliated global network or another firm, as part of the audit engagement. In March, the OCA issued a statement discussing the auditor’s responsibilities with respect to audits involving other auditors, as incorporated into the PCAOB standards, including their quality control standards.
Fraud and Enforcement
Wiggins discussed the auditor’s responsibilities around fraud. “We’ve often emphasized that the auditor plays an incredibly important role supporting high-quality financial information and protecting investors,” he said. “A critical aspect is this responsibility related to fraud detection during the audit; in other words, putting on that that fraud lens that the auditors should use in their work.” He said that auditors shouldn’t be biased towards looking for accounting errors and overlooking the risks of fraud.
He noted the following areas of concern: “potential auditor shortcomings around their responsibility to detect fraud are areas of concern identified through PCAOB inspections involving auditors’ application of due professional care and professional skepticism; instances of improper professional conduct identified through SEC enforcement actions, where auditors ignored red flags and contradictory information; and really an overall attitude by auditors focusing on what I would call the limits of their responsibility—saying what they are not responsible for regarding fraud rather than focusing on what they are responsible for.”
Wolfe described some examples of enforcement cases involving group audits, where a principal auditor is relying on other auditors in their network. One case he described as having fundamental failures throughout the audit: “When is it appropriate to have a remedy that goes both against the individual auditors and the firm? It’s where there is that pervasive quality control issues.” Wolfe also described cases where the SEC charged the issuer as well as the auditor, as well as cases involving registered investment companies.
Strauss raised a question about whether restatements lead the Division of Enforcement to take a closer look at a company. McCord said the new clawback rule that requires companies to check the box on the front cover of annual reports if the financial statements have been revised will provide the SEC with a lot of data on restatements. “We still hear from preparers that they just have their own management decisions, that they want to revise every error in the prior period, even if it’s not material, a big R or a little R.”
“From the perspective of the Division of Enforcement, it’s fair to say that every restatement, we’re definitely going to have eyes on,” Wolfe added. “However many restatements there are every year, we’re not bringing that many equivalent Enforcement cases. There’s policy. There’s judgment. There’s analysis that goes into it.”
“I think if you look at the numbers over time, the number of what is generally called a big R restatement, where there was something that was material to prior periods that needed to be corrected, that number has tended to decrease over time,” said Wiggins. “Some may point to that as evidence that Sarbanes-Oxley and other rules and regulations have helped improve the quality of financial reporting over time.”
“But there’s also been a shift from big R restatements to little R restatements, with that number increasing as a percentage of total restatements over time, not just a decrease in big R restatements. I would caution folks that, when thinking about whether a restatement requires a restatement of prior periods as a big R restatement or not, you should really focus on that materiality assessment. We’ve shared thoughts on that in the past and published statements on our website available regarding the application of materiality to accounting errors and the types of qualitative information that you would consider.”
Wiggins reminded the audience that auditor independence is a shared responsibility between management, auditors, and the audit committee. He added, “there’s a lot of new or innovative ways that companies are accessing the markets, entering into transactions, M&A activity, and other factors that increase the importance of monitoring processes around auditor independence. … If an issuer is contemplating a transaction, they need to think about the filings that would be impacted by that transaction, the rules that would apply to that filing, the auditors’ relationships with other counterparties, and how this transaction might impact auditor independence.”
Disclosures, Controls, Communications
Wiggins turned the conversation to professional responsibilities. McCord said that last year reminded everyone that you don’t have to have a material error to have a material weakness. She stressed that “disclosures about material weaknesses need to be robust and detailed. … Explaining the accounting error does not address the requirements for disclosure on material weaknesses.”
McCord also highlighted that “there is a lot of significant overlap between disclosure controls and procedures [DCP] and internal controls over financial reporting [ICFR]. … DCP is broader than ICFR. It is all your Regulation S-K disclosures. It is non-GAAP information.” McCord encourages people to think about DCP because she does not think most people are doing the same level of assessment as they do with ICFR when they find errors in the Regulation S-K disclosure items.
McCord stressed that “disclosures about material weaknesses need to be robust and detailed. … Explaining the accounting error does not address the requirements for disclosure on material weaknesses.”
“Having effective internal accounting controls really does tremendous work in elevating the overall quality of financial reporting,” Wolfe added. “It’s truly the gate to my gatekeeper and my one hope that one day my job might be made obsolete. But that’s going to take all of the gatekeepers and all of the gates out there doing their job to protect investors.” Wolfe talked about two cases, one involving a company that did not include all the relevant information investors would want to know before approving an executive pay package, and another where the separation agreements of outgoing employees violated the SEC’s whistleblower protection rules.
“Having effective internal accounting controls really does tremendous work in elevating the overall quality of financial reporting,” Wolfe added.
“It’s really important to think about financial reporting as a communication activity and not a compliance exercise,” Wiggins commented. “Good disclosure by an individual company, and by all public companies, increases confidence in the markets … but it takes the efforts of every individual to maintain that investor confidence, and it only takes a very few people to significantly damage that confidence and trust in our profession and in our capital markets.”
“It’s important for individuals that are participating in financial reporting, to not be siloed from the rest of the business,” Wiggins continued. When considering the composition of a disclosure committee, he suggested a mix of technical expertise from different backgrounds, but also “think about not just understanding technically what’s going on in the business, but are you telling the story of the business through your financial reporting, through your financial statements, through MD&A?”
“When we silo off financial reporting from other operations—whether it’s thinking about that communication activity or specifically about controls, operational controls versus financial statement controls, or ICFR and DCP—if we think about those as disconnected because the objectives may be different, we may fail to understand the connection.” Wiggins added: “A lot of times, the environment within which operational controls are designed involves the same types of personnel or control environment or tone at the top as the ICFR and DCP. There is an interrelationship there. It’s really important to not disregard the operations side and just stay focused in our financial reporting silo.”
“Those are really good points,” Wolfe replied, “and I think consistent with the idea that the more sophisticated you’re getting in your operations and the type of transactions that you’re doing in your business model, your financial reporting controls and your disclosure controls should be growing along with it.” He added, “Sometimes we see instances where the sophistication of a business is growing, but the financial reporting controls, the DCP, are not keeping up.”
Strauss asked whether the SEC still encourages filers to come to the them when they have questions about what to do. “Absolutely, I think it is an underutilized resource,” Wiggins answered. “We have a lot of professionals who are very sophisticated, can come to their conclusions subject to audit, can come to an agreement even on very challenging issues. But there are occasionally issues that may be very novel, very unique, or maybe the consequences to the issue are very high … where they’d like to work through some of the most complex issues in advance with the SEC staff.” Wiggins continued to explain the process, which need not be done in person but can take several days, especially with complex issues where the SEC will understand all of the relevant facts and circumstances.
“I just want to say that the prefiling consultation process really can be the best of the profession when done right,” added Wolfe. “The one thing I would caution, though, is treating it like a preclearance exercise, where you’re trying to cover yourself and not giving the full information. There’s nothing you can do if you’re not being forthright with the staff.”
“I just want to say that the prefiling consultation process really can be the best of the profession when done right,” added Wolfe.
“I know that’s always the biggest concern of every preparer is, ‘If I talk to OCA on a preclearance, it triggers CorpFin’s review, or it triggers enforcement, or if I call the staff on anything, they’re going to review me.’ That’s not necessarily what happens,” McCord added. “A simple news article could trigger a review … a lot of different factors that go into that. I just want to highlight just calling the staff to give them a heads-up on something is not a preclearance, but it doesn’t trigger a review either.”