Posts Tagged ‘Financial reporting’

The Misrepresentation of Earnings

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Thursday April 3, 2014 at 9:12 am
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Editor’s Note: The following post comes to us from Ilia Dichev, Professor of Accounting at Emory University; John Graham, Professor of Finance at Duke University; Campbell Harvey, Professor of Finance at Duke University; and Shivaram Rajgopal, Professor of Accounting at Emory University.

While hundreds of research papers discuss earnings quality, there is no agreed-upon definition. We take a unique perspective on the topic by focusing our efforts on the producers of earnings quality: Chief Financial Officers. In our paper, The Misrepresentation of Earnings, which was recently made publicly available on SSRN, we explore the definition, characteristics, and determinants of earnings quality, including the prevalence and identification of earnings misrepresentation. To do so, we conduct a large-scale survey of 375 CFOs on earnings quality. We supplement the survey with 12 in-depth interviews with CFOs from prominent firms.

…continue reading: The Misrepresentation of Earnings

SEC Investigations and Enforcement Related to Financial Reporting and Accounting

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Sunday February 16, 2014 at 9:00 am
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Editor’s Note: The following post comes to us from Randall J. Fons, partner and co-chair of the Securities Litigation, Enforcement, and White-Collar Defense Group and the global FCPA and Anti-Corruption Task Force at Morrison & Foerster LLP, and is based on a Morrison & Foerster publication by Mr. Fons.

“One of our goals is to see that the SEC’s enforcement program is—and is perceived to be—everywhere, pursuing all types of violations of our federal securities laws, big and small.”
— Mary Jo White, Chair of the SEC, October 9, 2013

“In the end, our view is that we will not know whether there has been an overall reduction in accounting fraud until we devote the resources to find out, which is what we are doing.”
— Andrew Ceresney, Co-Director of the SEC Division of Enforcement, September 19, 2013

“The SEC is ‘Bringin’ Sexy Back’ to Accounting Investigations”
New York Times, June 3, 2013

Much has changed since the collapse of Enron in 2001 and the ensuing avalanche of financial fraud cases brought by the SEC. For example, Sarbanes-Oxley raised auditing standards, imposed certification requirements on public company officers and required enhanced internal controls for public companies. The Public Company Accounting Oversight Board (PCAOB) was formed “to oversee the audits of public companies in order to protect the interests of investors and further the public interest in the preparation of informative, accurate and independent audit
reports.” [1] In pursuit of that goal, the PCAOB has conducted hundreds of audit firm inspections, adopted numerous auditing standards and brought dozens of enforcement actions against auditors for violating PCAOB rules and auditing standards.

…continue reading: SEC Investigations and Enforcement Related to Financial Reporting and Accounting

Executives’ ‘Off-the-Job’ Behavior, Corporate Culture, and Financial Reporting Risk

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Tuesday February 11, 2014 at 9:15 am
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Editor’s Note: The following post comes to us from Robert Davidson of the Accounting Area at Georgetown University, Aiyesha Dey of the Department of Accounting at the University of Minnesota, and Abbie Smith, Professor of Accounting at the University of Chicago.

In our paper, Executives’ ‘Off-the-Job’ Behavior, Corporate Culture, and Financial Reporting Risk, forthcoming in the Journal of Financial Economics, we examine how and why two aspects of top executives’ behavior outside the workplace, as measured by their legal infractions and ownership of luxury goods, are related to the likelihood of future misstated financial statements, including fraud and unintentional material reporting errors. We investigate two potential channels through which executives’ outside behavior is linked to the probability of future misstatements: (1) the executive’s propensity to misreport (hereafter “propensity channel”); and (2) changes in corporate culture (hereafter “culture channel”).

…continue reading: Executives’ ‘Off-the-Job’ Behavior, Corporate Culture, and Financial Reporting Risk

The SEC’s Refocus on Accounting Irregularities

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Monday January 27, 2014 at 9:14 am
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Editor’s Note: The following post comes to us from Paul A. Ferrillo, counsel at Weil, Gotshal & Manges LLP specializing in complex securities and business litigation, and is based on an article by Mr. Ferrillo, Christopher Garcia, and Matthew Jacques of AlixPartners that first appeared in D&O Diary.

On July 2, 2013, the United States Securities and Exchange Commission (the SEC) announced two new initiatives aimed at preventing and detecting improper or fraudulent financial reporting. [1] We previously noted that one of these initiatives, a computer-based tool called the Accounting Quality Model (AQM, or “Robocop”), [2] is designed to enable real-time analytical review of financial reports filed with the SEC in order to help identify questionable accounting practices.

…continue reading: The SEC’s Refocus on Accounting Irregularities

Regulating the Timing of Disclosure

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Tuesday December 10, 2013 at 9:15 am
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Editor’s Note: The following post comes to us from Lisa Bryant-Kutcher of the Department of Accounting at Colorado State University, Emma Peng of the Accounting Area at Fordham, and David Weber of the Department of Accounting at the University of Connecticut.

In our paper, Regulating the Timing of Disclosure: Insights from the Acceleration of 10-K Filing Deadlines, forthcoming in the Journal of Accounting and Public Policy, we examine how regulatory reforms that accelerate 10-K filing deadlines in 2003 affect the reliability of accounting information. The intended purpose of the new deadlines is to improve the efficiency of capital markets by making accounting information available to market participants more quickly. However, accelerating filing deadlines compresses the time available for firms and their auditors to prepare, review, and audit accounting reports, suggesting potential costs in the form of increased misstatements and lower reliability. We provide empirical evidence on the effects of accelerating deadlines by comparing the likelihood of restatement of 10-K filings before and after the rule change.

…continue reading: Regulating the Timing of Disclosure

Delaware Court: Missed Sales Forecasts Could be “Material Adverse Effect”

Posted by Kobi Kastiel, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Sunday December 8, 2013 at 9:06 am
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Editor’s Note: The following post comes to us from Robert B. Schumer, chair of the Corporate Department at Paul, Weiss, Rifkind, Wharton & Garrison LLP, and is based on a Paul Weiss client memorandum. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

In Osram Sylvania Inc. v. Townsend Ventures, LLC, the Delaware Court of Chancery (VC Parsons) declined to dismiss claims by Osram Sylvania Inc. that, in connection with OSI’s purchase of stock of Encelium Holdings, Inc. from the company’s other stockholders (the “Sellers”), Encelium’s failure to meet sales forecasts and manipulation of financial results by the Sellers amounted to a material adverse effect (“MAE”). The decision was issued in the context of post-closing indemnity claims asserted by OSI against the Sellers and not a disputed closing condition.

OSI, a stockholder of Encelium, agreed to purchase the remaining capital stock of Encelium not held by OSI pursuant to a stock purchase agreement executed on the last day of the third quarter of 2011. The $47 million purchase price was agreed based on Encelium’s forecasted sales of $4 million for the third quarter of 2011, as well as Sellers’ representations concerning Encelium’s financial condition, operating results, income, revenue and expenses. Following the closing of the transaction in October 2011, OSI learned that Encelium’s third quarter results were approximately half of its forecast and alleged that Encelium and the Sellers knew about these sales results, but failed to disclose them at closing in violation of a provision in the agreement requiring them to disclose facts that amount to an MAE. OSI also alleged other misconduct by Encelium and the Sellers, including, among other things, that they had manipulated Encelium’s second quarter results to make its business appear more profitable.

In considering the Sellers’ motion to dismiss OSI’s contract and tort-based claims, the court held that:

…continue reading: Delaware Court: Missed Sales Forecasts Could be “Material Adverse Effect”

The Effect of Audit Committee Expertise on Monitoring Financial Reporting

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Thursday December 5, 2013 at 9:10 am
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Editor’s Note: The following post comes to us from Udi Hoitash, Ganesh Krishnamoorthy, and Arnold Wright, all of the Accounting Group at Northeastern University, and Jeffrey Cohen, Professor of Accounting at Boston College.

In our paper, The Effect of Audit Committee Industry Expertise on Monitoring the Financial Reporting Process, forthcoming in The Accounting Review, we examine the impact of audit committee (AC) industry expertise on the AC’s effectiveness in monitoring the financial reporting process. Despite the increased responsibilities, authority, independence, and financial expertise requirements placed on ACs by the Sarbanes-Oxley Act (SOX), ACs may, nonetheless, lack sufficient industry expertise to understand and thus properly monitor complex industry specific accounting issues. For instance, expertise in the retail industry may assist ACs to ensure that companies take an adequate write-down of inventory when their products face potential obsolescence. Similarly, revenue recognition, a prominent area of accounting manipulation (Beasley et al. 2000, 2010), entails an evaluation and understanding of the earnings process, which is tied to a company’s business processes that are often industry specific.

…continue reading: The Effect of Audit Committee Expertise on Monitoring Financial Reporting

Achieving High Quality Audits to Promote Integrity and Investor Protection

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Saturday November 16, 2013 at 9:06 am
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Editor’s Note: The following post comes to us from Jeanette M. Franzel, board member of the Public Company Accounting Oversight Board. This post is based on Ms. Franzel’s remarks at the NACD 2013 Board Leadership Conference, available here. The views expressed in this post are those of Ms. Franzel and should not be attributed to the PCAOB as a whole or any other members or staff.

I want to commend the NACD on its mission to “advance exemplary board leadership” with the compelling vision of aspiring to “a world where businesses are sustainable, profitable, and trusted; shareowners believe directors prioritize long-term objectives and add unique value to the company; [and] directors provide effective oversight of the corporation and strive to deliver exemplary board performance.”

Audit committees are instrumental in achieving this vision and maintaining public trust and investor protection through their oversight of corporate financial reporting and auditing. I would also like to recognize the important role and difficult jobs that each of you have as audit committee members in these oversight functions, as well as the many other areas that are being assigned to audit committees during a time of ever increasing business complexity and risk.

…continue reading: Achieving High Quality Audits to Promote Integrity and Investor Protection

Blockholder Heterogeneity and Financial Reporting Quality

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Thursday October 10, 2013 at 9:35 am
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Editor’s Note: The following post comes to us from Yiwei Dou of the Department of Accounting, Taxation & Business Law at New York University; Ole-Kristian Hope, Professor of Accounting at the University of Toronto; Wayne Thomas, Professor of Accounting at the University of Oklahoma; and Youli Zou of the Accounting Area at the University of Toronto.

An issue of considerable interest to accounting researchers is the association between shareholders and firms’ financial reporting quality (FRQ). In our paper, Blockholder Heterogeneity and Financial Reporting Quality, which was recently made publicly available on SSRN, we examine a specific type of shareholder, blockholders, because (1) they offer a sample of shareholders that are expected to have a significant impact on firms’ financial reporting decisions and (2) we are able to track individual blockholders and their association with FRQ. As discussed in more detail below, these two sample design features allow us to provide a test of the extent to which (large) shareholders influence FRQ. Blockholders also provide an interesting and economically important sample because of their large presence in U.S. capital markets in recent years.

…continue reading: Blockholder Heterogeneity and Financial Reporting Quality

Tone at the Top (of the SEC): Tough

Posted by David L. Caplan and Richard J. Sandler, Davis Polk & Wardwell LLP, on Tuesday October 8, 2013 at 9:10 am
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Editor’s Note: Richard J. Sandler is a partner at Davis Polk & Wardwell LLP and co-head of the firm’s global corporate governance group, and David L. Caplan is a partner and global co-head of the firm’s mergers and acquisitions practice. This post is based on a Davis Polk client memorandum.

As the fiscal year comes to a close—even while the Securities and Exchange Commission, amidst the government shutdown, continues to fund its operations through a carryover balance from FY 2013—it is a good time to review recent signs of SEC skepticism regarding financial statement reporting practices and the SEC’s current focus on public company officers, directors, and auditors as targets of potential enforcement actions. Since Mary Jo White was confirmed as the new Chairman in April, and George Canellos and Andrew Ceresney were named Co-Directors of the Division of Enforcement later that month, a number of enforcement actions and SEC statements suggest a heightened vigilance, particularly with respect to potential corporate accounting failures.

…continue reading: Tone at the Top (of the SEC): Tough

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