working paper advising public company during difficult times

Working paper: Advising Public Company during difficult times by Arthur Mboue, SEC reporting VP, GE and Faculty Researcher (Freelance)

I. Introduction

Everyone involves in the representation of the public company facing accounting matters should play a role of advisor whether he is a lawyer or a SEC/external or compliance controller.

During this time, a company is going through a hose of major business challenges in addition to a potential restatement, low market valuation and confidence. The company must address difficult accounting issues while preparing to face a public relations nightmare, often with the US department of Justice and SEC at its door steps as ‘angry ex-partner’ and the clock ticking toward past, present and future disclosure deadlines. At this difficult time, prioritization of problems are all difficult and their choices are all bad while senior executive’s freedom and job securities are at risk.

Although there is no ‘one size fits all’ strategy to overcome the problems of a financial restatement and related issues, this is a tentative practical checklist for a SEC reporting advising team who advises senior executives facing a possibility for financial restatement. These checklists aim to help the public company to avoid huge cost associated to these accounting matters including low market value of the company shares, low confidence from the investing public and potential legal liability in connection with the impending restatement. The checklist is empowering company SEC reporting advisors with strategic tools to use in order to solve issues that commonly arise in advising a company during these difficult times and the considerations involved in guiding the company through those issues.

1. The investigation

The process of helping your company to avoid potential huge penalties and undervaluation in connection with accounting matters including restatement prescribes a mandatory checklist including a multi-department investigation. The finding of this problem can arise through Federal agents, through an employees’ work, through a

1 Research conducted by Arthur Mboue

company audit or review by internal or outside auditors, through a whistleblower, through news media and even through anonymous research tips. The company SEC reporting advisory team should have strategic answers of these questions:

Is any immediate disclosure required ? An initial assessment of a problem indicates that there is a probable significant misreporting, this is enough in itself to trigger a duty to disclose and you have 4 days to file form 8-K on top of news releases. At the same token, the company may be making other disclosures including form 10-Q, 10-K, registration statement and the like that could be affected by the results of the investigation. It is why a good strategy will dictate the filing of form 12b-25 when impending forms (10-K, 10-Q,...) will be due.

Who should perform internal investigation? A team composed of a company lawyer, SEC reporting and compliance leader(s) should conduct the internal investigation under the protection of the attorney-client privilege, the work product doctrine, respondeat superior and the scope of employment. You must remember that the client here is the corporation, not the employee who may or may not need a separate representation.

When should the outside auditors be informed of the problem? Company executives involved in this internal investigation must understand that although it is good to get external help sooner, they should exercise due care (be informed by gathering enough data for this case) before seeking any external help including external auditor. The company executives must communicate their problems accurately as soon as possible because their communication to the external auditor will not be protected by any privilege or work product doctrine.

2- The Board of directors’ decision to restate

The decision to restate rests on the board of directors with input and recommendation from the company management, outside auditors and company counsels. Because the board of directors is entitled to due care under fiduciary duty, it can choose to seek external experts help in order to make an informed decision. To reduce their job


security and freedom exposures risks, company counsels and management should make sure that their presentations, documents and inputs to the board of directors contain fair and accurate data which are not subject to second opinion by any external experts or later during litigation.

Should the board of directors delegate this decision making to the audit committee or panel reporting to the full board? Most data subject to restatement have direct or indirect relationship with the company revenue and executive compensation package, it is why in the best interest of fairness, this decision can be delegated to a committee or panel of independent board of directors.

Are data before the board of directors reliable and adequate to allow the board to make an informed decision ? The SEC reporting advisory team must make sure that the board exercises its fiduciary duty by making a fully informed decision including authorization of restatement filing. It is why they must interview everyone involved in this matter before to write their report to the board of directors. It is true that the same management team is potential witnesses or/and defendants but this interview is protected by the work product doctrine.

Table1: Numbers of top management (white collar style targets CEO, CFO, COO and the like, you must be rich to be wanted) with reputation and freedom value at risk. You are called to protect the company and people who can be identified themselves with the companyNumber of Entities and individuals Charged 175Number of delinquent filing enforcement 107Number of CEOs, CFOs and Other Senior Corporate Officers Charged 70Number of individuals who have received Officer and Director bars, industry bars or Commission suspensions

40

Penalties Ordered or agreed to >$1.87 BillionDisgorgement and Prejudgment interest ordered or agreed to >$1.28 Billion

3. Separate Representation;

Does any executive, auditor or board members need a separate representation? Normally, company legal team will represent any one in this group whether for conflict of interest or decision making leading to the restatement filing. But if the internal investigation did find that one executive did violate company policies and guidelines, went beyond his scope of employment and training and


violate any law, respondeat superior doctrine will not apply to him. At this time, the SEC reporting advisory team will advise him to obtain his own and separate legal team.

II. The outside auditors

1. Discussion with auditors

Any complex accounting issue about what went wrong will dominate the auditors’ interview. They can turn out to be complex accounting principles, standards and opinions applied to this case.

Did the company create a ‘disagreement’ with its auditors? If it was a friendly or immaterial ‘disagreement’, they are not required to disclose it to the SEC or during CFO and CEO interviews. CEO and CFO must interview auditors before signing the financial report. During this interview direct questions about the auditor independence and disagreement will be asked.

Did the outside auditors previously audit or review these questionable transactions that are being restated? If he did so without disclosing its lack of reliability and his lack of independence, the auditor must ready himself for a date in court as a defendant in case of litigation

2. Will the company change auditors?

A restatement or planned restatement can result in the resignation or firing of the auditors and other company executives. Whether a disagreement or not with the auditors, this event of change of auditors triggers disclosure duties under SEC Reg S-K, item 304 (a) (i) (iv). Although reason of changes of auditor will raise public relation issues and affects the interactions of the new and incoming auditors, by law, the company must file a Form 8-K (item 4.01) with the reason of firing and the auditor or auditing team’s response.

What investigation does the new external auditor need to undertake? The new auditing team need to understand the problem and should be ready to defend the restated data against any scrutiny or in case of investigation and


litigation. Management and the SEC reporting advisory team need to understand this concern and make sure it is done with highest expertise argument to be used later on.

3. Creating a Record

The new auditing team must create work papers that reflect the restatement process. These work papers are not protected because they will become a part of evidence in case of litigation. Several issues to consider;

Is the company communicating the privileged legal advice to the external auditors? If yes, this privileged legal advice can be used as part of evidence because it is not fully protected by the law. That means there is no attorney-client relationship between the external auditor and the company lawyers.

Is the company auditor creating analyses for the company in preparation of the impending litigation? The company most likely will require the new auditing team to prepare certain financial analyses in connection with the restatement. The company should make sure that the analyses are as accurate as possible and that they do not include aggressive or vague statements that could be misconstrued and used against the company in the impending litigation.

Table 2: Recent star companies charged leading to restatement :[These settlements show that the old abuses of excuses will not fly no more, accepting suspect advices is no longer acceptable form of management because it will end up being a huge financial liabilities for the companies and their leaders ]

J.P Morgan SEC charged the company for misleading investors in a complex mortgage backed securities transaction. JP Morgan agreed to pay $153.6 Million in a settlement that enabled investors to receive all of their money back (rescission)

Bank of America

SEC charged the bank and two subsidiaries with defrauding investors in offering of residential mortgage backed securities by failing to disclose key risks and misrepresenting facts about the underlying mortgage

Tier One bank

SEC charged three former bank executives in Nebraska for participating in a scheme to understate millions of dollars in losses and mislead investors and federal regulators. Two executives settled the charges by paying penalties and agreeing to officer-and-director bars.

Capital One SEC charged Capital One financial Corporation and two senior executives for understating millions of dollars in auto loan losses incurred during the months leading into the financial crisis. Capital One agreed to pay $3.5 Million to settle the


SEC’s charges. The two senior executives also agreed to pay penalties to settle the claims against them

Brooke Corporation

SEC charged 6 executives for misleading investors about the firm’s deteriorating financial condition and for engaging in various fraudulent schemes designed to conceal the firm’s rapidly deteriorating loan portfolio. Five executives agreed to settlements including financial penalties and officer and director bars.

Citigroup SEC charged Citigroup’s principal U.S broker-dealer subsidiary with misleading investors about $1 billion CDO tied to the housing market showed signs of distress. The court approved a settlement of $286 Million which was supposed to be returned to aggrieved investors.

III. DISCLOSURE

1. When should the restatement be disclosed? Although the company will have as much time as it needs to prepare the restated financial statements, it must disclose as soon as possible that its previous filings cannot be trusted. The company has 48 hours for any news release after learning of the existence of material fraudulent previous filing or errors. After that the management can be charged criminally. But, it is in the best interest of company market value and reputation to prepare and disclose restated numbers as soon as possible. The SEC reporting advisory team should consider several issues;

Does the company have impending deadlines to file a Form 10-Q, Form 10-K or other SEC documents? If the board of directors is going to authorize a restatement, it should be done before filing any financial report (except Form 3, 4, 5 and the like) with the SEC

If the restated numbers are not ready, should the company get an extension of time to file its Form 10-Q or 10-K? if the final number are not ready there may be no possible way to avoid to request 5 or 15 days extension to file by filing Form 12b-25. But, you must know that any delay will worsen your company public relation because analysts waiting for your restated numbers will assume that only something very bad will delay the disclosure of your restated numbers. It is why a request for extension should be accomplished by a press release explaining the internal mess on top of the free writing.


Does the company have a scheduled date for its earnings announcement? You must know that any presentation of the current earnings will involve a comparison and addition or subtraction of prior periods’ earnings. That said, it is impossible to announce current earnings without disclosing restated numbers or finding of errors or shenanigans. The only exit for company at this stage is to delay its earnings calls. But, analysts who were invited to attend, access or get connected to the earning announcement will treat this strategic delay as bad signs including trouble in the company management, finding of aggressive or more aggressive filings and dysfunctional corporate governance.

Table 3: Chain of False and Misleading filings with the SEC (SEC vs. Skilling & Richard Causey, case no. H 04-0284) [Only a retrospective adjustment can fix this data because years after years, these data did heir 1999 and 2000 aggressive financial statements]

95. ‘in furtherance of the scheme to manipulate Enron’s financial results and inflate its stock price, Lay, Skilling, Causey, and others filed and caused to be filed with the SEC false and misleading reports of Enron, including:

Annual and Quarterly Reports:

Form 10-Q for the 3rd quarter 1999,(filed on or November 15, 1999) Form 10-K for the FY 1999 (filed on or about March 30, 2000 Form 10-Q for the 1st Quarter 2000 (filed on or about May 15, 2000) Form 10-Q for the 2nd quarter 2000 (filed on or about August 14, 2000) Form 10-Q for the 3rd quarter 2000 (filed on or about November 14, 2000) Form 10-K for FY 2000 (filed on or about April 2, 2001) Form 10-Q for the 1st quarter 2001 (filed on or about May 15, 2001) Form 10-Q for the 2nd quarter 2001 (filed on or about August 14, 2001)

Registration Statements:

Form S-3 filed on or about April 4, 2000 Form S-3 filed on or about June 15, 2000 Form S-3, filed on or about July 19, 2000 Form S-3, filed on or about January 26, 2001 and Form S-3, filed on or about June 1, 2001 and Amended on July 13, 2001

Other:

Form 8-K dated November 9, 2001


2. What should the company say in its announcement of the restatement? The explanation for a restatement can be as important to Wall Street analysts and investing public as the numbers themselves. The SEC reporting advisory team with a duty to review a press release regarding a restatement should consider the following strategies;

Have the auditors reviewed the press release? Because the auditors will be called as witnesses in case of litigation, they must review and sign the restated numbers and the full amendment filed to the SEC.

If the company is announcing the restatement before the results are complete, what should the company say about the numbers? For public relation and legal reasons, companies usually announce the restatement before the restated numbers are complete. That said, the company must decide whether to announce simply that there will be a restatement or finding of significant errors in prior filings. This style of announcement will be a signal of the worst. If the company decides to add an estimate of the impending restated numbers, it must focus on the exact range or open up for more potential liabilities if the new estimate turns out to be off the range.

How can the company proceed with this cautionary disclosure? The company should provide a public notice and press release with a reasonable period of time ahead of the event announcing:

i. The proposed state of release of the earnings results, andii. The details of any accompanying oral, telephonic, webcast, or similar

presentation, including1. The date and time of the presentation (at GE, it is Friday 8:30 AM,

too early but you can open your laptop outside) 2. The subject matter of the presentation (normal course, GE can

bring an additional staff to make a presentation about its area of business)

3. The call in number and web address


4. Example : “ GE 1st Quarter, 2015, Earnings Webcast, Jeff Immelt, Chairman and CEO, Jeff Bornstein, CFO and Matt Cribbins, VP, investor communications, GE will host a webcast to discuss 1st quarter results”

iii. Review all the documents before any releaseiv. Review the press releases and coach very well potential presentersv. After any presentation, your team must immediately review videos and

transcripts of the presentation to make sure that there’s not unintentional disclosure. In case of unintentional disclosure, you have 24 hours to cure this disclosure through a roadshow including public notice, press release, webcast sessions, call-in interviews and 8-K filing (if required)

What can the company say about the status of its business? Investing public and Wall Street professional will want to know whether the restatement is merely a technical accounting issue, manual errors issue, human errors issue, cyber hacking or reflects an underlying problem in the business.

Table 4: Evidences from Enron Case- Government exhibit 1901 [Do you want more executives to follow their footsteps?]

Addit’l interpretationsThis brevity style means that there is something else he is not telling us


Was he coached? I do not think so because he is saying what is doing. He is hiding uncertainty just to maximize Enron value

The most damaging evidence is this timeline. The first attempt is just 3 weeks after leaving office. In addition, in the eyes of the SEC, he left when they did file a 8-K. It does mean that he did not want to share risks with the company.Did his team review his phone conversation transcript before this SEC testimony? I don’t think so

CONCLUSION: SEC reporting experts who advise public companies in the process of dealing with accounting shenanigans and filing restatement to the SEC must understand the difficulty his company will go through while preparing to face the public relations


nightmare, the Department of Justice and SEC at the same time and the clock ticking toward impending disclosure deadlines. While performing this process they must know that the decision to restate the company previous filings to the SEC is versed on the company board of directors. Also, to help the board performs an informed decision making with good faith; it will need reliable inputs from the management, corporate counsel office, external reporting (disclosure) team and outside auditor. Indeed, it is not unusual for the board of directors to exercise its fiduciary duty and delegate this decision making authority to a special committee or panel of independent directors and appointees. That said, this is a series of questions and expert guidelines this process must answer and follow in order to protect the company shareholders value and minimize court penalties

When should the external auditors be involved in this investigation? Is the record before the board adequate and reliable to allow it to make

informed decision that will undermine any possible public and regulatory scrutiny?

Does any employee involved in this restatement need to obtain non company legal advisor and lawyer?

Was the company inadvertently creating a disagreement with auditors leading to this restatement

Since the restatement can result in the resignation or firing of the auditors and/or financial reporting head, will the company change its external auditors?

If the external auditor previous audit or reviews of the transaction are being restated, what investigation the new external auditor needs to undertake?

Did the company waive the company work product doctrine by communicating privileged legal advises or thoughts, whether in written or oral, to the auditors or others?

Is the external auditor creating analyses for the company in preparation of impending litigation to be filed by the SEC, US DoJ and/or investor?

When should the restatement disclose?


Does the company have an impending deadline to file its Form 10-Q, 10-K, 10 Q/A. 10 K/A, 8-K and/or 8-K/A?

Does the company cancel any scheduled earning release with a good public relations notice and press release?

What should the company say to the curious market analysts, investing public and regulators about its cancellation and numerous filing of Form 12b-25?

How can the company proceed with this cautionary disclosure? What should the company CEO and CFO say about the status of its business

and its future?

Guidance from Expert Advises:

Quarterly checklists for the disclosure committee to avoid this kind of mess or fix it

Staffing inadequate in the disclosure process The level of experience of those drafting the reports The reliability of the information systems used Whether those preparing the reports have access to the persons that have the

information required and whether such persons are responsible to request information

Whether material transactions and issues were included in early drafts and how long did it take for issues to surface

Whether sufficient time was allowed for review, comment and Q & A on drafts; whether transaction papers were completed or they were missing documents

Whether disclosures were accurate, whether Form checklists revealed any problems and if so whether they were corrected

Whether there are adequate controls over related party transactions; and whether there was sufficient time to discuss issues and maintain a sufficient dialog between the gatekeepers (CEO, CFO, Audit VP,...) of the information. The results of this periodic evaluation should be discussed with the CEO, CFO, the board of directors and the audit committee.


For Staff calls about this matter, don’t lie Martha, if unsure, let the talking to your talented securities attorney (a member of in-house counsel office or outside hired)

For cooperation strategy, voluntary production to the Staff all requested data within the work product guidelines; it can lessen the tool of this matter.

In case of subpoenas vote by the commission (it is just an examination to determine what to do with the case, further action or closed case). You will be under oath with opening and closing examinations, then the SEC lawyers will decide about any impending charge. Please get the transcript of the proceedings.

In case of appeal of any bar (same process except that the commission vote will decide your faith)

PS: it must be an internal policy related to these thresholds for these checklists

What should management ask themselves before signing a report

Did you read the report and does it provide an accurate picture of the company’s financial condition as you know it?

Have you ask for explanations of anything you did not understand and were you satisfied with the answers?

Did you evaluate the controls and procedures and are you satisfied that they are adequate to ensure that they capture all potential matters for disclosure in a timely manner?

Did you get a second opinion at those areas most likely to raise issues with the SEC?

Did you talk to critical people preparing the report? Did you ask them how comfortable they were with the contents of the disclosure and if they would sign it under oath, if the law were to require them to?

Did you talk to the independent auditors about the report? Did you ask them, whether they were anything in the report they would have recorded differently than the internal auditors recorded?

Did you ask the external auditors if they were satisfied with their independence doing their job and their communications with company staff?


Did you ask the external auditors whether they were any disagreements with company staff and internal auditors or senior management regarding the contents of the financial statements or the report?

Did you ask external auditors directly if the company’s accounting was aggressive? Did you keep a record of all steps taken to give you the comfort necessary to sign

the report? Did you assess the adequacy of documentation of accounting policies and

judgments? If the extent company practice diverges from the written policies, did you make

sure that the issue is addressed and policies are revised or the practices are adjusted as appropriately under US GAAP?

Did you document your consultation with independent auditors in addressing these issues?

Did you prepare yourself and the company for potential information requests from the Staff with quick responses to such inquiries?

Did you gather and prepare substantial information that may satisfy the Staff official curiosity regarding the issues facing the company and may help to bring these matters to an early close and extinguishment?

Given the Staff use of new word searching software to analyze the MD&A, did you review MD&A disclosure to ensure it is clear?

Did you review disclosure committee process to ensure its design and operation are effective?

Did you reassess compliance reporting and internal investigation processes to encourage internal reporting of misconduct?

Did you continue to cultivate and communicate a culture of compliance? Did you ensure your employees that any new or revised rules or guidance would

be among the key matters to be communicated through mail, poster, webcasts and periodic training sessions?


working paper advising public company during difficult times

Law