Tag: Audits


Chamber of Commerce Airs Grievances Related To Internal Controls Inspections

Jason M. Halper is a partner in the Securities Litigation & Regulatory Enforcement Practice Group at Orrick, Herrington & Sutcliffe LLP. This post is based on an Orrick publication by Mr. Halper and William J. Foley Jr.

In recent months, issues related to internal control systems and reporting have taken on an increased profile and significance. For example, as previously noted by the authors here and here, the SEC has sought to prioritize compliance with internal controls by initiating a growing number of investigations into companies based on allegations of inadequate internal controls.

By way of background, “internal controls” refers to the procedures and practices that companies use to manage risk, conduct business efficiently, and ensure compliance with the law and company policy. Public companies are required to maintain sufficient internal controls by the securities laws. In particular, Section 404 of the Sarbanes-Oxley Act (as amended by the Dodd-Frank Act) requires, among other things, that: (i) company management assess and report on the effectiveness of the company’s internal control over its financial reporting, and (ii) the company’s independent auditors verify management’s disclosures. Sarbanes-Oxley also created the Public Company Accounting Oversight Board (“PCAOB”) to oversee public company audits, including the audits of internal control reporting. The PCAOB, in turn, conducts regular inspections to ensure compliance with laws, rules and professional standards.

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Government Preferences and SEC Enforcement

Jonas Heese is Assistant Professor of Business Administration in the Accounting & Management Unit at Harvard Business School.

The Securities and Exchange Commission’s (SEC) enforcement actions have been subject to increased scrutiny following the SEC’s failure to detect several accounting frauds. A growing literature investigates the reasons for such failure in SEC enforcement by examining the SEC’s choice of enforcement targets. While several studies recognize that the SEC and its enforcement actions are subject to political influence (e.g., Correia, 2014; Yu and Yu, 2011), they do not consider that such influence by the government may also reflect voters’ interests. Yet, economists such as Stigler (1971) and Peltzman (1976) have long emphasized that the government may also influence regulations and regulatory agencies to reflect voters’ interests—independent of firms’ political connections. In my paper, Government Preferences and SEC Enforcement, which was recently made publicly available on SSRN, I examine whether political influence by the president and Congress (“government”) on the SEC may reflect voters’ interests.

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Foreign Institutional Ownership and the Global Convergence of Financial Reporting

Vivian Fang is an Assistant Professor of Accounting at the University of Minnesota. This post based on an article by Professor Fang, Mark Maffett, Assistant Professor of Accounting at the University of Chicago, and Bohui Zhang, Associate Professor at the School of Banking and Finance, University of New South Wales.

In our recent paper, Foreign Institutional Ownership and the Global Convergence of Financial Reporting Practices, forthcoming in the Journal of Accounting Research, we examine the role of foreign institutional investors in the global convergence of financial reporting practices. Regulators frequently espouse comparability as a desirable characteristic of financial reporting to facilitate investment decision-making and allocation of capital. Over the past 15 years, significant regulatory effort has gone into promoting comparability, the most prominent example of which is the International Accounting Standards Board’s (IASB) push for global adoption of International Financial Reporting Standards (IFRS). However, recent research (e.g., Daske, Hail, Leuz, and Verdi [2008], Christensen, Hail, and Leuz [2013]) shows that mandating the use of a common set of accounting standards alone is unlikely to achieve financial reporting convergence.

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Monitoring the Monitors

The following post comes to us from Jodi Short, Professor of Law at the University of California Hastings College of the Law; Michael Toffel of the Technology and Operations Management Unit at Harvard Business School; and Andrea Hugill of the Strategy Unit at Harvard Business School.

Drawing on insights from the literatures on street-level bureaucracy and on regulatory and audit design, our paper, Monitoring the Monitors: How Social Factors Influence Supply Chain Auditors, which was recently made publicly available on SSRN, theorizes and tests the factors that shape the practices of private supply chain auditors. We find that audits are conducted most stringently by auditors who are experienced and highly trained, and by audit teams that include female auditors. By contrast, auditors that have ongoing relationships with audited factories, and all-male audit teams conduct more lax audits, identifying and citing fewer violations. These findings make five key contributions and suggest strategies for designing audit regimes to more effectively detect and prevent corporate wrongdoing.

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A New Tool to Detect Financial Reporting Irregularities

The following post comes to us from Dan Amiram and Ethan Rouen, both of the Accounting Division at Columbia University, and Zahn Bozanic of the Department of Accounting and MIS at Ohio State University.

Irregularities in financial statements lead to inefficiencies in capital allocation and can become costly to investors, regulators, and potentially taxpayers if left unchecked. Finding an effective way to detect accounting irregularities has been challenging for academics and regulators. Responding to this challenge, we rely on a peculiar mathematical property known as Benford’s Law to create a summary red-flag measure to capture the likelihood that a company may be manipulating its financial statement numbers.

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A Few Things Directors Should Know About the SEC

Mary Jo White is Chair of the U.S. Securities and Exchange Commission. This post is based on Chair White’s remarks to the Twentieth Annual Stanford Directors’ College; the full text, including footnotes, is available here. The views expressed in this post are those of Chair White and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

The SEC today has about 4,200 employees, located in Washington and 11 regional offices across the country, including one in San Francisco that is very ably led by Regional Director Jina Choi, who is here [June 23, 2014]. Many of you have likely had some contact with our Division of Corporation Finance, which, among other things, has the responsibility to review your periodic filings and your securities offerings. Some of you that work for or represent a company that we oversee know our staff in our National Exam Program, and I imagine a few of your companies know something about our Enforcement Division staff. Our other major divisions are Investment Management, Trading and Markets and the Division of Economic and Risk Analysis.

So that is just a quick snapshot of the structure of the SEC and as you undoubtedly know, the SEC has a lot on its regulatory plate that is relevant to you—completion of the mandated rulemakings under the Dodd Frank Act and JOBS Act, adopting a final rule on money market funds, enhancing the structure and transparency of our equity and fixed income markets, reviewing the effectiveness of disclosures by public companies, to name just a few. But what you may not be as focused on is the mindset of the agency on some other things that are also relevant to you as directors.

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PCAOB Adopts New and Amended Auditing Standards

The following post comes to us from Michael Scanlon, partner in the Securities Regulation and Corporate Governance and Corporate Transactions practice groups at Gibson, Dunn & Crutcher LLP, and is based on a Gibson Dunn alert by Mr. Scanlon.

On June 10, 2014, The Public Company Accounting Oversight Board (“PCAOB”) adopted new and amended auditing standards that expand audit procedures required to be performed with respect to three important areas: (1) related party transactions; (2) significant unusual transactions; and (3) a company’s financial relationships and transactions with its executive officers. The standards also expand the required communications that an auditor must make to the audit committee related to these three areas. They also amend the standard governing representations that the auditor is required to periodically obtain from management.

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The PCAOB Proposed Auditor’s Reporting Model

Alan L. Beller is a partner focusing on complex securities, corporate governance and corporate matters at Cleary Gottlieb Steen & Hamilton LLP. This post is based on Mr. Beller’s testimony at the Public Company Accounting Oversight Board’s (PCAOB) public hearing in Washington, D.C. on proposed enhancements to the auditor’s reporting model; the complete text is available here. The views expressed in his testimony are based on his knowledge and experience as both a government official and a legal advisor to private clients.

The proposed enhancements to the auditor’s reporting model would be the first change to the standards in more than 70 years. Furthermore, they could significantly impact the content and format of auditors’ reports; the treatment of that information by investors and other users of financial statements; and the relationship and structure of interactions among management, audit committees and auditors as they have developed since the enactment of the Sarbanes-Oxley Act of 2002.

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SEC Institutes Administrative Proceedings Against KPMG For Auditor Independence Violations

Lee A. Meyerson is a Partner who heads the M&A Group and Financial Institutions Practice at Simpson Thacher & Bartlett LLP. This post is based on a Simpson Thacher memorandum by Avrohom J. Kess, Karen Hsu Kelley, and Yafit Cohn.

On January 24, 2014, the Securities and Exchange Commission (“SEC”) issued an order instituting settled administrative and cease-and-desist proceedings against KPMG LLP (“KPMG”) for violating auditor independence rules in its relationships with affiliates of three of its SEC-registered audit clients. [1] At the crux of the SEC’s order are its findings that:

  • KPMG provided prohibited non-audit services to affiliates of its audit clients;
  • KPMG hired a former employee of an affiliate of one of KPMG’s audit clients and subsequently loaned him back to the affiliate to do the same work he had done as an employee of the affiliate;
  • Certain KPMG employees owned stock in KPMG’s audit clients or affiliates of its audit clients; and
  • KPMG repeatedly represented in its audit reports that it was “independent.”

KPMG settled the charges for approximately $8.2 million.

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SEC Investigations and Enforcement Related to Financial Reporting and Accounting

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.

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