On April 3, 2020, the SEC's Chief Accountant, Sagar Teotia, issued a Statement on the Importance of High-Quality Financial Reporting in Light of the Significant Impacts of COVID-19 (the "OCA Statement"). The OCA Statement emphasizes that while the SEC Office of the Chief Accountant ("OCA") appreciates the challenging environment that companies and their auditors face in attempting to comply with their financial reporting obligations due to COVID-191, and will not second-guess their reasonable judgments, OCA expects financial reporting to continue to "provide investors with high-quality financial information." The OCA Statement also reaffirms OCA's views on the importance of gatekeepers by pointing out the critical need for auditor independence in this uncertain economic environment. In addition to this general theme, the OCA Statement contains several notable points that will have implications for companies in the current situation, both in preparing their financial statements, and in taking steps to mitigate litigation and enforcement risk.
CARES Act – GAAP Reporting Obligations
The OCA Statement addresses implications of provisions in the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act") that allow certain entities relief from the application of two elements of U.S. Generally Accepted Accounting Principles ("GAAP").2 Section 4013 of the CARES Act allows financial institutions to elect to suspend troubled debt restructuring accounting in certain circumstances. Section 4014 of the CARES Act allows insured depository institutions, bank holding companies, and their affiliates to delay adoption of current expected credit loss ("CECL") accounting methodology, which generally requires earlier recognition of credit losses on certain assets compared to current accounting standards and otherwise was required to be implemented starting January 1, 2020. The relief from these GAAP provisions lasts until the earlier of December 31, 2020 or 60 days following termination of the National Emergency declared by the President on March 13, 2020.
The OCA Statement clarifies that the SEC Staff would not object to the conclusion by eligible entities relying on the CARES Act provisions that application of these provisions "is in accordance with GAAP." This relief resolves a conundrum for issuers that rely on the relief, and for their auditors, because the statute does not, by its terms, change GAAP.
Some institutions may decide not to avail themselves of these provisions, particularly the delay of CECL, for a variety of reasons. For example, an institution might no longer have the appropriate controls and procedures in place to report credit losses under "old" GAAP, given the new standard's implementation date of January 1, 2020. Other concerns include the uncertainty and potential short-term nature of the delay. In addition, even institutions that adopt CECL as of January 1, 2020 are permitted to delay the regulatory capital impact of CECL for two years under temporary relief issued by federal banking agencies.3
Judgments and Estimates
The OCA Statement highlights several areas in which the SEC Staff recognize that companies may have to make significant financial reporting judgments and estimates in light of the impact of COVID-19 on their business. OCA identifies the following illustrative examples: fair value and impairment considerations, leases, debt modifications or restructurings, hedging, revenue recognition, income taxes, going concern, subsequent events, and adoption of new accounting standards (such as the new credit losses standard).
Companies should pay particular attention to revenue recognition as an area that may require reporting judgments and estimates, given the relatively recent changes in those rules, which continue to be the subject of SEC guidance and comments.4 Many companies may face challenging issues revolving around revenue recognition caused by COVID-19.
In light of the significant judgments that companies likely will have to make in the context of an evolving crisis, the OCA Statement re-emphasizes that OCA has not "objected to well-reasoned judgments that entities have made, and . . . will continue to apply this perspective." However, the OCA Statement highlights that it is more important than ever for companies to apply their standard controls processes to their financial statements. Companies should document and disclose the reasoning and decision-making process for varying from standard accounting assumptions in light of the COVID-19 pandemic. In the aftermath of the pandemic, the SEC may focus its investigative and enforcement efforts on companies that significantly changed their processes and assumptions in issuing financial statements during the pandemic without adequate justification and sufficient disclosure.
In addition to potential SEC investigations and enforcement actions, the market volatility and uncertainty caused by COVID-19 will provide fertile ground for private litigation. Disclosures will of course be viewed in hindsight, and if a company's stock price decreases, the company can expect heavy scrutiny from investors regarding its disclosures. Particular attention should be given to whether additional qualifying language should be included in the risk factor and other sections of a company's reports, particularly where processes and assumptions in financial statements were changed as a result of the impact of COVID-19. Forward-looking statement disclaimers should also be carefully examined and updated regularly in light of the new and evolving environment.
Auditor Examinations and Independence
Consistent with OCA's continued focus on auditor independence,5 the OCA Statement reaffirms that the SEC Staff "remains actively focused on independence matters in these unprecedented times." The OCA Statement highlights the role of audit committees and management with respect to auditor independence, repeating earlier statements that "auditor independence is a shared responsibility among audit committees, management, and their auditors," and that "management and audit committees should be aware of how an auditor independence violation may affect the company's required SEC filings."
Companies may face unusual independence issues during this time. For example, there may be an increased need to hire outside experts to help value assets that are difficult to value in the current business environment, and they may seek expert assistance in modifying internal controls. Companies will need to be mindful of the potential independence implications if they use an auditing firm for this kind of non-audit service.
The OCA Statement also touches on audit quality in emerging markets, particularly in China. OCA has previously addressed efforts to improve audit quality and challenges in auditing public company operations in China.6 The recent statement signals that this remains a priority for OCA, although COVID-19 may disrupt work on the issue in the near term.
Focus Going Forward
The OCA Statement follows recent guidance from the Division of Corporation Finance concerning disclosure of the risks presented by COVID-19 and its effects7, as well as a statement from the Division of Enforcement's Co-Directors reminding market participants of their obligations with respect to material non-public information.8 The PCAOB also issued staff guidance last week that touches on many of the same issues.9 Taken together, these statements highlight the regulatory focus on accounting, reporting, and potential insider trading in relation to the pandemic.
In addition to the COVID-19 interest areas, the OCA Statement reaffirms OCA's focus on priorities existing before the pandemic. OCA has recently discussed these priorities, which include engaging with stakeholders, overseeing the FASB and PCAOB, and contributing to international accounting standards.10 Of particular importance to companies, OCA's priorities also include fostering effective internal control over financial reporting and ensuring the independence of auditors.
In sum, the OCA Guidance is of a piece with the other cautionary statements to market participants emanating from the SEC during this time of economic dislocation. Consistent with lessons learned from prior financial crises, companies can best protect themselves by making good-faith and well-documented judgments and estimates in their accounting choices, being transparent in disclosing material facts to the public, including appropriate qualifying language and disclaimers in their reports, and focusing on compliance with their controls and procedures to safeguard material non-public information.11
Footnotes
1 In recognition of these difficulties, the SEC has provided relief from deadlines for certain reporting requirements. See Division of Corporation Finance, SEC Extends Conditional Exemptions From Reporting and Proxy Delivery Requirements for Public Companies, Funds, and Investment Advisers Affected by Coronavirus Disease 2019 (COVID-19) (March 25, 2020), available at https://www.sec.gov/news/press-release/2020-73; see also Cleary Gottlieb's article New SEC Coronavirus Actions: Extended Conditional Relief for Filing Deadlines, New Disclosure Guidance, Temporary Relief for EDGAR Form ID Applications (March 30, 2020), available at https://www.clearygottlieb.com/-/media/files/alert-memos-2020/new-sec-coronavirus-actions-pdf.pdf.
2 Coronavirus Aid, Relief, and Economic Security Act, H.R. 748, §§ 4013, 4014 (2020); see also Cleary Gottlieb's article President Signs CARES Act: Emergency Relief Provided to Businesses and Consumers (March 28, 2020), available at https://www.clearygottlieb.com/-/media/files/alert-memos-2020/president-signs-cares-act-pdf.pdf.
3 See 85 Fed. Reg. 17723 (Mar. 31, 2020). See also Board of Governors of the Federal Reserve, Federal Deposit Insurance Corporation, & Office of the Comptroller of the Currency, Joint Statement on the Interaction of Regulatory Capital Rule: Revised Transition of the CECL Methodology for Allowances with Section 4014 of the Coronavirus Aid, Relief, and Economic Security Act (Mar. 31, 2020), available at https://www.federalreserve.gov/supervisionreg/srletters/SR2009a1.pdf. For a discussion of similar measures in Europe, see also Cleary Gottlieb's Article COVID-19 – Monetary Stimulus and Relief Measures announced by the European Central Bank and Member States Banking Authorities (March 25, 2020), available at https://www.clearygottlieb.com/-/media/files/alert-memos-2020/covid19-monetary-stimulus-and-relief-measures-announced.pdf.
4 Chief Accountant Sagar Teotia, Statement in Connection with the 2019 AICPA Conference on Current SEC and PCAOB Developments (December 9, 2019), available at https://www.sec.gov/news/speech/teotia-speech-2019-aicpa-conference.
5 Chief Accountant Sagar Teotia, Statement in Connection with the 2019 AICPA Conference on Current SEC and PCAOB Developments (December 9, 2019), available at https://www.sec.gov/news/speech/teotia-speech-2019-aicpa-conference.
6 Id. See also SEC Chairman Jay Clayton, SEC Division of Corporation Finance Director Bill Hinman, SEC Chief Accountant Sagar Teotia, PCAOB Chairman William D. Duhnke III, Statement on Continued Dialogue with Audit Firm Representatives on Audit Quality in China and Other Emerging Markets; Coronavirus – Reporting Considerations and Potential Relief (February 19, 2020), available at https://www.sec.gov/news/public-statement/statement-audit-quality-china-2020-02-19.
7 SEC Division of Corporation Finance, CF Disclosure Guidance: Topic No. 9 (March 25, 2020), available at https://www.sec.gov/corpfin/coronavirus-covid-19.
8 SEC Co-Directors of Enforcement Stephanie Avakian and Steven Peikin, Statement from Stephanie Avakian and Steven Peikin, Co-Directors of the SEC's Division of Enforcement, Regarding Market Integrity (March 23, 2020), available at https://www.sec.gov/news/public-statement/statement-enforcement-co-directors-market-integrity. See also Cleary Gottlieb's article Insider Trading Risk During the COVID-19 Outbreak (March 27, 2020), available at https://www.clearyenforcementwatch.com/2020/03/insider-trading-risk-during-the-covid-19-outbreak/.
9 PCAOB, COVID-19: Reminders for Audits Nearing Completion (April 2, 2020), available at https://pcaobus.org/Documents/COVID-19-Spotlight.pdf.
10 Chief Accountant Sagar Teotia, Statement in Connection with the 2019 AICPA Conference on Current SEC and PCAOB Developments (December 9, 2019), available at https://www.sec.gov/news/speech/teotia-speech-2019-aicpa-conference.
11 This blog post was prepared with the assistance of Lucas Hakkenberg and Ben Rosenblum.
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