As a result of the COVID-19 pandemic, U.S. public companies face significantly increased challenges, and legal risks, relating to their accounting and financial reporting. This is especially so in the realm of judgment and estimates, which are used in a wide variety of important accounting areas – e.g., valuation of assets, recognition of revenue and losses, and setting of reserves for losses and expenses – but which are notoriously difficult to make in the face of great uncertainty.
Sagar Teotia, Chief Accountant of the U.S. Securities and Exchange Commission, has acknowledged the difficulties in navigating complex accounting issues during the current economic crisis, but has also made clear that “[during] these challenging times, investors and other stakeholders need high-quality financial information more than ever.” Steven Peikin, Co-Director of the SEC’s Division of Enforcement, recently stated the issue more pointedly: “Previous economic downturns proved that stresses on the financial conditions of issuers may raise the risk to investors from financial statement and issuer disclosure frauds.”
Enforcement actions over the past decade by both the SEC and the U.S. Department of Justice have demonstrated that management’s exercise of judgment in an environment of uncertainty is no defense to charges if a judgment or an estimate is based on insufficient evidence or clearly unreasonable assumptions or methodologies. Management of public companies and recognized “gatekeepers” – particularly audit committees and independent auditors – need to pay particular attention to accounting judgments and estimates during these difficult times and take steps to avoid the issues that have led to SEC and criminal charges in the recent past.
Practical Lessons for Management and Audit Committees
Management should take proactive and diligent steps to ensure – and to document – that its judgments and estimates are based on reasonable methodologies, data and assumptions. For example, management should:
Audit committees should, as part of their financial reporting oversight responsibilities:
We explore these issues in depth in a broader article published by the NYU Compliance & Enforcement blog, which can be found here.