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Audit Committee Panelists Review Restatements, Corporate Crises

Michael R. McAlevey, chief corporate and securities counsel for General Electric Company, provided tips on effectively managing the audit committee at the Practising Law Institute's recent audit committee workshop. He said to set clear expectations for the financial reporting team and ask the team to communicate back to the committee whether the expectations make sense and the necessary resources are available. McAlevey said he subscribes to the Senate model of advice and consent for audit committees.

Carol Stacey, the departing chief accountant in the SEC's Division of Corporation Finance, discussed restatements. She referred interested parties to a speech given by Todd Hardiman in December. The staff is considering issuing a staff accounting bulletin on quarters, she said. The staff believes that quarters matter in financial reporting. Stacey added that some people have called for the whole materiality issue to be opened up again out of concern that restatements have lost their importance.

The panelists discussed when or whether to bring the SEC into the conversation about a restatement. Meredith Cross, with Wilmer Cutler Pickering Hale and Dorr LLP, said she would not go to the SEC for guidance, but would give the staff person who handles the company's industry a courtesy call about the restatement. Stacey advised that companies can pre-clear accounting questions with the office of the chief accountant, which is much easier than having "to fix it again."

Cross recommended letting the chair of the audit committee know about an intended restatement sooner rather than later, and to let the auditor know. Otherwise, the auditor may feel misled and may call for a 10A investigation, she explained. She suggested that companies do not file an Item 4.02 Form 8-K reporting non-reliance on previously issued financial statements until the audit committee reaches that conclusion. Stacey added that the staff may be suspicious when the Form 8-K and the restatement happen close together.

Cross said that filings will have to be amended. The staff will say that you have to amend all of your old filings, but that is not what is done, she said. The disclosure is usually loaded into one Form 10-K. If your filing was wrong, you have to fix it, according to Stacey. She agreed that you can do a cumulative catch-up 10-K, but advised calling the staff about that intent. Cross said she does not consult with the staff first. If the staff wants more, the company will provide it, she said.

Cross recommended that companies stop using Form S-8 once they file an Item 4.02 8-K. If wrongdoing is discovered, she recommended calling enforcement. The staff reviews every Item 4.02 8-K, she said, and will comment pretty quickly after one is filed. The staff does not review restatements right away.

Managing Crisis Situations

John Olson, a partner with Gibson, Dunn & Crutcher LLP and a co-chair of the program, predicted that there will be more crises involving personal excess by executives. The subject is endlessly fascinating to members of the press, he said. Audit committees must understand the whole executive pay package, including issues that people might be a little embarrassed to raise. Personal conduct is another area where, if it reaches a certain level, the audit committee should take a look at it, especially if it involves corporate assets, he said.

Revenue recognition is on the hit list at the Enforcement Division, Olson advised, along with bill-and-hold practices and side letters. Audit committees would be well advised to spend some time on these issues. Olson added that too many companies are still surprised by whistleblower episodes. The tendency is to paint the whistleblower as a disgruntled employee, but in almost every case, there's a kernel of truth, he said. The audit committee should receive summary reports of all such events.

In a large company, it may not make sense to report every single incident to the audit committee chair, according to Olson. Some companies have a grid that helps define which areas are brought to the audit committee's attention. Large companies may receive several whistleblower complaints a month, he advised, but in his experience, most are human resources issues.

Albert Lilienfeld, a partner with Deloitte Financial Advisory Services LLP, said a common mistake is to underestimate the whistleblower's allegations and initially take insufficient steps, rather than determining whether there are matters of independence, privilege and the preservation of documents that should be addressed. Olson said that someone in the law department can usually make those determinations, but small companies may have to get outside expertise. If the matter involves financial accounting or reporting, the audit committee should be informed early.

If senior people are implicated, Olson recommended hiring a public relations person on a privileged basis. Lawyers will not always be able to see how the press and others will view the situation, especially if it involves personal peccadilloes, he explained. Joele Frank, a managing partner at Wilkinson Brimmer Katcher, said that dribbling information out, as was done at Hewlett Packard in the Patricia Dunn matter, is a bad idea. Outsiders are also much better at advising when to "cut the cord," she said.