Now back to work, SEC Enforcement once again takes up the issue of internal control over financial reporting. In this instance, the SEC announced settled charges against four public companies for failing to remediate internal control weaknesses—for years! We’re talking seven to ten years. The companies seemed to be under the misimpression that, as long as they disclosed the material weaknesses, they were in the clear. But they learned the hard way that that was not the case. According to Melissa Hodgman, an Associate Director in Enforcement, “Companies cannot hide behind disclosures as a way to meet their ICFR obligations. Disclosure of material weaknesses is not enough without meaningful remediation. We are committed to holding corporations accountable for failing to timely remediate material weaknesses.”

These are the four settled actions:

  • Grupo Simec S.A.B de C.V. trades on the NYSEAMER and disclosed “persistent and extensive” material weaknesses in high-risk areas for ten years in a row and, for two years, management also failed to even complete the required evaluation of the effectiveness of ICFR. For example, in each of eight years, the company disclosed that it lacked an “appropriate consolidation system to allow management to properly supervise the preparation of consolidated financial information…” That was just one of the problems cited in the order. However, the “company did not make significant progress in devising a control structure and remediating material weaknesses until after the SEC staff contacted it. The company continues to have material weaknesses that are being addressed through remediation.” The SEC imposed the largest penalty ($200,000) on this company and required retention of an independent consultant “to ensure remediation of material weaknesses, including those involving related party transactions.”
  • Lifeway Foods Inc. is listed on Nasdaq and also disclosed material weaknesses in high-risk areas in each of ten years and failed to complete the management evaluation of ICFR for two years. The SEC contends that many of the material weaknesses were recurring, involving either financial reporting, accounting or entity controls, and were identified by the management team in the course of its (almost) annual ICFR evaluation. Although the company engaged an outside SOX consultant to assist in developing a remediation plan for its material weaknesses in multiple periods, the company did not fully remediate its material weaknesses and conclude that ICFR was effective for ten years. In addition, during the same period, the company announced three restatements, including two in the same year. The penalty for this company was only $100,000.
  • Digital Turbine Inc. is listed on Nasdaq and disclosed material weaknesses each year for (only) seven years, related primarily to its financial close and reporting process and controls over its accounting information technology systems. The company did not fully remediate its material weaknesses until this past fiscal year.
  • CytoDyn Inc. trades in the OTC market and disclosed material weaknesses each year for nine years, related primarily to segregation of duties and the review, recording and financial reporting of transactions. In its public filings, according to the SEC, the company repeated the same “boilerplate disclosure” of material weaknesses each year, which the SEC characterized as a “general and sweeping description [that] provided no information as to the specific material weaknesses observed.”

SideBar

You may recall that ICFR has been a noteworthy topic of late at the SEC (when it was functioning, that is.) Just a few months ago, the SEC issued an investigative report under Section 21(a) that advised public companies of the need to consider cyber threats when implementing internal accounting controls. The report investigated whether a number of defrauded public companies “may have violated the federal securities laws by failing to have a sufficient system of internal accounting controls.” (See this PubCo post.) And, at the 2018 AICPA Conference on Current SEC and PCAOB Developments, there were two presentations by SEC accounting fellows providing guidance on ICFR: one focusing on the evaluation of operating effectiveness of controls and preparation of material weakness disclosures and the other addressing issues related to the evaluation of control deficiencies. (See this PubCo post.)