Directors Beware:
Errors in Financial Reporting Issues Are On The Rise To Address
In 2023, the landscape of financial reporting witnessed a notable increase in class actions and regulatory enforcement cases, continuing an upward trend as reported by Cornerstone Research (source). Daniel Goelzer highlighted in his latest Audit Committee and Oversight Update that this surge suggests a growing prevalence of accounting errors in U.S. public companies. Glass Lewis, in a recent blog post (source), provides insights into the factors contributing to these financial reporting challenges, emphasizing overburdened audit committees as a significant issue. The firm stresses its readiness to recommend proxy votes against audit committee members failing to fulfill their core duties.
Glass Lewis reports a significant rise in SEC enforcement actions related to issuer reporting, auditing, and accounting, increasing from 70 cases in 2021 to over 100 in 2023. During the 2023 proxy season, concerns over financial reporting, particularly regarding material weaknesses and restatements, led Glass Lewis to make adverse proxy voting recommendations 2.5 times more frequently than in 2022. Glass Lewis notes that these recommendations reflect broader challenges across various issuers, from newly public SPAC mergers to established companies.
Drivers of Financial Reporting Issues
Glass Lewis identifies three primary drivers behind the escalating financial reporting problems:
- SPAC and IPO Boom: The surge in listings driven by SPACs and IPOs during 2020 and 2021 has introduced many less experienced public companies to the rigorous demands of financial reporting. Glass Lewis notes that the SPAC process, with its regulatory bypasses compared to traditional IPOs, contributed to numerous restatements following SEC guidance issued in April 2021 on SPAC warrant accounting.
- Lack of Qualified Accountants: A shortage of qualified accounting professionals exacerbates the issue, with companies attributing material weaknesses to difficulties in hiring sufficient staff (source).
- Increasing Audit Committee Oversight Responsibilities: The expanding scope of audit committees' responsibilities, including oversight of cybersecurity and ESG disclosures, adds complexity. Glass Lewis cautions that while understandable, these expanded mandates could divert attention from core financial reporting oversight, particularly with the potential added strain from proposed PCAOB NOCLAR rules (source).
Impact on Proxy Voting Recommendations
Glass Lewis anticipates ongoing challenges in corporate accounting, driven by factors such as de-SPAC transitions, accounting personnel shortages, and increased audit committee responsibilities. The firm's proxy voting policies focus on how audit committees respond to financial reporting errors and material weaknesses in internal control over financial reporting (ICFR), with specific scrutiny on timely remediation efforts and the materiality of restatements.
Conclusion
As companies navigate these evolving challenges, Glass Lewis advises boards to review committee structures and responsibilities carefully. Boards must meet heightened investor expectations regarding cybersecurity and ESG oversight without compromising financial reporting integrity. Strategies may include increasing board size, forming new committees, or engaging specialized consultants to manage these complexities effectively.
Audit committees are urged to maintain a balance between new oversight responsibilities and their core financial reporting duties. Candid discussions within the board are essential to ensure effective governance amid these challenging dynamics.
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Dr. Deb Carlin 
