Imagine you are counsel to a public company and are tasked with reviewing its annual 10-K. In the course of your review, you confer with a number of individuals in the finance and accounting functions and they report that a significant number of post-close adjustments were made at year end and these adjustments significantly improved the company's financial presentation. Because post-close adjustments can raise a red flag, you discuss the number and dollar value of the adjustments with the company's General Counsel. She responds that the company is committed to proper accounting and full disclosure and that she will investigate the propriety of the post-close adjustments. Later that week, she advises that all of the adjustments were driven by a change in the company's revenue recognition policies, which had been approved by the company's auditors, and that all of the adjustments had proper documentation. You suspect, but do not know, that the policies were changed so that the company could recognize more revenue and report a strong performance for the year and pay its senior executives cash bonuses. Existing draft language in the 10-K explains the change in the company's revenue recognition policies. You revise that language to underscore that the policies were changed at year end which permitted the company to recognize significant additional revenues and that bonuses were paid to the executive management team on the basis of the company's financial results for the year. The General Counsel includes your proposed revisions in the draft 10-K circulated to the CEO and to the Audit Committee of the company's Board. At the invitation of the Audit Committee, you attend its meeting where the draft 10-K is reviewed. You explain your concerns regarding the timing and effect of the changes to the company's revenue recognition policies and caution that the 10-K could be incomplete if it fails to clearly explain the effect of the changed policies on the company's revenue stream. The Audit Committee responds that these policy changes had been under consideration for almost a year and were closely vetted by the company's external auditor and that the company had baked the expected additional revenue into its financial projections for the year. It declines to accept your suggested disclosures.
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Originally published in the April 14, 2014 edition of Bloomberg BNA's Securities Regulation & Law Report, Vol. 46, No. 711.
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