June 21, 2005

The SEC’s Latest Take on Qualitative Materiality

A few weeks back, the SEC settled a civil enforcement action alleging that Huntington Bancshares (and its CEO, former CFO and former controller) engaged in financial reporting fraud in connection with the company’s 2001 and 2002 financial statements. The complaint also alleges failure to maintain accurate books and records and adequate internal controls, and the filing of materially false CEO and CFO certifications.

As noted in this Sullivan & Cromwell memo (posted in’s “Hot Topics Box” on the home page), the following points are of particular interest from this action:

– In assessing the materiality of the alleged accounting improprieties, the SEC focused on qualitative materiality factors. In particular, the SEC stressed that, while the increases in reported operating earnings resulting from the improper accounting methods may have been quantitatively fairly small (3% in 2001 and 5% in 2002), they were material because they enabled Huntington to meet or exceed Wall Street analysts’ earnings per share estimates and to meet internal EPS targets that determined management bonuses.

– The alleged improper accounting occurred despite Huntington and its management team having a due diligence and disclosure process in place, involving meetings at which senior management discussed the accounting treatment with, among others, external auditors and legal advisors. The SEC alleged that, in some cases, the defendants acknowledged in these meetings that the accounting was improper, but concluded it need not be changed because the errors were not material.

– In several cases, the alleged improper accounting was a continuation of accounting practices that were established years earlier – before the individual defendants were at the company – and were approved by outside auditors at the time of establishment and on an ongoing basis.

The bottom line is that qualitative materiality analyses are alive and well at the SEC. This case is a reminder that even very small percentage amounts can still be material under the circumstances.

Bona Fide CEO Succession & Selection Processes

With CEO succession in the news, there is much food for thought in this lengthy interview with Mark Van Clieaf on Bona Fide CEO Succession & Selection Processes. Mark is a key session leader for an upcoming August 8th symposium about the 5 Levels of Corporate Governance and related director strategic duties and liabilities to be held in Toronto.

Task Force Report on Private Placement Broker-Dealers

During last week’s meeting of the SEC Advisory Committee on Smaller Public Companies, some members noted a reference to an ABA Task Force Report on Finders that was recently published. This 71-page Report on private placement broker-dealers is quite interesting and comprehensive – and covers a wide range of issues, from M&A to litigation. It is posted under “Alerts” on the home page and in “Hot Topics Box.”