August 31, 2005

KPMG and Deferred Prosecutions

The deferred prosecution of KPMG by the U.S. Department of Justice regarding KPMG’s sale of abusive tax shelters to individuals continues to receive quite a bit of press. A “deferred prosecution” agreement is an agreement under which the government can still seek an indictment of the firm until if it violates the settlement during a certain period of time (in KPMG’s case, until the end of 2006). The government is increasingly turning to deferred prosecutions as a means of protecting jobs and businesses.

We have posted a copy of KPMG’s 28-page deferred prosecution agreement in our “Securities Litigation” Practice Area, where there also is this Wachtell Lipton memo on Bristol Myer’s recent deferred prosecution agreement.

Interestingly, the PCAOB put out this statement about how it remains confident in KPMG’s ability to perform high quality audits of public companies. In comparison, the SEC Chief Accountant’s statement on KPMG is much more “regulator-like” in tone – notably, it states that KPMG’s prior conduct “does not require or call for Commission action.”

Sorry About that Reg FD Gaffe

As I wrote this Reg FD blog yesterday, I heard this voice call out, “dude, you need a Reg FD refresher.” Sure enough, I received a few emails from astute members providing that refresher. Here is one of them: “You may have slipped down a slope. FD does not prevent all privileged access: only those to the enumerated financial audience. No problem showing a sneak preview to a bunch of movie reviewers, or telling a reviewer that you’ve signed Brad (aren’t the reviewers like any news reporters – ok under FD) or even to showing it to a bunch of randomly selected college students, but if you are showing the movie to analysts, there is only one reason. Yes, they may be taking all of the fun out of the analysts’ jobs, but it doesn’t seem like a stretch.”

FASB Reexamines GAAP Hierarchy

One of the first things I did when I got this job was post an explanation of the GAAP hierarchy, because that was always a confusing concept to me when I began my career as a corporate & securities lawyer – that explanation is posted in our “Accounting Overview” Practice Area.

Now, the FASB is considering changing the GAAP hierarchy, as noted by in this article – which I repeat: “These days, it’s rare to find an accounting standard that’s not awash in some type of controversy. But with its latest initiative, the Financial Accounting Standards Board has finally given Corporate America nothing to gripe about.

FASB insists that its proposed standard, The Hierarchy of Generally Accepted Accounting Principles, should have little or no impact on the practice of preparing financial statements, in part because it has been effective for decades under the American Society of Certified Public Accountants. The AICPA established the five levels of hierarchy in 1975 in Statement on Auditing Standard No. 69, which defines GAAP and provides accountants with guidance on where to turn for answers to certain questions: FASB standards, the Emerging Issues Task Force, and so on.

FASB and many other practitioners, however, have maintained that the board should issue its own standard, directed at companies and other reporting entities — which, after all, are responsible for selecting the accounting principles used in their financial statements — in place of the current standard, which is directed at auditors. In FASB parlance, its proposal “moves the GAAP hierarchy for nongovernmental entities from the auditing literature to the accounting literature.”

Former FASB chairman Dennis Beresford observes that after all the “earth-shattering changes” introduced over the past couple of years, the business community will likely welcome the board’s latest statement with a sigh of relief. Beresford, now an accounting professor at the University of Georgia, recalls that during his tenure at FASB, accountants would often joke with him that every once in a while, the board should “do something that isn’t controversial.” The hierarchy project comes pretty close, he says.

Last Wednesday the board reexamined certain areas of its exposure draft; for the most part, the board members stood by their conclusions and the staff recommendations. The one big issue that arose, as it did last November, concerned the elimination of an exception to Rule 203 of the AICPA Code of Professional Conduct. That exception allows auditors to deviate from the GAAP hierarchy in unusual circumstances — essentially, only when adhering to the GAAP pronouncements would render a company’s financial statements misleading.

Beresford, for one, cannot remember a case where the exception has been invoked. The issue has disappeared over the years, he says, “in part because accounting firms didn’t want to stick their neck out” and risk legal backlash.

Although 8 of the 32 respondents to FASB’s exposure draft on the GAAP hierarchy argued that the Rule 203 exception should be retained, FASB board member G. Michael Crooch says that, in the end, “we determined that we would stick to our guns” and eliminate the exception. It “was almost never used,” maintains Crooch, adding that it’s very hard to come up with those “unusual circumstances” that would make financial statements misleading and the GAAP literature inappropriate.

Under the proposed rule, FASB’s statement on the GAAP hierarchy will be effective for periods beginning after September 15. The date was chosen to coordinate with the effective date of literature from the AICPA and from Public Company Accounting Oversight Board that will be amended as a result of FASB’s statement.”