July 16, 2021

Internal Controls: “Red Flag” Events

This Audit Analytics blog discusses events concerning a company’s control environment that should serve as “red flags” for investors.  Nothing discussed in the blog is a surprise – material weaknesses in ICFR, weak disclosure controls, late filings and cybersecurity breaches all make the list. But the blog also walks through the reasons why each of these events are red flags, and the discussion is both succinct and useful. If you ever find yourself having to educate a new public company officer or director about the potential consequences of a late filing, you might find this excerpt on why a late filing is a red flag helpful:

A late or non-timely (NT) filing is a key indicator of the health of a company’s financial reporting and internal control environment. SEC filings, such as annual and quarterly reports, are required to be filed within a certain timeframe. As this is a continuous, recurring requirement, the inability for a company to file one of these periodic reports on time is a significant red flag.

Aside from a negative stock market reaction, late filings can impose other costs on shareholders. Timely filing of reports is a critical requirement, and a delinquent report can trigger debt covenant violations or regulatory penalties, including de-registration with the SEC. In the event of a prolonged failure to file, a company can eventually be delisted from its stock exchange.

While there is a litany of reasons a company may be unable to timely file a report – a recent auditor change, the new discovery of a material weakness in controls, the need to restate financial statements, etc. – it generally indicates other issues with financial reporting and the control environment and heightens the risk for adverse events in the future.

John Jenkins