TheCorporateCounsel.net

A recent Watchdog Research blog reports that there’s been a dramatic uptick in the use of Form 10-K/As as the vehicle for making initial disclosures of internal control deficiencies, going concern qualifications, and restatements.  According to the blog, over the past decade, an average of 19 ineffective internal controls disclosures, 3 going concern opinions and less than 1 non-reliance restatement were initially reported on Form 10-K/A filings during each year.  In contrast, so far in 2021, there have been 80 ineffective internal controls disclosures, 31 going concern opinions and 5 non-reliance restatements initially reported on Form 10-K/As.

The blog says that SPACs are driving the increased reliance on Form 10-K/As as the vehicle for these disclosures. They have accounted for 70 of the 80 10-K/A internal controls disclosures, 30 of the going concern opinions and all of the restatements this year.  The blog points to troubled electric vehicle start-up Lordstown Motors as the poster-child for this trend:

For public companies, it is not just about when the disclosure is made, but how it is made. We are seeing a concerning trend in 2021 where companies are waiting to make their initial disclosures of bad news such as going concern opinions, ineffective internal control disclosures, and financial restatements in an amended annual 10-K filings (10-K/As), instead of 8-Ks and other traditional methods and long after the original “clean” 10-K was filed with the SEC.

Lordstown Motors is an electric car company that went public via SPAC. On June 8th, Lordstown Motors filed a 10-K/A, more than two months after it released its annual report on March 25th. As reported by Francine McKenna in The Dig, Lordstown disclosed a going concern opinion, an ineffective internal control assessment by management, and two subpoenas from the SEC (indicating that the SEC was conducting a formal investigation, not an informal inquiry). Lordstown also disclosed that their restatement announced in May would include an additional charge of $23.5 million, perhaps what tipped it into the “going concern” warning range.

The blog characterizes SPACs approach to making initial disclosures of this “bad news” trifecta in 10-K/A filings as “novel” and “a bit sneaky.” The approach is definitely novel, but I’m not so sure that it’s sneaky. That’s because these disclosures were themselves prompted by a novel set of circumstances – namely, the SEC’s highly publicized guidance on the proper accounting treatment of SPAC warrants & the consequences of that guidance.

This guidance prompted almost 90% of SPACs to restate their financial results. I’m guessing that for most SPACs, the 10-K/A disclosures concerning internal controls deficiencies and the addition of going concern qualifications were a direct result of those warrant restatements. A conclusion that internal controls were deficient flows almost inevitably from a decision to issue a non-reliance restatement, and the going concern opinions may (as in the case of Lordstown Motors) have been prompted by the financial statement impact of the warrant restatements.

I can see why a company might not feel compelled to disclose an inevitable internal control deficiency when it filed an 8-K announcing a non-reliance restatement.  A decision to defer disclosure of a going concern qualification would be more troubling, assuming the company knew that such a qualification would be required. But in the case of the warrant restatements, it’s not clear when many SPACs first became aware of this issue. The decision to add a going concern qualification sometimes turned on the results of a complex valuation process, and was likely the last piece of the puzzle to be completed before the 10-K/A was filed.

It does seem inappropriate to defer reporting a decision to restate financials until the filing of Form 10-K/A that includes those financials. If a company decides that its financial statements need to be restated & should no longer be relied upon, it has to file an Item 4.02 Form 8-K. Five SPACs apparently didn’t – but that’s out of a universe of more than 500 SPAC restatements and more than 300 non-reliance restatements.

– John Jenkins