Materiality: No, the SEC did not write SAB No. 99

Corporate Counsel serves up a mostly excellent article, Securities Law Disclosure Checklist for Alleged (or Confirmed) Misconduct. It outlines disclosures that public companies should consider regarding alleged misconduct by employees, directors, or officers (e.g., “accounting improprieties, disclosure failures, criminal or civil actions involving the company and/or management, scandalous personal indiscretions, threatened disciplinary actions, fraud, false statements, or omissions, bribery or forgery”).

I say “mostly excellent” because, while the checklist is comprehensive and helpful to both companies and prospective whistleblowers, it unfortunately perpetuates the oddly popular myth that SEC Staff Accounting Bulletins (a.k.a. “SABs”), like SAB No. 99 dealing with materiality, are promulgated by the SEC and, therefore, are binding legal rules:

“In Staff Accounting Bulletin 99, the SEC also noted. . .” blah, blah, blah.

The SEC noted no such thing. As each and every SAB bears explicit witness, SABs are not binding partly because the SEC specifically disavows each of them with this preface:

The statements in the staff accounting bulletins are not rules or interpretations of the Commission, nor are they published as bearing the Commission’s official approval. They represent interpretations and practices followed by the Division of Corporation Finance and the Office of the Chief Accountant in administering the disclosure requirements of the Federal securities laws.*

Under the Fifth Amendment and the Administrative Procedure Act, so-called legislative regulations can only come into being through due process development that includes public notice and opportunity to comment. If the SEC were to so decide, it might be able to sneak by with interpretative regulations, thanks in no small part to the Supreme Court’s 2015 decision in Perez v. Mortgage Bankers Assoc. So far, however, on a number of important disclosure topics, including materiality and revenue recognition, the SEC has studiously avoided promulgating any regulations at all.

Thus, left to their own devices, SEC staff have taken the easy way out, engaging in a form of extra-legal self-help by drafting SABs, which they cook up behind closed doors with zero input from financial market constituents (investors and registrants). This is why SABs are called “Staff Accounting Bulletins.”

The distinction between legitimate SEC rules and ersatz SABs is not trivial. Rules that emerge from the crucible of notice and comment would undoubtedly differ significantly from the contents of the SABs, Wanda Wallace observed in 2007.** Investors and SEC registrants need and deserve better, legitimate regulatory guidance than the SABs. Meanwhile, the SEC should get no credit for binding regulations it has not drafted.

* See, e.g., SAB No. 99, See also Kurt S. Schulzke, Wink, Wink, Nudge Judge: Persuading U.S. Courts to Take Accountants Seriously in Federal Securities Cases with Help from the U.K. Companies Act, 16 Tenn. J. Bus. L. 231, 267 (2015) ,  (noting the disturbing appearance of this SEC mythology during Jeff Skilling’s Enron trial and in other securities cases); Kurt S. Schulzke, Gerlinde Berger-Walliser & Pier Luigi Marchini, Lexis Nexus Complexus: Comparative Contract Law and International Accounting Collide in the IASB–FASB Revenue Recognition Exposure Draft, 46 Vand. J. Trans. L. 515, 524 (2013) (similar).

** Wanda A. Wallace, Commentary: With or without due process?, ACCT. TODAY, Nov. 26, 2007, n.p. (decrying multiple SABs for their negative impact on the quality of financial information).


Doctor’s orders: Follow Georgia advance directives!

When it comes to following orders, MDs don’t have the best track record. This brings to mind advance directives for health care. They’re touted as estate plan essentials but do they really work? It turns out that their practical impact depends on the willingness of healthcare providers to read and heed what patients write.

In her excellent book, The Nurses, Alexandra Robbins contends that medical personnel pay little attention to advance directives, especially if hovering family members are demanding that grandpa be kept alive. After all, who is more likely to sue? A patient on indefinite life support or a grieving daughter?

The Georgia Supreme Court explored this touchy territory in a 2016 drama featuring very busy medical doctors, a terminally ill nonogenerian patient, a hospital whose advance directives policy was not followed, and a very unhappy granddaughter.

Spoilers: In Doctors Hospital of Augusta v. Alicea (S15G1571, July 5, 2016), the Court held that advance directives and health care agent instructions are mandatory reading for doctors, and that a good faith attempt to follow them is a prerequisite to any immunity for failure to so do under OCGA § 31-32-10. For more details, read on.

In November 2009, Alicea’s grandmother, Bucilla Stephenson, executed an advance directive authorizing Alicea to consent to or refuse any medical treatment for Stephenson. It also specifically warned health care providers not to prolong her life (1) when she had an incurable and irreversible condition that would result in her death within a relatively short period of time; (2) when she became unconscious and, to a reasonable degree of medical certainty, would not regain consciousness; or (3) when the likely risks and burdens of treatment outweighed the expected benefits.* While the directive did not list specific medical technology, Stephenson told family members that no “machines,” including ventilators, were allowed.

On March 3, 2012, at age 91, Stephenson was admitted to the hospital and diagnosed with pneumonia, sepsis, and acute renal failure. On admission, she was disoriented and marginally responsive. Alicea gave the hospital a copy of the advance directive and the hospital placed it in Stephenson’s medical record.

The next day, March 4, Alicea reminded the treating surgeon, Dr. Catalano, of the advance directive and told him not to administer CPR or other heroic measures. Later the same day, she reiterated these instructions to a Dr. Joseph, adding that neither intubation nor mechanical ventilation should be used. Dr. Joseph duly noted these instructions in Stephenson’s treatment progress notes.

On March 5, Dr. Catalano–who had read neither the progress notes nor the advance directive–called Alicea to get approval to drain fluid from Stephenson’s chest cavity. He did not tell her that intubation would be required. After the procedure, Stephenson was extubated. Later, after Stephenson’s condition worsened,  on March 7 at about 4:50 a.m., Dr. Catalano again ordered Stephenson intubated without informing Alicea or seeking her approval.

When Alicea arrived later that morning, she was faced with choosing between affirmatively removing her grandmother’s life support or allowing it to remain in place. She told the hospital that having forced this choice on her, the hospital would be responsible for Stephenson’s care from that point forward. She remained in the ICU until March 14, when she was disconnected from the ventilator, and died on March 17.

Alicea, as administrator of Stephenson’s estate sued Doctors Hospital, LLC and Dr. Catalano, seeking compensatory and punitive damages, attorneys fees, and expenses of litigation. The defendants moved for summary judgment, arguing that the intubation and ventilation were immune from liability under OCGA § 31-32-10. The trial court disagreed, denying summary judgment because the defendants’ good faith was a disputed question of material fact to be decided at trial. The Georgia Court of Appeals affirmed; the Supreme Court agreed:

[I]t is clear that the Defendants were properly denied summary judgment on their immunity claim . . . The health care decision in question is the decision to intubate Stephenson and put her on a ventilator as a life-prolonging measure around 4:00 a.m on the morning of March 7, 2012. Although there is evidence to the contrary, there is ample evidence that in ordering that procedure, Dr. Catalano was not acting in good faith reliance – in honest dependence – on any decision Alicea had made as Stephenson’s health care agent . . . Instead, the evidence would support a finding that Dr. Catalano made the health care decision himself, in the exercise of his own medical and personal judgment. By his own account, when he directed the on-duty doctor to intubate Stephenson, he was not considering the stuff of advance directives and health care agents . . . he decided himself “what’s right for the patient,” and would check with Alicea later to see if she wanted to . . . “pull the tube out.” Dr. Catalano even rebuffed a nurse’s question about calling Alicea before ordering the intubation, saying that he would call her later “and tell her what happened.”

As discussed above, the Advance Directive Act is all about letting patients and their health care agents, rather than the health care provider, control such decisions. Also reflected in many provisions of the Act is a principle that Dr. Catalano apparently disagreed with – that the patient and her agent may see a real difference between passively allowing her life to slip away and requiring a loved one to make the affirmative decision to “pull the plug” and halt life-sustaining measures like mechanical ventilation so that the patient dies. . .

Because there is at least a disputed issue of fact as to whether Dr. Catalano acted with good faith reliance on any decision made by his patient’s health care agent, Dr. Catalano cannot on motion for summary judgment claim the immunity that subsections (a) (1), (2), and (3) give to providers who honestly depend on such a decision . . .

What about the hospital? Did Dr. Catalano’s disregard of hospital policy and Alicea’s instructions immunize the hospital from liability? To this, the Court answers with a firm “no”:

Likewise, the Hospital points to no evidence that its staff acted based on a decision by Alicea with respect to the March 7 intubation; when Dr. Catalano made the decision himself, the staff simply proceeded based on his directive.

Finally, the Court offered an alternative theory on which the defendant’s summary judgment motion should be denied:

There is also another straightforward ground for rejecting immunity under subsections (a) (2) and (3). . . [T]hose provisions immunize providers who are unwilling to comply with a health care agent’s directive, promptly inform the agent of that unwillingness, and take other steps regarding the patient’s care until a transfer can be effectuated. There is no evidence that Dr. Catalano and the Hospital staff were unwilling to comply with Alicea’s direction regarding intubating Stephenson, much less that they promptly communicated any such unwillingness to Alicea. If anything, the Defendants claim that they believed they were complying with Alicea’s directive, which would invoke immunity under subsection (a) (1).

Bottom line: Doctors and hospitals beware! Georgia takes advance directives and patient health care agents seriously. Every complete estate plan should include include an advance directive but patients or their healthcare agents should communicate clearly with healthcare providers to ensure that directives and agent instructions are followed.

* These instructions in Stephenson’s advance directive require several data-dependent probabilistic judgments–e.g., whether a patient will not regain consciousness “to a reasonable degree of medical certainty,” and whether treatment risks and burdens outweigh expected benefits–that will be discussed in a future blog post. Bayesian data talk incoming!

Happy Fourth, America!

Happy Fourth! Just watched The Perfect Game, a remarkable movie based on a true story that captures the American dream at its best. America’s game — yes, baseball — played (mostly) by the rules. Immigrant* underdogs win through sheer grit, pluck, and faith against enormous odds.

*Technically speaking, the kids in this story were not yet immigrants. But some of them later played professional baseball in the United States and most likely became immigrants at that time.


About that new FASB revenue recognition standard . . .

This morning, I made a short presentation on the new FASB-IASB revenue recognition standard, Revenue From Contracts With Customers, now at FASB Codification Topic 606. The slides appear below this post.

At the moment, Topic 606 will be effective for public company year ends beginning on or after January 1, 2017. We’ll see whether this effective date holds. Either way, a deeper dive on the new standard is available from three sources:

(a) Lexus Nexis Complexus: Comparative Contract Law and International Accounting Collide in the IASB-FASB Revenue Recognition Exposure Draft, co-authored by Gerlinde Berger-Walliser, Pier Luigi Marchini, and yours truly, now available online at the Vanderbilt Journal of Transnational Law;

(b) BNA’s Special Report, Navigating the New Road to Revenue Recognition by Lisa Starczewski; and

(c) FASB’s own Topic 606. It’s definitely not user-friendly — except, perhaps, to creative plaintiff’s counsel — but it’s big and it’s threatening.


Brief Overview of the New FASB-IASB Revenue Recognition Standard


SEC loses laptops. IRS, EPA lose emails. CDC loses Ebola. What next?

SEC OIG Laptop Report

What times are these when supposedly uber-competent government agencies lose control of, well, mission-critical stuff like laptops, emails, and deadly viruses? What’s next?

The SEC OIG says hundreds of laptops are unaccounted for. The good news is that OIG has disclosed they’re missing. Bad news? While the IRS and EPA “lose” only emails, the SEC loses entire laptops. More good news: These laptops almost certainly don’t carry Ebola. More bad news: SEC laptops should contain lots of really sensitive information about ongoing investigations and the people involved, most of whom will never be accused — let alone found guilty of or liable for — any wrongdoing. Kind of like securities law Ebola. Not to mention the possibility of lots of inside information, possibly including the identity of SEC whistleblowers.

Read the entire OIG report below.

SEC OIG – Laptops Missing

Statistician wins big with SAS 9.3 in False Claims Act case

Statistics and SAS 9.3 were big winners yesterday, in U.S. District Court for the Eastern District of Tennessee. In United States ex. rel. Martin v. Life Care Centers of America (1:08-cv-251), the court denied, after its own detailed analysis of proffered expert testimony, a defense motion to exclude the government’s testifying expert statistician, Dr. Constantin T. Yiannoutsos.

In this federal False Claims Act case, Dr. Yiannoutsos was hired to “estimate the number of claims submitted for non-covered services to Medicare or TRICARE that were provided by skilled nursing facilities (“SNF”) owned or operated by Life Care and to estimate the total overpayment by Medicare and TRICARE.”

To prepare his report and testimony, Yiannoutsos used SAS 9.3 to analyze six government data sets relating to 127,641 unique Medicare beneficiaries and 392,562 claims, all of which had a “positive claim paid amount” with values ranging from $0.05 to $44,617.87, plus 4,074 TRICARE beneficiaries and 10,960 unique claims, all with a “positive claim paid amount” with values ranging from $1.72 to $109,433.77. “Big data” called for a robust statistical solution. Dr. Yiannoutsos delivered.

Over defense objections to Yiannoutsos’ government-imposed sample size (400) and his own statistical methods and approach to the project, the court found in his favor, clearing him to testify if the case proceeds to trial:

Based on the reports submitted, the Court finds that Dr. Yiannoutsos is an expert proposing to testify as to scientific knowledge of statistics, which will ultimately assist the trier of fact to determine facts at issue. See Fed. R. Civ. P. 104(a); United States v. Jones, 107 F.3d 1147, 1152 (6th Cir. 1997). The number of claims and the loss associated with those claims are certainly facts of consequence in this action, even if they are not specific elements under the FCA. These facts indicate the size and scope of the Government’s case, which further supports them being deemed relevant. Accordingly, consistent with Daubert, the Court finds that the proposed testimony and evidence is relevant to the instant case and would be helpful to the fact finder. As the Court has now concluded that Dr. Yiannoutsos’ testimony is both reliable and relevant, Defendant’s Motion will be DENIED.

 The full order appears below.

U.S. ex rel Life Care Centers of America 1:08-cv-251

Which changes in accounting principle are material?

What misstatements or omissions are “material” and which are not?  With the recent roll-out of the SEC’s new whistleblower regulations, it is a popular question among companies and prospective whistleblowers.  This brief summary offers insights into this important topic as it applies to changes in accounting principle.

First, despite recent IFRS rumblings, SEC regulations require U.S.-based registrants (known as “domestic issuers”) to follow U.S. Generally Accepted Accounting Principles (a.k.a. “U.S. GAAP”).   The SEC is currently seeking input regarding a possible future move to International Financial Reporting Standards (“IFRS”) promulgated by the International Accounting Standards Board (“IASB”).  However, for now, U.S. GAAP is still published by the U.S.-based and controlled Financial Accounting Standards Board (“FASB”) through its Accounting Standards Codification (“Codification”).

Beyond U.S. GAAP as contained in the Codification, domestic issuers are also obligated to abide by the financial statement content standards prescribed by SEC Regulation S-X.  As a practical matter, issuers and their auditors tend to follow the technically non-binding opinions of SEC staff expressed through Staff Accounting Bulletins (“SABs”).

So what about changes in accounting principle?  At what point is a change material? Under U.S. GAAP, a presumption exists that an accounting principle once adopted shall not be changed in accounting for events and transactions of a similar type.[1] A change in the method of applying an accounting principle is considered a change in accounting principle. [2] Entities must report changes in accounting principle through retrospective application of the new accounting principle to all prior periods (including interim ones), unless it is impracticable to do so.[3]

Take mortgage banking, for example, an industry on the bleeding edge of the financial markets meltdown of 2007.  Issuers involved in the mortgage industry are required to disclose the method (aggregate or individual loan basis) used in determining the lower of cost or fair value of the mortgage loans carried on their balance sheets as assets.[4] An issuer who makes a material change in its method of accounting (including accounting for mortgage loans) must indicate the date of and the reason for the change and include as an exhibit in the first Form 10-Q filed subsequent to the date of an accounting change, a letter from the issuer’s independent accountants indicating whether or not the change is to an alternative principle which in the judgment of the accountants is preferable under the circumstances.[5]

For SEC purposes, a fact is material if there is a substantial likelihood that the fact would have been viewed by a reasonable investor as having significantly altered the “total mix” of information available.[6] While some financial market players — including some auditors — might prefer to define “materiality” solely with reference to an item’s numeric magnitude (because percentages make much better bright lines), materiality must be assessed for SEC purposes with respect to quantitative and qualitative factors.   As a result, in numerous circumstances, misstatements below an arbitrary quantitative threshold — say 5%-of-basis — may be material.[7]

Potentially significant qualitative factors include whether (a) the misstatement masks a change in earnings or other trends; (b) whether the misstatement affects the registrant’s compliance with regulatory requirements; (c) whether the misstatement affects the registrant’s compliance with loan covenants or other contractual requirements; (d) whether the misstatement involves concealment of an unlawful transaction.[8]

As one hypothetical illustration, a $5,000 embezzlement by the president of a Fortune 100 corporation might seem numerically insignificant in relation to the company’s balance sheet or income statement.  However, the fact that the president was involved in the embezzlement suggests serious weaknesses in the company’s governance and internal control systems and, therefore, would arguably be “material”.

Bottom line:  In assessing the materiality of a change in accounting principle (or any other aspect of an issuer’s SEC reports and disclosures), it is important to remember that easily quantified numbers and percentage thresholds are only a starting point for a thorough analysis.

[1] FASB Codification Topic 250-10-45-1.

[2] FASB Codification, Glossary.

[3] FASB Codification Topic 250-10-45-5 and 45-14.

[4] FASB Codification Topic 948-310-50-1, Financial Services, Mortgage Banking, Receivables, Disclosure.  This requirement has been in effect since the original issuance of FASB Statement No. 65 in 1982.

[5] Regulation S-X, Rule 10-01(b)(6).

[6] TSC Industries v. Northway, Inc., 426 U.S. 438, 449 (1976). See also Basic, Inc. v. Levinson, 485 U.S. 224 (1988).

[7] SEC Staff Accounting Bulletin No. 99.

[8] SEC Staff Accounting Bulletin No. 99.



Confidentiality agreements blocked by SEC Rule 21F-17

For whistleblowers and their past or present employers, one of the more important features of the SEC’s new whistleblower program regulations is Rule 21F-17,  copied in part below.  Over the years, targets of whistleblower claims have employed increasingly aggressive and sophisticated tactics — including “gag orders,” TROs, and breach of confidentiality agreement or even trade-secret-theft claims — to intimidate whistleblowers and prevent them from alerting regulators and law enforcement about wrongdoing.  Rule 21F-17 is a significant step toward ending such shenanigans and should encourage more SEC whistleblowers to come forward.

Among other things, Rule 21F-17 clearly prohibits any “person” from taking “any action to impede an individual from communicating directly with the Commission staff about a possible securities law violation, including enforcing, or threatening to enforce” most confidentiality agreements. (Emphasis added.)  Confidentiality agreements covering attorney-client privileged information are generally excepted from this ban under Rule 21F-4(b)(4). But even the 21F-4(b)(4) exceptions have exceptions outlined in 21F-4(b)(4)(v).

The bottom line: Attempting to silence a would-be SEC whistleblower is more dangerous now than ever before.  Employers would do well to carefully analyze the extent to which their “investigative” activities — which far too often include firing and suing the very whistleblowers who prompt such investigations — are themselves an additional violation of SEC Rule 21F-17.

§ 240.21F-17 Staff communications with individuals reporting possible securities law violations.

(a) No person may take any action to impede an individual from communicating directly with the Commission staff about a possible securities law violation, including enforcing, or threatening to enforce, a confidentiality agreement (other than agreements dealing with information covered by § 240.21F-4(b)(4)(i) and § 240.21F-4(b)(4)(ii) of this chapter related to the legal representation of a client) with respect to such communications.

(b) If you are a director, officer, member, agent, or employee of an entity that has counsel, and you have initiated communication with the Commission relating to a possible securities law violation, the staff is authorized to communicate directly with you regarding the possible securities law violation without seeking the consent of the entity’s counsel.

240.21F-4(b)(4) The Commission will not consider information to be derived from your independent knowledge or independent analysis in any of the following circumstances:

(i) If you obtained the information through a communication that was subject to the attorney-client privilege, unless disclosure of that information would otherwise be permitted by an attorney pursuant to § 205.3(d)(2) of this chapter, the applicable state attorney conduct rules, or otherwise;

(ii) If you obtained the information in connection with the legal representation of a client on whose behalf you or your employer or firm are providing services, and you seek to use the information to make a whistleblower submission for your own benefit, unless disclosure would otherwise be permitted by an attorney pursuant to § 205.3(d)(2) of this chapter, the applicable state attorney conduct rules, or otherwise; or …

(iii) In circumstances not covered by paragraphs (b)(4)(i) or (b)(4)(ii) of this section, if you obtained the information because you were:

(A) An officer, director, trustee, or partner of an entity and another person informed you of allegations of misconduct, or you learned the information in connection with the entity’s processes for identifying, reporting, and addressing possible violations of law;

(B) An employee whose principal duties involve compliance or internal audit responsibilities, or you were employed by or otherwise associated with a firm retained to perform compliance or internal audit functions for an entity;

(C) Employed by or otherwise associated with a firm retained to conduct an inquiry or investigation into possible violations of law; or

(D) An employee of, or other person associated with, a public accounting firm, if you obtained the information through the performance of an engagement required of an independent public accountant under the federal securities laws (other than an audit subject to §240.21F-8(c)(4) of this chapter), and that information related to a violation by the engagement client or the client’s directors, officers or other employees.

(iv) If you obtained the information by a means or in a manner that is determined by a United States court to violate applicable federal or state criminal law;

(v) Exceptions. Paragraph (b)(4)(iii) of this section shall not apply if:

(A) You have a reasonable basis to believe that disclosure of the information to the Commission is necessary to prevent the relevant entity from engaging in conduct that is likely to cause substantial injury to the financial interest or property of the entity or investors;

(B) You have a reasonable basis to believe that the relevant entity is engaging in conduct that will impede an investigation of the misconduct; or

(C) At least 120 days have elapsed since you provided the information to the relevant entity’s audit committee, chief legal officer, chief compliance officer (or their equivalents), or your supervisor, or since you received the information, if you received it under circumstances indicating that the entity’s audit committee, chief legal officer, chief compliance officer (or their equivalents), or your supervisor was already aware of the information.

Sharing PHI with attorneys: OK under HIPAA?

The single largest group of health care whistleblowers are health care workers themselves — nurses, doctors, dentists, therapists and billing professionals — who encounter fraud on the job.  Do such health care workers violate HIPAA by disclosing patient protected health information (“PHI”) when blowing the whistle?  There is no need for them to do so.  Naturally, it helps to work with knowledgeable legal counsel from an early stage in the process.  Continue reading

“Right GAAP” and the move to IFRS

Whenever “risk-management” professionals characterize their prognostications as near-certain, I get nervous.  Memories of the Berlin Wall, Black-Scholes, Long-Term Capital Management, Salomon Brothers and AIG dance before my eyes.  Today’s exhibit A: Bruce Pounder’s September 2, 2010 article, “Why the SEC Won’t Flip the IFRS Switch.”

Pounder’s “most significant” point — that “for the SEC to order a switch from future U.S. GAAP to future IFRS despite substantial differences … the SEC would have to conclude that the FASB and its standard-setting predecessors completely failed to get U.S. GAAP ‘right'” — embodies a whopping non sequitur.*  Why? Among other things, there is no “right” GAAP any more than there is “a” right spelling of “grey”. Continue reading