The number of material weakness reported by public companies ticked up in the final months of 2018, but new announcements and comments by CFOs during first-quarter earnings calls show that senior-level financial executives continue to focus on remediation of control issues going into 2019.
The number of material weaknesses reported by public filers ticked up 3% in the fourth quarter of 2018 when compared to the previous quarter, according to the FERF/Greenlight ICFR Tracker. Material weaknesses were detected within 23% of 5,600 reports, or 1,276 filings, reviewed by Greenlight Technologies from the U.S. Securities and Exchange Commission (SEC).
Growing Pains & Internal Controls
Material weaknesses and internal controls issues were most often seen in filers with less than $1 million in revenue and in their first year as a public company. In fact, over 60% of the material weaknesses reported in the quarter were from companies with little or no revenue, according to the ICFR Tracker.
Growing into a robust ICFR process can be a struggle for fast-growing companies where management has spent a majority of its time building products and sales rather than accounting systems and controls.
For example, Maxar Technologies said that it discovered a material weakness in its internal controls over financial reporting and said that it was “attributable to the amount of change being managed in 2018, our first year under SOX requirements.”
“[When] you read the opinion on internal controls, you will see a reference to just all the change that occurred during the course of the year,” said Biggs Porter, executive vice president and Chief Financial Officer for Maxar during
its fourth quarter earnings call. “The real challenge for us was the degree of change we were managing, which means controls actually changed during the course of the year, which made this very challenging to execute to perfection.”
Biggs became more specific, saying that new SOX filers will need to understand not only if the controls work but if they are the correct controls.
“There were concerns about us, specifically whether or not we identified all the controls we rely upon with respect to revenue recognition on EACs (Estimate at Completion), but once again it's a matter of did we identify all the right controls and test them? You can fail on that point even if you have the controls in place,” Porter concluded.
Remediation In The Spotlight
Companies with over $1 billion in revenue faced their own challenges and saw a significant jump. The number of these companies reporting a material weakness rose from 37 to 46 (a 24% increase) between the third and fourth quarter of 2018.
The increase is noteworthy, considering in February the SEC settled charges with four public companies for failing to maintain adequate internal control over financial reporting. In the
announcement the regulator emphasized that remediation of control issues will be a significant focus of 2019.
“Adequate internal controls are the first line of defense in detecting and preventing material errors or fraud in financial reporting,” said SEC Chief Accountant Wesley Bricker in a statement. “When internal control deficiencies are left unaddressed, financial reporting quality can suffer.”
Addressing internal control issues will continue to be a necessary focus area for issuers.
“We continue to make good progress on the remediation of this issue and expect to report in our 2018 Form 10-K later this month, the lifting of the related material weakness,” said MetLife CEO Steve Kandarian during his fourth quarter conference call in February 7. “At the same time, we also expect to report the lifting of the previously reported material weakness associated with over-reserving in our Japan variable annuity book.”
In the 10K, MetLife then detailed how it planned to remediate its reported material weaknesses, including enhanced procedures and controls, enhanced reconciliation, and changes in management.