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  • Writer's pictureDaniel Goelzer

Cornerstone: Accounting Class Actions and Enforcement Cases Continue Their Upward Trend

Cornerstone Research has issued three reports on litigation involving accounting and auditing violations.  Together, these reports indicate that these cases are increasing, as are the costs of resolving them. 

 

In its annual report on accounting-related class actions, Accounting Class Action Filings and Settlements—2023 Review and Analysis, Cornerstone finds that the number of class action filings against public companies for alleged accounting violations increased 10 percent last year compared to 2022.  The dollar value of accounting class action settlements rose 11 percent, even though the number of settlements fell.  Cornerstone's annual analysis of Securities and Exchange Commission accounting and auditing enforcement cases, SEC Accounting and Auditing Enforcement Activity—Year in Review: FY 2023, reports that the SEC brought 83 accounting and auditing enforcement actions in FY 2023, a 22 percent increase over FY 2022 and the highest number of actions initiated since FY 2019.  Cornerstone also reports that, in FY 2023, the Public Company Accounting Oversight Board expanded its auditing enforcement activity to the highest level since 2017 and that PCAOB monetary penalties set a record. See PCAOB Enforcement Activity—2023 Year in Review.  (For a summary of last year’s Cornerstone reports on accounting class actions and SEC accounting enforcement, see Accounting Class Actions are Increasing Slowly While SEC Accounting Cases are Skyrocketing, May-June 2023 Update.)

 

Accounting Class Action Filings and Settlements

 

Cornerstone found that, in 2023, plaintiffs filed 56 new class actions against public companies alleging accounting violations, a 10 percent increase from the 51 filings in 2022.  While an uptick from 2022, the 56 cases brought in 2023 were significantly below the 2014-2022 average of 62 new filings per year.  

 

Although fewer accounting class actions were settled in 2023, the cost of settlement rose considerably.  There were 35 accounting class action case settlements in 2023, down from 43 settlements in 2022 and well below the average of 42 settlements per year during 2014-2022.  Despite fewer cases settling, the total value of accounting case settlements increased from $1.4 billion in 2022 to $1.6 billion in 2023, and the average settlement amount rose from $33.3 million to $45.7 million.  The total value of accounting-related settlements, as a percentage of the value of all securities class action settlements, rose from 36 percent in 2022 to 41 percent in 2023.

 

Other key takeaways from the Cornerstone accounting class action report include:

 

  • Most accounting class action cases are eventually dismissed or settled, but it takes time.  From 2014 through 2022, 41 percent of accounting case filings were settled, 43 percent were dismissed, 1 percent were remanded, and 15 percent are continuing. In 2023, the median time from filing to settlement was 4.2 years, the longest since Cornerstone began its tracking in 1995.

 

  • Plaintiffs are bringing and settling cases against smaller companies. The median pre-disclosure market capitalization of issuer defendants in 2023 accounting class actions was $719.3 million, 46 percent less than the 2014 to 2022 average and almost 30 percent less than the $1.04 billion median in 2022.  2023 was the first year in which the median market capitalization of issuer defendants in new accounting cases was below $1 billion.  The median pre-disclosure market capitalization of issuer defendants in cases that settled in 2023 also fell sharply.  In 2023, settling defendants had a market capitalization of $1.34 billion, compared to $2.48 billion in 2022. 

 

  • The industry sectors that attracted the most 2023 filings were Financials, Consumer Non-Cyclicals, and Consumer Cyclicals.  Accounting cases filed against companies in the Financial sector doubled in 2023 and represented over 15 percent of all filings. Companies in the Consumer Non-Cyclical and Consumer Cyclical sectors together were the defendants in over one-third of 2023 new cases.  (In 2022, filings against Consumer Non-Cyclical and Consumer Cyclical companies were nearly half of the total.)  While there were no cases against companies in the Communications sector in 2022, in 2023 plaintiffs filed five accounting class actions against Communications companies.  

 

  • Class actions involving restatements continued to increase.  Twenty-one (38 percent) of the 56 accounting cases filed in 2023 involved restatements. This was the highest percentage of restatement cases since 2014 and a continuation of the upward trend of restatement cases that began in 2022, after hitting a low of 5 cases (11 percent of filings) in 2021.  (The average number of restatement cases filed per year from 2014 to 2022 was 16.) 

 

  • Internal control weaknesses are growing in popularity as a basis for litigation.  The number of accounting case filings alleging internal control weaknesses increased from 25 (49 percent of all cases filed) in 2022 to 35 (62 percent of filings) in 2023.  Sixteen percent of new cases alleged only internal control weaknesses, nearly triple the share of internal-control-only cases in 2021. 

 

  • Revenue recognition is the most common alleged GAAP violation. In 2023, 38 percent of new case filings alleged only GAAP violations and 46 percent alleged both GAAP violations and internal control weaknesses.  The most common alleged GAAP violation continues to be improper revenue recognition, which was involved in  27 percent of 2023 accounting case filings. The other top GAAP violation allegations are asset valuation/impairments (20 percent) and liability/contingent valuation (16 percent).

 

SEC Accounting and Auditing Enforcement

 

As noted above, Cornerstone’s study of fiscal 2023 SEC enforcement found that the Commission filed 83 accounting and auditing actions, a 22 percent increase from fiscal 2022. This increase in the level of SEC accounting enforcement exceeded the eight percent increase in overall SEC 2023 cases.  Although 2023 was a busy year for the SEC’s accounting enforcement program, the level of activity remains below the 93 cases brought in 2019.  Also, some of the noteworthy features of the SEC’s 2022 enforcement efforts – such as the focus on individual defendants and auditors – seem to have moderated in 2023. 

 

Other interesting points in Cornerstone’s SEC accounting enforcement analysis include:

 

  • The SEC relies heavily on in-house proceedings, rather than actions in federal court. The Commission brought 71 of the 2023 accounting and auditing cases as administrative proceedings (i.e., before an in-house administrative law judge) and 12 as civil actions in federal court.  Sixty-six of the 71 administrative proceedings were settled simultaneously with the filing of the case.  The 12 civil cases included 25 defendants; actions against 14 of those defendants remained pending at the end of fiscal 2023. 

 

  • Announcements of restatements or material control weaknesses are fertile ground for SEC enforcement.  Of the 83 enforcement actions, 35 referred to announced restatements, and 32 referred to announced material weaknesses in internal control.  Thirty-one percent of the actions (26 cases) referred to both a restatement and an internal control material weakness, the highest level of such cases during the 2018-2023 period.  

 

  • Revenue recognition remained a popular enforcement topic.  Like its counterparts in the plaintiff’s bar, the SEC enforcement staff relies heavily on revenue recognition cases.  Seventeen of the 35 SEC enforcement actions that referred to restatements alleged improper revenue recognition.  Twenty-one cases combined allegations of revenue recognition violations with allegations of internal control violations.

  

  • The SEC’s enforcement focus on individuals abated somewhat, but senior officials are at risk.  In 2023, the SEC charged 59 individuals in its accounting/auditing cases.  This compares to 66 individuals charged in 2022.  The SEC named one or more individuals as defendants or respondents in 49 of the 83 accounting cases it filed (59 percent), and 42 percent of SEC accounting and auditing actions initiated in 2023 involved only individual respondents or defendants.  By comparison, in 2022, there were also 49 cases in which one or more individuals were charged, but those cases represented 72 percent of total accounting/auditing actions.  In 2022, 53 percent of the cases involved only individuals.  

 

While there were fewer individual defendants/respondents in 2023, those who were charged tended to hold senior positions.  Nearly half (46 percent) were CEO and CFO at the time of the alleged violation.  Moreover, of the 45 charged individuals who were associated with SEC registrants, 17 were members of the board of directors (12 of these were also CEOs).  Twenty of the 59 defendants/respondents were CPAs. 

 

  • Cases involving auditors declined.  Twenty-two auditors and audit firms were charged in SEC actions in 2023. This was lower than the FY2018-2022 average of 25 such defendants or respondents.  Fourteen of the 59 individuals in SEC 2023 accounting/auditing cases were auditors.

 

  • The monetary cost of settling an accounting case with the SEC declined.  In fiscal 2023, 119 respondents/defendants settled with the SEC.  In those settlements, 101 of the settling parties were required to make a monetary payment.  These payments totaled $583 million, down from $625 million in 2022 and $1.627 billion in 2021. Civil penalties accounted for 33 percent of the $625 million, while the remaining 67 percent was disgorgement of illegally obtained funds (54 percent) and prejudgment interest (13 percent).  Interestingly, these figures are the mirror image of 2022 when civil penalties were 67 percent of total monetary settlements and disgorgement and prejudgment interest were 33 percent.


PCAOB Enforcement


Cornerstone’s report on 2023 PCAOB enforcement finds that the Board publicly disclosed 46 enforcement actions in 2023.  (Board enforcement matters are confidential unless and until settled or otherwise concluded in the Board’s favor.)  Thirty-seven of those actions involved the performance of an audit (Auditing Actions), a 28 percent increase over 2022; non-auditing actions involved such matters as reporting violations or failure to cooperate with a PCAOB inspection or investigation. The Board assessed monetary penalties of $19.7 million – a record for a single year and nearly double the 2022 amount.  

 

Other highlights of Cornerstone’s PCAOB enforcement report include:

 

  • The PCAOB shifted its emphasis from individuals to firms.  In 2023, the Board charged 19 individuals and 34 accounting firms in the 37 Auditing Actions it disclosed in 2023.  This reflects a significant change in approach.  During the period 2018-2022, on average 37 percent of respondents were firms and 63 percent were individuals.  In 2023, 22 percent of cases involved a firm and one or more individuals, 11 percent involved individuals only, and 68 percent involved only a firm. 

 

  • The PCAOB is focusing on independence and firm quality control.  Approximately 25 percent of the 2023 Auditing Actions involved alleged violations of the auditor independence rules.  In contrast, none of the Board’s 2022 Auditing Actions included independence violations.  Fifty-seven percent of the 2023 Audit Actions included alleged violations of the PCAOB’s quality control standards, roughly the same as in 2022.

 

  • Individuals charged by the PCAOB are likely to be barred or suspended from auditing public companies or broker-dealers while firms are generally required to undertake remediation.  The PCAOB permanently or temporarily barred from auditing public companies or broker-dealers 85 percent of the individuals it charged; an additional five percent were suspended.  By comparison, 64 percent of individuals were barred and 16 percent were suspended in 2022.  For firms, 67 percent were required to undertake remedial actions and 15 percent were required to retain an independent consultant.  Twenty-one percent of firm respondents had their PCAOB registration (and therefore their ability to audit public companies and broker-dealers) permanently or temporarily revoked.   Similarly, in 2022, 24 percent of firms had their registration temporarily or permanently revoked and six percent were suspended. 

 

  • The Board is taking monetary penalties to a new level.  As noted above, the PCOAB imposed $19.7 million in monetary penalties in 2023, almost double the $10.5 million in 2022 and about 18 times the $1.1 million it assessed in 2021.  Monetary penalties imposed on firms were $18.8 million – 95 percent of the total. Two-thirds of the firm penalties were levied against non-U.S. firms.  The PCAOB imposed monetary penalties against every respondent in its 2023 cases, although almost 80 percent of the total monetary penalties were paid by just six respondents.  

 

Comment:  While the frequency of both class action and SEC enforcement accounting cases is not at all-time record levels, this type of litigation is increasing and remains a risk for public companies and their senior management.  (PCAOB enforcement actions are also increasing, although only accounting firms and their employees are subject to PCAOB enforcement.)  Moreover, the cost of settling class action cases, and the time required to do so, is also increasing.  As stated in several prior Updates, accounting issues are a significant line of attack for the plaintiff’s bar, and restatements and disclosure of internal control weaknesses are likely to attract litigation, if they coincide with a significant drop in stock price.  Investing in strong internal controls, along with audit committee care and diligence in overseeing the company’s financial reporting, is a small price to pay to reduce the risk that the company will be exposed to the cost and distraction of litigation over accounting matters.

 

Another significant Cornerstone finding that audit committees and financial reporting management should keep in mind is the SEC’s stepped-up focus on individual culpability. As noted above, while the number of individuals charged in SEC accounting cases fell somewhat in 2023, those that the SEC did charge tended to hold senior positions, such as CEO or CFO.  SEC Chair Gensler has publicly committed to holding individuals accountable for company violations.  The risk that restatements, internal control material weaknesses, and other accounting-related problems will result in SEC enforcement action against the individuals involved, along with or instead of the reporting company, is likely to remain elevated for the foreseeable future.

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