By George Wilson
In this post we explored an SEC enforcement case related to ICFR. In that case MetLife reported that they had two material weaknesses and that as a result their ICFR was not effective. The relevant section of their December 31, 2017 Form 10-K ICFR report said:
Management evaluated the design and operating effectiveness of the Company’s internal control over financial reporting based on the criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO framework”). Solely because of the material weaknesses in internal control over financial reporting described below, in the opinion of management, MetLife, Inc. did not maintain effective internal control over financial reporting as of December 31, 2017.
A related question that must be addressed when there is a material weakness in ICFR is whether or not the company’s Disclosure Controls and Procedures (DCP) are effective. As a reminder, Exchange Act Rule 13a-15 defines DCP:
(e) For purposes of this section, the term disclosure controls and procedures means controls and other procedures of an issuer that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Act (15 U.S.C. 78a et seq.) is recorded, processed, summarized and reported, within the time periods specified in the Commission's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Act is accumulated and communicated to the issuer's management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
DCP clearly applies to an entire report. In a Form 10-K or 10-Q DCP applies to all the non-financial statement disclosures but also to the financial statements. This means that ICFR is essentially a subset of DCP. If a company has a material weakness in ICFR, and ICFR is a subset of DCP, how does that material weakness affect the effectiveness of DCP? Most likely, unless you can demonstrate otherwise with compensating controls or other factors, the company’s DCP are not effective either. Hence, this was MetLife’s DCP report in their December 31, 2017 Form 10-K:
Evaluation of Disclosure Controls and Procedures
The Company maintains disclosure controls and procedures as defined in Rule 13a-15(e) under the Exchange Act that are designed to ensure that information required to be disclosed in the Company’s reports filed under the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules, and that such information is accumulated and communicated to Company management, including the CEO and CFO, as appropriate, to allow timely decisions regarding required disclosure.
Company management, including the CEO and CFO, evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-15(b) under the Exchange Act as of December 31, 2017, the end of the period covered by this Annual Report on Form 10-K. Based on such evaluation, the CEO and CFO concluded that the disclosure controls and procedures were not effective due to the material weaknesses in internal control over financial reporting described below.
As always, your thoughts and comments are welcome!