1

Presentation of the PCAOB’s Investor Advisory Group

Working Group on Going Concern

March 28, 2012

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Going Concern

Agenda 1. Overview – Anniversary of Sarbanes-Oxley Act2. History3. Current – Survey4. Recommendations

Working Group MembersPete Nachtwey, Chief Financial Officer, Legg MasonDamon Silvers, Director of Policy and Special CounselAnne Simpson, Senior Portfolio Manager, Investment and Director of Corporate Governance, CalPERSLynn E. Turner, Director, LitiNomics and former SEC Chief Accountant

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Going Concern

10 Year Anniversary Sarbanes OxleyThe Market Before and After

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Going Concern

Ten Year Anniversary of Sarbanes-OxleyWhat did we gain?

• Public Company Accounting Oversight Board• Regulatory oversight of Auditors• Section 404 Evaluation of Internal Controls• CEO/CFO Certification of Internal Controls• Improved Financial Reporting

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Going Concern

History

• Initiatives Over the Years • Going Concern Definition• Top 10 Bankruptcies, Top 10 Issuers – TARP• Going Concern Opinions• Financial Accounting Standards Board – Current

Requirements• Enforcement

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Going Concern

History – How we got to where we are…• Cohen Commission• New Standard proposed• CFA weighs in• New SAS 59, Effective 1989• SOP 94-6

– Exposure draft “watered down”

• O’Malley Panel – August 2000– FASB recommendations– SEC urges FASB to act -

• FASB Project– Proposal October, 2008– Project Revised to disclosures only in 2012

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Going Concern

Top Ten U.S. Bankruptcies 2001-2011 Top Ten Bankruptcies Issuers by Market Cap Sector

Bankruptcy Filing Date ICFR Effective

Going Concern

Opinion Signature Date After Bankruptcy Filing

ICFR Effective

Going Concern

Signing Auditor (Pre and Post Opinions)

Auditor Since

Lehman Brothers Holding ($639B) Financial 9/15/2008 Y N N/A N/A N/A E&Y 1990

WorldCom, Inc. ($103.9B)

Telecom 7/21/2002

N/A - though

designated Max risk 1999-2001 N N/A

N2004 N/A

Arthur Anderson/KPMG

1989 / engaged May 2002

General Motors ($91.05B) Industrials 6/1/2009 N

Y2009 4/7/2010

N2009 N D&T 1918

CIT Group ($80.45B) Financial 11/1/2009N

2004 N 12/10/2009 N

2010 N PWC 2001

Enron ($65.50B) Energy 12/2/2001 N/A N N/A N/A N/AArthur Anderson 1946

Conseco Inc.($61.4B) Financial/ Insurance 12/17/2002 N/A N 2003 Y

Y2003 PWC 1985

MF Global Holdings ($41.05B)

Financial Derivatives Broker 10/31/2011 Y N N/A N/A N/A PWC 2007

Chrysler ($39.30B) Auto 4/30/2009 Y N 04/30/2010 Y N D&T* 1947*

Thornburg Mortgage($36.5B)

Residential Mortgage Lending 5/1/2009 Y

Y2008 N/A N/A N/A KPMG 2006

Pacific Gas and Electric ($36.15B) Utility 4/6/2001 N/A

Y2000 - 2003 3/1/2002 Y

Y 2001,2002,

2003 D&T 1999

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Going Concern

Top Ten U.S.Issuers Receiving TARP Funds

Top Ten Issuers Receiving TARP Funds

Total Disbursed ($M)2

First Date of TARP Disbursement ICFR Effective

Going Concern

Opinion Signature Date After TARP Disbursement ICFR Effective Going Concern

Signing Auditor (Pre and Post Opinions)

Auditor Since

AIG4 69,835 9/16/2008 N N 3/2/2009 Y N PwC 1980

General Motors5 50,745 12/29/2008 N N 3/4/2009 N Y D&T 1918

Bank of America 45,000 10/28/2008 Y N 2/25/2009 Y N PwC 1984

Citigroup 45,000 10/28/2008 Y N 2/27/2009 Y N KPMG 1969

JPMorgan Chase 25,000 10/28/2008 Y N 2/27/2009 Y N PwC 1965

Wells Fargo 25,000 10/28/2008 Y N 2/23/2009 Y N KPMG 1931

Goldman Sachs 10,000 10/28/2008 Y N 1/22/2009 Y N PwC 1926

Morgan Stanley 10,000 10/28/2008 Y N 1/28/2009 Y N D&T 1997PNC Financial Services 7,579 12/31/2008 Y N 3/2/2009 Y N PwC 2006

U.S. Bancorp 6,599 11/14/2008 Y N 2/23/2009 Y N E&Y 2003

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Going Concern

Fiscal Year 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Going Concerns 2795 2998 2817 2552 2554 2709 2864 3300 3328 2994 2875

Total Auditor Opinions 16997 18819 17191 17766 16794 16784 16462 16610 15848 15395 15503

% of All Opinions 16.44% 15.93% 16.39% 14.36% 15.21% 16.14% 17.40% 19.87% 21.00% 19.45% 18.54%

NOTE – The majority of Going Concerns were issued for non-accelerated filers, i.e. 2010 -with only 46 for large accelerated filers, or < 3%, Audit Analytics, "Going Concern Overview”, July 2011

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 20100%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

16.4% 15.9% 16.4% 14.4% 15.2% 16.1% 17.4% 19.9% 21.0% 19.4% 18.6%

Going Concerns Per YearPercentage of Going Concerns% of Auditor Opinions with Going Concern Uncertainty

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Going Concern

Going Concern Percentages by Filer Status  

FiscalYear

 Large

Acc.  Filers

 Accelerated

Filers

Non-Accelerated Filers  Total

All Small Reporting Company (subset) Other (subset)

 Going

Concerns

 Total 

Auditor Opinions

 Percentage

 Going

Concerns

 Total 

Auditor Opinions

 Percentage

 Going

Concerns

 Total 

Auditor Opinions

 Percentage

 Going

Concerns

 Total 

Auditor Opinions

 Percentage

 Going

Concerns

 Total 

Auditor Opinions

 Percentage

 Going

Concerns

 Total 

Auditor Opinions

 Percentage

10 Partial 3 1657 0.18% 43 1739 2.47% 2590 11347 22.83% 2008 4019 49.96% 31 153 20.26% 2636 14743 17.88%

2009 7 1725 0.41% 67 1935 3.46% 2920 11735 24.88% 2291 4312 53.13% 65 181 35.91% 2994 15395 19.45%

2008 23 1951 1.18% 144 2175 6.62% 3161 11722 26.97% 1915 3675 52.11% 499 790 63.16% 3328 15848 21.00%

2007 7 2038 0.34% 85 2237 3.80% 3208 12335 26.01% 346 1055 32.80% 1820 2950 61.69% 3300 16610 19.87%

2006 4 1983 0.20% 77 2287 3.37% 2783 12192 22.83% 19 23 82.61% 1735 3071 56.50% 2864 16462 17.40%

2005 2 1326 0.15% 61 2760 2.21% 2646 12698 20.84% 12 14 85.71% 934 1946 48.00% 2709 16784 16.14%

2004 1 6 16.67% 56 3673 1.52% 2497 13115 19.04% 8 10 80.00% 456 1226 37.19% 2554 16794 15.21%

2003 0 1 0.00% 40 3492 1.15% 2512 14273 17.60% 7 9 77.78% 1280 2760 46.38% 2552 17766 14.36%

2002 0 1 0.00% 49 2473 1.98% 2768 14717 18.81% 2 6 33.33% 1393 3297 42.25% 2817 17191 16.39%

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Going Concern

Current Accounting Standards

• International Accounting Standards – IAS 1 Management shall make an assessment of an entity’s ability to continue as a going concern. Prepare financial statements on a going concern basis unless intend to liquidate or cease trading or no realistic alternative but to do so. Significant doubt on ability to continue as a going concern.

• Financial Accounting Standards Board - Currently no guidance in GAAP about going concern and/or the point in time at which an entity ceases to be a going concern

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Going Concern

FASB – Current requirements• FASB Statement No 107 – Requires disclosures about

Concentration of Credit Risk • SOP-94-6-1 Requires disclosures if the Concentration

makes the enterprise vulnerable to the risk of a near-term severe impact– Since hurdle was so high did not see disclosures– Risk and Uncertainties existing

• Nature of Operations• Use of estimates in the preparation of financial statement• Certain significant estimates• Current vulnerability due to certain concentrations

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Going Concern

Auditing Standards and Guidance

• PCAOB Auditing Standards – GAAS AU 341• International Auditing and Assurance Standards – ISA 570• European Commission – “Impact Assessment – Amending

Directive 2006/43/EC on statutory audits of annual accounts and consolidated accounts”

• Institute of Chartered Accountants in England & Wales – “Guidance for Directors of UK Companies 2009”

• American Institute of Certified Public Accountants – SAS 59 Redrafting

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Going Concern

Enforcement• Investors surprised by demise of companies during

financial crisis without warnings or red flags• Lack of going concern opinions• Lack of disclosure of enforcement actions – so far• Standards are only worthwhile when they are followed and

enforced

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Going Concern

Going Concern Survey • Respondents included investors, some of whom were also

members of:– Council of Institutional Investors (CII)– Chartered Financial Analyst (CFA)– International Corporate Governance Network (ICGN)– Asian Corporate Governance Network (ACGA)– Global Peer Group ESG Exchange– Global Investors Governance Network (GIGN)– 40 respondents to survey

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Going Concern

Is the Concept Going Concern Important?

65.00%

27.50%

5.00% 2.50%

Yes, very importantSomewhatVery littleNo, not important at allNot sure

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Going Concern

Should There Be a Change in the Term Going Concern?

Definition Triggers Responsibility No need to change

Not sure0%

5%

10%

15%

20%

25%

30%

35%

40%

15.0%

37.5%

17.5%

27.5%30.0%

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Going Concern

When Should a Company Be Identified As a Going Concern?

22.5%

50.0%

17.5%

10.0%

There is "substantial doubt" (80+%)More likely than not (51% chance)Reasonably possible (<51%)Not sure

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Going Concern

Should the Assessment be Based on a Time Period Assessment?

5.0%

60.0%

27.5%

2.5% 5.0%

Limited to the next 12 months

Limited to next 12 months but also considered foreseeable events

The foreseeable future (1-3 years)

Other

Not sure

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Going Concern

Whose Responsibility to Report to Investors on Going Concern?

Management Auditors Audit Committee PCAOB - SEC Not sure0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

52.5%

77.5%67.5%

17.5%

2.5%

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Going Concern

What Disclosures Should be Provided to Investors?

Reason

ably d

etailed

discus

sion o

f the c

ompa

ny's a

bility t

o gen

erate

suffici

ent ca

sh

Expecte

d cou

rses o

f actio

n tha

t bea

r on f

in flex

ibility

New bo

rrowing

s

Raising

of ne

w capita

l

Liquid

ating o

f asse

ts

Reduci

ng co

sts

Reduci

ng div

idend

s

Reduci

ng lev

els of

servic

es or

produ

cts

Filing f

or ba

nkrup

tcy0%

10%20%30%40%50%60%70%80%90%

100% 92.5% 85.0%

52.5% 57.5%67.5%

55.0% 57.5%47.5% 55.0%

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Going Concern

How Should This Information be Disclosed?

An unaudited MD&A Footnotes of financials Included in auditor's report

Other0%

10%

20%

30%

40%

50%

60%

70%

80%

60.0%

50.0%

67.5%

2.5%

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Going Concern

Recommendations Disclosures - FASB

• Strengthen Going Concern Definition• Require Management Disclosure – When aware of conditions and

events that is reasonably foreseeable that an entity may not meet its obligations:

1. If reasonably estimable – pertinent conditions and events giving rise to the assessment, including when event is anticipated to occur.

2. Possible effects of conditions and events.3. Possible discontinuance of operations.4. Management’s evaluation of the significance of conditions and events that bear on

financial stability and any mitigating factors.5. Whether plans to mitigate events can be effectively implemented and the likelihood.6. Recoverability or classification of recorded asset amounts or the amounts of

classification of liabilities.

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Going Concern

Current Issues with Auditing Standards - AU 341

• Lack of specific objectives auditor should achieve• Auditor is not required to design their audit specifically to

look for evidence with respect to Going Concern• No requirement for auditor to communicate with audit

committee• Auditor not required to consider public domain information

that is contrary to evidence management has presented.

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Going Concern

Current Issues with Auditing Standards Cont’d.

• No requirement for auditor to gain understanding and evidence of management’s key assumptions in their plans for mitigating the risks associated with the business that may result in it being more likely than not it will fail.

• Auditor not required to conclude as to whether management’s key assumptions provide a reasonable basis for management’s conclusion.

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Going Concern

Recommendations – Audit Standards - PCAOB

• Refine Auditing Standards– Include basic objectives the PCAOB expects auditors to achieve– Auditors should be required to design the audit to obtain evidence

with respect to Going Concern– Auditors should be required to consider evidence available to

them in the public– Auditors should be required to understand the plan and its key

assumptions, check for consistency of assumptions and data, recognize key omissions, understand factors specific to the industry, and see past historical trends of the company

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Going Concern

Recommendations – PCAOB

• Refine Auditing Standards– Auditors should be required to communicate to the audit

committee how they reached their conclusion on going concern.

• Disclosures– Communicate to the audit committee whether or not they have

concerns as to whether it is reasonable to expect the company may not continue as a Going Concern and basis for conclusion.

• Roles– Board should include a statement of basic objectives it expects the

auditors to achieve and the process the audit committee uses in its oversight when there is a going concern issue.

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Going Concern

Recommendations – SEC

• Disclosure of not just risks, but also how risks are mitigated– in plain English

• Key Performance Indicators– Some but not all companies provide information in public domain– Factors critical to success and understanding of the company, its

operations and cash flows– Varies greatly by industry, e.g.• Backlogs, sales per square foot and customer, plant

utilization, tonnage shipped, etc.

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Going Concern

Summary Recommendations• Standard Setters - Strengthen Definition - Define Triggers

– Move auditing standard from Substantial Doubt to More Likely than Not– Require disclosure when Reasonable Possibility exists that the company is no longer

a going concern

• Independent auditor ultimately must make assessment– Extend the period of evaluation to 12 months plus foreseeable events beyond 12

months

• Key Performance Indicators– Management to disclose in SEC filings

• Audit Committee’s Role– Enhanced Communication between auditor and audit committee– Summary of discussion to shareowners

• Regulators – Disclosures – Mitigating Risks