Lehman – question for US GAAP/GAAS experts
Questions for the financial reporting and auditing experts. Without commenting on the specific facts and circumstances in the Lehman case, do you see a collision between technical GAAP compliance and ‘fair presentation’? Do GAAP/GAAS require companies to modify compliance with GAAP to avoid results and financial condition that are material misstatements?Here are the relevant sections from Examiner’s report. On page 954, there is this:
Asked whether, as part of its responsibility to ensure Lehman’s financial statements were not materially misstated, Ernst & Young should have considered the possibility that strict technical adherence to SFAS 140 or any other specific accounting rule could nonetheless lead to a material misstatement in Lehman’s publicly Schlich refrained from comment”
On page 964:
Even if Lehman’s use of Repo 105 transactions technically complied with SFAS 140, financial statements may be materially misleading even when they do not violate GAAP. The Second Circuit has explained that “GAAP itself recognizes that technical compliance with particular GAAP rules may lead to misleading financial statements, and imposes an overall requirement that the statements as a whole accurately reflect the financial status of the company.” GAAP’s ultimate goals of fairness and accuracy in reporting require more than mere technical compliance.” The court explained that “when viewed as a whole,” GAAP has no “loopholes” because its purpose, shared by the securities laws, is “to increase investor confidence by ensuring transparency and accuracy in financial reporting.” Technical compliance with specific accounting rules does not automatically lead to fairly presented financial statements. “Fair presentation is the touchstone for determining the adequacy of disclosure in financial statements. While adherence to generally accepted accounting principles is a tool to help achieve that end, it is not necessarily a guarantee of fairness.” Moreover, registrants are “required to provide whatever additional information would be necessary to make the statements in their financial reports fair and accurate, and not misleading.”
This view is echoed in an SEC enforcement order, concluding that GAAP compliance does not excuse a misleading or less than full disclosure regarding a transaction, especially if the transaction’s purpose is “the attainment of a particular financial reporting result.” “[E]ven if the transactions comply with GAAP, the issuer is required to evaluate the material accuracy and completeness of the presentation made by its financial statements.” Issuers must “ensure that the way they publicly portray themselves discloses, as required, the material elements of [their] economic and business realities and risks.”
I have personally been involved in one situation, at a company that no longer exists, where the auditors advised in favor an accounting treatment to comply with GAAP (a write-off of deferred tax assets) but admitted the results and financial condition would then be materially misstated. I was told there was no ‘true and fair’ presentation requirement – which the above sections appear to dispute. Expert insights would be appreciated.