SEC OCA Waves Big Red Flag About “Little R” Restatements

SEC OCA Waves Big Red Flag About “Little R” Restatements

Blog Keeping Current: Disclosure and Governance Developments

SEC Acting Chief Accountant Paul Munter released a statement last week, Assessing Materiality: Focusing on the Reasonable Investor When Evaluating Errors (the “Statement”), that is sure to become required reading for any company analyzing errors in its financial statements.

Pointing to statistics about the increased incidence of “little r” restatements relative to all restatements (76% in 2020, up from 35% in 2005), the Statement expresses skepticism around the materiality determinations conducted with respect to identified errors and the resulting conclusion as to the appropriateness of a “little r” restatement. 


When an accounting error has been identified, an analysis must be undertaken to assess whether the error is material and must be corrected by restating prior-period financial statements (i.e. a “Big R” restatement) or whether the error is not material to previously-issued financial statements and may instead be corrected in the current period by correcting the prior period information in the comparative financial statements (i.e. a “little r” restatement).  Traditional securities law concepts apply to this materiality assessment, with the Statement quoting Supreme Court precedent that an error is material if there is “a substantial likelihood that the ... fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.”

Objective Assessments of Materiality

Let’s begin with the Statement’s conclusion: “[w]hen an error is identified, it is important for registrants, auditors, and audit committees to carefully assess whether the error is material by applying a well-reasoned, holistic, objective approach from a reasonable investor’s perspective based on the total mix of information.” 

In response to a perceived bias in how companies make materiality determinations, the Statement makes clear that to “thoroughly and objectively evaluate the total mix of information,” all relevant facts and circumstances must be taken into account, including quantitative and qualitative factors.  The Statement notes that an objective analysis “should put aside any potential bias of the registrant, auditor, or audit committee that would be inconsistent with the perspective of a reasonable investor.” Given the potentially adverse consequences that could result from a “Big R” restatement (e.g., clawback of executive compensation, reputational harm, a decrease in the registrant’s share price, increased scrutiny by investors or regulators, litigation, etc.), the Statement suggests that these consequences could bias determinations by registrants, auditors and audit committees, leading them to seek to avoid a Big R restatement. 

With these perspectives in mind, the Office of the Chief Accountant (“OCA”) staff has identified the following concerns with materiality analyses it has observed:

  • Quantitatively Significant ErrorsSAB No. 99 speaks to circumstances where a quantitatively small error could still be material when considering qualitative factors. OCA has raised concern where the reverse is argued – that a quantitatively significant error is nevertheless immaterial because of qualitative considerations. The Statement flags two key perspectives in this regard:
    • [A]s the quantitative magnitude of the error increases, it becomes increasingly difficult for qualitative factors to overcome the quantitative significance of the error; and
    • [T]he qualitative factors that may be relevant in the assessment of materiality of a quantitatively significant error would not necessarily be the same qualitative factors noted in SAB No. 99 when considering whether a quantitatively small error is material.
  • Irrelevant Financial Statement Line Items. The OCA has observed arguments that certain elements of financial statements do not provide useful information to investors, so an error in those elements cannot be material, or that historical financial statements, or specific line items in those financial statements, are irrelevant to investors’ current investment decisions. The OCA does not find these arguments persuasive “because such views could be used to justify a position that many errors in previously-issued financial statements could never be material regardless of their quantitative significance or other qualitative factors.” As a result, the Statement makes clear that the OCA “view[s] financial statements prepared in accordance with U.S. GAAP or IFRS, as required by Commission rules, to be the starting point for any objective materiality analysis.”
  • Non-GAAP Impacts. Pointing to the need for a holistic, unbiased analysis, the Statement indicates that consideration should also be given to certain key non-GAAP measures, “in addition to, but not as a substitute for, the analysis of materiality to the financial statements.”
  • Management Intentions and Determinations by Other RegistrantsThe OCA has also observed arguments that an error to previously-issued financial statements is not material because the same error was made by other registrants, thereby negating any suggestion of an intention to misstate. These arguments have surfaced in a number of industries and issuer types, including last year by special purpose acquisition companies in the context of warrant accounting. As noted in the Statement, “SAB No. 99 states that while the intent of management does not render a misstatement material, it may provide significant evidence of materiality.” The OCA does not find persuasive the alternative; a lack of intentional misstatement cannot be cited as evidence that the error is not material.
  • Offsetting Errors. The OCA has often observed arguments that an error is not material because its effect was offset by other errors. The OCA lends no credence to arguments that the aggregate effects of errors can support a conclusion that individual errors are immaterial. As the Statement notes, per “SAB No. 99, registrants and their auditors first should consider whether each misstatement is material, irrespective of its effect when combined with other misstatements. The aggregated effects should then also be considered to determine whether an otherwise immaterial error, when aggregated with other misstatements, renders the financial statements taken as a whole to be materially misleading.”

Internal Control over Financial Reporting (ICFR) Considerations

As the Statement reminds, “the identification of an accounting error also impacts management’s assessment of the effectiveness of ICFR.” The basic principles discussed in the Statement regarding an objective assessment similarly apply when analyzing the severity of a control deficiency for an ICFR analysis. In this regard, the ICFR analysis “must consider the magnitude of the potential misstatement that could result from a control deficiency.”  The actual error in such a circumstance is only the starting point.  It is possible for an error to be identified that is not a material error but that nonetheless results in a material weakness because of the magnitude of the potential misstatement that could have resulted.

Consistent with the SEC’s focus on gatekeepers, the Statement also “encourage[s] ongoing attention, including audit committee participation and training, as needed, regarding the adequacy of and basis for a registrant’s ICFR effectiveness assessment—particularly where there are close calls in the assessment of whether a deficiency is a significant deficiency (and only required to be reported to the audit committee) or a material weakness (required to be disclosed to investors).”

* * * * *

Companies and their auditors and audit committees are well advised to keep the observations noted above in mind when making and documenting SAB No. 99 materiality analyses for an identified error. 


More from this series


Unless you are an existing client, before communicating with WilmerHale by e-mail (or otherwise), please read the Disclaimer referenced by this link.(The Disclaimer is also accessible from the opening of this website). As noted therein, until you have received from us a written statement that we represent you in a particular manner (an "engagement letter") you should not send to us any confidential information about any such matter. After we have undertaken representation of you concerning a matter, you will be our client, and we may thereafter exchange confidential information freely.

Thank you for your interest in WilmerHale.