Groupon: You Must Have Fallen From The Sky

By Francine • Apr 7th, 2012 • Category: Audit Quality, Fraud, Latest, Pure Content, The Case Against The Auditors

Last week was Groupon’s big week, although not in a good way. What happened? Well, the premier source of daily deal dish got knocked down a few more pegs after announcing a revision to 4th quarter earnings and the announcement by management that there was a material weakness in internal controls over financial reporting that was causing their disclosure controls to be ineffective. Groupon went public just a few months ago, last November, and the annual report was the company’s first filing as a public company.

Here’s one of the few journalists who got the details right, Jonathan Weil of Bloomberg, explaining why, in this case, the news was especially bad:

Didn’t Groupon know before its initial public offering that its controls were weak? A company spokesman, Paul Taaffe, declined to comment. Let’s assume for the moment, though, that its executives did know. Even then, they wouldn’t have had to tell investors beforehand.

That’s because there is no requirement to disclose a control weakness in a company’s IPO prospectus. Groupon would have had no obligation to disclose the problem until it filed its first quarterly or annual report as a public company — which is what it did. Sandbagging IPO investors in this manner is perfectly legal, it turns out.

The reason lies with a gaping hole in the Sarbanes-Oxley Act, which Congress passed in 2002 in response to the accounting scandals at Enron Corp. and WorldCom Inc. That statute had two main sections related to companies’ internal controls, which are the systems and processes that companies are supposed to have in place to ensure the information they report is accurate. Those provisions apply only to companies that are public already, not ones that have registered for IPOs.

One section, called 302, requires public companies’ top executives to evaluate each quarter whether their disclosure controls and procedures are effective. The other section, known as 404, is better known. It requires public companies in their annual reports to include assessments by management and outside auditors about the effectiveness of their internal controls over financial reporting. Congress left it to the Securities and Exchange Commission to write the rules implementing those provisions.

Here’s where it gets tricky. Groupon reported the weakness in its financial-reporting controls through a Section 302 disclosure, not a Section 404 report. In other words, the problem was serious enough that it amounted to a shortcoming in the company’s overall disclosure controls.

Groupon won’t have to comply with Section 404’s requirements until its second annual report, due next year, under an exemption the SEC passed in 2006 for newly public companies. Likewise, Groupon’s auditor, Ernst & Young LLP, to date has expressed no opinion on the company’s internal controls in its audit reports.

From the moment Groupon announced the revision on March 30, there were two important facts that almost all major media financial journalists got wrong:

1) The announcement of lower revenue and lower income for the fourth quarter was a revision of an earnings release, not a restatement. Groupon never filed a 10Q so there was no SEC filing to restate. Fessing up to the right numbers in the annual report was the first time the company was bound to report those numbers and, at that time, they corrected previously announced earnings for the 4th Quarter.

2) Management made the assessment of the material weakness in internal controls over financial reporting that caused disclosure controls to be ineffective, not auditor Ernst & Young. Ernst & Young deserves no credit for the announcement, nor any blame, just yet, for the fact that the weaknesses had to be finally admitted. There is no transparency regarding the auditor’s agreement or disagreement previously with Groupon, any public documentation of their discussions or any reason to believe Ernst & Young either encouraged or discouraged Groupon to get their act together sooner.

We just don’t know.

What we do know is that Ernst & Young signed the fourth clean audit opinion when it signed the audit report included in Groupon’s annual report. With the three audited financial statements included in the S-1, we can assume that control weaknesses Ernst & Young was aware of, if they were aware of any, were not serious enough in their opinion to qualify the audit opinion.

Because I was very busy with some other projects when the Groupon announcement came out I chose to be quoted regarding Groupon, rather than to blog about it, last week. I also tried to use Twitter to alert fellow journalists and the readers that the reporting had mistakes.

I was asked to comment on the Groupon story by three media outlets: the Marketplace radio program on PRI/NPR, Phil Rosenthal at the Chicago Tribune, and Crain’s Chicago Business.

I haven’t seen the story in Crain’s yet, but it Here’s the Crain’s link. It was nice to have two local media outlets notice they had someone who writes about these issues right here in Chicago where Groupon is based.

Marketplace’s Heidi Moore, who I follow on Twitter, wrote a short piece and my comment is strictly color. You can read the text and listen here.

The Tribune piece is extensive and Phil Rosenthal does a great job explaining why Groupon’s success or failure means a lot to the Chicago tech scene.  I get a long quote:

“As a Chicagoan, I’m really sad, because we’re proud when somebody does good here,” said Francine McKenna, an expert on the accounting and auditing industry who writes the Accounting Watchdog column for Forbes. “We love promoting our companies, especially homegrown success stories, and this is embarrassing.

“Because they’re growing so fast, because they’re trying to take a less conservative approach when they’re developing these numbers, because they want to shine the best possible light on what they’re doing, they got caught short. There was nothing they could do but admit they screwed up.”

To be honest, I’m holding back a bit on this subject because Groupon is a small part of a larger piece I’m wrapping up, hopefully, for the next issue of Forbes Magazine.  So let me make a few comments that did not make it to the magazine piece.

The role of the auditor, Ernst & Young, is confusing to experts, let alone the average investor or business reader.  Should the firm have caught Groupon’s errors before or after the IPO? Did Ernst & Young catch Groupon’s errors before the IPO and now?  Did Ernst & Young influence Groupon management’s decision to make the painful acknowledgement that they were caught short in the return reserves department and had to revise revenue and earnings? We’ll never know.

Here’s what Groupon management admitted in the annual report:

“…management concluded as of December 31, 2011 that our disclosure controls and procedures were not effective at the reasonable assurance level due to a material weakness in our internal control over financial reporting, which is described below.

In connection with the preparation of our financial statements for the year ended December 31, 2011, we concluded there is a material weakness in the design and operating effectiveness of our internal control over financial reporting as defined in SEC Regulation S-X. “

Groupon says they are deficient in:

  • Controls over monthly financial close process and procedures
  • Controls to insure accounts were complete and accurate and agreed to detailed support
  • Controls over account reconciliations to identify errors and omissions in journal entries
  • Controls over timely, effective review of estimates, assumptions and related reconciliations and analyses, including those related to customer refund reserves

That’s a lot of weakness. I find hard to believe these weaknesses only showed up in the last month or so of the year, after the IPO and multiple S-1 filings. Could Ernst & Young have stopped the IPO? Could the SEC have stopped the IPO?

One proposal that the audit industry regulator, the PCAOB, has on the table that could help in the future – but maybe not for pre-registration filings and auditor opinions – is the Auditor’s Discussion and Analysis. (The italics are my comments back to the PCAOB, the audit industry regulator under the SEC.)

b. In what ways, if any, could the standard auditor’s report or other auditor reporting be improved to provide more relevant and useful information to investors and other users of financial statements? Two places where the current report could be improved are:

1. Development of a clearing house of auditor names attached to public company audit engagements worldwide with their biographies and information about sanctions, suspensions and litigation against them.  I’m not so concerned about seeing a name on a printed report as knowing who is responsible for that audit over time and their qualifications and professional history.

2. The addition of an auditor’s “Disclosure and Analysis” would be priceless. It should be addressed directly to shareholders, not the Audit Committee, and be written in the style of Warren Buffet’s letter to shareholders.  It should state where the auditors and management disagreed and which one prevailed.  It should focus on judgments, estimates, and the range of practices especially regarding interpretation of key accounting standards amongst that issuer’s peer group.

c. Should the Board consider expanding the auditor’s role to provide assurance on matters in addition to the financial statements? If so, in what other areas of financial reporting should auditors provide assurance? Auditors should provide explicit assurance on MD&A. They are already required by standards to communicate with the Audit Committee regarding the adequacy of required disclosures. Interim Auditing Standard AU 380 requires auditors to determine whether all audit-related matters are communicated to the committee.

Potential Alternatives for Changes to the Auditor’s Report

A. Auditor’s Discussion and Analysis

Questions

5. Should the Board consider an AD&A as an alternative for providing additional information in the auditor’s report? Yes

a. If you support an AD&A as an alternative, provide an explanation as to why. See above 1.b.

b. Do you think an AD&A should comment on the audit, the company’s financial statements or both? Both. Provide an explanation as to why. Should the AD&A comment about any other information? The quality of management’s D&A and any disagreements in that regard over sufficiency or quality of disclosures.

c. Which types of information in an AD&A would be most relevant and useful in making investment decisions? I think information about how the issuer compares in key metrics, disclosures, aggressive interpretation of standards, and use of models and estimates to their peers would be very useful.  In some industries, one auditor has an audit relationship with several major companies, addresses similar issues, evaluates similar approaches and either sees consistent or inconsistent results. This type of discussion and comparison would be very useful to identify outliers and anomalies as well as instances of collusion amongst companies with significant business with each other.

Another factor to consider is the auditor’s responsibility right now with regard to disclosure or reporting of fraud and illegal acts – if errors and misstatements rise to that level even pre-IPO.  I’ve written previously that auditors are not very quick to tattle-tale on the executives of the companies they audit.  The audit firms prefer to work it out internally and over time. There’s just too much money at stake both as an auditor and as a consultant. We do not know what Ernst & Young’s fees from Groupon – or Zynga or Facebook – are yet.  The first proxies are not out.  But we do know how much money was at stake with some other clients that have had issues:

  • Ernst & Young was paid more than $150 million in fees by Lehman for 2001 to bankruptcy in 2008 according to the New York Attorney General complaint against Ernst & Young for fraud regarding lack of disclosure of Lehman’s issues.
  • Google paid Ernst & Young $13 million in 2010 and 2009. Google’s proxy did not explain how Ernst & Young could reduce its fee for audit services to this high-risk company by $1 million in 2010. Google is a serial subject of SEC investigations for its accounting for stock options and taxes. The company recently settled a Department of Justice criminal investigation over the illegal use of its AdWords program by Canadian pharmacies. Ernst & Young did charge Google $500 thousand more in 2010 to address those tax issues.
  • UBS, home of a recent rogue trader scandal, paid Ernst & Young $63 million in 2011 for their the audit, $12 million for audit-related activities such as assurance and attest services, control and performance reports, advisory on accounting standards, transaction consulting including due diligence, and tax advisory.  Ernst & Young also earns another $32 million for services performed on behalf of UBS investment funds, many of which have independent fund boards or trustees.
  • News Corp, where executives are accused of paying illegal bribes and hiding those payments on the balance sheet, paid Ernst & Young almost $35 million dollars in 2010 and about $31 million in 2009.  The increase equals about 10% more for more tax consulting services, which make up almost half – $16 million – of the total fees paid to EY by News Corp. That, to me, is a serious indictment of EY’s independence as auditor.

Getting back to Groupon and their erroneous earnings release and uncontrolled S-1s…

According to a recently published academic paper entitled, Pro forma disclosures, audit fees, and auditor resignations:

Pro forma disclosures are non-GAAP disclosures; however, under the provisions of SAS 8, auditors are still responsible for ensuring that no overtly misleading voluntary disclosures are released to investors. That is, auditors are required to review voluntary disclosures and prevent any misleading or overtly optimistic information from being released. In addition, auditors are potentially responsible for ensuring consistency of pro forma reporting in voluntary disclosures, such as press releases, with any pro forma numbers included in mandated disclosures, such as SEC 10-K or 10-Q reports (PwC Dataline 2010-03).

I know I expect the auditors to be earning their fees by looking out for investors. But maybe that’s just pie in the sky.

The video is Glen Hansard and Marketa Irglova singing “You must have fallen from the sky” from The Swell Season.

Original main page art from this site.

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23 Responses »

  1. Francine,

    I love your posts and you are raising very relevant inquiries. In would like to add another angle to this. Is the SOX compliance requirements used as a cover up to do more misdeeds by management? What does one do, when the management has established a full SOX control department and the only catch is that the most critical controls are never put on the control checklists. Everyone knows that they are intentionally left weak to commit frauds. In that case, the external auditors are supposed to be checking the details of compliance, by are they really doing it?

    Another angle which I see American bloggers ignoring or they are not aware of it, is that in the present global environment, 60-70% of the sales and back office operations are done in emerging countries. Hence, the quality of controls in US and emerging countries may be drastically different. The US auditors rely on the work of their counterparts in the merging countries, but accounting manipulations in emerging countries is much easier to hide than in US. In these cases, unless the subsidiarity companies financial statements are reviewed separately, without the consolidation, then a true picture can emerge. Consolidation allows one to hide more, than disclose properly.

    Sonia

  2. You missed the fact that while E&Y was not required to opine on GRPN’s internal controls, they should have pushed for the inclusion of a material weakness/significant deficiency RISK FACTOR in the S-1. Also, many newly public companies disclose the MW in the MD&A with the inclusion of a remediation plan (hiring additional staff, developing controls, etc.).

    The fact that GRPN has MW in internal controls is not surprising, MANY newly public companies do. Having not been subject to SOX previously, its not surprising they wouldn’t have the infrastucture in place pre IPO.

  3. An important, and as usual, well written article.
    There are several issues at hand, one is the technical discussion of what was “required” to be disclosed in the IPO versus what could have been disclosed for transparency purposes.
    The auditors, along with the financial staff of Groupon, are smart insightful individuals. It is often beyond me to understand how they could have NOT known that there was an Internal control blow here. They are focused on one Company – Groupon, and they are responsible for that company’s presentation to the public.it is management and their highly paid consultants – EY in this case – finding ways around the spirit of the those disclosure laws.
    For me, it comes down to the spirit of management.
    In the cases with EY stated above, how are they able to miss these matters. They have teams of auditors looking and looking. The decisions happen at those final closing meetings, where management and the auditors are in disclosure discussions that the deals are made. EY is tainted by the huge fees, the client tainted the goal of the IPO, its quarterly report, etc. They forget why we have disclosure and procedure.
    It is not that someone somewhere lacked the technical skill, what is lacking is the managements concerns for its communications with its shareholders. Moral will is trumped by technical loopholes.

  4. From someone not familiar with accounting or IPO’s etc. it seems to me almost an impossible nut to crack. Fee’s (necessary of course) and reporting to the “public” possible negative findings. Yet it’s the same problem. Accounting firm; Hey if we report this to the public then we may lose the client and other clients as well. If we don’t report we may lose our reputation.” Presently it seems clients come first as long as it technically legal. Same for the firms ; “If we report we may lose our investors. Is it technicall / legally required? If the answer is no then apparently they don’t.

  5. Hi Phil,

    Thanks for your comment. There is a risk factor in S-1 that comes close:

    We cannot assure you that we will be able to manage the growth of our organization effectively.

    We have experienced rapid growth in demand for our services since our inception. Our employee headcount and number of subscribers have increased significantly since our inception, and we expect this growth to continue for the foreseeable future. The growth and expansion of our business and service offerings places significant demands on our management and our operational and financial resources. We are required to manage multiple relations with various merchants, subscribers, technology licensors and other third parties. In the event of further growth of our operations or in the number of our third-party relationships, our information technology systems or our internal controls and procedures may not be adequate to support our operations. To effectively manage our growth, we must continue to implement operational plans and strategies, improve and expand our infrastructure of people and information systems, and train and manage our employee base.

    Sort of subtle but not completely absent. That being said, the auditor does have responsibility under the provisions of SAS 8 for ensuring that no overtly misleading voluntary disclosures are released to investors. The auditor is also responsible to telling the Audit Committee if something important is missing for disclosures and about any serious disagreements with management. As I said in the article, we really don’t know. It seems like Groupon beefed up its consultants this past year. Word is here in Chicago that every firm and staffing firm and controls expert has taken a bite out of the Groupon wallet. KPMG is supposed to be, according to the WSJ, helping them prepare for SOx.

    From the annual report: 2011 compared to 2010. In 2011, our selling, general and administrative expense increased by $624.4 million to $821.0 million, an increase of 317.5% . The increase in selling, general and administrative expense for the year ended December 31, 2011 compared to the year ended December 31, 2010 was due to increases in wages and benefits, consulting and professional fees and depreciation and amortization expenses.

    But that doesn’t mean Mason and crew, who have been notoriously disdainful of adult supervision, understand or are taking anyone’s advice.

  6. Francine,

    Thanks for pointing out that RF, thought I don’t think it is sufficient to address the MW. Rather than bury it, the best practice is to have a RF that explicity says “We have a material weakness in our internal controls…” They also missed the opportunity to further explain in MD&A what they are doing to remediate the MW.

    Some of the articles I’ve read make it seem as if having a MW is the kiss of death and should lead to the firing of the CFO. To me that is WAY overstated as a high percentage of newly public companies have MW, whether they disclose it or not.

  7. @Phil Johnson

    Agree and agree. However, the CFO has proved himself incompetent and the Chief Accounting Officer, the position that’s supposed to be the GAAP and SEC reporting expert, is a former PwC consultant, not a CPA. They are not qualified for this job. They’re relying on Ernst & Young and EY is apparently rolling over and playing dead. Period.

    Problem is there is nothing that forces either management or the auditor to disclose a material weakness in controls at the S-1 stage. Sarbanes-Oxley requirements do not kick in until registration and first filing as a public company. That’s the hole Weil is talking about it and it is gaping. It will only get worse under JOBS Act when investors have to wait five years for the first opinion on ICFR from the auditor. With five years to remediate, they’ll take it as slow as they can and investors are vulnerable in the meantime. How many newly public companies fail in the first five years as a result of sudden “liquidity” crises brought on by too much risk and not enough controls, even with three years of audits and an auditor having to sign off on an opinion on ICFR within a year? How many newly public companies have significant restatements and fraud in the first five years?

    There’s absolutely a higher risk in smaller companies for fraud and malfeasance due to poor or non-existent internal controls, lack of segregation of duties, lack of oversight by an independent auditor, non-arms-length transactions especially in legacy family owned or closely-held companies, and general legacy CEO intransigence regarding external interference in “my company.”

    http://online.wsj.com/article/SB123501158460619143.html

    You don’t hear as much about frauds in private companies because those frauds are handled quietly, with no transparency or accountability to anyone, even employees, creditors and other stakeholders.

    When fraud or accounting manipulation occurs in a public company, no matter how small, the curtain is drawn, and all of the self-serving and selfish actions, if not illegal and unethical actions, of formerly insulated management become SEC, PCAOB, and plaintiff’s bar potential actions. The stakes are much higher for public companies but many new IPO management teams want the benefit of public ownership (additional capital) without the responsibility and accountability to outsiders that comes with it.

  8. Kristina,

    I don’t know of any business journalist or blogger who is more insightful and accurate than you. Thank you.

    I have a question/comment about this statement:

    “The announcement of lower revenue and lower income for the fourth quarter was a revision of an earnings release, not a restatement. Groupon never filed a 10Q so there was no SEC filing to restate.”

    I would agree that if there were no accompanying financial statements, it would be correct to say that an earnings release was later “revised.” However, in this case, GRPN’s initial earnings release (filed with the SEC on February 8, 2012) included Balance Sheets, Statements of Income and Statements of Cash Flows.

    Of course, SEC Forms, including Forms 10-Q and 10-K are never “restated.” Instead, incorrect financial statements are restated within an amended Form 10-Q or 10-K. Accordingly, on March 30, 2012 Groupon amended the February 8, 2012 Form 8-K containing incorrect financial statements. The amended Form 8-K/A corrected (I would say restated) the financial statements in the earlier Form 8-K. Unless I’m missing something, it is technically incorrect to say that those financial statements were revised.

  9. I wonder the extent to which the role of software should be part of this discussion?

    NetSuite (which has provided the main accounting systems for Groupon in 43 countries) makes much of the fact they were able to roll out implementations in record time. However, that’s not the same as saying that the governance and controls for revenue recognition are up to the job.

    One thing I am aware of is that NetSuite is not hot on workflow and process control in the same way a SAP or FF system might be considered more robust if more rigid.

    If (and I do say IF) there are weaknesses here then everyone would/should have been aware of them during the IPO period.

  10. @ Dennis Howlett

    Thanks for this additional info. I was wondering which ERP they were using. Professors Ed Ketz and Tony Catanach, the Grumpy Old Accountants have been very vocal about how the controls could have in no way kept pace with the “fastest growing revenue for a start-up” in history. Let’s hope that doesn’t turn out to be a dubious honor. Right now it’s certainly looking like a red flag.

  11. @Keith Mautner

    I was told that “restatement” is a very precise term referring only to 10Q or 10K. That information came from former SEC Corp Fin/OCA folks. I will pass your take on to them in case they do not see your comments and get a further read.

    Thanks for your comment.

  12. [...] see also Dollar Dims on Fed Speculation (WSJ) • Groupon: You Must Have Fallen From The Sky (re: The Auditors) • In Target-Date Funds, a Hodgepodge of Styles (NYT) • ‘Big’ is bad for politicians this [...]

  13. Francine, as a retired CPA firm partner, current CFO of a high tech services customer, and general observer of accounting practices, I find it hard to believe that neither the CFO nor the CPA firm was able to identify this material weaknesses. My logic is simple. Service contracts where payment is paid up front and services are delivered at some future date require special attention to revenue recognition. Forget Sarbannes, forget complex SEC rules on S-1 filings, etc., the issue is simply a clear case of matching revenues to expenses/costs, a basic tenant of intermediate accounting courses taken by sophomores and juniors in any accounting school. This revenue recognition abuse has reared its head for generations in software licensing, service/maintenance contracting, etc. This issue would have been easily discovered by better sampling of contracts, better attention to how revenue could be manipulated for reporting purposes, and simple forensic accounting. An assumption of a potential weakness based upon historical experience with these issues in companies in audit frauds would easily have highlighted what a company could or would do with revenue recognition. This is not a question of regulation, just common sense. Apparently the auditors and the CFO lacked this basic underlying talent. Both the CFO and the auditor should resign in disgrace.

  14. [...] http://retheauditors.com/2012/04/07/groupon-you-must-have-fallen-from-the-sky/ [...]

  15. @ Dan Maher

    I have to agree. There is nothing “innovative new business model” about not estimating customer returns accurately and reserving appropriately. And it’s curious that auditor EY let another client, Medicis Pharmaceuticals, get away with same thing. Revenue recognition is a fundamental accounting principle that only has so many GAAP approaches. The rest is just an excuse for manipulating the results.

  16. Francine,

    I encourage you to re-examine your assertions that “Management made the assessment of the material weakness in internal controls over financial reporting …, not auditor Ernst & Young” and “almost all major media financial journalists got [that fact] wrong”. As in the fable about the blind men and the elephant, diverse perspectives on a subject can be individually accurate yet misleading in their incompleteness. And in the case of Groupon’s 10-K for 2011 (filed March 30, 2012), inconsistency in the source data has caused considerable confusion. It is that inconsistency—and its rather disturbing implications—to which I draw your attention.

    Specifically, Groupon’s recent 10-K contains not one but four different versions of how the company’s material weakness in internal control of financial reporting (ICFR) was detected:

    (1) Page 23, next-to-last paragraph: “In connection with the audit of our financial statements as of and for the year ended December 31, 2011, we concluded there is a material weakness in internal control over financial reporting related to deficiencies in the financial statement close process.”

    (2) Page 30, last paragraph: “In connection with the preparation of our financial statements for the year ended December 31, 2011, our independent registered accounting firm identified a material weakness in the design and operating effectiveness of our internal control over financial reporting …”

    (3) Page 104, first paragraph under Item 9A: “Our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of December 31, 2011… Based on this evaluation, management concluded as of December 31, 2011 that our disclosure controls and procedures were not effective at the reasonable assurance level due to a material weakness in our internal control over financial reporting …”

    (4) Page 104, second paragraph under Item 9A: “In connection with the preparation of our financial statements for the year ended December 31, 2011, we concluded there is a material weakness in the design and operating effectiveness of our internal control over financial reporting …”

    The diversity among these versions illustrates that Groupon’s material weakness in ICFR might have been detected during a standalone evaluation of the company’s effectiveness of controls and procedures as implied by version 3. Or the material weakness in ICFR might have been detected during the preparation of the company’s financial statements (versions 2 and 4) or during the audit of the financial statements (version 1). And it might have been Groupon’s management who identified the weakness (versions 1, 3, and 4) or the company’s independent auditor, Ernst & Young (version 2). Anyone who read only one version might have accurately reported (or blogged) what they read while understandably disputing accounts written by observers who had read a different version.

    As I discussed earlier this month with participants in my weekly webinar, what concerns me most is that in addition to whatever shortcomings may be attributed to Groupon’s management and/or auditor, the company’s management and auditor have further undermined their credibility by failing to tell a consistent story about an already-sensitive issue. You probably know the old saying among accountants: “If you can’t be right, at least be consistent.” Unfortunately, Groupon seems to have failed at both.

  17. The financial statements are the responsibility of management. That should be your first clue. The second one is this:

    From the Ernst & Young audit report/opinion:

    Ernst & Young clean audit opinion: “...Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.”

    Groupon may have other firms in there now helping them prepare for the SOx internal control opinion on management’s assertion from Ernst & Young that will be due for the next fiscal year. But whatever they came up with for this annual report or whatever they come up with next year , it is management who makes the assertion and the auditor gives their opinion only in their opinion letter. 9A is management talking.

  18. Keith,

    I got a further clarification on the revision/restatment issue from some figures I consider authorities.

    The word “restated” is used by everybody but is not defined in the accounting literature or in SEC regulations. The following three definitions of “restatement” are those used by accountants, although they are not found anywhere in the literature. Each definition differs from the other only slightly.

    1. Anytime financial statement numbers that have previously been publicly released are changed due to an error.

    2. Anytime financial statement numbers that have previously been published in an SEC Periodic Report (10-K, 10-Q) or selling document (S-1, S-3) are changed due to an error.

    3. Anytime a Periodic Report or selling document is amended to change the financial statements due to an error.

    Some consider only number 3 to be a true restatement, leaving out those errors that are corrected in a subsequent filing, rather than by amending the previous filing. If you believe that everything in 2 should be treated the same, intellectually, that’s the definition you would prefer. Definition 1 might be justified by saying that a company should not have a lower level of diligence on numbers issued in a press release, than on numbers issued in a 10-Q or 10-K. But Definition 1 is not the one accountants use. And definition 1 may be desirable but it’s a stretch when discussing auditor responsibility since auditors do not issue an audit opinion on press release filings or earnings releases or non-GAAP info.

    It’s a matter of interpretation.

  19. Francine,

    Thanks for your response. To be clear, I was not implying that the financial statements are anyone’s responsibility but management’s. Nor was I implying that E&Y had expressed an opinion on Groupon’s ICFR. I simply wanted to point out that any one version of the “detection story,” as told by Groupon’s management, could create an impression on readers that differs from the impression that other versions of the story could create. This includes, in the case of version 2, the impression that the independent auditor deserves credit for identifying the material weakness, which may in fact be true.

    I am still disturbed by the bigger picture—that Groupon’s management has told several apparently inconsistent stories about how the material weakness was detected and who detected it.

  20. There is an interesting aside to this. Almost from the get go, experienced investors/commentators who have been around the dot com boom/bust cycles were saying that Groupon’s business model is not unique or novel but echoes some of the features of the failed WebVan saga back in the day. Any business model that is NOT novel should therefore be capable of relatively easy understanding around the risks and therefore necessary provisions. The fact management has taken what appears to be a slack approach to the topic of returns must have been obvious. But then as we know from past failures and dodgy dealings, senior management is nearly always intimately involved.

    On the software side, the ability to correctly handle revenue recognition rules in service environments has been considered a solution differentiator for some years now. If Groupon was using the NetSuite acquired OpenAir package then they should have been in a position to at least apply some controls. See: http://www.netsuite.com/portal/products/netsuite/revenue-recognition/main.shtml but again, knowing and applying are not the same thing.

  21. This is not a system control issue. They got the accounting wrong, plain and simple. The partner for this account is obviously incompetent as was the SEC reviewer. Anyone that could buy into their mysterious accounting (ohhh – its cutting edge and new! yeah right). Accounting is very simple. UInfortunately the fraudsters find the supposed “gray”. I hope they fry them. They give auditor firms of all sizes a bad name.

  22. @Keith Mautner on April 8th, 2012 at 10:22 pm:

    Per KM: I would agree that if there were no accompanying financial statements, it would be correct to say that an earnings release was later “revised.” However, in this case, GRPN’s initial earnings release (filed with the SEC on February 8, 2012) included Balance Sheets, Statements of Income and Statements of Cash Flows.

    Just an FYI — an earning release is not “filed” with the SEC whereas S-1’s, 10Q’s, 10K’s, etc are filed with the SEC. It is clearly stated and understood that the Q4 earnings release and the furnishing of such unaudited financial information is subject to revision up until the Form 10-K is filed.

  23. Why isn’t anyone talking about the role of the audit committee in all of this?

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