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By: John Goselin and Ze’eva Kushner Banks
On March 10, 2016, the Securities and Exchange Commission announced a settlement with Texas-based oil company Magnum Hunter Resources Corporation, its former chief financial officer and its former chief accounting officer arising from a failure to properly evaluate and maintain internal control over financial reporting for more than a year and a half. Pursuant to the settlement, Magnum is paying a penalty of $250,000 subject to bankruptcy court approval, and the chief financial officer and former chief accounting officer are individually paying $25,000 and $15,000, respectively.
At the heart of the matter is a failure to identify staffing problems in the oil company’s accounting department, following four major acquisitions, as a material weakness that should be disclosed to the public. Although the company’s consultant and audit engagement partner had raised red flags about the staffing problems, the former CFO and CAO applied the wrong standard when determining the severity of this control deficiency. The executives based their decision on the lack of an actual error in the company’s financial reporting resulting from the staffing issue while they should have been considering whether there was a reasonable possibility that a material misstatement in the company’s financial reports would not have been detected in a timely manner.
Back in 2007, the Securities and Exchange Commission put out guidance on internal controls over financial reporting under Section 404 of the Sarbanes-Oxley Act of 2002. The underlying objective of internal controls over financial reporting is to provide the public with reasonable assurance that the financial reporting of the company is reliable. Every year, a company’s management must evaluate and report on the effectiveness of the internal controls over financial reporting. The S.E.C’s Order demonstrates that the S.E.C continues to monitor and value the importance of effective internal controls over financial reporting. Moreover, the Order against Magnum’s chief financial officer and chief accounting officer cautions such high level accounting executives to rigorously assess internal controls to avoid sanctions.