Two years after going public, Compass still has significant issues with its financial reporting, according to statements in its earnings reports analyzed by The Real Deal.
“These weaknesses are not actually weaknesses. They don’t matter. This is nonsense.”
Compass executive
The brokerage is in a critical window to resolve the issues, known as material weaknesses, which outside experts say are unusual for a company of its size and time in the public markets.
Its auditor, PwC, says it’s able to provide “reasonable assurance” Compass’ numbers are correct in spite of the issues.
“These weaknesses are not actually weaknesses,” said one Compass executive. “They don’t matter. This is nonsense.”
But the issues are on the punch list for Kalani Reelitz, who took over the CFO role in November. The former Cushman & Wakefield executive joined Compass after waves of layoffs, hundreds of millions in losses and a two-month stretch during which CEO Robert Reffkin served as interim CFO. Reffkin had stepped in after the departure of former CFO Kristen Anklebrandt, who had replaced a CFO who lasted just seven months.
Compass plans to fix some of the weaknesses by the end of the year, according to another executive, who said their presence in filings isn’t unusual for a recently public company.
The brokerage goes “through thousands of hours of testing both internally with our audit department as well as with our PwC partner,” a Compass executive said.
“I think this is a normal process, I feel good about where we’re at,” they added.
But outside experts urged the company to address the issues.
“I would not agree the weaknesses are nonsense,” said Amal Shehata, a professor of accounting at NYU and a former PwC auditor. “I would expect senior executives to view them as an opportunity to make improvements, specifically as it relates to having experienced employees in place who understand internal controls over financial reporting.”
Material weaknesses can take many forms. The disclosure generally refers to a systemic problem at a company that threatens the accuracy of its financial reporting. Many companies have material weaknesses in their earnings reports, but they’re more commonly seen in companies with limited funding that are new to the public markets.
“They have a hole that somebody can drive a truck through either via a big mistake or fraud.”
Francine McKenna, lecturer, the Wharton School
The SEC allows companies to go public with material weaknesses. Firms with a market cap over $700 million — like Compass — must come into compliance with regulations regarding internal controls over financial reporting after one annual report, according to Wharton accounting lecturer Francine McKenna’s analysis of the Sarbanes-Oxley Act, a federal law that mandates financial disclosure practices.
The weaknesses were identified before Compass went public and have been present in each report since the company’s IPO in April 2021. So far, Compass has not had to issue a misstatement, or a disclosure following an earnings report that corrects the record, because its numbers have been accurate. But experts say Compass is rolling the dice with each quarter it fails to resolve the issues.
“There’s significant risk of material misstatement or fraud,” said McKenna. “They have a hole that somebody can drive a truck through either via a big mistake or fraud.”
Attitude reflects leadership
Compass reported material weaknesses in several areas. The broadest was its control environment, which refers to the tone set by a company’s senior leadership around financial reporting.
“An auditor is supposed to come in and look management in the eye and say ‘do these guys exude a ‘we want to do things right attitude?’” said McKenna. “Do they look at how they respond to risk or changes in their business?”
PwC declined to comment for this story, as did representatives for the SEC. Leadership expects to fix the accounting issues by the end of the year, a Compass executive said.
Jeffrey Johanns, a business professor at The University of Texas at Austin, said the issues could snowball into broader reporting problems.
“They specifically state it’s a lack of appropriate level of experience and training,” said Johanns. “That indicates it’s an accounting personnel problem … Effectively it could affect all controls.”
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A Compass executive said the issues with control environment have to do with documentation, and are not related to any shortcomings on the part of senior management.
“We are not fixing our management control environment,” they said. “When you’re hearing ‘control environment,’ think more down-spectrum.”
Compass said in its filings that it has not maintained formal accounting policies and procedures and did not design, document, or maintain controls “related to substantially all of our business processes to achieve complete, accurate and timely financial accounting, reporting and disclosures.”
That includes a lack of controls over account reconciliations, segregation of duties and the review of journal entries. McKenna said ensuring adequate segregation of duties is particularly important in preventing embezzlement and fraud.
Compass also did not maintain effective controls over its IT systems relevant to its financial reporting, including measures related to access to sensitive financial data. A company executive said the IT weaknesses were focused on tracking and documenting login access.
In its first-quarter report, Compass said that the material weaknesses “could result in a misstatement of one or more account balances or disclosures that would result in a material misstatement to the annual or interim consolidated financial statements that would not be prevented or detected.”
Big leagues
Material weaknesses were in the spotlight in March, when a disclosure from Credit Suisse after prodding from the SEC caused it to delay its annual report.
Over the past five years, between a quarter and half of all traditional firms that IPO’d reported some kind of material weakness, according to data collected by KPMG.
But the frequency of those weaknesses varied, according to another analysis by KPMG, which included results from traditional firms and SPACs, or investment vehicles created specifically to raise money at an IPO to acquire another firm. KPMG found that 50 percent of IPOs in 2021 contained a material weakness regarding a lack of formal policies and procedures, but just 7 percent reported weaknesses around ineffective controls.
Compass reported six of the eight categories identified by KPMG, according to McKenna, including ineffective controls.
Shehata said it’s unusual for a company of Compass’ size and funding — the brokerage raised $2 billion between its fundraising as a private company and its IPO — to have such widespread material weaknesses linger for so long.
Only 19 out of 848 public companies audited by a Big Four auditing firm with annual revenue over $5 billion, like Compass, reported material weaknesses in their control environment last year, according to data from Audit Analytics provided by McKenna.
Compass executives maintained that such issues take time to resolve.
“I think the timeline is right where I expect,” said a senior executive. “I challenge somebody that says this is not a normal timeline.”
Analysts haven’t held the weaknesses against Compass because so far their numbers have been correct, said Shehata.
Misstatements, on the other hand, can cause stock prices to plummet and trigger costly lawsuits from shareholders.
“The problem is why hasn’t it been getting fixed?” said McKenna. “Either you want to play in the big leagues or you don’t.”
Compass has taken several steps to eliminate their material weaknesses, according to their filings. Its first hire aimed at fixing the weaknesses came in the first quarter of last year, nearly a year after its IPO, when it brought on a vice president of internal audit to oversee financial controls. In the first quarter of this year, it hired a chief information security officer and is looking for a new senior manager of IT risk and compliance.
But some outside experts think there’s still a long way to go.
“They need to get their act together,” said Shehata. “This is very basic stuff they need to get organized.”