The Stagwell Group and MDC Partners have one point in common when it comes to accounting: Both have acknowledged “material weakness” in their internal control over financial reporting.

The disclosures about Stagwell came in MDC’s 736-page registration statement filing Feb. 8 in which the companies offered more details about their pending merger, which they expect to complete in the first half of the year.

MDC’s stock Monday reached a 52-week intraday high of $3.36, a sign investors are focused on the deal’s upside. MDC closed Tuesday at $3.20, down five cents from Monday’s close. 

“The combined company is poised to deliver meaningful shareholder value creation, accelerated growth and enhanced services to clients,” MDC said in a press release announcing the registration statement.

MDC and Stagwell, already MDC's biggest shareholder, announced a merger agreement in December. MDC is the parent of agencies including Anomaly, CPB, Doner and 72andSunny. Stagwell’s holdings include digital creative shop Code and Theory; communications firm Sloane & Co.; digital agency Targeted Victory; and creative consultancy Wolfgang.

In the new filing, MDC said Stagwell “has identified material weaknesses in Stagwell’s internal control over financial reporting. If Stagwell’s remediation of such material weaknesses is not effective, or if Stagwell fails to develop and maintain a proper and effective internal control over financial reporting, Stagwell’s ability to produce timely and accurate financial statements or comply with applicable laws and regulations could be impaired.”

“A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of a company’s annual or interim financial statements will not be prevented or detected on a timely basis,” the filing said.

In the MDC filing, Stagwell notes: “As a privately-held company, we were not required to evaluate our internal control over financial reporting in a manner that meets the standards of public companies required by Section 404(a) of the Sarbanes-Oxley Act,” which regulates how public companies assess internal control on financial reporting.

It’s not uncommon for private companies to have to work through material weakness in internal control over financial reporting as companies shift to become public companies. Since 2015, an average of 39% of companies going public have disclosed at least one material weakness before going public, according to PricewaterhouseCoopers research.

Stagwell’s disclosed material weaknesses included “failure to maintain a sufficient complement of personnel with an appropriate degree of internal controls and accounting knowledge, experience and training commensurate with its accounting and reporting requirements” and “inability to design and maintain effective controls over information technology general controls for information systems relevant to the preparation of our financial statements.”

“We are evaluating the weaknesses identified by our auditors and intend to evaluate what remedial actions are necessary,” Stagwell said in the filing.  

Stagwell last September dismissed its auditor, the private-company practice of PricewaterhouseCoopers, which later identified material weaknesses, and hired Deloitte & Touche as its new auditor. After Stagwell’s “reverse merger” with MDC is completed, Deloitte & Touche likely will be the auditor for the merged public company going forward.

Stagwell said PwC’s audit reports for 2019 and 2018 “did not contain an adverse opinion or a disclaimer of opinion and were not qualified or modified as to uncertainty, audit scope or accounting principles.”

MDC previously has disclosed a material weakness in the company’s internal control over financial reporting for income taxes. An MDC filing in October 2020 said: “We are actively engaged in remediation efforts to enhance and improve our internal controls over financial reporting with respect to accounting for income taxes. … Our remediation efforts will continue to be implemented throughout our 2020 fiscal year. We believe the controls that will be put in place will eliminate the material weakness with respect to accounting for income taxes and solidify the effectiveness of our internal control over financial reporting.”

In the most recent annual financial filing, from March 2020, MDC’s accounting firm, BDO USA, said: “Our report on the effectiveness of internal control over financial reporting expresses an adverse opinion on the effectiveness of MDC Partners Inc.’s internal control over financial reporting as of December 31, 2019.”

MDC’s filing offered more details on events leading up to the merger deal.

After MDC in September 2018 announced its intent to “explore and evaluate potential strategic alternatives,” including a possible sale, the company’s financial advisers “contacted not less than 34 third parties … at least 21 of whom executed nondisclosure agreements and received non-public information.”

Those talks “resulted in no final or binding offers for an acquisition of, or investment in, the company from any party other than Stagwell,” which in March 2019 struck a deal to make a $100 million investment in MDC. As part of that deal, Stagwell’s managing partner, Mark Penn, became MDC’s CEO.

Stagwell in November 2019 “commenced a process to market and potentially sell the Stagwell business.” That potential sale ended up not happening.

Stagwell in March 2020 sent MDC “a presentation deck … outlining illustrative terms and pro forma financial metrics of a hypothetical business combination transaction between MDC and Stagwell.”

In June 2020, Stagwell publicly proposed a merger. MDC’s filing said that had the effect of “putting other potential third-party bidders on notice of a possible transaction,” but “no third-party had come forward during the approximately six-month period” before MDC and Stagwell in December announced a merger agreement.

The companies expect to complete the merger in the first half of this year.