United States: SEC Flexes Its Muscle On Accounting Fraud And Targets More Individuals

The Securities and Exchange Commission recently announced the settlement or filing of a number of significant accounting fraud cases. Coupled with recent statements by the SEC and the Department of Justice, it is clear that accounting fraud is a priority and that individuals are in the cross hairs.

This focus on accounting reflects a return to bread-and-butter issues that have been the agency's traditional focus, now that the financial crisis cases are largely behind it. The agency has signaled this trend for some time, through speeches by staff and commissioners.1 The data support this shift: The number of accounting matters has increased by more than 40 percent from 2013 to 2014, and 2015 appears to be at least on par with the prior year. Indeed, the early part of September saw the SEC bring five different financial reporting and accounting fraud actions over the span of a few days, demonstrating its commitment to this area. Below is a sampling of the most recent cases brought by the SEC.

  • The SEC sued a former U.S. Attorney for allegedly making materially misleading statements and omissions to investors and auditors during his term as chairman of a publicly traded staffing services company. 2 The SEC also announced a settlement with the company's auditors relating to their allegedly deficient audits. 3 The entire matter centered on $2.3 million (half of the company's assets and most of its cash) that went missing and then reappeared under "suspect circumstances." The SEC alleged the former U.S. Attorney not only knew where the $2.3 million initially went and how it eventually came back to the company, but that he also was acting as the agent for a convicted felon, the alleged orchestrator of the entire scheme.
  • The SEC announced that it had settled, for $15 million, accounting fraud charges against a company that operates an internet-based consumer banking and personal finance network. 4 The SEC alleged the company's former CFO, director of accounting, and vice president of finance had directed certain of the company's divisions to record unsupported revenue and had reduced or failed to book certain expenses, all in an attempt artificially to inflate its financial results to meet analyst earnings targets. The executives also allegedly provided misleading and generic explanations to auditors to justify the fabricated numbers. The former president of finance settled with the SEC, agreeing to pay a civil penalty, disgorge all ill-gotten gains, and accept five-year officer, director, and public-accounting bars. 5
  • The SEC reached an agreement with a sports nutrition company and four individuals, including the company's former audit committee chair, to settle a series of accounting and disclosure violations. 6 The SEC alleged the company's disclosures understated the perquisites paid to executives by almost $500,000. These included the use of a private jet, vehicles, meals, apparel, private golf club memberships, and medical costs for the birth of a child. The company also allegedly committed a number of other violations, including failing to disclose related party transactions, overstating revenue, and failing to implement internal accounting controls. The company agreed to pay a $700,000 penalty, and the executives who received the unreported perks agreed to pay $180,000 in penalties.
  • The SEC filed civil charges against the former CEO and CFO of a bankrupt online video management company. 7 The SEC alleged the executives engaged in a number of schemes to falsify the company's financial statements so that it appeared more profitable. The executives allegedly caused the company falsely to recognize revenue from sales that were never consummated and diverted money from the company to create a slush fund that was then used to create phony reductions in receivables. The SEC also alleged the executives hid a $2 million loss of cash and, as a result of their various frauds, caused the company to file false and misleading forms with the SEC.

What This Means

These cases, as well as the recent guidance from the DOJ and the SEC staff and commissioners, provide several important lessons or reminders to public companies and their officers and directors:

The SEC is intensely focused on accounting fraud and looking to bring cases. This is clear from the guidance from senior SEC leadership, the creation of the Financial Reporting and Audit Group, 8 the increasing number of filed matters, and the increasing number of financial reporting-related whistleblower complaints that the SEC is pursuing. And while many of the recent matters look like simple fraud cases, management and audit committees should avoid complacency when it comes to financial reporting. The SEC is looking more closely at internal controls failures, multiple revisions that do not individually amount to a material error, accounting errors that might result from misjudgments about estimates or reserves, disclosures relating to executive compensation and related party transactions, and other areas that are beyond simple fraud.

The SEC and DOJ are focused on naming individuals, not just companies, in these cases. In all the recent accounting cases, the SEC has named individuals, including a former audit committee chair, partners, CEOs, CFOs, and accounting directors. In the most egregious cases, the government has also brought criminal charges against individuals. The recent DOJ guidance emphasizing the prosecution of individuals highlights the new risks that face both individuals and companies. 9

Companies and boards must continue to focus on internal controls. This directive has been repeated over and over in SEC speeches, but it also comes through in the cases the agency has filed. Good controls can prevent fraud and accounting errors, or at least allow companies to detect such errors earlier. Companies and management must be diligent in not only putting appropriate and realistic internal controls in place, but also in adhering to them.

We are seeing the fruits of the SEC's whistleblower program: After being in place for more than three years, it is resulting in more whistleblower complaints, many of which relate to financial reporting and accounting and contain information the agency could not have obtained otherwise. This heightens the need for (i) strong procedures for promptly escalating and addressing whistleblower complaints internally and (ii) good controls for preventing retaliation against whistleblowers.

The risk of clawbacks against executives is also only increasing. Under Sarbanes-Oxley section 304 (and in the future under Dodd-Frank section 954), 10 executives face a fatal trap any time there is accounting or financial reporting misconduct. The best way to avoid the possibility of a clawback is to limit the opportunity and incentives for wrongdoing within the company.

Footnotes

1.See Andrew Ceresney, Director, SEC Division of Enforcement, Address at the American Law Institute Continuing Legal Education (Sept. 19, 2013); Oversight of the SEC's Division of Enforcement before the S. Comm. on Financial Services, 114th Cong. 1 (2015) (statement of Andrew Ceresney, Director, SEC Division of Enforcement); Oversight of the SEC's Agenda, Operations, and FY 2015 Budget Request before the H. Comm. on Financial Services, 114th Cong. 1 (2015) (statement of Mary Jo White, Chair, SEC); Daniel M. Gallagher, Commissioner, SEC, Remarks at the 21st Annual Stanford Directors' College (June 23, 2015); Kara M. Stein, Commissioner, SEC, Address at the Institute of Chartered Accountants in England and Wales (Sept. 9, 2015).

2.Complaint, No. 1:15-CV-7077 (S.D.N.Y. Sept. 9, 2015).

3.See id.; Exchange Act Release No. 75,862, Accounting and Auditing Enforcement Release No. 3692 (Sept. 9, 2015); Exchange Act Release No. 75,859, Accounting and Auditing Enforcement Release No. 3689 (Sept. 9, 2015).

4.See Securities Act Release No. 9901, Exchange Act Release No. 75,849, Accounting and Auditing Enforcement Release No. 3683 (Sept. 8, 2015).

5.Litigation against the former CFO and director of accounting is ongoing.

6.See Securities Act Release No. 9903, Exchange Act Release No. 75,851 (Sept. 8, 2015); Securities Act Release No. 9904, Exchange Act Release No. 75,852 (Sept. 8, 2015); Securities Act Release No. 9905, Exchange Act Release No. 75,853, Accounting and Auditing Enforcement Release No. 3685 (Sept. 8, 2015); Securities Act Release No. 9906, Exchange Act Release No. 75,854, Accounting and Auditing Enforcement Release No. 3686 (Sept. 8, 2015); Exchange Act Release No. 75,855, Accounting and Auditing Enforcement Release No. 3687 (Sept. 8, 2015).

7.See Press Release, SEC, "SEC Charges Video Management Company Executives With Accounting Fraud" (Sept. 8, 2015). In a parallel action, the U.S. Attorney's Office has announced criminal charges against the executives.

8.See Stephanie Russell-Kraft, "SEC's 'RoboCop' Drags Agency Into 21st Century," Law360 (Aug. 21, 2015).

9.Jones Day Commentary, "U.S. Department of Justice Announces Updated Guidelines on Individual Accountability for Corporate Wrongdoing" (Sept. 2015).

10.Jones Day Commentary, "SEC Proposes Dodd-Frank Act Clawback Rules" (July 2015).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.