The Securities and Exchange Commission has increased its enforcement efforts against lapses in accounting and financial reporting, while cracking down ever more on financial fraud, according to a new report.
The report, from the law firm Morrison & Foerster, studied SEC enforcement patterns in 2013. It noted that under the leadership of the SEC chair, Mary Jo White, and her Division of Enforcement co-directors George Canellos (who announced plans last month to step down) and Andrew Ceresney, the SEC recast its enforcement program in 2013. According to White, the changes are designed to highlight the SEC's “robust” enforcement program that is “aggressive and creative,” and that “continue[s] to focus on financial statement and accounting fraud.”
The trend last year toward increased enforcement of accounting and financial reporting cases follows somewhat restrained enforcement in these areas in the aftermath of the financial crisis, when the SEC focused more on cases related to the mortgage meltdown, accompanied by an intense wave of insider trading cases. But the balance began to tip towards accounting and financial reporting enforcement last year, with the SEC creating a task force to focus on accounting fraud and leveraging analytical software to ferret out unusual financial reporting behavior (see SEC Refocuses on Accounting Fraud and SEC Creates Task Force to Combat Accounting Fraud).
“If the public statements of the SEC commissioners and staff are to be believed, brace yourself for the coming wave of financial reporting and accounting enforcement matters,” said Brian Neil Hoffman, a former senior attorney in the SEC's Division of Enforcement and now a member of Morrison & Foerster's securities litigation, enforcement, and white collar defense group, who was chief author of the report.
The alleged misuse of corporate assets topped the list of accounting and financial reporting cases last year, followed by cases alleging overstated assets and those involving misstated business prospects. Areas that drew the least number of actions last year were those stemming from revenue recognition issues and understatement of assets, although SEC officials have stated that the agency plans to scrutinize those topics in the future.
The report includes infographics showing how different types of defendants stacked up in financial reporting cases in 2013. Directors and officers led all groups, comprising 42 percent of defendants, followed by public companies (29 percent), auditors (16 percent) and audit firms (4 percent).
Another chart compares the amount of cases that are litigated as opposed those that are settled and the forum in which the cases were filed. The report also compared which venues drew the most cases last year. The District of Columbia led the way, followed by the Southern District of New York, but cases also were filed in numerous other jurisdictions across the country.
The SEC has been increasingly relying on its whistleblower program to ferret out potential cases of wrongdoing, receiving 3,238 tips concerning possible violations of the federal securities in fiscal year 2013, an increase from 3,001 the previous year.
Revenue recognition remains a staple of the financial fraud caseload, according to SEC officials, but other performance benchmarks used by companies will probably also be carefully scrutinized. The SEC staff has emphasized on numerous occasions that the effectiveness of internal corporate controls are a major concern. Other areas highlighted in recent public comments from the SEC and cases include “asset valuation; recorded expenses, particularly capitalized expenses; estimated reserves and allowances; accounting in connection with acquisitions; off-balance-sheet financings; alternative tax treatments; MD&A disclosures, particularly looking at possible omissions and the use of non-GAAP measures; related-party transactions; and matters arising from foreign operations, including possible FCPA [Foreign Corrupt Practices Act] issues, cash controls, and other accounting and disclosure concerns,” the report noted.
However, despite the ramped up enforcement efforts, the SEC lost two big cases in court last year, the report pointed out. A jury in Kansas issued a verdict in favor of the CFO of NIC, Inc. whom the SEC had accused of concealing over $1 million in perks paid to the company’s former CEO. In addition, a court in California ruled in favor of the former CFO and former CEO of Basin Water, Inc., finding that the SEC failed to prove that they had entered into “sham transactions” to boost revenues.