SEC Trends & Developments - Summer 2011 - Recent SEC Enforcement Actions

August 01, 2011


Here, the SEC ordered an accountant to cease and desist from committing or causing violations of the books and records provisions of the Exchange Act. That CPA was the former CFO (the "CFO") of a reporting company's energy business segment. That segment focused on design and consulting services and operated and maintained oil and gas production facilities owned by third parties. The energy segment generated revenues on certain projects, principally "cost plus" contracts, pursuant to which it billed clients for project costs plus agreed-upon margins. Certain other costs were contractually "non-billable." Finance employees of the segment were required to regularly review project costs and to determine whether they were billable or non-billable and to record those costs on a monthly basis.

When an assistant controller left the reporting company in November, 2006, he informed the CFO that the manager of project accounting work could not be relied upon without close supervision or oversight. The CFO was ultimately responsible for the accuracy of manual journal entries and purportedly knew that the manager of project accounting's direct supervisor had departed, but the CFO reportedly did not review any supporting documentation for manual journal entries as part of his approval process. The SEC asserted that the CFO knew or should have known that the controls of the segment that were in place for reviewing manual journal entries were not adequate and that there was heavy reliance on a monthly review by him of all of the manual journal entries. The Commission further asserted that the CFO took no steps to improve that particular control and failed to properly implement those controls as a result of his own inadequate review.

The SEC argued that: (1) the CFO regularly approved month-end manual journal entries made by a manager of the segment but failed to review the supporting documentation for those entries, (2) certain of those entries did not comply with GAAP causing a material overstatement of the reporting company's revenue and net income in its SEC filings and (3) the CFO knew or should have known that the controls for reviewing manual journal entries were inadequate but took no action to improve upon those controls and failed to properly implement them.

Ultimately, the reporting company restated its consolidated financial statements for the first, second, and third quarter of 2007 because of improper recognition of non-billable costs and related margins on domestic managed services projects during those periods.

(AAER No. 3278, May 11, 2011, CCH Fed Sec L Rep Para 89,440)


The SEC denied a motion by a CPA (the "Controller") to lift a temporary suspension under the SEC's Rule of Practice 102(e)(3). That followed the finding in a jury trial that the Controller had violated provisions of the Exchange Act regarding internal controls and the falsification of books and records. After the trial, the district court permanently enjoined the Controller from violating Section 13(e)(5) of the Exchange Act and Exchange Act Rules 13b2-1.

The SEC alleged that the Controller of the reporting company knowingly falsified books, records and accounts in connection with the backdating of employee's stock option grants. The Commission also asserted that the Controller knowingly circumvented the reporting company's internal accounting controls to avoid recording compensation expense with respect to the backdated options.

After trial, the Controller responded to the SEC's positions by asserting that a temporary suspension was premature because he had filed "a meritorious action to amend the [final judgment]" in the case and because the Controller "will appeal any adverse ruling" with respect to his motion. The Controller further contended that the district court used an improper standard to determine requisite intent under Exchange Act Section 13(b)(5) and has challenged the evidence used against him at trial, asserting that the Commission improperly relied on the financial statements of the client company and elicited improper expert testimony about complicated accounting issues from lay witnesses.

Without expressing an opinion as to the merits of the Controller's claims, the SEC found that Rule 102(e)(3) permits it to suspend any accountant or other professional or expert who has been permanently enjoined from violating the federal securities laws or any related rules and regulations, as was done by the district court in an amended final judgment against the Controller, permanently enjoining him from violation Exchange Act Section 13(b)(5) and Exchange Act rule(13b2-1). While acknowledging that the Controller is entitled to appeal the underlying case, neither the pendency of his current motion in that case before the district court nor the possibility of an appeal alters the effect of the jury's findings of securities law violations or the imposition by the court of an injunction. The SEC further noted that, generally, a respondent in a follow-on proceeding is precluded from changing the basis for or findings in the underlying injunctive action. The Commission said that at this stage, the findings made in the injunctive proceedings and the injunction issued against the Controller justify continuing his suspension "until it can be determined what, if any, action may be appropriate to protect the Commission's processes."

(AAER No. 3287, June 3, 2011, CCH Fed Sec L Rep Para 89,456)


The SEC instituted precedings against a company (the "Registrant") for GAAP inaccuracies and violations of the 34 Act and the books and records provisions of the 34 Act caused by premature revenue recognition and by internal control deficiencies. That led to an agreed upon cease and desist order.

The Registrant, a manufacturer and seller of laser systems and other technology products, was found by the Commission to have had deficiencies in its system of internal controls attributable, in part, to a failure to understand and assess risks in its control environment and to design and execute monitoring procedures to evaluate the controls over those risks. That included a failure to communicate between the registrant's Systems Division personnel and its Finance Department. For example, sales representatives were found to have agreed to provide additional items to customers after the Registrant had received purchase orders, or to have offered customers other incentives, but failed to properly document or communicate those agreements to the Finance Department. The SEC also concluded that the Systems Division did not have a clear process to insure that concessions, upgrades or other terms agreed to with customers in the periods between booking and recognizing revenue, were included with transaction documents. The Finance Department was found to have been often unaware of actual transaction terms. The obligations to deliver additional items and the granting to customers of incentives impacted the timing of appropriate revenue recognition but the Finance Department relied on incomplete information when making revenue recognition decisions. The Commission also concluded that the Registrant failed to adequately oversee employees who were involved in revenue recognition decisions.

In addition, with respect to two particular transactions, the Commission concluded that the Finance Department was not aware of certain contractual obligations undertaken by the Registrant to upgrade certain products and that certain employees had represented to the Finance Department in writing that there were no side transactions or contingencies (such as the obligation to upgrade products). With respect to one of the two additional transactions, the Finance Department was not aware that the company had agreed to provide a customer with unique, customized software.

Ultimately, the Registrant restated annual and quarterly financial statements in fiscal years 2004-8. The Registrant was ordered to cease and desist from causing any violations and future violations of Section 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act and related rules 12b-20, 13a-1, 13a-11 and 13a-13.

(AAER No. 3283, May 13, 2011, CCH Fed Sec L Rep Para 89,446)


Sam Gunther is a CPA and attorney in New York. He consults and testifies as an expert witness on accounting and auditing matters.


SEC Trends & Developments - Summer 2011 Issue 

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