SEC Trends & Developments - Spring 2012 - Recent SEC Enforcement Actions

A complaint by the SEC alleged that F, the former Controller and Chief Accounting Officer of D, an SEC reporting company, engaged in conduct that resulted in several GAAP misstatements by D, in 2000 and 2001.  Three accounting subjects at issue were: mischaracterization of expense, sales with agreement to repurchase inventory, and improper accounting for a liability.
In the first transaction, in the third quarter of 2000, D allegedly made a payment to its former parent company pursuant to a settlement agreement.  D entity treated the transaction as if it primarily related to certain pension and other post-employment benefits even though certain officers and employees of D knew that the settlement related exclusively to warranty claims.  As a result of those mischaracterizations, D over-reported its earnings per share for the third quarter of 2000.
In the second transaction, the reporting company allegedly reported $270 million sales of inventory to two third parties while simultaneously agreeing to repurchase that inventory in the following quarter for the original sales price plus approximately $4 million in interest charges and structuring fees.  Because of the erroneous accounting for those transactions as sales, rather than as financing transactions, D improperly recognized approximately $200 million in cash flows from operations in the fourth quarter of 2000.
In the third transaction, the SEC’s complaint alleged that, in the fourth quarter of 2001, D  solicited a $20 million lump sum payment from its largest information technology service provider in exchange for which D provided new business to the IT provider and agreed to repay the $20 million lump sum payment, with interest, over a five-year period.  Despite knowing that the lump sum payment received should have been accounted for as a liability to the IT provider, D and personnel of the IT provider allegedly misrepresented the nature of the lump sum payment so that D could improperly account for that payment as an immediate reduction of information technology expense in the fourth quarter of 2001.  That resulted in an overstatement by D of originally reported EPS in that quarter.

Because a court of competent jurisdiction had permanently enjoined F from violating securities laws within the meaning of Rule 102(e)(3)(i)(a) of the SEC’s Rules of Practice, the Commission suspended F’s right to practice before the SEC for 30 days after which he could petition the SEC to lift the suspension.

In a complaint, the SEC alleged that a former CFO of a manufacturer of gaming equipment had provided substantial assistance to her employer in misstating revenue in several SEC filings that contained false and misleading financial statements.  She also was alleged to have provided substantial assistance in committing books and records violations under the Securities Exchange Act of 1934.
The CFO agreed to a suspension from appearing or practicing before the SEC for three years after which she may apply for reinstatement.  She also agreed to pay a $10,849 disgorgement, $3,509 of pre-judgment interest and a civil penalty of $30,000.
An SEC complaint alleged that a CPA had traded in call options of a target company during the last week before a public announcement that the company in whose options he traded had agreed to be acquired by a tender offer.  The CPA allegedly did so despite having performed buy-side due-diligence work on the underlying acquisition talks for the client of the accounting firm that employed him, which client acquired the company in whose options he traded.  The complaint also alleged that the CPA knew or had reason to know that the information the CPA possessed about the acquisition talks was material and non-public and that at the time that he traded the options in question, substantial steps had been taken in furtherance of the tender offer.
The CPA agreed to a suspension of practicing before the Commission for two years from the date of the SEC order, after which he may apply again to resume appearing or practicing before the SEC.

In denying a motion by G to dismiss an action brought against him by the SEC, the United States District Court for the District of Columbia addressed a subject that is of continuing interest to the Commission and to independent auditors.  The SEC alleged that G knew that information he had provided to independent auditors of USF was false and would be incorporated in USF’s publicly disclosed financial statements.  G was the President and CEO of KPC, a privately held company that sold products to USF, a publicly held distributor.  USF resold the product to end-users.
The SEC complaint alleged that G signed an audit confirmation letter to KPC’s independent auditors concerning billings and promotional advances allegedly owed by KPC.  In a second letter, separate from the confirmation letter, the parties allegedly agreed that any differences between the confirmation letter and actual activity during the time frame covered by the confirmation were not obligations of KPC.
In a motion to dismiss the action, the court held that, at this stage of the litigation, the SEC had provided sufficient evidence to raise genuine dispute of fact as to whether G knew that information in the audit confirmation letter would be incorporated into publicly disclosed financial statements and whether the information in the second letter was false and misleading.  Thus, the litigation continues.
This case demonstrates that in enforcing the securities laws, the SEC will consider the conduct of individuals who communicate with independent auditors, including individuals who are not employed by the entity being audited.
Sam Gunther is a CPA and attorney in New York.  He consults and testifies as an expert on accounting and auditing matters. 

SEC Trends & Developments - Spring 2012 Issue 

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