Settlements cut errant issuers down to size. The SEC closed its 2019 fiscal year with a frenzy of settlements, ending eight enforcement actions with public companies that agreed to pay penalties totaling $116.9 million (although the companies neither admitted nor denied liability). According to attorneys Dixie Johnson, Alec Koch, Dick Walker, and Jim Gorsline, the settlements show that the SEC is continuing to target filers’ judgment calls on accounting and disclosure items which suggest misleadingly positive results.
For example, one settlement over an accounting problem concerned a company’s violation of a GAAP principle that states expenses must be incurred and accrued concurrently. An officer of the corporation had timed and quantified expense accruals to raise or lower earnings and thereby match the consensus of analysts’ expectations as closely as possible. The SEC decided that the accounting entries in numerous accounts had been deferred, eliminated, or even “intentionally erroneous.” It also found that the issuer had used other “intentionally erroneous” entries to classify two types of reserves as increases to income from continuing operations.
The bank stacked the deck on weak loans. In another settlement, a bank holding company had violated an accounting standards codification (ASC) from the FASB on classifying and taking proper charges against impaired loans—as well as its own rules for rating loans according to risk—by materially understating its allowance and provision for losses. The bank had ignored signs of the financial distress of borrowers and relied too much on their and their guarantors’ reputations, their relationships with the bank, and the expectations of more business from them. In a third action described by the authors, the issuer bartered data sets with other companies and recorded revenue for transferred sets that had no reasonably determinable value under the applicable ASC. It also recognized revenue by accounting for linked transactions as if they had been distinct. Furthermore, side agreements to contracts also allowed the CEO to conceal from the accountants—both inside and outside—commitments to deliver data later, enabling the recognition of 100% of the contract revenue in the signing quarter.
It was vital to deal with inadequate disclosure. The SEC charged that companies had exaggerated performance by falsifying or omitting key financial measurements. One settlement arose after the SEC’s finding that the issuer’s workers had recorded certain vehicle sales only in months for which they wished to inflate results and that the issuer had paid dealers to report sham sales, which were subsequently reversed. Another settlement followed a finding that the issuer and its CEO had modified its counting methods but had not disclosed the result: comparisons to earlier periods thereby became “apples to oranges,” the authors point out. One company accelerated sales originally planned for future quarters to make actual results more closely resemble publicly released performance targets, offering buyers varied financial inducements to accept products early. Another company had incorrectly disclosed contingent losses from a Department of Justice investigation, failing to accrue for those losses and providing risk factors that minimized the DOJ’s opposition to the company’s policies. The factors mentioned the risk that the DOJ could take a certain position, when in fact the government had already done so.
There was sleight of hand on executive pay. The SEC settled an action against a carmaker, its former CEO, and a director who was the CEO’s subordinate. By means of such improprieties as secret contracts and backdated letters, the two individuals had increased the CEO’s compensation and retirement benefits but had hidden the increases. SEC filings consequently understated the CEO’s compensation and misstated why the issuer’s retirement allowances had risen, making the financial statements materially misleading. In another settlement, the issuer had used multi-level marketing in the United States and elsewhere that permitted this sales method; nevertheless, it asserted in SEC filings that it had operated differently in China, which banned the method. In fact, it had used essentially the same method in China. This case and several others, the authors suggest, indicate the SEC’s apprehension about companies that mislead investors by not only manipulating figures in the financials but also concealing risks and bad news.
Abstracted from Insights: Corporate & Securities Law Advisor, published by Wolters Kluwer Law & Business, 4025 W. Peterson Avenue, Chicago IL
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To read the full article in Dimensions Vol. 2020, No. 2, click here.
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