This is the fourth in a series of articles examining the creation of the Financial Reporting and Audit Task Force along with a Center for Risk and Quantitative Analysis. Today’s article examines select cases brought in the wake of Chairman Levitt’s Numbers Game speech in which issuers and others utilized improper techniques to distort financial statement trends or distort balance sheet items.
In some instances issuers have distorted revenue trends by improperly combining income from one source with that from another. This was typically done to mask the fact that the primary business of the company was not meeting expectations in terms of revenue.
Reserves: In a number of cases, issuers distorted trends by managing their earnings through the improper use of reserves. In some instances the company failed to release cash from the reserve as required by GAAP, holding it until needed to smooth an earnings trend. In other instances the company failed to add to the reserves as required by GAAP.
· See also, SEC v. Rand, Civil Action No. 1:09-CV-1780 (N.D. Ga. Filed July 1, 2009) (action against the former COO of Beazer Homes, USA, Inc. alleging that during some periods net income was decreased by improperly recording reserves between 2000 and 2005 to meet expectations and later reversing those entries to pay bonuses and mask declining financial performance. See Lit. Rel. No. 2114 (July 1, 2009).
Expenses: In some of the largest financial statement fraud cases the issuer’s earnings were distorted by minimizing the expenses which offset revenue.
Balance sheet. While most financial fraud actions focus on improperly boosting earnings, in some instances issuers have sought to enhance select balance sheet entries through improper techniques. Examples of these cases include:
Self-dealing/looting: Perhaps the ultimate financial statement fraud case is one centered on what is essentially the looting of the corporation by certain executives for their personal benefit. While these cases can be viewed as financial fraud actions because the financial statements of the company are distorted, they differ significantly from those where the focus is to meet street expectations. Examples of these cases include:
Next: Cases following the speech – multiple improper techniques
For more commentary on developing securities issues, visit SEC Actions, a blog by Thomas Gorman.
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