This is the eighth and concluding segment 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 analyses the likely focus of the New Task Force, suggesting steps that issues can take now to avoid liability tomorrow.
The new financial task fraud task force is currently being formulated. Its path has yet to be charted. Yet, if history is any guide, issuers and their directors, executives and auditors would do well to be prepared.
Following Chairman Levitt’s “Numbers Game” speech the Commission launched a very successful campaign against financial statement fraud. Significant cases were brought against dozens of issuers and their executives. In some instances the outside auditors of the firm and even business partners became embroiled in enforcement litigation. In several instances criminal prosecutions were brought.
Now under a new Chair, and with a freshly minted “get tough” policy, the Commission is launching a similar campaign. The new campaign has more weapons than in the past. There is a rich history of cases illuminating wrongful practices to serve as an initial guide. The SOX certification process provides a potential guide for investigators to what should be key company financial issues while serving as an enhancement to potential liability for the CEO and CFO. The electronic tags added to financial data filed with the SEC facilitate data evaluation. And, a reorganized enforcement program is keyed to risk and data analysis as well as the use of industry metrics to measure and evaluate performance as an indication of possible wrongful conduct.
In view of this, issuers and their executives should consider four key points. First, the lessons from the financial statement fraud actions brought in the wake of the “Numbers Game” speech that will serve as the roots of the new Task Force should be carefully assessed. An analysis of cases such as HealthSouth, Time Warner, Bristol-Myers, Xerox, GE and others yields a guide to improper practices which can be used as a red flag check list to identify improper practices. See generally Richard H. Walker, Director, Division of Enforcement, 27th Annual National AICPA Conference on Current SEC Developments (Dec. 7, 1999) (Identifying 10 lessons from financial statement fraud cases).
Second, the market crisis financial cases point to another key metric which the Task Force will clearly consider. Actions such as Mozilo where deteriorating assets were masked giving investors a distorted view of the company will surely be a central issue. This counsels a careful analysis of valuation and reserve issues as well as disclosure controls.
Third, the analytic and big data approach illustrated by the Aberrational Performance Inquiry offers a good guide for issuers evaluating performance. The focus is a risk based set of industry metrics that identify outliers. Issuers can conduct this same kind of analysis by evaluating trends in their performance in view of specific metrics. If, in view of those metrics, the company is an outlier or its performance is too good to be true, further inquiry may be warranted. Conducting that inquiry now before any SEC investigation is not just prudent, it is good business.
Finally, the stakes in these cases could not be higher. Senior executives of the company are frequently charged as in Cendant, Enron, WorldCom, Adelphia and other cases. In some instances business partners are charged as in Koninkijke Ahold. In others the outside auditors are named in Commission enforcement actions as in Xerox and Bally. And, since the line between civil and criminal securities fraud is at best murky, there may be criminal liability as in many instances. See, e.g., Thomas O. Gorman, SEC Enforcement Trends 2011, Financial Fraud, Secactions (April 18, 2011), available at http://www.secactions.com/sec-enforcement-trends-2011-financial-fraud.
Those who believe that the new Financial Task Force will find a vastly changed financial reporting landscape and fewer cases would do well to remember the predicate for Chairman Levitt’s “Numbers Game” speech. It was the constant pressure on companies and executives to meet street expectations, according to the Chairman. The string of cases brought in the wake of that speech bore out Chairman Levitt’s point. Today’s 24/7 news cycle, active class action bar, and waiting whistleblowers have done nothing but intensify those pressures. With a new SEC task force looming, the prudent company and executive will understand that acting today is good business for tomorrow. Acting today can ensure that those pressures do not turn their financial reporting into a “Numbers Game.” See, e.g., Ex-Olympus Chairman Gets Suspended Sentence for Fraud, Bloomberg (July 3, 2013) (Chairman of Olympus sentenced on criminal charges related to financial statement fraud).
For more commentary on developing securities issues, visit SEC Actions, a blog by Thomas Gorman.
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