The SEC recently announced three enforcement actions that highlight its continued focus on public company financial reporting. The SEC alleges fraudulent revenue recognition in all three of the cases, highlighting that revenues continue to top the SEC’s list of line items on which to focus. Moreover, the cases show the SEC’s continued pursuit of individuals in accounting matters, as well as the entanglement of audit firms in financial reporting investigations. Add in the SEC’s whistleblower bounty program and public companies, audit firms, and each of their personnel would be well-advised to take heed.
Three Recent SEC Enforcement Actions
In March 2018, the SEC announced a settled action against an Illinois-based pharmaceutical company, its former CFO, and its former controller, for alleged financial reporting, books and records, and internal control violations. The SEC alleged that a restatement revealed a material weakness in controls, as well as multiple accounting violations. Following a merger, the SEC alleged, the company’s accounting and accounting systems increased in complexity, but its processes and controls did not keep pace. As a result, the company allegedly improperly accounted for various billbacks and chargebacks that it offered to retail and wholesale customers. Moreover, the company allegedly recognized revenue for certain products based on an increased price point, even though the products were actually shipped pursuant to purchase orders issued at the prior, lower price and even though the buyer refused to pay the higher price. The company and individuals entered into neither admit nor deny settlements, with the individuals each agreeing to pay a $20,000 civil penalty.
Also in March 2018, the SEC announced a settled action against a California-based energy storage company, its former vice president of sales and marketing, its former CEO, and its former controller, for alleged antifraud, books and records, and controls primary and causing violations. The SEC alleged that the company, through its sales VP, prematurely recorded revenues on product sales that were subject to side deals, contingencies, rights of return, extended payment terms, and other alleged manipulations. The SEC alleged that the sales VP took steps to hide his actions, but other defendants allegedly saw red flags or knew about the actions and nevertheless assisted in overriding controls. The defendants entered into neither admit nor deny settlements. The company and the sales VP agreed to pay penalties of $2.8 million and $50,000, respectively, and the sales VP consented to a 5 year officer and director bar. The CEO agreed to pay a total of nearly $80,000 in disgorgement, interest and penalties, and the controller agreed to pay a $20,000 civil penalty. The former CFO was not charged with wrongdoing, but nevertheless agreed to a “voluntary” clawback – reimbursing the company $135,000 of incentive-based compensation he received during the relevant time frame.
Finally, in April 2018, the SEC announced a settled action against a Japan-based multinational corporation for alleged anti-bribery, antifraud, books and records, and controls matters. The bulk of the case concerned the company’s alleged FCPA violations involving the company’s US-subsidiary allegedly offering a lucrative consulting position to a government official at a state-owned airline to induce the airline to do business with the company. The SEC also alleged that the company overstated its pre-tax and net income by prematurely recognizing more than $82 million in revenue for a single quarter. The alleged fraud was accomplished by the company backdating an agreement with the airline and providing misleading information to the company’s auditor. The company entered into a neither admit nor deny settlement with the SEC, ageing to pay approximately $143 million in disgorgement and interest. The DOJ separately settled with the company, imposing a criminal penalty of more than $137 million as part of a deferred prosecution agreement related to causing books and records violations of the FCPA.
These cases highlight several critical points for public companies, auditors, and each of their personnel:
The SEC continues to focus its Enforcement resources on perceived financial reporting violations. A specific unit within the Enforcement Division focuses on proactively identifying potential investigation matters, and the SEC does not hesitate to react quickly when it receives reports of potential concerns from external forces.
The SEC continues to trumpet its whistleblower bounty program as a critical component of its Enforcement regime. Indeed, the SEC recently announced several whistleblower bounty awards of staggeringly large sizes to individuals who provided timely, concrete, and credible information to the SEC about perceived violations, which resulted in enforcement actions and recoveries. Additionally, the US Supreme Court recently ruled that the Dodd-Frank Act does not protect whistleblowers from retaliation unless they made their reports to the SEC—further incentivizing whistleblowers to take their concerns directly to the SEC. (As an aside, the Sarbanes-Oxley Act still prohibits retaliation against whistleblowers who report their concerns within a company but not to the SEC.)
Individuals remain in the SEC’s Enforcement spotlight. Not only will the SEC take enforcement action against top-level financial personnel, such as the CFO and controller, but it could also pursue involved front-line individuals as well, such as sales personnel. Moreover, CEOs and CFOs may be obligated to return incentive compensation when companies restate their financials. In sum, these recent SEC cases highlight the critical need for executives to engage separate individual counsel early in the process—even during an internal investigation – to protect their personal interests alongside company counsel.
The SEC also continues to focus on public company auditors, and their personnel. The SEC has repeatedly proclaimed its focus on gatekeepers, such as public company auditors, in virtually every financial reporting investigation. And even if not really facing direct enforcement risks, auditors nevertheless must endure SEC investigatory processes, including extensive document subpoenas and testimony. Just like for public companies, many audit firms wisely engage separate outside counsel to assist the firm, and/or individual audit team members, through these processes.
Brian Neil Hoffman is of counsel with Holland & Hart in their Denver, Colorado, and Washington, D.C., offices.