The SEC and Accounting Fraud
The SEC trumpets its FCPA enforcement program. It wants to send a message to the business community. Make no mistake – businesses have heard the message.
But what is the SEC doing when it comes to bread and butter issues like accounting fraud. In the early 2000s, the SEC aggressively prosecuted accounting fraud schemes committed by companies such as WorldCom and Enron. Politicians were forced to respond to the accounting scandals by enacting Sarbanes-Oxley. The Justice Department and the SEC started task forces to prosecute white collar crimes. Congress even considered imposing mandatory-minimums for various white collar crimes.
In the last few years, the SEC’s highest percentage of enforcement cases do not involve the FCPA — they involve corporate accounting fraud. About 20 percent of he SEC’s enforcement actions each year are against companies for fraud schemes for revenue or expnse fraud.
SEC guidance on when to recognize revenue or costs is fairly straightforward. See Staff Accounting Bulletin No. 104. Some of the violations are based on false revenue entries; some are based on misclassification of potential revenues, contrary to established accounting principles. Companies often play fast and loose with deliveries to customers and distributors, sometimes even coming up with schemes to satisfy orders in one quarter leading to returns of the same order in the beginning of the next quarter. With respect to expenses, companies try and manipulate accrual accounting requirements to defer expenses beyond a specific quarter or year.
The SEC knows how to zero in on these issues and the first source of such fraud is usually interactions between the auditors and senior management at the company. Management may argue with the auditors over the calculation, may try to mislead the auditors and auditors usually detect the problems and try to fix them.
Companies often face important milestones during the fiscal year. They are under extreme pressure to meet short-term revenue goals and to satisfy analysts’ expectations. It is a common game and often leads to pressure to cook the books.
In order to avoid these potential problems, company counsel need to be vigilant when financial reporting obligations are being addressed.