In a recent speech, a task force official described certain flags that might result in closer scrutiny, such as when a company writes off a large amount of debt in a short period, which could suggest it’s placing the debt into an accrual “bank” to smooth its income numbers. The SEC is developing similar tools to analyze text portions of annual reports and other filings for potentially misleading disclosures.
Heightened Efforts Bearing Fruit
In December 10 comments, another task force official touted recent enforcement actions as evidence that the SEC’s stepped-up efforts in the financial-reporting area are beginning to pay off.
In one action, the SEC settled with Paccar, a Bellevue, Washington-based Fortune 200 commercial truck manufacturer. The commission had alleged various accounting deficiencies that “clouded” the company’s financial reports dating back to 2008. Three violations were alleged: (1) failure to report the operating results of Paccar’s parts business as a reportable segment; (2) failure to maintain accurate books and records regarding the company’s impaired loans and leases; and (3) overstatements in equal and offsetting amounts to loan and lease originations and collections for two foreign subsidiaries in its statement of cash flows for two quarters in 2009. The company paid $225,000 to settle the case, without admitting or denying the charges.
Under U.S. accounting rules, companies are required to report segments’ results in the way management views them, allowing investors to get the same perspective of a company’s business as its executives. The Paccar case exemplifies the SEC’s focus on this area. Segment reporting was the third-most-common area discussed in SEC comment letters in the first three quarters of 2014 (435 letters to 184 companies), following tax and goodwill accounting issues, according to an analysis by Audit Analytics. For one, Barnes & Noble recently disclosed that the SEC is investigating how the bookseller split expenses among its devices and e-book segments.
The Risk of SEC Overreach
With the new resources and tools the SEC is devoting to detecting financial-reporting violations, the commission has created an expectation that it will bring more enforcement actions. Such heightened expectations may create an incentive for the Enforcement Division to bring marginal cases not well supported by the facts or law. Compounding that troubling incentive, in June SEC Chair Mary Jo White announced that in certain cases, the SEC would not settle unless the defendants admitted wrongdoing. As a result, it’s likely that more companies, officers and directors will test the SEC’s allegations and legal positions by litigating and going to trial.
Two recent trial losses for the SEC suggest its troubling willingness to allege financial fraud in cases where the facts or the law don’t support the allegations.