powerpoint slide presentation
TRANSCRIPT
Disclaimer
The views expressed in this presentation are those of Marc Fagel and are not necessarily shared by the Commission or
its staff.
Overview
The SEC’s Division of Enforcement
Financial Reporting Fraud
Recent SEC Enforcement Actions
The New Landscape
SEC Enforcement Staff
970 staff members
370 in Home Office
600 in regional/district offices
Enforcement Actions by Fiscal Year
0
100
200
300
400
500
600
19951996
19971998
19992000
20012002
Fiscal Year
FY 2001 Cases By Subject
Financial Fraud 23% Offering Fraud 20% Broker-Dealer 13% Insider Trading 12%
Financial Reporting Actions Filed
163 actions filed in FY02
Compared to:
112 in FY 2001
103 cases in FY 2000
94 cases in FY 1999
79 cases in FY 1998
SEC Investigations
Informal Inquiry
Formal Investigation
Confidential
Civil
SEC Enforcement Remedies* Injunction/C&D Order Temporary Restraining
Order Asset Freeze Trading Suspension
Disgorgement Civil Monetary
Penalties Officer/Director Bar 102(e) Order
*applicable to financial fraud cases
Financial ReportingFraud
Common Financial Fraud Schemes
Contingent sales, right of return Channel stuffing Bill and hold transactions Quarter cut-off
Improper Revenue Recognition
Common Financial Fraud Schemes
Improper Revenue Recognition Overstatement of Assets Understatement of Liabilities Failure to Record Expenses
Newer Financial Fraud Schemes
Earnings Management Off-Balance-Sheet Entities Barter Sales, Round-Tripping Pro Forma Earnings Releases
Newer Financial Fraud Schemes
“Cookie Jar” reserves “Big Bath” charges and write-downs Undisclosed changes in estimates Undisclosed changes in policies
Earnings Management
Recent SECFinancial Fraud
Enforcement Actions
National
Bay Area
Recent Cases (Nationwide)
Enron WorldCom Xerox Adelphia Communications Dynegy RiteAid
Enron
Enron Commission sued former CFO Andrew Fastow on
October 2, 2002. Complaint alleges: Secretly controlled 3 entities, hiding his role to keep items off Enron’s
balance sheet.
Sham sales, including sale to another off-balance-sheet entity he controlled.
Backdated documents to overstate value of technology company in which Enron had invested.
Siphoned millions of dollars for himself and family members.
Commission sued/settled with Enron officer Michael Kopper on August 21. Claims related to off-balance-sheet entities controlled by Fastow through Kopper. O&D bar, $12 million disgorgement.
WorldCom
Commission filed case within 24 hours of the company’s public
announcement of its restatement.
WorldCom Complaint alleges that WorldCom capitalized rather
than expensed approximately $3.8 billion of its costs, in violation of GAAP.
Within 48 hours, Commission obtained a court order preventing destruction of documents, prohibiting extraordinary payments to current and former officers, directors and other employees, and appointing a corporate monitor.
Subsequently filed cases against Controller David Myers and Director of General Accounting Buford “Buddy” Yates. Investigation continues.
Xerox
Commission sued Xerox on April 11, alleging undisclosed accounting actions that accelerated revenue recognition of equipment by over $3 billion and increased pre-tax earnings by $1.5 billion over a four-year period. Over 30% of pre-tax earnings resulted from undisclosed accounting actions.
Among other things, shifted leasing revenue from service/financing to hardware so could accelerate revenue recognition.
Xerox
*from SEC complaint
Xerox As part of the settlement:
Xerox paid a $10 million penalty – the largest ever levied in a Commission action against a public company for financial fraud. The penalty reflects the severity of the misconduct as
well as the company's lack of full cooperation in the investigation.
Xerox was required to conduct a special review of its accounting controls and to restate its financials. This ultimately led to Xerox’s acknowledgment that
it had misstated approximately $6 billion of revenues.
Adelphia Communications Commission filed
charges against Adelphia, its founder (John J. Rigas), his three sons, and two other senior executives, alleging one of the most extensive financial frauds ever to take place at a public company.
Adelphia Communications
SEC complaint alleges that Adelphia, at the direction of the individual defendants:Fraudulently excluded billions of dollars in liabilities from
its consolidated financial statements by hiding them on the books of off-balance-sheet affiliates;
Falsified operations statistics and inflated earnings; and
Concealed rampant self-dealing by the Rigas Family, including the undisclosed use of corporate funds for Rigas Family stock purchases and the acquisition of luxury condominiums.
Adelphia Communications The Commission is seeking:
Disgorgement of all ill-gotten gains, including:
Compensation received during the fraud
Property unlawfully taken from Adelphia through undisclosed related-party transactions
Severance payments
Officer and Director bars
Permanent anti-fraud injunctions
Civil penalties from each defendant, including Adelphia. Penalty against company sought because Adelphia failed early on to
cooperate with the Commission's investigation and actually allowed the fraud to continue until the Rigas family lost control over the company's conduct.
Dynegy
On September 24, Commission instituted settled administrative proceedings against Dynegy, Houston energy company, imposing $3 million penalty.
Dynegy Administrative Order finds that Dynegy used
off-balance-sheet special purpose entities to falsely disguise loan, inflating operating cash flow by $300 million (37%).
Dynegy entered into 2 massive “round-trip” electricity transactions, inflating revenue in press releases.
$3 million penalty in part reflects company’s lack of full cooperation in Commission investigation.
Rite Aid
Commission charged former CEO, CFO, and Vice Chairman with fraud in connection with wide-ranging accounting fraud scheme that enabled the company to overstate its income in every quarter from May 1997 to May 1999.
Non-fraud cease-and-desist settlement for company (based on cooperation with Commission, including declining to assert attorney-client privilege in giving access to internal investigation conducted by company counsel).
Rite Aid Accounting fraud alleged in complaint includes:
Systematically inflated deductions taken against future amounts owed to vendors for supposedly damaged & outdated products;
Reduced accounts payable by $75 million for vendor rebates that were contingent on future events;
Improperly reduced (or failed to record) various expenses;
Opened books after close of quarter to record various changes to make up financial shortfalls.
Recent Cases (Bay Area)
HPL Technologies Unify Quintus Legato
Recent Cases (Bay Area)
HPL Technologies
Settled injunctive action against former President & CEO David Lepejian
Over 80% of revenue for fiscal 2002 phony
Forged purchase orders and audit confirm responses
O&D bar, other relief
Recent Cases (Bay Area)
Unify
Civil injunctive action against former CEO Reza Mikailli and former CFO Gary Pado
Recognized revenue on contingent sales
Roundtripping (i.e. made investments in other companies, which used investments to buy Unify products)
Mikailli sold all his Unify stock for $8.2 million
Recent Cases (Bay Area)
Quintus
Civil injunctive action against CEO Alan Anderson
Forged purchase orders and audit confirm responses for 3 fake transactions
Barter transactions
Recent Cases (Bay Area)
Legato Systems
Settled cease-and-desist proceedings against Legato and CFO Stephen Wise
Contingent sales to distributors, side letters
The New Landscape
The New Landscape
1. Coordination with criminal authorities
The New Landscape
1. Coordination with criminal authorities
2. Emphasis on personal accountability
Greater use of O&D bars Disgorgement of compensation
Officer and Director Bars
Officer and Director bars sought:*
FY 2002: 126
FY 2001: 51
FY 2000: 38
*all categories of cases
Financial Reporting & Issuer Disclosure: Themes and Trends
1. Coordination with criminal authorities
2. Emphasis on personal accountability
3. Real Time Enforcement
Real Time Enforcement
Wider Use of Emergency ReliefTROs
FY 2002: 48 FY 2001: 31
Asset Freezes FY 2002: 63 FY 2001: 43
Trading Suspensions FY 2002: 11 FY 2001: 2
• Bring Cases Piecemeal
Financial Reporting & Issuer Disclosure: Themes and Trends
1. Coordination with criminal authorities
2. Emphasis on personal accountability
3. Real Time Enforcement
4. Hold companies accountable for non-cooperation
Section 21(a) Report on Cooperation
Establishes Framework for Evaluating CooperationCredit for extraordinary cooperationNot an amnesty program
Provides Expanded Spectrum of OutcomesMeaningful differences among different respondentsCredit for real cooperation
Benefits InvestorsEncourages self-reportingRewards companies with effective compliance procedures
What Does Cooperation Mean?
Self-Policing Before Misconduct DiscoveredEffective Compliance ProceduresAppropriate “Tone at the Top”
Self-Reporting Misconduct When DiscoveredThorough InvestigationPrompt Disclosure
RemediationDismissing or Disciplining WrongdoersInternal Controls and Procedures to Prevent RecurrenceCompensating Those Affected Adversely
Cooperation with law enforcement authorities
Consequences of Non-Cooperation:
Subpoena Enforcement Actions 19 actions in FY 2002 38% increase over last fiscal year
Tougher Sanctions Xerox: $10 million penalty Dynegy: $3 million penalty
The New Landscape
1. Coordination with criminal authorities
2. Emphasis on personal accountability
3. Effort to speed up our investigations
4. Hold companies accountable for non-cooperation
5. Compliance with GAAP not always enough
Edison Schools Commission found that Edison, despite
technical compliance with GAAP, inaccurately described aspects of its business in its SEC filings, in violation of the securities laws.
Specifically, Edison failed to disclose that a substantial portion of its reported revenues consist of payments that never reach Edison. Funds are instead expended by school districts to cover costs of operating schools managed by Edison.
The New Landscape
1. Coordination with criminal authorities
2. Emphasis on personal accountability
3. Effort to speed up our investigations
4. Hold companies accountable for non-cooperation
5. Compliance with GAAP not always enough
6. Facilitating another company’s reporting violations may create liability
The New Landscape
1. Coordination with criminal authorities
2. Emphasis on personal accountability
3. Effort to speed up our investigations
4. Hold companies accountable for non-cooperation
5. Compliance with GAAP not always enough
6. Facilitating another company’s reporting violations may create liability
7. Sarbanes-Oxley Act
Sarbanes-Oxley Act of 2002 Creates the Public Company Accounting Oversight Board Requires CEO and CFO certification of reports Increases penalties and other sanctions for corporate
wrongdoing Imposes new rules for audit committees Requires auditors to report additional information to audit
committee Additional rules governing auditor independence Attorney responsibility to report evidence of securities law
violations to CEO/audit committee Orders new rules for securities analyst independence
New Enforcement Tools Standard for obtaining Officer & Director bar lowered from
“substantial unfitness” to “unfitness”
Obtain Officer & Director bar in administrative proceeding
Obtain temporary freeze of extraordinary payments to officers or directors during an investigation of a public company or its senior management
Greater Commission access to foreign workpapers
Establish FAIR Funds to add amounts obtained as penalties to disgorgement funds returned to investors
Debts based on judgments and settlements resulting from violations of federal securities laws are nondischargeable in bankruptcy