In Conclusion Baruch College The Sixth Annual Financial Reporting Conference May 3, 2007 Susan G. Markel Chief Accountant, Div. of Enforcement The.

In Conclusion

Baruch CollegeBaruch CollegeThe Sixth Annual Financial The Sixth Annual Financial

Reporting ConferenceReporting Conference

May 3, 2007

Susan G. MarkelChief Accountant, Div. of Enforcement

The U.S. Securities and Exchange Commission, as a matter of policy, The U.S. Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of disclaims responsibility for any private publication or statement by any of its employees. Views expressed herein are those of the presenter and do not its employees. Views expressed herein are those of the presenter and do not necessarily reflect the views of the Commission or other members of the necessarily reflect the views of the Commission or other members of the staff of the Commission.staff of the Commission.

Today’s Topics

SEC Enforcement SEC Enforcement Focusing on Financial Fraud Focusing on Financial Fraud

and Financial Reporting and Financial Reporting MattersMatters

Financial Fraud is:“… “… Intentional or reckless conduct, whether act or Intentional or reckless conduct, whether act or omission, that results in materially misleading financial omission, that results in materially misleading financial statements…” statements…”

involvinginvolving

“ “ . . . gross and deliberate distortion of corporate . . . gross and deliberate distortion of corporate records, … falsified transactions, … [or] the records, … falsified transactions, … [or] the misapplication of accounting principles.”misapplication of accounting principles.”

Report of the National Commission on Fraudulent Financial Reporting; COSO, Report of the National Commission on Fraudulent Financial Reporting; COSO, October 1987October 1987

Fraud is Different than Errors

““Fraudulent financial reporting differs Fraudulent financial reporting differs from other causes of materially from other causes of materially misleading financial statements, such misleading financial statements, such as as unintentional errorsunintentional errors.”.”

Report of the National Commission on Fraudulent Financial Report of the National Commission on Fraudulent Financial Reporting; COSO, October 1987Reporting; COSO, October 1987

Three Conditions are Usually Present:

Management has an Management has an incentiveincentive or is under or is under pressurepressure

The The opportunityopportunity exists for a fraud to be perpetrated exists for a fraud to be perpetrated

The fraudsters The fraudsters rationalizerationalize their fraudulent acts their fraudulent acts

Statement on Auditing Standards 99, October 2002Statement on Auditing Standards 99, October 2002

Existence of an exit strategyExistence of an exit strategy

The Slippery Slope of a Financial Fraud:

Starts with “making the numbers”Starts with “making the numbers”

Then, “Managing the Numbers”Then, “Managing the Numbers”

Ends with “making up the numbers”Ends with “making up the numbers”

Rationalization includes:

““We need to make our projections…”We need to make our projections…”

““I’m getting pressure from the boss…”I’m getting pressure from the boss…”

““We need to meet Street expectations…”We need to meet Street expectations…”

““Our acquisition will fall through if we don’t…”Our acquisition will fall through if we don’t…”

And, as is frequently predicted --

““We’ll make it up next We’ll make it up next quarter…”quarter…”

But, even a simple mistake can be turned into a financial fraud

through “cover-up” efforts.

Categories of Fraud

Get rich quick – and disappear even fasterGet rich quick – and disappear even faster

Greed/ego/credibility fraudsGreed/ego/credibility frauds

Survival frauds – for the good of the Survival frauds – for the good of the companycompany

Sources of Enforcement Cases Other SEC Offices or DivisionsOther SEC Offices or Divisions

Issuers’ Self-ReportingIssuers’ Self-Reporting

Auditor Reports Auditor Reports Change in AuditorsChange in Auditors 10A10A

Sources of Enforcement Cases

PCAOBPCAOB 404 Reports404 Reports RestatementsRestatements Enforcement Complaint CenterEnforcement Complaint Center

Recent Actions Brought

McAfeeMcAfee Raytheon CompanyRaytheon Company DelphiDelphi AIGAIG Collins & AikmanCollins & Aikman Hollinger, Inc.Hollinger, Inc. RenaissanceRe HoldingsRenaissanceRe Holdings

And More . . . Tyco InternationalTyco International Fannie MaeFannie Mae Brocade Communications officersBrocade Communications officers Comverse Technology officersComverse Technology officers Buca, Inc.Buca, Inc. PBSJPBSJ Doral Financial CorporationDoral Financial Corporation Excelligence Learning CorporationExcelligence Learning Corporation

Common Fraud Schemes Improper revenue recognitionImproper revenue recognition

McAfee (formerly Network Associates)McAfee (formerly Network Associates)AremisSoftAremisSoftApplixApplixPeregrine Systems, Inc.Peregrine Systems, Inc.Safescript PharmaciesSafescript PharmaciesRobotic Vision SystemsRobotic Vision SystemseFundseFunds(and many more)(and many more)

Common Fraud Schemes Excess reserves to smooth earningsExcess reserves to smooth earnings Improper accounting for vendor rebatesImproper accounting for vendor rebates Improper capitalized costsImproper capitalized costs Changing estimates “to make the numbers”Changing estimates “to make the numbers” Top-Side and Period End Journal EntriesTop-Side and Period End Journal Entries ““Earnings Management”Earnings Management”

Other Types of Cases Related party transactionsRelated party transactions Undisclosed compensationUndisclosed compensation Non-financial metricsNon-financial metrics Variable-length quartersVariable-length quarters Financial products to manage earningsFinancial products to manage earnings False/misleading disclosures/omissions in MD&A False/misleading disclosures/omissions in MD&A

(Reg. S-K -- known trends and uncertainties) and in (Reg. S-K -- known trends and uncertainties) and in financial statements (Reg. S-X)financial statements (Reg. S-X)

FCPAFCPA Stock option backdatingStock option backdating

If It Seems Too Good To Be True -- It Probably Is

FINANCIAL REPORTING AND ISSUER DISCLOSURE

Areas of FocusAreas of Focus

Financial Reporting Requires Good Disclosure as Well as Good

Accounting

Individuals Should Be Held Personally Responsible for Misconduct

Officer & Director barsOfficer & Director bars

DisgorgementDisgorgement

Cooperation is Extremely Important in Financial Fraud Investigations

The Meaning of Cooperation

Self-policingSelf-policing prior to discovery of misconduct prior to discovery of misconductEffective compliance proceduresEffective compliance proceduresAppropriate “tone at the top”Appropriate “tone at the top”

Self-reportingSelf-reporting misconduct upon discovery misconduct upon discoveryThorough review of nature, extent, Thorough review of nature, extent,

origins & consequencesorigins & consequencesDisclosure to public and regulatorsDisclosure to public and regulators

The Meaning of Cooperation

RemediationRemediationDismissing or appropriately Dismissing or appropriately

disciplining wrongdoersdisciplining wrongdoersInternal controls and procedures to Internal controls and procedures to

prevent recurrenceprevent recurrenceCompensating those adversely Compensating those adversely

affectedaffected Cooperation with law enforcement Cooperation with law enforcement

authoritiesauthorities

Continued Coordination with Criminal Authorities

PerceptionPerception

Vs.Vs.

DeceptionDeception

Untested PerceptionUntested Perception

Allows forAllows for

Undiscovered Undiscovered DeceptionDeception

Areas of Focus

Conduct of Gatekeepers ScrutinizedConduct of Gatekeepers Scrutinized AttorneysAttorneys DirectorsDirectors Audit CommitteesAudit Committees And, of course . . .And, of course . . .

Accountants and Auditors

Every case STILL raises the Every case STILL raises the question:question:

Protecting the Integrity of the Audit Workpapers

“Process” Cases

Tenet Healthcare – KPMG AuditorsTenet Healthcare – KPMG Auditors

E&Y Audit Partner and Senior Manager E&Y Audit Partner and Senior Manager (NextCard)(NextCard)

SmarTalk Teleservices, Inc. and PwCSmarTalk Teleservices, Inc. and PwC

American Tissue – AA AuditorsAmerican Tissue – AA Auditors

Other Auditor Matters – and Settlements

“Basic” Audit Failures

PlanningPlanning

ExecutionExecution

AnalysisAnalysis

“Basic” Audit Failures Lack of evidenceLack of evidence Over reliance on management Over reliance on management

representationsrepresentations Improper confirmation processImproper confirmation process Inadequate testing of internal controlsInadequate testing of internal controls Incorrect disposition of identified errorsIncorrect disposition of identified errors

IndependenceIndependence

Facilitating Another Company’s Reporting Violations May Create

Liability

Recent Examples

DelphiDelphi

Royal Ahold – U.S. FoodserviceRoyal Ahold – U.S. Foodservice

Scientific-Atlanta (Adelphia)Scientific-Atlanta (Adelphia)

Areas of Focus

WHO ?WHO ? WHAT?WHAT? WHERE?WHERE? WHEN?WHEN? WHY?WHY? HOW? HOW?

AND THEN WHAT --- Appropriate remedy ?AND THEN WHAT --- Appropriate remedy ?