ROBOCOPS, WHISTLEBLOWERS AND THE NEW SEC TASK FORCE WHAT PUBLIC COMPANIES NEED TO KNOW ABOUT SEC ENFORCEMENT AND FINANCIAL REPORTING IN 2014 *This presentation is offered for informational purposes only, and the content should not be construed as legal advice on any matter.
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ROBOCOPS, WHISTLEBLOWERS AND THENEW SEC TASK FORCE
WHAT PUBLIC COMPANIES NEED TO KNOW ABOUT SECENFORCEMENT AND FINANCIAL REPORTING IN 2014
*This presentation is offered for informational purposes only, and the content should not be construed as legal advice on any matter.
Introductions
Moderator
Christine Besnard, Executive VP, General Counsel and Secretary,MFLEX
Panelists
Howard Scheck, Partner, Advisory Services, Former SEC Divisionof Enforcement Chief Accountant, KPMG LLP, Washington, DC
Jerry Arnold, NERA Economic Consulting, Leventhal School ofAccounting, Marshall School of Business, University of SouthernCalifornia, Los Angeles
Nick Morgan, Partner, DLA Piper, Los Angeles
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Agenda
SEC enforcement trends
SEC’s emerging tools and tactics
Hot enforcement topics in financial reporting
Other highlighted financial reporting topics
Possibility of SEC overreach?
Best practices for 2014
Questions and discussion
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Declining financial fraud/disclosure cases
Source: U.S. Securities and Exchange Commission.
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New SEC tools and tactics
Dodd-Frank Whistleblower Bounty Program
Financial Reporting and Audit Task Force
Accounting Quality Model, a/k/a Robocop
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SEC Whistleblower Program
Under the Dodd-Frank Wall Street Reform and Consumer ProtectionAct of 2010, the SEC may pay rewards to individuals who provide theSEC with information about a possible violation of the federalsecurities laws.
The SEC may provide monetary compensation to individuals whovoluntarily provide original information (i.e., previously unknown tothe SEC) leading to a successful SEC enforcement action resulting insanctions exceeding US$1 million.
The individuals may receive between 10 and 30 percent of theamount collected in the SEC action or a related action brought bycertain other agencies.
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Whistleblower awards
In August 2012, the SEC issued its first award to awhistleblower who received nearly US$50,000, which was30% of the amount collected in an SEC enforcement actionagainst the perpetrators of a securities scheme.
In June 2013, the SEC issued an order awarding threeunnamed whistleblowers 5% each of the funds that it ultimatelycollects from an action against a hedge fund and its principal.
On October 1, the SEC issued an order awarding US$14million, the largest award yet.
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Whistleblower tips by type:
2012 v. 2013
Source: US Securities and Exchange Commission, Annual Report on the Dodd-Frank Whistleblower Program, Fiscal Year 2013
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Financial Reporting and Audit Task Force
An expert group of attorneys and accountants dedicated todetecting fraudulent or improper financial reporting anddisclosures and audit failures
What will the Task Force do?
What are the areas of focus?
What are possible implementation issues?
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Accounting Quality Model: Robocop
AQM is an automated analytical tool
AQM attempts to detect earnings management by looking for:
risk indicators (factors that are directly associated with earningsmanagement) or
risk inducers (strong incentives for earnings management)
What does AQM do?
How will the SEC use AQM?
What are potential issues?
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Accounting Quality Model: Robocop
Top Robocop “risk indicators” and “risk inducers” include:
an accounting policy that results in relatively high book earnings,even though firms simultaneously select alternative tax treatmentsthat minimize taxable income
a high proportion of transactions structured as off-balance sheet
frequent conflicts with independent auditors
changes in auditors
filing delays
decreasing market share
lower profitability margins
use of words and phrasing choices in MD&A that have beencommon amongst fraudulent filers in the past
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Hot enforcement topics in financial reporting
Segment reporting: Paccar, Sony, Caterpillar
Staff notes that they are “serious about segment reporting”
How operating segments are aggregated and historical results areportrayed
Assignment of goodwill from prior acquisition to appropriatesegments
Topic 280 of FASB’s Accounting Standards Codification
Internal controls: Paccar, JPMorgan Chase & Co
Diamond Foods
Enforcement forecast
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Other highlighted topics in financial reporting
R&D expenses – for significant projects
Costs incurred by project
Nature of efforts and risks involved in completing
Resources needed if current liquidity is not adequate forcompletion
Income tax
Rate reconciliation
Valuation allowance for deferred tax assets
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Other highlighted topics in financial reporting
Pensions and other post-retirement benefits
Disclosures regarding expected return on assets (EROA) anddiscount rates
Goodwill
Insights on components of newly acquired goodwill if not obvious.For example, expected synergies
Information on impairments to goodwill. For example, “why now?”in terms of changes in circumstances
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Risk of SEC overreach?
SEC v. Kovzan
Fraud action alleging that CFO failed to disclose US$1.8 million inperquisites to the company’s former CEO
SEC alleged that the CFO knew or was reckless in not knowingthat the perquisites were not disclosed accurately
Kansas jury found for the CFO on all 12 charges (and found in hisfavor on every question on the jury verdict form)
SEC v. Jensen
Fraud action against former CEO and CFO alleging companyprematurely recognized revenue in six transactions, improperlyinflating its financial results in 2006 and 2007
Court concluded that while there were accounting errors, therewas no fraud or statutory violation
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Takeaways for 2014
Task Force Chair David Woodcock: Best weapons againstfinancial reporting fraud, particularly in areas involvingsignificant judgment
Robust compliance programs
Appropriately skeptical auditor
Diligent audit committee
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Questions?
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ModeratorChristine Besnard, Executive VP, General Counsel and Secretary, [email protected]
PanelistsHoward Scheck, Partner, Advisory Services, Former SEC Division ofEnforcement Chief Accountant, KPMG LLP, Washington, [email protected]
Jerry Arnold, NERA Economic Consulting, Leventhal School of Accounting,Marshall School of Business, University of Southern California, [email protected]
Nick Morgan, Partner, DLA Piper, Los [email protected]
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