Two public companies settled SEC charges for making accounting adjustments that resulted in improper quarterly earnings per share ("EPS") reporting. The two actions are the first brought forth that use risk-based data analytics from the SEC Division of Enforcement's EPS Initiative.
As described in an SEC Order, a company inaccurately presented its financial performance by inconsistently including a valuation allowance that was not supported by its mortgage servicing rights valuation process. The SEC stated that after including the valuation allowance for two quarters where it was on target to meet expectations, the company belatedly reversed its valuation allowance in the next quarter, which resulted in an increase in its EPS that otherwise would not have met analyst consensus expectations. The SEC found that the company's disclosures created the misleading appearance of consistent earnings over time.
As a result of its misleading accounting and disclosures, the SEC determined, the company violated the books and records and internal controls provisions of the federal securities laws found in Exchange Act Section 13(a) and SEA Rules 13a-1, 13a-13 and 12b-20 thereunder. To settle the charges, the company agreed to (i) cease and desist from future violations and (ii) pay a $1.5 million civil money penalty.
As described in a second SEC Order, a company's former corporate controller and chief financial officer ("CFO") both directed employees to make unsupported manual accounting adjustments to the company's management bonus accruals, expenses relating to "a key independent consultant" and stock-based compensation. The SEC stated that the adjustment methods did not comply with GAAP and inflated the company's EPS and income, resulting in the company meeting consensus estimates artificially. The SEC also found that the company made material misrepresentations in its disclosures regarding its actual EPS results.
As a result of the material misrepresentations in its disclosures and its manipulative accounting adjustments, the SEC determined that the company and its two executives violated the antifraud, books and records, and internal controls provisions of the federal securities laws found in Exchange Act Sections 17(a)(2), 17(a)(3), 13(a), 13(b)(2)(A) and 13(b)(2)(B) and SEA Rules 12b-20, 13a-1, 13a-11, 13a-13 and 13b2-1 thereunder. To settle the charges, the company agreed to (i) cease and desist from future violations and (ii) pay a $5 million civil money penalty. The settle their charges, the company's corporate controller and CFO agreed to (i) cease and desist from future violations and (ii) pay a $45,000 and $70,000 civil money penalty, respectively.
Commentary
These are the first enforcement actions resulting from a new SEC program called the EPS Initiative. According to the SEC, the initiative "utilizes risk-based data analytics" to identify potential accounting and disclosure violations. This is the latest example of the SEC Enforcement Division's continued focus on using data to generate new investigations. While the SEC has not provided any details about what specific risks or data points will trigger enforcement interest, public companies should expect that there will be additional investigations and enforcement actions focused on earnings management practices.
Primary Sources
- SEC Press Release: SEC Charges Companies, Former Executives as Part of Risk-Based Initiative
- SEC Order: Fulton Financial Corporation
- SEC Order: Interface, Inc.
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