Enforcement Heats Up at the SEC

Andrew Ceresney, Director of the SEC’s Division of Enforcement, gave the keynote address at last week’s Directors Forum 2016 in San Diego. In his speech, Mr. Ceresney made several points worth highlighting.

First of all, the SEC continues to aggressively pursue financial reporting deficiencies at all levels of public companies and within all industries. He notes, for example, that since 2013 the SEC more than doubled the annual number of actions related to issuer reporting and disclosure. Furthermore, the SEC has significantly increased the number of individuals charged with such violations. And despite substantial advances in the areas of internal control, audit committee oversight and corporate governance, violations still occur regularly and “gatekeepers” still fail to comply with their legal and professional obligations.

Here’s Mr. Ceresney’s list of the primary causes of financial reporting problems:

  • Significant pressure to meet earnings and other performance expectations;
  • Excessive focus on short term performance rather than longer term success;
  • Poor oversight in units and subsidiaries;
  • Growth outpacing the reporting and accounting infrastructure; and
  • Management’s over-reliance on processes and poor “tone at the top.”

It’s interesting to note when reading this list that these causes could apply to some degree, from time to time, to almost every company. In particular, consider the opportunities for missteps during periods of rapid growth through acquisitions, which many companies are currently experiencing. Think also about past situations where performance pressure felt particularly intense due to aberrational circumstances.

Mr. Ceresney then offered specific examples of the types of issues at the heart of the SEC’s enforcement actions, most of which you have seen before:

  • Improper revenue recognition, largely because revenues are a critical measure of performance;
  • Valuation and impairment issues, often resulting from the impact on assets of financial downturns or other macro market forces;
  • Managing earnings and other financial targets;
  • Missing or insufficient material disclosures, ranging from executive perks to related party disclosures; and
  • Deficient internal controls, even where no fraud was involved, since they create the opportunity for future misstatement or misconduct.

Finally, Mr. Ceresney noted that the SEC has aggressively used its authority under Section 304 of the Sarbanes-Oxley Act to claw back compensation from executives that have engaged in financial reporting misconduct that resulted in restatements. And as everyone knows, clawbacks will soon become much broader in scope due to the proposed new clawback rules. (See this Doug’s Note.)

The vast majority of companies work very hard to prevent just the kind of problems described above. Nevertheless, issues can arise even at companies with the best of intentions. It is essential to stay diligent.

All the best,

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