October 24, 2007

The SEC’s Corporate Penalties Debate Continues with the Nortel Settlement

Disagreement among the SEC’s Commissioners on the topic of corporate penalties appears to continue, despite the recent efforts directed at improving the situation. As Broc noted in the blog earlier this year, the SEC has changed its internal policies so that Enforcement lawyers must seek approval from the Commissioners before they begin settlement talks that involve fining corporations. That shift followed on the heels of a January 2006 policy statement outlining the analytical steps that the SEC follows in deciding whether to levy penalties against companies.

Despite these efforts, the much hoped for unanimity on penalties appears elusive. Along with last week’s announcement of the $35 million penalty obtained in the settlement of proceedings against Nortel Networks came a relatively unusual “real time” dissent from Commission Paul Atkins. As noted in this Bloomberg article, Commissioner Atkins issued a statement calling the $35 million penalty a “public relations gesture” and noting that the settlement “does nothing to further the SEC’s objectives” of protecting investors and maintaining far, orderly and efficient markets. The Commissioner also noted that the penalty “will be paid by Nortel shareholders, many of whom were victims of the financial fraud.”

While it is not surprising that Commissioner Atkins would oppose the terms of this settlement, it is certainly unusual to see this level of public dissent around the time of announcing the Commission-approved deal.

PCAOB Reports on Inspections of Smaller Audit Firms

Earlier this week, the PCAOB released a report on common issues identified in inspections of US audit firms that audited 100 or fewer public companies. The report is based on inspections conducted from 2004 through 2006, and it does not identify any particular firms. In the report, the PCAOB outlines significant areas where it believes firms should seek to ensure compliance with applicable standards and requirements.

The specific areas addressed in the report are:

– Revenue
– Related-Party Transactions
– Equity Transactions
– Business Combinations and Impairment of Assets
– Going-Concern Considerations
– Loans and Accounts Receivable (including allowance accounts)
– Service Organizations
– Use of Other Auditors
– Use of the Work of Specialists
– Independence
– Concurring Partner Review

The PCAOB notes that many of the smaller firms that were the subject of inspections had taken steps to address quality control deficiencies, including improving their methodologies through the use of audit programs and practice aids, arranging for annual technical training, improving the availability of appropriate technical resources, encouraging personnel to make appropriate use of external resources and enhancing their own internal monitoring of audit performance. For more analysis of the PCAOB’s report, check out Kevin LaCroix’s “D&O Diary” Blog.

Separately, the PCAOB announced that it had approved two amendments to PCAOB Rule 4003, which addresses the minimum frequency with which the PCAOB conducts inspections of different categories of registered public accounting firms. Specifically, the amendments would eliminate a requirement that the PCAOB regularly inspect each registered public accounting firm that plays a “substantial role” in audits but does not issue audit reports. Further, the amendments would eliminate the requirement to inspect each registered public accounting firm that issues an audit report, even if the firm does not regularly issue audit reports. These amendments to Rule 4003 will decrease the PCAOB’s inspection burden in low-risk areas, while maintaining the discretion to inspect any firms in these categories if necessary.

Test Your Section 16 Knowledge: Are You a Pro or Troll?

We have posted one of our popular quizzes – “Pro” or “Troll”? Test Your Knowledge – on It will score your answers as you go—and let you know how you compare against your peers.

Simply read each statement and decide whether you agree with it (by clicking “Ah Yes”) or disagree (by clicking “That’s Ridiculous”), except one of the questions offers answers of “Tuesday” or “Wednesday.” Then, you will be told whether you were correct—and we also provide some analysis if you wish to learn more about each answer.

For a Section 16 geek like myself, this one is great fun!

– Dave Lynn