August 5, 2009

Dissecting the SEC’s Enforcement Numbers – and Its Fines

With the SEC bringing this accounting fraud case against General Electric yesterday – costing the company a fine of $50 million – it’s clear that the SEC’s new aggressive approach to Enforcement is in full-gear with a trio of high-profile cases during the past two weeks (note that it’s likely that some – if not all – of these cases were commenced under the prior SEC Chair’s watch).

This case follows the Bank of America settlement, which cost that company a fine of $33 million. Some have complained that $33 million was too small an amount. I had the opposite reaction, that’s a large amount for a mere one-time disclosure violation allegation. Bear in mind that yes, Rule 14a-9 is an anti-fraud rule – but it’s a “non-scienter” fraud provision, so there is no requirement for intent or knowledge of wrongdoing. As a result, penalties often are pretty small – in fact, I recall that many cases are often settled with a C&D order and no fine at all (eg. GE’s “disclosure of perks” settlement with the SEC in ’04). Note the third in the trio is the CSK Auto clawback action.

These cases follow SEC Chair Schapiro’s comments back in April about overhauling the approach that the SEC’s Enforcement Division will take when considering which cases to pursue. We have posted memos regarding the SEC’s new settlement policy, etc. in our “SEC Enforcement” Practice Area.

As is true often in life, sometimes quantity is confused for quality – and the consequences can be disastrous. In Enforcement’s case, the Division’s former goal seems to have been a high number of cases brought (undoubtably to impress Congress, whose focus likely would be on numbers come funding time) – so low-hanging fruit often was pursued at the cost of not tackling some important cases (eg. Madoff). It sounds like that will now change.

I personally haven’t done the math for Enforcement’s reported caseload over the years – but a member recently sent me these thoughts:

I am very skeptical of the Enforcement numbers. Specifically, the SEC’s delinquent filing list recently constitutes a couple hundred each year. The delinquent filing list had 220 for fiscal ’08.

Enforcement claimed 671 completed actions in fiscal 2008. How many delinquent filing cases are included in this total? The entire group of 220? In comparison, the SEC listed only 11 delinquent filer cases in fiscal ’03. If the improvement in Enforcement’s number of cases over the past five year is due solely to delinquent filers, I think this fact pattern in problematic given that delinquent filings really isn’t fraud and simply requires the Staff to send out letters asking the company when they intend to become current.

This thought is not far from what Judith Burns of Dow Jones wrote in an article last Fall. Here is an excerpt from that article:

The Securities and Exchange Commission’s enforcement division brought a near record level of cases in the just-ended 2008 fiscal year, results that critics say are padded with relatively easy actions against companies that are late in filing quarterly or annual reports.

SEC Chairman Christopher Cox heralded the results Wednesday, calling fiscal 2008 the enforcement division’s second-best on record. That would put the total between the 656 enforcement cases brought in fiscal 2007 and the record 679 actions in fiscal 2003, the agency’s high-water mark. The SEC is expected to issue official figures within weeks.

Critics say the results are inflated by a record number of so-called 12(j) actions to deregister shares in companies that lack current financial reports. The SEC brought about 50 such cases in fiscal 2006, a level that appears to have doubled in fiscal 2008, which ended Sept. 30, accounting for roughly 15% of all cases.

Individuals familiar with the matter, who agreed to speak anonymously, said that in early 2008 the SEC’s enforcement division was on track to bring an abysmally low number of cases for the year. One reason for the declining output was a rush to issue cases at the end of fiscal 2007, leaving little in the pipeline for fiscal 2008, according to these individuals.

Delays in getting cases before by the five-member commission also are a factor, these individuals say. Critics say new internal controls and paperwork requirements are throwing sand in the enforcement division’s gears, reducing the amount of time that SEC cops have to spend on legwork.

Deregistration actions provided easy filler, allowing the SEC to paint a picture of an aggressive enforcement staff, according to critics. Some decry the practice, saying the cases need to be brought, but should not be counted toward overall output. Others worry that the SEC is using accounting tricks, sending the wrong message to corporate America: do as I say, not as I do.

More on “Early Problems for XBRL? A Mismatch with FASB’s GAAP Codification”

Recently, I blogged about the SEC’s mandatory XBRL deadline and the mismatch caused by the FASB’s new codification of accounting standards that was launched on July 1st (which becomes effective on September 15th) since all of the mandated XBRL standards are tied to the FASB’s now-superseded standards.

Yesterday, an extension taxonomy was jointly released by the FASB and XBRL US that is intended to bridge the GAAP between the old references and the codification. It’s a start, but Neal Hannon notes that the new codification references will not be accepted by the SEC’s EDGAR. So the mismatch problem still remains.

Neal points out another disconnect:The new extension taxonomy provides pointers only to the public sections in the Codification. In other words, if you are in an XBRL tool – which nearly all folks will be when working with XBRL – and want to see the authoritative literature, the hyperlink takes you out of your XBRL software and asks you to log into the FASB Codification to see the results. This is a major pain – but should eventually be rectified in the SEC’s next release of the taxonomy, slated for sometime early next year. In the meantime, those looking to discover a direct link from XBRL elements to the underlying authoritative literature will have to do a bit of discovery work on their own…

More on “The Mentor Blog”

We continue to post new items daily on our new blog – “The Mentor Blog” – for members. Members can sign up to get that blog pushed out to them via email whenever there is a new entry by simply inputting their email address on the left side of that blog. Here are some of the latest entries:

– Some Thoughts on Board Leadership Disclosure
– Rights Offerings: How Does the “European” Model Stack Up?
– Very Candid Disclosure: From the Company that Brought You “Dead Frogs”
– Carbon Emission and Cap Disclosures: Likely to Come Soon
– Managing Your Law Department: Top Ten Thoughts
– List of Online Job Databases
– The Kiss of Death: “Best of…”
– Regulation FD: When Does Information Become “Public?”

– Broc Romanek