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The SEC Enforcement Division’s “EPS Initiative” appears to be alive & well – by the looks of an “cease & desist” order from earlier this week – which resulted in a $4 million settlement (and a $75k penalty against the person who served as Chief Accounting Officer – and later, Chief Financial Officer – of the company in question). The claims were settled on a “neither admit nor deny” basis.

Earnings management cases in the recent past have resulted from backlog, loss contingencies, and revenue recognition. This time, the issue was bonus accruals.

In the SEC’s telling, the internal controls & supporting documents for the bonus accruals left gaping holes that allowed for manipulation. Here’s an excerpt from the SEC’s order:

15. On October 7, 2015, during the closing process for the third quarter of 2015, Nash directed the accrual of $300,000 for the PB Bonus Plan, which had not yet been approved by Gentex’s Board of Directors. This journal entry was made without any supporting documentation. Additionally, Nash did not maintain documentation of any purported analysis that was required to be performed pursuant to Accounting Standards Codification (“ASC”) Topic 450, Contingencies, concerning the loss contingency associated with the PB Bonus Plan.

16. On October 8, 2015, Nash realized that the initial accrual of $300,000 would cause Gentex to miss the consensus EPS estimate of $0.27 for the third quarter of 2015. He directed a journal entry to reduce the $300,000 accrual to $100,000. The journal entry for the revised accrual was again made without any supporting documentation and Nash did not conduct any analysis that should have been performed pursuant to ASC 450-20 concerning the PB Bonus Plan.

17. In an October 9, 2015 email exchange with the CFO, the CFO asked Nash if he had reserved some money for the PB Bonus Plan. Nash responded, “100K. had [sic] 300K, but had to reduce in order to keep .27 per share.” The CFO replied, “[g]ood call. That puts in line with consensus, right?” to which Nash replied, “[y]es.”

There were other internal controls sins here too, according to the SEC – but I was surprised that this $200k accrual adjustment appears to be so central to the case. That doesn’t seem like a lot in the grand scheme of things, but the company would have missed consensus EPS estimates by one penny if the adjustment hadn’t been made – and the SEC’s data analytics tools were sensitive enough to pick up something fishy with the situation.

One moral of this story is that if the SEC comes knocking, you want to make sure to have documentation of your internal controls & accounting analysis instead of a conversation about managing EPS to the consensus number.

– Liz Dunshee