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SEC Ramps Up Enforcement on Financial Fraud Cases in 2014

While there has not been much enforcement by the Securities & Exchange Commission recently, that is about to change. This year the SEC is intent on pursuing a record number of enforcement actions involving public company financial reporting violations. And it will have new resources and tools to implement its actions.

DLA Piper’s Securities Enforcement Alert warns its clients, franchisors and other corporations that are publicly traded, that the Commission will be more aggressive in 2014 than in previous years. In 2013, the SEC brought 68 enforcement actions involving financial fraud and issuer disclosure. Even when Foreign Corrupt Practices Act cases are added, the number is a record low of 73, fewer than the 94 cases brought the previous year.

Today, there are approximately 50 franchisors and a few franchisees that are publicly traded.

Latest developments

Attorneys Nicolas Morgan and Jennifer M. Feldman advise public companies that there are four developments they need to know.

The first is that the Dodd-Frank whistleblower bounty program is gaining steam. Their report states,

Under this program, informants who provide the SEC with original information may ultimately receive a percentage of any monetary recoveries obtained by the SEC as a result of an enforcement action.  For the first two full years of its operation, 2012 and 2013, the single biggest category of tips received by the SEC involved corporate disclosures and financials: 547 and 557 tips for each year, respectively.  On October 1, the SEC awarded its largest bounty to date:  US$14 million, which may drive the number of tips still higher in 2014.  As these tips work their way through the SEC, more enforcement actions in this area will result.

The second “weapon in the Task Force arsenal” is the much-discussed Accounting Quality Model (AQM), “colloquially known as RoboCop,” the authors of the Alert state in part below,

Using AQM, the SEC attempts to detect earnings management by looking at discretionary accounting choices such as by examining total accruals and then estimating discretionary accruals.  The AQM then classifies the estimated discretionary accruals as risk indicators (factors that are directly associated with earnings management) or risk inducers (strong incentives for earnings management). . . The SEC is developing similar tools to analyze text portions of annual reports and other filings for potentially misleading disclosures.

Morgan and Feldman report that the third development is that the latest enforcement actions are bearing fruit for the SEC. Again in part they state,

In one action, the SEC settled with a Bellevue, Washington-based Fortune 200 commercial truck manufacturer in a case where the agency alleged various accounting deficiencies that “clouded” the company’s financial reports, dating back to 2008.  The SEC alleged three issues: (1) failure to report the operating results of its parts business as a reportable segment; (2) failure to maintain accurate books and records regarding the company’s impaired loans and leases; and (3) overstatements in equal and offsetting amounts to loan and lease originations and collections for two foreign subsidiaries in its statement of cash flows for two quarters in 2009.  The company paid US$225,000 to settle the case, without admitting or denying the charges.

Lastly, the attorney report that great expectations create risk of SEC overreach.

With the amount of new resources and tools the SEC is openly devoting to detecting financial reporting violations, the SEC has created an expectation that it will bring a greater number of enforcement actions in this area.  Such heightened expectations may create an incentive for the Enforcement Division to bring marginal cases not well supported by the facts or law.

Compounding that troubling incentive, in June, SEC Chair Mary Jo White announced that in certain cases, the SEC would not settle unless the defendants admitted wrongdoing.  As a result, more companies, officers and directors, will test the SEC’s allegations and legal positions by litigating and going to trial.

The Securities Alert gives two trial losses by the SEC last December, one a civil fraud action against the chief financial officer  of a Kansas-based website management company alleging that the CFO failed to disclose US$1.8 million in perquisites to its former CEO.

The second case the SEC charged two former executives of a water purifying company with accounting fraud for improperly recognizing revenue for six transactions purportedly to disguise the company’s financial performance.

In closing, DLA Piper attorneys warn,

Because the SEC is likely to take an aggressive posture in bringing and litigating cases, 2014 will see more trials involving financial reporting issues.  If recent experience is any guide, the SEC will not be successful in all of those trials, meaning that some defendants will be put to the expense, reputational damage and emotional turmoil necessary to defend against accusations not supported by the law or facts.

DLA Piper Alert:  SEC Enforcement Cases to Increase in 2014

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About Janet Sparks

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Janet Sparks is the former publisher of the Continental Franchise Review, an industry newsletter that covered the franchise community for over 30 years. She has also been a columnist for a leading franchise magazine for the past 13 years. Today she is an independent journalist who engages in investigative reporting, tackling complex issues that impact the franchise industry.

Janet can be reached at or at 303-799-7398.