Following on the heels of a case, discussed in this post, in which a CEO and CFO were charged with internal control and books and records violations (but no typical financial statement fraud allegation), comes another case against a CEO and CFO that likewise concluded with violations of the books and records, internal controls, reporting, and certification provisions of the federal securities laws. In this case, the CEO and CFO were alleged to have engineered fictitious transactions (resales without economic substance) to falsely inflate their company’s revenues by $125 million, just enough to meet revenue growth guidance for several quarters. As result, the company misreported revenues in its periodic reports and the two officers signed false certifications, provided false information in earnings releases and on analyst conference calls and received higher bonuses based on the falsely inflated numbers. The SEC order states that the company violated section 13(a) by filing false reports, as well as the books and records and internal controls provisions of the Exchange Act, which violations the CEO and CFO caused. In addition, the order states that the CEO and CFO filed false certifications. As a result, they were the subject of cease-and-desist orders and agreed to collectively disgorge portions of their bonuses totaling $569,327, plus $104,000 in penalties. Ho hum. But what’s interesting here is the rare occurrence of a published Commissioner dissent, providing some unusual insight into the SEC’s preparation of orders, with the implication that there was a lot more to this case — as well as other cases — than meets the eye, at least in the settlement order.
In this stinging dissenting statement, Commissioner Aguilar vents his frustration that, in light of “the egregious conduct,“ the CEO and CFO are getting away with only “a wrist slap at best.“ In his view, the CEO and CFO engaged in a series of actions that facilitated the company’s misconduct, notwithstanding their roles as gatekeepers. Particularly with respect to accountants who engage in fraudulent misconduct, Commissioner Aguilar argues, the SEC ”must be willing to charge fraud and must not hesitate to suspend the accountant from appearing or practicing before the Commission [under Rule 102(e)]….This is true regardless of whether the fraudulent misconduct involves scienter. The Commission instead chose to charge [the CFO] with limited, narrow non-fraud charges, comprising… violations of the books and records, internal controls, reporting, and certification provisions of the federal securities laws. In the past, respondents with the same state of mind and similar type of misconduct as [the CFO] have been charged with violations of the antifraud provisions of the Securities Act, in particular, Sections 17(a)(2) and/or (3), as well as the books and record and internal control violations. In addition, where CPAs engage in this type of egregious securities fraud—especially misconduct that relates to the CPAs’ core expertise of financial reporting—the Commission has rightly required such persons to forfeit their privilege to appear and practice before the Commission by imposing a suspension under Rule 102(e) of the Commission’s Rules of Practice.”
Commissioner Aguilar is concerned about more than just this one case. Rather, he is concerned that the case reflects an increasing trend toward “accepting settlements without appropriately charging fraud and imposing Rule 102(e) suspensions against accountants in financial reporting and disclosure cases. I am also concerned that this reflects a lack of conviction to charge what the facts warrant and to bring appropriate remedies.” To support his case, he cites statistics showing a year-by-year decline in financial reporting and disclosure cases against issuers and individuals, as well as in Rule 102(e) suspensions, from 117 in fiscal 2010, with 54% subject to Rule 102(e) suspensions, to only 68 of those cases in fiscal 2013, with Rule 102(e) suspensions imposed in only 41% of those cases. In his view, this trend reflects
“a departure from the Commission’s efforts to keep bad apples out of the securities industry, and this puts investors and the integrity of the Commission’s processes at grave risk….A Rule 102(e) suspension is an appropriate sanction to be imposed when people choose to engage in deception and perpetuate fraud—in other words, when people engage in flagrant, harmful misconduct….I am concerned that this case is emblematic of a broader trend at the Commission where fraud charges—particularly non-scienter fraud charges—are warranted, but instead are downgraded to books and records and internal control charges. This practice often results in individuals who willingly engaged in fraudulent misconduct retaining their ability to appear and practice before the Commission. I fear that cases in the future will continue to be weak. More specifically, I fear that when the staff determines not to seek a Rule 102(e) suspension, it will also forgo bringing fraud charges. Likewise, I am concerned that Commission Orders may, at times, be purposely vague and/or incomplete, and written in a way so as to lead the public to conclude that no fraud had occurred. When this happens, the public is denied a full accounting and appreciation of the egregious nature of a defendant’s misconduct. In addition, this practice muzzles my voice by not allowing any statement by me (including this dissent) to include a fulsome description of facts that support the view that the Commission should have brought fraud charges. This adversely impacts my ability as a Commissioner to provide the American public honest and transparent information—including a description of facts discovered by the staff during its investigation. In the end, these behind-the-curtain decisions can make fraudulent behavior appear to be an honest mistake.”
It will be interesting to see if this dissent has any impact on SEC enforcement decisions going forward.