On July 30, the SEC announced the filing of administrative actions against the CEO/Chairman and against the former CFO of QSGI, Inc., alleging that they made misrepresentations to the company’s auditors and to the public concerning the adequacy of the company’s internal controls over financial reporting. The case is unusual in that there are no allegations that the financial statements themselves were inaccurate. The charges focus solely on books and records, control deficiencies, and inaccurate statements and disclosures concerning the controls.
The controls at issue in this case related to inventory. The Commission alleges that QSGI, a Florida-based reseller of used computer equipment company, which filed for bankruptcy in 2009, had experienced recurring inventory control problem over a period of years. Efforts to strengthen controls were unsuccessful because the company “failed to design procedures taking into account the existing control environment, including the qualifications and experience level of persons employed to handle accounting.” In addition, “[t]raining of accounting, sales, and warehouse personnel either did not take place or was inadequate.” Company personnel “regularly circumvented controls” including by improperly receiving product into inventory in order to inflate the inventory value in a calculation on which the company’s chief creditor relied in determining how much the company could borrow under a revolving credit facility.
Against this background, the SEC charged the CEO/Chairman and the former CFO with a laundry-list of control and disclosure violations, including misrepresenting the CEO’s participation in the company’s annual assessment of internal control effectiveness; falsely certifying that all significant deficiencies in internal controls had been disclosed to the company’s auditors; misleading the auditors concerning control adequacy in management representation letters; falsifying the company’s books and records; and signing and certifying to the accuracy of a Form 10-K containing a false management report on ICFR. They were also charged with causing company violations of the requirement to maintain accurate books and records and adequate internal controls.
In This Update:
SEC Files Enforcement Action Based on Internal Control Problems
SEC Sends an Internal Control “Wake-Up Call” to Companies in High Risk Markets
Internal Auditors Think They Should Spend More Time on Corporate Governance
Directors See Reputation, Cybersecurity, and Regulation as Top Risks
Council of Institutional Investors Reiterates Request for Audit Partners to Sign Audit Reports
Public Company Restatements Have Fallen Sharply Since SOX
Daniel L. Goelzer
+1 202 835 6191 Daniel.Goelzer@bakermckenzie.com
2 Update │ August 2014
The former CFO, without admitting or denying the Commission’s charges, agreed to the entry of a cease-and-desist order, 5-year bars against serving as an officer or director of a public company or practicing before the Commission as an accountant, and a $23,000 penalty. The CEO did not settle, and it appears that the case against him may be litigated.
Comment: This case is yet another illustration of the Commission’s focus on internal control. As noted, it is unusual – possibly unprecedented – for the Commission to bring a case alleging internal control violations, but not alleging a related substantive violation, such as false financial reporting. The case is also a reminder that management representation letters provided to auditors should be taken seriously. Rule 13b2-2 prohibits any director or officer of public company from making a materially false statement, or omitting to state a material fact, to an accountant in connection with an audit. The failure to disclose the inventory control deficiencies in the management letter was the basis for the alleged Rule 13b2-2 violation in this case.