Risk & Compliance

White-Collar Crime? Now It’s Button-Down-Collar Crime

SEC study reveals 65 percent of enforcement cases involve finance managers; improper revenue recognition most common fraud.
Stephen TaubJanuary 29, 2003

CFOs and senior finance executives have always wanted to be seen as crucial members of corporate management. And when it comes to fraud, it appears that some of them are.

Or at least that seems to be the takeaway from an exhaustive five-year study by the Securities and Exchange Commission of enforcement actions for financial reporting and disclosure violations.

During that period the commission filed 515 enforcement actions for financial reporting and disclosure violations arising out of 227 enforcement investigations. The 515 actions involved 164 entities and 705 individuals. (During that same timeframe, the commission filed a total of 2,508 enforcement actions arising out of 1,390 investigations.)

“The study revealed that the majority of the persons held responsible for the accounting violations were members of [corporate] senior management,” the SEC report said.

CEOs and presidents were each charged in 111 out of the 227 enforcement matters. (Most of the 227 enforcement matters involved more than one type of improper conduct.) Chairmen of the board were charged 75 times, while chief operating officers were hit with actions a mere 21 times.

But according to the survey, the real corporate culprits can be found in the finance department. The SEC noted that, out of the 227 enforcement actions, CFOs were charged 105 times, vice presidents of finance were charged 27 times, and chief accounting officers were charged 16 times. All told, that’s 148 actions against finance managers.

What’s more, the commission brought charges against 18 auditing firms and 89 individual auditors in those 227 cases.

Size didn’t matter when it came to the auditing firms. Rather, the charges stemmed mostly from auditors failing to gain sufficient evidence to support the issuer’s accounting, failing to exercise the appropriate level of skepticism in responding to red flags, and failing to maintain independence, said the study.

What was the most common transgression of the 227 enforcement actions? Improper revenue recognition accounted for well over half of the actions (126). That includes the fraudulent reporting of fictitious sales, improper timing of revenue recognition, and improper valuation of revenue.

The second most-common source of enforcement action involved improper expense recognition, including improper capitalization, or deferral of expenses, improper use of reserves, and other understatement of expenses, said the SEC.

Another 23 actions involved improper accounting for business combinations.

Yet another 137 enforcement matters involved other accounting and reporting issues, such as inadequate management’s discussion and analysis (MD&A) disclosure and improper use of off-balance-sheet arrangements.

In about 10 percent of the enforcement actions, the accounting or disclosure issue was reflected in financial statements that were included in the company’s registration statement filed with the commission in connection with an initial public offering, it added.

The research was conducted in response to the Sarbanes-Oxley Act, which calls for the study of “enforcement actions by the Commission involving violations of reporting requirements imposed under the securities laws, and restatements of financial statements.”

The report also calls for addressing two areas of issuer disclosure: the uniform reporting of restatements of financial statements and improved MD&A disclosure.

Based on the report, the commission also recommends the enactment of legislation that would allow companies to produce internal reports and other documents pertaining to investigations without waiving any privileges.

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