Risk & Compliance

Will the SEC Get Personal?

Stung by the scuttling of its Bank of America settlement, the regulator may step up its scrutiny of individuals.
Sarah JohnsonDecember 15, 2009

When a U.S. District Court judge rejected a $33 million settlement between the Securities and Exchange Commission and Bank of America in September, he was especially troubled that the regulator’s case had not singled out any employees for allegedly making misstatements.

In his ruling denying the settlement — in which BofA agreed to pay a fine but not admit wrongdoing in the allegation that it had misled shareholders before merging with Merrill Lynch — Judge Jed Rakoff queried why the lawyers who drafted the proxy statements that were apparently misleading weren’t also expected to pay penalties to the SEC. He concluded that the agreement between the regulator and BofA “was a contrivance designed to provide the SEC with the facade of enforcement and the management of the bank with a quick resolution of an embarrassing inquiry — all at the expense of the sole alleged victims, the shareholders.”

The public whipping could prompt the SEC to target the people behind a public company’s misdeeds “with renewed vigor,” theorizes a new report from NERA Economic Consulting. “The SEC is taking very seriously the role of individuals [in allegations of wrongdoing] and is actively enforcing against individuals because ultimately the conduct is done by individuals,” says Elaine Buckberg, senior vice president at NERA and a co-author of the report.

As it is, individuals are heavily targeted in SEC cases alleging misstatements. Most of the 353 settlements since 2002 involving false or misleading statements at public companies have led to both the company and at least one accused director or employee paying penalties. And in 28% of the cases, only a director or employee has had to pay, not the employer.

The SEC put accountants on notice last week during the annual meeting of the American Institute of Certified Public Accountants. “From the accounting clerk of a public company to the CFO…each and every one of you plays a crucial role in maintaining a capital market system of the highest caliber and integrity,” said Jason Flemmons, associate chief accountant in the SEC’s Division of Enforcement. “I urge all of you to take your gatekeeping responsibilities seriously and with utmost alacrity.”

Financial-statement and accounting fraud made up 23% of the enforcement actions — the largest category in the SEC’s enforcement division — conducted in fiscal year 2009, which ended September 30. And the commission expects to further scrutinize companies’ disclosures on the presumption that the downturn, combined with pressures to meet earnings targets, has “undoubtedly ignited temptations for many companies to commit financial fraud,” said Flemmons.

He added that transgressions by financial-statement preparers tend to be driven by “integrity lapses.” For example, the SEC has found many instances of “a troubling dearth of documentation” to back up companies’ accounting estimates, which, depending on their subjectivity, are susceptible to “both unintentional bias and unintentional manipulation,” said Flemmons.

To be sure, while Flemmons noted that the SEC has more than doubled the number of formal investigations it opened this past year, it has fallen behind in settlements. According to NERA, the regulator settled with 626 defendants in fiscal 2009, a 7% decrease from last year’s 673 settlements. The year marked the second-consecutive year of decline and the lowest number of settlements since the Sarbanes-Oxley Act was passed in 2002. (NERA’s tally does not include settlements related to delinquent filings and some administrative proceedings, such as those barring accountants from practicing.)

By all accounts, the SEC has been in a transition year. In addition to the public criticisms lobbed against it for the BofA settlement and for missing the Bernard Madoff Ponzi scheme, the commission went through a leadership change in January. Under new chairman Mary Schapiro, the SEC has reorganized its enforcement division by installing a new director, Robert Khuzami; taking out a level of management; and stopping the practice of requiring SEC staff to get the commission’s approval for levying financial penalties against companies. The latter change will presumably quicken the SEC’s negotiations with companies.

Most likely, Buckberg predicts, the SEC will have a higher number of settlements in 2010, as the commission is poised to receive more funding and is expected to have its enforcement bugs worked out.

Presuming there will be an uptick in enforcement action, defense attorney James Parkman cautions that CFOs should take steps to protect themselves. “If there’s any indication of a problem, don’t pass it off to someone else, thinking you can wash your hands of it,” says Parkman, whose most infamous client was Richard Scrushy, the former HealthSouth CEO acquitted of the health-care provider’s $2.7 billion fraud earlier this decade.

In other words, make any claims in a public forum within the company and follow through with them. Parkman also recommends researching any rumors of wrongdoing and warns against getting too cozy with other executives, which could cloud good judgment. Finally, to avoid auditor complacency, he suggests setting up a policy that the company will change accounting firms every four to six years.