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In Conclusion

In Conclusion. Baruch College The Sixth Annual Financial Reporting Conference May 3, 2007 Susan G. Markel Chief Accountant, Div. of Enforcement.

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In Conclusion

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  1. In Conclusion

  2. Baruch College The Sixth Annual Financial Reporting Conference May 3, 2007 Susan G. Markel Chief Accountant, Div. of Enforcement The U.S. Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. Views expressed herein are those of the presenter and do not necessarily reflect the views of the Commission or other members of the staff of the Commission.

  3. Today’s Topics • SEC Enforcement • Focusing on Financial Fraud and Financial Reporting Matters

  4. Financial Fraud is: • “… Intentional or reckless conduct, whether act or omission, that results in materially misleading financial statements…” involving • “ . . . gross and deliberate distortion of corporate records, … falsified transactions, … [or] the misapplication of accounting principles.” • Report of the National Commission on Fraudulent Financial Reporting; COSO, October 1987

  5. Fraud is Different than Errors • “Fraudulent financial reporting differs from other causes of materially misleading financial statements, such as unintentional errors.” • Report of the National Commission on Fraudulent Financial Reporting; COSO, October 1987

  6. Three Conditions are Usually Present: • Management has an incentive or is under pressure • The opportunity exists for a fraud to be perpetrated • The fraudsters rationalize their fraudulent acts • Statement on Auditing Standards 99, October 2002 • Existence of an exit strategy

  7. The Slippery Slope of a Financial Fraud: • Starts with “making the numbers” • Then, “Managing the Numbers” • Ends with “making up the numbers”

  8. Rationalization includes: • “We need to make our projections…” • “I’m getting pressure from the boss…” • “We need to meet Street expectations…” • “Our acquisition will fall through if we don’t…”

  9. And, as is frequently predicted -- “We’ll make it up next quarter…”

  10. But, even a simple mistake can be turned into a financial fraud through “cover-up” efforts.

  11. Categories of Fraud • Get rich quick – and disappear even faster • Greed/ego/credibility frauds • Survival frauds – for the good of the company

  12. Sources of Enforcement Cases • Other SEC Offices or Divisions • Issuers’ Self-Reporting • Auditor Reports • Change in Auditors • 10A

  13. Sources of Enforcement Cases • PCAOB • 404 Reports • Restatements • Enforcement Complaint Center

  14. Recent Actions Brought • McAfee • Raytheon Company • Delphi • AIG • Collins & Aikman • Hollinger, Inc. • RenaissanceRe Holdings

  15. And More . . . • Tyco International • Fannie Mae • Brocade Communications officers • Comverse Technology officers • Buca, Inc. • PBSJ • Doral Financial Corporation • Excelligence Learning Corporation

  16. Common Fraud Schemes • Improper revenue recognition • McAfee (formerly Network Associates) • AremisSoft • Applix • Peregrine Systems, Inc. • Safescript Pharmacies • Robotic Vision Systems • eFunds • (and many more)

  17. Common Fraud Schemes • Excess reserves to smooth earnings • Improper accounting for vendor rebates • Improper capitalized costs • Changing estimates “to make the numbers” • Top-Side and Period End Journal Entries • “Earnings Management”

  18. Other Types of Cases • Related party transactions • Undisclosed compensation • Non-financial metrics • Variable-length quarters • Financial products to manage earnings • False/misleading disclosures/omissions in MD&A (Reg. S-K -- known trends and uncertainties) and in financial statements (Reg. S-X) • FCPA • Stock option backdating

  19. If It Seems Too Good To Be True -- It Probably Is

  20. FINANCIAL REPORTING AND ISSUER DISCLOSURE Areas of Focus

  21. Financial Reporting Requires Good Disclosure as Well as Good Accounting

  22. Individuals Should Be Held Personally Responsible for Misconduct • Officer & Director bars • Disgorgement

  23. Cooperation is Extremely Important in Financial Fraud Investigations

  24. The Meaning of Cooperation • Self-policing prior to discovery of misconduct • Effective compliance procedures • Appropriate “tone at the top” • Self-reporting misconduct upon discovery • Thorough review of nature, extent, origins & consequences • Disclosure to public and regulators

  25. The Meaning of Cooperation • Remediation • Dismissing or appropriately disciplining wrongdoers • Internal controls and procedures to prevent recurrence • Compensating those adversely affected • Cooperation with law enforcement authorities

  26. Continued Coordination with Criminal Authorities

  27. Perception Vs. Deception

  28. Untested Perception Allows for Undiscovered Deception

  29. Areas of Focus Conduct of Gatekeepers Scrutinized • Attorneys • Directors • Audit Committees • And, of course . . .

  30. Accountants and Auditors • Every case STILL raises the question: Where were the accountants and auditors?

  31. Protecting the Integrity of the Audit Workpapers

  32. “Process” Cases • Tenet Healthcare – KPMG Auditors • E&Y Audit Partner and Senior Manager (NextCard) • SmarTalk Teleservices, Inc. and PwC • American Tissue – AA Auditors

  33. Other Auditor Matters – and Settlements

  34. “Basic” Audit Failures • Planning • Execution • Analysis

  35. “Basic” Audit Failures • Lack of evidence • Over reliance on management representations • Improper confirmation process • Inadequate testing of internal controls • Incorrect disposition of identified errors • Independence

  36. Facilitating Another Company’s Reporting Violations May Create Liability

  37. Recent Examples • Delphi • Royal Ahold – U.S. Foodservice • Scientific-Atlanta (Adelphia)

  38. Areas of Focus • WHO ? • WHAT? • WHERE? • WHEN? • WHY? • HOW? • AND THEN WHAT --- Appropriate remedy ?

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