In Conclusion

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.

 SEC Enforcement
 Focusing on Financial Fraud and Financial Reporting
Matters

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

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

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

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

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…”

And, as is frequently predicted --

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

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

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

Sources of Enforcement Cases
 PCAOB
 404 Reports
 Restatements
 Enforcement Complaint Center

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

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

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

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”

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

FINANCIAL REPORTING AND
ISSUER DISCLOSURE
Areas of Focus

Financial Reporting Requires
Good Disclosure as Well as Good
Accounting

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

Cooperation is Extremely Important in Financial Fraud Investigations

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

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

Continued Coordination with
Criminal Authorities

Untested Perception
Allows for
Undiscovered Deception

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

Accountants and Auditors
 Every case STILL raises the question:

Protecting the Integrity of the
Audit Workpapers

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

Other Auditor Matters – and
Settlements

“Basic” Audit Failures
 Planning
 Execution
 Analysis

“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

Facilitating Another Company’s
Reporting Violations May Create
Liability

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

Areas of Focus
 WHO ?
 WHAT?
 WHERE?
 WHEN?
 WHY?
 HOW?
 AND THEN WHAT --- Appropriate remedy ?