SEC Speech: Remarks at AICPA National Conference on Current SEC Developments (P. Berger)
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Speech by SEC Staff:
Remarks Before the AICPA National Conference on Current SEC Developments

by Paul R. Berger

Associate Director, Division of Enforcement
U.S. Securities & Exchange Commission

December 5, 2000

The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed herein are those of Mr. Berger and do not necessarily reflect the views of the Commission, the Commissioners, or other members of the Commission's staff.

Good morning. It is a pleasure to join you and have the opportunity to speak today at the AICPA conference. Even though it is the holiday season, you probably know Enforcement officials generally don't spread unqualified good cheer. While my remarks focus on new ways we are leveraging our resources to combat fraud, let me assure you we start from the premise that the vast majority of the profession operates on the highest ethical plane. In particular, what I'd like to talk about briefly is the Financial Fraud Task Force. The Financial Fraud Task Force is a separate group within the Division of Enforcement that was created to focus exclusively on financial reporting and accounting investigations. While there are many elements of the Task Force that I could discuss at length, today I'd like to elaborate on three. They are: Focus, Efficiency, and Cooperation. While none of these things are necessarily unique to the Task Force, I hope that by explaining how these aspects relate to the Task Force you'll have a better understanding of what the Task Force is and how it operates. And hopefully, my remarks will also provide you with some insight as to how the Division of Enforcement is moving forward with accounting and financial reporting investigations generally.

The first aspect I'd like to address is the Focus of the Financial Fraud Task Force. While the Commission and the Division of Enforcement have long viewed combating financial fraud as one of our highest priorities, the Task Force was created by the Division of Enforcement in the Spring of 2000, in response to what the Commission and the Division perceived as an alarming increase in financial reporting improprieties by public companies. One has only to look at the substantial increase in financial restatements by public companies to see the gravity of the problem. According to a September 25 Business Week article entitled "Accounting Wars" (I wonder what that could be about?), 362 companies have restated their annual financial statements just since 1997. These restatements have cost shareholders dearly – in just nine of the 362 cases, investors lost $41 billion dollars within a week of the restatements. Perhaps not surprisingly, private shareholder lawsuits involving restatements have soared – up 750% in the six years from 1992 to 1998, and the number continues to grow. Given this substantial uptick in the number of restatements in recent years, you can be sure the Division of Enforcement will be closely scrutinizing every restatement for potentially fraudulent activity.

And you only have to look at recent headlines to understand why the Commission created the Task Force, and why financial fraud continues to be one of the highest priorities throughout the Division of Enforcement. Every week, one or more companies announce that they will be restating earnings or revenues in a way that is tied to revenue recognition problems or other potential accounting violations. Some of these restatements, as reported by the companies, relate to isolated instances or limited time frames. Others appear to involve deeply entrenched problems the companies have throughout their operations worldwide, and may span many years of financial statements.

And, as the Commission's recent actions against companies such as Cendant, McKesson and America On-Line illustrate, these problems are not limited to newly public micro-cap companies with no history of earnings or revenues. Just in the last six months, several large multinational corporations with historically stable earnings have publicly reported accounting or revenue recognition problems that may substantially impact their past and future financial results.

And given today's increasingly unforgiving investing climate in the United States, these problems may get worse before they get better. Today's investors come to expect more and more from the companies in which they invest. Failure to meet earnings expectations, or even the slightest sign of slowing revenue growth, can wreak havoc on a company's stock price – sometimes lopping off hundreds of millions or even billions of dollars in market valuation in a single day. In short, the pressures on publicly traded companies to meet or exceed expectations are tremendous. And sometimes – unfortunately, apparently with increasing frequency – companies turn to creative accounting, or what Chairman Levitt called accounting hocus-pocus, to make up for profit or revenue shortfalls.

When creative accounting crosses the line into fraud, it damages the credibility not only of the individual company, but our markets as a whole – especially when the fraud involves large, established companies that investors around the world have come to rely on as having accounting standards and audit mechanisms that are above reproach.

This is the focus of the Financial Fraud Task Force. We created the Task Force to handle investigations of large, global companies that have failed to play by the accounting rules, and which through their fraudulent activities have harmed investors and tarnished the reputation of the US securities markets. The goal of the Task Force is to investigate these companies and their potentially fraudulent accounting practices swiftly and thoroughly, then to quickly and efficiently reach an appropriate resolution to the investigation. We will also examine the conduct of the auditors in every case. In so doing, the Division of Enforcement hopes to do its part in encouraging and, if necessary, prodding, US-listed companies to be the best corporate citizens in the world, to protect the interests of investors in those companies, and to encourage the trust that investors around the world rightly place in US markets.

As I just said, the goal of the Task Force is to complete its investigations not just thoroughly – but also swiftly (I'd say our goal is to make our investigations "full, fair, and accurate" but that line has already been taken). Effective law enforcement requires that we bring our cases close in time to the underlying conduct while the matter is still fresh in the public's mind and before wrongdoers can commit repeat violations. This leads me to the second aspect of the Task Force I'd like to talk about today – Efficiency. While talk of a government agency moving quickly may rightly produce its share of chuckles and yawns, I'm here to tell you this time, it's different.

With the Task Force, the Division of Enforcement really is reshaping its methods for investigating potential accounting fraud. And I want you to be aware of these changes so that, in the unfortunate event that your company or firm becomes involved in one of these investigations, you know what to expect.

At full strength, the Task Force is designed to include 7 lawyers, including a Deputy Assistant Director, and 5 accountants, including an Associate Chief Accountant, who are assigned exclusively to the Task Force, and you should know those numbers are likely to increase. The lawyers who were selected for the Task Force – either through experience or formal training – are well-versed in accounting matters. Similarly, the accountants on the Task Force, you will be happy to know, are highly talented individuals who have Big 5 experience and/or forensic accounting backgrounds. In short, this means that when it comes to accounting issues, the members of the Task Force will know what they are looking at, and they will know what to look for.

We purposefully structured the Task Force to maximize its investigative efficiency. Unlike the typical staff attorney or accountant in the Division who is involved in a half dozen or more investigations at any given time, Task Force members will be working on one or at most two investigations. Accordingly, they will be able to devote substantial time and sufficient focus to each matter. In addition, unlike in typical accounting fraud investigations which tend to be assigned to one attorney and one accountant, the Task Force works in teams, with multiple attorneys and accountants working on each investigation, all moving forward at the same time with different aspects of the investigation and coordinating their efforts as a team.

In addition to these structural aspects, we have streamlined the reporting structure of the Task Force to avoid bottlenecks that can at times slow down decision-making. The Task Force reports directly to Charlie Niemeier and me, rather than going through traditional intermediate reporting steps. In my experience thus far, this has been helpful in accelerating the decision-making process in certain aspects of our investigations.

What does this mean for you and your company? In short, if you become involved in an investigation that is being conducted by the Task Force, fasten your seatbelts [we hope it's not a bumpy ride, but for your safety, remain seated]. Seriously, because it is in the public interest, we will move forward much more quickly than in the past, and we will not tolerate lengthy "downtime" in obtaining the documents or testimony we need to complete our investigation. That means subpoenas, both for documents and testimony, will be going out quickly and on a rolling basis with response dates that are reasonable but less generous than you would like. It also means that we will press hard for timely production of evidence. If necessary, we already have mechanisms in place within the Task Force to go to court very quickly to seek enforcement of our subpoenas to get the evidence and information we need to complete our investigations.

And let me reiterate what you've already heard from Dick Walker. Among the evidence and documents that we expect to receive in a timely manner are the audit workpapers located both here in the United States and offshore with an auditor's foreign affiliates. These workpapers provide important evidence in any financial fraud investigation, shedding light not only on a company's internal controls and accounting methods, but also revealing a window into the company's operations, personnel and business. In many cases, the audit workpapers provide the best explanation and rationale for the numbers contained in a company's financial statements. Accordingly, and hopefully in cooperation with the auditors, we will take all appropriate steps in our power to obtain these documents from both US and foreign auditors, and we will take quick action in this regard.

In addition to documentary evidence, because the team structure of Task Force investigations allows attorneys and accountants to work on different aspects of the investigation at the same time, if the circumstances warrant we will schedule testimony sessions for multiple witnesses in quick succession, and even "double-track" testimony – where different attorneys take testimony from multiple witnesses on the same day at the same time in different locations.

This faster pace will apply not only to the discovery and investigative phases, but to settlement discussions as well. At the conclusion of our investigation, if circumstances warrant the Division recommending that the Commission file an enforcement action, your firm and its legal representatives should be prepared – if so inclined – to meaningfully enter and complete settlement negotiations in a short but reasonable time frame. If the firm under investigation attempts to unreasonably draw out or delay these negotiations, the staff will make its recommendation to the Commission, and if authorized, file the action without further ado. Protection of investors and our markets requires that these matters be resolved expeditiously, and we cannot permit attempts to frustrate those important goals.

Recently, in an ongoing Task Force investigation, we sent out on one day 10 subpoenas for testimony to a company under investigation. The subpoenas called for testimony of several witnesses on successive days, and in some cases double-tracking of witnesses. The attorney representing the company was surprised by our requests to get testimony so quickly, and told us that in his time practicing before the Commission he had never seen such an aggressive approach. Our response is: don't be surprised anymore. Going forward, these investigations will be expedited, and those we investigate should be prepared to hit the ground running, because the Division of Enforcement does not intend to slow down.

This leads me to the third aspect of the Task Force I wanted to talk about today: Cooperation. There are two different types of cooperation I'd like to talk about. There is the opportunity for the companies and individuals being investigated to benefit by cooperating with the Commission's investigation, which I will get to in a minute. But there is also increasing cooperation between the Commission and other government and regulatory entities in financial fraud cases, which I'd like to address first.

In our efforts to fight financial fraud, the Task Force and the Division of Enforcement as a whole will work with everyone and anyone who can help us complete our investigations as expeditiously and thoroughly as possible. Once again, the public interest demands no less. This includes the federal criminal authorities, and the self-regulatory agencies and exchanges that we have traditionally worked closely with, like the NASD and the New York Stock Exchange. But it increasingly includes other entities that we have been developing close working relationships with on financial fraud cases, such as foreign equity exchanges and foreign regulatory authorities.

On the criminal front, I'm sure most of you subscribe to CFO Magazine, but for those who do not, I would recommend you take a look at an article from the September 2000 issue, entitled "Jailhouse Shock." That article nicely summarizes the two points I'd like to make about the increasingly fruitful cooperation between the Commission and criminal prosecutors. First, in those financial fraud cases where we find evidence of criminal wrongdoing, the criminal authorities are increasingly interested in pursuing prosecution. Take comfort that our goal is not necessarily to criminalize GAAP violations. These cases, rather, are egregious and involve clear-cut fraud. Last year, the Commission granted 294 access requests from regulators and criminal authorities. Perhaps even more telling, criminal authorities obtained 64 indictments and 62 convictions from cases referred by the Commission. And prosecutors are interested in pursuing perjury cases against those who lie to the staff. The message should be clear – when circumstances warrant, we in the Division will work closely with the Department of Justice, the US Attorneys' Offices throughout the country and the State District Attorneys' Offices to make sure the wrongdoers are prosecuted and convicted.

The second point on the criminal front is that high level people – people as high ranking as CFO – are increasingly going to jail for criminal financial fraud. Contrast the five-year span from 1993 through 1997, for example, where 4 CFO's received criminal sentences, with the time period of 1998 through this year, where 18 CFO's have been sentenced to jail or are awaiting sentencing. Just this past June, the SEC and the New Jersey US Attorney's office filed coordinated actions in the Cendant case against the former CFO and controller of CFC International alleging widespread and intentional manipulation of the company's financial statements that resulted in an overstatement of more than $500 million of pre-tax income for 1996 through 1998. As you can see then, financial fraud is an increasingly important priority not only for the Commission, but state and federal criminal prosecutors as well.

Another area where the Task Force and the Division of Enforcement as a whole will increasingly benefit is in increased cooperation with international regulators and exchanges. As both companies and the equity markets become increasingly global, we find more and more fraudulent activity that occurs overseas has a substantial impact on US-listed companies and US investors. Because of the limits of Commission jurisdiction and federal subpoena power, it can be difficult at times to obtain information or evidence located overseas. Without the support or assistance of overseas regulators or exchanges, our ability to protect investors at times could be constrained. Now, however, with increased help from overseas entities, including over thirty foreign securities' commissions with which we have "memoranda of understanding" or MOU's, we are able to combat financial fraud that much more effectively.

This can perhaps be best illustrated through a hypothetical. Suppose there is a company based in, say, France. The company's stock trades on both the NASDAQ and the EASDAQ, the new NASDAQ market equivalent over in Europe. The SEC, through the Task Force or other enforcement staff, begins investigating the company for possible accounting irregularities. The company, being a foreign entity and knowing the jurisdictional limits of the Commission's subpoena power, decides to drag its feet in producing information to the Commission. In the past, the Commission's efforts to obtain information might have been delayed for a substantial period of time, to the detriment of current and prospective shareholders and the public interest.

Now, however, the staff explores another avenue to obtain the necessary information. The staff quickly contacts self-regulatory organizations such as the NASD and its EASDAQ equivalent, and explains its concerns about the company. In response to these concerns, the SROs make access requests to the SEC for information about the Commission's investigation, which after proper review are quickly granted. After receiving the documents and information in response to their access request, the SROs themselves request from the public company the same information sought by the SEC pursuant to the SROs own listing regulations. When the company fails to produce information to the SROs, they both issue trading suspensions. Within days, the company's access to the capital markets in both the US and Europe is closed. In such a scenario, the company – wherever it is located – might very well finally sit up and begin to be more cooperative with both the SROs and the Commission. The fact is, such a scenario, combined with potentially egregious financial fraud could precipitate the company's fall into bankruptcy.

While we are sensitive to the harm remedies like trading suspensions can cause to existing shareholders, the Commission is doubly concerned that there isn't further harm to investors purchasing shares in a company with falsely inflated financial statements. Companies must provide shareholders and potential shareholders with clear, accurate and honest financial statements, and the Commission will do whatever it takes to get publicly traded companies to be good corporate citizens in this regard. This includes cooperating and working together with domestic and foreign SROs as well as criminal authorities.

Now I'd like to turn to the second type of cooperation. If a company has engaged in a financial fraud, the benefits that can accrue to the company by coming clean and providing significant assistance to the Commission in its investigation can be substantial. If it significantly cooperates with the Commission's investigation, a company can be recognized for its efforts, and sanctions, penalties, and even the selection of forum may be adjusted as a result.

For cooperation to be significant, however, the standards a company must meet are high. The cooperation must be early, meaningful, and complete. In practice, this means a variety of things, including, but not limited to: producing documents and witnesses for testimony in a timely way – including foreign employees still employed by the company; providing materials and information gathered during internal investigations, even those conducted by in-house or outside attorneys; doing a comprehensive overview of internal controls and books and records to ensure that sufficient compliance mechanisms are in place for the future; and finally, cleaning house – firing the employees, wherever they are located whether in the US or abroad, who are involved in or responsible for the fraudulent conduct. Still more factors may arise, depending on the facts of a given investigation.

On the point of cleaning house, let me be clear – to receive credit for significant cooperation, the company must remove the problem employees as high up as the conduct goes. This means if it goes as high as the CEO, the CEO must go. Efforts to sacrifice lower level employees to protect or insulate higher level employees who are also responsible for the fraud not only fails the significant cooperation standard, we see it as an effort to obstruct and impede the Commission's investigation. For example, if a company conducts an internal investigation into possible financial wrongdoing, the investigation should expose the full extent of improper conduct and all of the people involved. It should not be limited in scope, either by geography or by the position of the individuals involved.

The willingness to clean house and cooperate in the other ways I've mentioned sends a message to the Commission that a company is serious about its desire to resolve its past problems and head in a better direction. Conversely, a company that tries to retain individuals who were substantially involved in the fraud sends a message to the Commission that the company has not understood the seriousness of its past conduct, and is not committed to setting a clearly better course for the future. Consequently, a company may receive little credit for substantial assistance until the Commission is given comfort on this issue.

I am aware that the standards for a company to receive credit for providing significant cooperation to the Commission may sound high. But in fact, they are simply the actions a responsible corporate citizen should take when it discovers financial fraud in its organization. Investors deserve no less.

I hope you find this information helpful. Just as it is important that we, the regulators, know how you operate, it is important that you know how we operate. The Task Force model with its increased focus on speedy and efficient results is in place and in use today, and will likely become the model for financial fraud investigations conducted by the Division of Enforcement in the future. In the end, investors will benefit, and the US markets will maintain and perhaps even enhance their unparalleled reputation for financial accuracy and rigor, from which we all benefit. Thank you.