SEC REPORTING SKILLS WORKSHOP 2017

Transcription

1 SEC REPORTING SKILLS WORKSHOP 2017 Workshop Leaders Cheryl L. Linthicum George M. Wilson

2 CHAPTER 18: Recent Enforcement Releases from the SEC: Xerox, Microsoft, America Online, Waste Management, Delphi Corporation, PACCAR, JDA Software, and Saba Software 483

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54 Home Previous Page U.S. SECURITIES AND EXCHANGE COMMISSION Litigation Release No / June 3, 2013 Accounting and Auditing Enforcement Release No / June 3, 2013 Securities and Exchange Commission v. PACCAR Inc, et al., Civil Action No. 2:13-cv (W.D. Wash. filed June 3, 2013) SEC Charges Fortune 200 Company for Accounting Deficiencies The Securities and Exchange Commission today charged a Bellevue, Wash.- based commercial truck manufacturer and a subsidiary for various accounting deficiencies that clouded their financial reporting to investors in the midst of the financial crisis. The SEC alleges that PACCAR's internal accounting controls included ineffective procedures that kept the company from adhering to various accounting rules. PACCAR failed to report the operating results of its aftermarket parts business separately from its truck sales business as required under segment reporting requirements, which are in place to ensure that investors gain the same insight into a company as its executives. PACCAR and its subsidiary also failed to provide complete information about their respective loan and lease portfolios, and PACCAR overstated some loan and lease originations and collections at two foreign subsidiaries in its statement of cash flows. PACCAR and its subsidiary PACCAR Financial Corp. agreed to settle the SEC's charges. According to the SEC's complaint filed in federal court in Seattle, PACCAR is a Fortune 200 company that designs, manufactures, and distributes trucks and related aftermarket parts that are sold worldwide under the Kenworth, Peterbilt, and DAF nameplates. From 2008 through the third quarter of 2012, PACCAR failed to report the results for its parts business as a separate segment from its truck sales as required under Generally Accepted Accounting Principles (GAAP). For example, PACCAR's 2009 annual report showed $68 million in income before taxes for its truck segment. However, PACCAR documents and board materials reviewed by senior executives depicted the trucks business with a $474 million loss and the parts business with $542 million profit to arrive at the net income before taxes of $68 million. By at least 2008, PACCAR should have been reporting aftermarket parts as a separate segment in its SEC filings, but failed to do so until yearend The SEC's complaint further alleges that PACCAR and PACCAR Financial Corp. failed to maintain accurate books and records regarding their 535

55 Practising Law Institute impaired loans and leases, causing them to improperly identify and disclose loans and leases for impairment. As a result, they understated the amounts of their impaired receivables and the specific reserve associated with the receivables in footnotes to their respective 2009 Form 10-K filings. PACCAR understated the amount of its impaired receivables by 65 percent and the amount of the specific reserve associated with the receivables by 78 percent. PACCAR Financial Corp. understated the amounts by 64 percent and 37 percent. As a result of these deficiencies, PACCAR also made inaccurate statements to the SEC's Division of Corporation Finance regarding its processes for calculating the specific reserves on its impaired receivables. According to the SEC's complaint, PACCAR also overstated equal and offsetting amounts in two lines within its statement of cash flows in the second and third quarters of PACCAR identified these errors during the first quarter of 2010 and reported corrected figures in its second and third quarter filings in The SEC's complaint charges PACCAR with violations of Sections 13(a), 13 (b)(2)(a), and 13(b)(2)(B) of the Securities Exchange Act of 1934 ("Exchange Act") and Rules 12b-20, 13a-1, and 13a-13 thereunder, and charges PACCAR Financial Corp. with violations of Sections 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act. Without admitting or denying the charges, they agreed to the entry of a permanent injunction, and PACCAR agreed to pay a $225,000 penalty. The settlement, which is subject to court approval, takes into account that PACCAR and PACCAR Financial Corp. have implemented a number of remedial measures to enhance their internal accounting controls and improve their compliance with GAAP. The SEC's investigation was conducted by Jason Habermeyer and Cary Robnett of the SEC's San Francisco Regional Office, and Peter J. Rosario of the SEC's Washington D.C. office. SEC Complaint Home Previous Page Modified: 06/03/

56 PRESS RELEASE SEC Charges Arizona-Based Software Company for Inadequate Internal Accounting Controls Over Its Financial Reporting FOR IMMEDIATE RELEASE Washington D.C., Sept. 25, 2014 The Securities and Exchange Commission today sanctioned a Scottsdale, Ariz.-based software company for having inadequate internal accounting controls over its financial reporting, which resulted in misstated revenues in public filings. An SEC investigation found that JDA Software Group Inc. failed to properly recognize and report revenue from certain software license agreements it sold to customers because its internal accounting controls failed to consider information needed for determining a critical component of revenue recognition for software companies. If companies are unable to demonstrate this component known as vendor specific objective evidence of fair value (VSOE) when determining the fair value of certain services related to a software license agreement, then they cannot immediately recognize the entire revenue from that agreement. With proper internal controls that appropriately considered VSOE, JDA would have recognized revenue from certain sales ratably over the term of a services agreement. JDA agreed to settle the SEC s charges by paying a $750,000 penalty. Companies must have adequate internal accounting controls designed to comply with their financial reporting obligations to the public, said Michael Maloney, Chief Accountant of the SEC s Enforcement Division. VSOE is a critically important component in determining the timing in which software companies recognize revenue, and JDA s internal accounting controls surrounding VSOE were inadequate in various ways. According to the SEC s order instituting a settled administrative proceeding, JDA s internal accounting controls surrounding VSOE were inadequate in several ways. For example, JDA lacked adequate revenue recognition policies and procedures and failed to identify all service-related contracts needed for VSOE testing to determine the fair value of certain services. Moreover, JDA did not have sufficient internal accounting controls to determine whether a software 537

57 license agreement and related services contract were linked to each other. As a result of these internal control failures, some of JDA s financial statements for 2008, 2009, 2010, and 2011 were materially misstated. JDA restated those financial statements in August 2012, reporting that it had overstated its revenue for fiscal year 2010 by 4 percent and overstated EBITDA by approximately 18 percent. In connection with the restatement, JDA identified control deficiencies that constituted a previously undisclosed material weakness in its internal control over financial reporting related to revenue recognition. The SEC s order finds that JDA violated the reporting, books and records, and internal controls provisions of the federal securities laws, namely Sections 13(a), 13(b)(2)(A), and 13(b)(2)(B) of the Securities Exchange Act of 1934 and Rules 12b-20, 13a-1, 13a-11, and 13a-13. In agreeing to settle the charges without admitting or denying the SEC s findings, JDA consented to the SEC s order imposing a $750,000 penalty and requiring the company to cease and desist from committing or causing any violations or any future violations of Sections 13 (a), 13(b)(2)(A), and 13(b)(2)(B) of the Exchange Act and Rules 12b-20, 13a-1, 13a-11, and 13a-13. The SEC s investigation was conducted by Noel Gittens and William Scarborough and supervised by Antonia Chion and Ricky Sachar. ### Related Materials SEC order 538

58 PRESS RELEASE SEC Charges Software Company in Silicon Valley and Two Former Executives Behind Fraudulent Accounting Scheme CEO Agrees to Return $2.5 Million Under Clawback Provision FOR IMMEDIATE RELEASE Washington D.C., Sept. 24, 2014 The Securities and Exchange Commission today charged a Silicon Valley-based software company and two former executives behind an accounting fraud in which timesheets were falsified to hit quarterly financial targets. An SEC investigation found that company vice presidents Patrick Farrell and Sajeev Menon were atop a scheme at Saba Software in which managers based in the U.S. directed consultants in India to either falsely record time that they had not yet worked, or purposely fail to record hours worked during certain pay periods to conceal budget overruns from management and finance divisions. The improper time-reporting practices enabled Saba Software to achieve its quarterly revenue and margin targets by improperly accelerating and misstating virtually all of its professional services revenue during a four-year period as well as a substantial portion of its license revenue. Saba Software agreed to pay $1.75 million to settle the SEC s charges, and Farrell and Menon agreed to settle the case as well. Under the clawback provision of the Sarbanes-Oxley Act, executives can be compelled to return to the company and its shareholders certain money they earned while their company was misleading investors. In a separate order instituted today, the SEC required Saba Software s CEO Babak Bobby Yazdani to reimburse the company $2.5 million in bonuses and stock profits that he received while the accounting fraud was occurring, even though he was not charged with misconduct. CEOs and CFOs can be deprived of bonuses and stock profits if there is misconduct on their watch that requires a restatement by their employer, said Andrew J. Ceresney, Director of the SEC s Division of Enforcement. We will not hesitate to pursue clawbacks in appropriate cases. 539

59 According to the SEC s order instituting a settled administrative proceeding, Saba Software offers professional services often sold simultaneously with software products. The professional services historically have accounted for about one-third of approximately $120 million in yearly revenues, and the company maintains a group of consultants within its subsidiary in India to help deliver professional services to its customers. The SEC s order finds that Saba Software s timekeeping practices of pre-booking and under-booking hours worked by these consultants precluded the time records from serving as reliable evidence under U.S. Generally Accepted Accounting Principles to recognize revenue in the manner that the company did. Therefore, from Oct. 4, 2007 to Jan. 6, 2012, Saba Software cumulatively overstated its pre-tax earnings by approximately $70 million. According to the SEC s order, Farrell and Menon were responsible for ensuring that the professional services group within Saba Software met financial targets set by senior management. Farrell was aware of situations where consultants planned to pre-book hours in order to achieve their quarterly revenue targets yet he failed to stop the practice. In other instances when they had overrun their budgets, he directed consultants to eat the hours or back them out of the timesheet database. Menon directed consultants reporting to him to book time to the timesheet database at quarter-end even though those hours would not be worked until the following quarter. In other instances, he advised them to avoid inputting in the timekeeping system non-billable hours that they had worked. The SEC s order further finds that internal accounting controls at Saba Software were ineffective to counter-balance the revenue and margin targets set by senior management. This problem was particularly acute in Saba Software s India-based consulting group, which was referred to throughout the consulting organization as a black box. This characterization reflected the fact that U.S. and European managers approving time records of India-based consultants for revenue recognition purposes had little visibility into who was performing what work and when. Saba Software used off-shore operations to cut costs, but also cut corners on its internal controls over financial reporting, said Jina L. Choi, Director of the SEC s San Francisco Regional Office. Weak internal controls create greater opportunity for accounting fraud, and investors are left holding the bag. 540

60 Saba Software consented to the entry of an order finding that it violated the anti -fraud, books and records, and internal control provisions of the federal securities laws. In addition to the $1.75 million financial penalty, Saba Software agreed to pay further penalties if it has not filed restatements of its earnings during those periods by later this year, and revocation of the registration for its securities if it doesn t file those restatements by early next year. Without admitting or denying the findings in the order, Saba Software also agreed to cease and desist from committing or causing future violations of these provisions of the securities laws. Farrell and Menon each consented to the entry of an order finding that they violated the anti-fraud provisions and caused Saba Software s violations. The order also finds that they falsified books and records and circumvented the company s internal controls. Farrell agreed to pay disgorgement and prejudgment interest of $35,017 and a penalty of $50,000, and Menon agreed to pay disgorgement and prejudgment interest of $19,621 and a penalty of $50,000. Without admitting or denying the findings, they each agreed to cease and desist from committing or causing future violations of these provisions the securities laws. Yazdani consented to reimburse Saba Software for $2,570,596 in bonuses, incentive compensation, and stock sale profits that he received following the regulatory filings that the company is now required to restate. He neither admitted nor denied the findings against the company in the order. The SEC s investigation, which is continuing, is being conducted by Mike Foley, Rebecca Lubens, and Erin Schneider of the San Francisco Regional Office. ### Related Materials SEC order: Saba Software, Farrell, and Menon SEC order: Yazdani 541

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