SEC Goes Full Focus on Manipulation & Find Ways to Tame it Down 

• The SEC focuses on going after individuals to alter company practices.
• SEC fined Gentex Corp. $4 million for alleged earnings-management strategies
• Roadrunner paid $20 million in 2019 to settle a class action lawsuit against alleged fraud.

Authorities are closely examining whether businesses are faking financial statistics to satisfy Wall Street targets – as pressure on executives to “make the numbers” increases due to a profit squeeze. 

There have been declines in both reported profits and future return estimates during this earnings season. According to FactSet, fourth-quarter earnings are down 4.65%, with more than 99% of S&P 500 companies having reported. Since the pandemic’s peak in the fall of 2020, that is the first year-over-year decrease.

SEC and the EPS Initiative

The so-called EPS Initiative, part of the SEC’s enforcement arsenal, employs data-driven analytics to try to uncover earnings manipulation. This has so far led to lawsuits being brought against six businesses and an extremely large number of people, including five present or past CFOs. 

In the EPS cases, the SEC has concentrated mainly on going after individuals to alter company practices. The intention is to deter CEOs from the temptation to invent numbers through accounting tricks. Even ostensibly minor accounting adjustments may give rise to legal action. 

The SEC fined Gentex Corp. $4 million in February in the most recent instance under the EPS Initiative for alleged earnings-management strategies that increased its reported EPS by just one penny.

SEC watching over disclosures 

To satisfy desired financial measures, the SEC is concentrating on quarter-end transactions or accounting changes made chiefly or exclusively by public businesses. According to Howard A. Scheck, a partner with StoneTurn and a former chief accountant in the SEC Division of Enforcement, companies should update financial reporting fraud risk assessments to ensure they are tackling earnings management. 

The premise that certain intentional acts impacting financial measurements, known as “earnings management,” are appropriate and don’t require disclosure has traditionally been applied to public firms. 

To achieve specific financial results, such as meeting investors’ expectations for revenue, net income, earnings per share (EPS), or another GAAP or non-GAAP financial measure, a company may use operational or accounting measures to accelerate or delay the recognition of income or expense items.

But recent Securities and Exchange Commission enforcement actions, such as the Marvell Technology Group (Marvell) case filed in September 2019 and some ongoing investigations evaluating potential improper rounding of EPS, suggest that the SEC is concentrating on quarter-end transactions or accounting adjustments made primarily or exclusively to meet desired financial metrics.

SEC’s history of taming down earnings manipulation 

The SEC has a lengthy history of attempting to stop earnings manipulation. Arthur Levitt, the agency’s then-chairman, blasted the widespread use of “accounting hocus-pocus” to smooth earnings 25 years ago. 

Mr. Buffett wrote, “That activity is disgusting.”

Analysts and scholars disagree that all earnings management is negative. According to a 2020 analysis of more than 43,000 quarterly earnings reports, if done well, it can help shareholders by reducing the impact of one-off events. 

According to Mr. Farber, the ability of the people in charge of the company, as determined by their capacity to transform assets into cash, is critical in determining whether smoothing benefits or hurts the share price. According to his research, high-quality management teams employ smoothing more frequently and successfully than low-quality ones. 

Illegal earnings manipulation is the opposite extreme of the scale, which may cost businesses and executives dearly. 

In Duluth, Minnesota, Peter Armbruster is incarcerated for two years for committing an accounting scam. The SEC claimed that his alleged actions included concealing incurred costs and failing to write down millions of dollars worth of overvalued assets.

Conclusion 

The fraud has had a significant negative impact on his former employer, Roadrunner. The transport company settled SEC complaints over the alleged fraud in February without denying responsibility. After restarting several years’ worth of financial statements, Roadrunner already paid $20 million in 2019 to settle a class action lawsuit brought by shareholders. 

Requests for comment from Mr. Ambruster’s attorneys went unanswered. The allegations, according to Roadrunner, “relate to conduct that occurred more than five years ago by personnel not affiliated with the firm since 2018,” the company stated in a statement.

Nancy J. Allen is a crypto enthusiast and believes that cryptocurrencies inspire people to be their own banks and step aside from traditional monetary exchange systems. She is also intrigued by blockchain technology and its functioning.

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