Enforcement News: SEC Cracks Down on Accounting and Auditing FraudPrint Article
- Posted on: Sep 27 2019
On September 19, 2013, Andrew Ceresney, then Co-Director of the Division of Enforcement of the Securities and Exchange Commission (“SEC” or the “Commission”), told an audience attending a continuing legal education program at the American Law Institute in Washington, D.C. about the importance of pursuing those who commit financial and accounting fraud (here).
Comprehensive, accurate and reliable financial reporting is the bedrock upon which our markets are based because false financial information saps investor confidence and erodes the integrity of the markets. For our capital markets to thrive, investors must be able to receive an unvarnished assessment of a company’s financial condition. Financial reports must provide transparency for investors, and must not obscure the truth, even if that truth is inconvenient.
Ceresney’s words reflect the SEC’s vigilance in cracking down on accounting and auditing fraud. Indeed, since the end of the financial crisis, the SEC has turned its attention to, among other things, the circumstances that create accounting fraud. To that end, the SEC has established a financial reporting and audit task force, implemented an array of investigatory techniques (such as data mining), and relied on tips from whistleblowers to identify the circumstances that allow accounting fraud to occur (here). These efforts continue to show results: in fiscal year 2018, accounting and auditing fraud constituted 16% of the standalone actions (i.e., actions brought in federal court or as administrative proceedings) brought by the SEC.
[Ed. Note: Since Jay Clayton took over the reins of the Commission in 2017, the SEC has focused on protecting the retail investor, imposing individual accountability, keeping pace with technological change, and imposing remedies that further the Commission’s enforcement goals. Consequently, the SEC’s enforcement actions with regard to financial and auditing fraud have declined from FY 2017 to FY 2018. Nevertheless, as the percentage of standalone cases brought in FY 2018 to redress accounting and auditing fraud show (i.e., 16% of the cases), preventing and stopping accounting and auditing fraud remains an important priority of the Commission.]
In today’s post, this Blog looks at two enforcement proceedings involving alleged accounting fraud. One involved accounting and disclosure fraud by Comscore, Inc., and its former Chief Executive Officer (“CEO”), and the other involved violations of the SEC’s auditor independence rules by PwC and one of its partners. Both actions resulted in settlements.
In the Matter of Comscore, Inc.
Comscore concerned a financial accounting and disclosure fraud allegedly committed by Comscore, Inc. (“Comscore” or the “Company”), a publicly-traded data services and measurement company, principally through the conduct of its former Chief Executive Officer (“CEO”), Serge Matta (“Matta” and, together with Comscore, the “Respondents”).
According to the SEC, from February 2014 through February 2016 (the “Relevant Period”), Comscore materially overstated revenue by approximately $50 million as result of a scheme to manipulate non-monetary and monetary contracts. Respondents’ actions, claimed the SEC, enabled the Company to artificially exceed analysts’ consensus revenue target in seven consecutive quarters. In addition, said the SEC, from April 2014 through February 2016, Comscore and Matta made false and misleading statements about two important performance metrics.
The Contracts at Issue
Comscore allegedly entered into non-monetary transactions (“NMTs”) for the purpose of improperly increasing revenue recognition. According to the SEC, Comscore valued these NMTs, which involved the exchange of data between Comscore and a counterparty, by assessing the fair value of the data it surrendered in each transaction. In negotiating certain of these arrangements, however, Matta allegedly included certain data that the counterparty did not ask for, want, need, or use. In addition, in communications with internal accountants and the independent auditor regarding the NMTs, Matta and other Comscore employees allegedly made false or misleading statements about the true purpose of the agreements, the commercial substance of the transactions, and the fair value of the assets. As a result, said the SEC, Comscore’s revenue related to these transactions was overstated by over $34.5 million during the Relevant Period.
Comscore also allegedly entered into certain monetary transactions that improperly increased revenue recognition. In two instances, said the SEC, Matta knew that contracts he negotiated were related and linked but he misrepresented or failed to disclose the true facts to Comscore’s internal accountants and its independent auditor, which had the impact of overstating revenue by approximately $12 million in 2015. In two other instances, noted the SEC, Matta agreed to deliver data to a counterparty by the end of a quarter and then entered into undisclosed side agreements to deliver additional data after the quarter closed. Placing future data delivery obligations into a side agreement, claimed the SEC, allowed Comscore to take the position that all data at issue had been delivered before the current quarter closed, thereby permitting Comscore to recognize all of the revenue associated with the transaction in that quarter rather than defer some or all of the revenue to subsequent quarters.
Comscore’s Performance Metrics
In addition, the SEC alleged that Comscore made false or misleading disclosures regarding two important performance metrics. In 2014 and 2015, Comscore disclosed customer totals that falsely conveyed a consistent increase in the number of net new customers added. In fact, said the SEC, the number of net new customers was declining. Comscore disclosed these overstated numbers in its periodic filings with the SEC and Matta highlighted them during earnings calls with investors. Also, in the third and fourth quarters of 2015, alleged the SEC, Comscore disclosed misstated revenue growth percentages concerning one of its flagship data analytic products. Matta described this purported revenue growth in earnings calls. In fact, contended the SEC, the product’s revenue had been declining. In both instances, said the SEC, Matta directed or approved incremental changes within Comscore to the methodology by which the disclosed figures were calculated without disclosing those changes to investors.
In February 2016, Comscore’s audit committee commenced an internal investigation. On March 23, 2018, Comscore, under new management, filed its Form 10-K for the year ended December 31, 2017, which included a restatement (the “Restatement”).
The Restatement provided restated and corrected financial information for the years ended December 31, 2014 and 2013. The Restatement also provided that Comscore restated certain information for the quarters ended March 31, June 30, and September 30, 2015, and adjusted information previously furnished on Form 8-K for the year ended December 31, 2015. In total, Comscore reversed approximately $50 million in revenue due to Respondents’ improper conduct and accounting. The Restatement also identified various material weaknesses in Comscore’s internal control over financial reporting and acknowledged that prior senior management did not establish or maintain an acceptable corporate culture.
The Settlement With the SEC
The SEC charged Comscore with violating Section 17(a) of the Securities Act of 1933 (“Securities Act”) and Sections 10(b), 13(a), 13(b)(2)(A), and 13(b)(2)(B) of the Securities Exchange Act of 1934 (“Exchange Act”) and Rules 10b-5, 12b-20, 13a-1, 13a-11, and 13a-13 promulgated thereunder.
Respondents settled the charges without admitting or denying the SEC’s findings. In connection with the settlement, Comscore and Matta agreed to cease-and-desist from future violations of the antifraud provisions of the federal securities laws and to pay penalties of $5 million and $700,000, respectively. Matta also agreed to reimburse Comscore $2.1 million, representing profits from the sale of Comscore stock and incentive-based compensation pursuant to Section 304(a) of the Sarbanes-Oxley Act and to the entry of an order barring him from serving as an officer or director of a public company for 10 years.
“As the SEC orders find, Comscore and its former CEO manipulated the accounting for non-monetary and other transactions in an effort to chase revenue targets and deceive investors about the performance of Comscore’s business,” said Melissa R. Hodgman, Associate Director in the SEC’s Enforcement Division. “We will continue to hold issuers and executives accountable for such serious breaches of their fundamental duty to make accurate disclosures to the investing public while giving appropriate credit for a company’s prompt remedial acts and cooperation.”
The press release announcing the settlement can be found here.
In the Matter of PricewaterhouseCoopers LLP
The SEC charged PricewaterhouseCoopers LLP (“PwC”) with improper professional conduct in connection with 19 engagements on behalf of 15 SEC-registered issuers and violating auditor independence rules in connection with engagements for one issuer where the firm performed prohibited non-audit services. The SEC also charged PwC partner Brandon Sprankle (“Sprankle”) with causing the firm’s independence violations. Both respondents agreed to settle the charges; PwC agreed to pay over $7.9 million in monetary relief.
The SEC found that PwC violated the SEC’s auditor independence rules by performing prohibited non-audit services during an audit engagement, including exercising decision-making authority in the design and implementation of software relating to an audit client’s financial reporting, and engaging in management functions. In connection with performing non-audit services for 15 SEC-registered audit clients, the SEC concluded that PwC violated Public Company Accounting Oversight Board Rule 3525, which requires an auditor to describe in writing to the audit committee of the company the scope of work, discuss with the audit committee the potential effects of the work on independence, and document the substance of the independence discussion. According to the SEC, PwC’s actions deprived numerous issuers’ audit committees of information necessary to assess PwC’s independence. As further detailed by the SEC, the alleged violations occurred due to breakdowns in PwC’s independence-related quality controls, which resulted in the firm’s failure to properly review and monitor whether non-audit services for audit clients were permissible and approved by clients’ audit committees.
“Auditors play a fundamental role in protecting the reliability and integrity of financial reporting and must ensure that non-audit services do not come at the cost of their independence on audits of public companies,” said Anita B. Bandy, Associate Director of the SEC’s Division of Enforcement. “PwC repeatedly provided non-audit services without having effective quality controls in place for monitoring whether the services impaired its independence on audit engagements and were properly disclosed to audit committees.”
The SEC also found that PwC and Sprankle violated the auditor independence provisions of the federal securities laws and caused one audit client to violate its obligation to have its financial statements audited by independent public accountants. The SEC further found that PwC and Sprankle engaged in improper professional conduct within the meaning of Rule 102(e) of the SEC’s Rules of Practice.
The press release announcing the settlement can be found here.