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  • <click> In the Report, the Commission articulated a framework for evaluating a public company’s cooperation in determining whether and how to charge violations of the federal securities laws. <click> The Commission identified when it would give credit for extraordinary cooperation <click> But its important to make clear that the report is not an immunity program like those in the Defense Contracting and Antitrust area, e.g. There is conduct that is so egregious that no amount of cooperation will earn a pass <click> The report is designed to explain and expand the spectrum of outcomes from an investigation and enforcement action <click> Help investors and the public generally understand why cases are charged and remedies are sought. <click> At the same time, it allows the SE to provide credit for real cooperation and to impose tougher sanctions in the worst cases <click> Report makes clear that the paramount issue in every enforcement judgment is what best protects investors. <click> Motivated by a belief that when businesses seek out, self-report, and rectify illegal conduct, and cooperate with Commission staff large expenditures of government and shareholder resources can be avoided. <click> Report strongly emphasizes the importance of putting compliance procedures into place before misconduct occurs. <click>
  • <click> The Commission outlined four broad measures it would look at in measuring a company’s cooperation. <click> Self-policing prior to the discovery of the misconduct, including establishing effective compliance procedures and an appropriate tone at the top; <click> Self-reporting of misconduct when it is discovered, including conduct a thorough internal investigation of the nature, extent, origins and consequences of the misconduct, and promptly, completely, and effectively disclosing the misconduct to the public, to regulators, and to self-regulators; <click> Remediation , including dismissing or appropriately disciplining wrongdoers, modifying and improving internal controls and procedures to prevent recurrence of the misconduct, and appropriately compensating those adversely affected; and <click> Cooperation with law enforcement authorities, including providing the Commission staff with all information relevant to the underlying violations and the company’s remedial efforts. The non-exclusive list of criteria is set forth in greater detail in the Report.
  • And just as there is credit for cooperation, there also consequences for non-cooperation: <click> We are certainly less tolerant of delaying tactics by those we investigate. We insist on, and enforce, tighter deadlines for production of documents and appearances for testimony. When these deadlines are unreasonably disregarded, we will seek to enforce our subpoenas in federal court. Already this fiscal year, the Commission has brought 14 18 actions to enforce subpoenas for documents or testimony. <click> This can result in unfortunate adverse publicity– some of you may recall Andrew Fastow, former CFO for Enron who refused to appear for testimony, and then had to schedule a press conference at which is lawyer wouldn’t let him speak. <click> We’ll also insist on tougher sanctions to resolve enforcement matters Couple of cases I’ll talk about <click> AA $7 million <click> Xerox $10 million/ press release <click> Last year the SEC obtained a jury verdict that David Lipson, CEO and Chairman of Supercuts, Inc., committed fraud when he sold 365,000 shares of Supercuts stock on the basis of material nonpublic information Court ordered relief: Permanent antifraud injunction Disgorgement of losses avoided: $621,875 Prejudgment interest on disgorgement: $348,097 Civil penalty of three times the amount of losses avoided: $1,865,625 Unusually high penalty warranted because of need to deter Lipson, who otherwise would be likely, in the Court’s opinion, to commit future violations. <click>
  • Before I turn to a discussion of some of the cases that we filed, I want to touch briefly on the Sarbanes Oxley Act and its ramifications for public companies and for the Division of Enforcement. The Act will effect significantly the work of the SEC You could have an entire conference on the Act, which was signed into law by President Bush on July 30, 2002, less than a month after his speech in NY. <Click>Perhaps of most significance, the Act changes dramatically the regulation of accounting in the United States It establishes the Public Company Accounting Oversight Board to enforce professional standards, ethics, and competence for the accounting profession; It also has provisions that strengthen the independence of firms that audit public companies; <Click> The Act includes measures that increases corporate responsibility and the usefulness of corporate financial disclosure; Among other things, the Act amends the securities laws to require reporting on a rapid and current basis information required by the SEC. Picking up on recent action by the SEC, the Act requires that the CEO and CFO to certify compliance with the reporting requirements of the Exchange Act. Pro Formas must be reconciled to GAAP. In the Corporate Governance Area many of the listing requirements of the NYSE and Nasdaq are codified and would apply to all public companies. The Act provides protections to internal whistleblowers. <Click> The Act provides for new and increased penalties for corporate wrongdoing; For example, if a company must must restate because of misconduct, the Act specifically provides that the CEO and CFO must reimburse the issuer for any bonus or equity based compensation. The Act creates a new federal crime for failing to retain audit and review workpapers. Another new crime is defrauding shareholders, and carries a maximum sentence of 25 years. <Click> The Act contains provisions designed to Protects the objectivity and independence of securities analysts; and requires new rulemaking in the area.p <Click> Finally, the Act significantly increases the SEC budget, and provides for a larger staff—needed because un addition to increased responsibilities 9 separate studies and over 30 rulemakings. <click>
  • Transcript

    • 1.  
    • 2. Disclaimer
      • The views expressed in this presentation are those of Marc Fagel and are not necessarily shared by the Commission or its staff.
    • 3. Overview
      • The SEC’s Division of Enforcement
      • Financial Reporting Fraud
      • Recent SEC Enforcement Actions
      • The New Landscape
    • 4.  
    • 5. SEC Enforcement Staff
      • 970 staff members
      • 370 in Home Office
      • 600 in regional/district offices
    • 6. Enforcement Actions by Fiscal Year Between 450 and 600 new cases each year
    • 7. FY 2001 Cases By Subject
      • Financial Fraud 23%
      • Offering Fraud 20%
      • Broker-Dealer 13%
      • Insider Trading 12%
    • 8. Financial Reporting Actions Filed
      • 163 actions filed in FY02
        • Compared to:
          • 112 in FY 2001
          • 103 cases in FY 2000
          • 94 cases in FY 1999
          • 79 cases in FY 1998
    • 9. SEC Investigations
      • Informal Inquiry
      • Formal Investigation
      • Confidential
      • Civil
    • 10. SEC Enforcement Remedies*
      • Injunction/C&D Order
      • Temporary Restraining Order
      • Asset Freeze
      • Trading Suspension
      • Disgorgement
      • Civil Monetary Penalties
      • Officer/Director Bar
      • 102(e) Order
      *applicable to financial fraud cases
    • 11. Financial Reporting Fraud
    • 12. Common Financial Fraud Schemes
      • Contingent sales, right of return
      • Channel stuffing
      • Bill and hold transactions
      • Quarter cut-off
      • Improper Revenue Recognition
    • 13. Common Financial Fraud Schemes
      • Improper Revenue Recognition
      • Overstatement of Assets
      • Understatement of Liabilities
      • Failure to Record Expenses
    • 14. Newer Financial Fraud Schemes
      • Earnings Management
      • Off-Balance-Sheet Entities
      • Barter Sales, Round-Tripping
      • Pro Forma Earnings Releases
    • 15. Newer Financial Fraud Schemes
      • “Cookie Jar” reserves
      • “Big Bath” charges and write-downs
      • Undisclosed changes in estimates
      • Undisclosed changes in policies
      • Earnings Management
    • 16. Recent SEC Financial Fraud Enforcement Actions
      • National
      • Bay Area
    • 17. Recent Cases (Nationwide)
      • Enron
      • WorldCom
      • Xerox
      • Adelphia Communications
      • Dynegy
      • RiteAid
    • 18. Enron
    • 19. Enron
      • Commission sued former CFO Andrew Fastow on October 2, 2002. Complaint alleges:
        • Secretly controlled 3 entities, hiding his role to keep items off Enron’s balance sheet.
        • Sham sales, including sale to another off-balance-sheet entity he controlled.
        • Backdated documents to overstate value of technology company in which Enron had invested.
        • Siphoned millions of dollars for himself and family members.
      • Commission sued/settled with Enron officer Michael Kopper on August 21. Claims related to off-balance-sheet entities controlled by Fastow through Kopper. O&D bar, $12 million disgorgement.
    • 20. WorldCom
      • Commission filed case within 24 hours of the company’s public announcement of its restatement.
    • 21. WorldCom
      • Complaint alleges that WorldCom capitalized rather than expensed approximately $3.8 billion of its costs, in violation of GAAP.
      • Within 48 hours, Commission obtained a court order preventing destruction of documents, prohibiting extraordinary payments to current and former officers, directors and other employees, and appointing a corporate monitor.
      • Subsequently filed cases against Controller David Myers and Director of General Accounting Buford “Buddy” Yates. Investigation continues.
    • 22. Xerox
      • Commission sued Xerox on April 11, alleging undisclosed accounting actions that accelerated revenue recognition of equipment by over $3 billion and increased pre-tax earnings by $1.5 billion over a four-year period. Over 30% of pre-tax earnings resulted from undisclosed accounting actions.
      • Among other things, shifted leasing revenue from service/financing to hardware so could accelerate revenue recognition.
    • 23. Xerox * from SEC complaint
    • 24. Xerox
      • As part of the settlement:
        • Xerox paid a $10 million penalty – the largest ever levied in a Commission action against a public company for financial fraud.
          • The penalty reflects the severity of the misconduct as well as the company's lack of full cooperation in the investigation.
        • Xerox was required to conduct a special review of its accounting controls and to restate its financials.
          • This ultimately led to Xerox’s acknowledgment that it had misstated approximately $6 billion of revenues.
    • 25. Adelphia Communications
      • Commission filed charges against Adelphia, its founder (John J. Rigas), his three sons, and two other senior executives, alleging one of the most extensive financial frauds ever to take place at a public company.
    • 26. Adelphia Communications
      • SEC complaint alleges that Adelphia, at the direction of the individual defendants:
        • Fraudulently excluded billions of dollars in liabilities from its consolidated financial statements by hiding them on the books of off-balance-sheet affiliates;
        • Falsified operations statistics and inflated earnings; and
        • Concealed rampant self-dealing by the Rigas Family, including the undisclosed use of corporate funds for Rigas Family stock purchases and the acquisition of luxury condominiums.
    • 27. Adelphia Communications
      • The Commission is seeking:
        • Disgorgement of all ill-gotten gains, including:
          • Compensation received during the fraud
          • Property unlawfully taken from Adelphia through undisclosed related-party transactions
          • Severance payments
        • Officer and Director bars
        • Permanent anti-fraud injunctions
        • Civil penalties from each defendant, including Adelphia.
          • Penalty against company sought because Adelphia failed early on to cooperate with the Commission's investigation and actually allowed the fraud to continue until the Rigas family lost control over the company's conduct.
    • 28. Dynegy
      • On September 24, Commission instituted settled administrative proceedings against Dynegy, Houston energy company, imposing $3 million penalty.
    • 29. Dynegy
      • Administrative Order finds that Dynegy used off-balance-sheet special purpose entities to falsely disguise loan, inflating operating cash flow by $300 million (37%).
      • Dynegy entered into 2 massive “round-trip” electricity transactions, inflating revenue in press releases.
      • $3 million penalty in part reflects company’s lack of full cooperation in Commission investigation.
    • 30. Rite Aid
      • Commission charged former CEO, CFO, and Vice Chairman with fraud in connection with wide-ranging accounting fraud scheme that enabled the company to overstate its income in every quarter from May 1997 to May 1999.
      • Non-fraud cease-and-desist settlement for company (based on cooperation with Commission, including declining to assert attorney-client privilege in giving access to internal investigation conducted by company counsel).
    • 31. Rite Aid
      • Accounting fraud alleged in complaint includes :
        • Systematically inflated deductions taken against future amounts owed to vendors for supposedly damaged & outdated products;
        • Reduced accounts payable by $75 million for vendor rebates that were contingent on future events;
        • Improperly reduced (or failed to record) various expenses;
        • Opened books after close of quarter to record various changes to make up financial shortfalls.
    • 32. Recent Cases (Bay Area)
      • HPL Technologies
      • Unify
      • Quintus
      • Legato
    • 33. Recent Cases (Bay Area)
      • HPL Technologies
        • Settled injunctive action against former President & CEO David Lepejian
        • Over 80% of revenue for fiscal 2002 phony
        • Forged purchase orders and audit confirm responses
        • O&D bar, other relief
    • 34. Recent Cases (Bay Area)
      • Unify
        • Civil injunctive action against former CEO Reza Mikailli and former CFO Gary Pado
        • Recognized revenue on contingent sales
        • Roundtripping (i.e. made investments in other companies, which used investments to buy Unify products)
        • Mikailli sold all his Unify stock for $8.2 million
    • 35. Recent Cases (Bay Area)
      • Quintus
        • Civil injunctive action against CEO Alan Anderson
        • Forged purchase orders and audit confirm responses for 3 fake transactions
        • Barter transactions
    • 36. Recent Cases (Bay Area)
      • Legato Systems
        • Settled cease-and-desist proceedings against Legato and CFO Stephen Wise
        • Contingent sales to distributors, side letters
    • 37. The New Landscape
    • 38. The New Landscape
      • Coordination with criminal authorities
    • 39. The New Landscape
      • Coordination with criminal authorities
      • Emphasis on personal accountability
        • Greater use of O&D bars
        • Disgorgement of compensation
    • 40. Officer and Director Bars
      • Officer and Director bars sought :*
        • FY 2002: 126
        • FY 2001: 51
        • FY 2000: 38
      *all categories of cases
    • 41. Financial Reporting & Issuer Disclosure: Themes and Trends
      • Coordination with criminal authorities
      • Emphasis on personal accountability
      • Real Time Enforcement
    • 42. Real Time Enforcement
      • Wider Use of Emergency Relief
        • TROs
            • FY 2002: 48
            • FY 2001: 31
        • Asset Freezes
            • FY 2002: 63
            • FY 2001: 43
        • Trading Suspensions
            • FY 2002: 11
            • FY 2001: 2
      • Bring Cases Piecemeal
    • 43. Financial Reporting & Issuer Disclosure: Themes and Trends
      • Coordination with criminal authorities
      • Emphasis on personal accountability
      • Real Time Enforcement
      • Hold companies accountable for non-cooperation
    • 44. Section 21(a) Report on Cooperation
      • Establishes Framework for Evaluating Cooperation
        • Credit for extraordinary cooperation
        • Not an amnesty program
      • Provides Expanded Spectrum of Outcomes
        • Meaningful differences among different respondents
        • Credit for real cooperation
      • Benefits Investors
        • Encourages self-reporting
        • Rewards companies with effective compliance procedures
    • 45. What Does Cooperation Mean?
      • Self-Policing Before Misconduct Discovered
        • Effective Compliance Procedures
        • Appropriate “Tone at the Top”
      • Self-Reporting Misconduct When Discovered
        • Thorough Investigation
        • Prompt Disclosure
      • Remediation
        • Dismissing or Disciplining Wrongdoers
        • Internal Controls and Procedures to Prevent Recurrence
        • Compensating Those Affected Adversely
      • Cooperation with law enforcement authorities
    • 46. Consequences of Non-Cooperation:
        • Subpoena Enforcement Actions
          • 19 actions in FY 2002
          • 38% increase over last fiscal year
        • Tougher Sanctions
          • Xerox: $10 million penalty
          • Dynegy: $3 million penalty
    • 47. The New Landscape
      • Coordination with criminal authorities
      • Emphasis on personal accountability
      • Effort to speed up our investigations
      • Hold companies accountable for non-cooperation
      • Compliance with GAAP not always enough
    • 48. Edison Schools
      • Commission found that Edison, despite technical compliance with GAAP, inaccurately described aspects of its business in its SEC filings, in violation of the securities laws.
        • Specifically, Edison failed to disclose that a substantial portion of its reported revenues consist of payments that never reach Edison. Funds are instead expended by school districts to cover costs of operating schools managed by Edison.
    • 49. The New Landscape
      • Coordination with criminal authorities
      • Emphasis on personal accountability
      • Effort to speed up our investigations
      • Hold companies accountable for non-cooperation
      • Compliance with GAAP not always enough
      • Facilitating another company’s reporting violations may create liability
    • 50. The New Landscape
      • Coordination with criminal authorities
      • Emphasis on personal accountability
      • Effort to speed up our investigations
      • Hold companies accountable for non-cooperation
      • Compliance with GAAP not always enough
      • Facilitating another company’s reporting violations may create liability
      • Sarbanes-Oxley Act
    • 51. Sarbanes-Oxley Act of 2002
      • Creates the Public Company Accounting Oversight Board
      • Requires CEO and CFO certification of reports
      • Increases penalties and other sanctions for corporate wrongdoing
      • Imposes new rules for audit committees
      • Requires auditors to report additional information to audit committee
      • Additional rules governing auditor independence
      • Attorney responsibility to report evidence of securities law violations to CEO/audit committee
      • Orders new rules for securities analyst independence
    • 52. New Enforcement Tools
      • Standard for obtaining Officer & Director bar lowered from “substantial unfitness” to “unfitness”
      • Obtain Officer & Director bar in administrative proceeding
      • Obtain temporary freeze of extraordinary payments to officers or directors during an investigation of a public company or its senior management
      • Greater Commission access to foreign workpapers
      • Establish FAIR Funds to add amounts obtained as penalties to disgorgement funds returned to investors
      • Debts based on judgments and settlements resulting from violations of federal securities laws are nondischargeable in bankruptcy
    • 53.  

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