In Conclusion

Baruch College The Sixth Annual Financial Reporting Conference May 3, 2007 Susan G. Markel Chief Accountant, Div. of Enforcement The U.S. Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. Views expressed herein are those of the presenter and do not necessarily reflect the views of the Commission or other members of the staff of the Commission.

Today’s Topics SEC Enforcement SEC Enforcement  Focusing on Financial Fraud and Financial Reporting Matters

Financial Fraud is: “… Intentional or reckless conduct, whether act or omission, that results in materially misleading financial statements…” “… Intentional or reckless conduct, whether act or omission, that results in materially misleading financial statements…”involving “... gross and deliberate distortion of corporate records, … falsified transactions, … [or] the misapplication of accounting principles.” “... gross and deliberate distortion of corporate records, … falsified transactions, … [or] the misapplication of accounting principles.” Report of the National Commission on Fraudulent Financial Reporting; COSO, October 1987 Report of the National Commission on Fraudulent Financial Reporting; COSO, October 1987

Fraud is Different than Errors “Fraudulent financial reporting differs from other causes of materially misleading financial statements, such as unintentional errors.” “Fraudulent financial reporting differs from other causes of materially misleading financial statements, such as unintentional errors.” Report of the National Commission on Fraudulent Financial Reporting; COSO, October 1987 Report of the National Commission on Fraudulent Financial Reporting; COSO, October 1987

Three Conditions are Usually Present: Management has an incentive or is under pressure Management has an incentive or is under pressure The opportunity exists for a fraud to be perpetrated The opportunity exists for a fraud to be perpetrated The fraudsters rationalize their fraudulent acts The fraudsters rationalize their fraudulent acts Statement on Auditing Standards 99, October 2002 Statement on Auditing Standards 99, October 2002 Existence of an exit strategy Existence of an exit strategy

The Slippery Slope of a Financial Fraud: Starts with “making the numbers” Starts with “making the numbers” Then, “Managing the Numbers” Then, “Managing the Numbers” Ends with “making up the numbers” Ends with “making up the numbers”

Rationalization includes: “We need to make our projections…” “We need to make our projections…” “I’m getting pressure from the boss…” “I’m getting pressure from the boss…” “We need to meet Street expectations…” “We need to meet Street expectations…” “Our acquisition will fall through if we don’t…” “Our acquisition will fall through if we don’t…”

And, as is frequently predicted -- “We’ll make it up next quarter…”

But, even a simple mistake can be turned into a financial fraud through “cover-up” efforts.

Categories of Fraud Get rich quick – and disappear even faster Get rich quick – and disappear even faster Greed/ego/credibility frauds Greed/ego/credibility frauds Survival frauds – for the good of the company Survival frauds – for the good of the company

Sources of Enforcement Cases  Other SEC Offices or Divisions  Issuers’ Self-Reporting  Auditor Reports  Change in Auditors  10A

Sources of Enforcement Cases  PCAOB  404 Reports  Restatements  Enforcement Complaint Center

Recent Actions Brought  McAfee  Raytheon Company  Delphi  AIG  Collins & Aikman  Hollinger, Inc.  RenaissanceRe Holdings

And More...  Tyco International  Fannie Mae  Brocade Communications officers  Comverse Technology officers  Buca, Inc.  PBSJ  Doral Financial Corporation  Excelligence Learning Corporation

Common Fraud Schemes  Improper revenue recognition  McAfee (formerly Network Associates)  AremisSoft  Applix  Peregrine Systems, Inc.  Safescript Pharmacies  Robotic Vision Systems  eFunds  (and many more)

Common Fraud Schemes  Excess reserves to smooth earnings  Improper accounting for vendor rebates  Improper capitalized costs  Changing estimates “to make the numbers”  Top-Side and Period End Journal Entries  “Earnings Management”

Other Types of Cases  Related party transactions  Undisclosed compensation  Non-financial metrics  Variable-length quarters  Financial products to manage earnings  False/misleading disclosures/omissions in MD&A (Reg. S-K -- known trends and uncertainties) and in financial statements (Reg. S-X)  FCPA  Stock option backdating

If It Seems Too Good To Be True -- It Probably Is

FINANCIAL REPORTING AND ISSUER DISCLOSURE Areas of Focus

Financial Reporting Requires Good Disclosure as Well as Good Accounting

Individuals Should Be Held Personally Responsible for Misconduct Officer & Director bars Disgorgement

Cooperation is Extremely Important in Financial Fraud Investigations

The Meaning of Cooperation Self-policing prior to discovery of misconduct Self-policing prior to discovery of misconduct  Effective compliance procedures  Appropriate “tone at the top” Self-reporting misconduct upon discovery Self-reporting misconduct upon discovery  Thorough review of nature, extent, origins & consequences  Disclosure to public and regulators

The Meaning of Cooperation Remediation Remediation  Dismissing or appropriately disciplining wrongdoers  Internal controls and procedures to prevent recurrence  Compensating those adversely affected Cooperation with law enforcement authorities Cooperation with law enforcement authorities

Continued Coordination with Criminal Authorities

Perception Vs. Vs.Deception

Untested Perception Allows for Undiscovered Deception

Areas of Focus Conduct of Gatekeepers Scrutinized  Attorneys  Directors  Audit Committees  And, of course...

Accountants and Auditors Every case STILL raises the question: Every case STILL raises the question:

Protecting the Integrity of the Audit Workpapers

“Process” Cases  Tenet Healthcare – KPMG Auditors  E&Y Audit Partner and Senior Manager (NextCard)  SmarTalk Teleservices, Inc. and PwC  American Tissue – AA Auditors

Other Auditor Matters – and Settlements

“Basic” Audit Failures  Planning  Execution  Analysis

“Basic” Audit Failures  Lack of evidence  Over reliance on management representations  Improper confirmation process  Inadequate testing of internal controls  Incorrect disposition of identified errors  Independence

Facilitating Another Company’s Reporting Violations May Create Liability

Recent Examples Delphi Delphi Royal Ahold – U.S. Foodservice Royal Ahold – U.S. Foodservice Scientific-Atlanta (Adelphia) Scientific-Atlanta (Adelphia)

Areas of Focus WHO ? WHO ? WHAT? WHAT? WHERE? WHERE? WHEN? WHEN? WHY? WHY? HOW? HOW? AND THEN WHAT --- Appropriate remedy ? AND THEN WHAT --- Appropriate remedy ?