HRO Securities Defense Blog

PCAOB INVESTIGATIONS AND ENFORCEMENT ACTIONS: THE “NUCLEAR OPTION” FOR SMALL FIRMS

In the wake of Enron and other accounting scandals, popular and Congressional sentiment strongly favored subjecting auditors to increased regulation.   Congress created the Public Company Accounting Oversight Board through passage of the Sarbanes-Oxley Act to oversee audit firms that are engaged in auditing SEC-reporting issuers. The PCAOB was given sweeping inspection and enforcement powers.  The PCAOB is now using these powers to strictly enforce its very strict interpretation of often-ambiguous accounting and auditing standards.  In light of the extremely onerous and burdensome nature of PCAOB inspections and investigations, and the board’s tendency to target sole practitioners and small firms, the accounting profession and the investing public have the right to ask whether the cost of PCAOB regulation is simply too high.

New Cooperation Initiative: Potential SEC Enforcement “Game Changer”

In a recent speech, Division of Enforcement Director Robert Khuzami announced a new cooperation initiative that has the potential to dramatically change the way the SEC staff interacts with individuals and companies. Historically, the SEC has insisted on punishing all individuals who engaged in wrongdoing and seeking the full array of harsh sanctions against them, regardless of the extent to which they cooperated with the staff, or whether they "self-reported" the misconduct. Mr. Khuzami’s initiative features cooperation agreements, deferred prosecution agreements, and non-prosecution agreements.

According to Mr. Khuzami, the Division of Enforcement will now use cooperation agreements in which it agrees to recommend to the Commission that a cooperator receive credit for cooperating in its investigations or related enforcement actions. Such credit will only be extended if the cooperator provides substantial assistance in those investigations and enforcement actions. Mr. Khuzami did not state what this "credit" will consist of, but presumably could include foregoing the imposition of civil penalties.

SEC Files First Regulation G Case

On November 12, 2009, the SEC filed an accounting fraud case against SafeNet, Inc.  Notably, the SEC touted the case in its litigation release as its  first case involving violations of Regulation G.  This regulation was mandated by Sarbanes-Oxley and was intended to address the widespread use of “pro-forma,” non-GAAP financial metrics, such as EBITDA by technology companies during the late 1990’s.  This case demonstrates the SEC enforcement program’s continuing efforts to crack down on financial fraud, but for the reasons discussed below, is a poor “message case” regarding Regulation G.

SEC Extends Compliance Deadline for Reg S-AM Implementation

On November 5, 2009, the SEC announced that the "compliance date for Regulation S-AM is extended from January 1, 2010 to June 1, 2010."  (See http://www.sec.gov/rules/final/2009/34-60946.pdf.)  See also our previous discussions of Reg S-AM.

Madoff Investors Sue SEC

   Yesterday, two Madoff investors sued the SEC for failing to detect the scheme that caused them to incur $2.4 million in losses.  In a complaint filed in the U.S. District Court for the Southern District of New York, Phyllis Molchatsky, a disabled retiree and single mother, and Steven Schneider, M.D. accuse the SEC of “serial, gross negligence” during its multiple investigations and examinations of Madoff’s firm, Bernard L. Madoff Investment Securities, LLC. The complaint relies heavily on the recent report by the Office of the Inspector General detailing numerous opportunities to detect Madoff’s huge Ponzi scheme that were missed by the agency. [1]