Clarification On Fair Value Accounting; Two More Financial Fraud Cases
As the market crisis continues to dominate the news, the staff at the SEC and FASB clarified certain points regarding the application of fair value accounting, which is central to the valuation mortgage backed securities. In addition, the Commission, as is customary as the government fiscal year draws to a close, filed several enforcement actions. The financial fraud cases filed are discussed below. Others will be detailed in subsequent posts.
Fair value accounting
Fair value accounting has come under scrutiny in the current market crisis in view of its impact on the mortgage backed securities which are at its center. Some have called for its suspension, claiming that it does not work where there is no market. Others disagree.
On Tuesday, the SEC’s office of Chief Accountant and the staff of the FASB issued a press release clarifying certain issues surrounding fair value measurement guidance in FASB Statement No. 157. The release today is interim guidance while the FASB and ISAB discuss issues connected to fair value accounting.
The subjects covered by the guidance issued on September 30 include:
• The use of management’s internal assumptions when the relevant market does not exist;
• How to use market quotes when assessing the mix of information available;
• Consideration of disorderly transactions in assessing fair value;
• Transactions in an inactive market being indicative of fair value; and
• Factors to consider in assessing whether an investment is other than temporarily impaired.
Previously, on September 16, 2008, the International Accounting Standards Board Expert Advisory Panel issued a draft document titled “Measuring and disclosing the fair value of financial instruments in markets that are no longer active.” The Panel has requested comments on the draft by October 3, 2008.
Financial fraud cases
In SEC v. The Penn Traffic Company, Civil Action No. 08 Civ. 01035 (N.D.N.Y Sept. 30, 2008), the Commission filed a settled financial fraud case against Penn Traffic, a New York based operator of supermarket chains and a wholesale food distribution business. The company filed for Chapter 11 protection in May 2003 from which it emerged in April 2005. The company’s stock is now traded in the pink sheets.
As with many of the Commission’s financial fraud cases, the conduct on which the complaint is based is centered on a years-old scheme which traces to fiscal year 2000, continued through fiscal year 2003 and culminated in a September 2002 restatement of the company’s financial statements.
The complaint is based on two schemes. Under the first, the company recognized promotional allowances in advance of certain key continent activities. As a result, Penn Traffic improperly reduced its cost of goods sold. This scheme was implemented by routinely submitting false information to the accounting department. The scheme resulted in the misstatement of about $10 million from the second quarter of FY 2001 through the third quarter of FY 2003.
In the second, the company used fraudulent entries and/or adjustments to the books of its wholly owned bakery subsidiary so that it would meet its earnings goals. As a result of this scheme, the company misstated more than $7 million of income over a three and one quarter year period.
To resolve this case, the company consented to the entry of a permanent injunction prohibiting future violations of the antifraud, books and records, internal controls and periodic reporting provisions of the federal securities laws. The company also agreed to certain undertakings. The Commission previously filed actions against company executives. SEC v. Lawer, 05 Civ. 1233 (N.D.N.Y. Sept. 29, 2005) (settled with a consent decree prohibiting future violations of the antifraud and reporting provisions); SEC v. Jones, 07 Civ. 957 (N.D.N.Y. Sept. 17, 2007) (pending).
The Commission also filed another is a series of actions related to BISYS Group. In SEC v. Wevodau, 08-Civ-8348 (S.D.N.Y. Filed Sept. 30, 2008), the Commission filed a settled fraud action against Steven Wevodau, former vice president of finance for the Insurance and Education Services group of the BISYS Group.
For fiscal years 2001 through 2003, BISYS Group overstated its income by approximately $180 million, largely as a result of a fraud in its Insurance Services unit. From about July 2000 through at least March 2002, Mr. Wevodau was responsible for a variety of fraudulent or improper accounting practices which included: using improper acquisition accounting by recording as revenue to BISYS the bonus commission income that was already earned but not recorded by the company BISYS had acquired; creating inflated and unsupported receivables for commissions on the sale of certain products; and improperly eliminating expense.
To resolve the case, Mr. Wevodau consented to the entry of a permanent injunction prohibiting future violations of the antifraud and books and records and internal controls provisions. In addition, he consented to the entry of an order requiring him to pay disgorgement, penalties and prejudgment interest totaling about $225,000 and an order barring him from serving as an officer or director for five years. See also, SEC v. BISYS Group, 07 Civ. 4010 (S.D.N.Y. May 23, 2007) (settled with consent injunction and payment of $25 million in disgorgement); In the matter of David Blain, C.P.A., Adm. Proc. File No. 3-13226 (Sept. 19, 2008) (consent to C&D re books and records provisions and 102(e) order with right to reapply after one year).