Illustrations of SEC Remedies in Financial Fraud Actions

Two settled administrative proceedings filed yesterday that relate to the previously settled actions brought against PNC Financial Services and accounting giant AIG reflect contrasting remedies in financial fraud actions.  Both actions are based on the SEC’s investigation along with the Federal Reserve into the use of special purpose entities sold by AIG to PNC. 

In PNC, the SEC brought a cease and desist action against the financial services company for a false quarterly filing made in 2001.  Specifically, the Order for Proceedings as to PNC claimed that the company entered into an arrangement with AIG to create special purpose entities used to remove approximately $762 million in loan and venture capital assets from its books.  The SEC claimed that these “transactions were an effort to eliminate PNC’s risk of loss on the transferred loans and other assets while allowing it to benefit from any long-term improvement in their values.  Had PNC continued to include these transferred assets in its financial statements, it would have been required to reflect in its financial statements any losses incurred and the benefit of any improvement in the value of these assets.”  Instead, the company transferred the assets to SPEs under an arrangement, which permitted it to book any long term increase but avoid the losses.  According to the SEC, under the arrangements although AIG invested 3% or more in the entities as required by GAAP, in fact its fees exceeded this amount so that its net investment was less than required.  Thus, the arrangements did not comply with GAAP.  According to the Order for Proceedings, during the third quarter of 2001 the Federal Reserve had “incomplete” communications with PNC in which it raised questions concerning the propriety of the arrangements.  Nevertheless, PNC continued with the improper arrangements, incorporating the false financial statements in registration statements filed with the SEC.  PNC also issued a press release in January 2002 that incorporated the false financial data despite the fact that it knew it would have to restate the results. 

PNC consented to the entry of an order directing that it cease and desist from violations of the antifraud provision of the Securities Act, Sections 17(a)(2) & (3) and various Exchange Act books and records provisions.  PNC also entered into an extensive supervisory agreement with the Board of Governors of the Federal Reserve. Release No. 33-8112; SEC v. American International Group, Inc., No. 1:04CV02070 (GK) (D.D.C. judgment entered Dec. 7, 2004. 

Yesterday, Thomas Garbe consented to the entry of an order directing him to cease and desist from causing violations of the reporting provisions of the Exchange Act. Release No. 34-54906 Mr. Garbe is a CPA who was PNC’s director of Accounting Policy at the time the false quarterly reports were prepared and filed with the SEC.  According to the Order for Proceedings, Mr. Garbe participated in meetings about the proposed SPE transactions with AIG and researched and analyzed the accounting issues involved with the accounting treatment:  “During 2001, Garbe was the head of PNC’s Accounting Policy department, and, as such, had responsibility for ensuring that PNC’s accounting for each of the . . .[SPE transactions] was in conformity with GAAP.”  In January 2002, Mr. Garbe became director of Financial Accounting for PNC.  

In another action filed yesterday, former EY partner Michael Joseph consented to the entry of an order directing that he cease and desist from causing violations of the books and records provisions of the Exchange Act and the antifraud provisions of the Securities Act, Sections 17(a)(2) & (3) and an order under Rule 102(e) denying him the right to practice before the SEC but permitting an application for a right of reentry after three years.  Mr. Joseph was a partner in the national office of EY and helped develop and market the accounting product AIG sold to PNC and used to improperly remove assets from its books.  Not only should Mr. Joseph have known that the product did not conform to GAAP but, according to the Order, he violated auditor independence standards by advising PNC during its audits on the appropriateness of the accounting for the product he helped develop and market. Release No. 33-8759,