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SEC Uses New Initiative For First Time


Image via Sarah Shaffer on Unsplash

The temptation for unscrupulous executives of publicly traded companies to play games with financial results to please Wall Street and enjoy the payouts from a higher share price is high.


As the ability for companies to manage their financial results becomes more sophisticated, the U.S. Securities and Exchange Commission has to find new ways to catch this behavior. What the SEC's Division of Enforcement came up with is the EPS Initiative, which uses risk-based data analytics to uncover potential accounting and disclosure violations resulting through actions such as earnings management practices.


Yesterday the SEC filed actions against two companies for violations that resulted in the improper reporting of quarterly earnings per share that matched or exceeded the consensus analyst estimates. The move marks the first enforcement action resulting from an investigation generated by the EPS Initiative.


"Public company financial reporting should not present a misleading picture of performance," Director of the SEC's Division of Enforcement Stephanie Avakian said. "As demonstrated by today's actions, we will continue to leverage our internal data analysis tools to identify violations, including evidence of earnings management and other accounting or disclosure improprieties."


The two companies that are the first to be handed an enforcement action as a result of the program are Interface Inc. and Fulton Financial Corporation.


Interface, a modular carpet manufacturer based in Georgia, was found by the SEC's order to have made unsupported, manual accounting adjustments that do not comply with GAAP, in multiple quarters in 2015 and 2016. The action found that the adjustments were made in quarters in which internal EPS estimates came in below the consensus analyst estimates. The SEC's order found that Interface's former Controller and Chief Accounting Officer Gregory J. Bauer as well as former CFO Patrick C. Lynch had participated in the adjustments.


Fulton, a financial services company based in Pennsylvania, was found by the SEC's order to have managed its earnings in 2016 and 2017 using a valuation allowance for its mortgage servicing rights that contradicted the methodology used in the same filing. Fulton then reversed the allowance in a subsequent quarter to boost its EPS when it would have fallen short of the consensus analyst estimates.


"While difficult to detect, improper quarterly adjustments can have a material impact on reported EPS and how investors view a company's reported financial results," Associate Director in the Division of Enforcement Anita B. Bandy said. "Public companies must have accounting and disclosure controls sufficient to provide reasonable assurance that quarter-end adjustments comply with GAAP and do not hide weaker than expected performance."


Without admitting or denying wrongdoing, Interface will pay a $5 million civil fine while Fulton will pay a $1.5 million civil fine. Bauer and Lynch were fined $45,000 and $70,000, respectively, and barred from participating in the financial reporting or audits of public companies for three years and one year, respectively.


With the pressure on management to beat or exceed the expectations placed on their companies by Wall Street, the SEC is likely to continue using this approach to track down companies who are fudging their numbers.

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