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Why Financial Statements Matter: Enforcement and Litigation Implications Breon S an a.s. Pratt & sons Publication october 2013 Headnote: The new Problems Facing banks Steven A. Meyerowitz dealing witH civil investigative demands From tHe cFPb: rules, resPonses, and Practice considerations Joseph T. Lynyak III and Rebecca Tierney When talking Politics leads to Prison: Political intelligence & tHe STOCK act Kerry Burke, Robert Kelner, and Zachary Parks Why Financial statements matter: enForcement and litigation imPlications Breon S. Peace, Jonathan S. Kolodner, and Tamara J. Britt When is it too late For investors to bring RMBS-related claims? Joseph Cioffi and James R. Serritella is tHere a PatH tHrougH tHe woods? retention requirements For managed CLOs Kevin Ingram and Martin Sharkey unautHorized UCC Filings: a cautionary tale Marc Hanrahan and Sarah Griffin delaware bankruPtcy court Affirms lender’s ability to recover 37 Percent make- Whole Premium as Part oF its secured claim Luc A. Despins and G. Alexander Bongartz Caveat Cesso. tempus Fugit…. (creditors in bankruPtcy must beware delay, as time Flies) John D. Demmy The nature and Priority oF security under canada’s bank act Luciana Amaral banking brieFs Terence G. Banich editor-in-cHieF Steven A. Meyerowitz President, Meyerowitz Communications Inc. board oF editors Paul Barron Douglas Landy Elizabeth C. Yen Professor of Law Partner, Milbank, Tweed, Hadley Partner, Hudson Cook, LLP Tulane Univ. School of Law & McCloy LLP Bankruptcy for Bankers George Brandon Paul L. Lee Howard Seife Partner, Squire, Sanders & Of Counsel, Debevoise & Partner, Chadbourne & Parke Dempsey LLP Plimpton LLP LLP Barkley Clark Jonathan R. Macey Regional Banking Outlook Partner, Stinson Morrison Hecker Professor of Law James F. Bauerle LLP Yale Law School Keevican Weiss Bauerle & Hirsch LLC John F. Dolan Martin Mayer Professor of Law The Brookings Institution Recapitalizations Wayne State Univ. Law School Christopher J. Zinski Stephen J. Newman Partner, Schiff Hardin LLP Thomas J. Hall Partner, Stroock & Stroock & Partner, Chadbourne & Parke Lavan LLP Banking Briefs LLP Terence G. Banich Sarah L. Reid Member, Shaw Fishman Glantz Jeremy W. Hochberg Partner, Kelley Drye & Warren & Towbin LLC Arnold & Porter LLP LLP Intellectual Property Kirk D. Jensen Heath P. Tarbert Stephen T. Schreiner Partner, BuckleySandler LLP Partner, Weil, Gotshal & Manges Partner, Goodwin Procter LLP LLP Satish M. Kini Partner, Debevoise & Plimpton Stephen B. Weissman LLP Partner, Rivkin Radler LLP The Banking Law JournaL (ISBN 978-0-76987-878-2) (USPS 003-160) is published ten times a year by Matthew Bender & Company, Inc. Periodicals Postage Paid at Washington, D.C., and at additional mailing offices. Copyright 2013 Reed Elsevier Properties SA., used under license by Matthew Bender & Company, Inc. No part of this journal may be reproduced in any form — by microfilm, xerography, or otherwise — or incorporated into any informa- tion retrieval system without the written permission of the copyright owner. For customer support, please contact LexisNexis Matthew Bender, 1275 Broadway, Albany, NY 12204 or e-mail [email protected]. Direct any editorial inquires and send any material for publication to Steven A. Meyerowitz, Editor-in-Chief, Mey- erowitz Communications Inc., PO Box 7080, Miller Place, NY 11764, [email protected], 631.331.3908 (phone) / 631.331.3664 (fax). Material for publication is welcomed — articles, decisions, or other items of interest to bankers, officers of financial institutions, and their attorneys. This publication is designed to be accurate and au- thoritative, but neither the publisher nor the authors are rendering legal, accounting, or other professional services in this publication. If legal or other expert advice is desired, retain the services of an appropriate professional. The articles and columns reflect only the present considerations and views of the authors and do not necessarily reflect those of the firms or organizations with which they are affiliated, any of the former or present clients of the authors or their firms or organizations, or the editors or publisher. POSTMASTER: Send address changes to The Banking Law JournaL LexisNexis Matthew Bender, 121 Chanlon Road, North Building, New Providence, NJ 07974. Why Financial StatementS matter: enForcement and litigation implicationS BReon S. Peace, Jonathan S. KoLoDneR, AnD Tamara J. Britt Public companies continue to face serious risks from accounting irregularities and misstatements that result in errors in financial statements. Accounting irregularities can lead to regulatory and even criminal investigations, as well as significant claims in civil litigation. Regulatory and criminal investigations and civil litigation often result in resolutions or settlements involving large financial penalties and other sanctions. Further, the underlying internal investigation and forensic analysis necessary to identify the root of the problem and correct it can itself be costly, a public relations nightmare, and a major distraction. This article examines different types of accounting-related fraud and applicable legal provisions that can be the basis of an enforcement action or civil litigation and describes how an accounting error leading to a restatement can come to light. The article concludes with a survey of some recent trends and cases. ACCOUNTING FRAUD PROSECUTION: a RETURN TO tHe “BREAD AND BUTTER” oF tHe SEC? In 2003, several years before the financial crisis, accounting fraud was the hot button issue, with cases like Enron, Adelphia, and WorldCom dominating the news. Over the course of the last decade, civil litigation and criminal Breon S. Peace is a partner based in the new York office of Cleary Gottlieb Steen & Hamilton LLP. Jonathan S. Kolodner is counsel based in the firm’s new York office. Tamara J. Britt is an associate based in the firm’s new York office. Heejin Choi, a summer associate at firm, assisted in the preparation of this article for publication. The authors can be reached at [email protected], jkolodner@ cgsh.com, and [email protected], respectively. 794 Published by Matthew Bender & Company, Inc. in the october 2013 issue of The Banking Law Journal. Copyright © 2013 Reed elsevier Properties SA. WHY FInAnCIAL SettleMents MatteR prosecutions involving allegations of accounting fraud have steadily declined, with the Securities and Exchange Commission and other governmental agencies focusing their attentions on the subprime mortgage fallout, Ponzi schemes, and other cases related to the financial crisis.1 However, there are signs that the focus of regulators is returning to ac- counting fraud cases. When Mary Jo White was appointed as chairman of the SEC, there was much fanfare surrounding her background as a “tough prosecu- tor,” and sure enough, she has indicated that under her leadership, the SEC will be “bold and unrelenting” in its efforts “to further strengthen [its] enforce- ment function.”2 The SEC’s investment in resources that will provide it with the electronic means to detect accounting fraud exemplifies these efforts. In a December 2012 speech to the Financial Executives International Committee on Finance and Information Technology, Craig M. Lewis, chief economist and director, Division of Risk, Strategy, and Financial Innovation at the SEC talked about a new predictive accounting model that the SEC would be implementing in 2013. According to Lewis, this proactive risk modeling tool will help the SEC analyze corporate filings, identify firms that might be outlier firms, and “assess the degree to which registrants’ financial statements appear anomalous.” Experienced lawyers who have dealt with enforcement matters have expressed the view that these technological developments will aid the SEC’s return to its “bread and butter” enforcement program focused on accounting issues, par- ticularly as the crisis-era cases draw to a close.3 TYPES oF ACCOUNTING-RELATED FRAUD There are many types of accounting-related fraud that have been the subject of enforcement actions and civil litigation, including: • inappropriate revenue recognition; • improper expense calculations;4 • earnings mismanagement;5 • reserve manipulation;6 • misappropriation;7 and • violations of the Foreign Corrupt Practices Act (“FCPA”). 795 THe BAnKInG Law JouRnAL This article focuses on inappropriate revenue recognition, which, of late, is one of the more common types of accounting-related fraud involving finan- cial statements, and the FCPA — particularly the so-called “books and re- cords” provisions, which have been increasingly used by the SEC as a basis for enforcement actions, although we will briefly address accounting fraud in all of its different forms. Generally, revenue is realizable and earned when all of the following con- ditions are met: • persuasive evidence of an arrangement exists; • delivery has occurred or services have been rendered; • the seller’s price to the buyer is fixed or determinable; and • collectability is reasonably assured.8 Accelerating or otherwise manipulating revenue recognition on a finan- cial statement provides a tempting way to appear to improve a company’s outward financial performance. However, if the decision to do so is too ag- gressive and inconsistent with accepted accounting principles, it can, at a minimum, result in significant errors in a company’s financial statements. And, to the extent that such a decision is made deliberately to mislead the public, it can result in an enforcement action, civil litigation, and even crimi- nal charges. Foreign corrupt Practices act
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