THE IMPACT OF COOPERATION
Cooperation can have a significant impact on the outcome of an enforcement action for the company and its executives. The Seaboard Release in 2001, regarding corporate charging and cooperation principles, for example offers the prospect of no charges or reduced sanctions in exchange for cooperation. Last January, the Commission expanded its efforts to secure cooperation to individuals while also broadening its proposals to business organizations as discussed here.
For the company or individual considering the question of cooperation, the potential impact of cooperation can be difficult to assess. A recent study and a case last week shed some light on the question.
In a forthcoming paper tiled “SEC Enforcement: Does Forthright Disclosure and Cooperation Really Matter?” (available here), Professor Rebecca Files finds “that cooperation increases the likelihood of being sanctioned, perhaps because it improves the SEC’s ability to build a successful case against the firm. However, both cooperation and forthright disclosures are rewarded by the SEC through lower monetary penalties.” The paper is based on an analysis of 1,249 companies which restated their financial statements between 1997 and 2005. The study reports that as a reward for cooperation, the SEC reduces firm penalties on average by $37.4 million when the company initiates its own investigation into the law violation. In addition, penalties are reduced on average by $609,000 for each week earlier that the restatement is announced to the public.
A concrete illustration of cooperation can be seen in the recently filed settled enforcement action against the owner and two executives of Sunrise Living, Inc. SEC v. Sunrise Senior Living, Inc., Civil Action No. 1:10-CV-01247 (D.D.C. Filed July 23, 2010). This accounting fraud action was brought against the company and two of its former senior officers, Larry Hulse, former CFO, and Kenneth Abode, former Treasurer.
The Commission’s complaint alleges an earnings management scheme that began in the second half of 2003 and continued for 2005. It spawned two false annual reports, six incorrect quarterly reports, a false registration statement which incorporated the flawed financial statements and incorrect SOX CFO certifications. The scheme ended with a March 2008 restatement.
The complaint, built on allegations of intentional conduct primarily by Mr. Hulse, centers on improper accounting in the corporate bonus accrual account and the health and dental reserve to make earnings forecasts. For example, guidance for the fourth quarter of 2003 informed investors that earnings would be between $2.63 to $2.65 per share for fiscal year 2003 and between $0.66 and $0.68 per share for the quarter. About two weeks before the fiscal year end internal projections showed that EPS for the fourth quarter would be $0.57. According to the complaint, the day after this projection was made Mr. Hulse, who was aware of it, directed his accounting staff to eliminate the balance in the 2003 bonus accrual account for the company. Yet, before the earnings release for the quarter was issued, senior management, including Mr. Hulse, agreed to pay the bonuses. The company, however, did not have a reserve since it had been released.
In subsequent quarters, similar actions were taken. In each instance, the action was taken to meet guidance. In each instance, the adjustments made to the reserve were improper and, in the end, were restated.
In resolving the case, the Commission gave Sunrise credit for what it termed “its substantial assistance in the investigation.” As is typical, there is no delineation of the steps which constitute that assistance. It does however appear to be reflected in the settlement.
• The company settled by consenting to the entry of a permanent injunction prohibiting future violations of Exchange Act Sections 13(a) and 13(b)(2)(A) and (B). No penalty was imposed.
• Mr. Hulse consented to the entry of a permanent injunction prohibiting future violations of Securities Act Sections 17(a)(2) and (3) and Exchange Act Sections 13(a), 12(b)(2)(A) and (B) and 13(b)(5). He also agreed to pay disgorgement of $83,333 and prejudgment interest and a civil penalty of $50,000. In a related administrative proceeding, Mr. Hulse consented to the entry of an order under Rule 102(e) suspending him from appearing or practicing before the Commission as an accountant, with a right to reapply after three years.
• Mr. Abode was only named as a defendant in count two, which alleges violations of Exchange Act Section 13(a), and count three, alleging violations of Exchange Act Sections 13(b)(2)(A) and (B) and Section 13(b)(5). According to the Commission’s Litigation Release No. 21600 (July 23, 2010), Mr. Abode consented to pay a civil penalty of $25,000 (his settlement papers are not available at this date). In a related administrative proceeding, he consented to the entry of a cease and desist order from causing any violations of Section 13(b)(5) of the Exchange Act and related rules. He also agreed to the entry of an order denying him the privilege of appearing or practicing before the Commission as an accountant with a right to reapply after one year.