In an earlier post Carol and George talked about the SEC Enforcement Division ramping up its activities and focusing on financial reporting fraud. And, sure enough, on March 11, 2014 the SEC announced their latest financial reporting fraud enforcement. We could make a bad joke about the SEC going “hog wild” with this one, but we won’t! The company involved, AgFeed, which is a hog raising and selling company, committed what the SEC calls a “massive accounting fraud”. The areas where fraud was found were the “usual suspects”, primarily revenue recognition. (Being and agricultural company, the fraud areas were really interesting, including things like saying hogs for sale were fatter than they really were.) And, adding a bit of intrigue to the fraud and the related enforcement, the bulk of the company’s operations are in China.
So, you might be tempted to say, well, this is just another typical fraud, similar to the accounting fraud cases we have seen historically.
But, when you read into the case, there turns out to be a lot more going on, and a lot more to learn. While the company’s operations were primarily in China, they also had US operations, and the Chair of the audit committee and CFO were in the US.
One of the key aspects of this enforcement action is that the audit committee chair and the CFO became aware of several “red flags” about the company’s reporting in China, including the classic “we keep two sets of books” situation. When they became aware of the “red flags”, as “gatekeepers”, they have a serious responsibility, which is where they fell down and where the SEC makes one of the key point in the enforcement action.
The real lesson of this case is seeing what the US based audit committee chair and CFO did. What they did was essentially try to keep it all internal. As gatekeepers, they failed in their responsibility. According to the enforcement press release, the audit committee chair actually consulted with others who told him that there was “not just smoke but fire” and instead of taking action, “ignored the recommendation and internalized the situation while false financial reporting continued”.
In the words of Andrew J. Ceresney, director of the SEC’s Division of Enforcement, “This is a cautionary tale of what happens when an audit committee chair fails to perform his gatekeeper function in the face of massive red flags.”
This is the lesson. We are all gatekeepers. And, as the SEC’s Enforcement Division ramps up its focus on financial reporting fraud, starts to use “Robocop” and charters its special task force for financial reporting fraud, we all need to remember our roles as gatekeepers.
Even accountants in staff rolls have this responsibility. The Mckesson case, where a revenue recognition director of contract accounting was enforced against and lost her license for not challenging her supervisors clearly inappropriate instructions to record revenue is another clear example of the responsibility we all have. For the lesson check out:
According to the enforcement division, the analyst, “a former Certified Public Accountant and former Manager of Contract Accounting at HBOC, also participated in the fraud by abdicating her gatekeeper role over the recording of software revenue when she repeatedly booked revenue on contracts where she knew it was improper to do so.”
So, lets stay away from the lion!