powerpoint slide presentation

Disclaimer

The views expressed in this presentation are those of Marc Fagel and are not necessarily shared by the Commission or

its staff.

Overview

The SEC’s Division of Enforcement

Financial Reporting Fraud

Recent SEC Enforcement Actions

The New Landscape

SEC Enforcement Staff

970 staff members

370 in Home Office

600 in regional/district offices

Enforcement Actions by Fiscal Year

0

100

200

300

400

500

600

19951996

19971998

19992000

20012002

Fiscal Year

FY 2001 Cases By Subject

Financial Fraud 23% Offering Fraud 20% Broker-Dealer 13% Insider Trading 12%

Financial Reporting Actions Filed

163 actions filed in FY02

Compared to:

112 in FY 2001

103 cases in FY 2000

94 cases in FY 1999

79 cases in FY 1998

SEC Investigations

Informal Inquiry

Formal Investigation

Confidential

Civil

SEC Enforcement Remedies* Injunction/C&D Order Temporary Restraining

Order Asset Freeze Trading Suspension

Disgorgement Civil Monetary

Penalties Officer/Director Bar 102(e) Order

*applicable to financial fraud cases

Financial ReportingFraud

Common Financial Fraud Schemes

Contingent sales, right of return Channel stuffing Bill and hold transactions Quarter cut-off

Improper Revenue Recognition

Common Financial Fraud Schemes

Improper Revenue Recognition Overstatement of Assets Understatement of Liabilities Failure to Record Expenses

Newer Financial Fraud Schemes

Earnings Management Off-Balance-Sheet Entities Barter Sales, Round-Tripping Pro Forma Earnings Releases

Newer Financial Fraud Schemes

“Cookie Jar” reserves “Big Bath” charges and write-downs Undisclosed changes in estimates Undisclosed changes in policies

Earnings Management

Recent SECFinancial Fraud

Enforcement Actions

National

Bay Area

Recent Cases (Nationwide)

Enron WorldCom Xerox Adelphia Communications Dynegy RiteAid

Enron

Enron Commission sued former CFO Andrew Fastow on

October 2, 2002. Complaint alleges: Secretly controlled 3 entities, hiding his role to keep items off Enron’s

balance sheet.

Sham sales, including sale to another off-balance-sheet entity he controlled.

Backdated documents to overstate value of technology company in which Enron had invested.

Siphoned millions of dollars for himself and family members.

Commission sued/settled with Enron officer Michael Kopper on August 21. Claims related to off-balance-sheet entities controlled by Fastow through Kopper. O&D bar, $12 million disgorgement.

WorldCom

Commission filed case within 24 hours of the company’s public

announcement of its restatement.

WorldCom Complaint alleges that WorldCom capitalized rather

than expensed approximately $3.8 billion of its costs, in violation of GAAP.

Within 48 hours, Commission obtained a court order preventing destruction of documents, prohibiting extraordinary payments to current and former officers, directors and other employees, and appointing a corporate monitor.

Subsequently filed cases against Controller David Myers and Director of General Accounting Buford “Buddy” Yates. Investigation continues.

Xerox

Commission sued Xerox on April 11, alleging undisclosed accounting actions that accelerated revenue recognition of equipment by over $3 billion and increased pre-tax earnings by $1.5 billion over a four-year period. Over 30% of pre-tax earnings resulted from undisclosed accounting actions.

Among other things, shifted leasing revenue from service/financing to hardware so could accelerate revenue recognition.

Xerox

*from SEC complaint

Xerox As part of the settlement:

Xerox paid a $10 million penalty – the largest ever levied in a Commission action against a public company for financial fraud. The penalty reflects the severity of the misconduct as

well as the company's lack of full cooperation in the investigation.

Xerox was required to conduct a special review of its accounting controls and to restate its financials. This ultimately led to Xerox’s acknowledgment that

it had misstated approximately $6 billion of revenues.

Adelphia Communications Commission filed

charges against Adelphia, its founder (John J. Rigas), his three sons, and two other senior executives, alleging one of the most extensive financial frauds ever to take place at a public company.

Adelphia Communications

SEC complaint alleges that Adelphia, at the direction of the individual defendants:Fraudulently excluded billions of dollars in liabilities from

its consolidated financial statements by hiding them on the books of off-balance-sheet affiliates;

Falsified operations statistics and inflated earnings; and

Concealed rampant self-dealing by the Rigas Family, including the undisclosed use of corporate funds for Rigas Family stock purchases and the acquisition of luxury condominiums.

Adelphia Communications The Commission is seeking:

Disgorgement of all ill-gotten gains, including:

Compensation received during the fraud

Property unlawfully taken from Adelphia through undisclosed related-party transactions

Severance payments

Officer and Director bars

Permanent anti-fraud injunctions

Civil penalties from each defendant, including Adelphia. Penalty against company sought because Adelphia failed early on to

cooperate with the Commission's investigation and actually allowed the fraud to continue until the Rigas family lost control over the company's conduct.

Dynegy

On September 24, Commission instituted settled administrative proceedings against Dynegy, Houston energy company, imposing $3 million penalty.

Dynegy Administrative Order finds that Dynegy used

off-balance-sheet special purpose entities to falsely disguise loan, inflating operating cash flow by $300 million (37%).

Dynegy entered into 2 massive “round-trip” electricity transactions, inflating revenue in press releases.

$3 million penalty in part reflects company’s lack of full cooperation in Commission investigation.

Rite Aid

Commission charged former CEO, CFO, and Vice Chairman with fraud in connection with wide-ranging accounting fraud scheme that enabled the company to overstate its income in every quarter from May 1997 to May 1999.

Non-fraud cease-and-desist settlement for company (based on cooperation with Commission, including declining to assert attorney-client privilege in giving access to internal investigation conducted by company counsel).

Rite Aid Accounting fraud alleged in complaint includes:

Systematically inflated deductions taken against future amounts owed to vendors for supposedly damaged & outdated products;

Reduced accounts payable by $75 million for vendor rebates that were contingent on future events;

Improperly reduced (or failed to record) various expenses;

Opened books after close of quarter to record various changes to make up financial shortfalls.

Recent Cases (Bay Area)

HPL Technologies Unify Quintus Legato

Recent Cases (Bay Area)

HPL Technologies

Settled injunctive action against former President & CEO David Lepejian

Over 80% of revenue for fiscal 2002 phony

Forged purchase orders and audit confirm responses

O&D bar, other relief

Recent Cases (Bay Area)

Unify

Civil injunctive action against former CEO Reza Mikailli and former CFO Gary Pado

Recognized revenue on contingent sales

Roundtripping (i.e. made investments in other companies, which used investments to buy Unify products)

Mikailli sold all his Unify stock for $8.2 million

Recent Cases (Bay Area)

Quintus

Civil injunctive action against CEO Alan Anderson

Forged purchase orders and audit confirm responses for 3 fake transactions

Barter transactions

Recent Cases (Bay Area)

Legato Systems

Settled cease-and-desist proceedings against Legato and CFO Stephen Wise

Contingent sales to distributors, side letters

The New Landscape

The New Landscape

1. Coordination with criminal authorities

The New Landscape

1. Coordination with criminal authorities

2. Emphasis on personal accountability

Greater use of O&D bars Disgorgement of compensation

Officer and Director Bars

Officer and Director bars sought:*

FY 2002: 126

FY 2001: 51

FY 2000: 38

*all categories of cases

Financial Reporting & Issuer Disclosure: Themes and Trends

1. Coordination with criminal authorities

2. Emphasis on personal accountability

3. Real Time Enforcement

Real Time Enforcement

Wider Use of Emergency ReliefTROs

FY 2002: 48 FY 2001: 31

Asset Freezes FY 2002: 63 FY 2001: 43

Trading Suspensions FY 2002: 11 FY 2001: 2

• Bring Cases Piecemeal

Financial Reporting & Issuer Disclosure: Themes and Trends

1. Coordination with criminal authorities

2. Emphasis on personal accountability

3. Real Time Enforcement

4. Hold companies accountable for non-cooperation

Section 21(a) Report on Cooperation

Establishes Framework for Evaluating CooperationCredit for extraordinary cooperationNot an amnesty program

Provides Expanded Spectrum of OutcomesMeaningful differences among different respondentsCredit for real cooperation

Benefits InvestorsEncourages self-reportingRewards companies with effective compliance procedures

What Does Cooperation Mean?

Self-Policing Before Misconduct DiscoveredEffective Compliance ProceduresAppropriate “Tone at the Top”

Self-Reporting Misconduct When DiscoveredThorough InvestigationPrompt Disclosure

RemediationDismissing or Disciplining WrongdoersInternal Controls and Procedures to Prevent RecurrenceCompensating Those Affected Adversely

Cooperation with law enforcement authorities

Consequences of Non-Cooperation:

Subpoena Enforcement Actions 19 actions in FY 2002 38% increase over last fiscal year

Tougher Sanctions Xerox: $10 million penalty Dynegy: $3 million penalty

The New Landscape

1. Coordination with criminal authorities

2. Emphasis on personal accountability

3. Effort to speed up our investigations

4. Hold companies accountable for non-cooperation

5. Compliance with GAAP not always enough

Edison Schools Commission found that Edison, despite

technical compliance with GAAP, inaccurately described aspects of its business in its SEC filings, in violation of the securities laws.

Specifically, Edison failed to disclose that a substantial portion of its reported revenues consist of payments that never reach Edison. Funds are instead expended by school districts to cover costs of operating schools managed by Edison.

The New Landscape

1. Coordination with criminal authorities

2. Emphasis on personal accountability

3. Effort to speed up our investigations

4. Hold companies accountable for non-cooperation

5. Compliance with GAAP not always enough

6. Facilitating another company’s reporting violations may create liability

The New Landscape

1. Coordination with criminal authorities

2. Emphasis on personal accountability

3. Effort to speed up our investigations

4. Hold companies accountable for non-cooperation

5. Compliance with GAAP not always enough

6. Facilitating another company’s reporting violations may create liability

7. Sarbanes-Oxley Act

Sarbanes-Oxley Act of 2002 Creates the Public Company Accounting Oversight Board Requires CEO and CFO certification of reports Increases penalties and other sanctions for corporate

wrongdoing Imposes new rules for audit committees Requires auditors to report additional information to audit

committee Additional rules governing auditor independence Attorney responsibility to report evidence of securities law

violations to CEO/audit committee Orders new rules for securities analyst independence

New Enforcement Tools Standard for obtaining Officer & Director bar lowered from

“substantial unfitness” to “unfitness”

Obtain Officer & Director bar in administrative proceeding

Obtain temporary freeze of extraordinary payments to officers or directors during an investigation of a public company or its senior management

Greater Commission access to foreign workpapers

Establish FAIR Funds to add amounts obtained as penalties to disgorgement funds returned to investors

Debts based on judgments and settlements resulting from violations of federal securities laws are nondischargeable in bankruptcy