On
Following two cases from last year, the action against HCSG is the third enforcement action—and likely not the last—resulting from the
As the
- pay close attention to the data and metrics they disclose;
- document their accounting judgments; and
- ensure compliance with their disclosure controls and procedures.
Case Background
According to the
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HCGS paid
Takeaways
The question we receive from clients time and time again is whether all earnings management is inappropriate and at what point does a company cross the line into inappropriate earnings manipulation. The answer is that “earnings management” means different things to different people. Investors expect companies to engage in responsible financial and operational management. But if issuers are seen to be “managing” or manipulating their earnings to give an overly positive view of their operations and finances, the
Given that rooting out accounting and disclosure fraud in the context of earnings management is a clear priority for the
- To assess your risk, pay attention to your data. The EPS Initiative uses risk-based data analytics to uncover potential accounting and disclosure violations. In the three cases brought by the
SEC under its EPS Initiative, each issuer had patterns of meeting or slightly exceeding consensus EPS estimates for consecutive quarters, followed by significant drops in EPS. The issuers also touted record-high or record-setting EPS. Issuers should review and examine their own data, metrics, and communications to assess the risk of being swept up in the EPS Initiative. - Materiality: The adjustment amounts need not be huge to look manipulative. The cases in the EPS Initiative don't involve massive adjustments. Rather, these cases generally involve smaller adjustments made consistently over multiple quarters that affected the company's EPS, often by pennies. The
SEC appears to have concluded that these adjustments are qualitatively material. - Document accounting judgments. The HCSG case serves as an example where adjustments were made without adequate documentation. Whether in the quarter-end closing process or in its analysis of a litigation loss contingency, HCSG did not document why it made particular adjustments. The
SEC pointed out that HCSG's finance staff regularly recorded manual journal entries with no or inadequate documentation. And theSEC's case against HCSG's controller seems rooted in the fact that she was responsible for ensuring that all accounting entries were supported by adequate documentation. Without contemporaneous documentation, adjustments and manual journal entries made at quarter-end—that also happen to guarantee meeting analyst expectations—will appear self-serving and manipulative. - Pay attention to your policies and procedures and make sure they are being followed. HCSG actually had policies and procedures requiring that accounting entries have adequate supporting documentation. The company also had a Disclosure Control Committee that met each quarter to ensure that adequate disclosure controls and procedures (DCPs) were developed, documented, and implemented; in turn, these DCPs were made to ensure that the company's financial statements and disclosures were complete and accurate. But the
SEC accused the company of failing to follow its own policies and procedures, and its controls did not seem to have caught those instances of non-compliance. It is important that companies develop appropriate DCPs, follow them, and have some sort of mechanism or audit trail to verify and document that they are being followed.
Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.
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