SEF D.C. -- Minding Your Ks and Qs: The Latest Issues and Developments in Financial Reporting Fraud
Here is a transcript from the financial reporting panel at the excellent post-election Securities Enforcement Forum in Washington, D.C. The panelists were:
Jason Flemmons, Senior Managing Director, Ankura Consulting Group
Mark Cave, Associate Director,
SEC Jennifer Leete, Partner, Cravath, Swaine & Moore
Jonathan Tuttle, Partner, Debevoise & Plimpton
Sarah Walters, Partner, Ropes & Gray
You can find the video here and the full agenda here.
00:00 - 00:44
Kurt Wolfe: Welcome back to our 3:15 panel, Minding Your K's and Q's, the Latest Issues and Developments in Financial Reporting Fraud. We have another great panel for you this afternoon. Our moderator is Jason Flemmons. Jason is Senior Managing Director at Ankura Consulting Group here in D.C. He has over 30 years of experience in forensic accounting, corporate investigations, and technical accounting and auditing matters. He previously served as the deputy chief accountant of the SEC's Division of Enforcement. Next to Jason is Mark Cave. Mark is an associate director in the SEC's Division of Enforcement here in DC. During his tenure,
00:44 - 01:27
Kurt Wolfe: Mark has also served as senior counsel to the director of enforcement. Mark has led and supervised numerous significant enforcement actions involving public company accounting and disclosure violations, market manipulation, hacking, FCPA violations, SPACs, ICOs, and insider trading. Next to Mark is Jennifer Leete who is a partner at Cravath. Jennifer is a member of the firm's investigations and regulatory enforcement practice. She is also a former associate director in the Division of Enforcement at the SEC, where she served for more than 20 years. Next to Jennifer is Jonathan Tuttle, who is managing partner of the Washington, D.C. Office of
01:27 - 02:09
Kurt Wolfe: Debevoise & Plimpton and a member of the firm's Litigation Department. Jon has significant experience investigating accounting issues, including disclosure and reporting of accounting restatements, responding to whistleblower complaints and interactions with independent auditors. And next to John is Sarah Walters, not Dan O'Connor. So we can just ignore the one picture up there. I promise you that is Sarah. She is a partner at Ropes & Gray in Boston, where she conducts investigations on behalf of audit and other board committees in matters involving accounting and disclosure issues. Sarah previously served as an AUSA and Chief of the Economic Crimes
02:09 - 02:16
Kurt Wolfe: Unit in the USAO for the District of Massachusetts. With that, I'll turn it over to Jason.
02:17 - 02:53
Jason Flemmons: Great, thanks Kurt. All right, so in this panel, we will be talking all things, accounting, auditing, internal controls, disclosure, so I kind of expected we'd have more people fill in seats here. This is a cutting edge materially that we want to talk about. So I think it's fair to say, look, we continue to see a lot of activity in this particular space, and particularly this last year. And I think just to kick things off, I thought we'd turn it over to Mark Cave and throw him a softball and just kind of let him give us a really
02:53 - 02:58
Jason Flemmons: brief overview of just some of the key focus areas and priorities in this particular arena.
02:58 - 03:29
Mark Cave: Yeah, thank you, Jason. And thank you, Bruce. I don't see Bruce, but thank you for having us here today. Before I start, I have to give a standard disclaimer, which is that the views that I expressed today are my own and my capacity as the associate director of the Division of Enforcement. They do not necessarily reflect the views of the SEC staff or the Commission. That should have brought more people into the seats, Jason, but it didn't seem to work. We'll keep trying. We're going to try. We're going to try. All right. So, all right. So,
03:29 - 04:27
Mark Cave: financial fraud initial disclosure, I agree with you. A very interesting topic and a very, I think, interesting year for the Commission in this extraordinarily high priority area for the Enforcement Division. The year included a number of very significant actions, including financial fraud actions against a high-flying pharmaceutical company, Cassava, a former SPAC darling, Lordstown, conventional exchange listed issuers like Austal and many others. These actions touched on a range of issues and we're going to go deeper into some of these during the panel later, but conventional gap reporting violations, non-gap reporting violations, as well as a variety of
04:28 - 05:17
Mark Cave: related disclosure issues. You see when you look across the financial fraud docket for the SEC this year, a continued emphasis on individual liability with charges against CEOs of multiple exchange listed companies, including and this is something I want to touch base on a little bit more later, including founder CEOs in at least 5 actions. So, charging CEO founders in multiple cases. The cases, if I can brag a minute, not on myself, but on the incredible staff of the SEC, they really do illustrate the incredible investigative work done by the attorneys and accountants in the division of
05:17 - 06:18
Mark Cave: enforcement. Whether that's, you know, multiple sets of books in cases like Medly or fake medical devices or partially fake medical devices like those in Stimwave or fake medical or rather clinical trials like those in Cassava, you know, through to the more conventional financial fraud cases involving bogus revenue forecasts and inflated market opportunity estimates, really just across the board showing the breadth and depth of the SEC experience and ability to really effectively investigate cases sort of regardless of the subject area. The actions also brought this year also in addition to sort of showing, continuing to sort of
06:18 - 07:01
Mark Cave: emphasize the Commission's interest in pursuing individual liability as a primary means of deterrence, as well as meaningful accountability for misconduct, also show the advantages of cooperation. And you know, the former director of enforcement spoke earlier this year on sort of what meaningful cooperation looks like. And there are a number of matters this year that really do illustrate, I think, effectively what good cooperation looks like. And I think that as the division has really emphasized that over the last year or two, you've started to see some maturity in how corporate issuers attempt to cooperate and try to
07:01 - 07:49
Mark Cave: cooperate and communicate their cooperation with the staff. And we can come back to that. But those are cases like, like CIRCOR and Cloopen in particular. You know, in addition to kind of a wide range of conduct, it's a wide range of issuers, issuers in all types of different parts of the market. And then just kind of coming back to this point about founder CEOs, five separate actions involving fraud charges against fraud or negligence based fraud charges against founder CEOs, some litigated, some resolved. Those really do illustrate, I think, an area of the market where there are
07:49 - 08:32
Mark Cave: some, I think, really kind of interesting and challenging disclosure related issues given the type of influence that founder CEOs often have within the issuer. And so I think we would talk later today during the panel about the kind of disclosure issues. I think thinking through kind of what some of the unique challenges posed in situations where there's a founder CEO who's intimately involved in the financial reporting is something that's worth further emphasis. Many of those cases also involve both cases in the IPO stage as well as the pre-IPO stage. And so where you see issuers in
08:32 - 09:12
Mark Cave: sort of the C and the D round where I think there's some expectation from investors that there will be reasonably mature financial controls and reporting controls, where there are really a lot of opportunities I think for abuse in those situations. And that's, you know, as companies, issuers move from the C and D round into the IPO, really kind of the challenges that issuers face in trying to bring appropriate controls into the financial environment in a way that protects investors. And then finally, continued focus on gatekeepers, a number of significant matters against audit firms, including I think
09:12 - 09:49
Mark Cave: really a signature matter against BF Borgers involving hundreds of misleading audit reports that were signed off on by the firm and really significant relief. And then I think we'll touch on it a little bit more kind of on kind of what we're thinking about and what relief has looked like, kind of in the post, you know, in the last few months, I think, as there have been some changes in the legal environment. But that's really the summary. A lot of really, I think, interesting work, a lot of really interesting cases, a lot of, again, emphasis on
09:49 - 10:00
Mark Cave: cooperation, but also twinning that with accountability that's appropriate in order to achieve sort of maximum protection for investors.
10:01 - 10:34
Jason Flemmons: Yeah, thanks. That's a really good overview and broad brush, and a lot of those topics we'll delve into in a little more detail. And at the very end of your overview, one thing I wanted to maybe get into now at the outset is, and This is one item that's really caught a lot of attention lately and it's on the heels of the Supreme Court's Jarkesy decision was the series of dismissals of a number of 102(e) actions that occurred. And John would like to turn over to you and get your read on what do we make of
10:34 - 10:39
Jason Flemmons: this? I mean, and what does that mean for the enforcement program against accountants?
10:40 - 11:12
Jonathan Tuttle: Well, I mean, I think in large measure what we make of it is probably different now than it was 12 hours ago or 15 hours ago. I think before the election, you know, there was how are we going to manage through this view. I think post-election, you know, probably everyone including the lawyers around here and the lawyers who are litigating these kinds of cases are stepping back and trying to figure out kind of where this leaves us. So, dracosy, you know, it came down, for those of you, on kind of right to counsel and right to
11:12 - 11:54
Jonathan Tuttle: a jury trial violation findings. But what it didn't do was overrule the other two areas that the Fifth Circuit had originally vacated the administrative law judge's decision and the Commission's action. And those are kind of non-delegation and some of the removal issues that have been floating around for years. So I think now you're in a position where to litigate a 2(e) or 102(e) case really requires you probably to take on that and really think about what the appetite is for taking on those other issues now with a kind of a Trump Justice Department by your side
11:54 - 12:26
Jonathan Tuttle: or not by your side if you're the SEC and how that kind of factors into thinking about what they're going to do with it. But where it leaves really, I think, is that it's very hard to see, at least in the near term, a kind of resurrection of the kind of type of 102(e) or litigated 102(e) actions that, you know, you might have seen kind of ten years ago or even five years ago. So I think you're going to be looking. Where I think you're going to see more of is the SEC brought a case at
12:26 - 13:09
Jonathan Tuttle: the end of September against an auditor and his firm, the Oyebola case, if I'm pronouncing that correctly. And in that, kind of using the broad approach of 21D5 that allows them, the Commission, to ask for any equitable relief necessary, essentially, in their mission, part of the relief they requested was effectively a conduct injunction against the auditor and the firm providing audit and accounting services to U.S. public companies. So I think you could see that as part of the tool. They've also brought it against a couple of individuals in another case. So I think you could
13:09 - 13:35
Jonathan Tuttle: see that as part of the tool. They've also brought it against a couple of individuals in another case. And so, I think you could see that as a path forward. I think some of the real questions you have is, you know, is that discretion or is the court's discretion there going to be guided by, you know, because there's not really a developed body of law in that. Are they going to look to something like the, you know, penny stock bar where courts have developed and adopted kind of an egregiousness standard. So then you're thinking the SEC's
13:35 - 14:02
Jonathan Tuttle: ability to pursue those kinds of that kind of relief is going to be limited to really 10(b), 17(a) kind of fraud cases where you would have something like a scienter standard even if they weren't required to bring scienter for like an underlying aiding and abetting books and records or internal controls. So I think that's an interesting thing to watch and something that will be played out over to the extent that that's where the Commission decides to go in terms of its enforcement proceeding.
14:03 - 14:43
Jason Flemmons: Yeah, and what's interesting is the case that you mentioned where there was equitable relief that was sought basically to bar auditors from appearing or practicing before the Commission, being done in a civil district court context. But that was an audit firm. That was a series of auditors. There have also been a couple of cases, I believe, one very recently involving a couple of individuals at a company called Lovesac, where the SEC sought to do the same thing, or is seeking to do the same thing against a couple of internal accountants. And I find that to be
14:43 - 15:24
Jason Flemmons: very new here, because typically under the 102(e) program, yes, there were certain prongs and criteria you would follow for whether an auditor would be held or deemed to have committed professional malpractice through unreasonable or highly unreasonable conduct, and there was a separate paradigm for internal accountants where you would have follow-on actions for committing underlying violations of the securities laws. So I guess the question here too would be, does all of this that we're talking about with Jarkesy, does that impact both the auditors and the internal accountants and the follow on 102e program? You know, Mark, are
15:24 - 15:35
Jason Flemmons: we going to see more of this kind of equitable relief seeking in district court for accountants of all shapes and sizes.
15:36 - 16:22
Mark Cave: Yeah. I think that it remains a priority for the Division of Enforcement to ensure that gatekeepers in particular, both the auditors and the professionals within the internal financial control are held accountable for their role in misconduct. And so I think you're going to continue to see the staff explore, you know, really what the best available options are for ensuring that the Commission is able to obtain appropriate relief on behalf of investors. And you know, there are, I think, questions obviously raised by Jarkisy, but I think that sort of the fundamental principle is that, you know, that
16:22 - 16:38
Mark Cave: effective deterrence of misconduct in financial fraud requires holding gatekeepers accountable and I think you're going to see a continued emphasis on that even if there are some challenges posed by the court's ruling in Jarkesy.
16:39 - 16:56
Jason Flemmons: Yeah, and relatedly with regard to auditor conduct, I do wonder Also, and John, if you have any thoughts on whether that's going to also trigger maybe more handoffs by the SEC to the PCAOB, I don't know if you have any thoughts on that.
16:56 - 17:33
Jonathan Tuttle: Yeah, I think you're going to see some pushing of, I mean, just particularly what I would describe as more negligence-based cases, they're going to get pushed down to the PCOB and you know maybe that's a more appropriate outcome anyway for those for those types of cases to have them handled by a regulator, a quasi-regulator, whatever you want to call them, that is responsible for the profession and public company accounting. So I think that's an interesting. I do think you might see, you could continue to see, depending on where the SEC comes out on Jarkesy on the
17:33 - 17:44
Jonathan Tuttle: ALJ program in general, you could continue to see follow-on actions in the way that you used to see them in the past, like purely derivative of the underlying judgment in a civil proceeding.
17:45 - 17:56
Jason Flemmons: Yeah. And that may be the case. It was interesting in this recent case that it was more preemptive to seek that in district court rather than waiting for the case to play out and then doing the follow on 102(e) at the tail end.
17:56 - 18:24
Jonathan Tuttle: Yeah, I mean there's an interesting penny stock case looking at it as a model. The Fierro case from New Jersey in May of this year where the SEC brought a penny stock bar in court. The court found that they didn't meet the adjudicative standard, refused to enter the penny stock bar, and then two weeks later the SEC brought a follow-on, administrative proceeding against the defendant for the penny stock bar in an administrative form. And that still opens.
18:25 - 18:59
Jason Flemmons: Great, so, Mark, you had mentioned also conventional accounting cases that have been brought over the last year. And certainly over the last couple of decades, we've seen different kinds of trends and themes in certain cases. We saw the financial crisis cases. We saw stock options backdating. We saw more recently the SPACs in a lot of those cases. So Jennifer, I'm interested from kind of what you're seeing. Are there any trends that are occurring or under generally what what kinds of messages and things are you seeing in the activity?
19:01 - 19:45
Jennifer Leete: one reason thing that's noteworthy particularly in light of some of the themes we keep hearing today is, you know, everything that's old is new again. There's nothing new under the sun. The end of the fiscal year in August and September, we saw a flurry of just sort of old school revenue recognition accounting fraud cases. They all involved 10(b). They showed that the division has really been working hard to get individuals all the cases involved individuals from the C-suite to some mid-level accounting folks in one of the cases. And I think in the Kubient case, that caught
19:45 - 20:15
Jennifer Leete: a lot of people's attention. They charged, Mark charged an audit committee chair. But then when you dig into that case, you see false and misleading statements. It was a 10(b) case. So I think while the headline might have grabbed a fair amount of attention, it really wasn't anything new. And if we're going to see the SEC and the new administration move back to its roots, these are some of the kinds of cases we may see more of, I would think.
20:16 - 20:55
Mark Cave: Yeah, and on that, just to build on that with the audit committee chair and Kubient, that tells with what I was talking about earlier with sort of venture stage, IPO stage companies. The misrepresentations that issue with Kubient were in connection with its IPO and the allegation there, and this is a litigated action, so whatever I say, obviously the complaint stands for itself and I don't have it in front of me, so I'm not referring back to it, but the allegations, as I recall them, were that the audit committee chair was aware of the misrepresentations at issue
20:55 - 21:33
Mark Cave: that related to fabricated revenue. And so, you know, to your point, it wasn't a case about some standard of care for the audit committee chair that he fell to it here, too. It was really, or it is really, I think, something that looks really a lot like a conventional 10b5 case. And it just shows, I think, again, the risks where you don't have the kinds of controls in place at that IP0 stage I you know that that the company what at the time it's going public you know I think a lot of more you know mature
21:34 - 21:47
Mark Cave: issuers with appropriate controls right it's you're not going to have that kind of cross contamination the way that you might in a smaller company where there may be less daylight between management and the board.
21:48 - 22:04
Jennifer Leete: I'm just looking at my notes. I think Medly Health is another example of that with pretty early stage. No, it was defunct by the time the CEO and the CFO were charged, but I think that was another pretty early stage.
22:04 - 22:06
Mark Cave: That was a pre-IPO case.
22:06 - 22:06
Jennifer Leete: Pre-IPO
22:06 - 22:47
Mark Cave: case. And again, what's, you know, one of the interesting things there is that this was a case, I think this one's interesting. Medly was a company that was founded by some guys who had an interest, I think it was part of a family business in pharmacies and they wanted to create an online pharmacy. And what ended up happening is one of their, I think they called him like head of prescriptions or something, ended up, and again this is litigated so please refer back to the complaint, but just for purposes of the discussion, fabricated a bunch of
22:47 - 23:22
Mark Cave: prescriptions and made it look like the revenues obviously through the fabricated prescriptions were a lot higher. The allegation is of course that that comes to the knowledge of the CEO and I believe the CFO although I don't remember now. And so it's, and then it's the things that flow from that, right, that ultimately implicate the CEO. And so it's somewhere, you know, and this is right, this is a pretty normal story, right, somewhere deeper in the organization, There's someone who's working to meet some target. They fabricate something, they make something up, they exercise judgment in a
23:22 - 23:36
Mark Cave: way that's particularly reckless, and then the CEO becomes aware of it, right? And now what? Now what does he see? And that's where the CEO really has the choice, right? And in these cases, we're alleging that the CEO, you know, essentially made the wrong choice.
23:36 - 24:10
Jennifer Leete: We didn't actually plan this back and forth thing, but it's working nicely. Because that makes me think of Austal Shipbuilders, which is another one. They're the estimate accounting, the estimate for cost of estimates of completion or something, I forget. They had been aggressively not updating their estimates in order to meet targets. You know, again, more junior level accounting folks and the CEO and the CFO learned of it, didn't stop it.
24:10 - 24:44
Mark Cave: Yeah, and what, in a case like Austal, what you'll all come in and tell me is, Mark, you understand cost completion cases, there's a lot of judgment involved. And you can't really, you know, you can't really unpick that. But in Austal, the manipulated numbers were provided to a manager using disposable sticky notes to ensure that the adjustments that were being made to the internal systems were untraceable. And I think in the vernacular we would say that's evidence of scienter.
24:46 - 24:47
Jennifer Leete: But did they eat the sticky notes?
24:47 - 24:57
Mark Cave: They did not eat the sticky notes in this case. And I think that's part of the problem. You know, compliance departments are pretty good now following that matter of saying don't eat the sticky notes.
24:57 - 24:58
Jennifer Leete: Don't eat the sticky notes.
24:58 - 24:59
Mark Cave: And so they didn't.
25:01 - 25:20
Jason Flemmons: Well, I guess we all know not all enforcement cases are fraud, you know, 10(b) cases. So Sarah, I don't know if you have witnessed any particular trends or things going on in kind of the non-fraud umbrella or just developments in those kinds of cases.
25:21 - 26:00
Sarah Walters: Yeah and what I loved about this Jason is you asked the former prosecutor to speak about the non-fraud cases. So this is a good exercise for me to go back. Yeah, I mean so certainly, and a lot of this has been touched on already today. I mean, there was a recent controls case, national energy services, just this past August. That feels like the more traditional controls case that I think was a SPAC. They had acquired target companies and ended up having to restate three years of financial statements because they hadn't done enough diligence and had been
26:00 - 26:35
Sarah Walters: relying on the financial controls of the target companies that were clearly insufficient that ended with a $400,000 penalty that actually engaged in a lot of remediation before the before leading up to the settlement. So I think that reading the tea leaves there suggests that the penalty, although they also were trading on the Pink Sheets by that time, probably related to that. But there's also a springing penalty of a $1.2 million penalty that will kick in if they don't complete their remediation efforts in a year and complete the certification. So that feels a little bit more
26:35 - 27:17
Sarah Walters: straight and narrow. And what I would predict we may continue to see going forward even after an administration change. The ones that are more novel, and when I was on the other side of the V, would think we're very clever, and on this side of the V, think maybe overreaching and complicated. But you go back to charter communications, we saw R.R. Donnelly this past summer, and Donnelly again was an example of a breach. It was settling just about the same time the SolarWinds decisions were coming out, carving out the internal controls pieces of it. So
27:18 - 27:59
Sarah Walters: what I would have said yesterday morning is that what I've seen the trend of these novel theories around the internal controls cases, and there's been some dissents coming out about them because they were novel theories in questioning whether they belong here, but the cases were signed off and resolved in many cases. I would expect, I think as a lot of other panelists today have said, that those might be the ones we see scaled back on a go-forward basis, but you could see a steady trend of where the Commission was going over the past year with some of these more, I think, aggressive controls cases.
28:00 - 28:41
Jason Flemmons: Yeah, the springing penalty aspect of that one case was very interesting and that's something that I recall seeing before. I remember years ago there were a couple of cases the SEC brought that had springing C&Ds, which was kind of a very, very different thing as well. But moving on to more of the disclosure angle, I mean, as everyone knows, issue reporting cases don't just involve the numbers inside the financial statements under Reg SX, but also disclosures that might be made outside of the financial statements under MD&A or elsewhere under Reg S-K. So Mark, I don't know
28:41 - 28:48
Jason Flemmons: if you could share your perspectives on any recent trends within the enforcement program in that particular area?
28:48 - 29:39
Mark Cave: Yeah, it's hard to say whether there's a trend. It's something that the issuers are required to report on a few things, they're required to report on their financials, and they're also required to, under Regulation S-X and under Reg S-K, they're required to report on a number of things, including the nature of their business and, and certain trends that may be material. And so there's always enforcement activity in, you know, sort of under that S-K umbrella. And a lot of those are, if they're not, you know, misrepresentations in the financials themselves, they often do link into the
29:39 - 30:38
Mark Cave: overall presentation of the company's financial performance and projected performance. And in, you know, in Lordstown, for instance, that was a matter involving alleged misrepresentations about the number of preorders that Lordstown had for its electric vehicle or its electric truck. Other cases have involved in, there's a case out of the San Francisco Regional Office called Scale, which is another pre-IPO case where we also sued a founder CEO. And that was inflation of annual recurring revenue, switches a non-GAAP metric, also not something that's part of the audited financials, but obviously something that for a software company, that annual
30:38 - 31:26
Mark Cave: recurring revenue is very significant to how people think about the valuation. In the there's a case also out of the San Francisco office called Zymergen. That was a 17(a)(2) and (3) negligence case that settled with a $30 million penalty. And there are a couple of misreps that issue in that case that I think are particularly interesting. one is kind of the conventional misleading revenue forecasts, which you see, you know, most of you say misleading revenue forecast, you obviously see in pre-IPO cases a lot of revenue forecasts, right? That's pre-revenue companies, they need to make revenue forecasts.
31:26 - 32:14
Mark Cave: They're not gap financials, but they are the thing that investors are relying on and they're not a lot of controls often around how those forecasts are designed. They're not necessarily audited. They're not necessarily subject to any kind of rigorous due diligence. A lot of opportunities for manipulation of those. And so that's an important category of sort of non-gap disclosure. The other misrepresentation issue in the Zymergen case involved what the complaint style is, an inflated market opportunity estimate. And so if you've ever worked with a sort of a SPAC or a company that's de-spacking or a pre-IPO
32:14 - 32:55
Mark Cave: company, The first thing that they put in the deck that goes to investors is what the market opportunity is, right? That's the, this is just the, every single investor presentation says look, this is the market opportunity that we're defining. And we're going to try to tap into that market opportunity, and this is why we think we can be profitable tapping into that market opportunity. And here the claim is that the Zymergen essentially inflated the size of the market opportunity that it could access through its technology. So again, another really interesting kind of disclosure case, those are
32:55 - 33:34
Mark Cave: disclosures that tie into, in an obvious way, I think to the financial performance and and so they they pair naturally with the the audited financial statements so that if I guess if that's a trend right I mean I know that's it's not new but it's definitely something that particularly kind of following on from the SPAC boom a few years ago, now looking at companies that are raising a lot of capital in the pre-IPO stage. And just to give you some scale, these companies aren't, It's not the $5 or $10 million A round. These are C and
33:34 - 33:57
Mark Cave: D rounds where there's $40, $50, $60, $70 million being raised on the basis of these disclosures. Or there's even more being raised in the IPO. So These are just really important disclosures outside the financials that investors rely on in trying to make informed investment decisions. And I could talk about other types, but maybe I should give someone else the mic.
33:58 - 34:05
Jason Flemmons: Sure. John, I know you've been involved in some matters involving these issues. Do you have any additional thoughts on that?
34:05 - 34:34
Jonathan Tuttle: Well, I have a lot of personal thoughts, but I won't share them all. No, so when you think about a case like the scale case where it really is going after kind of, whether it's non-GAP or a KPI, where the Commission, both of those, the Commission has a lot of, and CorpFin in particular, has a lot of guidance out there, their enforcement actions. I mean the one thing that they, you know, probably shouldn't have to say is you can't fabricate it. So as a basic rule you can take away from this is you can't
34:34 - 35:12
Jonathan Tuttle: fabricate whether it's a non-financial key performance indicator or a financial non-GAAP measure. It has to actually be real and connected your business. In that case the CEO was claiming that the company had millions in annually recurring revenue, which was a kind of devised metric, a software metric, but that turned out to be actually 10x the real number. So that's kind of a problem from any disclosure perspective. You know, I think as you look at that, at kind of the current enforcement environment for, you know, again, whether you're talking about non-GAAP or KPI under the different guidance,
35:13 - 35:45
Jonathan Tuttle: you know, I think in non-GAAP you want to focus on and think about two areas really, which is how is it calculated and how is it presented and that's where the guidance is and when you think about calculation you're thinking consistency between periods so you can't, you're thinking about cherry picking so do, you know, is a non-gap measure created by removing expenses from from an activity or a business unit? But you're not removing maybe non-recurring gains And then that leads you into the whole world of what is non-recurring and what isn't non-recurring And
35:45 - 36:19
Jonathan Tuttle: I think in large measure you know as long as you're thoughtful as a company in dealing with those, it probably doesn't get to Mark and his team. It becomes a, it's a CorpFin issue. It's a discussion, it's a comment letter, it gets hashed out, you make changes, people do that all the time. It's where you kind of get to the next level and you know you're presenting non-recurring revenue or adding revenue that you know maybe isn't actually real revenue. You're estimating what it would have been had some other activity happened, you are doing something like
36:19 - 36:55
Jonathan Tuttle: removing expenses that are ordinary and regular course business. Even if they are not regular expenses, if they recur, then by definition the SEC views them as nonrecurring. I think a good case to think about there, it's a year old, we talked about it a little bit last year, but it's one that Mark brought, the DXC case, where they were removing from a non-GAAP measure essentially transaction and integration costs, but it turns out they didn't really have a good definition of what was a transaction and integration cost, and it lets people involved in the organization at various
36:55 - 37:29
Jonathan Tuttle: levels put their thumb on the scale of, you know, well this quarter maybe this is going to be a transaction cost or we don't have good data, so we're going to assume that X percent of this is a transaction cost as opposed to actually having a methodology, following the methodology and being consistent period to period. So I think that's really where things are. You know, the cases that have come out, you know, most of the SPAC cases that have involved disclosure, you know, they've really been focused on, you know, people that were manufacturing or fabricating kind
37:29 - 38:03
Jonathan Tuttle: of wholesale at some level what they were doing. I think the interesting case in the disclosure area, I'd love to get Mark's take on it, or anyone else's is the Keurig case. It's just one of my favorites. You were misstating the extent to which the little pods could be recycled, and apparently whether they had enough information, you know, that would indicate that the statements they were making. It's more a false statements disclosure case or an omissions disclosure case, depending on how you think about it, but it is, it's another kind of key area of their business
38:03 - 38:09
Jonathan Tuttle: and a key concern of their business that the staff said they were not presenting accurately.
38:11 - 38:48
Mark Cave: The only thing I'll say about that is I'm guilty of not recycling my Keurig K-cups. So I don't really know how that cuts. It maybe makes me not objective as a commentator on that case. But again, that was a disclosure in the, I think it was in the MD&A, right, that said, you know, we've conducted extensive testing with municipal recycling facilities to validate the pods can be effectively recycled. And the claim there, right, there's not a fraud charge in that case. That was a 13(a) charge that essentially says, look, there's a material omission associated with
38:48 - 39:35
Mark Cave: that representation. But John, going back to your point about DXC and other non-GAAP cases, I think one of the things that we see because there's a, there's sometimes you see a donut hole in the controls where the auditor says this is not my thing to audit. But it's presented to the auditors and the auditors see it. So management says well I showed it to the auditors. So management, we'll hear that defense, management says well the auditors were aware of it. And then we talk to the auditors. The auditors say, well, that's not in the financial statements. I didn't audit that, right? And so, you know, I think most corporate issuers have controls to ensure that the
39:35 - 40:05
Mark Cave: non-GAP metrics that are presented are presented as John was describing, that they are consistent, right, over time, that they're not cherry picking data. But you do see breakdowns in a lot of these non-GAAP cases, and the breakdowns often occur because management has more control over the final kind of content of that disclosure than they would if it was something that was ultimately subject to the scrutiny by an independent auditor.
40:08 - 40:43
Jason Flemmons: Yes, so another topic I want to pivot to, and I know we've touched on this on a couple of the other panels, is the topic of cooperation. And the reason I think we should probably touch on it is because it is an area that is maybe not entirely unique, but certainly highly relevant for accounting and financial fraud cases. These are cases where there's really a lot of opportunity to demonstrate cooperation and receive cooperation credit. And there continue to be a number of cases that are brought and are identified in the charging instruments that will mention that
40:43 - 41:31
Jason Flemmons: the company cooperated and that some of the remedies or the penalty or even the violations may have been reduced in light of company cooperation as well. one theme within that umbrella that I'm finding more and more interesting is particularly related to one of the criteria for cooperation, which is self-reporting and specifically timely self-reporting. And I know there have been some comments that have been made by the former or the recently departed director of enforcement about the timing of cooperation and that there may be some expectation that not only should you self-report early, but you should self-report
41:32 - 41:53
Jason Flemmons: even when there's a possible violation. So I'm curious, maybe start with Jennifer, if you have any thoughts on kind of what you're seeing with regard to cooperation generally, how you advise your clients, particularly given some of this evolution with regard to how the program is being administered.
41:53 - 42:33
Jennifer Leete: Sure. Well, with respect to your first point, there were a couple of cases this year where the Commission was careful to say, either in the press release or in the order or both that the company self-reported within a couple of days of hiring independent counsel or forensic accountants or something like that. In the Cloopen case, within a couple of days was the phrase. And so in addition to promptly self-reporting, they really emphasized. That was one I think Ghurbir, there was a press release about it and he's spoken about it a couple of times. It was a
42:33 - 43:20
Jennifer Leete: revenue recognition case. And then the Commission has continued this year, as I think has been mentioned multiple times today, to do a very nice job of detailing pretty specifically what kinds of things can really get cooperation credit. We didn't use to do that, but like you see sometimes now 2, 3, 4 paragraphs in an order. And one thing I tell clients is anything we can do to speed things up benefits both you and the SEC and could result in some cooperation credit later. You know, explaining complicated transactions, making a presentation on what we're seeing, things like that.
43:22 - 43:36
Jason Flemmons: Yeah, and I think that's a clear example, the one you mentioned, where if a company self-discloses within a couple days of counsel being retained, that's certainly one end of the spectrum. I don't know that that's the actual standard that's being held. And when you look at the-
43:36 - 43:37
Jennifer Leete: Well, that's clearly what they're encouraging.
43:37 - 43:38
Jason Flemmons: Sure.
43:38 - 43:41
Jennifer Leete: It's scary as a defense attorney, right, to do that sometimes.
43:42 - 44:15
Jason Flemmons: Sure, sure. And, you know, there are other cases that are highlighted on the SEC's website as the poster children of cooperation that the orders may be silent to when the self-reporting occurred. Behind the scenes, a lot of us know when that actually happens and there is a lot of diversity in practice, but I don't know if there's something that you could tell clients or how you think about the timing of self-reporting in light of this kind of change, what that advice would or could be.
44:15 - 44:52
Jennifer Leete: Well, it could be almost anything. I think it's impossible to generalize. Right? It totally depends on the circumstances. And, you know, even if you don't know what you're dealing with, what does it look like? Is the company at fault? Is the company a victim? You know, we've self-reported in the last year a couple of things that where wasn't really it was an easy self report in the sense that it wasn't really about our client, but they were involved in a situation that they thought the Commission would want to know about. It can be anything from that to, I mean, you just, it's very hard to know in the abstract.
44:52 - 44:53
Mark Cave: Right, right.
44:54 - 45:01
Jason Flemmons: Well, I think we are about out of time. I know that Sarah, if you guys want to chat with her on the hallway about individual liability.
45:01 - 45:02
Sarah Walters: I have strong opinions.
45:02 - 45:04
Jennifer Leete: She was very eager to hear
45:04 - 45:07
Jason Flemmons: that. But thank you very much. I think we're all done.