On March 3, 2017, the SEC announced that homebuilding company Desarrolladora Homex S.A.B. de C.V. (Homex) has agreed to settle charges that it used accounting fraud to overstate its revenues by approximately $3.3 billion during a three-year period. According to the SEC’s complaint, the company reported fake sales of more than 100,000 homes, which increased its revenue by 355 percent.

To uncover the accounting scheme, the SEC used satellite imagery proving that Homex reported revenue for unbuilt homes. For example, Homex recorded revenues allegedly derived from a project site in the Mexican state of Guanajuato.   But satellite images of the project site showed that a vast majority of the purportedly sold homes remained unbuilt.  Disclosing this type of accounting fraud to the SEC can lead to a whistleblower award under the Dodd-Frank SEC Whistleblower Program.

SEC Whistleblower Program

Under the SEC Whistleblower Program, whistleblowers may receive an award for providing the SEC with original information about violations of federal securities laws (including accounting fraud) that leads the SEC to bring a successful enforcement action that results in monetary sanctions exceeding $1 million. Whistleblowers are eligible to receive between 10% and 30% of the monetary sanctions collected

Importantly, even auditors and accountants may be eligible to receive rewards under the program. 

The largest award to date was issued in September 2014, when the SEC announced it would give more than $30 million to a foreign resident who provided key original information that led to a successful enforcement action.

SEC’s Focus on Combatting Accounting Fraud

In a recent speech, SEC Enforcement Director Andrew Ceresney confirmed the SEC’s continued focus on accounting fraud and disclosure violations in issuers’ filings. Similarly, former SEC Chair Mary Jo White emphasized in another speech that “[c]omprehensive, accurate, and reliable financial reporting is the bedrock upon which our markets are based, and is essential to ensuring public confidence in them.” In fact, the SEC has more than doubled its actions in the issuer-and-reporting area, from 53 in fiscal year 2013 to 114 in fiscal year 2015.

These enforcement actions revealed accounting fraud and other violations that qualify for an SEC whistleblower award, such as:

·       Inadequate Internal Accounting Controls

On February 9, 2016, the SEC announced that Monsanto agreed to pay an $80 million penalty for insufficient internal accounting controls. According to the SEC’s order, the company failed to properly account for millions of dollars in rebates offered to retailers and distributors of Roundup after generic competition had undercut its prices and caused the company to lose significant share in the market. Monsanto booked substantial amounts of revenue from sales incentivized by the rebate program, but failed to recognize all the related program costs at the same time. A whistleblower was rewarded more than $22 million for disclosing this fraud to the SEC.

·       Period-End “Stuffing”

On April 27, 2015, the SEC obtained a $131 million judgment against Symbol Technologies Inc. for fraudulent revenue-recognition practices, including quarter-end “stuffing” of Symbol’s distribution channel to help meet revenue and earnings targets imposed by its CEO.

·       Fraudulent Management Estimates and “Cookie Jar” Reserves

On June 5, 2015, Computer Sciences Corporation agreed to pay $190 million to settle charges that the company engaged in a wide-range accounting-and-disclosure fraud that materially overstated its earnings and concealed from investors significant problems with its largest contract. According to the SEC’s order, the company’s former Finance Director prepared a fraudulent accounting model in which he included made-up assumptions to avoid reporting a negative hit to the company’s earnings. The company also overstated its earnings by using “cookie jar” reserves and by failing to record expenses as required.

·       Post-Closing Entries

On September 27, 2016, Weatherford International agreed to pay a $140 million penalty to settle charges that it inflated its earnings by using deceptive income-tax accounting. According to the SEC’s order, Weatherford fraudulently lowered its year-end provision for income taxes each year so the company could better align its earnings results with its earlier-announced projections and analysts’ expectations. The company lowered its year-end provision for income taxes by making numerous post-closing adjustments to fill gaps and meet its previously disclosed effective tax rate.

·       Auditor-Independence Violations

On September 19, 2016, the SEC announced that public accounting firm Ernst & Young had agreed to pay $9.3 million to settle charges that two of the firm’s audit partners had “inappropriately close personal relationships” with their clients and thereby violated independence rules designed to ensure that firms maintain their objectivity and impartiality during audits. In one of the SEC’s orders, an EY audit partner was having a romantic relationship with a client’s Chief Accounting Officer. The main EY audit partner on the account noticed signs of this romantic relationship but failed to perform a reasonable inquiry. In the SEC’s second order, an audit partner was accused of excessive socializing with a client’s Chief Financial Officer. This socializing included attending sporting events, taking vacations, and incurring other significant entertainment expenses that did not serve a proper a business purpose.

·       Improper Asset Valuations

On August 6, 2015, Miller Energy Resources Inc. was charged with inflating values of oil and gas properties, resulting in misstated financial statements. According to the SEC’s order, the company overstated the properties’ value by more than $400 million as a result of the CFO’s relying on a reserve report that did not reflect fair value of the assets. In addition, the CFO double-counted $110 million of fixed assets already included in the reserve report.

·       Misleading Non-GAAP Financial Measures

The SEC recently issued new guidance on the agency’s interpretation of the rules and regulations on the use of non-GAAP financial measures. In a previous enforcement action, the SEC fined a company more than $1 million for misleading non-GAAP financial measures