Switch from GAAP to IFRS could expose accounting fraud to whistleblowers.

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Last week, James Schnurr, the new chief accountant for the Securities and Exchange Commission, told reporters that he was reviewing prior agency work on the potential accounting switch from Generally Accepted Accounting Principles (GAAP) to International Financial Reporting Standards (IFRS). The transition, which the SEC has been considering since at least 2007, will be revisited again by Scnhurr, a partner at Deloitte LLP prior to starting at the SEC a month ago. No decision has been made on the ultimate course of action the agency will pursue, although it will have implications for the method of accounting used by public companies distributing financial statements to shareholders.

The Wall Street Journal identified computer software and wireless communications as two industries where this transition could lead to dramatic changes in corporate accounting. In areas where GAAP and IFRS differ, there is the possibility that the rule switch could potentially expose accounting irregularities at large corporations as historical treatments are re-examined or lead to new situations of accounting fraud if companies attempt to adopt more favorable treatments during the transition.

More than 100 countries including the European Union currently use IFRS. The United States still uses GAAP in company-issued financial statements. When measured by market capitalization, more than half of the world’s companies still use US GAAP.

DEVELOPMENT OF ACCOUNTING STANDARDS

GAAP has been used extensively in the United States since the 1930s. Development started during the Great Depression as the country needed a way to restore confidence in the financial statements of corporations. The SEC encouraged the private sector to develop the accounting standards in 1938.

The movement for development of a set of international accounting standards started to grow in the 1960s. In the 1970s, the Financial Accounting Standards Board was created and began developing the International Accounting Standards. In 2001, the International Accounting Standards Board took over development and the name change to IFRS happened.

In 2005, companies began using IFRS in the European Union. Canada replaced its GAAP with IFRS in 2011. Japan has been promoting greater use of IFRS on a voluntary basis.

The SEC began exploring convergence with the IFRS set by the IASB in 2007. The initial roadmap published in 2008 suggested the potential for use by US issuers as early as 2014. However, according to the Wall Street Journal, “concerns about cost, implementation and the burden on smaller companies” stalled momentum.

IMPLICATIONS FOR WHISTLEBLOWERS

If new rules are adopted, the transition may expose problematic accounting treatments currently on the books or lead to new cases of accounting fraud. If the transition happens, and accountants are asked to adopt questionable accounting practices, they should consider the appropriate response given available options at their employer, the company and the SEC. The SEC whistleblower program or even the IRS program are options.

The IESBA is still working on a new code of ethics for professional accountants but the proposed guidelines currently open the door for an accountant to follow their conscience and report suspected noncompliance with laws and regulations.

SEC Investigates Channel Stuffing at British Liquor Company

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The British liquor company that makes Smirnoff, Johnnie Walker, Baileys and Guinness is under investigation by the Securities and Exchange Commission for shipping excess inventory to distributors to boost revenue.

The company, Diageo PLC, is based in Britain but has issued American Depository Receipts which trade here in the United States on the New York Stock Exchange. The company is the largest producer of spirits in the world and a major beer and wine producer. Its shares trade on the London Stock Exchange and the company has a market capitalization of more than $45 billion GBP.

Diageo ships its product to wholesalers who then distribute the product to retailers. Prior to an accounting change in January, it recorded revenue when it shipped its product to the wholesalers. It is accused of shipping them more inventory then they wanted.

The SEC will take insider tips about revenue recognition problems and shareholder fraud like these through its whistleblower office. An individual does not need to be an employee of the public company that is reported. An individual at a distributor and aware that it is being forced to take more inventory than it would like to purchase would also be able to submit a TCR. A successful tip would entitle an eligible individual to receive a 10 to 30 percent reward of monetary sanctions recovered in excess of $1 million.

If you have evidence of accounting fraud, contact one of our whistleblower attorneys for additional information on reporting it to appropriate agency at the U.S. Government. An attorney can be reached by our contact form or calling 1-800-590-4116.

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Following the Toshiba Accounting Fraud, More Scandals in Japanese Companies Expected

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An article in Bloomberg View suggests that the accounting issues at Toshiba and Olympus are just the start of what could be equivalent to the more than dozen accounting frauds revealed in the United States after the Tech bubble burst in 2000. The article expressly indicates that there will probably be more revelations of problems due both to corporate governance and culture in Japanese businesses.

According to the article, most boards of Japanese public companies are made up of employees of the company. The lack of external oversight encourages them to expand employee perks instead of maximize shareholder value. The stagnant economy has allegedly led them to fake profitability in order to keep their lifestyle and bank loans going. The conclusion of this section of the article is that if one of the shining stars of the Japanese economy has been cooking the books, then the less successful companies are likely doing so as well.

The U.S. response to the scandals was the Sarbanes-Oxley Act. Japan’s Prime Minister Shinzo Abe has apparently introduced a new corporate governance code requiring outside directors on boards. The opinion piece indicates it is an important but encourages the Japanese Government to take additional action.

We were contacted last week from a reporter in Japan asking for our opinion of whistleblower law in Japan and the Toshiba scandal. The essential question was why an individual had not come forward to report this scandal before now.

Japan has a law protecting whistleblowers from retaliation that was enacted in 2006. According to our research, the fines in the law are so small that companies would rather just pay the fines than comply with the law.

Japan also hasn’t historically treated its whistleblowers well, so there was probably reluctance to come forward. The whistleblower who brought a case against Olympus under this anti-retaliation law did not fare well. This was the first to reach Japan’s highest court. Additionally, Michael Woodford, the whistleblower in the Olympus accounting scandal, was also fired after blowing the whistle. Until Japan is able to reassure whistleblowers that they will be protected, they won’t come forward to stop scandals like the one at Toshiba.

However, there are options. Employees in Japan of companies listed on a U.S. stock exchange may decide instead to avail themselves of the confidentiality of the Dodd-Frank whistleblower program instead of reporting to either the company or the Japanese government. The SEC whistleblower reward program has provided a financial incentive encouraging thousands to come forward every year to report violations of US securities laws. If the SEC takes action and recovers a monetary penalty of more than $1 million, an eligible whistleblower is due between 10 and 30 percent of the recovery.

There are nineteen examples already of whistleblowers coming forward to this program and helping to put a stop to problems before investors lost all of their money, and receiving an award. The US has received tips from around the globe about violations but since the program is still new, people are still being educated about it. Four people from overseas have received rewards.

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Ethics Code Now Guides Accountant Whistleblowers

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The International Ethics Standards Board for Accountants (IESBA) has revised the Code of Ethics for Professional Accountants to address ethical concerns about how to handle a client’s suspected non-compliance with laws and regulations (frequently referred to as “NOCLAR”). The changes to permit whistleblowing in the Ethics Code, which serve as guidance for professional accountants around the world, will be effective on July 15, 2017, although early adoption is permitted.

Eric Young on Accountant Whistleblowers in Pennsylvania CPA Journal

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The Pennsylvania CPA Journal published a piece by McEldrew Young Purtell Merritt Partner Eric L. Young in its Winter 2017 edition on the changes to the International Ethics Standards Board for Accountants (IESBA) Code of Ethics. The new ethics guidelines greatly clarify the steps for accountants to take when they confront suspected noncompliance with laws and regulations (NOCLAR) during the performance of their duties for clients.

Accounting Fraud Continues with Bankrate Settlement, Toshiba Announcement

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At the beginning of this year, the Wall Street Journal wrote an article about how the Securities and Exchange Commission was investigating a surge of cases involving accounting fraud. It looks like we might be seeing the outcomes of some of those cases soon, as suggested by the Bankrate settlement today. Bankrate, best known for its online comparison tool for mortgages and other types of bank lending, agreed to settle charges of accounting fraud brought by the SEC for $15 million.

The allegations by the SEC involved a scheme to meet analyst estimates by inflating revenue and underbooking expenses in the second quarter of 2012. The insurance and credit card divisions were asked to book additional, unjustified revenue. When the credit card division balked at the full amount, additional revenue was booked to two mortgage clients. Bankrate also had an expense account to manipulate financial results for at least a year.

Bankrate is by no means the largest company to have announced problems with its books right now. Toshiba, although a Japanese corporation, is also undergoing scrutiny by investors around the world. In fact, it has been the prime example since May, when the company withdrew its net profit estimate of $1 billion for the last fiscal year, ultimately posting a net loss of $318 million. Toshiba announced revised earnings statements for seven years today, noting that it overstated revenue by approximately $1.9 billion and profits $1.3 billion over the time period at issue.

The Japanese conglomerate’s accounting issues reportedly stemmed from divisions within the company fudging numbers in order to meet the high quarterly targets set by Toshiba’s management. There has been speculation by at least one commentator that if the practice is going on at the company, which had an excellent reputation, then it may also be going on at other companies in Japan. Some of those may be listed on a U.S. stock exchange and subject to a possible fine by the SEC for providing materially misleading information to investors.

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How Common is Accounting Fraud?

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Accounting irregularities have come up a fair amount recently, from the increase in SEC investigations in this area announced at the beginning of the year to the SEC fine against CSC for $190 million in June. With a wave of new stories hitting the media, it doesn’t seem like this area of securities law is going to slow down anytime soon. Here are the latest areas related to accounting fraud to be getting coverage:

MBTA

At the end of June, Harry Markopolos, the whistleblower that famously attempted to notify the U.S. Government of the Bernie Madoff ponzi scheme, warned the SEC about accounting and investment reporting issues with the MBTA pension fund. After a six month investigation, Markopolos told the SEC and other agencies that the pension fund may be overstating its books by as much as $470 million out of the $1.6 billion pension.

Among the issues noted in their study of publicly released information by the pension fund:

  • They discovered statistically improbably events, such as a return on investment two years in a row of 17.7 percent.
  • They used a different accounting approach three years in a row to calculate asset valuation.

The Massachusetts Bay Transportation Authority operates the leading share of the bus, subway, commuter rail and ferry system in greater Boston. The pension plan is funded partly by taxpayers and covers the workers and retired employees of the transit system.

Interestingly, Markopolos did not submit the tip to the SEC whistleblower program for a reward.

CalPERS

A former SEC attorney is attempting to crowdsource an investigation into CalPERS. The California Public Employees’ Retirement System is America’s largest public pension plan with over $300 billion in assets.

Earlier this year, CalPERS told its Investment Committee that it couldn’t track how much money it was spending on private equity firms. Given that the SEC has been investigating advisers and the private equity industry for problems with their fee disclosures and hidden fees, we wouldn’t be surprised if a whistleblower emerges with information about how investment banks or private equity firms were fleecing public pension funds and is able to capture a reward in the future.

Toshiba

This Japanese corporation known in America for its personal computers is expected to have to restate profits lower by more than $1 billion due to accounting irregularities. The amount is nearly double the earlier estimates as it has discovered overstated profits in its computer and semiconductor business in addition to the earlier reported problems related to its contract with Tokyo Electric Power for smart grid technology. The company has yet to file its latest annual report due to the need for the accounting restatement.

Will accounting fraud be the next big area for the government to pursue once it wraps up the smaller mortgage fraud cases?  We’ll just have to wait to find out.

If you have evidence of accounting fraud at a publicly traded company, contact one of our SEC whistleblower attorneys to discuss reporting it to the U.S. Government. An attorney can be reached by our contact form or calling 1-800-590-4116.

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Another Example of the SEC Accounting Fraud Pursuit: Weatherford

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The SEC has announced a $140 million settlement with Weatherford International over the use of deceptive income tax accounting to inflate its earnings. Weatherford is one of the largest oil and natural gas companies internationally and is now a repeat player in settling government investigations. They were fined a few years back by the SEC for a violation of the Foreign Corrupt Practices Act.

SEC Charges Rio Tinto with Accounting Fraud

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The U.S. Securities and Exchange Commission has filed a complaint in the Southern District of New York alleging violations of the Securities Act and the Exchange Act for an accounting fraud related to the valuation of a coal business in Mozambique, Africa. Rio Tinto settled the investigation of the UK Financial Conduct Authority for $35.6 million (USD). Australia is also reportedly investigating the allegations. Rio Tinto is one of the world’s largest metals and mining corporations with headquarters in London, England and Melbourne, Australia.

SEC Investigations into Navistar, ETFs while Investment Advisors fined $21.5 million

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The SEC has been busy this week with a few different news items breaking. It issued a Wells Notice to trucking company Navistar, settled charges against Taberna Capital Management for $21.5 Million, while starting its investigation into the ETF debacle and Rule 48 that may have caused the recent 1000+ point market crash on open.

Navistar Wells Notices

Navistar manufactures commercial trucks, diesel engines, school buses and chassis for motor homes, among other things. The company was previously involved in a settlement with the SEC over alleged accounting fraud from 2001 to 2005. The company was accused of overstating its pre-tax income by $137 million.

The SEC has now issued two Wells notices to the company. Wells notices, for those not familiar with them, are an announcement to the company that the SEC has concluded its investigation and is recommending an enforcement action. However, it doesn’t mean that the SEC will necessarily take action.

The precise scope of the investigation in this case is still a bit obscure as different media outlets are reporting the investigations into different violations of the law. Among the various investigations reported are:

– false or misleading statements during its quest to get EPA approval of its new engines.
– disclosures related to Chairman and CEO Daniel Ustian’s retirement in August 2012.
– potential violations of the 2010 settlement agreement.

The DOJ is also investigating Navistar on behalf of the EPA for selling engines in 2010 that did not meet EPA standards. The company claims the engines were made in 2009 and did not need to meet higher standards.

Taberna Capital Settlement

The SEC reached a settlement with Taberna concerning the diversion of client funds in a case concerning allegations that they fraudulently retained fees from collateralized debt obligations. The investment advisory firm did not disclose the conflict of interest related to the funds and their retention was not disclosed or permitted by the governing documents, according to the SEC.

Conflicts of interest and fee disclosures to investors have been a bit of a hot topic lately, with the Department of Labor considering imposing a fiduciary standard on ERISA advisors and the SEC looking into the fees and disclosures of hedge funds. This case appears to be along a similar vein.

ETFs and Rule 48

SEC Commissioner Dan Gallagher also confirmed that the SEC will look into exchange traded funds and the operation of Rule 48 in light of the panicked opening in the market last week. Rule 48 has been blamed for exacerbating the “flash crash” in ETFs last week as the market opened down on Monday. It’s unclear that there was any misconduct occurring but as the CFTC enforcement action in the 2010 flash crash shows, the securities regulators will go after market manipulation when it leads to disruption in the normal operation of trading.

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