Securities Regulation Daily SEC’s risk-based initiative snares two firms for massaging earnings
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Friday, October 2, 2020

SEC’s risk-based initiative snares two firms for massaging earnings

By John M. Jascob, J.D., LL.M.

The settled actions are the first to result from the Enforcement’s Division’s EPS Initiative.

The SEC has announced settled actions against two public companies for improper reporting of quarterly earnings per share (EPS) that met or exceeded analyst consensus estimates. The separate actions against Interface Inc. and Fulton Financial Corporation are the first arising from the Division of Enforcement’s EPS Initiative, which uses risk-based data analytics to uncover potential accounting and disclosure violations (In the Matter of Fulton Financial Corp.Release No. 34-90017In the Matter of Interface, Inc.Release No. 33-10854, September 28, 2020).

Fulton Financial. In the action against Fulton Financial Corporation, a financial holding company that operates regional banks in the mid-Atlantic region, the SEC alleged that Fulton’s public filings during late 2016 and early 2017 inaccurately described the process that Fulton used to value its mortgage servicing rights (MSR) asset and determine its MSR valuation allowance. According to the SEC’s order, over two quarters Fulton departed from its stated valuation practices and maintained a $1.3 million MSR valuation allowance that was not supported by its publicly disclosed MSR valuation process. The company later reversed the allowance in the following quarter, which increased its earnings per share by a penny at a time when it otherwise would have fallen short of analyst consensus expectations.

Taken together, the SEC claims, Fulton’s disclosures misrepresented both the role played by Fulton’s management and by a third-party expert in valuing the MSRs and inaccurately presented the company’s quarter-over-quarter financial performance. In addition, Fulton failed to devise and maintain a sufficient system of internal accounting controls and maintained inaccurate books and records that reflected an erroneous valuation allowance over two quarters that was $1.3 million higher than it would have been if Fulton had followed its disclosed valuation process. Accordingly, the Commission found that Fulton violated Exchange Act Section 13(a) and Rules 13a-1, 13a-13 and 12b-20 and Exchange Act Sections 13(b)(2)(A) and (B). Without admitting or denying the SEC’s findings, Fulton agreed to cease and desist from future violations and to pay a $1.5 million penalty.

Interface. In the action against Interface Inc., a global designer and manufacturer of modular carpet, the SEC found that from the second quarter of 2015 through the second quarter of 2016, the company reported earnings per share that did not accurately reflect the company’s underlying performance. During five consecutive financial quarters, Interface’s then-controller and chief accounting officer, Gregory J. Bauer, directed or otherwise caused his subordinates to book unsupported, manual accounting adjustments. These adjustments did not comply with GAAP and artificially inflated Interface’s income and EPS, which resulted in Interface meeting or beating consensus estimates for EPS and showing earnings growth. Interface’s former CFO, Patrick C. Lynch, also caused Bauer to direct entries in two quarters that lacked support and did not comply with GAAP, the SEC found.

The SEC’s order found that the company and Bauer violated certain antifraud provisions of the Securities Act of 1933 and that Bauer and Lynch violated the books and records provisions of the Exchange Act. The order also finds that Interface violated the reporting, books and records, and internal controls provisions of the Exchange Act, and that Bauer and Lynch caused those violations. Without admitting or denying the SEC’s findings, Interface, Lynch, and Bauer have agreed to cease and desist from future violations of the charged provisions and pay civil penalties of $5 million, $70,000, and $45,000, respectively. Bauer and Lynch have also agreed to be suspended from appearing and practicing before the Commission as accountants.

"Public company financial reporting should not present a misleading picture of performance," said Enforcement Division Director Stephanie Avakian in a news release. "As demonstrated by today’s actions, we will continue to leverage our internal data analysis tools to identify violations, including evidence of earnings management and other accounting or disclosure improprieties."

In a recent remarks at a virtual program sponsored by the University of Pennsylvania Carey Law School, Avakian noted that the Division's focus on financial fraud and issuer disclosure has begun to bear fruit while elaborating on its approach. "We routinely look at all public information about an issuer – statements made by a company or its officers, in filings, during investor presentations, in tweets or blogposts; related commentary by others including analysts, shorts, competitors, shareholders – to develop a deep understanding of the company’s reporting environment and industry," Avakian said. "This is not a low cost investment, but it has provided substantial value in identifying potential financial fraud."

The releases are No. 34-90017 (Fulton) and No. 33-10854 (Interface).

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