SEC Taking an Interest in Accounting Enforcement

The implosions of Silicon Valley Bank and Signature Bank this month may have come as a surprise to KPMG LLP, one of the so-called Big Four accounting firms.

Both banks collapsed within two weeks of KPMG signing off on their audits. In the wake of the failures by SVB and Signature, the firm has defended its work in reviewing both financial institutions’ financial statements and internal controls, noting that its opinions “are based on audit evidence available up to and at the date of the opinion.” In other words, KPMG can’t predict “market-driven events,” such as a run on deposits, that could result in a bank biting the dust.

Regulatory authorities and government officials will undoubtedly have questions for KPMG as they sift through the wreckage, piecing together what happened to the banks. The firm should count on a visit from the Securities and Exchange Commission, especially, as the agency seems to be making accounting issues one of its top enforcement priorities.

As it happens, on the same day SVB went under, March 10, The Wall Street Journal published a feature article delving into the SEC’s recent fixation on accounting irregularities. The thinking goes that in an environment in which both reported earnings and earnings guidance are lackluster, companies might get more creative with their accounting practices.

To that end, the SEC has bolstered its accounting enforcement efforts with the EPS (Earnings Per Share) Initiative, a data-driven campaign to identify accounting funny business. According to the WSJ, the commission is using the program to pursue enforcement actions against individuals at a higher rate than usual – the better to deter earnings manipulation.

The effort is producing results, to be fair. In February, in connection with the EPS Initiative, the SEC charged automotive electronics manufacturer Gentex and its CFO, Kevin Nash, with violations arising out of the company’s accounting for its executive and employee bonus compensation programs. The SEC found that during the quarter closing process in the third quarter of 2015, Nash, without performing an analysis of relevant criteria under U.S. GAAP and without documenting the basis for his decision, directed the reduction of an accrual for a performance-based bonus program, resulting in Gentex reporting EPS that met consensus research analyst estimates. These and additional similar violations “were made possible by Gentex’s failure to devise and maintain a sufficient system of internal accounting controls related to its closing process, including its accounting for bonus compensation, and failure to maintain internal control over financial reporting.”

And the SEC isn’t just leaning on the EPS Initiative for its accounting enforcement program either. To wit, earlier this month, Pittsburgh-based Evoqua Water Technologies Corp. reached an $8.5 million settlement with the SEC regarding allegations the company used some financial sleight of hand to pump up its revenue in 2017 and 2018. Though not connected to the EPS initiative, the case did include charges against a former executive at the company, who agreed to an injunction and civil fines and disgorgement as part of Evoqua’s deal with the commission.

Meanwhile, regulators in the United Kingdom are getting in on the act when it comes to enforcement against auditors. PwC had to pay roughly $9.2 million (USD) in fines for multiple missteps in its audits of engineering company Babcock. According to the Financial Reporting Council, which oversees accounting in the UK, PwC’s breaches in the case included “repeated failures to challenge management and obtain sufficient appropriate evidence, reflecting a general reluctance to challenge management across these parts of the audits.” In one instance, the FRC said PwC’s due diligence didn’t entail translating one of Babcock’s contracts written in French.

Note that in the PwC case, the FRC also issued sanctions against two of the firm’s former audit partners. Looks like regulators in the U.S. and across the pond are on same enforcement wavelength.