Tuesday, December 30, 2008
On December 29, the SEC issued an Order Instituting Administrative Proceedings Pursuant to Section 21C of the Securities Exchange Act of 1934, Making Findings and Imposing a Cease-and-Desist Order (Order) against Stewart Enterprises, Inc. (Stewart), Kenneth C. Budde, CPA (Budde) and Michael G. Hymel, CPA (Hymel). The Order finds that, from 2001 through 2005, Stewart, the second largest publicly traded provider of death care services in the United States, and Budde, Stewart's former chief financial officer and chief executive officer, and Hymel, Stewart's former chief accounting officer, made repeated public filings with the Commission that materially misrepresented Stewart's revenue recognition policies and methodologies with respect to the sale of cemetery merchandise made prior to the need for a funeral (pre-need cemetery merchandise). Stewart misleadingly represented that it utilized a straightforward delivery method to recognize revenue for the sale of pre-need cemetery merchandise, by which, upon delivery, Stewart would recognize as revenue the full contract amount paid by the customer. However, Stewart could not actually identify the pre-need contract amount and instead created an estimate of the amount of revenue to be recognized. Stewart's failure to disclose this methodology of estimating revenues in its public filings with the Commission rendered its financial statements not in conformity with Generally Accepted Accounting Principles. Only when required to comply with Section 404 of the Sarbanes-Oxley Act of 2002 and informed by its outside auditor that it would no longer issue unqualified audit opinions if this estimated methodology continued to be used did Stewart finally shift to a revenue recognition system no longer reliant on estimates. Errors arising from the assumptions underlying Stewart's methodology for estimating revenues resulted in an overstatement of net revenue from 2001 through 2005 by more than $72 million, overstated annual net earnings before taxes during this period by amounts ranging from 10.76% to 38.76%, and were the primary basis for a subsequent material restatement of earnings.
Based on the above, the Order ordered Stewart to cease and desist from committing or causing any violations and any future violations of Sections 13(a), 13(b)(2)(A), and 13(b)(2)(B) of the Exchange Act and Rules 12b-20, 13a-1, 13a-11, and 13a-13 thereunder; ordered Budde to cease and desist from committing or causing any violations and any future violations of Exchange Act Rule 13a-14 and cease and desist from causing any violations and any future violations of Section 13(a), 13(b)(2)(A), and 13(b)(2)(B) of the Exchange Act and Rules 12b-20, 13a-1, 13a-11, and 13a-13 thereunder; and ordered Hymel to cease and desist from causing any violations and any future violations of Sections 13(a), 13(b)(2)(A), and 13(b)(2)(B) of the Exchange Act and Rules 12b-20, 13a-1, 13a-11, and 13a-13 thereunder. Stewart, Budde and Hymel consented to the issuance of the Order without admitting or denying any of the findings contained therein. In the Matter of Stewart Enterprises, Inc., Kenneth C. Budde, CPA, and Michael G. Hymel, CPA.
The SEC delivered to Congress its Report and Recommendations Pursuant to Section 133 of the Emergency Economic Stabilization Act of 2008: Study on Mark-To-Market Accounting that recommends against the suspension of fair value accounting standards. Instead the report recommends improvements to existing practice, including reconsidering the accounting for impairments and the development of additional guidance for determining fair value of investments in inactive markets, including situations where market prices are not readily available.
As mandated by the Act, the report addresses the following six key issues:
the effects of such accounting standards on a financial institution's balance sheet;
the impacts of such accounting on bank failures in 2008;
the impact of such standards on the quality of financial information available to investors;
the process used by the Financial Accounting Standards Board in developing accounting standards;
the advisability and feasibility of modifications to such standards; and
alternative accounting standards to those provided in such Statement Number 157.
Among key findings, the report notes that investors generally believe fair value accounting increases financial reporting transparency and facilitates better investment decision-making. The report also observes that fair value accounting did not appear to play a meaningful role in the bank failures that occurred in 2008. Rather, the report indicated that bank failures in the U.S. appeared to be the result of growing probable credit losses, concerns about asset quality, and in certain cases, eroding lender and investor confidence.
The Emergency Economic Stabilization Act of 2008 directed the SEC, in consultation with the Board of Governors of the Federal Reserve System and the Secretary of the Treasury, to study mark-to-market accounting standards as provided by the FASB Statement of Financial Accounting Standards No. 157, Fair Value Measurements. The Act, which was signed into law on Oct. 3, required that the study be completed within 90 days.
While the report does not recommend suspending existing fair value standards, it makes eight recommendations to improve their application, including:
Development of additional guidance and other tools for determining fair value when relevant market information is not available in illiquid or inactive markets, including consideration of the need for guidance to assist companies and auditors in addressing:
How to determine when markets become inactive and whether a transaction or group of transactions are forced or distressed;
How the impact of a change in credit risk on the value of an asset or liability should be estimated;
When should observable market information be supplemented with and/or reliance placed on unobservable information in the form of management estimates;
How to confirm that assumptions utilized are those that would be used by market participants and not just a specific entity;
Enhancement of existing disclosure and presentation requirements related to the effect of fair value in the financial statements.
Educational efforts, including those to reinforce the need for management judgment in the determination of fair value estimates.
Examination by the FASB of the impact of liquidity in the measurement of fair value, including whether additional application and/or disclosure guidance is warranted.
Assessment by the FASB of whether the incorporation of credit risk in the measurement of liabilities provides useful information to investors, including whether sufficient transparency is provided currently in practice.
The report also recommends that FASB reassess current impairment accounting models for financial instruments, including consideration of narrowing the number of models under U.S. GAAP. The report finds that under existing accounting requirements, information about impairments is calculated, recognized and reported on basis that often differs by asset type. The report recommends improvements, including: reducing the number of models utilized for determining and reporting impairments, considering whether the utility of information available to investors would be improved by providing additional information about whether current declines in value are consistent with management expectations of the underlying credit quality, and reconsidering current restrictions on the ability to record increases in value (when market prices recover).
The SEC filed an emergency action to halt a Ponzi scheme and affinity fraud conducted by Creative Capital Consortium, LLC and A Creative Capital Concept$, LLC (collectively, Creative Capital), and its principal, George L. Theodule. According to the Commission's complaint, the defendants raised at least $23.4 million from thousands of investors in the Haitian-American community nationwide through a network of purported investment clubs Theodule directs investors to form. The U.S. District Court for the Southern District of Florida issued an order placing Creative Capital under the control of a receiver to safeguard assets, as well as other emergency orders, including temporary restraining orders and asset freezes. In addition to the emergency relief obtained today, the Commission's complaint seeks disgorgement of the defendants' ill-gotten gains, civil penalties, and permanent injunctions barring future violations of the antifraud provisions of the federal securities laws.
Monday, December 29, 2008
The SEC today announced that it has unanimously approved revisions to modernize its oil and gas company reporting requirements to help investors evaluate the value of their investments in these companies. It has been over 25 years since the SEC last reviewed its rules in this area.
The new disclosure requirements include provisions that permit the use of new technologies to determine proved reserves if those technologies have been demonstrated empirically to lead to reliable conclusions about reserves volumes. The new requirements also will allow companies to disclose their probable and possible reserves to investors. Currently, the Commission’s rules limit disclosure to only proved reserves. The new disclosure requirements also require companies to report the independence and qualifications of a reserves preparer or auditor; file reports when a third party is relied upon to prepare reserves estimates or conducts a reserves audit; and report oil and gas reserves using an average price based upon the prior 12-month period rather than year-end prices. The use of the average price will maximize the comparability of reserves estimates among companies and mitigate the distortion of the estimates that arises when using a single pricing date.
The full text of the adopting release concerning these amendments will be posted to the SEC Web site as soon as possible.
Must reading in today's Wall St. Journal is the article on the last days of Lehman Brothers; the title says it all: The Weekend That Wall Street Died. It reports how it was every firm for itself as Lehman Brothers collapsed; Lehman's CEO Fuld couldn't even get Bank of America CEO Lewis to return his phone calls for help! In a separate story, Alvarez & Marsal, the restructuring adviser for Lehman, reports that as much as $75 billion of Lehman's value was destroyed by Lehman's "unplanned and chaotic" bankruptcy filing in September. Billions could have been saved if an orderly and less-rushed process had been followed. Estimates are that unsecured creditors will receive 10 cents on the dollar. WSJ, Lehman's Chaotic Bankruptcy Filing Destroyed Billions in Value.
Sunday, December 28, 2008
Shopping in Securities Class Actions?: Doctrinal and Empirical Analyses, by James D. Cox, Duke University School of Law; Randall S. Thomas, Vanderbilt University - School of Law and Vanderbilt University - Owen Graduate School of Management; and Lynn Bai, University of Cincinnati - College of Law, was recently posted on SSRN. Here is the abstract:
Federal appellate courts have promulgated divergent legal standards for pleading fraud in securities fraud class actions after the Private Securities Litigation Reform Act (PSLRA). Recently, the U.S. Supreme Court issued a decision in Tellabs v. Makor Issues & Rights that could have resolved these differences, but did not do so. This article provides two significant contributions. We first show that Tellabs avoids deciding the hard issues that confront courts and litigants daily in the wake of the PSLRA's heightened pleading standard. As a consequence, the opinion keeps very much alive the circuits' disparate interpretations of the PSLRA's fraud pleading standard. To be sure, Tellabs might ultimately be applied by lower courts to narrow the range of permissible approaches to satisfying the strong inference standard, but leaves a good deal of room within which wide variations in approach will continue.
Our second contribution is empirical in that we seek to answer the question: do plaintiffs' attorneys take advantage of the differences among the circuits' interpretation of the pleading standard to select more favorable venues to file their cases as some scholars have claimed? We find that 85% of the securities fraud class actions in our sample are filed in the home circuit of the defendant corporation. In the remainder of cases, those that are filed outside the defendant's home jurisdiction, our analysis shows that differences in the pleading standards do not explain a statistically significant amount of the reason for that decision.
While the differences in the circuits' pleading standards do not have a statistically significant impact on the plaintiffs' choice of venue, we find that plaintiffs are more likely to file low value cases in jurisdictions other than the one in which the defendants' headquarters is located. In particular, we find that cases with smaller provable losses and without an accompanying SEC investigation are statistically significantly more likely to be filed in circuits other than where the defendant's principal place of business is located. We interpret the former result as consistent with the hypothesis that in lower value cases, plaintiffs' counsel is more likely to select jurisdictions that are convenient to themselves rather than to the defendant. Conversely, when an SEC investigation is proceeding on the basis of the same operative facts, our results are consistent with the claim that plaintiffs' counsel will avoid filing outside of the defendant corporation's home jurisdiction to avoid procedural delays.
The Foreign Corrupt Practices Act, SEC Disgorgement of Profits, and the Evolving International Bribery Regime: Weighing Proportionality, Retribution, and Deterrence, by David C. Weiss, University of Michigan at Ann Arbor, was recently posted on SSRN. Here is the abstract:
The international framework governing foreign bribery has been in a state of flux during the preceding decade. For the first time since the passage of the Foreign Corrupt Practices Act, countries besides the United States are enforcing statutes prohibiting foreign bribery. Practitioners and academics have not yet analyzed foreign implementing legislation and enforcement levels nor the United States' changing enforcement strategy that has occurred simultaneously with the rise in foreign enforcement. In particular, the Securities and Exchange Commission's use of disgorgement damages has received scant attention despite the fact that it has begun to eclipse the importance of the SEC's express fining authority.
While disgorgement of ill-gotten gains has clear attractions from both retribution and deterrence perspectives, it raises new questions in the Foreigh Corrupt Practices Act context. In addition, as an increasing number of foreign statutes authorize disgorgement of profits in cases of foreign bribery and leverage the extraterritorial application of those laws, foreign enforcement raises serious questions regarding the propriety of disgorgement damages and suggests the necessity for foreign enforcement agencies to work together if multinational firms are to receive fair treatment when facing foreign bribery charges. Ultimately, the SEC's use of disgorgement damages has yet to cause firms unjustifiable multiple exposure for the same conduct, but as each SEC settlement seemingly sets a new benchmark for the size of disgorgement, multinational firms, corporate counsel, international regulators, and Congress should closely monitor the shifting enforcement climate with an eye toward fostering predictability, uniformity, and fairness for firms operating on a transnational scale.