“What is an internal accounting controls violation? Anything that the SEC staff thinks—and three out of five Commissioners agree—is a righteous case and to which a public company is willing to settle.”
A good read here from Walker Newell (Woodruff Sawyer and former Senior Counsel in the SEC’s Division of Enforcement in San Francisco) titled “Uncooked Books: Avoiding SEC Accounting Scrutiny.” The article discusses recent trends in the SEC’s accounting enforcement activities.
As stated in the article:
“In recent years, the SEC has been fond of using the disclosure controls, internal accounting controls, and books and records provisions of the securities laws to bring accounting-related charges against companies, even when there is no evidence of materiality or fraudulent intent.
One recent example: The SEC’s November 2023 case against Royal Bank of Canada. The SEC alleged that RBC failed to capitalize certain software development costs appropriately under accounting rules. There were no allegations that the accounting errors were material to RBC or that any executives or accounting personnel had attempted to cook the books.
Instead, as it is wont to do in these technical cases, the SEC attributed the accounting errors to RBC’s failure to maintain a sufficient system of internal accounting controls and accurate books and records. Fair enough, but what does this really mean?
Well, the books and records and internal accounting controls rules were originally adopted in connection with the Foreign Corrupt Practices Act. The theory was that it’s bad for a public company’s financials to reflect illegal bribery payments to foreign officials, and the government needs tools to punish that behavior.
In the non-FCPA context, as discussed, these provisions are commonly used to penalize general accounting-related violations. Often, it can appear that the SEC uses internal controls whenever it sees accounting errors that it really doesn’t like but when it can’t make out a fraud case. What is an internal accounting controls violation? Anything that the SEC staff thinks—and three out of five Commissioners agree—is a righteous case and to which a public company is willing to settle.
The internal accounting controls statute has also been leveraged at times in non-accounting settings, most prominently in recent years in share buyback and cyber-related cases. Certain SEC Commissioners have vocally opposed these actions, accusing the agency of using the provision as “a multi-use tool handy for compelling companies to adopt and adhere to policies and procedures that the Commission deems good corporate practice.”
Public companies rarely litigate against the SEC, so we haven’t seen many judicial decisions considering the limits of the SEC’s authority under these provisions. In the ongoing SolarWinds litigation, however, we may see a judge weigh in.“
