Improper revenue recognition topped enforcement actions by the Securities and Exchange Commission last year, consistent with previous years although the number of total actions was down by a third as the Biden administration transitioned into its role amid the pandemic, according to an analysis by Cornerstone Research.

The SEC took only 34 actions, compared to 50 in the last year of the previous administration, and all of them were administrative proceedings, which means they were presented to an administrative law judge rather than a U.S. district court. It was the first time in four years no civil actions were initiated. Administrative proceedings tend to move more quickly than civil actions.

About a third of the actions concerned inaccurate revenue recognition, including two that involved ASC 606 standards that took effect a few years ago for public companies and more recently for private companies and nonprofits.

The standards govern how organizations allocate revenue tied to contractual performance obligations, which can get complex when the term extends over multiple reporting periods. 

One of the revenue recognition actions stemmed from the earnings per share (EPS) initiative the SEC launched in 2020. The initiative uses data mining to identify reporting anomalies that could be the result of misreporting.

In the one EPS case, the SEC in August hit Healthcare Services Group with a $6 million settlement charge for leaving loss contingencies out of its reporting, allegedly as a way to inflate its quarterly earnings per share (EPS) to align with analyst estimates. The CFO and controller were also hit with settlement charges.

When it announced the action, SEC Enforcement Chief Gurbir Grewal touted the initiative. “As today's actions demonstrate, we will continue to leverage our in-house data analytic capabilities to identify improper accounting and disclosure practices that mask volatility in financial performance,” he said.  

Inadequate controls

The big enforcement area in addition to revenue recognition last year applied to companies’ internal accounting controls.

In one case, Tandy Leather Factory allegedly failed to maintain inventory cost information and used an inventory tracking system that didn’t support the company’s inventory accounting methodology.

"Tandy’s inventory tracking system and related controls were critical to both its business and the information it provided investors, yet they were wholly insufficient,” said David Peavler, director of the SEC’s Fort Worth regional office. 

In addition to its other sanctions, the SEC imposed monetary settlements totaling $158 million, a big drop from $1.4 billion the previous year and $670 million in 2019. 

The SEC’s enforcement chief said penalties could go up if “historical penalty amounts are not having the desired effect,” Grewal said. 

Civil penalties accounted for about two-thirds of the settlement amounts, while disgorgement and prejudgment interest accounted for 31% and 6%, respectively. 

No-admit settlements

Notwithstanding an SEC policy shift in October to move away from so-called no-admit settlements, none of the actions last year included admissions of wrongdoing. That means those charged with violations were able to settle without admitting or denying guilt. In its policy shift, the SEC said it wants to make these no-admit settlements harder to get.

“When it comes to accountability, few things rival the magnitude of wrongdoers admitting that they broke the law,” said Grewal. “We will, in appropriate circumstances, be requiring admissions in cases where heightened accountability and acceptance of responsibility are in the public interest.”