Accounting Defense: What to Do When the Sec Questions Your Numbers

The SEC's Division of Enforcement investigates companies and individuals for violations of the federal securities laws governing financial reporting and disclosure. Common SEC violations include revenue recognition fraud, manipulation of financial results to meet earnings guidance, improper capitalization of expenses, and failure to disclose material related-party transactions. A formal order of investigation gives the SEC subpoena power over documents and witnesses. Individuals who receive SEC subpoenas are not required to testify without legal representation. Do not appear at an SEC testimony without counsel present. Companies and individuals under SEC financial reporting investigation should immediately seek SEC investigations legal counsel to manage the subpoena response and evaluate disclosure obligations.

The IRS Criminal Investigation division investigates cases involving tax fraud, tax evasion, and financial crimes with a tax component. An IRS criminal investigation is fundamentally different from a routine IRS audit. IRS special agents are law enforcement officers gathering evidence for criminal prosecution. If IRS special agents contact you, they are building a criminal case, not resolving a tax dispute. Accounting irregularities generating understated taxable income or fraudulent tax credits can trigger IRS criminal referrals alongside SEC enforcement actions. Companies and individuals who receive contact from IRS special agents should immediately seek IRS audit defense legal counsel before speaking with any IRS investigator.

Scienter is the element that separates civil securities fraud from criminal financial statement fraud. The SEC can bring civil charges based on negligence in some contexts. Criminal prosecutors must prove that the defendant knew the financial statements were false or acted with reckless disregard for their accuracy. An accounting defense built on the absence of scienter challenges the government's ability to prove the defendant knew the reported numbers were wrong. This defense requires establishing good-faith reliance on auditors, outside counsel, or internal accounting staff. It also requires demonstrating that the accounting treatment was disclosed, documented, and consistent with industry practice. Individuals facing potential criminal accounting charges should immediately seek accounting fraud legal counsel to evaluate the scienter issue and build a good-faith defense before charges are filed.

The Sarbanes-Oxley Act imposes direct personal liability on CEOs and CFOs of public companies for the accuracy of financial statements. Section 302 of SOX requires the CEO and CFO to certify in each periodic SEC filing that the financial statements do not contain any material misstatement or omission. Section 906 imposes criminal penalties of up to $5 million and 20 years imprisonment for knowingly certifying a false report. A SOX certification made while the officer knew the financial statements were inaccurate is a federal crime. SOX also requires companies to maintain adequate internal controls. Material weaknesses must be disclosed. Failure to disclose can independently support SEC enforcement and criminal liability. Executives who have signed SOX certifications for financial periods now under investigation should immediately seek Sarbanes-Oxley Act legal counsel to evaluate personal liability exposure.

An internal investigation must begin immediately when accounting irregularities are identified or when a regulatory inquiry is received. The internal investigation must be conducted by independent outside counsel to preserve credibility and maintain attorney-client privilege over the investigation's conclusions. A litigation hold must be implemented on the first day. Destroying documents after a regulatory inquiry is received is obstruction of justice. It is a separate federal crime. The investigation must interview all relevant personnel, review all supporting documentation for questioned transactions, and produce a written report. Companies and audit committees initiating an internal accounting investigation should seek financial statement audit legal counsel to structure the investigation and maintain its independence and privilege.

The Public Company Accounting Oversight Board inspects registered public accounting firms and can initiate enforcement proceedings against auditors who fail to comply with auditing standards. A PCAOB inspection that identifies audit deficiencies can result in sanctions against the audit firm, individual auditors, or both. Auditors who signed off on materially misstated financial statements face personal liability under Rule 102(e) of the SEC's Rules of Practice. Rule 102(e) allows the SEC to suspend or bar professionals from practicing before the SEC. An auditor bar effectively ends the auditor's career in public accounting. Auditing firms and individual auditors facing PCAOB inspections or SEC enforcement proceedings should seek PCAOB inspection legal counsel to manage the inspection response and evaluate individual exposure.

The SEC resolves the majority of accounting enforcement actions through negotiated settlements. A settlement with the SEC typically requires payment of disgorgement, civil monetary penalties, and agreement to an injunction prohibiting future violations. Individual officers frequently face bars preventing them from serving as an officer or director of any SEC-reporting company. A settlement with the SEC does not resolve criminal exposure. The SEC and DOJ coordinate closely on accounting fraud cases. Individuals resolving SEC civil charges while facing a parallel criminal investigation should seek SEC enforcement legal counsel. A civil settlement can inadvertently compromise the criminal defense.

A financial restatement is one of the most consequential events in an accounting defense. It signals to the SEC, shareholders, and prosecutors that the prior financial statements were materially inaccurate. The timing, scope, and characterization of a restatement are critical strategic decisions. A restatement that is too narrow exposes the company to follow-on SEC scrutiny. A restatement that is too broad overstates the problem and invites additional liability. Whistleblower complaints under the Dodd-Frank Act generate mandatory regulatory inquiries. Formal investigations frequently begin within weeks of filing. Companies must not retaliate against the whistleblower. Retaliation is a separate federal violation. Companies navigating a financial restatement or responding to a whistleblower complaint should seek IRS whistleblower reporting legal counsel to develop a coordinated disclosure and defense strategy.