Gee, I wonder if ZSUN had any of these 20 SEC "hot points?": HOT BUTTON: DUBIOUS FINANCIAL REPORTING The Fudge Factor
Valley companies face trouble with the SEC
for stretching their numbers
BY DAVID M. SACARELOS
HERE'S a prediction for 2000: Expect the
Securities and Exchange Commission to work with
federal prosecutors to bring high-profile criminal
cases against Silicon Valley companies.
Most of the world is familiar with the Silicon Valley
story. The first generation of Internet entrepreneurs
created a massive amount of wealth and championed
the concept of the start-up combining impish
curiosity, long work weeks and an appetite for
tremendous financial returns.
The Silicon Valley culture they created is not only
high risk, deliberately eccentric, anti-establishment
and libertarian, but is also ruthless in pursuit of
the
``next big deal.' And it is unfortunately a culture
that
too frequently overlooks financial reporting
standards that ensure shareholder value.
Securities and Exchange Commission Chairman
Arthur Levitt believes that auditors and financial
executives are part of the Internet industry's
undoing.
Levitt is concerned about companies that, while
perhaps not engaged in outright intentional fraud,
have shown a disturbing willingness to stretch or
``fudge' the numbers, particularly when it is
necessary to meet analysts' earnings targets.
Others have purposely misapplied Generally
Accepted Accounting Principles (GAAP), apparently
believing that their reports pass legal and
professional muster because unreported
irregularities are not ``material.' And others have
employed the concept of ``earnings management,' the
practice of misapplying accounting principles to
report artificially ``smoothed earnings.'
SEC Enforcement Director Richard Walker
somewhat ironically dubbed 1999 the ``Year of the
Accountant' at the commission. But it's no laughing
matter. The Enforcement Division is targeting for
discipline, among other tactics, improper revenue
recognition, unjustified restructuring charges and
``cookie-jar reserves,' the manipulation of balance
sheet reserves for the purpose of smoothing earnings
in difficult quarters.
The SEC has been positioning itself to focus
specifically on Internet companies for several
months. Last October, the commission's Office of the
Chief Accountant asked the accounting and financial
reporting community to address 20 ``hot points' that
have arisen in Internet businesses. These include
improper accounting of advertising, barter
transactions, distributing or reselling third party
products or services, rebates, free or heavily
discounted products or services, costs of developing
Web sites, ``hosting' contracts and Internet
distribution rights.
The SEC has noted the Internet industry's propensity
to inaccurately report large revenues by
miscategorizing costs related directly to the
generation of gross revenues. These costs should be
deducted from gross revenues to produce net
revenues but often are not. The effect of this
practice
is to help Internet companies meet the revenue
expectations of Wall Street analysts, who are often
singularly focused on revenues, even in the face of
soaring losses.
Last month was marked by a lot of SEC saber
rattling, particularly with regard to the accounting
issue of revenue recognition. One day, the
commission issued accounting guidelines aimed at
abuses in the way dot-com companies book their
revenues. For example, many dot-coms, acting only
as ``an agent' for a sale between other parties,
artificially expand their revenue by booking the
entire sale price for a product or service when they
are only entitled to book the commission on the sale.
The next day the SEC's Walker told a meeting of
accountants in Washington, D.C., that the commission
will work with federal prosecutors to bring more
criminal cases for accounting fraud against officers
and directors of high-tech and other industries.
That same day, Helane Morrison, district
administrator of the San Francisco District Office of
the SEC, told a consortium for accountants in Silicon
Valley that her office is extremely busy fighting
outright financial reporting fraud by valley
companies. She repeated the earlier caution for
accountants to be clear about the SEC's list of 20
points and its mandate for proper accounting and
reporting by financial executives and accountants.
We who live and work in Silicon Valley should not
take the SEC's warnings lightly. We are at risk
because we, as stakeholders in this region, are
ultimately vulnerable to misconduct involving
financial reporting. A significant part of our
compensation and retirement is connected with the
value of high-technology/Internet companies.
As a CPA in Silicon Valley, I know that most of my
colleagues are committed to excellence and integrity.
Our Codes of Professional Conduct, both national
and state, require CPAs to look out for the public
interest, and our record in this regard is generally
sterling.
However, I also realize that Silicon Valley
companies are enticed to ignore fundamental and
sound reporting standards in exchange for short-term
gain. We -- accountants, shareholders and executives
-- must acknowledge this temptation and take
appropriate action by conforming to the SEC's
requests.
Management and members of audit committees of
publicly held companies in Silicon Valley must
develop policies to require truthful reporting. More
boards of directors should include a higher
percentage of outside directors and be accountable to
shareholders. Financial officers must begin to openly
discuss questionable financial reporting, especially
to determine the proper reporting of ``gray areas.'
Investors and employees must begin to voice concern
for just and truthful financial reporting from the
valley's business leaders.
As the saga of Silicon Valley -- the world's most
successful and powerful experiment in free
enterprise -- continues, we in the financial
community must remember that our actions are
important because they will affect the future
institutions and people of Silicon Valley.
David M. Sacarelos is a senior manager in the
Redwood City office of Seiler & Co. LLP, a Bay
Area accounting firm. He is a director of the
California Society of CPAs and chairman of
CalCPAs Silicon Valley Forum task force." |
