The Securities and Exchange Commission recently delivered enforcement actions to two audit committee chairs, a rare enforcement target, accusing both of failing to act on obvious red flags of fraudulent accounting and financial reporting.
Both cases involve China companies, AgFeed Industries and L&L Energy, where the SEC says audit committee chairs learned of massive accounting fraud and then looked the other way and continued to oversee the filing of false financial statements. In the case of AgFeed, the SEC says the company and top executives developed an elaborate accounting fraud to report false revenues from China operations to meet financial targets and drive up the stock price. When Ivan Gothner, chair of AgFeed's audit committee, learned of the China-based fraud, he failed to act on recommendations that he pursue an internal investigation and instead allowed false reporting to continue, the SEC says.
At L&L Energy, the SEC says Shirley Kiang, audit committee chair, learned that the company's financial statements were certified in the name of a CFO who didn't work for the company and turned down a job offer. The SEC says Kiang signed subsequent financial statements knowing the CFO listed in the filing and purported to have certified the filing was not even on the company's payroll. She is barred from serving in any role that involves any certification of SEC filings. Gothner is similarly barred and is awaiting trail along with five other executives.
Daniel Goelzer, a partner with law firm Baker & McKenzie and former SEC general counsel and former member of the Public Company Accounting Oversight Board, says the enforcement actions should serve as a fresh warning to audit committee members to take their duties seriously. “SEC enforcement actions against audit committee members are rare,” he wrote in an alert to his clients.
While the cases are connected to China, where flagrant violations are more common, Goelzer says U.S. audit committee members may see only limited significance or connection to themselves. He warns them not to brush the cases aside so hastily. “During the past year, the SEC chair and staff have announced a new focus on gatekeepers, such as attorneys, accountants, and directors, and these cases seem to illustrate how the Commission intends to apply its gatekeepers program to audit committee members,” he wrote.
In the case of AgFeed in particular, Andrew Ceresney, SEC enforcement director, said in a statement that executives and audit committees should take notice. “This is a cautionary tale of what happens when an audit committee chair fails to perform his gatekeeper function in the face of massive red flags,” he said.