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SEC Whistleblower Lawyer Blog

What To Know About The SEC’s “EPS Initiative”

Glass-300x200On September 28, 2020, the Securities and Exchange Commission (SEC) announced it had settled actions against two public companies for improperly reporting their quarterly Earnings Per Share (EPS). These actions were the first to come out of the agency’s Division of Enforcement’s “EPS Initiative.” A handful of other companies have been investigated since then due to the initiative, and there are signals that this is just the beginning. For SEC whistleblowers, the EPS Initiative and related enforcement actions shine new light on companies’ malfeasance and liability.

Understanding The Earnings Per Share (EPS) Initiative: How The Numeral “4” Is Revealing Firms’ EPS Manipulation

As the Wall Street Journal explained last fall, companies routinely make EPS estimates for quarterly earnings, based on their projected growth. Concerned that a company that misses its projection could use sleight-of-hand to make it look instead as though they met (or even exceeded) the EPS predictions, the SEC launched the new initiative to use “risk-based data analytics to uncover potential accounting and disclosure violations caused by, among other things, earnings management practices.”

More than simply re-running companies’ financials, the EPS Initiative looks for evidence that indicates companies are manipulating their reporting. For example, investigators check whether the numeral “4” appears sufficiently in the data.

If the distribution of numerals in the accounts is truly random and the data hasn’t been adjusted, then each numeral between 0 and 9 should appear as frequently as any other—i.e., each one should appear 10 percent of the time. But research shows that people manipulating an EPS tend to leave out the numeral “4,” opting instead to round up or down: a return worth “0.54” becomes “0.5” or “0.6.” This leaves fewer “4”s in the data. An underrepresentation of “4,” it turns out, strongly correlates with firms issuing restatements of earnings.

Gentex: Missing Its EPS By A Penny Cost The Company $4 Million

In February 2023, the SEC announced it was charging Gentex Corporation and the firm’s Chief Financial Officer for inconsistencies in its financial reporting, an action arising from the EPS Initiative. A deeper dive into the SEC order shows both what types of violations are being discovered by the initiative and—from a broader perspective—provides insight into how companies’ misreporting violates securities law.

According to the SEC order, Gentex set aside money for staff bonus compensation on a quarterly basis, but the set-asides were calculated and paid based on pre-tax profits. On one occasion in 2015, the company’s CFO ordered a $300,000 set-aside; the next day, realizing this would mean that Gentex would miss its quarterly EPS by one penny, he reduced the bonus compensation accruals by $200,000.

The SEC concluded that the CFO, Kevin Nash, had failed to analyze his decision under generally accepted accounting principles (GAAP):

As a result of his conduct, Nash violated Section 13(b)(5) of the Exchange Act, which prohibits knowingly circumventing or knowingly failing to implement a system of internal accounting controls. Nash further violated Rule 13b2-1 under the Exchange Act, which prohibits any person from directly or indirectly falsifying, or causing the falsification of, any book, record, or account required by the Exchange Act.

The SEC also faulted Gentex for not having sufficient accounting procedures and controls in place to prevent the CFO from manipulating the company’s EPS—something Nash did in other quarters as well in an effort to protect the firm’s EPS.

The unwillingness to miss their EPS by a penny ultimately cost Gentex $4 million in sanctions.

Gentex: Lessons For Whistleblowers

Whistleblowers don’t have to wait for the SEC to come calling. They can perform their own version of an EPS Initiative by looking for missing fours or any numbers that appear to be strategically rounded. They can also review accounting procedures more generally to see how manual entries and adjustments are being recorded and reviewed.

If they find a manipulation but wonder whether it’s big enough to bring forward to the SEC, potential whistleblowers should remember the Commission’s prosecution of Gentex on the finding of a one-penny difference in the company’s EPS.

When it comes to securities and reporting requirements, circumvention of GAAP alone may constitute an SEC violation. Whether the company has profited or not from the misleading record is beside the point.

If you’re considering becoming a whistleblower, Silver Law Group and the Law Firm of David Chase have created a strategic alliance to represent SEC whistleblowers like you.

With years of experience representing SEC whistleblowers, coupled with an SEC Enforcement lawyer on our team, we have an in-depth understanding of the SEC Whistleblower Program. We understand what the SEC is looking for. We can help you submit a tip that is more likely to result in a successful covered action. We are here to help whistleblowers maximize their opportunity to receive a financial bounty. For a free, confidential consultation, contact us by email or call us today at (800) 975-4345.

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