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The following are “real world” scenarios of small business issuers who were not accountable to
actions.
Pump-and-Dump Scheme
Scenario: Public company had a CEO who was unaccountable to the company’s board of
directors and shareholders. He issued false press releases and drove the stock from $0.50
per share to over $5.00 per share in one month.
Consequences: The SEC halted trading on the stock, the company’s shareholders lost over $5
million resulting in a shareholder lawsuit, the CEO and other “insiders” sold personal shares
during the run-up of the stock price.
Cost to the Company: Poor reputation. Devalued stock price. Legal and accounting fees in
excess of $50,000 to respond to SEC investigation. Company ceased to do business, was
delisted from the US stock exchange, and officers were banned from association with any public
company.
(See SEC v. World Information Technology, Inc.)
Solution: A system of internal controls includes a Code of Ethics which is adopted by the board
of directors. The Code of Ethics would have given the board control over the CEO and
mandated accountability to the shareholders by both the CEO and the board of directors. The
board could have identified and possibly fixed the problems early, and either terminated or
reprimanded the CEO and possibly prevented any SEC action.
Accounting Irregularities/Errors
Scenario: Public company issued stock options for compensation to officers and employees
for services. The CFO ignored back-dating of the options by the CEO in order to not have a
negative impact on the financial statements.
Consequences: The financial statements were misstated and required restatement and
amended filing with the SEC. The SEC initiated an informal investigation resulting in
unnecessary time and accounting (auditor) and legal fees to correct the errors and respond to
the SEC inquiry. The CFO was slapped with civil penalties and a disgorgement order that in
total exceeded $420,000.
(See SEC v. Michael J. Byrd)
Solution: A system of internal controls over issuances of stock options would have made the
CEO and CFO accountable to the board of directors for all activity related to the stock options.
The board could have identified and possibly fixed the problems early, and terminated or
reprimanded the CEO and CFO and possibly prevented any SEC action.
Fraudulent Issuance of Stock
Scenario: For a period of two years, eleven individuals and two entities assisted a small public
company in fraudulently issuing hundreds of billions of shares of unrestricted stock to a stock
promoter, the company’s CEO, and their nominees and associates. While the company’s stock
price varied between $0.0001 and $0.001, the promoter and CEO, and their nominees sold
billions of shares into the public markets. As a result, 40,000 investors lost $64.2 million.
Consequences: Civil penalties and disgorgement orders that totaled more than $61 million
(See SEC v. CMKM Diamonds, Inc. etal)
Solution: A system of internal controls would have given the board of directors more effective
control and oversight over the CEO and other company associates. The board may have been
able to control the amount of stock issued fraudulently and could have greatly diminished the
loss to investors.
Data Security Breach
Scenario: A web-based application company developed, maintains, and stores its software
and database internally. The company processes personal loans to customers and collects
personal data from its customers. A hacker stole the database which caused the company to
notify all of its customers and inform them of the theft.
Consequences: The notification caused the company to lose integrity with its customers and
resulted in an immediate 70% drop in revenues.
(See “Rising Costs of Data Breaches”)
Solution: A system of internal controls designed around IT and data security would have
required constant database and IT security monitoring and audits. The system of internal
controls may have mitigated the loss, or prevented the theft altogether.
actions.
Pump-and-Dump Scheme
Scenario: Public company had a CEO who was unaccountable to the company’s board of
directors and shareholders. He issued false press releases and drove the stock from $0.50
per share to over $5.00 per share in one month.
Consequences: The SEC halted trading on the stock, the company’s shareholders lost over $5
million resulting in a shareholder lawsuit, the CEO and other “insiders” sold personal shares
during the run-up of the stock price.
Cost to the Company: Poor reputation. Devalued stock price. Legal and accounting fees in
excess of $50,000 to respond to SEC investigation. Company ceased to do business, was
delisted from the US stock exchange, and officers were banned from association with any public
company.
(See SEC v. World Information Technology, Inc.)
Solution: A system of internal controls includes a Code of Ethics which is adopted by the board
of directors. The Code of Ethics would have given the board control over the CEO and
mandated accountability to the shareholders by both the CEO and the board of directors. The
board could have identified and possibly fixed the problems early, and either terminated or
reprimanded the CEO and possibly prevented any SEC action.
Accounting Irregularities/Errors
Scenario: Public company issued stock options for compensation to officers and employees
for services. The CFO ignored back-dating of the options by the CEO in order to not have a
negative impact on the financial statements.
Consequences: The financial statements were misstated and required restatement and
amended filing with the SEC. The SEC initiated an informal investigation resulting in
unnecessary time and accounting (auditor) and legal fees to correct the errors and respond to
the SEC inquiry. The CFO was slapped with civil penalties and a disgorgement order that in
total exceeded $420,000.
(See SEC v. Michael J. Byrd)
Solution: A system of internal controls over issuances of stock options would have made the
CEO and CFO accountable to the board of directors for all activity related to the stock options.
The board could have identified and possibly fixed the problems early, and terminated or
reprimanded the CEO and CFO and possibly prevented any SEC action.
Fraudulent Issuance of Stock
Scenario: For a period of two years, eleven individuals and two entities assisted a small public
company in fraudulently issuing hundreds of billions of shares of unrestricted stock to a stock
promoter, the company’s CEO, and their nominees and associates. While the company’s stock
price varied between $0.0001 and $0.001, the promoter and CEO, and their nominees sold
billions of shares into the public markets. As a result, 40,000 investors lost $64.2 million.
Consequences: Civil penalties and disgorgement orders that totaled more than $61 million
(See SEC v. CMKM Diamonds, Inc. etal)
Solution: A system of internal controls would have given the board of directors more effective
control and oversight over the CEO and other company associates. The board may have been
able to control the amount of stock issued fraudulently and could have greatly diminished the
loss to investors.
Data Security Breach
Scenario: A web-based application company developed, maintains, and stores its software
and database internally. The company processes personal loans to customers and collects
personal data from its customers. A hacker stole the database which caused the company to
notify all of its customers and inform them of the theft.
Consequences: The notification caused the company to lose integrity with its customers and
resulted in an immediate 70% drop in revenues.
(See “Rising Costs of Data Breaches”)
Solution: A system of internal controls designed around IT and data security would have
required constant database and IT security monitoring and audits. The system of internal
controls may have mitigated the loss, or prevented the theft altogether.
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SOX 404 "Worst-Case Scenarios" for Small Business Issuers |
