by Arthur Greenspan, James Walker, David Massey and Jakob Sebrow 

Accounting fraud has long been a staple of the enforcement program at the U.S. Securities and Exchange Commission (SEC) and the U.S. Department of Justice (DOJ), as corporate officers and employees continue to engage in efforts to improperly enhance financial results.  Based on the widespread use of “non-GAAP” financial metrics by public companies and recent SEC and DOJ emphasis on such measures, we believe that non-GAAP metrics will feature prominently in the government enforcement priorities that are likely to follow the significant market correction caused by COVID-19.

As we discuss below, companies and their senior executives risk SEC and criminal fraud charges based on misuse of non-GAAP metrics, and audit committee members risk scrutiny for failure to maintain adequate internal controls concerning non-GAAP metrics.  United States v. Carroll, a criminal case currently pending before Chief Judge Colleen McMahon in the Southern District of New York, is an important example of the government’s expansive theories of materiality and the real risks faced by companies and executives who emphasize non-GAAP measures in their public disclosures and comments.  Indeed, a confluence of factors—including the prosecutors’ core theory that the defendants sought to “smooth” an ancillary non-GAAP metric, their reliance on qualitative materiality, and their willingness to bring criminal charges notwithstanding the conclusion of the outside auditors that the misstatements were immaterial—makes Carroll a striking and novel prosecution. Continue reading →