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Thursday
Aug072014

CEO and CFO charged with SOX violations for hiding internal controls problems

The SEC last week charged two officers of a now bankrupt computer equipment company with misrepresenting the state of its internal controls over financial reporting.

The CEO of Florida-based QSGI Inc., Marc Sherman, and the former CFO, Edward L. Cummings, "represented in a management’s report accompanying the fiscal year 2008 annual report . . . that Sherman participated in management’s assessment of the internal controls. However, Sherman did not actually participate," the SEC said.

Without admitting or denying the SEC’s findings, Cummings consented to a cease-and-desist order finding that he willfully violated the securities laws.

He agreed to pay a $23,000 penalty and be barred from serving as an officer and director of a publicly traded company for five years. 

Cummings was also suspended for at least five years from practicing as an accountant on behalf of any publicly traded company or other entity regulated by the SEC.

Sherman didn't settle the charges. The SEC said it will "litigate its case against Sherman in a separate administrative proceeding." The means the agency won't file a a civil complaint against Sherman or take him to court. Instead the SEC will handle his case through an internal, out-of-court procedure.

Sherman is charged with violating Sections 10(b) and 13(b)(5) of the Securities Exchange Act of 1934 and Rules 10b-5, 13a-14, 13b2-1, and 13b2-2. He's also charged with causing QSGI’s violations of Exchange Act Sections 13(b)(2)(A) and 13(b)(2)(B), the SEC said. He hasn't settled the charges.

The Sarbanes-Oxley Act of 2002 requires a management’s report on internal controls over financial reporting to be included in a company’s annual report. 

The CEO and CFO must sign certifications confirming they’ve disclosed all significant deficiencies to the outside auditors, reviewed the annual report, and attest to its accuracy.

The SEC alleged that Sherman and Cummings each certified that they had disclosed all significant deficiencies in internal controls to the outside auditors. 

"On the contrary," the SEC said, "Sherman and Cummings misled the auditors -- chiefly by withholding that inadequate inventory controls existed within the company’s Minnesota operations." 

The SEC said,

They also withheld from auditors and investors that Sherman was directing and Cummings participating in a series of maneuvers to accelerate the recognition of certain inventory and accounts receivables in QSGI’s books and records by up to a week at a time.  The improper accounting maneuvers, which rendered QSGI’s books and records inaccurate, were performed in order to maximize the amount of money that QSGI could borrow from its chief creditor.

QSGI’s efforts in 2008 to introduce new internal controls to the operations at its Minnesota facility largely failed, the SEC said. 

"The deficiencies existed throughout that fiscal year and continued until the company filed for bankruptcy in July 2009," the SEC said in its administrative order.

The SEC's July 30, 2014 release and administrative orders are here.

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Richard L. Cassin is the publisher and editor of the FCPA Blog. He can be contacted here.