Fraud Examination Introduction

The Securities Exchange Commission issued a ruling on its website against Panasonic Corporation. It had investigated the company for violations under Section 21C of the Securities Exchange Act of 1934, and the investigation resulted in a cease-and-desist order. This paper will walk through the case, analyzing the facts and the ruling that was made.

Major Facts of the Case

The case against Panasonic concerns "violations of anti-bribery, anti-fraud, books and records, and internal accounting control provisions of the federal securities law by Panasonic, a global electronics corporation headquartered in Osaka, Japan."

The anti-fraud component of the case is based on an overstatement of pre-tax income by $38.5 million and net income by at least $22.4 million for the quarter ended June 30, 2012. The defendant backdated an agreement with a government airline and provided misleading information about the agreement to its auditor in order to include the revenue in the quarter. The SEC takes this as Panasonic intentionally prematurely recognizing revenue, which is in violation of generally accepted accounting principles.

Section 21C of the SEC Act of 1934 states that if a violation occurs, and it is determined that a penalty will be in the public interest, then a penalty shall be applied to the guilty party. If the act involved fraud, deceit or manipulation, then 21C can be applied. Furthermore, if there is an extent to which the person or entity committing the fraud was unjustly enriched, or if a person or entity was harmed as the result of the action, then a penalty can be assessed.

The timing of revenue flows is one of the more common ways that a company might attempt to commit a fraud. The impact is that the quarter that receives the revenues sees inflated income, both gross and...

In this case, Panasonic's quarterly net income was overstated by approximately 16%. This could reasonably be seen as having a positive impact on the company's stock price, at the very least. Panasonic would still need to find a way to earn more money in subsequent quarters to make up for this timing , but companies often prefer this approach to overstate the current quarter, especially if income would otherwise show as being down, causing a decline in the stock price (K@W, 2004).
There were also issues that the SEC found with Panasonic's internal controls. They spent $1.76 million on consultants that apparently provided few if any legitimate consulting services. This allegation related back to the allegation about corruption, where a government official was paid as a consultant but without doing work this payment was seen by the SEC as a bribe. For the SEC, however, this also raises an issue about internal control, which should have identified a high payment for which no legitimate value was provided.

The payments in question were made through a third-party vendor, and thus were not accurately reflected on Panasonic's financial statements, as they would have looked like payments for goods and services from that vendor, rather than payments to "consultants". Some of the fraud involved sales agents operating in the Middle East, and the facts of the case date back to 2004. There were allegations from the local Panasonic subsidiary in Dubai that the sales agent was using bribes to win business, but Panasonic took no action against the sales agent, and instead continued to shelter the agent from investigation. It was these actions that led to some of the issues with the SEC, and those issues in turn led to further allegations about the lack of internal controls, and the discovery of the mistimed revenue recognition.

The…