The SEC recently announced the settlement of charges against DGSE Companies Inc. and its former CFO for accounting fraud resulting primarily from his manipulation of the company’s accounting for inventory. DGSE disclosed in April 2011 that it had a material weakness in its internal control related to account reconciliations associated with inventory, depository accounts, and intercompany accounts as of December 31, 2010 and that it had restated its financial statements for the quarters ended June 30 and September 30, 2010 in order to adjust the amounts of customer deposits, accounts payable, and inventory.
In April 2012, DGSE announced that, based on an internal investigation conducted by the company, its board had identified accounting irregularities that began during the second quarter of 2007 and had engaged forensic accountants to analyze the accounting irregularities. DGSE explained that management believed that the accounting irregularities were the result of improper accounting for inventory and other balance asset accounts by its former CFO. In June 2012, the company announced that it had changed auditors and that its prior auditor had advised it that the company did not have the internal controls necessary to develop reliable financial statements. In addition, DGSE announced that the SEC had initiated a private investigation into certain accounting irregularities and noted that the company had advised the SEC of the accounting irregularities and would continue to cooperate fully with the SEC Staff in the investigation.
In October 2012, DGSE filed restated financial statements for the fiscal year ended December 31, 2010 and explained, in a press release, that the accounting irregularities were caused by the following three main factors:
- Inadequacies in the company’s internal processes and controls, including decisions made by prior management that the current management believed were not consistent with GAAP
- Inappropriate set-up and implementation of the company’s AccountMate Enterprise Resource Planning system
- Adjustments and other journal entries made to the general ledger by prior management that lacked adequate support
Regarding the May 27 settlement, David Woodcock, chair of the SEC Enforcement Division’s Financial Reporting and Audit Task Force, stated that DGSE’s CFO “took advantage of DGSE’s weak internal control environment to intentionally manipulate its public filings.”
The SEC complaint in the matter cited the following deficiencies in the company’s accounting systems and controls:
- Many unsupported and/or improperly described accounting entries
- No standard, formalized process for reconciling intercompany accounts
- Booking unsupported entries directly into the general ledger rather than the appropriate subsystems
- Lack of regular inventory counts and matching to the general ledger
- Lack of an audit trail with which to identify the reason for accounting adjustments
- Use of antiquated accounting systems that did not maintain the proper audit trail and thus allowed for the manipulation of the general ledger
- Improper data security
- No backup of the accounting data
These deficiencies, including the failure to record intercompany transactions, such as inventory transfers between stores, significantly compromised the integrity of the DGSE’s financial data. This lack of sufficient internal controls allowed the former CFO to manipulate the company’s intercompany accounts such that they were out of balance by millions of dollars.
The DGSE case is another example of the SEC’s increased focus on accounting fraud and internal control over financial reporting. For additional information on this topic, read our January 24 post.