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Home > Blogs > Ian Fraser > Dodd-Frank better suited than Sarbox for rooting out accounting fraud

Dodd-Frank better suited than Sarbox for rooting out accounting fraud

Dodd-Frank Bill | Dodd-Frank better suited than Sarbox for rooting out accounting fraud Ian Fraser

The recent settlement between Houston-based computer manufacturer Dell and the US Securities & Exchange Commission provides further evidence of the failure of the Sarbanes-Oxley Act to improve corporate behavior in the US.

Despite Sarbox – a draconian, “tick box” set of rules introduced in the wake of the Enron scandal in 2002 – Dell was able to carry out an accounting fraud between 2001 and 2006. The scam enabled the Texas-based PC maker to deceive investors whilst enabling supplier Intel to tighten its grip on the global semiconductor market.

Dell, founded by Michael Dell at the University of Texas in Austin in 1984, failed to disclose material payments (which Intel likes to call “discounts”) from what the SEC described a “cookie jar” provided by the California-based semiconductor manufacturer.

In 2001-06 Dell seems to have dipped into this “cookie jar” with gay abandon. The only condition for this unfettered access, according to the SEC ruling, was a promise from Dell not go and buy semiconductors from suppliers other than Intel (and specifically not from Intel’s dread rival AMD)!

Dell used the “free” money to artificially inflate its own earnings, ensuring it never missed earnings targets. This miraculous performance enabled it to have an entire establishment of analysts, academics and journalists eating out of its hand.

Christopher Conte, associate director of the SEC’s enforcement division, said in a statement: “Dell manipulated its accounting over an extended period ... Dell was only able to meet Wall Street targets consistently during this period by breaking the rules."

The money from Intel's “cookie jar” amounted to an astonishing 38% of Dell's operating profit in fiscal  2006, and 76% (or $720m) of operating profit in the first quarter of 2007. The funds were virtually all incorporated into Dell's component costs, but their existence was never disclosed.

To many, it seemed Dell walked on water. Writing in Wall Street Journal Law Blog, Ashby Jones said:

During much of that time, Dell’s share price nearly doubled, and investors and professors credited the company’s ultra-efficient supply chain and direct-sales strategy for its fast growth ….. The SEC alleges Mr. Michael Dell and other Dell executives repeatedly cited to investors “cost reduction initiatives” and “declining component costs” as the reason for Dell’s growing profit margins when they knew the increase was due to Intel’s payments.

And according to a disillusioned Andrew Orlowski in The Register, the accounting ruse “casts the entire PC market in an entirely new light.”

Given Sarbox's failure to prevent this sort of creative accounting, what hope is there it will be stamped out in future? Well it seems the legislation just enacted by Congress, the Dodd-Frank Act, is more likely to prevent such chicanery than Sarbox.

Writing in the New York Times White Collar Watch legal blog, professor Peter J. Henning said the recently enacted legislation will ensure accounting frauds are brought to regulators' attention much earlier. He said this is because the Dodd-Frank Act envisages whistleblowers being more handsomely rewarded. In the case of the Dell debacle whistleblower could have received at least $11m under Dodd-Frank, and the SEC could have awarded up to $33m for information leading to the enforcement action, Henning said.

So even though it may not be sufficient to prevent a further systemic crisis, the Dodd-Frank Act will at least have some positive effects!

By the way, Dell's penalty for the transgression is a £100m settlement, while three of its past and present directors forked out $11m between them. The company has admitted no wrongdoing, as is the customary in such settlements (see the $550m Goldman Sachs settlement over Abacus 2007 AC-1). Intel has denied wrongdoing. In an email, spokesman Chuck Mulloy said, "Since we are not a party [to the SEC suit] we will have no comment other than to point out this is a settlement and the 'facts' asserted by the SEC have not been tested or adjudicated."

Further reading on US financial regulation and the Dodd-Frank Act

Tags: accounting fraud , Dell , manufacturing , Sarbanes–Oxley Act , Securities and Exchange Commission , transparency , US
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