Foamex International agreed this month to settle an investigation by the Securities and Exchange Commission relating to the company’s internal controls. The SEC’s informal inquiry of Foamex—which was revealed in April—marked what appeared to be the first time that a Commission investigation specifically targeting internal controls under The Sarbanes-Oxley Act of 2002 had been made public.
In settling the matter, Lynnwood, Penn.-based Foamex did not admit to any wrongdoing or have to pay a fine. However, the company did agree to a cease and desist order that, among other things, requires that a special consultant issue a special report making recommendations relating to changes to internal control over financial reporting to address any continuing deficiencies.
Ryan
Russell Ryan, a partner with the law firm King & Spalding in Washington, D.C., told Compliance Week that the Foamex case is interesting because “the primary focus of the case is the inadequacy of internal controls rather than any misconduct that happened as a result of the deficiency." According to Ryan, the reverse is usually the case. "It’s more typical to charge a company primarily with accounting misconduct and only secondarily with having inadequate internal controls that led to the misconduct.”
Ryan, who worked for 10 years in the SEC’s Division of Enforcement, adds that the Foamex case is slightly unusual because there are no individuals named as respondents. "Typically, if internal control deficiencies are as bad and longstanding as the SEC alleges they were here, and there are repeated warnings from outside auditors for several years, the SEC would ordinarily seek to hold one or more individuals responsible. In this case there were no individuals [named].”
Although Ryan says it’s possible that the Commission might focus more in the future on cases mainly involving internal controls, he adds that he wouldn’t expect it to become a significant area of focus. "Primarily, the Commission will focus on accounting fraud and disclosure cases. And those cases typically also involve some failure of controls.”
Since the informal inquiry of Foamex was announced on April 4, at least one other company—BearingPoint—has revealed that it too is the subject of an informal inquiry by the Commission targeting its internal controls. The McLean, Virg.-based business consulting firm said it received a letter from the SEC on April 13 informing the company of the investigation and asking for documents related to its internal control procedures.
Repeated Observations Of Auditors
Foamex, which makes polyurethane foam for carpets and furniture, made a series of acquisitions between 1983 and 2001 that expanded the company’s operations to encompass more than 50 manufacturing and distribution facilities in the United States, Canada and Mexico.
“The companies Foamex acquired utilized different accounting procedures, computer systems and software, and Foamex did not integrate all of these systems,” the SEC notes. “These differing systems, particularly those related to inventory, created inconsistencies in the company’s books and records, which the company did not reconcile in a timely manner.”
In August 1999, Foamex’s auditor notified the company’s audit committee of the need to improve its internal controls. In particular, the auditor reported that Foamex’s systems for the preparation of interim financial information did not provide an adequate basis for the auditor to complete in a timely fashion its reviews of the company’s interim financial statements.
Less than a year later, in May 2000, Foamex’s auditor issued a report that identified reportable conditions and recommended that Foamex: make significant improvements in the control environment and reporting practices of its foreign operation; conduct a comprehensive analysis of financial results on a quarterly basis; improve inventory reporting; and develop a comprehensive information technology strategy. The auditor noted similar reportable conditions in February and March of 2001 and in July of that year resigned.
In mid-2002, Foamex informed SEC staff that the company was initiating corrective actions to address its internal control deficiencies. But, in March 2003, the company’s new auditor issued a report to the Audit Committee that restated many of the problems that the prior auditor had identified.
In March 2004, Foamex’s auditor identified for the Audit Committee four reportable conditions, three of which had been previously identified. A month later, the Audit Committee retained a new auditor.
Since that time, the Commission notes, a new management team “has initiated steps to remediate the reportable conditions. It has strengthened financial management through the hiring of additional financial and accounting personnel and continues to implement an enterprise-wide IT system. Foamex has also retained, through its counsel, a special consultant on internal accounting controls.”
However, the SEC says that the “repeated observations of the auditors and Foamex’s history of restating its interim financial reports show that Foamex did not devote the appropriate managerial effort and other resources to remediate its deficient internal controls, which were identified as reportable conditions in 1999. As a result, Foamex encountered undue delays in implementing an effective remediation program.”
Related coverage and documents are available from the box above, right.
No comments yet