From the banking industry perspective, the Securities and Exchange Commission has joined the big league of regulators using hardball tactics to enforce federal law.

The potent SEC has given itself the mission of investigating possible securities violations by publicly held financial institutions.

Those companies, particularly en route to mergers, are discovering increased SEC emphasis on maintenance of internal controls to assure accurate and adequate disclosure of obligatory information.

In late 1989 - with considerable publicity and a record budget - the SEC announced the creation of the financial institution disclosure task force. Its new - and largely untested - remedies include the ability to ask a judge to bar certain individuals from serving as officers or directors of a public company.

So all public financial institutions - and their directors and officers - should remember and consider the SEC as a significant regulator, particularly in preparing periodic filings.

Central Focus of Investigations

Public disclosure by financial institutions, particularly management's discussion and analysis, is a central focus of task force investigations.

The SEC requires the discussion and analysis to provide historical and prospective textual disclosures that will enable investors to assess current and future financial conditions and results.

These disclosure duties apply to currently known trends, events, demands, commitments, and uncertainties that are reasonably expected to have material effects on the company.

This duty prevails when a trend, demand, commitment, event, or uncertainty is known to management and reasonably likely to have material effects on an issuer's financial condition or operating results.

An exception is made for an objectively reasonable decision (viewed at the time made) that the trend, demand, commitment, event, or uncertainly is not likely to occur.

Recent enforcement actions have resulted in increased emphasis on the procedures all types of companies use to assure compliance with these standards.

Inadequate Procedures Cited

A recent enforcement proceeding against Caterpillar Inc. was the first SEC action involving solely the discussion and analysis requirement.

It centered on Caterpillar's failure to disclose in quarterly and annual reports that nearly 25% of 1989 net earnings came from a Brazilian unit - and that such a level of earnings probably would not occur the following year.

In a footnote to the administrative decision, the SEC noted: Caterpillar did not have adequate procedures in place designed to ensure compliance with the [management discussion and analysis] requirements."

Ultimately, Caterpillar settled this action by agreeing to implement and maintain adequate procedures designed to ensure compliance with disclosure requirements.

Internal Controls Emphasized

The SEC task force also emphasized the importance of internal controls in a 1990 enforcement action against the Bank of New England Corp.

This matter alleged that the Bank of New England failed to maintain internal controls sufficient to assess information in its loan files concerning the value of collateral.

It also allegedly did not provide reasonable assurance that the financial statements were prepared in accordance with generally accepted accounting principles.

One component of the SEC's allegation focused on deterioration in real estate loans, the declining property values underlying the loans, and the bank's failure to document and account for these events.

Incentives for Compliance

Given the continued weakness in the real estate market in many parts of the United States, the SEC's enforcement activities Provide a strong incentive for officers and directors to review and adopt stronger internal controls, especially those designed to assure compliance with disclosure requirements.

One senior SEC staff member has indicated that Practically every investigation shares one feature in common: a search for consistent and systematic lack of attention and adherence to internal controls.

Appropriate Responses

For officers and directors of an institution, one of the most fundamental and effective responses to this SEC focus is to review the adequacy of internal controls.

This review should ascertain that the institution's procedures, in fact, follow its guidelines. While this review can be time-consuming and expensive - as well as yet another administrative burden - the benefits of pre-incentive steps far exceed the costs of complying with an SEC investigation.

Moreover, such a review is within the spirit of the Federal Deposit Insurance Corporation Improvement Act of 1991. For this reason, it should assist the audit committee and all directors in meeting their statutory and regulatory obligations.

Institutions must evaluate the costs and benefits of "auditing" and possibly updating their internal controls. But the SEC task force provides yet another reason for publicly held holding companies banks. and thrifts to review the adequacy of those controls.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.