SEC Files 1st Suit in Its Accounting Fraud Battle

Federal securities regulators, launching an opening volley in their declared war on corporate accounting fraud, on Tuesday accused chemical giant W.R. Grace & Co. of manipulating earnings during the early 1990s to meet Wall Street’s expectations.

The Securities and Exchange Commission also charged seven former Grace executives, including former Chief Executive J.P. Bolduc, with carrying out the alleged company fraud from 1991 to 1995.

The civil fraud case is the SEC’s first enforcement action since Chairman Arthur Levitt outlined plans recently to stem company manipulation of financial reports.

“This is the first of a number of cases that will carry the message that we have made combating financial fraud our No. 1 enforcement priority,” said SEC enforcement director Richard H. Walker.

The SEC, in a suit filed in federal district court in Miami, alleged that senior Grace executives deferred reporting some 1991 and 1992 income from National Medical Care, then the main Grace health-care unit.

Grace assigned $10 million to $20 million of this unexpected profit to corporate reserves, which it then used to increase the reported earnings of both the health-care unit and the company between 1993 and 1995, the SEC said.

The actual earnings of the unit and its parent company sometimes fell short of analysts’ expectations during this period, the suit alleged. Thus, Grace misled shareholders by reporting results buttressed by the reserves, the SEC said.

Grace said it “continues to assert the financial statements were not fraudulent.” The company said its outside auditor at the time, Price Waterhouse, now PricewaterhouseCoopers, issued unqualified opinions on Grace’s earnings.

“We stand behind the work we did for Grace,” said David Nestor, a spokesman for PricewaterhouseCoopers, still Grace’s auditor.

Grace’s stock fell $1.63 to close at $14.63 on the New York Stock Exchange, though the firm said it does not expect the dispute to have a material impact on its earnings.

Grace received notice in April 1996 of the SEC’s formal probe into its health-care reserves. The company has since spun off National Medical, a kidney dialysis business. It is part of Germany’s Fresenius.

The SEC lawsuit seeks unspecified financial penalties and a permanent injunction against such violations.

The SEC alleged that Grace began manipulating earnings at its National Medical unit in 1991.

Grace’s management directed National Medical to create excess reserves that year and report earnings that were consistent with a targeted growth rate of 24%.

According to the SEC, Grace took that step after deciding the parent wouldn’t be credited by investors for a growth rate over 24%.

Most of the excess reserves were placed in an account used by National Medical to record liabilities to physicians who managed its dialysis clinics, the SEC said.

In 1992, Grace directed National Medical to manipulate its reserves to report 27% to 28% growth in the health-care unit’s annual net income, the complaint said. Similar steps were taken through at least the first quarter of 1995, the SEC said.

In addition, the parent used some of the reserves to bolster its own earnings per share, the SEC said.

In September, SEC Chairman Levitt criticized what he called a “game of nods and winks” by corporate executives, auditors and analysts to distort financial reports to meet projections--often with the goal of bolstering stock prices--and outlined plans for the SEC and accounting groups to take steps to make financial statements present a clearer picture of a company’s bottom line.

Levitt also has criticized companies that “stash accruals in ‘cookie jar’ reserves during the good economic times and reach into them when needed in the bad times.”