On August 27, 2010, the SEC charged two former Dell executives with fraud for their alleged misconduct relating to the use of the company’s excess tax reserves. SEC v. Davis, Docket No. 1:10-cv-01464 (D.D.C.); SEC v. Imhoff, Docket No. 1:10-cv-01465 (D.D.C.). The SEC’s complaint alleges that Dell improperly used “cookie jar” reserves to meet consensus earnings targets, which caused it to materially misstate its operating income, operating expenses, and certain other financial metrics.

The complaint alleges that Dell improperly used $17 million in an excess Japanese consumption tax reserve that it had decided was unnecessary. Under Generally Accepted Accounting Principles (GAAP), the SEC argues, Dell should have released the entire reserve by the end of the 2003 fiscal year. Instead, Dell allegedly released only $5 million of the reserve to its income statement at the end of the fiscal year 2003 and transferred the remaining $12 million to another account. The SEC alleges that Dell then released $7.1 million of the $12 million to soften the 2004 fiscal year earnings impact of an unrelated $9.3 million litigation settlement for which Dell had not created a reserve. In addition, it is alleged that Dell released the remaining $5 million to its income statement to prop up its fiscal year 2004 operating figures.

The SEC’s complaint is particularly troubling given the relatively small amounts at issue. While many companies extensively document the establishment of tax reserves, the SEC’s complaint may spur companies to enhance their documentation surrounding the release and maintenance of financial statement tax reserves.