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SEC “Refocuses” on Accounting Fraud

acctg4It is almost a government rite of passage – when a new leader takes the reins, the chessboard has to be reorganized to reflect the new leader’s “new priorities.”  When it comes to the SEC, and the new Chairwoman Mary Jo White, the “new priority” is the return to an oldie but goodie – accounting fraud.

Let’s face it – the SEC does it best work when it regulates and enforces the law to prevent financial statement fraud.  At the heart of the Sarbanes-Oxley enforcement era in the early 2000s was major accounting fraud committed at the highest levels of large publicly-traded companies.

The SEC has announced that it is returning to this mission and it is doing so with new and valuable tools.

From a public policy standpoint, it is a no-brainer.  Right now, we have a number of major companies led by talented CEOs and senior executives who have written and specific incentives to achieve certain financial milestones on a quarterly basis.  Long-term management incentives have been replaced with expedited quarterly financial report incentives.  As a consequence, companies have every incentive to play close to the line (or even cross the line) to ensure that compensation standards are met.

The SEC has announced the creation of a new Financial Reporting and Audit Task Force, which will lead the effort, not in prosecuting the cases but in identifying and developing cases for further investigation by other SEC prosecutors.  The new accounting fraud enforcement effort will include two new important sources for investigations – a data mining system used to identify certain markers in financial reporting and disclosures, along with information provided through the SEC Whistleblower Program.

The SEC has seen a dramatic dip in the number of accounting fraud cases from approximately 20 percent to around 10 percent of its docket.  While some of its other initiatives were important, the SEC is returning to its bread and butter.acctg3

Publicly-traded companies need to take notice and redouble their efforts to develop accurate and transparent financial reports.

At the core of any compliance and ethics program (aside from the importance of a culture of compliance) is the principal of documentation – the need to document judgment calls and decisions which are made and could be second-guessed.  Accounting is not black and white, as we all know, but involves a number of potentially significant judgment calls.  Each of these important decision have to be documented and decisions need to reflect a good faith basis for the decision.  The company has to adhere to written policies and GAAP, and if it deviates from these standards, the decision has to be well documented.  In addition, like advice of counsel, the judgment and communications with the independent auditor has to be documented as well.

The SEC’s accounting enforcement effort will focus on a number of areas, including: (1) corporate restatement of earnings, which is a number one red flag of potential negligence or even fraud; (2) revenue recognition policies, which have been cited in several criminal cases referred by the SEC to the Department of Justice; and (3) accrued liabilities, which can be manipulated just like revenue recognition, to meet certain bottom line figures.

acctgOne other significant focus in this area is likely to be disclosure controls, meaning how does a company identify, evaluate and ultimately decide on whether disclosure of information is required and the manner in which it is done.  The SEC has been aggressively enforcing Regulation FD and it is likely to combine these efforts with the work of the Task Force.

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  1. October 4, 2013

    […] his podcast series. The FCPAProfessor continues his series on old enforcement actions. Mike Volkov focuses on the SEC’s return to fraud […]