SEC takes aim at fraudulent financial reporting again

Photo courtesy of Juho Holmi on Flickr

Photo courtesy of Juho Holmi on Flickr

Rob Swystun, Pristine Advisers

The Securities and Exchange Commission has turned its attention back to fraud and faulty financial reporting.

For the past few years, as CFO’s David Katz says, the SEC had been cleaning up the mess from the 2008 financial crisis, focusing on collateralized debt obligations, subprime mortgages and similar products of the financial crisis. But it seems poised to start tackling financial fraud again on a level it was doing previous to the financial crisis.

As evidence of this, the SEC created new task forces last year to utilize the organization’s heightened data-mining capabilities to detect reporting fraud based on tools related to the SEC’s Accounting Quality Model.

SEC Chair Mary Jo White has also alluded to an increase in fraud detection activity, as well as a number of corporate and regulatory insiders who spoke at a Directors Roundtable program on accounting crises held in November at the New York City offices of Weil, Gotshal & Manges.

And, if that’s not proof enough, the SEC’s whistleblower program is going strong and continues to prompt people to call in if they have a tip.

The numbers tell the tale of the SEC’s turn away from fraud detection starting in 2008. In fiscal-year 2012, the SEC opened 124 financial fraud and issuer disclosure investigations. But in 2006 it opened 304, and in 2007 it opened 228. Specifically, accounting fraud related cases took a nosedive with the SEC filing 79 of them in 2012 compared to 219 five years prior to that in 2007.

Obviously the drop in financial reporting related investigations had something to do with the SEC necessarily having to turn its attention to real estate, investment and banking related fraud in the years after the collapse of Lehman Brothers.

But another theory that’s been floated is that the SEC has cut down on financial reporting fraud out of necessity because the Sarbanes-Oxley Act improved internal controls so dramatically that fraudulent activity dwindled of its own accord.

Harvey Kelly, for one, disagrees.

“I subscribe to the theory that Sarbanes-Oxley did not cure all, and I’m sure some people’s eyes would bug out if they saw some of things that I’ve seen happen in this day and age, whether it’s the emails people write or flagrant accounting abuse,” he said.

Kelly is a managing director and global head of financial advisory services at AlixPartners.

It’s not just straight up fraud that Kelly is referencing, though, it’s activities on the fringes of fraud. According to Kelly, he’s been privy to “aggressive practices to get transactions into a quarter, to improve the profitability for a particular time period.”

He notes that these activities have attracted less attention from regulators than they would have before the financial crisis.

However, now that the SEC has swung around and set its sites on financial reporting fraud again, the numbers for investigations into these minor sorts of fraud will likely start rising.

“Without a doubt, I can tell you that I’ve been to various SEC offices in the last several months for lots of different clients, and there is no question that they are taking this topic very seriously,” Kelly said.


Something else that points to the SEC getting ready to bring the hammer down on financial reporting related fraud again is that it now wants fraudulent companies and individuals to admit publicly to the facts of the fraud, something it wasn’t doing previously when its policy was to settle cases on “a no-admit-no-deny basis” according to the SEC’s co-director of its enforcement division, Andrew Ceresney.

While that approach helped the commission get fast results, conserve resources and avoid litigation risk, I think we can all agree that we’d rather see fraudsters face the music publicly. Knowing they’ll be named publicly adds a deterrent element to the SEC’s policy.

And Ceresny seems to agree with that sentiment, too, as he said there’s “a group of cases where a public airing of unambiguous facts — whether through admissions or a trial – serve such an important public interest that we will demand admissions, and if the defendant is not prepared to admit the conduct, litigate the case at trial.”

No-admit-no-deny settlements will likely still continue, but to a lesser extent than before.

Go SEC! Having weathered the financial crisis and the slow recovery with the rest of us, it looks like the regulator is taking aim at fraudulent financial reporting again.


One response to “SEC takes aim at fraudulent financial reporting again

  1. Pingback: SEC aims to clear up CEO pay-for-performance numbers |·

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