The SEC’s Financial Fraud and Accounting Task Force

This article was republished with permission from Michael Volkov’s Corruption, Crime & Compliance.

The SEC likes to reorganize, refocus and re-energize.  In the last 10 years, the SEC has continued to reinvent itself.  Whether it has been effective or not is still up for questioning.

Some have questioned if the SEC’s initiatives and reorganization have diverted it from monitoring bread-and-butter issues, such as financial fraud, particularly in the accounting area.

The SEC’s new chairwoman, Mary Jo White, has refocused the SEC on accounting fraud issues.  She created the Financial Fraud and Accounting Task Force.

Everyone recalls the WorldCom, Enron and Adelphia scandals from more than 10 years ago.  In reaction to these major accounting fraud scandals, the SEC created a task force to address accounting fraud.  The new task force has a much different mission – it is aimed at proactively identifying suspicious corporate accounting practices in order to prevent the recurrence of similar scandals.

The new SEC task force is built on the mantra of proactive enforcement.  It consists of a team of attorneys and accountants with significant financial fraud experience who are charged with understanding the origins of financial reporting fraud and trends needed to identify potential financial fraud, including revenue recognition, off-balance sheet transactions and revisions of financial statements.

In the area of enforcement, the task force will play a critical role in identifying potential cases for further investigation by the SEC’s Division of Enforcement.  Early investigations will allow the task force to identify potential targets, monitor their financial reporting, request and review documents and/or refer the matter, along with preliminary assessments, to the Division of Enforcement attorneys.

If identified as the subject of a financial fraud case, the task force’s inquiry will create interesting strategic responses by companies.  If identified by the task force, the subject company will have to investigate the matter quickly so that it understands the basis for the SEC’s concern.  From the company’s perspective, a proactive investigation, if accurate, can be an important way to avoid a massive financial fraud disaster.  The key in these cases will inevitably turn on the accuracy of the SEC’s determination that a company has engaged in or is likely to suffer from a financial fraud scheme.

The task force relies on several methods for identifying financial fraud.  The SEC’s Division of Economic and Risk Analysis uses the Accounting Quality Model (AQM) to identify potential issues.  AQM is not a cut-and-dried process.  It relies on text and data analytics.  Some fear that text analytics may result in a focus on disclosures and the accuracy of such disclosures.

The task force has a unique opportunity to refocus on cutting-edge ideas for identifying and preventing financial fraud.  It will form important theories and new approaches based on academic research and other sources of ideas.

The SEC has taken a lot of heat for its performance in the last 10 years.  Whether the latest reinvention has any merit will quickly be revealed in new enforcement actions for financial fraud.