The creation of the Financial Reporting and Audit Task Force (“Task Force”) was announced by the Securities and Exchange Commission (“SEC”) on July 2, 2013 in an effort to strengthen the agency’s efforts to identify and prosecute securities law violations as they relate to fraudulent or improper financial reporting and audit failures.
As noted by SEC Enforcement Co-Director Andrew Ceresney, in the wake of the financial crisis, the SEC’s focus was on financial crisis cases; cases involving Ponzi schemes, Collateralized Debt Obligations and other similar transactions that resulted in massive losses to investors. As a consequence, the SEC initiated fewer accounting fraud investigations. In his address to the American Law Institute Continuing Legal Education, Washington, D.C. in September 2013, Mr. Ceresney noted that in FY 2012, 124 financial fraud/issuer disclosure investigations were opened, compared to 304 in FY 2006. There was also a steep decline in the number of fraud/issuer disclosure actions with 79 filed in FY 2012 compared to 219 filed in FY 2007. Restatements also fell from a peak of 1,771 in 2006 to 768 in 2012. While the cause for such declines may be the result of Sarbanes-Oxley reform driving an overall improvement in financial reporting, Mr. Ceresney brought this idea into question noting “In the end, our view is that we will not know whether there has been an overall reduction in accounting fraud until we devote the resources to find out, which is what we are doing.”
As a result, the Financial Reporting and Audit Task Force was formed with approximately 12 staffers consisting of both lawyers and accountants. The Task Force is devoted to developing state-of-the-art methodologies to better uncover accounting fraud, as well as incubating cases that will then be handled by other groups within the Enforcement Division. To meet this goal, the Task Force launched various initiatives which include analyzing performance trends by industry, monitoring high-risk companies to identify potential misconduct, reviewing class action and other filings related to alleged fraudulent financial reporting, conducting street sweeps in particular industries and accounting areas and tapping into academic work on accounting and auditing fraud. The Task Force is also utilizing new technologies such as the Accounting Quality Model, which identifies anomalies that may indicate financial reporting fraud by analyzing XBRL data to review how public filers are reporting performance. While a deviation noted by this model may represent an attempt at fraudulent financial reporting, it may also generate a comment letter to the filer from the SEC’s Division of Corporate Finance.
While the Task Force is focusing on a wide variety of issues, those specifically highlighted by Mr. Ceresney were:
- Reserves relative to asset valuation and the manner in which management and auditors make decisions with respect to material estimates and reserves
- Revenue recognition, an area through which fraud is commonly perpetrated
- Audit firms as a whole, with an emphasis on (i)audit engagement partners and quality reviewers and (ii) independence violations - auditors violating the SEC’s independence rules for both public and non-public audits, including broker-dealer audits
- Audit committees who are charged with overseeing and monitoring the financial reporting process for failing to recognize potential red flags
- Companies publicly traded in the US with substantial foreign operations
- Company executives including the CEO, CFO and Controller in instances where a significant restatement or improper accounting occurs
Additionally, as noted by David Woodcock, the task force is placing a strong emphasis on indicators of fraud in non-GAAP measures, omissions from management discussion and analysis and faulty internal controls over financial reporting. It is expected that the task force will evolve and work to proactively identify accounting and disclosure issues, which could lead to the SEC prosecuting more common types of accounting irregularities.
“I generally like to say that the SEC is back and better than ever – and that certainly is the case when it comes to pursuing financial reporting and accounting fraud,” said Andrew Ceresney. With the SEC’s renewed focus on accounting fraud, the number of investigations undertaken by the enforcement division continues to increase. With this increased focus, the importance of reviewing and maintaining controls relating to financial performance and anti-fraud programs must remain a top priority for management. Additionally, a skeptical auditor, diligent audit committee, and a robust compliance program remain critical to avoiding unwanted exposure for public company directors and personnel.