Calling Off the Dogs

Recent signals from the SEC raise the question: Is Harvey Pitt taking a softer line on financial fraud?

More Bark than Bite?

But while Pitt is clearly promoting a more conciliatory tone, it’s worth questioning how much a change of philosophy will change the life of the average corporate issuer. While Levitt wasn’t shy about using his bully pulpit to warn companies about straying from the straight and narrow of GAAP, a closer look at his overall record raises some questions about whether the agency’s bite ever lived up to his bark.

On balance, the average company’s chances of being slapped with an SEC lawsuit for financial-statement fraud during the Levitt regime hardly increased over previous years. The SEC initiated financial fraud actions involving 29 companies in fiscal 1999, 33 in 2000, and 28 in 2001, according to CFO’s analysis of the SEC’s litigation releases. These statistics fit smoothly into trends revealed in the 1999 fraud report sponsored by the Committee of Sponsoring Organizations of the Treadway Commission (known as the COSO Report), which found an average 27 companies per year facing penalties for financial-statement fraud between January 1987 and December 1997.

The types of issues that led to charges weren’t particularly distinctive, either. “These cases represent good old meat-and-potatoes deception; there’s nothing unusual about them or the number of people involved,” says Jack Ciesielski, publisher of the newsletter Analyst’s Accounting Observer. Indeed, prematurely or falsely recognized revenues were cited in an average 51 percent of the cases taken in each of the past three years, compared with 50 percent recorded in the COSO Report. Understatement of expenses or liabilities showed up in 18 percent of the COSO cases, compared with an average of 26 percent of those taken between 1998 and 2001.

And what of the ferocious Financial Fraud Task Force? Officially, the SEC has been tight-lipped about the specialized unit, which had no publicized involvement in any case for its first 18 months of existence. But at least one division insider pronounces the task force a mere “publicity ploy,” noting that “at most, they can take on only one or two cases at a time,” which doesn’t make a dent in the total number of potential enforcement actions.

Under any chairman, in fact, tight budgets and low salaries mean the SEC is unlikely to ever take on many more cases or move faster on them. “Congress has in no way given them sufficient resources to be an active watchdog,” says Turner. The enforcement division has only 20 to 25 accountants on staff, meaning it can work on only about five major cases at any given time, he says. Simply taking depositions from lower-level accounting staff to gather the ammunition necessary for CFO depositions can last several months, and when a case ultimately gets heard depends on the whims of administrative law judges. Cases can then be appealed to the commission, and beyond that, to a district court.

The Sunbeam case, which the SEC has been investigating since mid-1998, is a classic example of the sluggish process, says Turner: “My guess is they probably won’t even get to court until next year.”


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