A casual observer of Securities and Exchange Commission trends could be forgiven for concluding that the SEC has lost interest in pursuing enforcement of financial reporting regulations. In fact, the commission is intent on bringing record numbers of such cases and has some new tools and resources for doing so.
In 2013, the SEC brought fewer enforcement actions involving financial fraud and issuer disclosure — 68 — than during any year in the previous decade. Even including Foreign Corrupt Practices Act cases, the number was still a record-low 73, compared to 94 cases brought the previous year and far down from the high-water mark of 219 in 2007. But recent developments suggest that the downward trend will turn, perhaps dramatically, in 2014.
Whistleblower Bounties and Tips
For one thing, the Dodd-Frank whistleblower bounty program is gaining steam. Under the program, informants who provide the SEC with original information may ultimately receive a percentage of any monetary recoveries as a result of enforcement action. For the first two full years of the program’s operation, 2012 and 2013, the single biggest category of tips received by the SEC involved corporate disclosures and financials: 547 and 557 tips, respectively, for those years. On October 1, the SEC awarded its largest bounty to date: $14 million, which may drive the number of tips still higher in 2014. As these tips work their way through the SEC, more enforcement actions will result.
Special Tools and Tactics
In July, the SEC’s Enforcement Division announced the formation of the Financial Reporting and Audit Task Force, a group of enforcement attorneys and accountants from across the country who will be tasked with identifying financial-statement, issuer-reporting and disclosure violations. The task force will work with the Enforcement Division’s Office of the Chief Accountant, the SEC’s Office of the Chief Accountant, the Division of Corporation Finance and the Division of Economic and Risk Analysis.
One weapon in the task force arsenal is the much-discussed Accounting Quality Model (AQM), colloquially known as RoboCop. The SEC describes AQM as a quantitative analytic “model that allows us to discern whether a registrant’s financial statements stick out from the pack.”
Using AQM, the SEC attempts to detect earnings management by looking at discretionary accounting choices by, for instance, examining total accruals and then estimating discretionary accruals. The AQM then classifies the estimated discretionary accruals as risk indicators (factors that are directly associated with earnings management) or risk inducers (strong incentives for earnings management). AQM produces a score for each filing and compares it with the filer’s industry peer group, assessing the likelihood that fraud is occurring.