SEC renews its focus on accounting fraud

When the financial crisis hit Wall Street, regulators at the Securities and Exchange Commission turned their focus to financial institutions, Dodd-Frank and the like. Now, however, as the financial markets recover and many assume the economic crisis has passed, the agency is going back to the basics.

SEC sets its sights on accounting
Before the recession, the SEC put a much greater focus on accounting fraud and financial disclosure missteps. According to The Wall Street Journal, these cases made up 25 percent of civil-enforcement actions filed by the SEC between 2003 and 2005. This number dropped to 11 percent after the subprime mortgage crisis, when the SEC switched its focus to deal with other issues. Now, however, The Wall Street Journal reports that the SEC is refocusing on classic accounting fraud by issuers once more as the number of enforcement cases related to subprime loans and mortgage bonds wind down.

The refocused effort involves, predictably, big data analytics. The SEC has already had success using its new "Accounting Quality Model," a project that takes advantage of the SEC's ability to mine its own data. Craig Lewis, chief economist and director of the Division of Risk, Strategy and Financial Innovation at the SEC, described the AQM in a speech given in December of 2012. As he put it, AQM is designed to "provide a set of quantitative analytics" that the SEC can use to see to what degree a particular registrant's filings "appear to be anomalous" when compared to its peers.

The SEC isn't just looking at the numbers. It also plans to use specially designed software to help analyze a registrant's MD&A (Management Discussion and Analysis) section. The SEC believes that the word choices used in reports may play a part in detecting fraud. Lewis has noted that companies that are playing fast and loose with accounting rules are prone to playing "word shell game[s]." The Wall Street Journal spoke with experts who claimed businesses that knowingly break the rules often draw attention to unimportant issues, while minimizing the time spent discussing the company's core risks.

Future reports should be filed with caution
With the SEC's renewed focus on detecting discrepancies and filing enforcement actions against corporations it believes have committed accounting fraud, businesses filing reports with the SEC will need to be increasingly cautious. Proper disclosure of risks and accounting practices that may have an impact on shareholders will be even more important as the SEC's enforcement strategies shift. Failure to  accurately report could spark significant issues for many reporting companies.

The views expressed in this blog are solely those of the author. This blog should not be taken as insurance or legal advice for your particular situation. Questions? Comments? Concerns? Email: phuskins@woodruffsawyer.com.