SEC and PCAOB Team to Combat Accounting Fraud
The Securities and Exchange Commission and the Public Company Accounting Oversight Board are expanding their efforts to deter accounting fraud, reaching out to academics, practitioners and others to find ways to better detect accounting fraud.
The SEC announced new initiatives in July to target the problem, including a new Financial Reporting and Audit Task Force (see SEC Creates Task Force to Combat Accounting Fraud). SEC chief accountant Paul Beswick and PCAOB board member Jay Hanson talked more about the initiative during a joint discussion Tuesday at Financial Executives International’s Current Financial Reporting Issues conference in New York.
The SEC’s Financial Reporting and Audit Task Force has roughly eight accountants and attorneys, according to Beswick.
“The idea is to have this group act as an incubator to build accounting fraud cases and hand over the cases to the larger sections within the SEC,” said Beswick. “To provide a little more context on this, for the last several years, we spent a lot of time on financial fraud cases within the financial crisis. We’ve brought cases against 161 individuals, including 66 CEOs, CFOs and senior officials and recovered almost $2.7 billion. As we’re getting to the end of the financial fraud cases, we’re continuing to think about what investigations are appropriate. One of the things that was interesting to some of the leadership in the enforcement division was that the financial reporting cases used to be a much larger percentage of the investigations relative to some of the other types of investigations we do.
"There can be a number of reasons for that," he continued. "One is that it would coincide with the decrease in the number of restatements. There has been speculation that Sarbanes-Oxley has improved the quality of financial reporting and therefore there has been less reason to bring financial fraud cases. Personally I think all of those have had a positive effect on the quality of financial reporting, but we’re continuing to look in this space. What we’re trying not to do is come up with a set number of cases that we need to bring, but really just focus on the accounting and make sure that we’re bringing the right kinds of cases.”
Some of the areas of focus for the task force are revenue recognition, valuation, capitalized versus noncapitalized expenses, reserves, acquisition accounting and other performance benchmarks, Beswick noted.
“One of the things that the enforcement division has been highlighting recently is the fact that many of our accounting fraud cases come as a result of whistleblowers,” he added. “Last year, 547 tips relating to corporate disclosure were received. That process has been really helpful in terms of identifying cases to bring.”
The SEC also has been developing computer analytics tools to detect accounting fraud, including a so-called Accounting Quality Model, or AQM, which is designed to provide a set of quantitative analytics that could be used across the SEC to assess the degree to which registrants’ financial statements appear anomalous.
Beswick was asked by Accounting Today during a press conference following the presentation about what specific indicators are used in the model by the SEC’s Division of Enforcement, which works with the SEC’s Office of the Chief Accountant that he leads, as a sign of accounting fraud.
“I think the Enforcement Division does a good job of looking at a number of different things that could result in indications of where fraud might exist,” he responded. “I think the AQM model is one sort of toolkit to try to identify areas to focus on. In terms of a specific item within the AQM model, we probably need to be a little careful, in that any one of those isn’t determinative of whether or not there might be fraud. You need to look at the whole picture. I forget the number, but it’s somewhere between 15 to 20 different items that could be listed as an indicator to build a total picture, but it’s just one toolkit. I’m a little worried about context, that this is always an indicator of fraud. It’s not. You have to think about everything that’s going on at the company.”
Hanson noted that the PCAOB is developing its own audit quality indicators, but it is still early in that process. However, it is also working with the SEC on enforcement activities.
“Holistically, there is a lot of interaction between the PCAOB enforcement staff and the SEC enforcement staff,” he said. “The SEC enforcement division has the right to bring cases against auditors. They’ve always had that right. We’re newer on the scene in the last 10 years, and for the most part we take the lead on audit-related cases, but not always. There’s always a discussion about the cases. With the audit quality indicators project, we haven’t drawn a lot of linkage yet in that group, but we’re very, very early on in that project with SEC enforcement. However, at our Standing Advisory Group meeting last week, we had a couple of hours’ discussion about something we’re thinking about forming, which is a Fraud Risk Task Force. The two leaders of the SEC enforcement task force would join us on a panel so they could talk about what they were doing. The ultimate output of our Fraud Risk Task Force is a little bit unclear. It would be gathering academics, practitioners and auditors and others with a strong interest in the topic to holistically consider whether there are things that we could and should be doing, either in enforcement, standard setting or inspections relative to financial statement fraud and fraud risk. Through that process, I would expect there will be a lot of dialogue back and forth to share some common interests.”
Mandatory Firm Rotation and IFRS
Hanson also discussed at the conference about some of the PCAOB’s other work, including its concept release proposing mandatory audit firm rotation, which appears increasingly unlikely given the overwhelmingly negative feedback it received and a lopsided bipartisan vote by the House of Representatives earlier this year on a bill that would prohibit requiring companies to rotate their auditing firms.
“We have no current activities going on relative to mandatory firm rotation,” said Hanson. “We’re watching what’s happening with all the audit reforms in Europe. We’re considering that, but I personally cannot imagine that we would ever go forward with mandatory firm rotation.”
Beswick pointed out that the proposals in Europe and other parts of the world for mandatory firm rotation or retendering are important, however. “There is a lot in the fact that what we’re hearing is there are U.S.-listed companies that are also listed over in Europe that are getting caught up in the rotation issue. There are people who have come in and said, I wouldn’t have rotated, but I’m listed in these two jurisdictions and it’s required for me to rotate there.’ Large multinationals are having to face this issue to the extent they’re listed in more than one exchange in the U.S.”
Beswick also gave an update on what is happening with the SEC approving use of International Financial Reporting Standards by U.S. companies, which isn’t much right now as the SEC continues to focus on drawing up regulations related to the Dodd-Frank Act. “In terms of timing, we frequently get that question, when is the commission going to move forward? As everyone is well aware, they’ve gotten out a lot of the Dodd-Frank rulemakings, but they continue to have to work through some, like the Volcker Rule and others,” said Beswick. “That’s not to say it’s not important, but at times you have to think about what the commission can handle in terms of bandwidth. But I’m hopeful the commission can turn its attention to this issue [of IFRS] soon and provide some clarity because that’s the one thing we do hear from people, in terms of how they would like to have the commission provide more clarity on what the next steps are.”