The Securities and Exchange Commission’s enforcement division is launching three new initiatives to combat financial reporting and microcap fraud and enhance its risk analysis capabilities with the use of sophisticated analytical technology.
The Financial Reporting and Audit Task Force will be devoted to detecting fraudulent or improper financial reporting, enhancing the Division of Enforcement’s ongoing efforts related to accounting and disclosure fraud. The SEC said Tuesday the Financial Reporting and Audit Task Force would concentrate on expanding and strengthening the division’s efforts to identify securities-law violations relating to the preparation of financial statements, issuer reporting and disclosure, and audit failures. Word of the SEC’s increasing focus on accounting fraud began leaking out of the agency earlier this year after new SEC chair Mary Jo White, a former federal prosecutor, hired two co-directors of the enforcement division, George Canellos and Andrew Ceresney, who are also former prosecutors (see SEC Refocuses on Accounting Fraud).
“These initiatives build on the division’s unmatched record of achievement and signal our increasingly proactive approach to identifying fraud,” Ceresney said in a statement. “By directing resources, skill, and experience to high-impact areas, we will increase the potential for uncovering financial statement and microcap fraud early and bring more cases aimed at deterring these types of unlawful activity.”
The principal goal of the task force will be fraud detection and increased prosecution of violations involving false or misleading financial statements and disclosures. The task force will focus on identifying and exploring areas susceptible to fraudulent financial reporting, including on-going review of financial statement restatements and revisions, analysis of performance trends by industry, and use of technology-based tools such as the SEC’s Accounting Quality Model.
In a speech last December, Craig M. Lewis, chief economist and director of the SEC’s Division of Risk, Strategy and Financial Innovation, discussed what the Accounting Quality Model is. He said the AQM was 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. “At the highest level of generality it is a model that allows us to discern whether a registrant’s financial statements stick out from the pack, while taking into account the contemporaneous attributes of that pack,” he said. “The goal is to facilitate comparison across firms within their industry while accounting for and illustrating industry differences as well.”
The new task force will include SEC enforcement attorneys and accountants from across the country, working in close consultation 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. David Woodcock, director of the Fort Worth Regional Office, who is also a CPA, will serve as chairman of the new task force, and Margaret McGuire, senior counsel to the directors, will serve as vice-chair.
Targeting Microcap Fraud
The SEC also said Tuesday it was setting up a Microcap Fraud Task Force to target abusive trading and fraudulent conduct in securities issued by microcap companies, especially those that do not regularly publicly report their financial results. The Microcap Fraud Task Force will investigate fraud in the issuance, marketing and trading of microcap securities. The abuses frequently involve serial violators and organized syndicates that employ new media, especially Web sites and social media, to conduct fraudulent promotional campaigns and engage in manipulative trading strategies to amass ill-gotten gains, largely at the expense of less sophisticated investors, according to the SEC. The principal goal of the task force will be to develop and implement long-term strategies for detecting and combating fraud in the microcap market, especially by targeting "gatekeepers," such as attorneys, auditors, broker-dealers, and transfer agents, and other significant participants, such as stock promoters and purveyors of shell companies.
The Microcap Fraud Task Force will build on the extensive and successful work of the Microcap Fraud Working Group—which was created in 2010 to bring together enforcement and examination staff with common interests in detecting and preventing microcap fraud—in amassing data, developing new approaches to investigations in this sector of the market, and forging relationships with criminal law enforcement authorities. The new task force will not replace the working group but will differ from it in that it will consist of staff dedicated exclusively to investigation of participants in the microcap securities market. Elisha Frank, assistant regional director in the Miami Regional Office, and Michael Paley, assistant regional director in the New York Regional Office, will lead the Microcap Fraud Task Force.
The third new initiative announced Tuesday, the Center for Risk and Quantitative Analytics, will use quantitative data and analysis to profile high-risk behaviors and transactions and support initiatives to detect misconduct, increasing the enforcement division’s ability to investigate and prevent conduct that harms investors.
The Center for Risk and Quantitative Analytics will support and coordinate the enforcement division’s risk identification, risk assessment and data analytic activities by identifying risks and threats that could harm investors, and assist staff nationwide in conducting risk-based investigations and developing methods of monitoring for signs of possible wrongdoing. It will work in close association with other SEC offices and divisions, especially the Division of Economic and Risk Analysis, and provide guidance to the enforcement division’s leadership on how to allocate resources strategically in light of identified risks. As a central point of contact for risk-based initiatives nationwide, CRQA will serve as both an analytical hub and source of information about characteristics and patterns indicative of possible fraud or other illegality.
Lori Walsh, formerly deputy chief of the Office of Market Intelligence, will lead the CRQA.
“The best investigative ideas usually come from the grass roots—staff in the field observing the market first-hand,” said Canellos in a statement. “A key objective of the Center for Risk and Quantitative Analytics will be to assist these staff members, bringing them analytical techniques and computing capacity with special expertise in data mining, and help them translate their valuable ideas into timely, thoughtful and targeted investigations of national scope.”