[Editor’s Note: The following update is authored by Arnold & Porter LLP]
On July 2, 2013, the Securities and Exchange Commission (SEC) announced three new enforcement initiatives: the Financial Reporting and Audit Task Force, the Microcap Fraud Task Force, and the Center for Risk and Quantitative Analytics. According to the SEC’s announcement, these initiatives are an effort to “build on its Division of Enforcement’s ongoing efforts to concentrate resources on high-risk areas of the market and bring cutting-edge technology and analytical capacity to bear in its investigations.”
These new initiatives, along with recent press reports that the Enforcement Division would no longer settle certain cases without obtaining admissions of wrongdoing (for example, where misconduct harmed a large number of investors), are among the first steps taken by the SEC under the leadership of new Chairman Mary Jo White, who has pledged “to further strengthen the enforcement function of the SEC” in a way that is “bold and unrelenting.”
Financial Reporting and Audit Task Force
It has been reported in the press that the financial crisis that emerged in 2008, along with the widely publicized Ponzi schemes that came to light around the same time, shifted the SEC’s primary focus away from financial reporting fraud such as the high-profile investigations of WorldCom, Adelphia, and Enron that had taken place in the early 2000s. Notably, at the beginning of the Obama Administration, the Enforcement Division established five specialized units focusing on particular enforcement priorities but none with a particular emphasis on accounting fraud and financial reporting issues. Now, as financial crisis and other fraud litigation wanes, the SEC is establishing a task force specifically focused on financial reporting and auditing.
The Financial Reporting and Audit Task Force will concentrate on the preparation of financial statements, issuer reporting and disclosure, and audit failures with the goal of detecting fraud and increasing the prosecution of violations involving false or misleading financial statements and disclosures. The Task Force will identify issues for potential investigation by reviewing restatements, looking at industry trends, and using technology-based tools such as the SEC’s proprietary Accounting Quality Model (AQM). The AQM is a model that compares registrants’ filings and seeks to identify filings that are anomalous, with a particular aim at identifying instances of earnings management. The SEC has employed a similar tool, the Aberrational Performance Inquiry (API), in overseeing hedge funds.
Although the Financial Reporting and Audit Task Force formalizes the SEC’s renewed focus in this area, there already has been an increase in SEC administrative proceedings against auditors in recent months, primarily under SEC Rule of Practice 102(e). Although many of these cases arose from audits of companies that were impacted by the financial crisis, it is likely that the Task Force will continue to make use of Rule 102(e) proceedings in enforcement actions against accounting firms and auditors.
The Financial Reporting and Audit Task Force will be led by David Woodcock, Director of the Fort Worth Regional Office. The Task Force will include Enforcement Division attorneys and accountants from across the country who will work with the 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.
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