Automated Detection in SEC Enforcement: Anticipating and Adapting to Emerging Accounting Fraud Enforcement Strategies

Mon May 19 16:24:38 EDT 2014
By Dr. Jerry Arnold and Raymund Wong

Although US Securities and Exchange Commission (SEC) enforcement actions related to financial fraud and issuer disclosures have been on a decline since 2007, recent statements and actions suggest that the SEC is likely to re-focus its efforts on detecting, pursuing, and preventing accounting fraud. Since her confirmation as Chair of the SEC, Mary Jo White has made it clear that her administration will focus on identifying and investigating accounting abuses at publicly-traded companies. Among the recent initiatives announced by the SEC are the increased focus on the whistle blower program and the establishment of the Financial Reporting and Audit Task Force, the Microcap Fraud Task Force, and the Center for Risk and Quantitative Analytics.

In this NERA paper, Affiliated Academic Dr. Jerry Arnold and Senior Consultant Raymund Wong examine the Accounting Quality Model (AQM), one of the tools that the SEC will utilize in the automated detection of fraudulent or improper financial reporting. The authors note that this may well shift the SEC's regulatory approach to increasingly incorporate the detection of potential accounting issues at earlier stages, prior to more rigorous examinations by the SEC. While it is unclear how the SEC might proceed after applying these first-stage screens, existing regulatory guidelines suggest that the theoretical economic impact of any potential accounting issues will be one important criterion in the mix of information considered by the SEC.

Companies, their outside accountants, corporate counsel, and others servicing the company’s reporting needs and obligations should be aware of what may trigger scrutiny in order to anticipate it and be prepared to explain legitimate financial reporting anomalies that may appear suspicious. To preempt SEC scrutiny, the authors advise, companies should demonstrate the application of acceptable accounting standards, anticipate potential market reactions and interpretations, and disclose the business reasons for potential financial reporting anomalies. A multi-disciplinary approach is advisable, given the broad areas of expertise required.