Thursday, February 12, 2015

Current and Former SEC Officials Discuss Financial Fraud Developments

[This story previously appeared in Securities Regulation Daily.]

By Amanda Maine, J.D.

The SEC’s whistleblower program has been a “game changer” as a source for financial fraud cases, according to the Division of Enforcement’s chief accountant, Michael Maloney. Maloney made his remarks at a program sponsored by the D.C. Bar and was joined by Senior Legal Advisor Charles Wright, as well as former Enforcement chief accountants Howard Scheck and Susan Markel.

Although the Division still finds potential cases through traditional sources such as restatements, SEC filings, self-reporting, and internal and external referrals, tips received through the SEC’s whistleblower program have been a helpful development, Maloney said. It allows the staff a birds-eye view how events potentially implicating financial fraud occurred and sometimes the staff is able to receive information from whistleblowers in real time.
Maloney also said he was “pleasantly surprised” by large companies self-reporting on complex issues. Markel, now at AlixPartners, voiced her concerns about self-reporting, advising that some companies do not want to “put their neck in a noose” by self-reporting possible financial statement irregularities. She wondered if companies could be incentivized to self-report in a system similar to the whistleblower program.

Cooperation and collaboration. Wright said that communication with the PCAOB is important in the chief accountant’s office. The staff reviews the board’s accounting standards and concept releases and provides feedback from an enforcement perspective. The enforcement divisions of the respective organizations have also collaborated by bringing cases together, such as the 2011 enforcement actions against PricewaterhouseCooper’s India affiliates for deficient audits, as well as recent sanctions against auditors of broker-dealers that violated auditor independence rules, he said.

Enforcement’s Office of the Chief Accountant also works with the Commission’s Office of the Chief Accountant (OCA), including consulting with OCA on action memoranda to the Commission, which set forth Division recommendations and provide a comprehensive explanation of the recommendations’ factual and legal foundations. One audience member inquired how Enforcement’s chief accountant staff resolves differences with OCA. Maloney said that the two offices generally work through any disagreements and, at the end of the day, the Commission itself has the final say. Scheck, now with KPMG, advised that the two offices will make sure that contentious issues are resolved before the action memo stage.

At what stage in an investigation Enforcement will reach out to other offices within the SEC or agencies outside the SEC may depend on what kind of accounting issue is involved, Scheck said. For issues considered to be “close calls,” the staff will reach out earlier. Wright added that for risk-based investigations, Enforcement is more likely to seek input from others.

Defense counsel. Another audience member asked how receptive the staff is to receiving input from accounting experts hired by defense counsel. Maloney said that having an expert explain opinions can be helpful to understanding how the individuals being investigated arrived at their decisions, even if the staff doesn’t necessarily agree with the opinions. Scheck cautioned, however, that the opinion of an expert is only helpful if he or she is realistic about an issuer’s weakness, and is not there just to “offer spin.”

The panel was also asked about the use of “pre-Wells submissions” or white papers, and whether they are helpful to an SEC investigation. Wright said that these submissions can be useful, particularly for inquiring about the use of an expert prior to the Wells stage. He warned that a series of several white papers is less useful, however.

Trends. Revenue recognition issues continue to top the list of problem areas encountered by his office, Maloney said. Expense recognition and valuation issues also arise frequently. He also highlighted the importance of maintaining effective internal controls, noting that important cases that involve frequent issues in financial statements often implicate the effectiveness of a company’s internal controls over financial reporting.

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