Manual What Every Investor Needs to Know About Accounting Fraud

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We have additional controls, but controls are not always effective at finding fraud. In the end, our view is that we will not know whether there has been an overall reduction in accounting fraud until we devote the resources to find out, which is what we are doing. The importance of pursuing financial fraud cannot be overstated.

What Every Investor Needs to Know about Accounting Fraud

Comprehensive, accurate and reliable financial reporting is the bedrock upon which our markets are based because false financial information saps investor confidence and erodes the integrity of the markets. For our capital markets to thrive, investors must be able to receive an unvarnished assessment of a company's financial condition. Financial reports must provide transparency for investors, and must not obscure the truth, even if that truth is inconvenient.

The last decade is full of painful reminders of how important reliable information is to investors, to markets and to regulators.

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And so, in a post-crisis world, the SEC must renew its focus on financial reporting and accounting so that investors and regulators receive the accurate information that sustains our markets. We decided the best way to pivot away from the financial crisis cases and refocus on accounting fraud was through the task force model.

As you know, three years ago, we created five specialized units to handle specific areas of the securities laws. We did not at that time create an accounting fraud unit. There were many reasons for that, including that such a unit would need to be very large, would have to include many lawyers and accountants, and that accounting fraud cases are the bread and butter of many different parts of the Division.

Those same concerns are still with us now, as we look to the future. We decided instead that what we needed was a small group of people focused on case generation — on exploring proactive initiatives that would generate new accounting fraud investigations for staff in the Division to pursue.

There are a lot of promising methods out there for determining the companies on which we should be focused. We have new ways of crunching data that allow us to isolate potential red flags and trends; other regulators are uncovering potential issues; whistleblowers are bringing us invaluable information But we thought we needed a group of people to focus on harnessing all of these resources.

What Every Investor Needs to Know About Accounting Fraud

Often, when you get a group of smart people in a room focused on a problem, you can find the answer. Kind of reminds me of that scene in Apollo 13 where they bring all of the disparate tools available on the space capsule into a room, dump it on to a table in front of a bunch of smart people, and say find a way to fix the problem.

This is our Apollo 13 moment. The task force has about 12 staffers, both lawyers and accountants. Its objective is to improve our ability to detect and prevent financial statement and other accounting fraud. It will be devoted to developing state-of-the-art methodologies that better uncover accounting fraud and incubating cases that will then be handled by other groups within the Enforcement Division.

To fulfill its mandate and find promising investigations, the task force is launching various initiatives. These may include closely monitoring high-risk companies to identify potential misconduct, analyzing performance trends by industry, reviewing class action and other filings related to alleged fraudulent financial reporting, tapping into academic work on accounting and auditing fraud, and conducting street sweeps in particular industries and accounting areas.

With this tool, we can better compare performance across industries and detect outliers that suggest possible fraud. As for specific areas of focus, I anticipate that the task force and our investigative staff will continue to cover a wide variety of issues. For example:. While we expect that the task force will develop additional methodologies for uncovering fraud, and will generate additional cases, it is also important to note that we recently brought several significant financial reporting cases and have plenty more in the pipeline.

We also charged BP with misleading investors during the Deepwater Horizon oil spill by significantly understating the oil flow rate in multiple reports filed with the SEC.

Detecting Financial Statement Fraud

And we charged a Fortune company for various accounting deficiencies that distorted their financial reporting to investors in the midst of the financial crisis. We also brought an action against the Chinese affiliates of the Big Four accounting firms for refusing to produce audit work papers and other documents related to China-based companies under investigation by the SEC for potential accounting fraud against U.

The coming weeks will see some additional accounting fraud and disclosure cases being brought. Ultimately, the task force demonstrates our renewed commitment to prosecute those who betray the trust of the public markets. But bringing actions after the fact is no substitute for full and honest disclosure at the outset. Enforcement actions are little comfort for investors who lost their savings after relying on misrepresentations and half-truths.

Shareholders should be able to rely on accurate accounting, effective auditing, and transparent financial reporting.

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And we believe that our renewed focus on accounting and financial reporting fraud will result in better compliance within the industry by sending a clear, strong message that deters both current and future wrongdoers. Finally, let me be clear that we will use all the tools in our arsenal, including disgorgement, monetary penalties and e bars against accountants.

Sarbanes Section also provides us with the ability to claw back bonus money received or the proceeds of stock sales that occurred during a period when the company's financial statements were misstated. And in appropriate cases we will exercise this authority. I should add that accounting fraud cases take lots of resources and effort.

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  • They often require a lot of financial analysis, mounds of documents, and lots of testimony. But we are prepared to devote the resources. These are important cases and our performance should be judged by the quality, and not the quantity, of our cases. And we will in appropriate cases seek admissions to the misconduct under our new settlement approach of seeking admissions of facts in certain types of cases.

    As many of you know, our settlement approach, much like numerous other federal regulators, had been to settle essentially all of our cases on a no-admit-no-deny basis. The SEC has been incredibly successful in achieving great settlements with this policy and it will still be an important approach that applies in most cases. This settlement approach has allowed us to achieve quick results and provide prompt relief to investors, while also allowing us to conserve resources and eliminate litigation risk.

    This interest in obtaining quick relief, conserving resources, and avoiding litigation risk will typically trump the need for admissions in order to better achieve the goals of our enforcement program. We recently modified our traditional approach in cases where there has been a criminal or regulatory settlement with admissions.

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    But there also is a group of cases where a public airing of unambiguous facts — whether through admissions or a trial — serve such an important public interest that we will demand admissions, and if the defendant is not prepared to admit the conduct, litigate the case at trial. I analogize it to a guilty plea in a criminal case — there is a certain amount of accountability that comes from a defendant admitting to unambiguous, uncontested facts.

    It is in many respects a cathartic moment. And there can be no denying the facts under those circumstances. This could include matters involving a large number of harmed investors, where the conduct presented a significant risk to the market, where admissions would safeguard the investing public from risks posed by defendants, and where a recitation of unambiguous facts is important to send a message to the market about a particular case. At the same time, the majority of cases will continue to be resolved on a no admit no deny basis, as the interest in quick resolutions and settlements will, in most cases, outweigh the interests in obtaining admissions.

    We believe this new policy will strengthen our hand in enforcement actions without hampering our ability to effectively and efficiently enforce our securities laws. And the policy is already starting to bear fruit as we recently had our first instance of obtaining these sorts of admissions. In the Harbinger case, Mr. Falcone agreed to admissions in connection with both the loan and short squeeze cases against him — serious misconduct that amounted to violations of the securities laws.

    In that case, we felt that the egregiousness of the conduct, as well as the fact that Falcone is still dealing with investors who should know the unvarnished truth, justified this approach and that admissions brought accountability and acceptance of responsibility. Then follows two sections on how board practices should serve the owners of the companies and governmental regulatory initiatives and bodies related to financial supervision.

    I expected some discussion on how to use financial tools like cash conversion, change in accruals, change in Days Sales Outstanding, Days Sales in Inventory or other less frequently used metrics perhaps in combination with other more subtle signs of ethical collapse in companies. This is a rather superfluous message since it has to a large extent been the overall message so far.

    Invest in mutual funds, ETFs, T-bills and bonds instead of individual stocks. Talk about a let down! In all honesty there are two other chapters that look into investing in stocks. Nov 01, David rated it liked it.

    What is accounting fraud?

    About two thirds of this book is useful. The useful parts explain common ways fraudulent behavior happens and how to detect it to a lesser extent. The last third, for some odd reason, tries to be an introduction to investing book. This part has no correlation with the rest of the book. I would still recommend this book skipping the last part if you aren't familiar with accounting fraud and are an investor.

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