Securities Enforcement Forum 2014 -- Financial Reporting and Accounting Fraud

Today I'm blogging from Securities Enforcement Forum 2014, Bruce Carton's excellent one-day conference, this year being held at the Four Seasons hotel in Washington, D.C.  The posts will be fairly raw, and certainly not verbatim accounts of what is being said. This post covers the accounting fraud panel. Marty Wilczynski at FTI Consulting moderating. 

Steve Cohen at the SEC:  Under new Chief Accountant Mike Maloney, we're redistributing staff accountants to enforcement groups to build knowledge and familiarity. 

Wilczynski: How are accountants working with the staff under the Financial Fraud Task Force? 

Cohen: The task force is a hybrid group. It generates leads and then farms them out to investigative groups. The Task Force is about a year old and trying to integrate more staff. We can consolidate best practices in how we look for cases and investigate them. 

Bill Baker at Latham & Watkins: Are regional offices part of this? 

Cohen:  Yes. 

Baker: Can you be talked out of proceeding? 

Cohen: Yes, but in the early stages of an investigation probably not. 

Jonathan Tuttle at Debevoise: What is the handoff point from Task Force to an investigative group? 

Cohen:  It depends on how complex the matter is. The harder it is, the longer the Task Force will keep it and develop it. 

Wilczynski: Bill, do you see differences in your interactions with the staff?

Baker: To me the biggest change is inquiries from CorpFin or comment letters can now turn into Enforcement investigations easily. You have to educate lawyers dealing with CorpFin staff that rewordings can lead to Enforcement involvement. David Woodcock and Margaret McGuire, the Task Force chairs, are not bashful about showing up early. 

Tuttle: You can end up in an enforcement investigation much sooner than corporate lawyers realize. 

Baker: The issuers can think enforcement defense lawyers are the problem by holding off indiscriminate document productions to CorpFin. 

Deborah Conner at U.S. Attorney's Office in D.C.: My office hasn't seen much generated from the Task Force.  Expect to see more as it grows.  We do training together but there's not regular reporting on this issue between SEC and DOJ.  We do have forensic accountants on our staff. 

Cohen: We've seen a lot of interest from DOJ in our accounting cases. 

Wilczynski: Any particular areas or trends that you're seeing? 

Baker: Internal controls, internal controls, internal controls.   Outgrowth of FCPA issues, but much broader today. 

Tuttle: More focus on technical accounting issues. 

Mike Trager at Arnold & Porter: We're seeing the staff be more methodical and so looking into areas that might not be obvious. 

Wilczynski: Internal controls. Extension of broken windows philosophy? 

Cohen: No. We're seeing an increase in revisions vs. restatements. Often we see large frauds in places without a lot of visibility to senior management. You can expect the focus on internal controls to continue, even in stand-alone, non-fraud cases.  Hard in my mind to segregate fraud/scienter from internal controls. But we're investigating internal controls from the outset more and more. 

Marty: Technology. New investments in this area by the government?  Effective?

Connor: We have to keep up with big law firms producing all of this data. We have data management systems to review and analyze information. I tell our staff to be careful about subpoenas because we have to understand what we collect. We also use technology from the FBI and IRS. 

Trager: Of course you could always narrow your requests for information. 

Wilczynski: Accounting Quality Model. What's the status? 

Cohen: We're seeing a renaissance in technology, both reacting to data and in seeking out accounting fraud. Commission created the Center for Risk and Quantitative Analytics last year. CRQA has been able to centralize these tools. Also access to a wide range of data and we assemble tools in house to process it. AQM is really just one small piece of what we're doing.  It's been refined over the last year and will get better, especially for earnings management. 

Trager:  What about false positives? 

Cohen: The AQM, e.g., looks at accruals compared to industry peers. It's just a red flag, not the entire case. We take those leads and then do due diligence from other sources. We don't want to waste staff resources either. Earlier meetings with companies can actually be useful to them. 

Baker: Yeah, but we're always in reactive mode. The requests we get are very open-ended. 

Tuttle: The staff won't share their specific concerns. From the defense side, there often are rational explanations for seemingly aberrant accounting. 

Cohen: We're not guided only by technology. The AQM and other tools are only leads. These tools (and reasonable corporate explanations) have sometimes led us not to pursue investigations. 

Linda Thomsen (Davis Polk) question: How frequently can defense counsel talk the staff out of a case? 

Trager: Rarely. An early presentation can backfire and give the staff more information to pursue. 

Cohen: I can't think of an investigation where we held it against the company for not knowing all the facts very early in an investigation. 

Cohen: Gatekeepers and auditors are very important for our investigations.  We're willing to bring cases against auditors for their failures even if not necessarily fraud by the underlying companies. 

Tuttle: Before maybe there were too many restatements. It's a pendulum going back and forth on that. 

Baker: Last week I spent three hours in testimony where the staff accountant went through SAB 99 line by line. Unusual to see that level of detail. 

Cohen: An admission is not a negotiable part of a settlement. We've raised them early so people aren't caught off guard. 

Connor: If a person chooses to admit or not, we have our own DOJ investigation. 

Baker: As a result of a PCAOB exam, an auditing firm can change its position in a way that causes a company to make a restatement. Then an investigation opens. It changes how the auditors react to you in real time. 

Mark Adler at PCAOB: I'd like to think we're contributing to the mission.  We do cooperate with the SEC. 

Trager:  What about admissions in non-fraud cases? 

Cohen: Scienter isn't necessarily required for admissions.  There are about a dozen of them.  Soon we'll stop counting but it will continue to be an exception rather than the rule. 

Trager:  Also may help avoid a fraud charge if you admit to negligence. 

Tuttle: When you add admissions, you may remove the last benefit of settlement and force a case to trial.  Individuals have a lot of incentive to litigate. 

Cohen: And you can assume that's fine with us. 

Baker: Sharp increase in trials, but those have mostly not involved accounting cases.