One of the challenges for the compliance community and private securities bar is trying to anticipate what the focus of the various regulators will be in coming years and months. Recently, the Securities and Exchange Commission (“SEC”) provided guidance as to where the Division of Enforcement is planning on directing its resources in coming months. In July 2013, the SEC announced the formation of a new enforcement task force, the Financial Reporting and Audit Task Force. This task force was created after Mary Jo White announced, upon joining the Commission in May, that she was going to give a hard look to accounting fraud. The Financial Reporting and Audit Task Force is headed by David Woodcock and Margaret McGuire, both attorneys in the Enforcement Division.
Through recent speeches and interviews, the team leading the new task force have made their priorities clear. They are assembling a group of attorneys and accountants, including forensic accountants, to be “thought leaders” in the area of accounting fraud. This team will work together to investigate matters, but also act as a resource for the entire Enforcement Division in its investigations of accounting fraud. The team believes that as the economy improves, accounting fraud increases because it is easier to hide.
The task force is focused initially on five areas of potential fraud: accounting revisions, differences in book earnings versus taxable income, off-balance-sheet transactions, non-GAAP measures, and material weakness and internal controls failures. While some of these areas of focus apply primarily to public companies, others, such as material weakness and internal controls failures, apply to alternative investment vehicles and the accounting companies that audit these vehicles. If the Big Four are under increased scrutiny, this will also apply to their clients and could result in notice letters or withdrawn audits. If an audit is withdrawn, the accounting firm will notify the SEC, and both the accounting firm and the investment vehicle will be subject to increased scrutiny and examination. When the SEC is aware of these issues, through reporting requirements, audits, or whistleblowers, this will be a large red flag for enforcement staff and will prompt increased attention. Often an organization will not even know it is under investigation in the early stages of the matter, as investigations are non-public and subpoenas are not issued immediately.
Fortunately, there are ways to avoid being the subject of an investigation by the Financial Reporting and Audit Task Force. As McGuire said in a recent interview, "the best weapon against financial reporting issues is a robust compliance program." A robust compliance program not only promotes a culture of accountability, thereby reducing the opportunity for any misconduct, but it also would be a way to spot any failures before they create large accounting issues. Material weakness and internal controls failures can, unfortunately, take place at alternative investment vehicles, as well as large public corporations, and a compliance program can flag these areas before they become a liability. With a well-run compliance program, the chances that your organization ends up in the cross-hairs of the new task force are greatly reduced because the team will flag areas of concern and provide opportunities for remediation prior to potential violations occurring. In addition, if there is a failure in the organization, a robust compliance program has the added bonus of bringing the failure to the compliance officer’s attention, making it possible for the organization to self-report if it would be advantageous to do so. The SEC, FINRA, and other similarly situated agencies all give significant credit to institutions that self-report, as was emphasized by Woodcock himself in discussing the work of the new task force.