Outliers and broken windows – SEC vows closer scrutiny of financial reporting and audit fraud

After several years of focusing primarily on litigation and other actions stemming from the financial crisis, the Securities and Exchange Commission has indicated that it will now be looking toward other areas, including financial reporting and audit fraud. Andrew Ceresney, the SEC’s head of enforcement, recently commented to the Wall Street Journal CFO Network that his agency’s watchdogs will be looking more closely for red flags at corporations as well as audit firms that could indicate fraudulent activity or cover-ups.

And SEC Chairwoman Mary Jo White has stated that one of the commission’s goals is to see that the enforcement program is everywhere, both in actuality and perception, “pursuing all types of violations of our federal securities laws, big and small.” She cited the “broken window” theory that was used so successfully by New York in its crackdown on crime – that when somebody breaks a window and nothing is done in response, it “is a signal that no one cares, and so breaking more windows costs nothing.”  

What does this mean for IROs? A Latham and Watkins webinar this past week noted that the SEC is expanding its Accounting Quality Model to include more stringent analysis of a company’s MD&A, press releases and other investor communications. The SEC also is beefing up its staff expertise by conducting more rigorous training, hiring industry experts with quantitative skills and forming specialized units such as the Financial Reporting and Audit Task Force and Center for Risk and Quantitative Analysis.  

Such an environment will require public companies to take a closer look at all of their communications to investors, to avoid raising suspicions. Here are some recommendations: 

Don’t be an outlier.

Be familiar with best practices in your industry for metrics and risks, and be sure to understand how your organization looks in comparison with its peers.  And, if the industry standards don’t work for your company – make sure that you clearly provide a clear and helpful explanation as to why that is the case. 

Be consistent in your messaging.

Pay careful attention to the accuracy and consistency of your messaging, including calculations used in marketing materials and quarterly reports.  This is an area where the Disclosure Committee can play an important role, and where clear communication among members of management, auditors and the audit committee will help to prevent inquiries from the SEC.      

Adopt a rigorous social media policy.

While electronic communications have been the subject of SEC reviews for some time, the SEC has expanded beyond employee emails to now include text messages, instant messaging and other forms of online communications.  So, it is important to have a social media policy, make sure employees understand it and know how it is being used every day. It is all fair game now, and the rise of social media brings a host of new challenges for companies. 

Chairwoman White notes that ignoring “broken windows” can quickly foster a culture that sees laws as “nothing more than toothless guidelines.” That’s why, in the future, the SEC will be looking to uncover even the smallest infractions, and companies will need to be more diligent than ever in establishing strong internal controls supported by clear and transparent messaging.

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