SEC Reveals Growth and Trends in Financial Fraud Reporting

By Kate Prouty

Over a quarter (27 percent) of the 598 actions that the Securities and Exchange Commission’s Division of Enforcement filed in 2002 fell under the financial fraud and issuer reporting category, making it the SEC’s largest category of cases received.

In order to manage this volume of cases, the Division of Enforcement is making strides to speed up its investigations, Susan Markel, SEC chief accountant, said at the SEC Practice Under the Sarbanes-Oxley Act Conference on Sept. 9. One of the major ways it does so is by bringing cases in pieces as they come, rather than waiting until all the details are neatly tied together in the end. Often this quick action prevents the destruction of important documents and the continuation of extraordinary payments to those perpetuating the fraud. Markel noted the SEC’s recent case with WorldCom as a situation in which her division’s immediate action secured a court order within 48 hours of fraud detection, thus preserving documents that might have been destroyed, complicating or delaying the case even further.

Financial fraud is categorically different from unintentional error and, Markel said, often happens when management feels the need to hit target numbers or tries to cover up simple mistakes. Regardless of the cause, some incentive or pressure for management to present misleading financial statements, whether it’s through action or omission, is most often present. The most common rationale for committing fraud is the assumption that a company will be able to meet false financial landmarks it projects in its next fiscal quarter, Markel said.

Over the past five years, the SEC has seen significant growth in the amount of enforcement investigations, financial fraud actions and actions involving Fortune 500 companies. Markel noted that in 1998 only about 5 percent of the actions the SEC filed involved Fortune 500 companies; in 2002, almost 18 percent did.

With Fortune 500 fraud on the rise, the SEC has placed more emphasis on personal accountability and the disgorgement of financial gains and bonuses, Markel said. The SEC assesses the financial impact of bad acts differently in every case, but paying increased attention to disgorgement in general could deter companies from committing financial fraud in the future. In addition to focusing on rescinding the liable executives’ bonuses, stock options and other forms of compensation, the SEC is also scrutinizing the conduct of other parties connected to the accused entity. Former employees and auditors, for example, would now face potential investigation.

Aside from Fortune 500–specific cases, the total amount of actions the SEC filed in 2002 (163) has more than doubled from what it filed five years ago in 1998 (79). In filing this exponentially growing number of cases, the Division of Enforcement has noticed a trend of more active and effective coordination with criminal authorities. It used to be difficult to get criminal authorities involved in accounting cases because they thought the data would be too dense for a jury to understand, Markel said. Now, because financial fraud is more common and publicly scrutinized, criminal authorities are much more likely to pursue a case. U.S. attorneys also seem to want the cases more than they ever did before, Markel added.

In addition to support from criminal authorities, the SEC now has more resources for monitoring fraud, such as its corporate fraud tax force. The general public also plays a huge role in fraud detection, Markel said. The SEC hears about potentially fraudulent acts through other agencies, self-reporting from businesses that want to fix errors they admit to making, auditor reports, informants and the SEC Complaint Center. The Complaint Center, online under Investor Information at www.sec.gov, gets 500 to 800 complaints a week, many of which concern financial fraud. The quality and specifics of these complaints vary greatly, Markel said, but they often lead to legitimate investigations of fraudulent activity.

After her presentation on financial fraud, Markel took questions in a panel discussion along with Carol Stacey, chief accountant for the SEC in the Division of Corporate Finance.