Accounting fraud is ripe for fresh scrutiny

December 30, 2014

By Reynolds Holding

The author is a Reuters Breakingviews columnist. The opinions expressed are his own. 

Dodgy numbers will replace insider trading as Wall Street watchdogs’ preferred prey in 2015. New auditing and analytics have already given the U.S. Securities and Exchange Commission a head start, even if the 2002 Sarbanes-Oxley reforms make cases of accounting fraud harder to track down.

American enforcers have racked up hefty settlements and priceless publicity pursuing the likes of SAC Capital for trading illegally on secrets. The SEC alone filed 52 such cases in fiscal 2014, near the 2006 high of 61.

Meanwhile, the number of accounting fraud actions has fallen about 60 percent since peaking at 219 in 2007. SarbOx’s strict rules on internal company controls and officer responsibility deserve some credit: Far fewer listed firms restate their financials now than a decade ago, the SEC says.

Yet the watchdog may also have missed some serious misconduct. None of the five enforcement units it created in 2010 focused on accounting. And big cases like intentional financial statement errors at American Realty Capital Properties emerged only after being reported by the companies themselves.

The SEC seems determined to do better. It says a new audit task force is using software to analyze annual reports for accounting red flags. The “management’s discussion and analysis” section, for example, can signal trouble with certain words or too much talk about minor matters. The task force’s “accounting quality model” also sifts company filings for unusual numbers, auditor changes and off-balance-sheet transactions – which Enron, Lehman Brothers and other failed firms used to conceal debt and inflate profits.

The efforts are already bearing fruit. The watchdog touts 2014 accounting fraud actions against Bank of America, Diamond Foods and CVS Caremark as well as smaller companies like Arizona-based JDA Software.

None of these cases match Enron, of course, but that’s not necessarily bad. Enforcers overreached in some ways in that famous situation, putting the company’s auditor, Arthur Andersen, out of business and costing thousands of employees their jobs.

The trick will be balancing tough enforcement against companies’ good-faith attempts to comply with the law. That’s no easy task when so much accounting is based on judgment calls. With the likes of SAC chastened, though, it makes sense to refocus on the next possible Enron.

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Accounting homework is too broad of a subject to give a simple answer to this question, but the best advise that you can take to find accounting answers is to make sure that you’re meticulous, that you keep track of every number, and that you know the formulas or algorithms that you’re supposed to be using.

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