Lessons to Learn from SEC Accounting and Auditing Enforcements: 5 Principles Can Help Prevent, Detect, or Correct the Most Frequent Securities Law Violations Adjudicated by the SEC

By Kanter, Howard A. | Journal of Accountancy, December 2017 | Go to article overview

Lessons to Learn from SEC Accounting and Auditing Enforcements: 5 Principles Can Help Prevent, Detect, or Correct the Most Frequent Securities Law Violations Adjudicated by the SEC


Kanter, Howard A., Journal of Accountancy


Since enacting the Securities Exchange Act in 1934, Congress has repeatedly expanded the arsenal of the SEC to protect investors through enforcement actions. As a result, the SEC--though constrained by limited resources-- has steadily increased the number of enforcement actions. In 2016, the SEC brought 868 actions, the most in the agency's history.

The author's analysis of 1,563 accounting and auditing enforcement cases from 2008 to 2014 shows the most frequent securities law violations adjudicated by the SEC, the penalties rendered, and the person most often at the center of a case during this period.

By studying and understanding the findings, accountants can learn where standard accounting practices failed or were subverted and how to best deter, prevent, detect, or correct violations. The best practice recommendations are based on five general principles derived from the lessons learned and include examples of high-frequency frauds and high-dollar penalties.

ENFORCEMENT OF FRAUD CASES

Research suggests that enforcement actions reflect priorities the SEC sets to target violations that are considered to cause the most harm to investors. The majority of the 1,563 SEC accounting and auditing enforcement cases were of an administrative nature, but about 12% were classified as frauds. Financial reporting frauds were the most frequent, followed by violations of standards set by the PCAOB, independence violations, acts of foreign corruption and bribery, and internal control violations (see the chart "Frequent Frauds, 2008-2014").

Violations of the Foreign Corrupt Practices Act resulted in the highest penalties, averaging $43.8 million per case and constituting 47% of the more than $1.02 billion in penalties the SEC assessed in fraud cases during the six-year period. Internal control violations represented about 23% of the penalties assessed, followed by financial reporting violations (8%) and independence violations (1%). PCAOB violations accounted for less than 1% of total penalties assessed (see the chart "Penalty Totals Per Fraud, 2008-2014").

The industry that was assessed the highest penalty total during the period studied by far was financial services (44.1%), followed by mining (17.1%), energy (16.3%), apparel and accessories (6.7%), and manufacturing (4.6%) (see the chart "Total Dollar Penalties by Industry, 2008-2014). The research did not address why the financial services industry made up such a large portion of the total penalties assessed. It should be noted, however, that the six years studied coincided with a global financial crisis that started in the United States and led to the establishment of the Financial Fraud Enforcement Task Force in 2009.

Fraud charges enforced by the SEC were most often focused on the CFO (25%), followed by the corporation (23%) and the CEO (14%). But corporations paid higher penalties than individuals (see the chart "Total Assessed Fines by Level of Profession, 2008-2014").

The highest fine and punishment levied upon individuals was $208 million, designated as restitution, to be paid by the CEO, the chairman of the board, and the CFO of a financial services company.

The SEC case was accompanied by an FBI investigation and federal prosecution. The CEO received 50 years in prison, the chairman of the board got 25 years in prison, and the CFO 10 years in prison. All three executives also were sentenced to two years of supervised release. About 5,000 investors were defrauded of more than $200 million, and state regulators were deliberately misled.

The Sarbanes-Oxley Act of 2002 includes a clawback provision, Section 304. If there is a restatement because of material noncompliance, due to misconduct, with financial reporting requirements under the federal securities laws, Section 304 generally requires public company CEOs and CFOs to disgorge bonuses, other incentive- or equity-based compensation, and profits on sales of company stock that they receive within the 12-month period following the public release of financial information. …

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