The Securities and Exchange Commission is utilizing enhanced tools to tighten its regulatory oversight, focusing fraud and corruption in particular, according to an expert panel presenting to the June 14th Boston breakfast meeting of the National Association of Corporate Directors of New England.
According to the current head of the SEC’s Boston office and to the former co-director of the SEC’s national Division of Enforcement, three particular tools are receiving substantial focus.
First, an explosion in the availability of data permits robust quantitative analysis of a company. Aggregating and analyzing this data may provide indicators of fraud. For example, by analyzing data concerning inventory, sales and income, data might provide predictability with respect to risk of income misstatement.
Second, the whistle-blower program provides persons who notify the SEC of wrong-doing with a reward of not less than 10% and up to 30% of any governmental recovery. There was discussion as to the efficacy of this program, however; many whistle-blowers prove to be disgruntled employees, or raise insubstantial matters, or are unsophisticated and lack understanding. It was proposed that an intelligent whistle-blower with good motives would almost certainly have come forward in any event. However, because of the likelihood of SEC focus (any whistle-blower advising the company is likely to also advise the SEC), whistle-blowing is forcing companies to take greater interest in employees disclosures.
Third, the SEC-Department of Justice recently announced a program to treat companies committing Foreign Corrupt Practices Act violations less harshly if the companies self-report. In no event will disgorgement of improperly obtained economic benefit be avoided, but DOJ penalties may be abated. It was noted, however, that one of the alleged “rewards” for self-reporting, the grant by the SEC of a “non-prosecution” agreement, is really illusory; in such cases, the SEC will issue a press release containing the same kind of damaging information as would have been publicized in a “prosecuted” case (which results in a consent decree outlining the same negative facts).
The SEC also is paying attention to the growing prominence of utilization of non-GAAP economic measures in reporting earnings; these alternate financial statements, typically keyed to the elimination of non-recurring expenses, are not subject to rigorous accounting standards and fall under deep SEC scrutiny if they are given “prominence” in disclosure or in the marketplace.
Finally, the SEC is focusing on municipal debt. Many municipal issuers are unsophisticated in finance and disclosure, are subject to manipulation by advisors, and present the risk of political corruption. Munis are an opaque market where valuations are arbitrary; bonds are purchased for long-term hold and tax-advantaged income (thus not subject to active trading which would ultimately mark-to-market).