SEC Strengthens Its Enforcement

September 12, 2003
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GRAND RAPIDS — Given human nature, there will probably always be some level of financial fraud going on.

“Financial fraud is always going to be around. I’m not that much of an optimist to say we can eradicate it completely,” Susan Markel, chief accountant of the SEC’s Division of Enforcement, told members of Financial Executives International gathered at the University Club Wednesday evening.

But if public companies “build up their ethics and the tone at the top,” some of the fraudulent activity could be eliminated, she said.

Markel has been involved in a number of high profile accounting investigations, including cases against Cendant, WorldCom and Xerox.

Most cases of financial fraud have some common underpinnings, she observed. Usually management has an incentive or is under some sort of pressure, there’s an opportunity for the fraud to be committed, and people committing the fraud rationalize their acts to themselves.

Oftentimes fraud begins when a company is just working to make the numbers and hit its target, Markel noted. There’s nothing wrong with trying to make the numbers if it’s done in a legitimate way.

But there may be pressure from the boss to make a financial projection that will meet Wall Street’s expectations, or, perhaps, an acquisition will fall through if the numbers don’t look good. People don’t necessarily start out thinking they’re doing something bad, Markel said.

“Sometimes it then turns into managing the numbers. You’re not quite getting there on your own so you’re going to play with the numbers a little bit — and oftentimes that ends with just making up the numbers.”

She said many times companies tell themselves that they’ll make it up in the next quarter, but the plan snowballs. The next quarter isn’t as good as they had hoped for, and they end up digging themselves into a hole.

“Sometimes companies just make a simple mistake, but the impact of correcting it to a future period would be devastating,” Markel explained. “Instead of correcting it, owning up to it and fixing it, they cover it up and hope nobody ever finds out.”

The SEC’s enforcement division, which brings in from 450 to 600 cases each year, has 11 regional offices and about 1,000 employees, the majority of whom are attorneys.

It receives 500 to 800 complaints per week regarding everything from financial fraud to insider trading to market manipulation. At any given time, the division has about 2,500 open investigations.

Last year was a record year, with 598 cases. Financial fraud typically makes up 25 percent to 30 percent of cases and half of the division’s resources go to those because they tend to be the longer, more complex cases, Markel said.

Five years ago only four of the financial fraud cases were against Fortune 500 firms. Last year, 29 financial fraud cases involved Fortune 500 companies.

Markel said that probably reflects a couple of different things.

“One, it may be occurring more in the Fortune 500 companies, but also, we’ve shown a willingness and a dedication to doing some of the bigger, more complicated cases and taking on some of the larger companies.”

Markel said SEC enforcement has more muscle now that it’s being coordinated with criminal authorities at the state and national levels. President Bush formed the Corporate Fraud Task Force last year that includes representation from all of the various enforcement agencies, such as the FBI, the Justice Department, the DEA and the IRS.

The U.S. attorneys want the cases. In fact, they sometimes fight over the cases, she said. State attorneys want the cases, too.

In the past year 17 federal districts brought securities fraud cases against 259 people and entities.

“So people are more often seeing jail time, which I think is something that has probably made the biggest impact on people in the business community — seeing that some of these people are actually going to jail. Now you’ve got criminal authorities interested in this and they’re going to pursue the cases.”

The SEC is a civil agency. It doesn’t use guns and handcuffs. It can’t throw people in jail. What it can do is bar guilty parties from serving as corporate officers and directors of public companies, make them give back the money and fine them penalties.

The use of officer and director bars has increased, Markel said. Last year the SEC barred a record 126 individuals. Already this year, 144 have been barred and that number will likely rise by year’s end.

Markel said her division is trying to figure out what it can do to speed up investigations. The trouble is, financial fraud cases can involve millions of documents and take a long time. Should enforcement do trading suspensions? Should it freeze people’s assets?

The SEC also is going to hold companies accountable if they don’t cooperate in an investigation, she said. One way is stiffer civil money penalties.

The division is also stepping up scrutiny of the “gatekeepers” — the auditors, lawyers and directors of public companies — because they are the ones who are supposed to help the company and keep it in line, Markel added.

The newer approach puts a lot more emphasis on guilty parties accepting personal responsibility for their actions, as well.

Markel said the SEC enforcement arsenal is also being strengthened by some new tools coming out of the Sarbanes-Oxley Act of 2002, such as the new whistleblower provisions, and provisions for CEO and CFO certification, Public Company Accounting Oversight Information, and the Federal Account for Investor Restitution (FAIR), a mechanism that returns ill-gotten gains from corporate executives back to investors.   

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