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Financial Reporting and the Law

Margaret McGuire, Vice Chair of the SEC’s Financial Reporting and Audit Task Force, recently offered insight into the purpose and goals of the Task Force. Speaking at a D.C. Bar event on February 11, McGuire indicated that the Task Force was established in an effort to ensure that the SEC is doing everything it can to detect and investigate financial fraud issues as early as possible. Acknowledging that there have been fewer financial reporting enforcement actions over the last several years, McGuire said that it is hard to determine whether less fraud occurred or whether the SEC missed fraud that occurred.

McGuire stated that the Task Force is dedicated to the following five goals:

  • Establishing a deep understanding of financial fraud—how it happens and how it is going to happen next
  • Developing a state-of-the-art methodology for detecting financial fraud
  • Sharing information about financial fraud throughout the SEC
  • Collaborating and coordinating with others outside the SEC on financial fraud issues
  • Engaging the public, academics, and whistleblowers to help achieve the Task Force’s objectives

McGuire noted that tips about improper financial reporting practices come from many sources, including the SEC’s Division of Corporation Finance (Corp. Fin.), whistleblowers, regulatory partners, the media, class action lawsuits, and a deep analysis of issues by the Task Force. She indicated that areas of focus for the Task Force will include Management’s Discussion and Analysis (MD&A), revenue recognition, off-balance-sheet transactions, and instances where there are multiple revisions to financial statements over several reporting periods.

One of the tools that the Task Force will use to identify financial reporting matters will be the Accounting Quality Model (AQM) developed by the Division of Economic and Risk Analysis. The AQM is a computerized quantitative analytics model that is used to identify anomalies in companies’ financial statements. McGuire explained that use of the AQM will not automatically result in a Matter Under Inquiry being created for a company, but the results will be analyzed by the SEC Staff to determine whether any further investigation is warranted.

McGuire described the Task Force’s close working relationship with the PCAOB, which also has a disciplinary responsibility interest with respect to auditors. We believe that the Task Force may use information it receives from interactions with the PCAOB to identify financial reporting issues. McGuire also indicated that these issues may be identified as a result of the Task Force’s risk-based initiatives, including industry-specific initiatives to see if there are recurring issues in certain industries.

According to McGuire, the Task Force will not conduct full-blown investigations. Instead, generally, it will serve as an incubator for financial reporting actions that will be investigated by others in the SEC Enforcement Division. The Task Force will maintain a continuing advisory role with respect to each matter it generates, however, and will advise other members of the SEC Staff regarding best practices for financial reporting cases. McGuire also indicated that the Task Force’s review of potential instances of financial fraud may result in various types of outcomes, including (1) a determination that no further action is required, (2) a determination to rely on Corp. Fin.’s comment process for resolution of financial reporting issues for companies currently under review by Corp. Fin., (3) a determination to conduct a preliminary investigation to develop a legal theory for an enforcement action, and (4) an assignment of the matter to SEC Enforcement Staff to conduct an investigation.

The Task Force’s original term was one year, with a potential for renewal. McGuire noted that, given the positive results of the Task Force thus far, she expects the Task Force will be renewed.