Accounting & Tax

Accounting Investigations Grow to Highest Number Yet

As probes increase, the SEC's already-thin resources are stretched even further.
CFO.com StaffJuly 6, 2001

The Securities and Exchange Commission’s list of companies under investigation for possible accounting fraud is growing longer, just as the agency’s limited resources are being stretched more than ever before, says the Wall Street Journal.

SEC officials say they have nearly 260 accounting investigations under way, says the Journal, a significant increase in recent years. They’re not just small firms — which have usually the ones the SEC has targeted. Some 15 percent of the probes, or about 40, are focusing on companies that are among the nation’s 500 biggest.

SEC enforcement chief Richard Walker told the newspaper that “if we had nothing else to do, the accounting investigations alone could keep us busy for the next five or 10 years.”

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Lawmakers are starting to take notice, thanks to the high-profile accounting scandals of Cendant Corp., Sunbeam Corp., Rite Aid Corp., and others. Legislators are beginning to call for more SEC resources to combat fraud, says the Journal. It is well known that the SEC is understaffed. The SEC’s division of corporation finance has the staffing to review only a tiny fraction of earnings statements filed by public companies, and until this year it has been swamped by the huge crush of technology initial public offerings of stock.

The SEC’s current crackdown on accounting misdeeds began in 1998, when then-chairman Arthur Levitt beefed up policing efforts, approved new auditor-independence rules and issued new accounting guidance to curb bookkeeping practices used to inflate revenue. Last year, the regulator brought 100 financial-fraud actions, and there has been a 28 percent increase in accounting-related cases in the past three years, says the Journal.

The most visible indicator of improper accounting — and source of new investigations — is the growing number of restated financial reports. Restatements ballooned to 233 last year, twice the number in 1997, according to a recent study by Arthur Andersen LLP. Of those, only 9 percent resulted from new accounting methods required by the SEC.

One of the reasons for such widespread accounting improprieties is the pressure senior managers feel to assure maximum compensation, which is tied to share price. Companies fear that missing Wall Street’s quarterly earnings targets even by a few pennies can send a stock price tumbling, says the Journal.

Meanwhile, the accounting industry is arguing that the number of restatements and accounting-fraud cases is just a tiny percentage of the 13,000 public companies that file annual financial reports. But regulators believe the accounting violations may be even more pervasive than the statistics suggest.

The SEC relies on the press, company whistleblowers and its investigators for leads. While the regulator investigates most alleged frauds after word of a company’s accounting problems has leaked and battered its stock price, SEC accountants are focusing on ferreting out questionable accounting in financial statements earlier, says the Journal.

With the cooling of the IPO market, the SEC is using its freed-up resources to ramp up its review of annual financial reports. During the fiscal year ended Sept. 30, 2000, the SEC reviewed about 1,100 of the 13,000 annual reports filed on form 10K with the agency, or about eight of every 100. This year’s goal: one of every four annual reports.

Rep. John LaFalce (D., N.Y.), ranking member of the House financial- services committee, said recently that his panel will look into the accounting-fraud issue and has called for a 200- to 300 percent increase in the SEC’s enforcement staff to bolster oversight, says the Journal. Such an increase would boost the SEC’s total $423 million annual budget this year by as much as $400 million.

Critics also complain that the SEC would also be less burdened if the accounting industry did a better job of policing auditors, ostensibly the first line of defense in the fight against fraud, says the Journal. Last year, the SEC worked with industry groups to improve self-regulation and the disciplinary peer-review process, but progress has been slow.

At the request of Rep. John Dingell, (D., Mich.), the General Accounting Office, an independent research arm of Congress, has agreed to study whether the various accounting regulatory groups should be replaced by one full-time self-regulatory organization, says the Journal.