The Securities and Exchange Commission has ramped up its efforts to deter accounting fraud and auditing failures, with a new report showing that enforcement actions increased 55% in fiscal year 2022 compared to the prior year, although total monetary settlements were down more than 60%.
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Half of those actions came in the fourth quarter, with 28% of all FY 2022 actions initiated in September alone, the last month of the SEC's fiscal year. Monetary settlements totaled $625 million, down more than 60% from FY 2021, and 44% lower than the average total monetary settlements between FY 2017 and FY 2021. Total monetary settlements dropped due, in part, to the absence of any very large settlements (i.e., those over $1 billion).
"Accounting and auditing enforcement activity increased sharply, making up 15% of the 462 new or 'stand-alone' actions initiated by the SEC in FY 2022," said Elaine Harwood, a report coauthor, senior vice president, and head of the accounting practice at Cornerstone Research, in a statement. "However, it was surprising to see such a marked decline in monetary settlements — not only in relation to total monetary settlements in the past few years, but also in relation to the SEC's record $6.4 billion in total penalties and disgorgement in FY 2022."
The high inflation rates seen over the past year and the fallout on the economy could lead companies to manipulate their financials. "In a downturn, there's frequently an increase in the amount of financial fraud, or at least the risks around financial fraud that exist," said Brad Wilson, managing partner and CEO of the global advisory firm StoneTurn. "Every company would like to show ever-increasing revenue and earnings, and in a downturn, it's incredibly hard to do that. For some businesses, when people start to think about, unfortunately, manipulation of their earnings, the SEC is aware of that and there are a number of things they are doing to try to prevent it, and once it happens, to investigate issues of manipulation."
The SEC has been using data analytics to help uncover fraud and smoothing of the earnings per share that companies report to investors as part of what it calls the EPS Initiative.
"The SEC is pretty proud of its data analytics capabilities in-house to be able to identify companies that are worth investigating," Wilson told Accounting Today. "Their efforts around earnings management recently, specifically what they call their EPS Initiative, is a good example of driving toward that, where they're looking for companies that seem to be potentially manipulating their earnings based on the fact that they get just to the right EPS target, or they're always rounding up and never rounding down."
"They can use analytics to identify those," he explained. "We've worked with some companies on that front that are dealing with questions from the SEC around that. And there are instances that are public, where the SEC has identified real fraud in that space. If you're sitting as an accounting executive inside a company, being aware of that is helpful because you know that the SEC, or anyone looking at the financial statements, might have the ability to identify at least red flags that show up in your reporting as a result of data manipulation."
The SEC is imposing stiff penalties on companies that get caught violating its rules. According to the Cornerstone Research report, the civil penalties imposed in fiscal year 2022 represented 67% of total monetary settlements, up from 56% in FY 2021. The high proportions of civil penalties to total monetary settlements in both fiscal years 2021 and 2022 represented a shift from the FY 2017-2020 period, where civil penalties averaged approximately 35% of total monetary settlements.
Of the 68 enforcement actions by the SEC, 41 referred to announced restatements and/or material weaknesses in internal control over financial reporting, the highest level in recent years. The percentage of initiated actions referring to these areas (60%) was 1.5 times the FY 2017–2021 average. The SEC's most common allegations in FY 2022 involved revenue recognition and internal control over financial reporting. One or both violations were alleged in more than 63% of FY 2022 actions.
"In FY 2022, there was a substantial increase in actions alleging violations of Section 304 of Sarbanes-Oxley," said Simona Mola, a report coauthor and principal at Cornerstone Research, in a statement. "The SEC initiated nine actions alleging violations of the so-called 'clawback' provision, compared to just three such actions in FY 2021 and a total of 18 actions initiated in the five-year period between FY 2017 and FY 2021."
There were 103 respondents named in accounting and auditing-related SEC actions in fiscal year 2022, an increase of close to 50% from the 70 respondents in FY 2021, but slightly less than the average of 111 from FY 2017 through FY 2021. More than half of all actions involved individual respondents only, a sharp increase from the 2017–2021 average of 37%. After SEC Chairman Gary Gensler's swearing-in through the end of FY 2022, approximately 49% of actions were initiated against individual respondents only.
"Under Chair Gensler's leadership, the SEC has identified 'holding individuals accountable' as a key priority area in its enforcement program," said Alison Forman, a report coauthor and principal at Cornerstone Research, in a statement. "So, it is not a surprise that the percentage of actions initiated against individual respondents in FY 2022 was notably higher than those actions initiated during Jay Clayton's administration."
The trends have been playing out for several years at the SEC.
"For a while now — though I think it has probably increased the last couple of years — they have been really focused on individual enforcement as well as company enforcement," said Wilson. "Something like two-thirds of their enforcement actions over the last few years have focused on or have involved individuals as well as the company. They have a regime around bonus clawbacks. That's intended not only to be punitive, but also to sort of protect against fraud in the first instance, to make sure that people are thinking about their motivations and the potential downside of taking that action or agreeing to or participating in earnings manipulation, or straight-up financial statement fraud. That focus on individual accountability is an important topic for them as well."
The Cornerstone Research report found that of the 68 actions initiated during fiscal year 2022, 51 were administrative proceedings and 17 were civil actions. The SEC acknowledged that 24% (17 firms and five individuals) of the 90 respondents who settled in 2022 offered cooperation and/or undertook remedial efforts, up from 20% in 2021.
Not advancing everywhere
Nevertheless, the SEC pulled back in some important ways on the enforcement front. In FY 2022, the number of actions initiated in the first quarter (only nine) was at the lowest level in recent years. For the fourth year in a row, enforcement activity in the second quarter of the fiscal year (i.e., the first quarter of the calendar year) was lower than in other quarters. The commission initiated five actions in FY 2022 alleging violations of auditor independence, compared to four in 2021, and it initiated five actions against non-U.S. respondents, lower than the average of 10 a year from 2017 to 2021.
It's not only the SEC that has been ramping up enforcement. Cornerstone Research released a
After taking action against companies and forcing them to agree to remedy the problems, the SEC is getting some outside help to make sure the companies comply.
"It looks like they have increased their use of independent compliance consultants in connection with enforcement actions to make sure that — for some companies that get into trouble — there's someone outside the organization that's looking at their internal controls and compliance programs to say, 'Are these sufficient to prevent against similar frauds in the future?'" said Wilson. "Taken together, their ability to identify the red flags on the front end from an analytical perspective, to hold the individuals accountable, and then put someone else in the back end to make sure that the controls improve are all part of the SEC suite of tools to help prevent — or at least identify after it's happened — financial statement fraud."
