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For defense lawyers of a certain vintage, the early 2000s were a veritable golden age for accounting fraud cases. The marquee cases and investigations of the day – Enron, Computer Associates, Xerox, Adelphia, WorldCom, and Royal Ahold, among many others – were big, complex, and resource-intensive. They also were interesting and nuanced. And while many did result in guilty verdicts or onerous SEC settlements, most were a mixed bag for the government. As a result, many significant investigations relating to revenue recognition or other complex accounting matters ultimately died on the vine or resulted in express declinations. In many of these cases, convincing the government to abandon its case (or decline bringing one in the first place) typically required going hammer and tong with law enforcement authorities and regulators over the intricacies of corporate finance and accounting rules.
However, while financial statement fraud continues to be a focus of the SEC and other authorities, these kinds of cases now appear to be fewer and farther between. Practitioners have noted this shift, as have the experts and forensic accountants who were in the thick of many of these accounting battles. Other cases and investigations may have taken the place of these accounting inquiries, but it is worth asking where and why they have gone.
One intriguing possibility here is that there is now simply less “fraud” in the first place, or that corporate executives are less inclined to risk their financial security or liberty to cook their employers’ books. The enforcement cases and prosecutions of the last decade were well-publicized and their significance was not lost on senior management, and so it is certainly possible that the government’s enforcement efforts had some deterrent effect. Moreover, it is also possible that the additional requirements imposed by the Sarbanes-Oxley Act (“SOX”) have caused senior executives to focus more carefully on the financial results that are being reported under their signoff authority.
The problem with this explanation is that it ignores the reality that investigations and prosecutions can start and rumble along even when senior management acted innocently and in good faith. Moreover, knowing and intentional frauds involving the financial results of public companies were no less illegal prior to 2002, and yet the well-publicized accounting scandals of the late 1990s (including Cendant and Waste Management) clearly did not stop the later investigations and prosecutions from happening.
The more likely explanation here involves a mix of factors: SOX procedures and the incentives of professionals and accounting firms, the shifting focus of law enforcement, and a more subtle shift in the manner in which public companies may be reacting to accounting controversies.
First, SOX’s principal impact on public companies is more likely administrative and bureaucratic, rather than didactic. With added layers of regulatory oversight has come added involvement of legal professionals and compliance personnel. Even without a fundamental shift in human nature or deterrence, this may be making it more difficult for misstatements or mistakes to go undiscovered or uncorrected. Moreover, it also provides a layer of insulation where inevitable mistakes get made along the way – making it less likely that they will result in public claims or charges.
Second, the scrutiny given to the conduct of major accounting firms likely has had an impact. No accounting firm wants to be investigated or sued because of a financial misstatement, and restatements and investigations frequently result in a change in auditors. In the wake of the last decade’s scandals, major risk areas and significant revenue recognition decisions therefore receive far more attention and focus from auditors than they previously did. This makes it more difficult for problems to arise in the first place. Moreover, as with enhanced internal compliance relating to the financial reporting process, this focus makes it more difficult to characterize legitimate accounting-related differences or oversights as fraud.
Third, enforcement trends and interests matter. Thus, while regulators and prosecutors continue to demonstrate interest in accounting-related frauds, the government’s attention of late has been focused on insider trading, FCPA enforcement, and antitrust inquiries. Not only do these cases garner significant press coverage, but they are much easier for juries and the general public to understand. They also may involve fewer uncertainties and complexity for the government, which is one reason why they may be receiving more focus.
Fourth, and finally, the manner in which public companies deal with accounting-related problems may be impacting the enforcement bottom line. One sure-fire way to get noticed by the SEC or law enforcement is to restate financials. There are times when a public company has no choice about this, but frequently the choice is a close one and reasonable minds can differ reasonably about the need to do so. For a number of years, close calls in this regard appear to have been resolved in favor of restatement, with significant consequences for both corporate executives and shareholders. However, public companies appear to be giving this question – including the question of materiality – more careful scrutiny. Whatever the reason, the absolute numbers are much reduced. Based on some publicly available analyses, public restatements reached their peak in 2006 with more than 1200 restatements. Restatements for 2010 were a little more than a third of that amount.
Enforcement trends are cyclical, and the accounting rules are no less complex today than they were in 2000. Moreover, accounting experts whose opinions I know and trust have suggested that the next wave of accounting inquiries may involve fair value accounting for assets and liabilities. See http://www.navigant.com/insights/library/ disputes_and_investigations/2012/fair_ value_ in_financial_reporting. It remains to be seen whether the SEC’s recent focus on fair value accounting will actually translate into enforcement actions and prosecutions.
To read more from Stephen Juris, please visit www.maglaw.com