Financial Fraud Actions – The New SEC Staple?

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With the creation last year of the Financial Reporting and Audit Task Force, the Commission is returning to one of its enforcement staples – financial statement fraud. Following then Chairman Levitt’s “Numbers Game Speech” in 1998 the SEC brought a series of significant financial statement fraud actions against issuers, their executives and in some instances the auditors and third parties. The driving force behind the wrongful conduct was often the same: Making the numbers or meeting street expectations.

Some commentators have argued that with the passage of Sarbanes-Oxley things have changed, and financial statement fraud is less prevalent. In probability it will be some time before the results of the Task Force work, and that of its partner, the Division of Economic and Risk Analysis, are known.

One possible indication of those results is the new report on accounting class actions filings and settlements published by Cornerstone Research titled “Accounting Class Action Filings and Settlements 2013 Review and Analysis” (here). While the private bar does not have the benefit of the new Accounting Quality Model or “RoboCop” being developed by the agency – a kind of big data and metric approach to identifying possible fraud – the statistics may give some notion of things to come.

The number of accounting cases brought in 2013 compared to the prior years was essentially flat. Last year 47 cases were filed, up 1 case from the prior year. As a percentage of the number of cases filed however, the number of accounting cases declined to 28% compared to 30% in 2012. Indeed, the 28% figure is the lowest in the last decade.

In contrast, for the second year in a row, the number of cases settled involving accounting issues increased. In 2013 44 cases were resolved compared to 38 in 2012 and 33 in 2011. The 44 cases settled involving accounting issues last year represents 66% of the overall total. That percentage has remained relatively constant over the decade, ranging from a low of 55% in 204 to a high of 75% in 2008.

Traditionally, accounting cases have represented a large majority of the total value of cases settled, according to Cornerstone. Yet last year, for the first time since the passage of SOX, the total value of accounting case settlements was lower than for others. In 2013 the dollar value of the accounting cases was just 25% of the total amount of settlements. That is by far the lowers percentage in the last decade in which the range ran from 73% to 97%. The 2013 settlements were, however, more evenly distributed over the various business sectors and fewer actions were brought against those in the financial sector.

One key metric is the number of cases involving allegations of an internal control weakness. Last year the percentage of cases alleging such a weakness was the highest since 2008 at 70%. In other years the percentage ranged from 30% to 45%. Similarly, the number of settled accounting cases involving such a claim was at a six year high of 66% last year, compared to a range since 2008 of 28% to 41%.

Recently the number of restatements by large firms has increased, the Report notes. Correspondingly, the number of accounting cases involving restatements increased. Last year 40% of the accounting cases filed involved a restatement. That reflects an increase from the 37% in the prior year and is the largest percentage since 2008.

In contrast, the number of settled cases involving accounting issues declined last year to 35%, compared to 47% in 2012. The 32% for last year represents the lowest number of settlements involving a restatement since 2008. The Report notes that this may reflect the fact that it takes about three years from filing to settlement for these actions.

Overall, while the number of cases filed has remained flat this year but there are indications things may change. The increase in restatements, large number of actions involving internal control issues and the increased number of accounting cases recently filed centered on a restatement suggest that perhaps the Task Force and its big data approach may start churning out actions. And, perhaps SOX did not cure the driver of financial fraud identified by Chairman Levitt years ago.

Topics:  Enforcement Actions, Financial Crimes, Fraud, SEC

Published In: Business Torts Updates, Finance & Banking Updates, Securities Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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