Howard Scheck, Chief Accountant of the SEC’s Division of Enforcement broached one of the most important current topics in the accounting world: fraud. He explained that fraudulent accounting activities are still very prevalent today, despite the SEC’s continued effort to eliminate improper practices. Since Arthur Levitt’s “The Numbers Game” speech in 1998, the various methods of circumventing the rules have evolved. In 1998, Levitt addressed problems like cookie-jar reserves, big bath charges, and creative acquisition accounting. He also discussed revenue recognition improprieties, as well as materiality issues. According to Howard Scheck, these practices continue today, in addition to some new ones.
Howard Scheck mentioned that a common scheme that has advanced over the years is “cross-border” accounting. The SEC launched an investigation into this issue in June 2010. Cross-border accounting involves the reliability of foreign based financial statement issuers. The other aspect of this is whether or not audit firms are capable of properly auditing these foreign-based statements. It was determined that many of the foreign-based statements have been falsified; companies are hiding accounts, showing fictitious accounts, and not disclosing their liabilities appropriately. In addition, due to lack of supervision, education, and language skills, auditors are failing in their roles as well. The investigation into this problem is ongoing, and the SEC has not released all of its information yet, but the message is clear: the SEC is closing every loophole they can identify so that investors will be receiving truly reliable information.
Another area that the SEC’s Division of Enforcement is putting a heavy emphasis on is Section 10A violations, which relate directly to auditors. Section 10A dictates the proper procedure that should be followed by all independent auditors to carry out an accurate audit. The other two facets of this statute require the auditor to inform the audit committee and the SEC of the situation. Investor confidence is firmly linked to the reliability of the information being reported by companies; this is the same information that auditors have to inspect. This is an extremely important responsibility, and Mr. Scheck is doing everything in his power to assure investors that auditors are ethical and capable. Richard Paul, a partner at Deloitte & Touche LLP and a Baruch alum, also stressed the importance of keeping auditors educated and giving them guidance on applying the accounting standards. Speaker Jeanette Franzel, a board member of the PCAOB, said it best: “The auditors’ client is actually the investor.” This is the type of mindset all auditors would ideally have in approaching their work.
Mr. Scheck also gave some very interesting examples of the aforementioned fraudulent practices. He mentioned the cases of Puda Coal, SinoTech Energy, and Satyam (Pricewaterhouse Coopers India). Just this past year, Puda Coal was targeted by the SEC for a multi-million dollar indirect ownership violation. The chairman of this company secretly transferred the sole source of revenues to himself before selling shares to the public, leaving Puda Coal as a shell corporation and betraying U.S. investors. Another noteworthy case was that of SinoTech Energy, who was charged by the SEC for misleading investors on asset valuation. SinoTech Energy was only public for a short time before the SEC discovered their improprieties totaling over $120 million. Mr. Scheck also briefly discussed the Satyam/PwC India scandal from 2009; the sum of this fraud was over $1 billion. Satyam Computer Services falsified their accounts, showing inflated earnings. Pricewaterhouse Coopers LLP came under intense scrutiny for these possible Section 10A violations. Investors were shocked by the fact that this scandal wasn’t uncovered sooner by PwC. Mr. Scheck is pushing for stronger enforcement actions so that situations such as this one can be avoided in the future; both by companies, and by auditing firms.
Mr. Scheck ended his speech with a prompt for everyone to continue to be mindful of the frauds that exist in so many companies today. The SEC can only succeed in their goal of enhancing financial reporting with the cooperation and support of all accounting professionals. As future accountants and auditors, we as students must understand that the power will one day be in our hands, and we will be counted on to make ethical choices.
By Supreet Kesar