Take a guess how many corporate accounting fraud cases the SEC has prosecuted through the first half of this year.

Give up? The answer is 79. And that’s the lowest level in over a decade, according to the Wall Street Journal.

A couple months ago, Craig M. Lewis, who heads the SEC’s risk division, unveiled the SEC’s “new”, pro-active approach – an accounting quality model that helps “assess the degree to which registrants’ financial statements appear anomalous.” The analysis will also look at the wording in financial reports concerning companies’ results and future prospects, particularly those under “management discussion and analysis.”

Sounds like a good idea, but…this is “new”?  I’m a bit surprised no one has thought of this before, but apparently that is the case. The SEC acknowledges that its previous means of uncovering fraud have been primarily passive and market-based (i.e., trading irregularities). Really? Isn’t that akin to always closing the stable door after the horse has bolted? Even my $30 tax software has an algorithm that alerts me to audit risk, based on the numbers in my return, before I file my taxes.

I don’t mean to cast stones. I appreciate that accounting fraud is actually very difficult to find, prove, and successfully prosecute. Gathering evidence requires detailed, often forensic accounting work to see whether a company has failed to report its results according to the then prevailing “accounting rules” (my emphasis). And proving there actually was a violation – most often relative to generally accepted accounting principles (GAAP) – includes an additional layer of difficulty because GAAP itself is often vague and malleable.

Case in point…in a recent accounting fraud prosecution in California involving a high-tech company, the United States Court of Appeals for the Ninth Circuit overturned the conviction of the company’s chief financial officer because the government could not prove that his aggressive accounting in recognizing revenue violated GAAP. On the contrary, the appeals court actually opined that the government’s evidence showed he was “doing his job diligently” by skating right up to the line.

Mary Jo White, the SEC’s new chairwoman, has said that she wants to turn the agency’s attention back to what was once seen as its core mission: policing corporate disclosure to ensure everyone is protected. I wish her luck. It’s a crazy world out there, and there’s not much active oversight. Caveat emptor, my buyside brethren. Good thing I’ve got my trusty copy of Financial Shenanigans handy…

Posted by: Mory Watkins