Three’s Company, Too: The SEC’s New Enforcement Initiatives Will Be Waiting For You

Last week the SEC announced the creation of three new Division of Enforcement initiatives designed to combat fraud in financial reporting and microcap securities and to enhance risk identification and analysis: (1) The Financial Reporting and Audit Task Force; (2) The Microcap Fraud Task Force; and (3) The Center for Risk and Quantitative Analytics.

The Financial Reporting and Audit Task Force will focus on expanding and strengthening the Division’s work in identifying securities violations, particularly in the areas of preparation of financial statements, issuer reporting and disclosure, and audit failures.  Using technology-based tools like the Accounting Quality Model, designed to identify red flags in areas particularly susceptible to fraudulent financial reporting, along with ongoing review of financial statement restatements and revisions, and analyzing industry performance trends, the Task Force will aim to detect fraud early and to increase prosecution of alleged securities violations involving false or misleading financial statements and disclosures.

The Microcap Fraud Task Force is a much more specialized unit, focusing exclusively on investigating fraud in the issuance, marketing and trading of microcap securities (typically low-priced securities issued by very small companies with limited assets).  The principal goal of this Task Force is to develop and implement long-term strategies for detecting and combating fraud in the microcap market, in particular by targeting who the SEC deems as “gatekeepers” or “significant participants,” namely, attorneys, auditors, broker-dealers, transfer agents, stock promoters and purveyors of shell companies.

The Center for Risk and Quantitative Analytics (CRQA) will be the SEC’s central point of contact for all of its risk-based initiatives nationwide. The Center will be dedicated to supporting risk identification and assessment at the Division by conducting risk-based investigations and developing methods of monitoring for signs of potential wrongdoing.  It will also be a resource for information about characteristic and patterns of possible fraud and other illegality.

These initiatives demonstrate the Division of Enforcement’s ongoing commitment to identifying and regulating high-risk areas of the market with the most up-to-date tools available.  Just a month earlier, SEC Co-Director George Canellos had indicated at a Federal Bar Association’s Securities Law Section panel that the SEC remained focused on combating suspected accounting and financial fraud and hinted that a specialized microcap fraud unit may be forthcoming.  The creation of the financial fraud unit may also be a response to the fact that for nearly the past decade, the number of financial fraud enforcement actions has declined year after year, to the point that it is now a fraction of what it was at its peak.  Canellos had also mentioned that the SEC would be focused on the identification of potential violations.  With these three new initiatives, it is clear that identifying and prosecuting securities violations at an early stage is one of the SEC’s top priorities.

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