The early part of the last decade was a busy time for the Securities and Exchange Commission, as it responded to a corporate crime wave perpetrated by companies such as Enron, WorldCom, and HealthSouth. It filed a record 679 enforcement actions during its 2003 fiscal year. Of those, 199 cases—or nearly 30 percent (also a record high)—fell into the category of financial fraud and issuer disclosure cases. In the 10 years that have followed, the number of financial fraud cases brought by the SEC has steadily declined. Indeed, in 2012, the agency brought just 79 financial fraud or issuer disclosure cases, a 10-year low that has drawn the attention of the SEC's new chairman, Mary Jo White. What has caused the marked decline in financial fraud cases over the past 10 years? Is the decline due to better corporate citizenship or a decline in the Commission's ability to prosecute cases? And what, if anything, should the SEC do to reverse this trend?

In hindsight, 2003 was the high-water mark for the SEC's efforts against financial fraud by public corporations. This type of fraud began to attract more of the SEC's attention in the late 1990s, when SEC Chairman Arthur Levitt gave his well-known “Numbers Game” speech. In the September 1998 speech, Levitt shined a light on the “widespread, but too little-challenged custom” of earnings management. He warned that corporations' motivation to meet Wall Street earnings expectations had turned into a game of “nods and winks” among market participants that involved accounting trickery such as “big bath” restructuring charges, creative acquisition accounting, and “cookie jar reserves.”

Levitt promised that the SEC's Enforcement Division would harshly scrutinize any companies that appeared to be managing earnings and observed that if such practices were not stamped out soon they would surely have “adverse consequences for America's financial reporting system.” His words seemed prophetic just a few years later when the misdeeds of WorldCom, Enron, Tyco, Adelphia, and many others came to light. The SEC ultimately brought cases against these companies in the early 2000s, resulting in some of the largest settlements in its history.

Thus far, the talk of an increased focus on financial fraud cases under White is just that—talk. Even assuming there has been a change in enforcement priorities, it may be a while before we see any clear results from such a change as it often takes years to investigate and bring financial fraud cases to court.

Since 2003, however, the number of financial fraud enforcement actions brought by the SEC has declined steadily. The trend has been particularly linear in the past five years, with financial fraud enforcement actions falling significantly every year, from nearly 150 in 2008 down to just 79 in 2012. The cause of this decline in financial fraud cases has been a topic of much debate in the securities enforcement bar, as well as in the SEC itself. Possible reasons for the decline include: 

·  The Success of the Sarbanes–Oxley Act of 2002. Sarbanes–Oxley was a response to the corporate scandals that emerged in the early 2000s. Among other things, Sarbanes-Oxley required corporate management to individually certify the accuracy of reported financial information, raised penalties, strengthened audit committees, enhanced auditor independence, and established independent oversight of public company audits by the Public Company Accounting Oversight Board. In short, some believe that SOX has led to less financial fraud, and that the lower number of SEC financial fraud cases is a logical outcome.

·  Changing SEC Priorities. The SEC's failings in the Bernard Madoff matter, which became public in 2008, led many on Capitol Hill to ask, quite seriously, whether the SEC needed to be shut down. Following Madoff, the SEC took a hard look at its priorities and created five specialized units in 2010 to better pursue cases in the areas of asset management, market abuse, bribery and corruption, municipal securities, and structured and new products. Financial fraud was not included in any of the specialized units, but former Enforcement Director Robert Khuzami told Forbes at the time that accounting expertise existed throughout the agency. He added that the SEC was constrained by limited resources and “the reorganization helped to focus us on where the fraud is and not where the fraud isn't, while allowing us to remain fully capable of addressing cases of accounting and disclosure fraud.”

·  Disbanding of the SEC's Financial Fraud Task Force.  In May 2000, the SEC established a “Financial Fraud Task Force” within the Enforcement Division that teamed up the expertise of the division's accounting staff with its investigative attorneys to better combat financial fraud.  Although the task force was widely regarded as an effective tool, it was disbanded in 2010 around the time that the Enforcement Division created its specialized units. Khuzami cited the decline in the number and severity of earnings restatements since the mid-2000s as one of the reasons the task force was disbanded.

·  Metrics Used to Evaluate the Enforcement Division's Performance. The SEC has acknowledged that the number of actions brought each year is not an ideal barometer of enforcement, and that qualitative standards such as timeliness, programmatic significance, and deterrent effect are more significant. Nonetheless, “actions brought” continues to be the easiest metric for the agency to use to summarize its performance in a given year, and remains the focus of newspaper headlines. Financial fraud cases are complex and time-consuming, however, and can take much longer to complete than, say, an insider-trading case. If the agency is attempting to maximize the number of actions brought, then pursuing fewer financial fraud cases would be consistent with such a strategy.

After a decade of watching its financial fraud caseload trend downward, however, there are suddenly signs that the SEC, under White, may soon try to reverse the tide. According to reports, White and her new co-heads of enforcement, George Canellos and Andrew Ceresney, will soon announce a reallocation of the division's resources that will include a renewed focus on accounting fraud. Although the existing specialized units are expected to remain intact, changes to some of the units may be on the way that will help the agency prioritize accounting fraud.

In addition, the SEC is rolling out new tools designed to help identify accounting fraud. One such tool is the “Accounting Quality Model.” As explained in December 2012 by Craig Lewis, chief economist and director of the SEC's Division of Economic and Risk Analysis, the AQM is a data-driven monitoring program that will allow the SEC to flag financial statements that “stick out from the pack, while taking into account the contemporaneous attributes of that pack.  The goal is to facilitate comparison across firms within their industry while accounting for and illustrating industry differences as well.”

The AQM will consider factors including a corporation's choice of accounting policy; a high proportion of transactions structured as “off-balance sheet”; and the frequency and types of conflicts with, or changes in, independent auditors. Lewis said that the AQM will be used by the Enforcement Division to focus its investigative process and to better evaluate claims of financial fraud made by tipsters.

Another tool potentially being added to the SEC's arsenal is software that analyzes the “management's discussion and analysis” section of companies' annual reports looking for certain key words that may be red flags for earnings manipulation. If it proves effective, this type of word analysis will be integrated into the AQM, as well.

Thus far, the talk of an increased focus on financial fraud cases under White is just that—talk. Even assuming there has been a change in enforcement priorities, it may be a while before we see any clear results from such a change as it often takes years to investigate and bring financial fraud cases to court. It is refreshing, however, to hear that the SEC is looking closely at how it can reinvigorate its efforts in an area that has historically been a fundamental part of its enforcement program.