SEC Enforcement Actions

 Excerpt from Hansen, J.C. 2010. Where were the auditors? Using AAERS in introductory or advanced auditing courses. Journal of Accounting Education 28 (2): 114-127. SEC Accounting and Auditing Enforcement Releases – Background and Importance The responsibilities of the SEC are performed through five divisions (Division of Corporation Finance, Division of Trading and Markets, Division of Investment Management, Division of Enforcement, and Division of Risk, Strategy and Financial Innovation). On their website ( the SEC gives a brief description of the responsibilities of each of these divisions. Responsibilities for the Division of Enforcement are described as follows: First and foremost, the SEC is a law enforcement agency. The Division of Enforcement assists the Commission in executing its law enforcement function by recommending the commencement of investigations of securities law violations, by recommending that the Commission bring civil actions in federal court or before an administrative law judge, and by prosecuting these cases on behalf of the Commission… The Division obtains evidence of possible violations of the securities laws from many sources, including market surveillance activities, investor tips and complaints, other Divisions and Offices of the SEC, the self-regulatory organizations and other securities industry sources, and media reports. All SEC investigations are conducted privately. Facts are developed to the fullest extent possible through informal inquiry, interviewing witnesses, examining brokerage records, reviewing trading data, and other methods. With a formal order of investigation, the Division’s staff may compel witnesses by subpoena to testify and produce books, records, and other relevant documents. Following an investigation, SEC staff present their findings to the Commission for its review. The Commission can authorize the staff to file a case in federal court or bring an administrative action. In many cases, the Commission and the party charged decide to settle a matter without trial. The SEC also explains on its website ( that their list of AAERs: …provides links to financial reporting related enforcement actions concerning civil lawsuits brought by the Commission in federal court and notices and orders concerning the institution and/or settlement of administrative proceedings. This list only highlights certain actions and is not meant to be a complete and exhaustive compilation of all of the actions that fall into this category. Feroz, Park, and Pastena (1991) examine the first 224 AAERs issued by the SEC. They give a brief history in their study on AAERs and state (Feroz et al., 1991, p. 109): that the first 224 AAERs “describe allegations of financial disclosure violations by 188 firms and their employees including fraud, nonfraudulent but reckless disclosure, and accounting disputes that allege neither fraud nor recklessness. The number of releases alleging reporting violations exceeds the number of cited violations because some violations are the subject of multiple releases.” The findings described in the AAERs are important to regulators and academics. Academics have outlined how AAERs can be used in auditing courses. Licata, Bremser, and Rollins (1997) examine AAERs from their inception in 1982 until August 1995 and they select specific AAERs that deal with SEC actions against auditors. In their Appendix, they identify 60 out of the first 695 AAERs that deal with (1) the Auditing Profession; (2) Audit Process; (3) Application of the Auditing Process: Transaction Cycles; and (4) Completing the Audit and Offering Other Services. Licata et al. (1997) provide specific cases for 7 out of the 60 AAERs, to be used as classroom instructional material. Academic studies have used the AAERs as data. For example, Dechow, Sloan, and Sweeney (1995) use AAERs to test the ability of different accrual-based-earnings-management models to detect earnings management. They use AAERs as their sample of companies that are known to have committed earnings management. Dechow, Sloan, and Sweeney (1996) look at corporate governance of firms that have AAERs issued for them. They find that firms manipulate earnings to obtain low-cost external financing. They also find that AAER companies’ board of directors were composed of a majority of non-independent board members and were less likely to have an audit committee. Beasley, Carcello, and Hermanson (1999) compiled a report commissioned by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) that identifies instances of fraudulent financial reporting that were reported in AAERs between January 1987 and December 1997. Their search identifies “nearly 300 companies involved in alleged instances of fraudulent financial reporting during the 11 year period” (Beasley et al., 1999, p. 4). The implications of the findings of Beasley et al. (1999) provided a foundation for portions of the Sarbanes Oxley Act (US House of Representatives, 2002). Case Requirements Go to and select a recent AAER to analyze. Please DO NOT select an AAER related to insider trading or bribery as you will have difficulty responding to Question 3 in such instances. Look for AAERs related to accounting firms and CPAs. Additionally, it is important that you select an AAER that you understand and can succinctly summarize the major details within 2 pages. 1. Briefly summarize the ethical issue underlying the AAER. 2. How do the facts described within this AAER align with the risk factors discussed in Chapter 4 of your textbook pertaining to inherent risk, control risk, or detection risk? 3. Discuss how auditors could have prevented the AAER from happening. (Note: If it is not directly clear how the external auditor may have prevented the AAER from happening, discuss the role the internal auditor may have been able to play in preventing the issue.) 4. How do you think this AAER may impact investor confidence in the capital markets? How do you foresee this action impacting other stakeholders? Please try to be specific.

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