When You See Something, Do Something: Companies must address financial reporting problems fast – or face the wrath of an invigorated SEC

Wednesday, March 30, 2016 - 14:01

With nearly 15 years in the Division of Enforcement at the Securities and Exchange Commission, including five years as Chief Accountant, AlixPartnersSusan Markel knows a thing or two about financial fraud. Below, she discusses the state of the SEC, its Financial Reporting and Audit Task Force, and what’s on the agency’s enforcement horizon. Her remarks have been edited for length and style.


MCC: Why is the Foreign Corrupt Practices Act still a priority for the Securities and Exchange Commission and other regulators?


Markel: The FCPA has been a law for almost 40 years. But in the past decade, we’ve seen regulators focus on it more intently, and they continue to do so. I think this has occurred primarily because of the increased emphasis on internal controls, which represent a key aspect of the law. Companies should have adequate internal controls to prevent bribery and other misconduct from occurring. In addition, one reason the government may be more interested in looking at these cases is the increased threat associated with terrorism. An FCPA investigation that spans countries or regions that present risks could be concerning because it may not be clear where funds are being directed. 


MCC: What would you say are the top three things that are keeping corporate counsel up at night? What should they be concerned with in today’s environment?


Markel: Financial reporting and ensuring the integrity of financial statements are important things. Also, whistleblowers are becoming increasingly important. The SEC is creating and promoting incentives that support the activities of whistleblowers as key means of uncovering potential misconduct or wrongdoing in areas it may want to investigate. This includes such areas as financial reporting and the FCPA. 


MCC: How can general counsel get ahead of this?


Markel: I think it’s important for counsel to make sure they have an appropriate mechanism for dealing with whistleblower tips or other indicators of potential problems. When the government conducts investigations, it often asks for information on any prior tips. So you don’t want to find yourself in a situation in which a tip came in or an internal audit report discussed an issue and the company didn’t take action. Rather, it’s important to be sure that when something does come to their attention in the first instance, they deal with it appropriately. 


MCC: Did you see cases at the SEC that covered issues that continue to pose challenges for companies? 


Markel: Certainly, cases that involve financial fraud in such areas as revenue recognition expenses or purchase accounting occur. One area I appreciate more – now that I’ve transitioned to the private sector – is the increased emphasis on internal controls. The SEC has indicated that it is interested in looking at broken windows, and in my view, that covers the control environment. The SEC could be interested in pursuing cases where the accident hasn’t yet happened but could pose a risk – particularly in light of Section 404 of Sarbanes-Oxley. 


MCC: Has your experience at the SEC informed the way you assist clients?


Markel: I work with a lot of great people, and one of the things that interested me in coming to AlixPartners is not only making a contribution based on my agency experience but also understanding my colleagues’ perspectives and so complementing the knowledge and experience at the firm. It’s helpful to educate the people working on our team internally and also working with clients to help clients understand what specifically goes on at the agency. I believe having the perspective of someone who’s been at the agency helps – particularly when we’re trying to interpret issues or questions that arise in a matter we’re involved in. 


MCC: Do you see a competitive advantage for AlixPartners because you have a multidisciplinary service offering? 


Markel: One of the things I found appealing about AlixPartners was the firm’s deep industry expertise, which can really benefit clients in the cases we work on. Whether it’s semiconductors or energy, we have technical experts who understand an industry’s underlying issues. The same goes for e-discovery expertise, where we can help companies not only with forensic analysis and litigation support but also with data analysis. And that means really starting from day one: What data do you have to make sure is locked down? If issues come up, how do you deal with them? And I believe it’s an added value that we can provide an integrated approach. A client benefits by dealing with one team and not multiple vendors. We take responsibility for gathering data, analyzing it, and reporting on it to the client and, if necessary, third parties. I think that’s very helpful – and something I definitely like being able to provide our clients.


MCC: What is the value of AlixPartners’ ability to navigate these different channels of communication?

Markel: When we conduct an investigation, we want to look at several areas. First, there usually is a database of email and text messages. We also frequently deal with the actual data that exists at the client company, such as general ledger, payables and payroll. We have tremendous capabilities for working with data and analyzing it quickly in order to identify other areas where there may be potential problems. 


MCC: What else is occurring from a regulatory perspective that should be on the minds of corporate counsel? 


Markel: The SEC’s Financial Reporting and Audit Task Force was developed to help the commission find cases to investigate, particularly in the financial-reporting area. That’s a game changer in my mind. The SEC has added resources to that task force, which is now a permanent group, and that’s its mission. So it may be that a company gets contacted on something well before even realizing a potential problem may exist. That group is using different analytic techniques and pulling information from whistleblower tips, public filings and many other data sources. 


MCC: Can you point to other examples that illustrate the impact of the new task force and similar initiatives? 


Markel: The Financial Reporting and Audit Task Force has been working on a number of different data tools that will enable it to look more quickly at a company’s financial statements. For example, the task force may use data analysis to compare the company with peers or to analyze the overall industry to determine whether there are anomalies. There’s also the Financial Fraud Enforcement Task Force, which leads into whistleblowers, wherein as part of the program, the SEC can offer 10 percent to 30 percent of the amount of money recovered in excess of $1 million. In a financial fraud case, that may involve fines or penalties and monies collected in the millions and even hundreds of millions of dollars, so the potential rewards for someone who reports possible wrongdoing are significant. The SEC is also working with the retaliation provision of the program and may pursue an action against a company if it believes the company has retaliated against a whistleblower. 


MCC: Do companies get weighed down by the vast amount of information they may need to obtain or provide in connection with an investigation? 


Markel: What we see resulting from FCPA and other whistleblower tips is that companies are often put in a position of proving a negative. In that case, you want to do it as efficiently as possible, since it can last several years and be costly in money and time while diverting people from running their businesses. So it’s important that companies select outside counsel or consulting firms they can trust to investigate thoroughly but efficiently. 


MCC: Are there other areas of enforcement that general counsel should be mindful of? 


Markel: I should talk about the SEC’s clawback rules, which were initially put in place under Sarbanes-Oxley. The agency has increasingly used them to claw back incentive compensation from the CFO and the CEO when there’s an issue of a restatement to the financial statements as a result of financial misconduct. Again, that was a rule that did not exist prior to Sarbanes-Oxley. With Dodd-Frank, the clawback rules become much broader. They are broader in terms of who is subject to the clawbacks and why. So whereas previously only CEOs and CFOs were subject to the clawback rule, the new rule, which is currently being drafted, could potentially affect former or current executive officers. The new rule also includes all restatements that result in increased incentive compensation, not just those resulting from misconduct. The new rule can also claw back monies for three years. So I think that’s an area companies should be looking out for: How are they going to write their policies? And what impact will the new rules have on their compensation programs? There are a number of questions, but this is something people should be paying close attention to.


MCC: Is the rationale that if the compensation packages are less incentive driven, there’s less incentive to do wrong in the first place? 


Markel: That’s right. I think the idea is to drive companies to invest in their internal control systems because controls really matter, and they exist to help prevent certain financial-reporting types of restatements. Perhaps such investments can change behavior, since when compensation is based on a short-term goal, people may take steps to hit those goals. If a problem arises, it may not occur until years down the road and so may not affect them. With the new rules, the SEC can go back and claw back those funds. Along with the FCPA and the increased focus on that area, regulators have been looking more and more at money-laundering controls. They want to follow the money trail to determine where the money came from, where it was directed and which parties were involved in helping use it for illicit purposes.


Susan MarkelAlixPartners’ Managing Director in the Financial Advisory Services group in Washington, D.C. smarkel@alixpartners.com