SEC’s ‘Robocop’ Tool ‘in Limbo,’ Former Enforcement Official Says

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By Yin Wilczek

Nov. 4 — The Securities and Exchange Commission's Accounting Quality Model (AQM)—a data analytics tool to ferret out financial fraud that some have dubbed “Robocop”—is “in limbo” right now, a former senior staffer said Nov. 4.

Howard Scheck, the former chief accountant of the SEC Enforcement Division who now is a partner at KPMG, said his understanding is that the commission really isn't using the tool “in the way that they had hoped and the way it had been talked about at least a year ago.”

“So I think it remains to be seen how soon we'll really see results and investigations that are really coming out of that particular program,” said Scheck, who spoke on an enforcement webcast hosted by Dorsey & Whitney LLP.

SEC spokesman John Nester declined to comment.

Earnings Management

As originally envisioned by the SEC, AQM reviews earnings management disclosures against fraud risk indicators and inducers to determine if any company financial statements are outliers compared to its industry and peers. While at the SEC, Scheck had worked with Craig Lewis, the then-director of the SEC Division of Economic and Risk Analysis (DERA), to refine the tool.

Scheck told the panel that one of AQM's problems is its generation of false positives. One of the main reasons the SEC created its Financial Reporting and Audit Task Force was to “bridge that gap” and bring experienced human judgment to the data that would come out of the program, he said.

The other panelists agreed that generating false positives is especially problematic for the SEC, an agency that long has lacked the resources for its enforcement and other functions. Although the AQM could help whittle down the number of companies that potentially are engaging in financial fraud, investigating those companies may still be too much for the commission, said Raymond Wong, a senior consultant at NERA Economic Consulting.

From an economist's perspective, “you've improved the hit rate but that hit rate is not improved enough to really turn this into something” that aids the enforcement process, Wong said. Data analysis has to be combined with human interaction so that false positives are filtered out, he added. “So I think it's really a waiting game” that “will get there.”

Text Analytics

In other discussions, Scheck said DERA also is developing a text analytics tool that will index the disclosures of companies that have been identified in SEC accounting and auditing enforcement releases and that will compare them to current corporate filings to see if there has been over- or under-disclosure in certain subject areas.

However, Scheck suggested that ultimately the predominant sources for financial fraud cases will continue to be “reactive” sources—including corporate restatements, whistle-blower tips and self reporting—rather than “proactive” tools such as the AQM.

“I don't think” data analytics is the “holy grail” for financial fraud,” Scheck said. It is important for the commission to develop the tool, and it could prove useful if the SEC can make it work, he said. “But I think we're a couple of years or more away from that, in my view.”

Although data analytics may not currently pinpoint those companies that are cooking their books, it could still help to educate the SEC staff as to common factors that lead companies to financial fraud, said Georgetown University law professor Donald Langevoort.

The message about potential fraud indicators also should be delivered “most aggressively” to audit committee chairmen and compliance personnel, Langevoort said. Planning compliance and audit committee programs based on those assumptions is “probably healthy,” he added.

Compliance Tips

In other compliance tips in the era of data analytics, Scheck suggested that companies perform vigorous fraud risk assessments in key areas, such as accounting and the Foreign Corrupt Practices Act. Companies also should ensure that their disclosure and financial reporting controls are robust and take seriously their materiality assessments, especially qualitative materiality assessments, he said.

Meanwhile, compliance personnel should be on the lookout for people in their companies who may have “drunk the Kool-Aid” and determine whether there are incentives that may make them “push the edge,” said Thomas Gorman, a Washington-based Dorsey & Whitney partner.

Companies want a compliance culture that doesn't encourage employees to push the edge, Gorman said. “You want a culture that backs off from the edge.”

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