Finance & terrorismSEC's Increasing Focus on Terrorism May Limit Financial Oversight
When SEC asks companies about potential ties to terrorism, it catches fewer reporting errors. The SEC’s shift of attention to firms’ financial ties to states sponsoring terrorism (SSTs) began at Congress’s behest in 2003, leading to a shift in the composition of SEC review staff — the number of lawyers the review staff has grown while the number of accountants has decreased.
When Iranian authorities started seizing Barbie dolls from Tehran toy shops in 2012, Mattel Inc. execs faced concerns not only about the dolls’ attire – miniskirts and swimsuits considered immodest in an Islamic country – but also questions from the U.S. Securities and Exchange Commission (SEC) about Mattel’s ties to Iran.
U.S. businesses are restricted from business in Iran, which U.S. authorities have designated a state sponsor of terrorism (SST). The number of SEC inquiries about potential terrorist ties has grown substantially in recent years, and according to new research from Duke University’s Fuqua School of Business, the increase could reduce the quality of the agency’s financial reporting oversight.
“Comments on terrorism are getting to a critical level of importance in terms of what the SEC is asking companies about,” said Bill Mayew, a Fuqua accounting professor and co-author of research, which is forthcoming in the Journal of Accounting & Economics. “Investors want to be aware if the companies they invest in are potentially supporting terrorism, but they also want financial statements that are correct. The SEC has to balance both of these issues to protect investors.”
Tracking focus areas at the SEC
Mayew, along with Fuqua Ph.D. alumni Robert Hills of Pennsylvania State University and Matthew Kubic of the University of Texas at Austin, analyzed the more than 17,800 comment letters from SEC review staff from 2005 to 2016. Comment letters are typically sent after SEC staff reviews a firm’s disclosures to gather more information or notify a firm that its filings contain inaccuracies or errors.
Of the 825 comment letters the SEC sent in 2005, only 2.2% included comments related to SST, the analysis showed. By 2016, that number had grown to 8.4%. Terrorism has become as commonplace a topic in comment letters as questions about financial information such as intangible assets, revenue recognition and taxes, Mayew said.
The researchers found that when SEC comment letters included references to terrorism, the letters were less likely to identify the firm’s financial reporting errors.
To determine cases in which errors were caught and missed, researchers analyzed comment letters as well as subsequent corrections, or restatements, from the firms that received comment letters.
Among restatements that investors typically care most about – those containing severe errors – the SECs’ average error-detection rate was 31.1%, the data showed. The error-detection rate dropped to 10.6% when letters included the topic of terrorism disclosures, the researchers found.
