SEC's Increasing Focus on Terrorism May Limit Financial Oversight
“The inference from our paper is that when the focus turns to terrorism it appears to come at the expense of financial reporting oversight,” Mayew said.
The SEC bases some of its terrorism-related inquiries on contents in financial filings, but may also proactively review sources such as the news and websites for the company and its affiliates for information about firms’ possible ties to countries on the U.S. Department of State’s SST list, which also includes Cuba, North Korea and Syria.
During the same year news coverage piqued the SEC’s interest in Mattel, the SEC also contacted Heinz after reports suggested its ketchup was available in both Cuba and Syria. After financial disclosures, news coverage was the most common source the SEC referenced in its questions about SST issues, the research showed.
An influx of attorneys
The SEC’s attention to firms’ financial ties to SST countries began at Congress’s behest in 2003 after incidents such as the 2001 World Trade Center attacks spurred new counter-terrorism efforts, Mayew said.
The researchers found that this coincided with 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, the researchers found. Data showed accountants were more likely to ask accounting questions and detect errors in financial statements while lawyers were more likely to ask questions about terrorism-related activities, which limited the likelihood that the review detected errors.
The data also showed when SEC reviewers asked firms about potential ties to SST, the reviewers were less likely to ask a question regarding core financial reporting, which included topics like accounting policies, disclosures related to a firm’s narrative explanation about its financial statements (known as MD&A disclosures), or non-GAAP metrics (metrics that fall outside of those reported under Generally Accepted Accounting Principles).
“Core financial reporting topics are known to be associated with financial misreporting,” Mayew said. “Interest in SST crowds out inquiries on core financial reporting topics, likely underpinning why SST questions appear to inhibit the SEC’s ability to detect financial misreporting.”
Should the SEC review more or less?
Experts inside and outside of the agency have questioned whether the SEC is sufficiently suited to regulate SST disclosure. As long ago as 2008, the Securities Industry and Financial Markets Association publicly opposed the SEC’s activities, involvement in what the professional organization called matters of national security. Even a former SEC chair spoke publicly on the importance of the SEC’s independence from political persuasion, and that the commission has, at times, been pushed into areas that may not fall within its core mission.
More recently, the SEC has also been called upon to facilitate accountability on how firms address environmental, social, and governance (ESG) factors, and other social issues, such as diversity, equity and inclusion. One such call to action was recently authored by faculty at Duke Law’s Global Financial Markets Center, calling on the SEC to integrate ESG disclosures across a number of areas.
“As the SEC considers regulating disclosure in other domains such as ESG, our research demonstrates that careful thought must be placed into how the commission changes its staffing and how that could spill over to other areas like financial reporting,” Mayew said. “If you now start making SEC staff members review whether financial filings adequately capture climate change risk or racism, for example, it may be headed down the same path as it has with investigating ties to terrorism.”
This story, originally posted to the website of Duke University’s Fuqua School of Business, is published courtesy of the Fuqua School of Business.
