December 23, 2020
Published: Journal of Accountancy
The precise effect the COVID-19 pandemic is having on financial fraud may take time to sort out — regulatory enforcement actions against accounting violations can take years to piece together.
But some forensic accounting specialists said during a session at the AICPA Conference on Current SEC and PCAOB Developments that fraudulent reporting trends from recent years draw attention to some areas financial executives, directors, and auditors should examine and some steps they might take to lessen fraud risk.
There are early indications that the pandemic’s severe financial pressure may tempt some employees to be overly aggressive in meeting budget cuts or sales quotas, said Kristin Rivera, CPA/CFF, the global forensics leader for PwC LLP. Some frauds are being caught at a relatively early stage, which could suggest that internal controls are effective in rooting out problems before they become material to investors.
Rivera added that executives, directors, and auditors need to be alert to how midlevel employees perceive the pandemic’s unique pressures. She advised management to be cautious when announcing directives to motivate employees to take the steps needed to ride out the crisis.
“We may need to be extra cautious of how our words are being interpreted and implemented,” Rivera said. “People feel an obligation to help the company pull through. They might be putting more pressure on themselves to meet those expectations.”
Nathan Seltzer, a partner in the London office of the law firm Latham & Watkins LLP, reviewed SEC Accounting and Auditing Enforcement Releases from 2014 through June 2019. The review was conducted with financial advisory firm AlixPartners LLP, and it is scheduled to be published in January 2021. The survey found that regulators were often concerned with more than the standard tone-at-the-top problems that are often evident in fraud cases. They also wanted to understand how fraud percolated throughout the financial reporting process and involved midlevel managers and staff.
“There’s often someone in the middle, or lower, who was told to do something, or who may have seen something, but didn’t speak up and had the opportunity to do that,” Seltzer said. As a result, there’s a growing interest among some companies to empower midlevel staff to speak out when they witness fraudulent behavior.
Rivera said tone-at-the-top problems are fixable, and a failure to address them will almost certainly lead to problems.
“The least expensive, and easiest thing, you can do is really pay attention to your culture,” Rivera said. “That hard-driving CEO that expects nothing less than meeting the expectations. Even when that’s not the intent, that can be misinterpreted.”
Susan Markel, CPA/CFF, an AlixPartners managing director and a former chief accountant with the SEC’s Division of Enforcement, said auditors and other gatekeepers need to be mindful of the pandemic’s changes to work habits. People have gone for months without venturing into their place of work. Meetings that used to be held face-to-face are now held via Zoom.
“People may not have that ability to walk down the hallway if they have a question,” Markel said. “They might be making decisions that they otherwise would not have.”
Auditors need to be alert to the heightened risk caused by lapses in regular communication among managers and staff. Executives can lessen the risk by making more of an effort to communicate with their staffs.
“There’s no substitute for communication, and it doesn’t cost very much either,” Rivera said.
The accounting fraud survey found that revenue recognition remains the most common source of abuse by people committing accounting fraud. The next highest source of trouble included schemes to manipulate accounting reserves.
Auditors and other corporate gatekeepers may need to pay attention to how remote work has become so commonplace during the pandemic and determine whether that is adding to the risk of financial fraud, Rivera said. People are distracted because they’re fulfilling professional commitments at the same time they’re juggling personal responsibilities like parenting. The unique challenges of working remotely during 2020 may be opening people up to rationalizing some behaviors they should avoid.
“It is an indication that those of us that are part of the ecosystem and part of governance need to redouble our efforts to educate and remind that that is never an appropriate tack to take in order to meet the numbers,” Rivera said.
Executives and auditors are also well advised to review SEC statements in enforcement releases and other public announcements since the pandemic’s onset to get a read on the issues that most concern regulators, Markel said.
Markel added that SEC officials are also assessing disclosures in the management discussion and analysis section of regulatory filings to focus on where individual companies may be exposed. For example, while it’s generally understood that some lines of business — transportation, hospitality, and retailing — are being hit hard by the pandemic, other industries may not be suffering. Companies need to clearly communicate their exposure to the pandemic in their regulatory filings.
“People have to be careful that they are disclosing how severely impacted they are,” Markel said.
Companies will also have to make sure that, despite the extreme financial pressures they endured this past year, they don’t cut their compliance or internal audit functions and expose themselves to a heightened risk of fraud.
“Regulators are expecting a continued focus on compliance,” Seltzer said.
“It’s important to be thoughtful about where resources are allocated but also document decisions,” Seltzer said. Prosecutors who are tasked with investigating suspicious financial activity from 2020 in three, four, or five years may not fully grasp the challenges businesses have faced due to the pandemic. Companies can protect themselves by establishing clear policies for documenting all decisions that affect financial reporting and then make sure they support their decisions with the documentation.
Auditors and compliance teams need to be mindful that basic financial reporting functions, such as journal entries, are being handled properly, Markel said. If there are problems in the journal entries, that would indicate a breakdown in the company’s internal controls and would need to be resolved quickly.
“You need to look at that now and make sure that that is an area of focus,” Markel said. “The SEC has made control reviews an area of focus recently.”