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The Sec

In: Business and Management

Submitted By gsleiman
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Overview of the SEC

Primitive economies are basically barter economies (goods and services traded for other goods and services), while in other mature economies, businesses are organized into proprietorships, partnerships, and joint venture. These types of closely held businesses, in which owners manage their own business, do not need external reporting of the results of operations. However, external reports have become essential with the increase in the size and number of business enterprises, along with the increased amount of people investing capital resources in these businesses. The corporate form of business also increases the need for objective verification of data and creates a need for disclosure of more and better information to owners and potential investors. Furthermore, the increase in value, size and activity of capital exchange in security market also increases the opening of taking advantage in lax conditions and to profit by misrepresentation and manipulation. Hence, the main reason for establishing the securities legislation was because large security market requires operating procedures that would protect investors from fraud and guarantee an adequate supply of capital for economic growth.

Background of the SEC

The Securities and Exchange Commission (“SEC”) is one of several public and private sector rule-making organizations that have an effect on financial reporting for businesses. It plays a crucial role in the development and improvement of financial reporting theory and practice. Frequently the work, accomplishments and contributions of the SEC do not receive the attention given to other group, such as the Financial Accounting Standards Board, the Government Accounting Standards Board, or the American Institute of Certified Public Accountants. A common mistaken belief is that securities legislation only begun around the time of the Great Depression and the stock market crash of 1929 and the ensuing years.1 However, back in 1852, securities legislation was perceived as necessary by lawmakers in Massachusetts. Also, the federal government continuously tried obligating licensing of all companies involved in commerce under the Interstate Commerce Clause. In 1911, Kansas State legislators led the way into combat, and by 1912, 22 other states had passed laws aimed at controlling the sale of securities. These laws were divided into two categories, fraud laws and regulatory laws. The fraud laws imposed penalties where evidence indicated fraud has been committed in the sale of securities, where as the regulatory laws, attempted to prohibit the sale of securities until an application was filed and permission was granted by the state.2 These early laws then became known as “blue-sky” laws, and all securities sold in Kansas had to be registered under the blue-sky law.3 Moreover, in 1921 in New York State the Martin Act was passed. These state laws were not competent and lacked the scope and clout to halt fraudulent activities, nor did the investors make this a priority for their interest. This collection of regulation covered the issue of securities by a company; information contained in a prospectus; and the buying and selling of securities in an initial distribution and in secondary trading on the exchanges. However, the difference between states and among industries provided insufficient protection for the investor.4 The shaping of the Securities and Exchange Commission or SEC was the result of the completion of many years of stock manipulations, financial abuses of the security markets, and a decrease of public’s faith in the securities market. During the 1920’s and into the early 1930’s, many people demanded for some measure of legislation that would ensure and regulate that fair market practices were being implemented. Many individuals advocated a fraud law, patterned after New York State’s Martin Act, which reflected the view that securities legislation should be as supportive to honest business as possible.5 The Martin Act set forth the statutes for securities sale and exchange in New York State as well as the Attorney Generals role in investigations and prosecution. The Martin Act was prominent and the public wanted it to be nationally implemented. Scholars of public administration consistently wrote about the benefit to bring greater knowledge, or professionalism, into government to counter the influence of dominant economic interests, as well as to enhance the efficiency of government activities.6 However, the result of these demands and changes were not reached until the market crash of 1929 which affected the market until the year of 1932. Throughout the 1920’s, various unethical commonplace practices were undertaken which affected the beliefs of several people in regards to finding it to be the key points in the slump of the market. The following are two examples of these practices. The first example is the utilization of corporate information by individuals with prior knowledge, getting a tip about the direction of the corporation before this knowledge became available to the public. These executives and people of power would align themselves and take advantage of the fluctuations in the market, which in actual fact is an early case of insider trading. The second example, many brokers tried to drive up prices of securities by creating a false sense of activity regarding certain securities. This would be accomplished by initiating a high volume of predetermined sales orders called “wash sales” which would lead to an increase in the prices of those securities. Additionally, brokers were engaged in outright deceit by publishing false information regarding financial statements of corporations that lead to an inaccurate judgment of value.

After the severe market decline that caused market prices drop from $89 billion to $15 billion over the span of three years, the congress found that it was necessary to begin regulating the market. Congress held hearings to address these issues and determine what had to be done in order to redeem the faith of the public and for the markets to regain traction and start rebuilding, public confidence. Legislation was considered necessary to combine solutions to all the aspects of malpractice but with disclosure being the main concern. The result was the passing of the Securities Act of 1933 and the Securities Exchange Act of 1934, which also brought about the creation of the Securities and Exchange Commission.7 The general idea of these Acts was twofold. First, there must be an idea of full disclosure to the public, and secondly the brokers and the dealers must treat the investors with honesty and with complete fairness. Based upon this framework, the SEC has been policing and regulating the securities and exchange markets for the past years. The SEC itself claims as its mission is “…to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation”.8 The SEC was given the duty to ensure “full and fair” disclosures of all material facts concerning securities offered for public investment. The commission’s intent was not necessarily to prevent speculative securities from entering the market, but rather to insist that investors be provided with adequate as well as accurate information. Therefore, the SEC regulation is assumed to be in the public interest and holds a close relationship to the informational objective of accounting.9

Organization Structure of the SEC

The SEC is organized into various divisions and offices. It is directed by a team of five commissioners, of whom a maximum of three commissioners can belong to the same political party to guarantee non partisanship. Each member of the commission is presidentially appointed by the president of the United States with the approval of the Senate. The term of each commissioner is five-years and the term of one commissioner expires on June 5 of every year to create a staggered effect.10 The President also designates one Commissioner to Chair the commission. The SEC is overseen from Washington, D.C. headquarters and has many regional and a branch office in the major financial centers of the U.S. The Commission is assisted by many professionals, including accountants, lawyers, engineers and etc. Below is an illustration of the organizational structure of the SEC.


Five divisions in the SEC The SEC has five divisions, in which some of them have overlapping authorities. These five divisions are; Corporation Finance, Market Regulation, Enforcement, Corporate Regulation and Investment Management.

❖ Division of Corporation Finance

The Division of Corporation Finance is perhaps the most important division for individuals in business and specifically for accountants. This division plays a major role in assisting the Commission in requiring corporate disclosure of important information to the investing public under the SEC jurisdiction and administering disclosure requirement for the Securities Act, the Security Exchange Act, the Public Utility Holding Company Act and the Investment Company Act.11 The Division of Corporation Finance also reviews all prospectuses, registration statements, the annual 10-K and quarterly 10-Q reports, proxy materials sent to shareholders before annual meetings and sales literature concerning mergers and acquisitions. According to the SEC, this division is now organized along individual lines to allow the division to better ascertain the particular disclosure needs of different industries and to more readily identify industry trends.

Corporations are required to obey the regulations pertaining disclosure that must be made when stocks are at first sold and then on a continuing periodic basis rather than on disclosure documents concerning particular transactions.

These documents disclose information about the company’s financial condition and business practices to aid investors make a knowledgeable decision. This Division uses a Division's review process, in which the staff checks to see if publicly-held companies are meeting their disclosure requirements and strive to improve the quality of the disclosure. To meet the SEC's constraint for disclosure, all companies issuing securities or if their securities are publicly traded, then all information that might be relevant to an investor's decision to buy, sell, or hold the security must be made available, whether it will have a negative or positive impact.12

Additionally to possessing a review function, the Division of Corporation Finance also serves as an interpretive and advisory service to help clarify the applications and requirements of the securities laws of the SEC to issuers, accountants, lawyers, and underwriters. Furthermore, individuals can obtain guidance from the Division by using an instrument called the “no-action letter”. An individual can seek a no-action letter from the SEC when it begins new and previously unknown methods regarding the securities market. At this point, the individual must wait for a response from these no-action letters on whether the Division staff would or would not advocate the Division to take action against the entity for engaging in its new practice. Therefore, this will allow the individual to conclude whether the practice did or did not meet the regulations and standards of the SEC and whether to continue in this new practice.

❖ Division of Market Regulation

The Division of Market Regulation assists the commission in the regulation of national securities exchanges and of brokers and dealers registered under the Investment Advisors Act. This Division cooperates with the regional offices in investigating and inspecting exchange of trading markets. The Division also exerts its influence by an active and ongoing surveillance of the markets to ensure no misconduct, manipulation or fraud, and to maintain fair, orderly and efficient markets regarding the stabilization of securities prices.13

Also, this division supervises the broker-dealer inspection program. The periodic reports submitted by brokers-dealers are analyzed to guarantee proper disclosure and to promote the proper conduct of these dealers. The Division of Market Regulation can permanently prohibit broker-dealers from transacting business or, as more commonly, suspend them for a shorter period of time.

❖ Division of Enforcement

This Division is responsible for the review and direction of all enforcement activities, all investigations conducted pursuant to the securities laws and the institution of injunctive actions. The Division of Enforcement must also determine whether available evidence supports allegations.14 Furthermore, this Division has two main methods as outlined by the SEC, to enforce securities laws.

The primarily means where the Commission leans towards for passive actions is thorough the administrative route. It is the most common and straightforward path it follows in dealing with such situations when arise. This process typically requires an administrative judge who will act as a third party. The judge must have no ties to either party so that his hearing process will not be biased. “The judges act as independent judicial officers who preside over public hearings involving allegations of securities law violations instituted by the Commission”.15 After the Commission takes note of the findings from the administrative law judge, they decide to either accept, or reverse or even defer for an additional hearing. Furthermore, the defendant may accept or deny the allegations or settle or even appeal the ruling. Administrative action can range from financial penalization, suspension, civil monetary penalties, cease, or even demand the return of any unlawfully or criminally attained source of money.

Another option that Commission can pursue in a case is to file through civil action for enforcement through a District Court. “The SEC can assert that an adverse inference should be drawn against an individual who has asserted the Fifth Amendment privilege .It is well established that the privilege against self incrimination applies in civil as well as criminal cases, particularly conferred before testimony is sought.”16 Civil actions involve holding an individual such as a corporate officer in federal courts where as administrative action involves revoking the SEC registrations. Depending on what the SEC find appropriate, both actions can be implemented on a case.

❖ Division of Corporate Regulation

The Division of Corporate Regulation has two major responsibilities. The first responsibility is to aid in administering the Public Utility Holding Company Act of 1935 and the second responsibility is to perform the Commission’s advisory functions to federal courts in corporate reorganization proceedings under chapter 11 of the bankruptcy reform act of 1978.17The Public Utility Holding Company Act of 1935 requires that large utilities be physically integrated and regulated to prevent unnecessary complexities in corporate structure. All the extensive work done by the Commission under the Public Utility Holding Company Act of 1935 is because of the Division of Corporate Regulation effort. To illustrate the extensive work accomplished under this Act, more pronouncements of official policy and procedures have been given pursuant to the 1935 act than under any other federal securities law. Also, the extensive work includes more securities release-official pronouncements of policy and procedures have been more pursuant than under any federal securities law.

❖ Division of Investment Management

The Division of Investment Management assists the Security and Exchange Commission in the administration of the following two acts: the Investment Company Act of 1940 and the Investment Advisors Act of 1940. All investigation and inspections arising from these Acts are the responsibilities of this division. Under the Investment Company Act, the SEC has the responsibility to protect investors. The SEC accomplishes this responsibility by obligating all investment companies to register with the SEC. The act's purpose, as stated in the bill, is "to mitigate and... eliminate the conditions... which adversely affect the national public interest and the interest of investors."18 This act helps all parties both directly and indirectly by preventing any conflict of interest from occurring. On the other hand, the Investment Advisors Act is an Act that requires there to be full disclosure about the investment-advisor. This could be information about their backgrounds, their business affiliations and other information that could show any conflicts or discrepancies leading to violations of law. Hence, the Investment Advisors Act regulates all actions of investment advisors as set by law. Finally, the Division of Investment Management has the responsibility of investigating and inspecting matters that involve the investment companies and the individuals offering those services.

Mission of the SEC

The security and exchange commission’s (SEC) objective is to standardize and maintain a regulatory system for industries and stock markets, offering security to new investors. The SEC administrates several laws that govern securities of industries allowing them to keep a close eye on corporate takeovers. In additions, the commission’s main interest is to facilitate the overall capital formation and strengthen the market infrastructure by preventing corporate abuse.19 Their very large responsibility to protect the first-time investor entering the market is due to the reflection in protecting the investor’s personal responsibilities, such as, securing enough funds to pay for homes and being able to send their children to colleges.

An important belief that SEC follows is the right for investor regardless of their size, in having easy access to all true information regarding basic facts about any investment they are interested in purchasing and for as how long they have it. “This provides a common pool of knowledge for all investors to use to judge for themselves whether to buy, sell, or hold a particular security”. To further support this right, SEC requires significant meaningful information of the companies to be provided to investors. This will facilitate the investor decision making process and allow them to have a good calculated plan. As a result, it will offer them protection and will avoid potential financial crisis.20

Companies and all market related investors are expected to complete files and reports according to financial and auditing standards. SEC will keep documentation and follow up with their histories. Information about their business practice and periodical movement of the company’s stock are recorded. The U.S. public companies must generally file at least one annual report namely the 10-K and three quarterly reports, the 10-Qs.21 Not all data and material information is consistently defined by the SEC, however SEC still requires companies to outline reasonable information that are considered of value and importance for investment decision making. 22

Having a clear apparent understanding of the market is an aim that was established with the foundation of the SEC. It puts a huge toll of importance on disclosure. The direct impact that disclosure has on the protection and security of both, investors and market shareholders is inevitable. An overall financial stability of the market will be maintained with disclosure. The Commission uses the help of the Office of Chief Accountant to carry out its responsibilities in establishing accounting principles and understands auditing standards. It also consults on financial disclosure requirements. SEC successfully tracks and enforces actions against civilians who practice fraudulent accounting and supply inaccurate, misleading false information about their investments, companies and securities. Their consistent achievement is directed from the universal framework enforcement of disclosure.

SEC makes sure that their goals are always met and always complete their mission and achieve their objective by keeping a thorough workflow with all the candidates who play an important role in the markets. They are the supervisor of the U.S. securities world but yet keep close relations and network with other institutes including Congress, stock exchange regulatory organization, security brokers, mutual funds, and private sector organizations. This is crucial as SEC system does not guarantee and securities by stocks or bonds for the first-time investor, unlike how the Federal Deposit Insurance Corporation (FDIC) does. Therefore, the SEC’s attention is directed to maintain and assure the access of straightforward, valid and true information to the public while arresting any fraudulence.

Primary Acts

There are two primary Acts administered by the SEC, the Securities Act of 1933 and the Securities Exchange ACT of 1934. These primary acts (explained in details below) both of them have been revised through amendments and the emphasis on disclosures has been increased.

• Securities Act of 1933

This Act is often referred to as the “truth in securities” law. A popular misconception is that the Securities Act of 1933 was passed during the chaotic days of the 1920’s, but it actually was during the peak time when reform was being called for, all due in part to the collapse of the financial market. In 1933 the Act was commented on by Felix Frankfurter, and he was quoted saying “By compelling full publicity of ‘every essentially important element attending the issue of new securities’ so that the public may have an opportunity to understand what it buys, the Act seeks to promote standards of competence and candor in dealing with the public.” 23 This Act has two basic objectives; (a) to provide investors with material financial and other information concerning securities offered for public sale and (b) to prohibit misrepresentation, deceit, and other fraudulent acts and practices in the sale of securities generally (whether or not required to be registered).24

The most prominent mean of accomplishing these goals is the requiring of disclosure of important financial information through the registration of securities by any firm by any firm offering securities for public sale (except for those specifically exempted). These disclosures enable investors, not the government, to make knowledgeable judgments about whether to purchase or not to purchase a company's securities. While the SEC requires that the information provided be accurate, it does not provide any guarantees. The intent of the law is that the government should not take the responsibility for determining the investor’s choice among investment opportunities but should only make certain the investors has an opportunity to make such choice on the basis of full disclosure. The investors, whom purchased securities and suffered losses, can demand for a recovery if and only if they can prove that there was incomplete or inaccurate disclosure of important information.

As an answer to the public regarding the failing markets, the Securities Act came and was seen as long overdue legislation. The legislation was well greeted at first and liked by many; however, shortly many in the financial circles began to see it as very limiting and burdening on their activity. Many predicted a paralysis of the nation’s capital raising mechanisms if more legislation were to be passed.25

• Securities Exchange Act of 1934

In a bid to bring the United States out of the Great Depression, president Franklin D. Roosevelt created the New Deal - a series of economic programs and were focused on what historians came to call the three R’s; Relief, Recovery, and Reform. As part of Roosevelt’s New Deal, the Securities Exchange Act of 1934 was essential for the continuation of securities legislation. Unlike the 1933 Act, which restricts itself primarily to initial offerings, the 1934 Act is concerned with several aspects of securities trading. The 1934 Act initially extended the full and fair disclosure doctrine to include all companies that had securities registered on the national securities exchange. The Securities Exchange Act introduced laws to govern the securities industry and trading in stocks, bonds and debentures. It created the Securities and Exchange Commission (SEC) and gave it administrative oversight of the securities industry as a whole. .21 It also put into law the rules that would define the fraudulent types of securities transaction which constitute insider trading and the disciplinary action that needed to be taken in case of infraction. Additionally, the Act stipulated that companies which met certain income standards need to file quarterly and annual financial reports and make these reports available to the public through the EDGAR system. Finally, the act required those wishing to participate in the market to register with the SEC and disclose pertinent information about themselves 22– an example of the disclosure-enforcement principal. The SEC set rule and regulations governing how corporations would communicate with their shareholders and the public in order to ensure that the shareholders had all the information they would need to make well informed decisions. They required that the information contained in proxy materials had to be disclosed to shareholders and that it had to adhere to the proxy rules set out by the SEC. This is another example of the disclosure-enforcement principal. Another provision authorizes the Board of Governors of the Federal Reserve System to control the use of "margins" in securities trading. The SEC retains the responsibility of enforcing the credit restrictions in connection with its periodic review of the exchanges and brokers.

Secondary Acts

• Public Utility Holding Company Act of 1935

This Act was passed by Congress to correct many abuses which congressional inquiries had disclosed in the financing and operation of electric and gas public-utility holding –company systems. This act gives the SEC a regulative device, section 11, to become commonly known as the “death sentence”.26 Furthermore, the 1935 Act also authorized the SEC to regulate the terms and form of securities issued by utility companies, such as to promote competition among investment banks for underwriting and to render other services to utility companies. Hence, this will provide protection to the interest of both consumers and investors. Additionally, the 1935 Act gives the SEC power to regulate registered companies accounting system, to regulate intercompany transactions such as loans and dividend payments and to approve any acquisition or disposition of assets and securities.

Trust Indenture Act of 1939

Passed in 1939, this law was meant to protect bond investors. The law stipulated that a trustee be appointed to all bonds to guarantee the rights of all bond holders are maintained. Debt securities which are issued pursuant to trust indentures under which more than one million dollars of securities may be outstanding at any one time. Additionally, all bond issues valued over $5m could not be put on sale without a formal written agreement (and indenture) singed by the bond issuer and holder. Finally, should a bond become insolvent, the law stipulated that the party that issued the bond may have its assets seized and sold to recoup the investors’ losses.

Investment Company Act of 1940

This law was put into place to protect investors from conflicts of interests that may arise when dealing with a company that invests in securities which may include its own securities. The intent of this act is to remedy and control many of the abuses uncovered in the intensive study and to work out a compromise between industry representatives and the SEC. It accomplishes this by requiring companies to disclose information that is used to monitor for conflicts of interest.27

Investment Advisers Act of 1940

This law was put into place to track and monitor securities investment advisors. This law requires proper and complete disclosure of information about investment advisors, their backgrounds, business affiliation, and bases for compensation. It stipulates that all such advisors need to register with the SEC and that they abide by the SEC rules and regulations. The Commission has the power either to deny registration or to suspend or revoke existing registration when it finds that the investment advisors do not make the proper disclosure. The SEC may initiate injunctions or recommend prosecution of advisors for willful violations of security laws and may issue rules defining fraudulent practices.

• Securities Investor Protection Act of 1970

The Securities Investor Protection Act of 1970 is an amendment to the securities Exchange act of 1934, and it created the Securities Investor Protection Corporation (“SIPC”). This SIPC is a non-profit organization whose membership comprises the brokers and dealers registered under Section 15(b) of the 1934 Act and members if the national securities exchange.

Funds for the SIPC were raised by collecting fees from the membership, which were used for the protection of investors to a limit of $50,000 for each account and a maximum of $20,000 for cash claims in each account.28 Furthermore, the SIPC is required to file financial statements and annual reports with the SEC, and the commission can make inspection of all SIPC activities. Also, the SEC has authority in connection with the bylaws and rules of the SIPC.

• Foreign Corrupt Practice Act of 1977

The Foreign Corrupt Practice Act (“FCPA”) generally controls and prohibits questionable or illegal foreign payments. Under provisions of the Act, all companies in the United States of America and their officers, directors, employees, agents, or stockholders are prohibited from bribing foreign governmental or political officials. Bribing a foreign government is defined as “payments, or the offering of anything of value” to foreign officials as a means of promoting business interests.29

Another important factor of the FCPA is the requirement that all public companies must keep reasonably detailed records which “accurately and fairly” reflect company financial position. Also it requires all public companies to develop and maintain a system of internal accounting controls sufficient to provide reasonable assurance that transactions are properly, recorded, authorized and accounted for. These provisions are applicable to all publicly held companies, all companies with securities registered under Section 12 of the 1934 Act and companies required to file periodic reports pursuant to Section 15(d) of the 1934 Act.30

For any company in the United States found guilty of making bribes, or not complying with FCPA, can be subjected to fines up to one million dollars, and individuals can be fined a maximum of $10,000 or imprisoned up to five years or both.

• Sarbanes-Oxley Act of 2002

Created in response to the corporate scandals and financial abuses that shook the market took in the 1990’s and early 2000’s this law aims to establish clear accounting and reporting practices that needed to be followed by all companies. It’s aimed at protecting investors from the kinds of losses that they suffered when the stock prices of companies such as Enron and WorldCom tumbled, causing investors to lose billions. The drop in stock price was due to the uncovering of several unethical and illegal activities that were used to mislead investors and hide debt from the public, in addition to insider trading.31 Those scandals had eroded public trust in the US markets and the laws were meant to rectify that. The regulation was a bid to win back public trust and confidence. They were substantial in scope, prompting President George W. Bush to call them “the most far reaching reforms of American business practices since the time of Franklin Delano Roosevelt.”32 The act established the Public Company Accounting Oversight Board (PCAOB) which was tasked with protecting investors from fraudulent activities. The PCAOB provides independent audit reports about public companies. The act sought to reassure investors by that they are being protected from such scandals as WorldCom by forcing companies to disclose information that investors can use to make sound decisions on their investments.

The role of the SEC in reducing fraudulent financial reporting

The indication that there was a growing concern for fraudulent financial reporting was the establishment in 1985 of the National Commission on Fraudulent Financial Reporting. The NCFFR was assigned to investigating the problem of fraudulent financial reporting, conducting research, and making recommendations designed to reduce the severity of the problem. Part of that research was that of the Securities Exchange Commission. The study examined its historical role and the effectiveness of current policies and procedures.

The SEC has undergone many changes, through its infancy and puberty years between 1933 and 1945, the focus was on building the agency envisioned by Congress. The overall financial reporting goal that the SEC aims to achieve is full disclosure by registered companies of all material information that financial report users require to make informed decisions. The effectiveness of the Securities Acts in achieving this goal depends in part on the effectiveness of the set of accounting principles which guide financial statement reporting.

The Securities and Exchange Commission is the Federal Government's major participant in the accounting establishment. To a sounding degree, the SEC has permitted, and even insisted upon, establishment of accounting standards which have substantial impact on the Federal Government and the public by self-interested private accounting organizations. The result has been an extraordinary delegation of public authority and responsibility to narrow private interests.

The SEC currently utilizes to reach the financial reporting goal of full disclosure; oversight of private sector efforts in establishing accounting and auditing standards; rulemaking initiatives; the review and comment process; and the enforcement program.33 The oversight process seeks to improve the quality of the standards setting process. Through the office of the Chief Accountant, the SEC continuously consults with standard setting entities, such as the Financial Accounting Standards Board. The SEC also has taken an active role in initiating rules where it perceives a need to supplement privately developed accounting standards. These rules are also used to establish financial disclosure requirements and to define independence criteria for auditors. SEC reviews of registration statements and periodic and special filings are used to improve filings, identify emerging accounting issues, and identify problems warranting enforcement action. The SEC seeks to reinforce activities and redress violations of the securities laws and publicizes enforcement outcomes in order to encourage registrants and their attorneys and accountants to exercise care in complying with the securities laws.

The Securities Exchange Commission is directed by five Commissioners.34 The efforts of the SEC in dealing with fraudulent financial reporting involve both the Commissioners and the staff. Various policies and activities are involved in the SEC's efforts to prevent, detect and discipline cases of fraudulent financial reporting. The very establishment of requirements for securities registration and continuing financial reporting has fraud prevention aspects, as the penalties for violating the federal securities laws provide a motivation for presenting non-fraudulent financial reports. The SEC review and comment process may also deter fraudulent financial reporting, again because the process motivates compliance with the laws. Also, the publicity associated to SEC enforcement actions and investigations can act as a fraud deterrent.

There are multiple fraud detection efforts. These include monitoring registration statements and continuing reporting filings, monitoring market activity, and responding to public complaints and tips from informants.35

All corporations operate under a set of constraints. There are three major constraints that the SEC operates under in dealing with fraudulent financial reporting: a multiplicity of objectives, conflicting desires of its constituents, and financial and human resource constraints.36 Although the SEC has multiple major roles that they balance, the most important would be fraudulent financial reporting. The former chief accountant of the Division of Enforcement, Glen Perry, reiterates this belief by arguing strongly that it is the first priority for enforcement. He states that his mentioning financial fraud as the first enforcement priority in intentional. That it is the way that the Commission views it. This is because financial statements and the disclosure of financial information are central to the disclosure system. No other aspect of the disclosure process has a greater impact on the judgment of investors and on market prices. So when the commission spends money, it puts it where it needs it the most, which is in fraudulent financial reporting. The SEC also has many other roles and objectives such as with investment companies and financial advisors and their efforts in insider training.

A second constraint that the SEC is under is that it serves multiple constituencies, who do not always have compatible needs or desires. The conflicting desires of the SEC's constituencies are also reflected in broader legal constraints. On the one hand, Congress and the public express a mandate for the SEC to step up enforcement activities and on the other hand, recent legislative acts and court decisions have as a damper on enforcement activity. Another major restraint is that the SEC is subject to financial and human resource constraints, especially in regards to allocation of positions and funding.

Several changes have been made over time at the SEC in an effort to more effectively deal with fraudulent financial reporting and increase productivity. One change has been to increase the participation of accounting experts on the staff in investigations. Other efforts to increase effectiveness and productivity include action to automate work, to reduce the amount of duplication involved in disclosure filings, to create a market surveillance system, and to move toward electronic filings.

There are many corporations and people that have been called out by the SEC. A prime example is Arthur Andersen, the auditor for Enron and World Com, which has become synonymous with unethical and illegal practices of auditing firms in the US. This reputation for unethical behavior is a far reach from their original reputation of being an honest and respectable company known for their integrity and ethics.

Arthur Anderson was once one of the “Big Five” accounting firms in the United States. The company was known for its “rock solid integrity” and prestige in the auditing profession. The scandals surrounding Arthur Anderson’s clients resulted in costing their investors nearly $300 billion, the economic impact as a whole to the nation was huge. Thousands of people lost their jobs, a sense of distrust and stress was revoked in Corporate America and the stock market declined substantially.37 One could never have envisioned that accounting firms could prove to be such a crucial element in melting down an otherwise strong economy.

The images of auditing firms across the country were sullied by Arthur Andersen scandal. The many lawsuits in which Andersen was involve which were settled on the basis of accounting irregularities which has a negative toll on the image of an auditing company in general. Auditing firms are there as a line of defense against inaccurate financial reporting, Andersen’s actions did not just effect themselves, but attributed to a mistrust of the field of auditing.

The collapse of energy giant Enron also revealed that Arthur Anderson an accounting firm was also involved in political ties that overlapped for the employees of both companies. Employees of Arthur Anderson working for Enron had contributed close to $200,000 to George W. Bush’s campaign; in addition to spending approximately $25,000 for his inauguration to the office of governor in Texas in 2002.38 Arthur Anderson had a strong political lobby for an auditing firm.

The fall of Arthur Anderson was a result of series of law suits filed against the company for corrupt auditing practices. A list of Anderson’s clients included the Baptist Foundation of Arizona, Sunbeam, Waste Management and Enron.39 Arthur Anderson paid millions of dollars to settle each lawsuit and the company was forced to separate its auditing services and consulting services by the SEC in 2002.

One of the legal issues surrounding Andersen’s growth was the method by which independent audits were conducted. Arthur Andersen, by placing an emphasis on recruiting and retaining big clients came at the expense of quality and independent audits, created an illegal and unethical upheaval that the company could never recover from. Arthur Andersen linked its consulting business in a joint cooperative relationship with its auditing departments, which compromised its auditors’ independence, a quality control issue which is crucial to the execution of a credible audit. The firm’s focus on growth generated a fundamental change in its corporate culture, one in which obtaining a high profit was regarded in higher regard than providing objective auditing services. This business model raised alarm with the Securities and Exchange Commission. This led to proposals to include new rules that would restrict some services they would be able to offer their clients which Andersen opposed.

The accounting and consulting illegal actions and the demand from the American public for higher standards for auditing companies inspired Congress to pass the Sarbanes-Oxley Act 2002, which established guidelines for corporate and accounting responsibility. The Sarbanes-Oxley act oversees, investigates and disciplines all accounting firms that are involved in auditing public firms. The act not only restricts auditors to audit activities only but it also outlines strict crime and punishment penalties that can prevent possible irregular and misleading accounting practices.40

The SEC initially brought a fraud case against Arthur Anderson for its involvement in the waste management scandal. After that revelation came, other bigger audit failures like Enron and WorldCom, preceding the Sarbanes-Oxley wave. 41 The SEC found the domino effect present in all of these organizations. Fraudulent financial reporting was becoming the foundation that these organizations were thriving upon. This case led a trail for the SEC to discover other companies that were also fraudulent.


In conclusion, investor confidence in securities is crucial because public financing is essential to the U.S. economy. After the confidence shook in the depression, restoration of the confidence was the key to economic recovery. Even in more recent times where fraud ridden companies such as Arthur Anderson, Enron, and WorldCom, existed and thrived. It is clear that there has been a continuous evolution of the securities and investment markets. This is evident with new standards and laws that followed major corporate scandals, such as the Sarbanes-Oxley Act of 2002, also known as the Public Company Accounting Reform and Investor Protection Act and the Corporate and Auditing Accountability and Responsibility Act. Legislations are passed to regulate and prohibit any type of misconduct that can arise.

The Securities Act of 1933 and the Securities Exchange Act of 1934, along with other statutes, were challenged to create a new character of trust in securities market while protecting the public from fraudulent losses. The primary objective of the newly formed SEC became the disclosures of relevant information, coupled with the power to enforce the law against fraudulent acts. Basically, once a company has decided to “go public”, which is to publicly distribute its securities, it must register with the SEC if it is covered by the provision of the 1933 act.

The SEC has been highly praised as one of the most effective government agencies in behalf of the investing public for its ability to ensure accurate disclosure of business activity and to control the securities market. The SEC is involved in a wide range of activities and has great power, which makes it an influential member of the business community. However, a common view is that most legislation is not preemptive. They occur after the fact; they are passed to save certain situations. Furthermore, the SEC has been condemned for inconsistency with the way it operates. It has been believed that the SEC goes through lax phases which in turn help create an environment developed for misconduct. While all this may be true, it is still regarded as one of the most successful and an efficient system in the US government and its influence continues to expand.

Figure 1 – Illustration of the SEC organization structure

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