United States: Whistleblowing For Accounting Fraud: Racing The SEC’s Robocop

In recent years SEC cases alleging fraudulent accounting practices have been in decline (only 11% of enforcement cases in 2012). FCPA and insider trading cases are more exciting, and generate more media attention, while financial fraud can be more time-consuming, difficult to detect and to prove. Nevertheless, when I was in the trial unit at the SEC, I enjoyed litigating these cases as they often involved complex facts, phony accounting entries, earnings management schemes, and a sort of cat-and-mouse game played against people we always thought were really bad guys taking advantage of gullible investors. We especially enjoyed catching high-level managers like CFO's, Controllers, and complicit legal or auditing gatekeepers. The SEC staff seemed to stumble into these cases in random ways, through tips, newspaper stories, and referrals from other agencies.

Fortunately, financial fraud is back in vogue at the SEC. The new SEC Chairman, former prosecutor Mary Jo White, has announced that these cases will get renewed attention. Last July, the SEC announced new programs to discover accounting fraud through the creation of a new "Financial Reporting and Audit Task Force" and a "Microcap Fraud Task Force." Most interesting perhaps will be the impact of the work of a new "Center for Risk and Quantitative Analysis" (CRQA or "RiskFin"), headed up by former Vanderbilt University Economist Craig M. Lewis.

RiskFin is, according to Mr. Lewis, "developing cutting-edge ways to integrate data analysis into risk monitoring." This SEC geek squad will mine data tagged by the new XBRL reporting system to pick out financial reports that "appear anomalous" and will automatically flag them for review by an examiner. The SEC has come a long way from the days when enforcement lawyers in DC and New York would race to get the day's Wall Street Journal to hunt for potential investigation targets and claim the case first by getting to their computer at dawn to log in a MUI ("matter under investigation").

The computer models at RiskFin will, within a day of the filing of a 10K or other report, use the new XBRL tags to identify firms that have made unusual accounting choices relative to their peer group. As Mr. Lewis described it recently to the Merrill Disclosure Solutions Blog:

If a firm was having a down year and felt that the actual numbers were lower than its peer group, it may seek ways to try and boost income, maybe by not recording as much bad debt expense....A manager may simply say: "Well, it's a bad year; let's take something out of the accrual bank." To do this, one would then say: "These credits look solid to us; we don't think we're going to lose that much." In a good year, you look at the exact same set of accounts and you say: "You know something? A lot of these credits are likely to be unable to pay us, so we want to take a little more bad debt expense." This allows you to make a deposit to the accrual bank.

Mr. Lewis noted that looking at peer group firms is logical: "If you are an oil and gas producer, there are a lot of accounting rules about how oil and gas producers have to book income, account for reserves, etc. If you are a software manufacturer, those same rules would not apply to you, so you would not want to compare a software manufacturer against an oil and gas company." The new SEC system, informally being called the SEC's Robocop, is, as Lewis described it: "[A] fully automated system that effectively takes a firm's filing the day it comes in, processes it, and then keeps it in the database so that somebody who is interested in a report on that company would be able to do so within 24 hours of the filing being posted on EDGAR."

RoboCop (officially known as the Accounting Quality Model" AQM) can model and determine how much of the total reported accruals are "discretionary." As two astute observers recently wrote: "RoboCop's objective—to identify earnings management--is not a novel one; rather, it is the model's proficiency that should worry filers... [Robocop can classify] discretionary accruals as either risk indicators or risk inducers. Risk indicators are factors that are directly associated with earnings management while risk inducers indicate situations where strong incentives for earnings management exist. Based on a comparison with the filings of companies in the filer's industry group, [RoboCop] produces a score for each filing, assessing the likelihood that fraudulent activities are occurring." Corporate Filers Beware: New "RoboCop" Is On Patrol, Jay Carney and Francesca Harker, BakerHostetler, Forbes.Com , August 9, 2013.

Director Lewis, for example, cites as a potential "risk indicator" an "accounting policy that results in relatively high book earnings, even though the firms simultaneously select alternative tax treatments that minimize taxable income...[a]nother accounting policy risk indicator might be a high proportion of transactions structured as 'off balance sheet.'"

RoboCop will also be able to look for other potential fraud indicators such as frequent auditor changes or disagreements with auditors, and will be able to analyze the MD&A sections of annual reports to look for word and phrasing choices that are tip offs to fraud, based on similar language in past filings by known fraudsters. Lewis noted in a recent speech that "fraudsters have tended to talk a lot about things that don't really matter much and they under-report all the risks that other firms that aren't having these same issues talk quite a bit about." It is pretty scary to think that a computer at the SEC can figure all this out in a few seconds, without even taking a lunch break over at the Union Station food court.

Which brings me back to whistleblowing, a favorite subject as I represent whistleblowers and continually think I should be getting more clients (what lawyer doesn't?) given what I believe is the massive amount of accounting fraud still out there, undiscovered. If RoboCop works as planned, the SEC will be uncovering all that fraud first, although my experience with government programs is that few work out as brilliantly as predicted. "The SEC has also said it plans to use the risk scores as a means of corroborating (or invalidating) the approximately 30,000 tips, complaints, and referrals submissions it estimates will be received each year through its Electronic Data Collections Systems or completed [whistleblower] forms TCR." Carney and Harker, id.

These observers also suggest that the SEC will use the RoboCop scores to weed out whistleblower complaints: "With the SEC's new whistleblower program in place, illegitimate tips from individuals seeking a payday are sure to increase dramatically. A low score from RoboCop will make tipsters' claims less likely to be investigated." While I tend to think the SEC will not turn away a good tip simply because the company's "score" suggests lack of fraud, I am concerned that the staff will tend to rely too much on the tireless RoboCop to target investigations that may catch some offenders while still missing many others.

Rather, I suggest that would be whistleblowers become their own, less mechanized, RoboCops, and utilize the tools the SEC is using to evaluate their own company, and perhaps others in the same industry, for the same red flags the SEC's in-house robotic wizard is supposed to uncover almost instantaneously. If you are familiar with your firm's accounting policies, its books and records, and the manner in which it books accruals, for example, or makes top-side entries each quarter, you may be able on your own to sniff out earnings management or similar forms of accounting fraud. Read your company's MD&A disclosure. Contrast it with what you know to be the true facts. Compare it to your peer companies. You may also be an in-house accountant or internal or external auditor, compliance officer or in house counsel, and know the truth, or be on terms familiar enough with one of the above to ask the right questions. Certain (usually junior) members of the external audit team often know where the bodies are buried and given a conscience and a few beers may be willing to unburden themselves.

While there are complicated rules for when such insiders can become whistleblowers, the bottom line is that the SEC rules, under the right circumstances, allow almost anyone inside or outside a company to become a whistleblower. The challenge is to get the facts, find the documents, and be sure to make your internal report first (if you choose to do so) and then your submission to the SEC, in accord with its procedures.1

The encouraging news is that the SEC is once again back in the business of pursuing accounting fraud, and has geared up with new teams of lawyers, accountants, and the omni-vigilant super staffer RoboCop to ferret out the fraudsters. Happily as well, the whistleblower who beats RoboCop to the evidence will presumably receive the lion's share of the award, because as good as it is, it will never occur to RoboCop to apply for a piece of the pie.


1. I have tried to explain these rules and offer guidance in prior articles. See, e.g. Daniel J. Hurson, "The 'New Rules' For Becoming A Successful SEC Whistleblower", Mondaq News Service, September 2013"; Daniel J. Hurson, "When Can the Independent Auditor Become An SEC Whistleblower?", Mondaq News Service, Nov. 20, 2012.>/sup>

Daniel J. Hurson is former Assistant Chief Litigation Counsel at the SEC and former federal prosecutor. He practices securities enforcement and white collar defense law in his own firm in Washington D.C and represents SEC whistleblowers. His email is dan@hursonlaw.com. His website is http://www.hursonlaw.com

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Similar Articles
Relevancy Powered by MondaqAI
The Law Offices of Daniel J. Hurson, LLC
In association with
Related Topics
Similar Articles
Relevancy Powered by MondaqAI
The Law Offices of Daniel J. Hurson, LLC
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions