Auditing Enforcement Releases Research Articles

Using AAERs in Financial Accounting Courses: A Case Study to Integrate Ethical and Technical Competencies

ABSTRACT Using the Securities and Exchange Commission’s Accounting and Auditing Enforcement Releases, this assignment builds critical thinking and ethical decision-making skills in a financial accounting setting. It requires students to analyze a real-world fraud from the perspective of an employee, manager, or executive (a “case participant”) involved in the accounting impropriety. The case features individual and group components that may be customized to fit the instructor’s needs. The individual component examines a case participant’s choices in committing accounting improprieties using an ethical decision-making framework. The group component includes an analysis of the accounting, the fraud triangle, possible preventative measures, and takeaways applicable to students’ future careers. By requiring students to step into the shoes of a case participant, this assignment increases student awareness of deliberate choices leading to financial reporting fraud and equips students with an ethical decision-making framework should they encounter a financial reporting ethical conflict in the workplace.

Financial statement fraud litigation, material weaknesses, and board characteristics

PurposeThe purpose of this study is to investigate whether the likelihood that a firm will face financial statement fraud litigation is affected by the disclosure of internal control material weaknesses (MW) and the “busyness” of a firm’s board of directors.Design/methodology/approachThe results are derived from logistic regression models and data are collected from the Audit Analytics database augmented by data from CompuStat, the Stanford Law School website and the SEC Accounting and Auditing Enforcement Releases. The authors also test for endogeneity with a propensity score matching procedure.FindingsThe authors find that an MW report is strongly associated with the likelihood of subsequent financial statement fraud litigation, and that the influence of entity-level MW on litigation likelihood is stronger than that of account-level MW. Moreover, the number of outside board directorships significantly increases the influence of entity-level MW on the likelihood of litigation, indicating that board of directors’ busyness significantly increases the risk of litigation.Originality/valuePrevious research notes that board members holding multiple directorships cannot effectively oversee the financial reporting process and, thus, are associated with poorer governance. The authors extend this implication of board busyness to the association between disclosure of MW type and the filing of subsequent litigation alleging financial statement fraud. To the best of the authors’ knowledge, no other research has done so.

Accrual‐Based Earnings Management and Regulation: A Literature Review*

ABSTRACTThis paper reviews how the accounting literature has investigated accrual‐based earnings management (AEM) in relation to regulation. After describing the development of accrual‐based models to measure earnings management, I provide evidence that the accounting literature has investigated AEM and regulation to answer six types of research questions. First, researchers investigate whether firms manage earnings before a regulatory event to benefit from it or to avoid its negative consequences. Second, they look at whether firms engage in AEM after the implementation of a new regulation to avoid the regulatory costs associated with lack of compliance or to respect regulatory industry ratios. Third, researchers use accruals quality metrics to investigate the change in quality of accounting after a change in regulation. Fourth, they use accruals quality metrics to analyze the impact of differences between regulatory environments. Fifth, researchers exploit Accounting and Auditing Enforcement Releases to clearly identify samples of low‐quality firms in order to develop new earnings management models, test the specifications of existing models, or identify new patterns linked to earnings management. Sixth, the accounting literature employs regulation to investigate potential complementarity or substitution effects between accrual‐based and real earnings management. I also discuss how the emergence of new technologies such as machine learning, the ongoing debate between single‐accrual and aggregate models, regulatory events other than laws, and recent regulations create opportunities for future research into AEM in relation to regulation.

Compensation structure impact on executive value judgment shift resulting in occurrence of fraud

PurposeThe purpose of this study is to examine whether executive compensation structure is a predictor of a value judgment shift facilitating fraud. The Raval (2018) disposition-based fraud model theorizes that in a fraud, a judgment shift occurs that results in an intentional action. Judgment shifts are influenced by intertemporal rewards, an executive compensation structure comprising salary (immediate reward) and delayed compensation in performance-based incentives.Design/methodology/approachUsing an archival data set consisting of frauds identified through Securities and Exchange Commission Accounting and Auditing Enforcement Releases, the compensation structure of executives involved in frauds is compared against the compensation structure of executives in a peer control group.FindingsThere was a significant difference in the intertemporal rewards of the compensation structures between the two groups, indicating that compensation structure presents intertemporal choices leading to a judgment shift that influences the deliberate action of fraud.Research limitations/implicationsThis study represents the first empirical test of the disposition-based fraud model using intertemporal rewards leading to judgment shift.Practical implicationsExecutive compensation structure should reduce intertemporal rewards for executives reducing judgment shifts that can result in risk of fraud.Originality/valueThis study addresses how executive compensation structure can result in fraud.

Adopting Nonlinear Activated Beetle Antennae Search Algorithm for Fraud Detection of Public Trading Companies: A Computational Finance Approach

With the emergence of various online trading technologies, fraudulent cases begin to occur frequently. The problem of fraud in public trading companies is a hot topic in financial field. This paper proposes a fraud detection model for public trading companies using datasets collected from SEC’s Accounting and Auditing Enforcement Releases (AAERs). At the same time, this computational finance model is solved with a nonlinear activated Beetle Antennae Search (NABAS) algorithm, which is a variant of the meta-heuristic optimization algorithm named Beetle Antennae Search (BAS) algorithm. Firstly, the fraud detection model is transformed into an optimization problem of minimizing loss function and using the NABAS algorithm to find the optimal solution. NABAS has only one search particle and explores the space under a given gradient estimation until it is less than an “Activated Threshold” and the algorithm is efficient in computation. Then, the random under-sampling with AdaBoost (RUSBoost) algorithm is employed to comprehensively evaluate the performance of NABAS. In addition, to reflect the superiority of NABAS in the fraud detection problem, it is compared with some popular methods in recent years, such as the logistic regression model and Support Vector Machine with Financial Kernel (SVM-FK) algorithm. Finally, the experimental results show that the NABAS algorithm has higher accuracy and efficiency than other methods in the fraud detection of public datasets.

Political connections, tacit power and corporate misconduct

AbstractThis paper examines the impact of political connections (i.e., lobbying and political contributions) on the time it takes to detect corporate misconduct and the size of penalties following securities class actions (SCAs), restatements and Accounting and Auditing Enforcement Releases (AAERs). We find firms with political connections exhibit longer misconduct periods for SCAs, and such ability to conceal misconduct for longer translates into a larger settlement size. In addition, we find politically connected firms are associated with greater shareholder losses and are less likely to be involved in Securities Exchange Commission enforcement actions on restatements. Finally, while we do not find any relation between political connections and the likelihood of AAERs being settled, we find political connections are associated with lower AAER settlement size.

Gender board diversity and corporate fraud: empirical evidence from US companies

PurposeThis study aims to examine the effect of gender board diversity on corporate fraud. Particularly, it is to gain empirical evidence whether firms with more female corporate leaders are more (less) likely to engage in corporate fraud.Design/methodology/approachThe authors use data of fraud firms from Accounting and Auditing Enforcement Releases. As a focus of the study, the authors take the fraud sample observations from the last 10 years, from 2011 to 2021. The idea is that the number of firms sectioned due to corporate fraud reached a peak in such periods.FindingsIn the context of non-state-owned enterprise environments, the authors find female corporate leaders are less likely to engage in corporate fraud. However, among firms with a state-owned background, the authors’ empirical evidence shows that the roles of female corporate leaders remain under-represented in the boardrooms. As reported, the presence of female corporate leaders does not bring a significant impact on enhancing group ethical decision-making and governance quality. This situation does appear when political connections between firms and governments or politicians are prevalent.Research limitations/implicationsThis study has practical and theoretical implications. Given the increased pressure on companies around the globe to have more females in their boardrooms, this study provides insight into the effect of female corporate leaders on the prevalence of corporate fraud. As such, this study offers critical consideration for policymakers and regulators. Moreover, an analysis of whether and when the gender board diversity is associated with the firm’ propensity to perpetrate corporate fraud, particularly from the US corporate fraud, is sorely lacking. This study contributes to such gaps.Originality/valueThis study provides insightful discussion about the topical issue of whether, and under what circumstances, female corporate leaders influence (or do not influence) corporate fraud.

The incidence of accounting fraud is increasing: is it a matter of the gender of chief financial officers?

PurposeThe purpose of this paper is to examine the association between accounting fraud and the gender of chief financial officers (CFOs).Design/methodology/approachThis study uses a sample of US-listed firms for the period from 2000 to 2010. This paper takes this distribution of the sample observations because firms sanctioned by the Securities and Exchange Commission as reported in Accounting and Auditing Enforcement Releases for fraud are more heavily weighted in the 2000 to 2010 period.FindingsThis study provides considerable evidence to suggest that firms with female CFOs are negatively associated with accounting fraud. The study also suggests that in state-owned enterprises, in which political concerns are likely to be more pronounced, the relationship between female CFOs and accounting fraud is negatively less significant. This study conducts an additional test about when and why boards’ diversity reduces accounting fraud or concerns. The result shows that the structure of gender-mixed boards is better than male-only boards. Therefore, it is important to control the activities or decisions of powerful chief executive officers.Research limitations/implicationsIn general, the findings contribute to the current discussion on the necessity of increasing gender diversity as a corporate governance mechanism. This study is specifically focussed on CFOs that may directly have important implications for financial reporting and corporate governance.Originality/valueThis paper extends prior research by addressing the potential effects of female CFOs on accounting fraud. For example, Zhou et al. (2018) examine the relationship between executive compensation and the incidence of corporate fraud in Chinese listed companies from the perspective of delisting pressure. The result documents that there is no a relationship between CFO gender and accounting fraud. The results, however, find that female CFOs are negatively associated with accounting fraud; meaning that the presence of female CFOs brings positive implications for financial reporting and corporate governance.

Fraud detection in publicly traded U.S firms using Beetle Antennae Search: A machine learning approach

In this paper, we present a fraud detection framework for publicly traded firms using an optimization approach integrated with a meta-heuristic algorithm known as Beetle Antennae Search (BAS). Existing techniques include human resources, like financial experts and audit teams, to determine the ambiguities or financial frauds in the companies based on financial and non-financial ratios. It is a laborious task, time-consuming, and prone to errors. We designed an optimization problem to minimize the loss function based on a non-linear decision function combined with the maximization of recall (Sensitivity and Specificity). We solved the optimization problem iteratively using the BAS. It is a nature-inspired algorithm and mimics the beetle’s food-searching nature. It includes a single searching particle to find an optimal solution to the optimization problem in n-dimensional space. We used a benchmark dataset collected from SEC’s Accounting and Auditing Enforcement Releases (AAERs) for the simulation. It includes 28 raw financial variables and the data collected between 1991–2008. For the comparison, we evaluated the performance of BAS with the recently proposed approach using RUSBoost. We also compared it with some additional algorithms, i.e., Logit and SVM-FK. The results showed that BAS is comparable with these algorithms and outperformed them in time consumption.

Corporate opacity and effectiveness of independent female directors

Research shows female directors are associated with proxies for improved monitoring, yet finds mixed results as to their effect on firm performance. Hypothesizing that their performance impact depends on the firms' information environment, we find that independent female directors have a negative (positive) effect on performance in opaque (transparent) firms, an effect which is incremental to that of independent male directors. We then explore the channels which drive this finding. The standard measure of the information environment considers opacity from the view of external parties such as analysts and investors. However, independent directors have greater access to information than external parties. Consequently, we investigate whether additional data sources, if they exist, mitigate the impact of “external” opacity on the effect of independent female directors on firm performance. We find that when independent female directors have greater access to information either from sources inside, e.g., an independent board chair, or outside, e.g., a large network, the firm, their negative effect on performance in opaque firms dissipates. Investigating their positive impact in transparent firms, we find that independent female directors decrease both discretionary accruals and the likelihood of an Accounting and Auditing Enforcement release.

An examination of the influence of mutual CFO/audit firm tenure on audit quality

This study examines whether the extent of professional relationships between an audit firm and their client’s CFO influences audit quality. If regulators’ concerns that the relationship that develops over time between an audit firm and their client’s CFO impairs auditor judgment are justified, then we should observe a negative relationship between the length of audit firm’s tenure with their client’s CFO and audit quality. The results suggest that mutual audit firm-CFO tenure is associated with lower audit quality measured by the magnitude of discretionary accruals, the reduced incidence of issuance of going-concern audit opinions for distressed companies, and an increased likelihood of the receipt of an Accounting and Auditing Enforcement Release (AAER) from the US. Securities and Exchange Commission (SEC). These affects are concentrated in a subsample of firms with higher levels of corporate governance concerns. These findings have implications for policies related to audit firm rotation. Specifically, the results suggest that regulators need to consider other relationships underlying audit firm tenure, such as the relationships that form between audit firm and client personnel, when evaluating audit firm rotation policies.

Equity Incentives and Financial Misreporting: Evidence from the Wealth Pursuit Motive of CEOs

The incentive effect of CEO portfolio delta (i.e., the sensitivity of CEO wealth to changes in stock price) on financial misreporting is inconclusive given a complex reward-risk tradeoff faced by CEOs (e.g., a positive “reward effect” versus a negative “risk effect”). We propose that the prevalence of CEO hedging pushes the tradeoff more in favor of the “reward effect” side, resulting in a positive net incentive effect of CEO portfolio delta on misreporting. As the tradeoff is associated with a CEO’s explicit focus on personal wealth, we extract unstructured data from the Accounting and Auditing Enforcement Releases (AAERs) for the sample period 20042016 to identify misreporting driven by a CEO’s wealth-pursuing motive. We document that such misreporting is not only widespread in the sample but also positively explained by CEO portfolio delta. Consistent with our theoretical framework, we find that CEO hedging opportunities moderate the positive relationship between CEO portfolio delta and wealth-pursuing misreporting. We also use a simulation to illustrate how including misreporting cases not associated with the reward-risk tradeoff in the analysis might account for the mixed evidence of the delta-AAER association documented by prior studies. Our findings have important implications for compensation design and corporate governance policy.

Does IRS Monitoring Deter Managers From Committing Accounting Fraud?

We examine whether monitoring by the Internal Revenue Service (IRS) affects managers’ decisions to engage in fraudulent financial reporting. We argue that IRS monitoring provides a disciplining effect reducing managements’ incentives to engage in rent diversion activities such as costly financial statement misreporting. Using information on IRS audit rates and instances of fraud disclosed in Securities and Exchange Commission (SEC) Accounting and Auditing Enforcement Releases (AAERs), we find evidence consistent with IRS monitoring providing positive spillover effects in reducing the likelihood of accounting fraud. Our results are robust to using a matched sample of fraud and nonfraud firms. Altogether, we find evidence that tax authorities provide positive externalities in reducing agency costs through monitoring and enforcement.

SEC enforcement targets: a Christian virtue ethics perspective

PurposeThe purpose of this paper is to provide a summary and synthesis of US Securities and Exchange Commission accounting and auditing enforcement release (AAER)-based research on financial misreporting firms and the firms’ management. Christian virtue ethics (CVE) is used as a framework for this review. Suggestions for future research are presented.Design/methodology/approachThis is a review of the academic literature covering AAERs. The findings are viewed through the lens of CVE.FindingsSeveral financial misconduct studies use samples developed from AAER targets. These studies commonly focus on specific characteristics of AAER targets. This paper presents and analyzes characteristics of AAER targets and considers how CVE may mitigate fraudulent reporting.Research limitations/implicationsThe main limitation of the research is that the literature review is confined to studies of financial fraud that use an AAER-based sample. Nevertheless, the sample is sufficient to provide insight into the common characteristics of AAER target firms and related entities. The benefits of CVE are considered. This study has relevant implications for investors, regulators and researchers concerned with financial reporting quality, fraud, regulatory oversight and business ethics.Originality/valueThis paper provides a set of AAER target features and considers how CVE may mitigate financial fraud. Financial regulators, accounting standards setters and researchers may be interested in the findings presented in this study.

Disclosure readability of firms investigated for books-and-records infractions

Purpose The paper examines the difference in the disclosure readability of SEC investigated firms and the population of firms traded in the USA. This study aims to further refine the obfuscation hypothesis and broader impression management theory. Design/methodology/approach The paper used quantitative cross-sectional analysis of archival data gathered from the SEC Accounting and Auditing Enforcement Release Archive and the SEC EDGAR database. A one-sample t-test was used to compare mean readability levels. Findings The paper provides empirical evidence to support the assertion that disclosures of the firms being investigated for “books-and-records” infractions are more difficult to read than the disclosure of the average publicly-traded firm in the USA. Research limitations/implications First, the study did not make direct matched-pairs comparisons of the readability level. Second, the unique nature of the sample means that the results may not be generalizable. Further research is necessary to expand on this current work. Practical implications The paper includes implications for consideration by accounting standards setters, financial regulators and annual report readers. Originality/value This paper addresses an identified need to study the existence and degree of complexity and obfuscation in financial disclosures.

Does Government Report Readability Matter? Evidence from Market Reactions to AAERs

We investigate whether market reactions to Accounting and Auditing Enforcement Releases (AAERs) of the U.S. Securities and Exchange Commission (SEC) vary with different levels of readability in the AAERs. After controlling for the complexity of an AAER report and the severity of the enforcement case, we find that when the AAER is more difficult to read, with readability measured based on the directives of the Plain Writing Act of 2010, markets react more negatively to the AAER announcement. Cross-sectional tests indicate that the effect of AAER readability is attenuated by investor sophistication and firm visibility, whereas the effect is more pronounced when AAER firms are exposed to greater uncertainty. Contrary to conventional wisdom that linguistically complex disclosures receive reduced market reactions, our results suggest that complex AAER announcements could trigger more negative stock price reactions, since investors under uncertainty and ambiguity tend to assume the worst and bid down the market value of AAER firms. Our study offers meaningful implications for regulators concerned with writing clarity in government documents.

Does government report readability matter? Evidence from market reactions to AAERs

We investigate whether market reactions to Accounting and Auditing Enforcement Releases (AAERs) of the U.S. Securities and Exchange Commission (SEC) vary with different levels of readability in the AAERs. After controlling for the complexity of an AAER report and the severity of the enforcement case, we find that when the AAER is more difficult to read, with readability measured based on the directives of the Plain Writing Act of 2010, markets react more negatively to the AAER announcement. Cross-sectional tests indicate that the effect of AAER readability is attenuated by investor sophistication and firm visibility, whereas the effect is more pronounced when AAER firms are exposed to greater uncertainty. Contrary to conventional wisdom that linguistically complex disclosures receive reduced market reactions, our results suggest that complex AAER announcements could trigger more negative stock price reactions, since investors under uncertainty and ambiguity tend to assume the worst and bid down the market value of AAER firms. Our study offers meaningful implications for regulators concerned with writing clarity in government documents.

Analisis Kualitas Auditor, Leverage Dan Persentase Saham Initial Public Offering Terhadap Earnings Management Perusahaan Go Public

AbstractThe action of corporate management to intervene in the process of drafting financial statements is an act of dysfunctional behavior that will affect the enhancement of personal welfare management and The company's employees and the value of its leadership. This research aims to test and prove empirically the cause and influence of earnings management in the company that go public after the enactment of Accounting and Auditing Enforcement Release (AAER) by Security Exchange Commission (SEC). The variables tested were reputation Auditor, Leverage and stock percentage of Initial Public Offering (IPO) at the company that go Public on the Indonesia Stock Exchange from 2000 to 2004. The method of analysis used is multiple regression that previously done testing through several stages. Results show that the leverage variable significantly affects earnings management. This indicates that the debt that is the source of external funds used to finance the business continuity is strongly associated with earnings management.

The Influence of Management Bonding on Firms’ Financial Reporting Risk

I investigate how top management cohesiveness/bonding affects firms’ financial reporting risk. I operationalize team cohesiveness/bonding by measuring the social connections among the top executives of firms through four types of social networks: educational background, employment history, off-the-job organization activities, and board positions. Using a sample of firms identified in the Accounting and Auditing Enforcement Releases (AAERs), I find that top management who are more cohesive and bonded through social connections are more likely to commit accounting misconduct. The cohesiveness/bonding among top management teams is associated with more years of financial misstatements and lower probability of misstatement detection. These results are consistent with a well-documented “groupthink” phenomenon in social psychology that is associated with dysfunctional decision-making processes. The results highlight the importance of considering social bonding status as a risk factor in investigating and detecting financial fraud.

Muhasebe Standartları Bankalarda İşletme Performansını ve Finansal Tablo Manipülasyonunu Etkiler mi

Financial statement manipulation has been well-rounded analyzed in both finance and accounting literature as it is important to determine whether firms could affect both performance and accounting standards. The purpose of this study is to examine cases of financial reporting manipulations which were subject to published enforcement actions by the Securities Exchange Commission (SEC), Securities Class Action Clearinghouse (SCAC), Accounting and Auditing Enforcement Releases (AAERs) and General Accounting Office (GAO) between 1996 and 2014 for reasons of alleged financial misstatements in the USA. Therefore, this study will provide to examine the relationship between bank performance and financial statement manipulations in the accounting standards. More importantly, although financial misconduct such as financial reporting manipulation is an emerging topic of great importance, a comprehensive literature review of the subject has yet to be carried out in terms of accounting standards. In this context, this study focuses on financial reporting manipulation within the context of International Financial Reporting Standards (IFRS). This study is contributed to the literature by examining the impact of financial reporting manipulation within the same or different systems of accounting standards on bank financial reporting. Findings suggest that banks that manipulate financial statements increase their operating profitability and productivity as a measure of financial performance used in the IFRS.