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Craig M. Lewis, Chief Economist and Director, Division of Risk, Strategy, and Financial Innovation, U.S. Securities & Exchange Commission, described the SEC’s “Accounting Quality Model,” or AQM.  This model is being designed to provide a set of quantitative analytics that could be used across the SEC to assess the degree to which registrants’ financial statements appear anomalous.  More particularly, it is a model that allows the SEC to discern whether a registrant’s financial statements stick out from the pack, while taking into account the contemporaneous attributes of that pack.  The goal is to facilitate comparison across firms within their industry while accounting for and illustrating industry differences as well.

One use of AQM is to identify “earnings management.” Importantly, the phrase “earnings management” is broad enough to capture both aggressive accounting practices that fall within GAAP and fraudulent accounting practices that violate GAAP.  Mr. Lewis noted outlier discretionary accruals can be a powerful indicator of attempts to manage earnings.

Mr. Lewis also described other successful uses of analytical models by the SEC.  In particular he noted the SEC developed an analytical model that uses performance data to identify hedge fund advisers worthy of further review by the Office of Compliance, Inspections and Examinations (which inspects investment advisors and broker-dealers) and the Division of Enforcement’s Asset Management Unit (which targets fraud by hedge funds and others).

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