On March 10, 2009, the SEC issued a request for quotation (request number SECHQ1-09-Q-0149) dealing with “public company accounting intelligence.” Specifically, the SEC describes what it wants this way. “The U.S. Securities and Exchange Commission (SEC) requires a service that analyzes U.S. public company financial information to identify entities with operational weaknesses and higher risk of financial statements fraud.  The service shall identify potentially fraudulent accounting practices and trends.  The service shall produce expert research reports and deliver them via a web interface and email alerts.”

Doesn’t the SEC do this already?  Don’t they identify business enterprises with significant financial weaknesses?  Don’t they assess who has high financial reporting risk?  Doesn’t this agency attempt to spot potentially accounting practices and trends years before they leave scars on investors and creditors?

The answer to all these questions is apparently no or the agency would not be advertising for this fraud detection system.  No wonder the SEC has to read about corporate accounting frauds in the news media so it knows what is going on!

The request for quotations continues.  “The service shall detect risk by tracking key indicators including, but not limited to, the use of unusual or aggressive accounting practices, changes in accounting policy, litigation activity (e.g., shareholder suits), significant related-party transactions, changes in accounting firms, independent auditors, and corporate governance.”

I don’t know where the money is coming from to pay for this service, whether its part of the yearly budget or whether it is some handout from one of the stimulus bills, but let me make a few simple suggestions.  First, the SEC and its staff should try reading business, finance, and accounting newspapers and magazines and internet sites and blogs.  Much can be gained by seeing what others are doing.  Bloomberg columnists, for example, regularly point out stupid accounting practices by a variety of managers.  You can almost write a litigation release by copying these essays.

Second, if the SEC has all this money, how about subscribing to various consulting groups that already amass these data and supply investor alerts to their clients?  I can think of several financial analysts that have an outstanding track record in identifying accounting reports that stink from cover to cover.  But, some of them deal with short sellers, and the SEC would have to lose its prejudice against them.

Third, how about educating the staff?  I suggest reading my Hidden Financial Risk, Mulford and Comiskey’s The Financial Numbers Game, Schilit’s Financial Shenanigans, and The Analysis and Use of Financial Statements by White, Sondhi, and Fried.  Maybe then the staff will be in a better position to address financial accounting fraud.

Fourth, maybe the SEC needs to hire some good help.  Possibly it needs to increase the salaries.  It might even consider paying bonuses to those staff members who unearth accounting frauds.

Maybe I am reading too much in this request for quotations.  Maybe the SEC merely desires a better and more efficient mechanism by which it can collect and process data about potential offenders.  Maybe it just wants to do a better job.

Still, given the language of this request and, more importantly, given its track record over the last decade, I think the SEC is in more trouble than it is admitting.  Maybe it has incompetent staff; maybe it has staff members who are merely using the SEC to jump into a high-paying corporate position that assists business entities in subverting truthfulness in accounting reports without getting caught; maybe the staff is politically divided on whom it should serve, whether investors or managers; maybe the SEC staff has morphed into mere politicians.