Editor’s Note: Stopping firms from doing business with states that sponsor terrorism seems like an obvious priority for the U.S. government. However, efforts to use bodies such as the Securities and Exchange Commission can create unexpected problems. Bill Mayew, Robert Hills and Matt Kubic (of Duke, Penn State, and the University of Texas, respectively) argue that the SEC’s focus on terrorism has made it more likely to miss more traditional financial misreporting.
The mission of the Securities and Exchange Commission (SEC) is “to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.” In the years following the 9/11 attacks, Congress instructed the SEC to review firm disclosures regarding activities in or with nations designated as “state sponsors of terrorism” (SSTs) by the U.S. Department of State. The logic was straightforward: Firms may have activities in SST countries, and unaware “American investors may be unwittingly investing in companies with ties to countries that sponsor terrorism.” The implementation of this congressional mandate has been difficult and has led to questions about the boundaries of financial reporting regulation. Those who oppose this expansion, such as the Securities Industry and Financial Markets Association (SIFMA), claim that “the SEC should leave foreign policy and national security matters to the government agencies charged with, and possessing significant experience in, carrying out those matters.”
In a new study, we investigated whether the SEC’s focus on SSTs limits its ability to effectively review registrants’ compliance with accounting standards. The short answer is yes, and it is costly for American investors.
The SEC first sought to raise awareness of firms’ potential SST activities by launching a terrorism web tool on June 25, 2007. The purpose of the web tool was to allow investors to easily identify financial statement disclosures regarding activities in one of five countries (Cuba, Iran, North Korea, Sudan and Syria) that, at the time, were designated as SSTs.
On July 20, 2007, the SEC announced a “temporary suspension” of the web tool after receiving substantial backlash from firms, the financial press and even members of Congress. The web tool was criticized for being a poorly executed word search that lacked context and information about materiality. For example, the financial services firm Western Union was identified as conducting business in Cuba. However, Western Union was granted a license by the Office of Foreign Assets Control (OFAC) to provide money services in Cuba. In Western Union’s view, the SEC web tool made no distinction between “legitimate business activities licensed by the U.S. Government” and activities that may “contribute to terrorism.”
While the SEC terrorism web tool was short lived, the SEC continued its filing review process, which is designed to “monitor and enhance compliance with the applicable disclosure and accounting requirements.” In a filing review, the SEC reviews a public firm’s disclosures to ensure that they comply with applicable accounting and disclosure regulations. If the SEC needs more information, or believes there is an inaccuracy in the disclosure, it will send a comment letter to the firm asking for additional information. To support filing reviews related to terrorism, Congress mandated the creation of the Office of Global Security Risk within the SEC.
In 2005, only 2 percent of comment letters focused on SST disclosures. But by 2018, 12 percent of comment letters referenced SSTs, according to Ernst & Young, making SST the seventh most frequent type of question. In many cases, it appears that the SEC is monitoring news releases or web traffic to identify potential activities with SST nations. For example, the SEC commented to Kraft Heinz: