Inspection of Corporation Finance 

Referrals, Memorandum 

September 30, 2008 

Report No. 433
UNITED STATES 


SECURITIES AND EXCHANGE COMMISSION 


WASHINGTON, D.C. 20549 


OFFICE OF 

INSPECTOR GENERAL MEMORANDUM 

September 29,2008 

To: 	 Linda Thomsen, Director, Division of Enforcement 

John White, Director, Division of Corporation Finance 

From: 	 H. David Kotz, Inspector ~ene*~ 

Subject: 	 Inspection of Corporation Finance Referrals, Memorandum Report 

No. 433 

This memorandum transmits the Securities and Exchange Commission, Office of 

lnspector General's (OIG) findings detailing the results of our review of the 

Division of Corporation Finance's referrals to the Division of Enforcement 

(Enforcement). We conducted this review as part of our continuous effort to 

assess management of the Commission's program and operations. 

The memorandum report contains 3 recommendations that the Divisions of 

Enforcement and Corporation Finance should implement to improve the referral 

process. Enforcement agreed with recommendations 1and 2, and Corporation 

Finance agreed with recommendations 1 and 3. Your written responses to the 

draft report, dated September 3, 2008, are included in their entirety in Appendix I. 

Should you have any questions regarding this report, please do not hesitate to 

contact me. During this audit we appreciate the courtesy and cooperation that 

you and your staff extended to our auditors. 

Attachment 

cc: 	 Peter Uhlmann, Chief of Staff, Chairman's Office 

Diego Ruiz, Executive Director, Office of the Executive Director 

Joan McKown, Chief Counsel, Division of Enforcement 

Brian Breheny, Deputy Director, Division of Corporation Finance 

Paula Dubberly, Associate Director (Legal) Division of Corporation Finance 

Lewis Walker, Acting Chief lnformation Officer, Office of lnformation 

Technology 

Susan Markel, Chief Accountant, Division of Enforcement 

Mary Kosterlitz, Office Chief, Office of Enforcement Liaison, Division of 

Corporation Finance 

Charles Wright, Counsel, Office of Chief Accountant, Division of 

Enforcement 
George Eckard, Assistant Director, Office of Finance and Administration, 

Office of Information Technology 

Darlene Pryor, Management Analyst, Office of the Executive Director 

Dan Lisewski, Branch Chief, Information Resources Management, Office 

of Information Technology 

Rick Hillman, Managing Director of Financial Markets and Community 

Investment, GAO 
Background and Objectives

Background 

The Securities and Exchange Commission (Commission)1 Division of 

Corporation Finance (CF) refers potential securities law violations to the Division 

of Enforcement (ENF) for investigation. CF categorizes these referrals as 

involving either delinquent or non-delinquent filers. Delinquent filer referrals 

pertain to individuals or entities that are not current in their Commission filing 

obligations. In contrast, non-delinquent filer referrals include all other types of 

potential securities law violations, such as accounting misstatements and the 

inadequacy of issuer disclosures. As discussed in the scope section below, this 

memorandum report focuses on non-delinquent filer referrals. 

When CF staff conduct reviews of registrant filings, they may identify potential 

securities law violations.2 If CF staff identify a potential securities law violation, 

they prepare a referral memorandum for CF’s Office of Enforcement Liaison (CFOEL) that describes the potential securities law violation.3 CF-OEL reviews the 

referral memorandum and then forwards it to either the ENF Office of the Chief 

Accountant (ENF-OCA) or ENF staff who are actively working on matters 

involving the same registrant. If ENF-OCA receives the referral, it reviews the 

referral and in conjunction with a Senior Officer in Enforcement makes an initial 

determination of whether ENF staff should investigate the referral. ENF-OCA 

forwards the referral to ENF staff for investigation if ENF-OCA believes the 

alleged securities law violation may warrant further investigation. This process 

determines the merits of a referral based on a variety of factors, such as the age 

and nature of the alleged securities law violation and the degree of potential 

harm to investors. 

Objectives, Scope, Methodology 

Objectives. To identify potential improvements in the referral process. 

Scope. The Office of Inspector General (OIG) conducted the review between 

July 2007 and August 2008. We performed an inspection in accordance with the 

Quality Standards for Inspections, January 2005, issued by the President’s 

1 See Appendix II for the acronyms used. 2 The staff may also identify potential securities law violations from other sources, such as current 

 publications (e.g. newspaper articles), investor complaints, etc. 3 In some cases, CF-OEL will prepare the memorandum in consultation with CF staff. 

Corporation Finance Referrals September 30, 2008 

Memorandum Report No. 433 

Page 1 
Council on Integrity and Efficiency and the Executive Council on Integrity and 

Efficiency. However, in September 2007, due to unforeseen changes in the 

OIG’s work priorities, the former Deputy and Acting Inspector General suspended 

work on the inspection. At that time, the review of non-delinquent filer referrals 

had just begun. 

In February 2008, the newly-appointed Inspector General directed the 

resumption of the inspection. Thereafter, we reviewed the previously-conducted 

inspection work. However, given the time lapse since the inspection began, we 

determined that the data previously obtained (and the work performed on the 

data) was no longer current. Thus, we concluded that continuing the inspection 

in its current form was not a viable option. Although we have not completed a 

comprehensive inspection of the CF referral process at this time, we are issuing 

this memorandum report, which identifies three findings and recommendations4 

involving non-delinquent filer referrals that we believe would significantly improve 

the referral process.5 

Methodology. We reviewed supporting documentation, such as policies and 

procedures, reviewed non-delinquent filer referral memoranda, conducted 

interviews with Commission staff, and analyzed management reports on nondelinquent filer referrals from Fiscal Years 2006 and 2007. 

4 See Appendix III for a list of our recommendations. 5 We may conduct a larger-scale audit of the CF referral process in the future, if circumstances warrant. 

Corporation Finance Referrals September 30, 2008 

Memorandum Report No. 433

Page 2 
Findings and Recommendations 

Finding 1: CF-OEL and ENF-OCA’s Referral 

Tracking Systems Should Be Centralized 

CF-OEL and ENF-OCA currently use separate Access databases 

that store similar referral information. As a result, the referral 

process is inefficient. In addition, there is an increased risk that 

ENF-OCA does not have a record of all potentially significant 

referrals. 

Maintaining Separate Access Databases 

CF-OEL and ENF-OCA use separate Access databases to track non-delinquent 

filer referrals. CF-OEL currently has read-only access to ENF-OCA’s database. 

In addition to tracking CF-OEL referrals, ENF-OCA’s database also tracks 

accounting related referrals received from other sources (e.g., anonymous tips). 

We determined that CF-OEL and ENF-OCA need a centralized referral tracking 

system for the following reasons: 

• The Offices’ use of separate databases to maintain similar information is 

not efficient. In addition, CF-OEL must periodically perform a laborintensive process using ENF-OCA’s database to update its referral data. 

• Based on our review of referral memoranda, it appears that ENF-OCA 

does not always receive a copy of the referral when CF-OEL sends a 

referral directly to ENF staff. Thus, ENF-OCA would be unaware of a 

referral unless it learned about it inadvertently (e.g., from the ENF staff 

working on the referral). This may increase the risk that ENF staff might 

not act on a potentially significant referral and that neither CF-OEL nor 

ENF-OCA would be aware of this lack of action because information on 

the outcome of the referral (e.g., whether it was accepted or rejected and 

the reasons for that decision) is not always obtained. See Finding Two for 

a detailed discussion of this issue. 

Recommendation 1: 

The Divisions of Corporation Finance and Enforcement, in consultation with the 

Office of Information Technology, should develop a centralized referral tracking 

system for non-delinquent filer referrals. The Division of Corporation Finance 

should record information about the potential securities law violation (e.g., date, 

registrant, and alleged violation, etc.) in the centralized database, and the 

Division of Enforcement should record information on the outcome of the referral 

Corporation Finance Referrals September 30, 2008 

Memorandum Report No. 433 

Page 3 
(e.g., whether the referral was accepted or rejected, and the reasons for that 

decision) in the centralized database. 

Finding 2: Information Concerning The Outcome 

Of The Referral Should Be Recorded In The ENFOCA Database 

ENF-OCA does not always record the outcome of referrals in its 

database, although other sources of outcome data are available to 

CF-OEL. 

CF-OEL currently obtains information about the outcome of non-delinquent filer 

referrals from either ENF staff or by reviewing ENF-OCA’s Access database. 

However, CF-OEL does not always obtain this information. According to CFOEL, ENF staff often do not contact them with the relevant information,6

 and the 

ENF-OCA database frequently does not contain the outcome information. ENFOCA may not have the outcome information because ENF staff working on a 

referral often do not provide ENF-OCA with any subsequent information about a 

referral. 

CF-OEL stated that receiving outcome information would be beneficial as it could 

improve the quality of future referrals by identifying shortcomings in previous 

referrals. In addition, as discussed in Finding 3, CF-OEL could use outcome 

information to enhance its role as a gatekeeper regarding CF referrals to ENF. 

Recommendation 2: 

The Division of Enforcement should record information about the outcome of 

non-delinquent filer referrals in its current Access database (and eventually in the 

centralized database system - see Recommendation 1) to improve the referral 

process, as discussed above. 

Finding 3: CF-OEL’s Role As Gatekeeper Needs 

Enhancement 

CF-OEL could enhance its role as a gatekeeper if it had outcome 

information (as discussed above). 

CF-OEL reviews referral memoranda to improve the quality of the referral and 

ensure that, for example, the referral clearly articulates the statutes and rules the 

6

 CF’s referral contains a form for ENF staff to complete regarding information on the outcome of the 

referral. However, according to CF, ENF staff generally do not complete this form. CF and ENF-OCA has 

 also indicated they do not have available resources to seek this type of outcome information proactively

 from ENF staff. 

Corporation Finance Referrals September 30, 2008 

Memorandum Report No. 433 

Page 4 
registrant may have violated. Accordingly, CF-OEL, in effect, acts as a 

gatekeeper for the referral process. In this role, CF-OEL declines to forward 

referrals it deems to be inappropriate from CF’s perspective or to lack a legal 

basis. However, CF-OEL’s ability to determine whether a referral might be 

worthy of an investigation from ENF’s perspective is limited. CF-OEL stated that 

it would like to increase its role in the referral process. However, CF-OEL 

currently lacks the necessary outcome information on referrals to understand 

fully the types of referrals ENF determines warrant an investigation. We believe 

that CF-OEL would be able to enhance its current gatekeeper role if ENF 

provided it with additional information on why ENF accepted or rejected referrals. 

Recommendation 3: 

The Division of Corporation Finance should enhance CF-OEL’s gatekeeper role 

once the outcome information becomes more available (see Recommendation 

2). 

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Memorandum Report No. 433 

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Appendix I 

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Memorandum Report No. 433

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Appendix I (continued) 

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Memorandum Report No. 433

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Appendix I (continued) 

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Memorandum Report No. 433

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Appendix II 

Acronyms 

CF Division of Corporation Finance 

ENF Division of Enforcement 

ENF-OCA The Division of Enforcement’s Office of 

the Chief Accountant 

CF-OEL The Division of Corporation Finance's 

Office of Enforcement Liaison 

OIG Office of Inspector General 

Corporation Finance Referrals September 30, 2008 

Memorandum Report No. 433 

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Appendix III 

Summary of Recommendations 

Recommendation 1: 

The Divisions of Corporation Finance and Enforcement, in consultation with the 

Office of Information Technology, should develop a centralized referral tracking 

system for non-delinquent filer referrals. The Division of Corporation Finance 

should record information about the potential securities law violation (e.g., date, 

registrant, alleged violation, etc.) in the centralized database, and the Division of 

Enforcement should record information on the outcome of the referral (e.g., 

whether the referral was accepted or rejected, and the reasons for that decision) 

in the centralized database. 

Recommendation 2: 

The Division of Enforcement should record information about the outcome of 

non-delinquent filer referrals in its current Access database (and eventually in the 

centralized system - see Recommendation 1) to improve the referral process, as 

discussed above. 

Recommendation 3: 

The Division of Corporation Finance should enhance CF-OEL’s gatekeeper role 

once the outcome for information becomes more available (see 

Recommendation 2). 

Corporation Finance Referrals September 30, 2008 

Memorandum Report No. 433 

Page 10 
Audit Request and Ideas

The Office of Inspector General welcomes your input. If you would like to 

request an audit in the future or have an audit idea, please contact us at: 

U.S. Securities and Exchange Commission 

Office of Inspector General 

Attn: Assistant Inspector General, Audits (Audit Request/Idea) 

100 F. Street N.E. 

Washington D.C. 20549-2736 

Tel. #: 202-551-6061 

Fax #: 202-772-9265 

Email: oig@sec.gov 

Hotline

To report fraud, waste, abuse, and mismanagement at SEC, contact the 

Office of Inspector General at: 

Phone: 877.442.0854 

Web-Based Hotline Complaint Form: www.reportlineweb.com/sec_oig