By:  Cydney Posner

Gretchen Morgenson published an article in the NYT on May 28, 2006 and discusses how one independent research firm got a head's up about SEC investigations into option backdating problems. The research firm, SEC Insight, warned its clients about possible regulatory risks after federal authorities had refused to release, following a FOIA request, records on a particular company because release of the information could interfere with enforcement activities. As it turned out, the research firm was correct, and its clients were able to avoid substantial losses on that company's stock.

The column reports that a significant part of the firm's research is based on SEC correspondence and other internal SEC documents it obtains by filing requests FOIA requests. The firm's founderbegan the practice when he was an analyst at American Express in the late 1990s. When the SEC Chairman announced in 1999 that the SEC was sending letters to 150 companies that it suspected of using aggressive accounting practices, he requested the names of the companies. After the SEC denied the request, he then requested information about a single company, Network Associates. The SEC coughed up a comprehensive 12-page comment letter challenging the company on a variety of accounting practices. Shortly thereafter, Network Associates warned that it would miss its earnings forecast.

Apparently, however, the SEC has recently stopped granting most of the firm's requests for regulatory correspondence and, in response, the founder has sued the SEC to compel it to turn over records on 12 companies. The column also notes that the SEC has been very slow to post correspondence on its website despite promises several years ago.

While the firm acknowledges in each report it publishes that it does not know the subject of investigations and cannot predict whether it will lead to an enforcement action, it views any question from the SEC about a company's practices as "an important data point for investors." Based on its research into SEC correspondence, the column observes that the firm was able to provide to its clients advance warnings about problems at Enron and Computer Associates, among other companies. The firm keeps a "focus list" of "troubled" companies where it has found signs of "compelling S.E.C. or other investigative activity" that may not have been disclosed to investors, as well as companies that need only be "monitored" because of possible regulatory risk.

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