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emerging/innovative research session

    Valerie Williams
    Small Business Fraud Assessment
    emerging/innovative research session posted July 30, 2012 by Valerie Williams 
    5558 Views, 17 Comments
    title:
    Small Business Fraud Assessment
    author(s), affiliation(s):
    Val Williams and Robert Kollar
    date:
    July 30, 2012 12:30am - August 11, 2012 12:30am
    session description:

    Learn how students assesses in a fraud awareness progam and assist companies with fraud prevention. 

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        • Valerie Williams

           Will be there

        • Robert E Jensen

          From The Wall Street Journal Weekly Accounting Review on August 10, 2012

          Fraud Fears Put a Chill in Fuel Program
          by: Ryan Tracy and Ben Lefevre
          Aug 03, 2012
          Click here to view the full article on WSJ.com
           

          TOPICS: Assurance Services, Auditing, Fraud

          SUMMARY: The article describes the credit trading programs used to meet mandates set by Congress in 2005 and 2007 for gallons of production of diesel-motor fuel made from sources such as waste cooking oil and soybeans. Major oil producers who have purchased credits from bio-diesel producers to meet their mandated quotas are now shying away from using the markets because increasing numbers of sellers of the credits have been shown to have committed fraud or are accused of doing so. The article also states that the EPA now requires companies purchasing bio-mass fuel credits to replace ones found to be bogus-putting the audit onus on the purchasers of these credits. An economic result also is that small producers' credit prices are slammed because of their perceived risk for fraudulent credits.

          CLASSROOM APPLICATION: Questions ask students to understand the nature of credit trading schemes to support innovation in fuel industries and the need for auditing the certificates sold in these schemes.

          QUESTIONS: 
          1. (Introductory) Summarize the government mandates described in the article that are helping to achieve growing levels of alternative fuel production. When were these programs put into place?

          2. (Introductory) Refer to the graphic entitled "Power Play." How long has it taken to see increasing production of alternative fuel relative to when U.S. Congress first initiated quotas for these fuels?

          3. (Advanced) How do the government systems over biomass fuel production require an audit verification process?

          4. (Advanced) Refer to the article description of Absolute Fuels of Lubbock, TX. What evidence indicates fraud may have occurred behind this company's sale of credits for biofuel production to large oil producers?

          5. (Advanced) What audit steps could be taken to identify these fraudulent practices? Who should be responsible for undertaking these audit steps? Explain your answer.
           

          Reviewed By: Judy Beckman, University of Rhode Island

           

          "Fraud Fears Put a Chill in Fuel Program," by Ryan Tracy and Ben Lefevre, The Wall Street Journal, August 10, 2012 ---
          http://professional.wsj.com/article/SB10000872396390444840104577550944057955070.html?mod=djem_jiewr_AC_domainid&mg=reno64-wsj

          A government program designed in part to foster innovative new producers of alternative diesel fuels is now endangered by fears of burgeoning fraud.

          Congress in 2005 and 2007 set mandates requiring major oil refiners to purchase credits representing gallons of diesel-motor fuel made from alternative sources, such as cooking oil and soybeans. The idea was to jump-start a new industry by attracting start-ups that otherwise would have trouble competing on price with established biodiesel producers.

          But federal charges that two small producers passed along worthless credits—and warnings that more cases could be coming—have spooked major buyers, threatening the viability of the small companies trying to gain a foothold.

          One company fearing the fallout is New Leaf Biofuel in San Diego, which makes diesel from used cooking oil collected at area restaurants. "We are nowhere near the margins that we had," said Chief Executive Jennifer Case, citing the case of a trash hauler with hundreds of trucks that backed away from doing business with her company.

          "The current issues as well as the future fraud threatens tens of thousands of jobs in the renewable-fuel industry," said Thomas Paquin, president of biofuel marketer VicNRG LLC, in testimony before Congress last month.

          When a producer such as New Leaf produces a gallon of alternative diesel fuel from sources deemed renewable by the EPA, it simultaneously creates a tradable credit representing roughly that amount of production, which is then assigned a 38-digit number.

          Big refiners can buy the credits to fulfill their legal requirements for biodiesel output, but at the moment they are offering low prices or nothing at all for credits from little-known producers that are perceived as risks for offering fake numbers.

          Allegedly bogus numbers are at the core of the federal cases.

          In December 2010, a Lubbock, Texas-based company, Absolute Fuels, sold about $1 million worth of numbers representing an equivalent amount of biofuel output to Tesoro Corp., one of the country's largest oil refiners, according to affidavits filed by a Secret Service investigator in federal court. Tesoro said it believed the numbers were valid and has turned in additional numbers to the EPA to replace those it bought from Absolute.

          The trade capped a big quarter for Absolute, which had closed similar deals with other big refiners. On Jan. 5, 2011, the firm registered a Gulfstream G-1159A multi-engine turbojet worth $2.5 million, according to documents filed by the Secret Service in federal court in Texas. Two months later, Environmental Protection Agency inspectors visited the Absolute factory and discovered the facility didn't appear to be producing any fuel, the documents said.

          Jeffrey Gunselman, Absolute's chief executive, was arrested last month and pleaded not guilty to the fraud charges, said his lawyer, Dan Cogdell. Mr. Cogdell said Mr. Gunselman has cooperated with investigators and that he was "instrumental in turning over tens of millions of dollars to the government during this investigation."

          The case against Mr. Gunselman is still pending.

          Rodney Hailey, owner of Maryland's Clean Green Fuel LLC, was convicted June 25 of fraudulently selling about $9 million of phony credits and is awaiting sentencing. His lawyer, Joseph Evans, says Mr. Hailey isn't guilty. Mr. Evans said an appeal was possible and that the government intends "to crush him beyond reason, even assuming that he did absolutely everything that they said he did."

          Under EPA rules, refiners that purchase phony credits are on the hook to replace them. According to an estimate by VicNRG, the biofuel marketer, the $140 million of allegedly fraudulent credits identified by the EPA so far would cost more than $200 million to replace at current market prices.

          While the market turmoil could temporarily help some established producers get higher prices for their credits, it could have negative longer-term effects for the alternative-fuel business. If too many producers drop out of the market, total output may fall short of the EPA's target of about one billion gallons a year.

          Continued in article

          Bob Jensen's Fraud Updates are at
          http://www.trinity.edu/rjensen/FraudUpdates.htm

        • Robert E Jensen

          "Fraud Reports Climb Still Higher: Employee reports of fraud are steadily increasing, both as a percentage of all compliance-reporting activity and in raw numbers," by Caroline McDonald, CFO.com, September 26, 2012 ---
          http://www3.cfo.com/article/2012/9/regulation_fraud-whistleblower-sec-jimmy-lin-jonny-frank

          Reports of fraud by corporate employees have continued their ceaseless rise so far this year, according to the Quarterly Corporate Fraud Index. The current drivers are increasing awareness of fraud, mandated whistle-blower protections, and changing company cultures.

          The index measures reported frauds as a percentage of all compliance-related reports. Most recently, for the second quarter of 2012, that ratio climbed to 22.9%, up from 21.7% for the same quarter in 2011.

          “This index essentially has been going up since the day we started tracking it [in 2005],” says Jimmy Lin, vice president of product strategy and corporate development at The Network, a provider of governance, risk, and compliance solutions that conducts the quarterly analysis in conjunction with BDO Consulting. The index looks at compliance-reporting activity at more than 1,400 clients of The Network worldwide, including nearly half of the Fortune 500.

          Corporate employees are simply becoming more aware of organizational issues and more willing to report compliance errors, especially fraud, Lin says. Fraud is more often covered in the news media these days, he notes. Also, he claims, the client companies have become more sophisticated in educating employees on what fraud looks like (which is a service The Network provides). “We see the index going up and up as a positive. Companies are getting more interested in a holistic approach than a check-box approach to compliance.”

          Employers are highly motivated to hear about alleged internal fraud before an employee instead makes an initial report to the Securities and Exchange Commission. “Even if it doesn’t turn into anything significant, they want to catch wind of it first,” notes Lin. Companies know that “even a hint of potential fraud issues in their organization, whether true or not,” puts their reputation at risk, not only with the public but also internally: “Employees may begin to wonder about the company’s ethics.”

          The whistle-blower protections under the Dodd-Frank Act, such as prohibiting retaliation against whistle-blowers, also may be having an impact. Companies are “couching it as building a better culture,” says Lin.

          Jonny Frank, a partner at forensic-accounting firm StoneTurn Group, points out that the SEC has offered incentives to encourage employees to use company-compliance hotlines. But another reason for the upward trend may be that the government expects companies to make the hotlines accessible to such third parties as customers and suppliers, as well as to employees.

          And a growing number of companies annually require employees to certify as to their knowledge of wrongdoing. “It’s one thing to put the burden on employees to come forward; it’s another to ask them to confirm they don’t know of any wrongdoing,” Frank says. That trend “suggests a culture where employees see that the company is serious and not just giving lip service to fraud.”

          Frank says compliance officers generally are doing a good job of pushing that message. Unfortunately, he adds, some companies’ finance teams are getting less involved as ethics and compliance controls mature. “It becomes easier for the CFO to just hand off that responsibility to compliance.”

          Lin observes that organizations are vulnerable if compliance enforcement is not a pervasive theme throughout the company. If functional areas, departments, and divisions aren’t working together to make sure fraud is addressed, “then everybody is going to lose,” he says.

          Continued in article

          Bob Jensen's Fraud Updates --- http://www.trinity.edu/rjensen/FraudUpdates.htm

           

        • Robert E Jensen

          "How Do You Spot The Thief Inside Your Company?" by Marc Weber Tobias, Forbes, December 21, 2012 --- Click Here
          http://www.forbes.com/sites/marcwebertobias/2012/12/21/how-do-you-spot-the-thief-inside-your-company/?utm_campaign=techtwittersf&utm_source=twitter&utm_medium=social

          The vast majority of annual losses that result from criminal activity in business and government entities are not caused by shoplifters or burglars in the United States. It is employee-thieves cloaked in many forms who commit their crimes, which are often discovered long after their various schemes begin.

          Their many schemes are identified as occupational fraud in the Report to the Nations, produced every two years since 1996 by the Association of Certified Fraud Examiners, or ACFE. The current report is based upon an analysis of 1388 cases that were investigated and documented by Certified Fraud Examiners in more than 100 countries on six continents. It provides a detailed look at the prevalence and culture of business thieves in categories such as misappropriation and theft of assets and cash, skimming, payroll fraud, financial statements and reporting schemes, conversion of assets, and corruption and misuse of influence.

          Based upon the Gross World Productthe ACFE estimates that global losses from fraud may be $3.5 trillion. In my career in both the public and private sectors, my colleagues and I have been involved in thousands of criminal and civil investigations involving thieving employees, vendors, contractors and suppliers. We’ve caught perpetrators trying to steal, defraud, and convert assets that included anything from cash to precious metals, and trade secrets and intellectual property. No entity is exempt and, in our world, just about everyone can be engaged in some form of fraudulent activity and theft, be it office supplies, time, gasoline, telephone calls, cash, assets, food, liquor, pictures hanging on the wall, bed sheets, dishes, narcotics, credit cards, checks, information, and whatever else is available for the taking or diversion. They pad time sheets and expense reports, submit false medical claims, forge mortgage documents, submit phony bills to clients and customers, and anything else that can be imagined.

          Our rule and mantra: “If it can be stolen, it will be, and often.”

          No one is exempt. We have worked cases in businesses, retail stores, banks, factories, hospitals, clinics, nursing homes, cruise ships, copper mines, construction sites, car dealerships, restaurants, bars, casinos and literally hundreds of other venues. Any entity can and has been a target, even law enforcement agencies and jails and prisons, where inmates, correctional officers, teachers and senior staff have been caught in a variety of schemes to steal, corrupt, defraud, extort and improperly obtain or divert assets and use their influence for personal gain.

          It is a multi-faceted problem but is rooted in two simple premises: everyone wants things they may not be able to afford (although that is often not the prime motivation for stealing) or they have a financial crisis that drives them to steal.

          The message for every reader: any entity can be the subject of losses. Sometimes you may not even know it for many months, years, or ever, with the average scheme taking eighteen months to discover.Companies, governments, and other entities must understand how to mitigate or reduce losses from a multitude of criminal schemes designed to siphon assets, in many forms, which ultimately destroy many enterprises.  The best protection against fraud is to prevent it before it can occur. If your entity or enterprise is operating without the proper controls and anti-fraud programs in place then you likely have been, are, or will be a victim. There are fraudsters everywhere and they are often destroying productivity, profitability, morale, and ultimately many businesses. They are able to get away with their crimes because the operation of almost all business is based upon trusting employees with resources and responsibility.

          This was going to be a simple article on the best way to alert companies about occupational fraud and their employees, and then describe one solution. After reviewing many investigations, discussing this with my colleagues, and examining the latest ACFE report, I decided that this article should profile the company thief and the companies that are most at risk, and then talk about one of the most effective means to stop people we work with from engaging in illegal activities in the workplace. So in this article I will look at who and what the looters are, and in the follow-up I will describe the work of a retired FBI Special Agent whom I first met forty years ago in Omaha when I was in law school.

          The businesses or entities most at risk

          The businesses most at risk to internal fraud and theft, in the order of losses from highest to lowest, are banking and financial services, government, and public administration, and the manufacturing sectors. Small employers (fewer than 100 workers) are more commonly victimized than larger companies because they usually cannot afford strong anti-fraud measures. They’re also often not in a financial position to absorb losses and less likely to recover either what was stolen or, in some cases, keep their business going as a viable entity.

          The implementation of anti-fraud control measures is highly correlative with significant decreases in the cost and duration of occupational fraud. While these controls cost money, not to implement them usually costs a lot more in terms of dollars, business reputation, litigation, and other costs. Those organizations that had implemented any of these controls had fewer losses and detection time than those entities that did not put such safeguards in place.

          Some sobering statistics about losses

          Businesses, on a global basis, experience losses of about 5% a year from schemes executed by and with employees. The median loss was about $400,000, and in one-fifth of businesses that were surveyed in the ACFE study, the loss was at least $1,000,000. In the least costly forms of fraud, the cost to business was about $120,000.

          In about 87% of the cases the appropriation of assets was the leading cause of losses. While financial statement fraud accounted for only about eight percent of all cases, it had the highest median loss of about $1,000,000 for each occurrence. Finally, corruption and various phony billing schemes made up about one third of all cases but more than fifty percent of the dollar losses, for an average of $250,000. This type of fraud was shown to pose the greatest overall risk on a global basis.

          Many cases will never be detected, and of those that are discovered, the actual amount of the losses may never be known or reported. Almost half of the victim organizations do not recover any of their losses. In cases that are referred to law enforcement, 55% of the offenders plead guilty, 19% of prosecutions are declined, and 16% are convicted at trial.

          A profile of the thieves within the workforce

          The ACFE report analyzed a number of parameters to identify who he or she is: education, criminal history, employment history, job description, administrative level and responsibilities, gender, lifestyles, and other factors that tell the story. In my world I have found that long-term employees are the most suspect because of their knowledge of the inner workings of the entity and understanding of the controls that they must circumvent.

          Report to the Nations
          by the Association of Certified Fraud Examiners
          http://www.acfe.com/uploadedFiles/ACFE_Website/Content/rttn/2012-report-to-nations.pdf

          How Not to Catch a Thief
          She was mostly just horsing around
          "Somehow the City of Dixon, Illinois Just Noticed (after six years) That $30 Million Was Missing," Going Concern, April 19, 2012 ---
          http://goingconcern.com/post/somehow-city-dixon-illinois-just-noticed-30-million-was-missing

          What a surprise. I thought she could gallop faster than the posse.
          "U.S. Attorney: Ex-Dixon comptroller to plead guilty," Chicago Tribune, November 13, 2012 ---
          http://www.chicagotribune.com/news/local/breaking/chi-us-atorney-exdixon-comptroller-to-plead-guilty-20121113,0,227018.story

          Former Dixon comptroller Rita Crundwell plans to plead guilty Wednesday to a federal fraud charge that alleges she siphoned more than $53 million from the small northwestern Illinois city’s coffers, according to the U.S. Attorney's office.

          The office released a statement saying Crundwell will change her plea to guilty at a hearing Wednesday morning before U.S. District Judge Philip G. Reinhard in federal court in Rockford.

          It was unclear from the release how Crundwell’s guilty plea to the federal charge will impact separate state charges she faces for the same wrongdoing. She also faces 60 counts of theft tied to her alleged embezzlement from the city's accounts.

          Crundwell is accused of stealing the money over two decades and using it to sustain a lavish lifestyle and a nationally renowned horse-breeding operation.

          Federal authorities have auctioned off about 400 horses and a luxury motor home that Crundwell allegedly bought with the stolen city funds. If Crundwell is convicted, much of the money will be returned to Dixon – after the federal government takes its cut for caring for the horses for months.

          How true can you get?
          As (Commissioner) Bridgeman left office last year, he praised (Controller) Rita Crundwell for being an asset to the city and said she "looks after every tax dollar as if it were her own," according to meeting minutes.
          As quoted by Caleb Newquest on April 27, 2012 ---
          http://goingconcern.com/post/heres-ominous-statement-former-dixon-city-finance-commissioner-made-about-accused-embezzler

           

          Bob Jensen's Fraud Updates ---
          http://www.trinity.edu/rjensen/FraudUpdates.htm

           

        • Robert E Jensen

          Anti-Fraud Collaboration Launches Website with Access to Anti-Fraud Tools
          Center for Audit Quality
          January 24, 2013
          News Release --- http://www.thecaq.org/newsroom/release_01242013.htm

          Anti-Fraud Collaboration Site --- http://www.antifraudcollaboration.org/

          Bob Jensen's threads on fraud ---
          http://www.trinity.edu/rjensen/Fraud.htm

        • Robert E Jensen

          The law does not pretend to punish everything that is dishonest. That would seriously interfere with business.
          Clarence Darrow --- Click Here  

           

          Why white collar crime pays for Chief Financial Officer: 
          Andy Fastow's fine for filing false Enron financial statements:  $30,000,000
          Andy Fastow's stock sales benefiting from the false reports:     $33,675,004
          Andy Fastow's estimated looting of Enron cash:                          $60,000,000
          That averages out to winnings, after his court fines, of $10,612,500 per year for each of the six years he spent in prison.
          You can read what others got at http://www.trinity.edu/rjensen/FraudEnron.htm#StockSales 
          Nice work if you can get it:  Club Fed's not so bad if you earn $29,075 per day plus all the accrued interest over the past 15 years.

           


          "CEO in fraud case needs more than seven days prison: court," by Jonathan Stempel, Reuters, February 15, 2013 ---
          http://www.reuters.com/article/2013/02/15/us-ceo-sentencing-decision-idUSBRE91E0W320130215

          A former chief executive who pleaded guilty to wrongdoing in a scheme that ultimately helped drive his company into bankruptcy could have been sent to prison for 10 years. The trial judge thought seven days was fair.

          Not long enough, a federal appeals court said on Friday.

          The 6th U.S. Circuit Court of Appeals said Michael Peppel, the former chief executive of the audio-visual technology company MCSi Inc, must be resentenced for his 2010 guilty plea to charges of conspiracy to commit fraud, false certification of a financial report, and money laundering.

          U.S. District Judge Sandra Beckwith in Cincinnati abused her discretion in sentencing Peppel to an "unreasonably low" week behind bars based almost solely on her belief that the defendant was "a remarkably good man," the appeals court said.

          Prosecutors had charged Peppel in December 2006 over an alleged fraud they said had begun six years earlier, amid financial difficulties at his publicly traded, Dayton, Ohio-based company.

          Peppel was accused of working with his chief financial officer to inflate results through sham transactions with a firm called Mercatum Ltd, and companies such as FedEx Corp (FDX.N) that were not implicated in wrongdoing. Prosecutors said he also sold $6.8 million of MCSi stock during this time.

          By the end of 2003, MSCI was bankrupt, and a reported 1,300 people had lost their jobs.

          Citing the need to punish Peppel and deter others, the government asked Beckwith at his October 2011 sentencing to impose a 97- to 121-month prison term. This was the length recommended, but not required, under federal guidelines.

          But the judge said the five years since the indictment had been "punishing, literally and figuratively" for Peppel, who had begun working for an online pharmacy to support his five children. He also had a brother with multiple sclerosis.

          "Michael's mistakes do not define him," Beckwith said. "I see it to be wasteful for the government to spend taxpayers' money to incarcerate someone that has the ability to create so much for this country and economy."

          She also imposed a $5 million fine and the maximum three years of supervised release.

          Circuit Judge Karen Nelson Moore, however, wrote for a unanimous three-judge appeals court panel that Beckwith was wrong to rely on "unremarkable aspects" of Peppel's life in imposing a "99.9975% reduction" to the recommended prison term.

          "There is nothing to indicate that the support provided by Peppel to his family, friends, business associates, and community is in any way unique or more substantial than any other defendant who faces a custodial sentence," Moore wrote.

          Beckwith was not immediately available for comment.

          Ralph Kohnen, a lawyer for Peppel, on Friday said: "We expect that the judge will exercise the same common sense and fairness in imposing a similar sentence on remand."

          Continued in article

          Bob Jensen's threads on how White Collar Crime Pays Even if You Know You're Going to Get Caught ---
          http://www.trinity.edu/rjensen/FraudConclusion.htm#CrimePays

           

        • Robert E Jensen

          From the CFO Morning Ledger on February 20, 2013

          FCPA Resource Guide: 10 Issues to Consider

          With the release of “FCPA: A Resource Guide to the U.S. Foreign Corrupt Practices Act,” executives have more information about how the Department of Justice and the SEC view compliance with the Foreign Corrupt Practices Act and companies' anti-corruption programs and efforts. Learn 10 overarching themes in the guide to consider when reviewing FCPA compliance programs and actions that might be taken to help strengthen them.

          See http://deloitte.wsj.com/cfo/2013/02/20/fcpa-resource-guide-10-issues-to-consider/

           

          Foreign Corrupt Practices Act Compliance Guidebook: Protecting Your Organization from Bribery and Corruption
          Martin T. Biegelman and Daniel R. Biegelman
          Wiley, 2010
          ISBN: 978-0-470-52793-1

        • Robert E Jensen

          Instructional Teaching Case for Accounting Teachers

          The Brooks Brothers Tangle With the SEC
          The company had four independent auditors over the course of this saga
          David Brooks apparently made threatening remarks to certain of his company's independent auditors
          "Of Hurricanes and Harness Racing:  The Accounting Fraud at DHB Industries, by Michael C. Knapp and Carol A. Knapp, Issues in Accounting Education, Vol. 28, No. 1, February 2013, pp. 131-152 ---
          http://aaajournals.org/doi/full/10.2308/iace-50297

          You can't make up a story like this.
          Andrew Cohen, Senior Legal Analyst, CBS News

          ABSTRACT:

          This instructional case focuses on an accounting and financial reporting fraud involving DHB Industries, Inc., the nation's largest manufacturer of bullet-resistant vests. Three executives of this Securities and Exchange Commission (SEC) registrant, including its founder and CEO, masterminded a large-scale fraud that grossly misrepresented DHB's financial statements. The three executives colluded to conceal their misdeeds from the four accounting firms that served as the company's independent auditors over the course of the fraud. In late 2010, a federal jury convicted DHB's former CEO and COO of multiple counts of fraud and related charges. This case addresses a wide range of auditing issues raised by the DHB fraud, including the identification of fraud risk factors, auditing of related-party transactions, the impact of frequent auditor changes on audit quality, and the internal control reporting responsibilities of auditors.

          . . .

          Circus Trial

          The criminal trial of David Brooks and his co-defendant Sandra Hatfield commenced in late January 2010. Brooks faced a 17-count federal indictment that included allegations of corporate fraud, insider trading, conspiracy, and obstruction of justice. Hatfield faced similar charges in the 16-count federal indictment filed against her.

          Throughout the trial, jurors were pelted with an unrelenting stream of evidence that documented how Brooks had used “DHB as his personal piggy bank” (SEC 2007). Personal expenditures paid with corporate funds included purchases of luxury automobiles, expensive art, jewelry, designer clothing, and real estate. Court testimony revealed that the largest benefactor of Brooks' embezzlement scheme was his beloved harness racing operation. Brooks reportedly diverted nearly $15 million of DHB funds through TAP to help finance his expensive hobby.

          Other testimony during the long criminal trial documented how Brooks had repeatedly lied to DHB's independent auditors to conceal his fraudulent scams. Schlegel's testimony laid out in minute detail the extreme lengths to which she, Brooks, and Hatfield had gone to mislead the auditors. The most elaborate hoaxes were required to conceal the large overstatements of inventory from the curious and persistent teams of auditors.

          Throughout the eight-month trial, the presiding federal magistrate, Judge Joanna Seybert, faced the daunting task of maintaining a sense of civility and decorum in her Long Island courtroom. The first drama involved the revocation of David Brooks' bail. In January 2008, three months after his initial arrest, Brooks' attorneys secured his release on bail. Because Judge Seybert believed that Brooks posed a significant flight risk, she required him to post a $400 million bail bond that included cash and other collateral of nearly $50 million. The bail terms also required Brooks to retain a security firm at an estimated cost of $3,500 per day to monitor him around the clock. ABC News (2008) reported that Brooks' bail terms were more stringent than those imposed years earlier by a federal judge on the infamous mobster John Gotti.

          Just as Brooks' trial was beginning, Judge Seybert revoked his bail and remanded him to jail because of two reports given to her by the FBI. An undercover video forwarded to the FBI by Scotland Yard detectives allegedly showed Jeffrey Brooks and one of his subordinates transferring millions of euros to a large safety deposit box in a London bank. The FBI was convinced that the funds belonged to David Brooks. The FBI also informed Judge Seybert that they had discovered evidence suggesting that Brooks had secretly transferred tens of millions of dollars to bank accounts in the tiny European nation of San Marino. Judge Seybert revoked Brooks' bail because the two incidents violated the conditions of his bail agreement that mandated that all of his financial assets be “frozen.”

          Midway through the trial, Judge Seybert threatened to have David Brooks removed from the courtroom after he was discovered attempting to smuggle anxiety-suppression medication into his jail cell. The anti-anxiety pills were hidden in a ballpoint pen that had been placed at Brooks' desk during a break in the courtroom proceedings. Following this incident, Judge Seybert barred Jeffrey Brooks and one of David Brooks' close friends from the courtroom. Brooks' personal psychiatrist subsequently testified that the psychiatrist at the correctional facility where Brooks was being held had prescribed him an insufficient dosage of the anti-anxiety medication. Brooks reportedly needed larger than normal dosages of that medication to ward off the panic attacks that he frequently experienced.

          Later in the trial, federal prosecutors revealed that several months earlier, David Brooks had allegedly asked a veterinarian who worked in his harness racing operation to obtain a medication administered to horses. If taken by a human, this medication would supposedly wipe out his or her memory. According to the veterinarian, Brooks hoped to somehow administer the medication to Dawn Schlegel, the prosecution's principal witness, prior to the beginning of his criminal trial. This revelation and Brooks' other antics during the trial caused Comedy Central's Stephen Colbert to name Brooks his “Alpha Dog of the Week” during the August 2, 2010, airing of the popular television program The Colbert Report.

          Andrew Cohen, a senior legal analyst for CBS News who monitored Brooks' trial, observed that many of its details were so salacious that major publications, such as The New York Times, would not report them (Cohen 2010). One veteran reporter summarized some of the more outrageous events and testimony that took place during the trial:

          It's not an everyday federal trial in which an FBI agent walks into the courtroom in the middle of a trial and seizes the contents of a defendant's wastebasket as part of a still ongoing investigation into whether Brooks tampered with the jury. Or in which the defense asserts that the payment of company money to prostitutes might be an acceptable technique to motivate employees. Or in which a defendant says he is entitled to have his company pay for the grave of his mother, camp tuition for his children, a $60,000 sculpture of a Wall Street bull, family trips to St. Barts and St. Tropez, or allegedly drains millions of dollars off through a shell company to pay for the upkeep of harness stables. (Cohen 2010)

          After spending two months studying the massive amount of evidence that prosecutors had presented to prove their allegations, a federal jury convicted Brooks on all 17 counts that had been filed against him. Sandra Hatfield, Brooks' former colleague and co-defendant, was found guilty on 14 of the 16 counts included in her federal indictment.

          Epilogue

          In April 2010, near the midpoint of David Brooks' criminal trial, Point Blank Solutions, the successor to DHB Industries, Inc., filed for protection from its creditors in U.S. Bankruptcy Court. To date, a reorganization plan for the company has not been approved by the federal judge presiding over the company's bankruptcy filing. Point Blank remains an operating entity and continues to claim that it is the world's leading manufacturer of body armor.

          Following the completion of Brooks' trial, his attorneys immediately appealed his conviction. Among other arguments, the attorneys maintained that Brooks was incompetent and unable to contribute to his defense during much of the trial because of the anti-anxiety medication that he was taking. With his appeal still pending, Brooks has yet to be sentenced. Shortly after his criminal trial ended, Brooks pled guilty to tax evasion charges that had been pending against him for several years. Brooks is yet to stand trial on contempt charges filed against him as a result of his behavior during his criminal trial.

          In February 2011, the SEC filed a civil complaint against three former members of DHB's audit committee. The federal agency charged the three individuals with being “willfully blind to numerous red flags signaling accounting fraud, reporting violations, and misappropriation at DHB” (SEC 2011). The civil complaint went on to allege that the three former audit committee members “merely rubber-stamped the decisions of DHB's senior management while making substantial sums from sales of DHB's securities” (SEC 2011).



           
          QUESTIONS
          1. Exhibits 1 and 4 present DHB's original 2003–2004 balance sheets and income statements and the restated balance sheets and income statements for those two years, respectively. Review the original and restated financial statements for 2004 and identify the “material” differences between them. (Note: You are not required to identify the sources of these differences.) Defend your choices.
          2. Identify the fraud risk factors posed by DHB for its independent auditors. Which of these factors, in your opinion, should have been of primary concern to those auditors?
          3. During the 2004 DHB audit, the company's independent auditors had considerable difficulty obtaining reliable audit evidence regarding the $7 million of obsolete vest components that allegedly had been destroyed by a hurricane. What responsibility do auditors have when the client cannot provide the evidence they need to complete one or more audit tests or procedures?
          4. What responsibility, if any, do auditors have to search for related-party transactions? If auditors discover that a client has engaged in related-party transactions, what audit procedures should be applied to them?
          5. Compare and contrast the internal control reporting responsibilities of the management and independent auditors of public companies.
          6. What potential consequences do frequent changes in auditors have for the quality of a given entity's independent audits? Identify professional standards or other rules and regulations that are intended to discourage auditor changes or provide disclosure of the circumstances surrounding them.
          7. David Brooks apparently made threatening remarks to certain of his company's independent auditors. What actions should auditors take when they are the target of hostile statements or actions by client executives or employees?
          8. Does the SEC have a responsibility to protect the investing public from self-interested corporate executives? Do professional auditing standards or other rules or regulations impose such a responsibility on independent auditors?
          9. The audit committee of DHB Industries was criticized for failing to carry out its oversight responsibilities. What are the primary responsibilities of a public company's audit committee?

           

          Bob Jensen's Fraud Updates are at http://www.trinity.edu/rjensen/FraudUpdates.htm

           

        • Robert E Jensen

          Today’s FBI: Facts and Figures 2013-2014—which provides an in-depth look at the FBI and its operations—is now available ---
           http://www.fbi.gov/stats-services/publications/todays-fbi-facts-figures/facts-and-figures-031413.pdf/view

        • Robert E Jensen

          The New Yorker:
          From maids to roofers to drug dealers the underground economy resulted in an estimated $2 Trillion (with a T) of underreported taxable income in 2012
          Unemployment and Welfare Fraud
          "The Underground Recovery," by James Surowiecki," The New Yorker, April 29, 2013 ---
          http://www.newyorker.com/talk/financial/2013/04/29/130429ta_talk_surowiecki

          When we all finished filing our tax returns last week, there was a little something missing: two trillion dollars. That’s how much money Americans may have made in the past year that didn’t get reported to the I.R.S., according to a recent study by the economist Edgar Feige, who’s been investigating the so-called underground, or gray, economy for thirty-five years. It’s a huge number: if the government managed to collect taxes on all that income, the deficit would be trivial. This unreported income is being earned, for the most part, not by drug dealers or Mob bosses but by tens of millions of people with run-of-the-mill jobs—nannies, barbers, Web-site designers, and construction workers—who are getting paid off the books. Ordinary Americans have gone underground, and, as the recovery continues to limp along, they seem to be doing it more and more.

          Measuring an unreported economy is obviously tricky. But look closely and you can see the traces of a booming informal economy everywhere. As Feige said to me, “The best footprint left in the sand by this economy that doesn’t want to be observed is the use of cash.” His studies show that, while economists talk about the advent of a cashless society, Americans still hold an enormous amount of cold, hard cash—as much as seven hundred and fifty billion dollars. The percentage of Americans who don’t use banks is surprisingly high, and on the rise. Off-the-books activity also helps explain a mystery about the current economy: even though the percentage of Americans officially working has dropped dramatically, and even though household income is still well below what it was in 2007, personal consumption is higher than it was before the recession, and retail sales have been growing briskly (despite a dip in March). Bernard Baumohl, an economist at the Economic Outlook Group, estimates that, based on historical patterns, current retail sales are actually what you’d expect if the unemployment rate were around five or six per cent, rather than the 7.6 per cent we’re stuck with. The difference, he argues, probably reflects workers migrating into the shadow economy. “It’s typical that during recessions people work on the side while collecting unemployment,” Baumohl told me. “But the severity of the recession and the profound weakness of this recovery may mean that a lot more people have entered the underground economy, and have had to stay there longer.”

          The increasing importance of the gray economy isn’t only a reaction to the downturn: studies suggest that the sector has been growing steadily over the years. In 1992, the I.R.S. estimated that the government was losing $80 billion a year in income-tax revenue. Its estimate for 2006 was $385 billion—almost five times as much (and still an underestimate, according to Feige’s numbers). The U.S. is certainly a long way from, say, Greece, where tax evasion is a national sport and the shadow economy accounts for twenty-seven per cent of G.D.P. But the forces pushing people to work off the books are powerful. Feige points to the growing distrust of government as one important factor. The desire to avoid licensing regulations, which force people to jump through elaborate hoops just to get a job, is another. Most important, perhaps, are changes in the way we work. As Baumohl put it, “For businesses, the calculus of hiring has fundamentally changed.” Companies have got used to bringing people on as needed and then dropping them when the job is over, and they save on benefits and payroll taxes by treating even full-time employees as independent contractors. Casual employment often becomes under-the-table work; the arrangement has become a way of life in the construction industry. In a recent California survey of three hundred thousand contractors, two-thirds said they had no direct employees, meaning that they did not need to pay workers’-compensation insurance or payroll taxes. In other words, for lots of people off-the-books work is the only job available.

          Sudhir Venkatesh, a sociologist at Columbia and the author of a study of the underground economy, thinks that many workers, particularly younger ones, have become comfortable with casual work arrangements. “We have seen the rise of a new generation of people who are much more used to doing things in a freelance way,” he said. “That makes them more amenable to unregulated work. And they seem less concerned about security, which they equate with rigidity.” The growing importance of services in the economy is also crucial. Tutors, nannies, yoga teachers, housecleaners, and the like are often paid in cash, which is hard for the I.R.S. to track. In a 2006 study, the economist Catherine Haskins found that between eighty and ninety-seven per cent of nannies were paid under the table.

          Continued in article

          Case Studies in Gaming the Income Tax Laws ---
          http://www.cs.trinity.edu/~rjensen/temp/TaxNoTax.htm

        • Robert E Jensen

          From the IRS
           IRS Criminal Investigation Issues Fiscal 2012 Report, IR-2013-50, May 10, 2013 ---
           http://www.irs.gov/uac/Newsroom/IRS-Criminal-Investigation-Issues-Fiscal-2012-Report

        • Robert E Jensen

          Grant Thornton Coughs Up $8.5 Million for Not Detecting Fraud
          "Koss settles claims against former auditor Grant Thornton," by Gary Spivak, Milwaukee Sentinel Journal, July 5, 2013 ---
          http://www.jsonline.com/business/koss-settles-claims-against-former-auditor-grant-thornton-b9948373z1-214372071.html

          Koss Corp. collected $8.5 million from Grant Thornton, the accounting firm that audited Koss' books during a portion of the time that Sujata "Sue" Sachdeva was stealing millions from the company.

          The payment made Wednesday settles a lawsuit filed in Cook County, Ill., in which Koss charged Grant Thornton with negligence for not discovering Sachdeva's thievery. Sachdeva's scheme ran for about 12 years and cost Koss, a maker of headphones, about $34 million. Her embezzlement, which financed an extravagant lifestyle that included trips and shopping sprees, intensified in the final years of the scheme.

          Sachdeva, who had been the company's vice president of finance, is serving an 11-year federal prison sentence and is expected to be released in August 2020, according to the Federal Bureau of Prisons.

          "I don't think it is possible to look at the size of the settlement and conclude that Grant Thornton didn't see some risk if this case came to trial," said Jeremy Levinson, a Milwaukee attorney not involved in the case. "Every story that gets written on this case, including this one, is bad for Grant Thornton."

          Grant Thornton charged Koss nearly $700,000 for work it performed from 2004 until it was fired shortly after Sachdeva was arrested in December 2009, according to records filed with the U.S. Securities and Exchange Commission. Baker Tilly, the auditing firm that replaced Grant Thornton, collected $570,679 for its first year of work — a time when the FBI, auditors and company officials scoured Koss' books to determine the level of damages she caused.

          Tracy Coenen, a Milwaukee forensic accountant who criticized Koss management on her Fraud Files blog, said the company should shoulder the blame for not detecting Sachdeva's crimes earlier.

          "Upper management was at least negligent in not properly overseeing what she was doing and for not having proper internal controls," Coenen said. Koss "management bears the bulk of the responsibility, if not all of it."

          Continued in article

           

          Grant Thornton said in a statement that it had met "all of our professional obligations and that our work complied with professional standards."
          See below

          "Koss embezzlement ran in spurts, lawsuit says $478,735 spent over three days in summer 2006" by Cary Spivak, Milwaukee Journal Sentinel, July 10, 2010 --- http://www.jsonline.com/business/98152439.html

          The $31 million embezzlement at Koss Corp. included several spurts of rapid-fire spending, according to a recent court filing - including one three-day span in 2006 during which nearly $500,000 flew out of the Milwaukee company's accounts and into the hands of three high-end retailers and a credit card company.

          The lists of checks and wire transfers shed new light on the scheme for which Sujata "Sue" Sachdeva, former vice president of finance for Koss, is facing six federal felony charges. She was arrested by the FBI in December and has pleaded not guilty.

          The list, which takes up the equivalent of about 10 single-spaced pages, is contained in a lawsuit that Koss filed last month against Sachdeva and its former auditor, Grant Thornton LLP.

          The list shows that in addition to expenditures at upscale clothing retailers, Koss funds also were spent on smaller luxury items such as a personal trainer and limousine rides. Koss charges that the payments listed in the lawsuit were used to pay for Sachdeva's personal expenses.

          The spending spurts left some experts wondering how the scheme could have gone unchecked for at least seven years.

          "If they just looked at a sample of the withdrawals, they would have found it," said Joel Joyce, a forensic accountant at Reilly, Penner & Benton, referring to Koss executives or outside auditors. "They might not have caught it in the first month . . . but my guess is it would not have been six to seven years."

          A case in point was a flurry of check-writing in the summer of 2006.

          On Aug. 1 of that year, two cashier's checks totaling $154,021 went to Valentina Inc., an exclusive Mequon clothing store.

          The next day, an $18,100 cashier's check was cut to Neiman Marcus and a $10,120 check was made out to Saks Fifth Avenue.

          Then, on Aug. 3, three checks totaling $296,494 were written to American Express, the credit card company that eventually blew the whistle on Sachdeva last year.

          Total over the three-day span: $478,735.

          The checks to retailers identified the merchants by their initials, Koss said in the lawsuit. For example Valentina was V Inc. and Saks Fifth Avenue was S.F.A Inc.

          Tony Chirchirillo, owner of Valentina, said he saw nothing suspicious about the large cashier's checks his company received from Sachdeva. He said he assumed the checks were backed by her own funds.

          It's believed that over a five-year period Sachdeva spent more than $5 million at the boutique, sources said, although Chirchirillo said that figure "seemed high."

          "I didn't know it came from Koss," Chirchirillo said, explaining that unlike personal checks, the cashier's checks did not list whose account the money was being drawn from. "I was told by an FBI agent that the money came from Koss. I would not have taken it if it said Koss."

          The largest withdrawals listed in the lawsuit went to upscale retailers and to American Express, the target of an earlier lawsuit filed by Koss that contended the credit card company should have raised suspicions about the expenditures sooner.

          The August spurt wasn't the only one. On Feb. 3, 2006, two cashier's checks were written to American Express, one for $102,836 and the other for $101,451.

          And from July 11 to July 17 of 2003, a check for $20,182 was written to Marshall Fields, a second for $26,420 went to Saks Fifth Avenue, and five checks totaling $104,738 went to American Express.

          The indictment against Sachdeva charges that she spent most of the embezzled money on luxury clothing and jewelry, furs, vacations and items for her Mequon home. More than 22,000 items - some with price tags still attached - have been seized by federal authorities in connection with the investigation, including fur coats, designer clothing, jewelry, art items and hundreds of pairs of shoes.

          Among the payments detailed in the latest lawsuit:

          • Carey Limousine received $16,706 from 2006 to 2008, with the bulk of the money coming in 2007. The most expensive ride was for $4,460 in September 2007.

          • Chris A. Aiello, a personal trainer, was paid $770 in 2005. Aiello said he trained Sachdeva two to three times a week, sometimes in a conference room at Koss headquarters and sometimes at her Mequon home. Normally, Aiello said, he was paid with personal checks by Sachdeva, although he recalled that on a handful of occasions Sachdeva told him to get his money from one of her assistants, Julie Mulvaney. He said he thinks those few checks came from Koss.

          "You question it in your mind, but you don't say anything," said Aiello, who no longer trains Sachdeva. "We weren't doing anything illegal."

          • Several payments, including one for $21,000 and another for $14,000, went to individuals. Ongoing investigations include an effort to determine what connection, if any, those people had to Sachdeva.

          • Mulvaney was paid a total of $14,000, and another Sachdeva assistant, Tracy Malone, was paid about $1,800. Both employees were fired by Koss last year, and attorneys for both women have said they did nothing wrong.

          In addition, more than $145,000 was taken from petty cash, in increments ranging from $482 to $9,049, according to the Koss list.

          "That's a lot of distributions coming out of petty cash," said Richard Brown, the retired head of accounting company KPMG's Milwaukee office. "But petty cash doesn't get a lot of attention."

          At the time of the scheme, Michael Koss held five high-level titles in the company including chief executive officer and chief financial officer. Koss, the son of the company's founder, remains CEO but is no longer CFO.

          "A CFO should have been reviewing financial reports that might have raised questions, which might have included 'Let me see the documents,' " said Brown, who now teaches accounting. That review would have likely led to question about why thousands, and in some cases millions, were being paid to retailers, he said.

          The suit, filed in Cook County, Ill., seeks damages from Grant Thornton and alleges the national accounting firm failed to spot the fraud and repeatedly assured Koss that it had adequate internal controls.

          Grant Thornton said in a statement that it had met "all of our professional obligations and that our work complied with professional standards."

          Michael Koss and the California attorney who filed the lawsuit did not return calls for comment.

          Brown said suits filed against auditors by companies that are fraud victims often are settled out of court.

          "A full blown civil lawsuit will bring out a lot of facts potentially embarrassing to both the company and the accounting firm," Brown said, adding it was impossible to say which side might prevail in litigation. "Both the company and the audit firm will suffer continued embarrassing publicity if the suit goes to completion. It is for this reason that these types of suits often get settled out of court before a trial

          The $31 million embezzlement at Koss Corp. included several spurts of rapid-fire spending, according to a recent court filing - including one three-day span in 2006 during which nearly $500,000 flew out of the Milwaukee company's accounts and into the hands of three high-end retailers and a credit card company.

          The lists of checks and wire transfers shed new light on the scheme for which Sujata "Sue" Sachdeva, former vice president of finance for Koss, is facing six federal felony charges. She was arrested by the FBI in December and has pleaded not guilty.

          The list, which takes up the equivalent of about 10 single-spaced pages, is contained in a lawsuit that Koss filed last month against Sachdeva and its former auditor, Grant Thornton LLP.

          The list shows that in addition to expenditures at upscale clothing retailers, Koss funds also were spent on smaller luxury items such as a personal trainer and limousine rides. Koss charges that the payments listed in the lawsuit were used to pay for Sachdeva's personal expenses.

          The spending spurts left some experts wondering how the scheme could have gone unchecked for at least seven years.

          "If they just looked at a sample of the withdrawals, they would have found it," said Joel Joyce, a forensic accountant at Reilly, Penner & Benton, referring to Koss executives or outside auditors. "They might not have caught it in the first month . . . but my guess is it would not have been six to seven years."

          A case in point was a flurry of check-writing in the summer of 2006.

          On Aug. 1 of that year, two cashier's checks totaling $154,021 went to Valentina Inc., an exclusive Mequon clothing store.

          The next day, an $18,100 cashier's check was cut to Neiman Marcus and a $10,120 check was made out to Saks Fifth Avenue.

          Then, on Aug. 3, three checks totaling $296,494 were written to American Express, the credit card company that eventually blew the whistle on Sachdeva last year.

          Total over the three-day span: $478,735.

          The checks to retailers identified the merchants by their initials, Koss said in the lawsuit. For example Valentina was V Inc. and Saks Fifth Avenue was S.F.A Inc.

          Tony Chirchirillo, owner of Valentina, said he saw nothing suspicious about the large cashier's checks his company received from Sachdeva. He said he assumed the checks were backed by her own funds.

          It's believed that over a five-year period Sachdeva spent more than $5 million at the boutique, sources said, although Chirchirillo said that figure "seemed high."

          "I didn't know it came from Koss," Chirchirillo said, explaining that unlike personal checks, the cashier's checks did not list whose account the money was being drawn from. "I was told by an FBI agent that the money came from Koss. I would not have taken it if it said Koss."

          The largest withdrawals listed in the lawsuit went to upscale retailers and to American Express, the target of an earlier lawsuit filed by Koss that contended the credit card company should have raised suspicions about the expenditures sooner.

          The August spurt wasn't the only one. On Feb. 3, 2006, two cashier's checks were written to American Express, one for $102,836 and the other for $101,451.

          And from July 11 to July 17 of 2003, a check for $20,182 was written to Marshall Fields, a second for $26,420 went to Saks Fifth Avenue, and five checks totaling $104,738 went to American Express.

          The indictment against Sachdeva charges that she spent most of the embezzled money on luxury clothing and jewelry, furs, vacations and items for her Mequon home. More than 22,000 items - some with price tags still attached - have been seized by federal authorities in connection with the investigation, including fur coats, designer clothing, jewelry, art items and hundreds of pairs of shoes.

          Among the payments detailed in the latest lawsuit:

          • Carey Limousine received $16,706 from 2006 to 2008, with the bulk of the money coming in 2007. The most expensive ride was for $4,460 in September 2007.

          • Chris A. Aiello, a personal trainer, was paid $770 in 2005. Aiello said he trained Sachdeva two to three times a week, sometimes in a conference room at Koss headquarters and sometimes at her Mequon home. Normally, Aiello said, he was paid with personal checks by Sachdeva, although he recalled that on a handful of occasions Sachdeva told him to get his money from one of her assistants, Julie Mulvaney. He said he thinks those few checks came from Koss.

          "You question it in your mind, but you don't say anything," said Aiello, who no longer trains Sachdeva. "We weren't doing anything illegal."

          • Several payments, including one for $21,000 and another for $14,000, went to individuals. Ongoing investigations include an effort to determine what connection, if any, those people had to Sachdeva.

          • Mulvaney was paid a total of $14,000, and another Sachdeva assistant, Tracy Malone, was paid about $1,800. Both employees were fired by Koss last year, and attorneys for both women have said they did nothing wrong.

          In addition, more than $145,000 was taken from petty cash, in increments ranging from $482 to $9,049, according to the Koss list.

          "That's a lot of distributions coming out of petty cash," said Richard Brown, the retired head of accounting company KPMG's Milwaukee office. "But petty cash doesn't get a lot of attention."

          At the time of the scheme, Michael Koss held five high-level titles in the company including chief executive officer and chief financial officer. Koss, the son of the company's founder, remains CEO but is no longer CFO.

          "A CFO should have been reviewing financial reports that might have raised questions, which might have included 'Let me see the documents,' " said Brown, who now teaches accounting. That review would have likely led to question about why thousands, and in some cases millions, were being paid to retailers, he said.

          The suit, filed in Cook County, Ill., seeks damages from Grant Thornton and alleges the national accounting firm failed to spot the fraud and repeatedly assured Koss that it had adequate internal controls.

          Grant Thornton said in a statement that it had met "all of our professional obligations and that our work complied with professional standards."

          Michael Koss and the California attorney who filed the lawsuit did not return calls for comment.

          Brown said suits filed against auditors by companies that are fraud victims often are settled out of court.

          "A full blown civil lawsuit will bring out a lot of facts potentially embarrassing to both the company and the accounting firm," Brown said, adding it was impossible to say which side might prevail in litigation. "Both the company and the audit firm will suffer continued embarrassing publicity if the suit goes to completion. It is for this reason that these types of suits often get settled out of court before a trial takes place."

          Continued in article

          Bob Jensen's Fraud Updates are at
          http://www.trinity.edu/rjensen/FraudUpdates.htm

          Bob Jensen's threads on Grant Thornton are at
          http://www.trinity.edu/rjensen/Fraud001.htm

           

        • Robert E Jensen

          "Accountants Should Focus on Detecting Fraud, Experts Say," by Ben DiPietro," The Wall Street Journal, October 9, 2013 ---
          http://blogs.wsj.com/riskandcompliance/2013/10/09/accountants-should-focus-on-detecting-fraud-experts-say/

          Accountants have been slow to embrace the idea that a core function of their job is to identify fraud during company audits. Part of the problem is it’s not always possible to know who in an organization is involved in deceptive number-crunching.

          Accountants have been slow to embrace the idea that a core function of their job is to identify fraud during company audits, and more education and training is needed to hasten the advancement of this idea. Part of the problem is while standards have evolved to incorporate fraud detection into the job description, it’s not always possible to know who in an organization is involved in deceptive number-crunching, say two accounting experts.

          While hard to believe, some CPAs believe detecting fraud still isn’t one of their core responsibilities, said Brian Fox, a certified fraud examiner and the founder and president of Confirmation.com, a cloud-based audit security tool used to prevent confirmation fraud. “For a long time we said finding fraud wasn’t our responsibility. Our responsibility was to find material errors in statements,” Mr. Fox said. “We’ve got great technology today, we don’t need to be paid to add up numbers. The public is relying on us to make sure accounting standards are being applied correctly and that management’s estimates are fairly stated and there is no fraud. They view us as the public’s watchdog.”

          Most auditors are not prepared to search for and identify the signs of financial fraud, and this lack of preparation is even more pronounced among staff and senior auditors, where the majority of the detailed audit work and client conversations take place, Mr. Fox said, adding this shows resistance remains as to whether this should be the responsibility of the accountant/auditor. “It’s also a bit of a legacy issue in not training our folks on ways to find fraud,” he said. “We cover some of that material but if you ask people in the public who rely on our audited statements they say it is our responsibility to find fraud. But the CPA exam, less than 1% focuses on fraud, it’s somewhat surprising, somewhat of a misalignment.”

          Standards requiring auditors to have responsibility for finding material misstatements in financial statements and designing audit procedures to detect that fraud have been around for more than a decade, but John Keyser, national director of assurance services at assurance, tax and consultant services firm McGladrey, said recent changes to rules have refined those standards to require additional procedures and additional inquiries of management and others charged with governance.

          Changes include more fraud awareness training, and identification of fraud control deficiencies that allow fraud to occur, he said, along with additional conversation among audit teams about where fraud could occur and the ways management might try to commit fraud, with the end result being the designing of policies to protect against those risks. “There’s been an evolution in required procedures, refined over time, of additional procedures directed at fraud,” Mr. Keyser said. He cited the development of the “fraud triangle,” or the three elements needed for fraud to occur: the opportunity to commit fraud, the incentive for someone to commit fraud and the ability to rationalize the fraud. Although auditors are good at identifying the areas where opportunities to commit fraud exist, it is harder for them to know who in an organization may have motivation to commit fraud and it is even more difficult to know who may be capable of rationalizing away such actions, he said.

          “I think there is more of a recognition of the types of fraud that occur and how those get perpetrated,” Mr. Keyser said. Auditors need to pay particular attention to year-end statements and performance targets that may be tied to executive bonuses, as these are areas where management may fudge the numbers to ensure they receive the most compensation they can. “Standards are pretty robust, I think, but at the same time we only can know what we can know. This does not provide absolute assurance. We can only make educated guesses and evaluate management’s assumptions to see if they are reasonable. There are limitations.”

          Continued in article

          Jensen Comment
          The problem with having CPA auditors detect fraud is that they are not very good at it.
          This is mostly because they generally do not have programs for rewarding whistle blowers like those whistle blower programs of the SEC (where an informant recently received $14 million) and rewards posted in the justice system, e.g., Crime Stopper rewards.

          Presumably whistle blowing rewards should be one of the first considerations if fraud detection is made part of the responsibility for CPA financial statement audits. Doing so, however, may add greatly to auditing costs that are already under fire for being too high.

          The PCAOB inspection reports over the past few years indicate that the auditing firms are often deficient in their auditing procedures focused on GAAP conformance. If these audit firms take on the added responsibility for fraud detection that does not materially impact financial statements, the likelihood of them installing highly effective fraud detection audit procedures is relatively low. One problem is that CPA financial statement auditors are not trained very well for fraud detection beyond GAAP conformance fraud.

          For example, GAAP conformance fraud places heavy reliance upon analytical reviews comparing a company's financial statements with benchmark financial statements for companies in a given industry. Analytical review procedures are almost useless in detecting whether Johnny Cash has been pilfering parts for a home made Cadillac over the past 10 years.
          One Piece at a Time by Johnny Cash
          http://www.youtube.com/watch?v=0ynSm1Ngfn8

          Veteran employees in warehouses have a hard time keeping from laughing out loud when neophyte college graduates in suits arrive to test check the inventory counts.

          Analytical review procedures are almost useless in detecting whether June Carter is kiting accounts receivable in the General Motors parts division. Without whistle blowers these types of frauds often go undetected.

          Fraud detection can become so granular that it entails examining the bras and briefs of workers who handle cash and other valuables like jewelry.
          She entered like Twiggy and exited like Dolly:  The "loss should have been spotted sooner"

          Nobody Questioned Why Her Bras Were Twice as Big as She Could Justify
          "Accountant suspected of embezzling school lunch money in Rialto:  Judith Oakes faces the prospect of embezzlement and grand theft charges. As much as $3.16 million might be missing," by Richard Winton, Los Angeles Times, October 4, 2013 ---
          http://www.latimes.com/local/la-me-rialto-lunch-money-20131005,0,3922960.story

          Usually it's the school bully who steals lunch money from the kids.

          But in Rialto, it's allegedly the accountant hired to keep an eye on the lunch money.

          When accountant Judith Oakes was arrested on suspicion of embezzling from the school district's nutrition services department this summer — allegedly caught on surveillance tape stuffing cash in her bra — officials said they were staggered when they were told that as much as $3.16 million might be missing.

          Oakes faces the prospect of embezzlement and grand theft charges, but the fallout from the lunch money episode could continue as law enforcement agencies and the state Department of Education investigate why the loss was not spotted sooner. FOR THE RECORD: Rialto accountant: An article in the Oct. 5 LATExtra edition about the arrest of accountant Judith Oakes on suspicion of embezzling from the Rialto school district's nutrition services department said her late husband had been a school principal in Rialto. He was a principal in San Bernardino. —

          An investigative firm hired by the Rialto Unified School District has so far found a "documented" loss of at least $1.8 million but warned it could reach as high as $3.16 million, including discrepancies that could not be documented. School records go back only to 2005.

          The district's superintendent and his deputy have been placed on leave by the school board.

          "That is money that should have been going to students," said school board Vice President Edgar Montes. "That this betrayal may have been going on for approximately 14 years is disturbing and disgusting."

          Oakes, 49, resigned the day after her arrest Aug. 7 on suspicion of embezzlement and grand theft. A mother of three, Oakes earned $60,000 in her accounting job. Her late husband was a well-respected school principal in Rialto.

          Rialto police Capt. Randy De Anda said Oakes, who had worked for the district 16 years, kept tabs on lunch money for 29 district schools.

          "The lunch money can really add up," he said. "She had unfettered access to enormous sums of money over the years — much of it in cash."

          Continued in article

          Why is this no longer a surprise?
          From the CFO Journal's Morning Ledger on October 1, 2013

          Auditors at big firms cited for more deficiencies
          Auditors at the seven largest U.S. accounting firms
          were cited for deficiencies in 37.5% of audits inspected by U.S. regulators in 2011, Emily Chasan reports. That figure was up from 32.6% in 2010, and has more than doubled from 14.8% in 2009. About 31% of the deficiencies involved auditors’ evaluation of the market prices companies supplied for complex assets, down from about half in the prior year. In previous years, the most common valuation errors were caused by auditors’ failures to understand methods and assumptions used by third-party pricing services. But one in three of those deficiencies uncovered by the 2011 inspections involved failures to test managers’ assertions about the methods and data used to value assets.

          Bob Jensen's updates on professionalism in auditing ---
          http://www.trinity.edu/rjensen/Fraud001c.htm

          Bob Jensen's Fraud Updates since 2002 ---
          http://www.trinity.edu/rjensen/FraudUpdates.htm

          October 10, 2013 reply from Mark Zimbelman

          Bob,

          This article isn't about detecting immaterial fraud it's about taking our current responsibility to provide reasonable assurance to detect material misstatements due to fraud seriously. When the firms take this responsibility seriously they will spend much more than the 1% of their audit effort at it that the article mentions. I've asked groups of practicing auditors from staff to partner if they have "responsibility to detect material misstatement due to fraud" and roughly 50% of them believe they don't. I agree with the premise of the article that the audit profession needs to focus more on this responsibility to detect material misstatements due to fraud. I also do not believe auditors or should be concerned with immaterial fraud.

          Mark Zimbelman

          October 11, 2013 reply from Bob Jensen

          Hi Mark,

          I agree that auditors should not focus heavily on immaterial fraud beyond examining internal control adequacy to help prevent and detect such fraud. One problem, however, is when immaterial fraud each day or each week mounts up to materiality.

          The cash-in-the-bra fraud is an excellent example. Cash lost in one bra full on one day is immaterial. The cash lost in a year's time is probably still immaterial from a financial reporting standpoint although we can't tell without knowing more about the financial statements. But over a decade the bra hauls added up to over $3 million which begins to sound like a material loss to school district.

          Materiality can also be defined in a lot of ways. I recall an AECM message from Denny Beresford showing how the Lehman Bros. repo sales were not material in amount relative to total leverage. However, the fact that Lehman's top executives saw this need for what the media later called repo "debt masking" suggests that the amounts were material to Lehman executives. I think the issue was one of leverage on the margin materiality that may have been more of concern than impact on total leverage.

          But I do agree that the author of the WSJ article was not thinking in terms of bra fulls of cash in companies the size of JP Morgan. A better example is the woman executive at Tiffany & Co. who was recently indicted for pilfering some of the jewelry she took home from sales shows. The loss only amounted to $1 million wholesale which is immaterial on the financial statements.

          The gray zone for auditors becomes how much of the audit is devoted to SOX investigation of internal controls. It was actually Tiffany's internal inventory control system that eventually detected the fraud. A better internal control system would have prevented the fraud. But since she only stole jewelry pieces valued at under $10,000 each, it took the internal control system a lot longer to catch up with her than if she'd only taken one piece worth $1 million.

          What was interesting is that this Tiffany & Co. executive thief was purportedly knowledgeable about the weakness of the internal control system for inventory items valued at under $10,000/

          Certainly an internal control system that allows a woman to daily fill her bra with cash or pilfer lower-valued jewelry is seriously deficient. Over decades the accumulated loss is probably becomes material.

          Bob Jensen

        • Robert E Jensen

          From the CPA Newsletter on July 31, 2014

          Avoid vendor fraud with these steps
          Without proper oversight, it's possible that vendors can be stealing from you in plain sight. Here are tips to avoid fraud from new and existing vendors.
          Corporate Finance Insider (7/2014)
          http://r.smartbrief.com/resp/fWdaBYbWhBCIerwzCidKtxCicNJFYx?format=standard

          Bob Jensen's Fraud Updates ---
          http://www.trinity.edu/rjensen/FraudUpdates.htm

          Bob Jensen's threads on Fraud Reporting ---
          http://www.trinity.edu/rjensen/FraudReporting.htm