Lessons Learned from Fraud Cases

1
Lessons Learned from Fraud Cases

• Can Better International Accounting and Auditing
  Standards Mitigate Fraud?
• Professor Paul Sheldon Foote
• California State University, Fullerton
• ACCOUNTING ACADEMICIANS COLLABORATION
  FOUNDATION
• MUHASEBE ÖGRETIM ÜYELERI BILIM VE DAYANISMA VAKFI
• 4th International Accounting Conference,
  Istanbul, Turkey

2
PricewaterhouseCoopers

• Global Economic Crime Survey, 2007 Turkey Report
• Larger frauds 3.9 million average
• Turkish fraudsters 31 to 40 year old males,
  high school educated, less than 5 years on job
• Only 21 of 105 companies brought criminal
  charges.

3
SmarTalk TeleServices Fraud

• 2003 PwC agreed to pay SEC 1 million for
  improper professional conduct
• Approved 25 million restructuring reserve to
  reduce expenses
• Revised, corrected, or discarded audit work papers

4
KPMG

• Typical fraudster long-time employee, top
  management, acting alone, many frauds, over many
  years, large amounts
• Whistle blowers catch far more than internal
  controls
• Theft, fraudulent financial reports,
  embezzlement, kickbacks

5
KPMG Xerox Audit Fraud

• 2003 SEC charged KPMG with fraud in Xerox
  audits (1997- 2000)
• KPMG approval of accounting errors inflated
  revenues by 3 billion and pre-tax earnings by
  1.2 billion

6
Deloitte

• Financial institutions
• External organized crime rings, sophisticated
  threats
• Internal financial fraud increased 19
• Disaster recovery Business Continuity Management
  (BCM)

7
Adelphia Sued Deloitte

• 2002 disclosed 2.3 billion off-balance-sheet
  debt, declared bankruptcy
• November 2002 Adelphia Communications
  Corporation sued Deloitte Touche for
  professional negligence, breach of contract,
  fraud and other wrongful conduct.

8
Ernst Young

• 20 of respondents would not invest in some
  countries because of fraud risk, especially
  bribes and kickbacks.
• The move towards International Financial
  Reporting Standards (IFRS) will drive changes to
  accounting practices, particularly in emerging
  market countries. Where these standards
  negatively impact financial results, the risk of
  financial statement fraud may increase.

9
Manhattan Investment Fund

• Phony financial statements certified by Deloitte
  (Bermuda, a tax haven) hiding 300 million short
  sale losses of 400 million hedge fund
• Ernst Young (Bermuda) fund administrator
• Settled with investors, 2001

10
Association of Certified Fraud Examiners (ACFE)

• According to research conducted by the
  Association of Certified Fraud Examiners (ACFE),
  U.S. organizations lose an estimated 5 percent of
  annual revenues to fraud. Based on the estimated
  U.S. Gross Domestic Product for 2006 13.037
  trillion this percentage indicates a staggering
  estimate of losses around 638 billion among
  organizations, despite increased emphasis on
  anti-fraud controls and recent legislation to
  combat fraud.

11
United States Army, Vietnam

• Army lieutenant, 1968 -1969
• False Claims Act (1863) because American
  government fails to prosecute many fraud cases
• Qui Tam provision 15 25 of recoveries to
  whistleblowers

12
Iraq War (2003 present)

• Ali Allawi, nephew of Ahmad Chalabi and my
  Harvard Business School classmate, has written a
  book describing massive fraud cases in the Iraq
  War. A single fraud case involved 1 billion.

13
War Fraud Lessons

• Massive increases in fraud and corruption
• Whistleblower (informer) system is weak
• Vietnam War military draft
• Iraq War all volunteers more private
  contractors than American military service
  members
• Corporate media can distract voters from
  important issues

14
Citibank--Lebanon

• 1972 Of more than 200 employees, few Muslim
  employees
• Foreign exchange trader frauds resulted in
  millions of dollars of losses in branches
  including Lebanon, Holland (The Netherlands),
  and in Hong Kong.

15
CitibankLebanon Lessons

• Not hiring based upon merit leads to incompetent
  work and audits and to fraud.
• Management training program included only one
  week of reading about and observing foreign
  exchange trading.
• Employees understand quickly that most managers
  are untrained and unfit to serve as managers.

16
Citibank--India

• 1972-1974 Reserve Bank of India (central bank)
  policy on bank auditor rotation
• Reserve Bank of India and Citibanks
  international internal audit team could find only
  10 of internal control failures.

17
CitibankIndia Lessons

• 2007 Reserve Bank of India and Institute of
  Chartered Accountants of India (ICAI), having
  failed to mandate audit firm rotation, are
  attempting to mandate audit partner rotation
  every 7 years.
• External auditors and international internal
  audit teams cannot find most fraud.
• If there is fraud in one activity, there is
  likely to be fraud in other activities.

18
Singer Sewing Machine--Turkey

• 1974 Store Manager fraudfictitious deposits,
  non-Singer repair parts
• Singer accountant in Istanbul reported concerns
  to marketing manager.
• Store Manager fled from Turkey.

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SingerTurkey-- Lessons

• Even accountants who understand internal control
  procedures might permit personal, political, or
  cultural considerations to be more important that
  fraud losses.

20
Singer Sewing Machine--Lebanon

• Nearly all employees were Christians
• Employees reported to me that they were paying
  10 of their salaries each month to Lebanese
  officer who had hired them.
• Incompetent employees

21
Singer Sewing Machine--Morocco

• Moroccan government fine for bad accounting
• Paying all employees in cash
• Accounting employees with high school bookkeeping
  or no training

22
SingerMorocco--Lessons

• In spite of a French general manager with a
  business school degree, accountants were copying
  from marketing reports.
• Imposition of voucher system revealed fake
  monthly reports to New York.
• Imposition of imprest payroll account revealed
  illegal workers using false names.

23
Gulf Investment Services (GIS)

• 1998 fraud audit in Muscat, Sultanate of Oman

24
GISErnst Young

• Following financial audits, Ernst Young did not
  detect any fraud.

25
GISBest Brokerage

• GIS first brokerage company in Oman to receive
  the coveted "Best Brokerage" award instituted by
  the Muscat Securities Market

26
GISISO 9002 Certification

• GIS first to be an ISO 9002 certified financial
  services company in Oman
• 1998 ISO representative had no clue there were
  frauds at GIS.

27
GISAndersen Consulting

• GIS used a special software system developed by
  Andersen Consulting (now Accenture) able to serve
  speakers of Arabic and English.
• System default all users can access entire
  system!

28
GIS--Omanization

• Since 1988, Oman has had a policy of Omanization,
  an attempt to increase percentage of Omani
  workers.
• GIS employees India, Jordan, United Kingdom,
  Oman

29
GIS--Fraud

• Focus of my fraud audit fraud involving British
  and Omani collaborators
• Collaborators included a manager with internal
  audit experience and an accountant with a CPA.

30
If you discover one fraud

• Like discovering a cockroach, if you discover one
  fraud in an organization, there are likely to be
  other frauds.
• Sometimes, you discover frauds your client or
  employer did not want you to discover.