Prevention and Detection of Fraud

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Prevention and Detection of Fraud

• Presentation by
• Bob JensenTrinity University San Antonio, TX
  78212rjensen_at_trinity.edu
• http//www.trinity.edu/rjensen/

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Prevention and Detection of Fraud

• Bob Jensens main directory to fraud
  linkshttp//www.trinity.edu/rjensen/fraud.htm
• The Enron, Andersen, and Worldcom Scandal Modules
  --- http//www.trinity.edu/rjensen/FraudEnron.htm
   
• Bob Jensen's Enron Quiz (and answers) ---
  http//www.trinity.edu/rjensen/FraudEnronQuiz.htm
  

November 16, 2005 in Trinidad
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Prevention and Detection of Fraud

• Cooking the Books --- http//www.trinity.edu/rjens
  en/fraud001.htmCooking
• Fraud Updates and Other Updates to the Accounting
  and Finance Scandals --- http//www.trinity.e
  du/rjensen/FraudUpdates.htm 
• Rotten to the Core  Mutual Fund, Investment
  Banking Scandals, and Security Analysis Frauds
  --- http//www.trinity.edu/rjensen/FraudRotten.ht
  m 

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Prevention and Detection of Fraud

• Future of Auditing --- http//www.trinity.edu/rje
  nsen/FraudConclusion.htmFutureOfAuditing
• Fraud Detection and Reporting ---
  http//www.trinity.edu/rjensen/FraudReporting.htm
  
• American History of Fraud ---  http//www.trinity
  .edu/rjensen/415wp/AmericanHistoryOfFraud.htm
• Accounting Humor http//www.trinity.edu/rjensen
  /fraud001.htmHumor
• Selected Scandals in the Largest Remaining Public
  Accounting Firms --- http//www.trinity.edu/rjense
  n/fraud001.htmothers

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Prevention and Detection of Fraud

• The Andersen, Enron, and WorldCom Scandals -
  http//www.trinity.edu/rjensen/FraudEnron.htm
•  The Saga of Auditor Professionalism and
  Independence - http//www.trinity.edu/rjensen/frau
  d001.htmProfessionalism
• Risk-Based Auditing Under Attack  ---
  http//www.trinity.edu/rjensen/fraud001.htmRiskBa
  sedAuditing  
• What's Right and What's Wrong With (SPEs), SPVs,
  and VIEs --- http//www.trinity.edu/rjensen//theo
  ry/00overview/speOverview.htm

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Good News

• Globally Networked Databases and Online Financial
  Reporting and Enterprise Resource
  Planning (ERP) Installations for Smaller
  Enterprises
• Dawning of the Age of XBRL
• Dawning of the Age of Continuous Auditing and
  Auditbots
• Dawning of Age of Customized Reporting and
  Aggregations
• Dawning of the Age of P2P File Sharing

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Good News

• Harmonization of Accounting Standards Is a More
  Serious Goal
• New Spirit of Reform and Ethics Awareness
• Expansion of Assurance Services
• Some Things Do Get Better Under Threatening
  Litigation Storm Clouds (There are signs
  that the Sarbanes Oxley legislation is working
  --- 500 companies, including Kodak, find
  internal control deficiencies)
• Lifelong Learning Alternatives in the Age of
  Distance Education

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Bad News

• Systemic Accounting Problems That Cannot
• ( or Otherwise Will Not Likely) Be Solved
• Systemic Problem  All Aggregations Combine
  Different Measurements With Varying Accuracies
• Systemic Problem  All Aggregations Leave Out
  Important Components
• Systemic Problem  All Aggregations Ignore
  Complex Synergistic Interactions of Value and
  Risk
• Systemic Problem  Disaggregating of Value or
  Cost is Generally Arbitrary
• Systemic Problem  Systems Are Too Fragile
• Systemic Problem  More Rules Do Not Necessarily
  Make Accounting for Performance More Transparent
• Systemic Problem  Economies of Scale vs.
  Consulting Red Herrings in Auditing
• Systemic Problem  Intangibles Are Intractable

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Bad News

• White Collar Crime Pays Big Even If You Get
  Caught
• Profitable Looting in the Capital Markets 
• Crime Keeps on Paying
• Debate Topic  Punishing the Many for Crimes of a
  Few  
• Accounting Education Shares Some of the Blame
• Accounting Tricks and Creative Accounting  

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Bad News

Outrageous Executive Compensation Schemes
That Reward Failure and Fraud Corporate Boards
and the SEC Will Not Solve Corporate
Governance the Crisis Incompetent and Corrupt
Audits are Routine (Clients give a grade
C-) Whistle Blowing is Not Rewarded
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Bad News

Cost Cutting Pressures Create Moral Hazards
Computer Security is Becoming More Fragile
in the Age of Electronic Warfare Collision
of Security and Privacy and Freedom Criteria
Investment Banking and Security Analysis
Professions Are Rotten to the Core
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Bad News

Dawning of the Age of Unaccountable Contracting
Failed Education Systems In the Early Years
Leave Weak Foundations to Build Upon Media
Coverage is Very, Very Good and Very, Very Bad
From Enron to Earnings Reports CPA
Career Passed Away The Three Cs of Fraudulent
Financial Reporting (Warning Signs) Will public
accounting audit services survive? Insurance
Versus Assurance?
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Enhancing Auditors Capabilities to Detect
Fraud  EY Faculty Connection Fall 2005

We should use major fraud cases to teach
accounting principles throughout our curriculum.
Students will understand accounting principles
better when they see how they have been abused.
For example, the difference between assets and
expenses can be effectively taught using
WorldCom. (Steve Albrecht) We can
teach a dedicated fraud course where students
learn why and how fraud is committedand how to
prevent, detect and investigate fraud. (Steve
Albrecht) In our classes, we should
use pedagogical tools such as inquiry, data
mining and brainstorming that our students will
be using as professionals to detect fraud. (Steve
Albrecht)
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Joint IASB-FASB Projects

From Paul Pacter's (Deloitte ) site on
international accounting on October 29, 2005 ---
http//www.iasplus.com/index.htm We have
updated the following agenda project pages to
reflect discussions at the joint IASB-FASB
meeting on 24-25 October 2005 in Norwalk, CT,
USA Conceptual Framework Financial
Instruments Performance Reporting
Revenue Recognition Short-term Convergence
- IAS 12 Income Taxes Bob Jensen's threads on
accounting standard setting are at
http//www.trinity.edu/rjensen//theory/00overview
/theory01.htm
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Key Reform Measures and Events

AICPA Launches Web Site to Promote Audit Quality
--- http//cpcaf.aicpa.org/  PCAOB Audit
Inspections Were Tough!!! Audits focus more on
fraud under SAS 99 The Sarbanes-Oxley regulation
requires that all CEOs must sign off on the
validityof the transactions EU 8th Directive
may require audit firm rotation
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ACCOUNTING FOR DERIVATIVES

• Bob Jensen's threads on Enron are at
  http//www.trinity.edu/rjensen/fraud.htm 
• Bob Jensen's threads on Derivative Financial
  Instruments Fraud are at http//www.trinity.edu/rj
  ensen/FraudRotten.htmDerivativesFrauds 
• Also note http//www.trinity.edu/rjensen/Fraud.htm
  FrankPartnoyTestimony 
• How Enron Used SPEs and Derivatives Jointly is
  Explained at http//www.trinity.edu/rjensen//theor
  y/00overview/speOverview.htm
•  
• Bob Jensens threads on derivatives accounting
  are at  http//www.trinity.edu/rjensen/caseans/000
  index.htm

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Frank Partnoys Works

• Of all the many documents and books that I have
  read about derivative financial instruments, the
  most important have been the books and documents
  written by Frank Partnoy. Some of his books are
  listed at the bottom of this message.

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Frank Partnoys Works

• The single most important document is his Senate
  Testimony. More than any other single thing that
  I've ever read about the Enron disaster, this
  testimony explains what happened at Enron and
  what danger lurks in the entire world from
  continued unregulated OTC markets in derivatives.
  I think this document should be required reading
  for every business and economics student in the
  world. Perhaps it should be required reading for
  every student in the world. Among other things it
  says a great deal about human greed and behavior
  that pump up the bubble of excesses in government
  and private enterprise that destroy the
  efficiency and effectiveness of what would
  otherwise be the best economic system ever
  designed.

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Frank Partnoys Works

• Testimony of Frank Partnoy Professor of Law,
  University of San Diego School of Law Hearings
  before the United States Senate Committee on
  Governmental Affairs, January 24, 2002 ---
  http//www.senate.gov/gov_affairs/012402partnoy.h
  tm

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Frank Partnoys Works

•  
• FIASCO The Inside Story of a Wall Street Trader
• FIASCO Blood in the Water on Wall Street
• FIASCO  Blut an den weißen Westen der Wall
  Street Broker.
• FIASCO Guns, Booze and Bloodlust the Truth
  About High Finance
• Infectious Greed How Deceit and Risk Corrupted
  the Financial Markets
• Codicia Contagiosa
• His other publications include the following
  highlight
• "The Siskel and Ebert of Financial Matters Two
  Thumbs Down for the Credit Reporting Agencies"
  (Washington University Law Quarterly)

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REASONS FOR NEW STANDARDS
Undisclosed Assets and LiabilitiesUnbooked
Assets and LiabilitiesMeaningless Measures of
Value Risk Rise in Scandals in the 1980s
1990sComplex Frauds --- Partnoys
Fiasco Explosion of Swap Contracts Evolution
Toward Fair Value Accounting
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PROBLEMS WITH NEW STANDARDS
Complex Contracts Technical Jargon Complex
Scoping of Coverage --- NPNS Complex Hedge
Accounting RulesMany Derivatives Are Difficult
to Value Difficult to Find Embedded
DerivativesComplex Effectiveness Testing
Rules Continuous Stream --- DIG,
Amendments Implementation Failures --- Freddie
Mac, etc. Held-to-Maturity Interim
DistortionsHedge Acctg. Denied to Most Macro
Hedges
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Differences Between StandardsFAS 133 vs. IAS 39
vs. CICA 13
Differences are relatively minor Links to Major
Differences http//www.trinity.edu/rjensen/caseans
/canada.htm
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PwC Corporate Crime Survey 2003http//www.trinity
.edu/rjensen/FraudCorporateCrimeReport2003.pdfPer
centage of Increase Between 2001 and 2003
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KPMG Fraud Survey 2003http//www.messageaware.com
/BeAware/Compliancy/KPMG20Fraud20Report.pdf
Percentage of Increase Between 2002 and 2003
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KPMG Fraud Survey 2003http//www.messageaware.com
/BeAware/Compliancy/KPMG20Fraud20Report.pdf
Percentage of Increase Between 2002 and 2003
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KPMG Fraud Survey 2003http//www.messageaware.com
/BeAware/Compliancy/KPMG20Fraud20Report.pdf
Percentage of Increase Between 1998 and 2003
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PwC Corporate Crime Survey 2003http//www.trinity
.edu/rjensen/FraudCorporateCrimeReport2003.pdfPer
centage of Respondents Reporting Frauds to Survey
in 2003
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PwC Corporate Crime Survey 2003http//www.trinity
.edu/rjensen/FraudCorporateCrimeReport2003.pdfPer
centage of Respondents Reporting Types of Crime
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PwC Corporate Crime Survey 2003http//www.trinity
.edu/rjensen/FraudCorporateCrimeReport2003.pdfPer
centage of Respondents Reporting Crime Losses
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PwC Corporate Crime Survey 2003http//www.trinity
.edu/rjensen/FraudCorporateCrimeReport2003.pdfPer
centage of Respondents Reporting Detection
Successes
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PwC Corporate Crime Survey 2003http//www.trinity
.edu/rjensen/FraudCorporateCrimeReport2003.pdfPer
centage of Respondents Corrective Policies and
Measures
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KPMG Fraud Survey 2003http//www.messageaware.com
/BeAware/Compliancy/KPMG20Fraud20Report.pdf
Methods of Uncovering Fraud
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KPMG Fraud Survey 2003http//www.messageaware.com
/BeAware/Compliancy/KPMG20Fraud20Report.pdf
Factors Contributing to Fraud
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Association of Certified Fraud Examiners Fraud
Prevention and Detection Resources

• Association of Certified Fraud Examiners ---
  http//www.acfe.com/home.asp
• In particular note the Code of Business Ethics
  and Conduct ---  http//www.acfe.com/documents/cod
  e_of_business_ethics.pdf
• Fraud Resources Center --- http//www.acfe.com/fra
  ud/fraud.asp Fraud Prevention Check-Up ---
  http//www.acfe.com/fraud/check.asp Fraud
  Prevention CD-ROM --- http//www.acfe.com/fraud/cd
  .asp How to Prevent Small Business Fraud ---
  http//www.acfe.com/documents/smallbusinessfraudex
  cerpt.pdf Other Downloads --- http//www.acfe.com
  /fraud/downloads.asp
• Also note the explosion of salaries of Certified
  Fraud Examiners --- http//www.acfe.com/documents
  /2005comp-guide.pdf CFE Career Center
  http//www.acfe.com/career/career.asp

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Theft of Assets --- http//www.acfe.com/documents/
smallbusinessfraudexcerpt.pdf

• Cash skimming and larceny (off-book fraud)
• Unrecorded sales (onsite and remote)
• Off-hours sales
• Mailroom theft (checks, rebates)
• Cash deposit lapping
• Deposits in transit
• Cash round-off
• Casino-style trickery

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Theft of Assets --- http//www.acfe.com/documents/
smallbusinessfraudexcerpt.pdf

• Skimming receivables
• Forcing account balances
• Unauthorized write-offs
• Debits to aging or fictitious accounts
• Receivables lapping (kiting)
• Stolen statements

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Theft of Assets --- http//www.acfe.com/documents/
smallbusinessfraudexcerpt.pdf

• Inventory theft
• Crime partners checking out at cash register
• Out the back door
• Declaring good merchandise unrepairable
• Replacing good parts with new parts

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Types of Asset Theft Schemes Factors
Contributing to Fraud

• Expense account fraud
• Credit card fraud
• Payroll fraud (FAMU)
• Workers Compensation fraud
• Conflicts of interest (family friends
  consulting)
• Kickbacks
• Financial and tax reporting fraud

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Enron Quiz Question 1

• What is the main temptation of white collar
  criminals?
• There will be white collar crime as long as it
  pays bigeven when caught
• Whistle blowers not rewarded 
• Why do auditors often lose professionalism?

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Main Lessons Learned From Enron http//www.citize
nworks.org/corp/reforms.php

• CRACK DOWN ON CORPORATE CRIME
• 1. Force Corporate Crooks to Pay it Back2.
  Toughen the Punishments for Corporate Crooks and
  Crooked Corporations 3. Increase the
  Corporate Crime Investigation and
  Prosecution Budget. 4. Track the Cost and Extent
  of Corporate Crime 5. Punish the Aiders and
  Abettors of Corporate Crime6. Crack Down on
  International Corporate Bribery.

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Main Lessons Learned From Enron http//www.citize
nworks.org/corp/reforms.php

• PROTECT WORKERS AND INVESTORS
• 1. Strengthen Pension Protections 2. Expand
  Whistleblower Protections 3. Protect the Rights
  of Shareholders 4. Curb CEO Pay 5. Expand
  Disclosure Standards 6. Stop Corporate Tax
  Dodgers

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Main Lessons Learned From Enron http//www.citize
nworks.org/corp/reforms.php

• ROLL BACK THE TIDE OF DEREGULATION
• 1. Reverse Electricity Deregulation 2.
  Regulate OTC Derivatives 3. Protect Main Street
  From Wall Street

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Main Lessons Learned From Enron http//www.citize
nworks.org/corp/reforms.php

• REDUCE EXCESSIVE CORPORATE POWER AND INFLUENCE
  OVER GOVERNMENT
• 1. Cut Corporate Welfare 2. Slow the
  Revolving Door Between Business and
  Government 3. Create a Public Interest
  Counterweight to the Corporate Lobbyists 4.
  Get Corporations out of Elections 5. Restore
  Direct Citizen Control over Corporations
  Through Their Charters6. End Corporate
  Personhood

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Main Lessons Learned From Enron http//www.citize
nworks.org/corp/reforms.php

• Restore audit quality (analytics vs. detail
  testing)
• Restore competence to audit committees
• Independent corporate boards
• Restore reasonable compensation controls
• Eliminate golden parachutes
• Improve audit reviews and inspections
• Prison terms correlated with amounts stolen
• Tough internal controls and independent auditing
• Reward whistleblowers

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Main Lessons Learned From Enron http//www.citize
nworks.org/corp/reforms.php

• Rotate auditors and possibly audit firms
• Ethics tone at the top
• Up experience requirements for auditors
• Up training and technical skills
• More skills in derivatives, VIEs, re-insurance,
  leasing
• More skills in detecting earnings managment
• More computer systems skills
• More centralized controls of local offices
• Competency over customer relations back slapping

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