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Occupational Fraud is defined as an employee using his or her occupation for personal gain through the deliberate theft or misuse of the assets of the employing organization (see Wells, Joseph T., Occupational Fraud and Abuse, Obsidian Publishing Company, 1997). Business owners, directors of not-for-profit organizations and trustees of employee benefit plans often have misconceptions about occupational fraud and its prevention and, consequently, leave their organization vulnerable to loss. Over the next few weeks we will look at some of these misconceptions and why organizations are not as well protected as they might think. Today’s Topic: Annual Financial Statement Audits.
False Assumptions about your yearly audit
“We have an annual audit by a CPA firm. They will catch any fraud that’s occurring.” If you think your organization is fully protected because you have an annual audit of the financial statements, what percentage of frauds do you suppose are initially uncovered each year by independent auditors? Would you say at least 90%? How about 50%? Do you think it certainly must be at least 20%? According to a survey conducted by the Association of Certified Fraud Examiners (ACFE) in 2008, only about 9% of occupational frauds are initially detected by independent auditors.
When a firm of Certified Public Accountants (CPA) conducts an audit of an organization’s financial statements, they have a responsibility under professional standards to take steps to detect fraud. However, their main objective in an audit is not the detection and prevention of fraud. Their main objective is to determine whether the financial statements are fairly presented in accordance with stated accounting policies so that they will not be misleading to a reader. Steps to detect fraud are only one aspect of an independent financial statement audit. And, while the CPAs conducting the audit may be very good at conducting a financial statement audit, they may not be Certified Fraud Examiners (CFE) and may or may not have received training in the detection and prevention of fraud through forensic auditing.
Financial Statement vs. a Forensic Audit
The standard financial statement audit is far different than a forensic audit or an operational audit. When our CFEs conduct a forensic audit, it is normally designed specifically and primarily to detect the occurrence of fraud. When we conduct an operational audit, it is specifically designed to determine the potential for the occurrence of fraud and provide advice on steps for its prevention. Such audits are far more extensive in their use of anti-fraud procedures and are quite different than the standard financial statement audit.
Resolving the Problem
Does this mean that having an audit by a firm of independent accountants is not useful in deterring occupational fraud in an organization? No, it does not mean that at all. Having an annual audit is one factor in achieving that goal. But the annual audit must be supplemented by other fraud prevention policies and procedures such as strong internal controls, internal audit procedures, employee background checks, hotlines and, occasionally, a forensic audit or operational audit. In short, if your organization’s only protection against occupational fraud and abuse is an annual financial statement audit, your organization is probably far more vulnerable than you realize.
Next Topic: Internal Control
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Last Updated ( Wednesday, 06 May 2009 )
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An on-going problem for both the Securities and Exchange Commission and the Internal Revenue Service is the fraudulent dating of stock options by corporations. By attaching false dates to the granting of stock options, a company may both distort its financial statements, thus misleading investors, and assist in the evasion of income taxes by those who were granted those options.
In April 2009, the SEC filed a complaint against Take-Two Interactive Software, Inc., charging that such a fraudulent dating scheme was perpetrated by Take-Two from 1997 through 2003. In 2007, Take-Two restated prior year financial statements, recording additional expenses of more than $42 million, net of taxes, in connection with option-related compensation.
Without admitting guilt, Take-Two has agreed to settle the case through payment of a $3 million civil penalty. Previously the CEO of Take-Two agreed to pay more than $7 million in disgorgement, interest and penalties related to his role in the scheme.
http://www.sec.gov/litigation/litreleases/2009/lr20982.htm
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Last Updated ( Thursday, 30 April 2009 )
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Each year the Internal Revenue Service announces its “dirty dozen” tax scams, representing twelve of the most prevalent and bothersome fraudulent scams and schemes perpetrated by taxpayers, paid preparers and others.
The IRS recently announced its Dirty Dozen for 2009 and it included hiding income offshore, filing false claims for refunds, taking frivolous positions on tax returns to lower tax liability and misuse of trusts. One of the schemes that has made the Dirty Dozen several times is the Zero Wages Scheme.
Under this scheme, taxpayers submit allegedly “corrected” wage statements indicating that W-2 forms issued by employers were issued in error. These “corrected” W-2 forms, which are generally totally fraudulent, indicate that the taxpayer actually had no taxable wages for the year.
Other Dirty Dozen schemes involve abuse of retirement plans. In these cases, taxpayers attempt to hide taxable distributions from retirement plans or conceal the fact that they have over-contributed to IRA accounts.
The IRS warns that each of these schemes is fraudulent and may subject the perpetrator to significant penalties and even criminal prosecution.
http://communitydispatch.com/IRS_Tax_Tips_30/Beware_of_IRS_2009_Dirty_Dozen_Tax
_Scams10338.shtml
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Last Updated ( Thursday, 30 April 2009 )
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David G. Friehling and his firm Friehling & Horowitz, CPA’s, P.C. have been charged with securities fraud by the Securities and Exchange Commission in connection with audits of the financial statements of Bernard L. Madoff Investment Securities LLC. The SEC charges that from 1991 through 2008, Friehling & Horowitz issued audit reports on the financial statements of Madoff’s company, indicating that the statements were fairly presented in accordance with generally accepted accounting principles, when in reality no legitimate audits had been performed. The SEC further contends that Friehling was aware that the audited financial statements would be filed with the SEC and distributed to investors represented by Madoff.
http://www.sec.gov/litigation/litreleases/2009/lr20959.htm
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ABC News reports that John Pistole, Deputy Director of the FBI, reported to Congress that the FBI has launched undercover investigations in response to the growing number of reports and allegations of fraud in financial institutions. Pistole reported that this is the FBI's attempt to be proactive in discovering fraud involving mortgage lending, securitizations, bankruptcies and other corporate and financial fraud.
http://www.abcnews.go.com/TheLaw/LawPolitics/story?id=7134443&page=1
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CFO.com reports that Lynn Turner, former chief accountant of the Securities and Exchange Commission, credited financial statement auditors for contributing to the general decline in major financial statement frauds since the collapse of Enron and WorldCom. Turner noted that auditors have stood behind fair value and tried to "get the numbers right". At the same time he criticized the Financial Accounting Standards Board for doing an abysmal job in standards setting, particularly with regard to rules on presentation of special purpose entities and off-balance-sheet-items. He also expressed skepticism about the future role of the International Accounting Standards Board noting that the IASB will never be able to develop high quality standards until it stops bending to political pressure.
http://www.cfo.com/article.cfm/13234318/c_13216637?f=home_todayinfinance
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While Bernard Madoff dominates the financial news with his conviction for cheating investors out of billions of dollars by operating a Ponzi scheme, the SEC continues to investigate lesser known advisors who may have mirrored Madoff on a smaller scale. The SEC recently filed charges against John M. Donnelly of Charlottsville, Virginia, accusing him of running a Ponzi scheme that defrauded as many as 31 investors out of $11 million. The SEC alleges that Donnelly sold limited partnership interests in three investment funds while claiming to have produced investment returns as high as 22%. The SEC charges that Donnelly claimed that he produced these great investment returns through trading of securities when in reality he has not made a single trade since 2002. They further allege that Donnelly used investor funds to payoff other investors while taking approximately $1 million for himself in the past three years.
http://www.sec.gov/litigation/litreleases/2009/lr20941.htm
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Last Updated ( Monday, 16 March 2009 )
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Should March be Fraud Awareness Month in the United States? It is in Canada. And, the Financial Consumer Agency of Canada (FCAC) offers some good advice which should be considered year round. The FCAC advises that consumers should not only check bank and credit card statements routinely, but should also order a copy of their credit report at least annually.
http://www.msnbc.msn.com/id/29490762/
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In an interesting case, ten franchisees of the Peaberry's coffee chain based in Denver, Colorado filed suit against Peaberry's claiming that the franchisor concealed material facts and provided false information through public statements. The franchisees claimed that because of this fraud they invested in Peaberry's franchises and lost millions of dollars on franchises that had little chance to succeed. The judge agreed that Peaberry's had concealed material facts and had made misleading public statements, but then ruled in Peaberry's favor. The judge noted that the written franchise agreements contained acknowledgements by the franchisees that they were not relying on any representations outside of those included in the agreements. The judge therefore concluded that the franchisees could not claim damages due to reliance on outside representations such as public statements. The franchisees have appealed the ruling.
http://www.9news.com/money/article.aspx?storyid=111250&catid=344
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Reuters reports that President Obama will ask for a budget increase of 13% for the Securities and Exchange Commission for fiscal year 2010. The increase is intended to improve the Commission's ability to detect fraud, resulting in better protection of investors. It is believed that the proposed budget will also provide increased funds to the Federal Bureau of Investigation to allow for more agents to investigate white collar crime.
http://www.reuters.com/article/politicsNews/idUSTRE51P5RD20090226
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The Financial Industry Regulatory Authority (FINRA), the largest independent regulator for securities firms doing business in the United States, is providing two new online tools for investors. The Scam Meter helps investors determine whether a potential investment may be too good to be true. The Risk Meter helps investors determine whether they share behavioral traits with people who have been found susceptible to fraud. FINRA has also issued an alert called Avoiding Investment Schemes to provide information on commonly used tactics in investment fraud.
http://www.finra.org/Newsroom/NewsReleases/2009/P118028
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Last Updated ( Monday, 02 March 2009 )
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