http://www.tampabaycfe.org

August 2004

COSO Study on Fraud in Financial Reporting - Principle Findings

The Committee of Sponsoring Organizations of the Treadway Commission (COSO) sponsored the study, Fraudulent Financial Reporting: 1987-1997. The study provides a comprehensive analysis of fraudulent financial reporting occurrences investigated by the SEC since the issuance of the 1987 Report of the National Commission on Fraudulent Financial Reporting (the “Treadway Commission” Report).

Several key findings can be generalized from COSO's detailed analysis of its sample of approximately 200 financial statement fraud cases. These findings are grouped into five categories describing the nature of the companies involved, the nature of the control environment, the nature of the frauds, issues related to the external auditor, and the consequences to the company and the individuals allegedly involved.

Nature of Companies Involved

• Relative to public registrants, companies committing financial statement fraud were relatively small. The typical size of most of the sample companies ranged well below $100 million in total assets in the year preceding the fraud period. Most companies (78 percent of the sample) were not listed on the New York or American Stock Exchanges.

• Some companies committing the fraud were experiencing net losses or were in close to break-even positions in periods before the fraud. Pressures of financial strain or distress may have provided incentives for fraudulent activities for some fraud companies. The lowest quartile of companies indicate that they were in a net loss position, and the median company had net income of only $175,000 in the year preceding the first year of the fraud period. Some companies were experiencing downward trends in net income in periods preceding the first fraud period, while other companies were experiencing upward trends in net income. Thus, the subsequent frauds may have been designed to reverse downward spirals for some companies and to preserve upward trends for other companies.

Nature of the Control Environment (Top Management and the Board)

• Top senior executives were frequently involved. In 72 percent of the cases, the AAERs named the chief executive officer (CEO), and in 43 percent the chief financial officer (CFO) was associated with the financial statement fraud. When considered together, in 83 percent of the cases, the AAERs named either or both the CEO or CFO as being associated with the financial statement fraud. Other individuals named in several AAERs include controllers, chief operating officers, other senior vice presidents, and board members.

• Most audit committees only met about once a year or the company had no audit committee. Audit committees of the fraud companies generally met only once per year. Twenty- five percent of the companies did not have an audit committee. Most audit committee members (65 percent) did not appear to be certified in accounting or have current or prior work experience in key accounting or finance positions.

• Boards of directors were dominated by insiders and “grey” directors with significant equity ownership and apparently little experience serving as directors of other companies. Approximately 60 percent of the directors were insiders or “grey” directors (i.e., outsiders with special ties to the company or management). Collectively, the directors and officers owned nearly 1/3 of the companies’ stock, with the CEO/President personally owning about 17 percent. Nearly 40 percent of the boards had not one director who served as an outside or grey director on another company’s board.

• Family relationships among directors and / or officers were fairly common, as were individuals who apparently had significant power. In nearly 40 percent of the companies, the proxy provided evidence of family relationships among the directors and / or officers. The founder and current CEO were the same person or the original CEO / President was still in place in nearly half of the companies. In over 20 percent of the companies, there was evidence of officers holding incompatible job functions (e.g., CEO and CFO).

Nature of the Frauds

• Cumulative amounts of frauds were relatively large in light of the relatively small sizes of the companies involved. The average financial statement misstatement or misappropriation of assets was $25 million and the median was $4.1 million. While the average company had assets totaling $533 million, the median company had total assets of only $16 million.

• Most frauds were not isolated to a single fiscal period. Most frauds overlapped at least two fiscal periods, frequently involving both quarterly and annual financial statements. The average fraud period extended over 23.7 months, with the median fraud period extending 21 months. Only 14 percent of the sample companies engaged in a fraud involving fewer than twelve months.

• Typical financial statement fraud techniques involved the overstatement of revenues and assets. Over half the frauds involved overstating revenues by recording revenues prematurely or fictitiously. Many of those revenue frauds only affected transactions recorded right at period end (i.e., quarter end or year end). About half the frauds also involved overstating assets by understating allowances for receivables, overstating the value of inventory, property, plant and equipment and other tangible assets, and recording assets that did not exist.

Issues Related to the External Auditor

• All sizes of audit firms were associated with companies committing financial statement frauds. Fifty-six percent of the sample fraud companies were audited by a Big Eight/Six auditor during the fraud period, and 44 percent were audited by non-Big Eight/Six auditors.

• All types of audit reports were issued during the fraud period. A majority of the audit reports (55 percent) issued in the last year of the fraud period contained unqualified opinions. The remaining 45 percent of the audit reports issued in the last year of the fraud departed from the standard unqualified auditor’s report because they addressed issues related to the auditor’s substantial doubt about going concern, litigation and other uncertainties, changes in accounting principles, and changes in auditors between fiscal years comparatively reported. Three percent of the audit reports were qualified due to a GAAP departure during the fraud period.

• Financial statement fraud occasionally implicated the external auditor. Auditors were explicitly named in the AAERs for 56 of the 195 fraud cases (29 percent) where AAERs explicitly named individuals. They were named for either alleged involvement in the fraud (30 of 56 cases) or for negligent auditing (26 of 56 cases). Most of the auditors explicitly named in an AAER (46 of 56) were non-Big Eight/Six auditors.

• Some companies changed auditors during the fraud period. Just over 25 percent of the companies changed auditors during the time-frame beginning with the last clean financial statement period and ending with the last fraud financial statement period. A majority of the auditor changes occurred during the fraud period (e.g., two auditors were associated with the fraud period) and a majority involved changes from one non-Big Eight/Six auditor to another non-Big Eight/Six auditor.

• Severe consequences awaited companies committing fraud. Consequences of financial statement fraud to the company often include bankruptcy, significant changes in ownership, and delisting by national exchanges, in addition to financial penalties imposed. A large number of the sample firms (over 50 percent) were bankrupt/defunct or experienced a significant change in ownership following disclosure of the fraud. Twenty-one percent of the companies were delisted by a national stock exchange.

• Consequences associated with financial statement fraud were severe for individuals allegedly involved. Individual senior executives were subject to class action legal suits and SEC actions that resulted in financial penalties to the executives personally. A significant number of individuals were terminated or forced to resign from their executive positions. However, relatively few individuals explicitly admitted guilt or eventually served prison sentences.

TRAINING

Association of Certified Fraud Examiners

"Financial Statement Fraud"

CPE Credits: 16
November 4-5, 2004 at the Holiday Inn Tampa near Busch Gardens
(813) 971-4710
Hotel Cut-off Date: 10/5/2004
Early Registration Cut-off Date: 10/04/2004 

Tampa Bay Chapter

Chapter dinner meetings are a great way to network while enjoying a meal. At $15, it is also an easy and affordable way to obtain an hour of CPE.

Dinner Meetings

September 14, 2004
Cancelled due to Ivan

October 19, 2004
"Medicaid Fraud"

January 11, 2005
"Mail Fraud"

February 8, 2005
"T.B.A."

March 8, 2005
"T.B.A."

April 12, 2005
"T.B.A."

6th Annual Fraud & Computer Crimes Seminar

May 10 - 11, 2005
FDLE Headquarters
4211 N. Lois Avenue
Tampa, Florida 33614

2004 - 2005
OFFICERS &
DIRECTORS

PRESIDENT
Penny Borjas, CFE, CIA
TriCenturion
(727) 786-8840 x15718

VICE PRESIDENT
Steve Hooper, CIA, CFE, CCSA
Clerk of the Circuit Court
Hillsborough County, FL
(813) 276-2029 x7648

SECRETARY
Roland Rodriguez, CFE, CBA
Bank of America
(813) 224-5211

TREASURER
Laura Krueger Brock, CFE, CPA
Cherry, Bekaert, Holland, LLP
(727) 822-8811

DIRECTOR
Mark Dubina, CFE
Florida Department of
Law Enforcement
(813) 878-7366

DIRECTOR
Ellen Wilcox, CFE
Florida Department of
Law Enforcement
(727) 298-2482

CHAPTER TRAINING
Wayne Boytim, CFE
City of Tampa
Internal Audit
(813) 274-7167

JOIN THE TAMPA BAY CHAPTER

Membership in the Tampa Bay Chapter costs only $20 to $25. There are four categories of members: CFE, ACFE Associate, Chapter Affiliate and Student. For more info, visit our web site.

ADVERTISE YOUR BUSINESS or JOB OPPORTUNITY

We have two pages of our web site devoted to publicizing members' businesses and career opportunities. If you are interested in advertising with us, visit the pages to see what is offered and send your copy to TampaCFE@ TampaBayCFE.org.

Why Financial Statement Fraud is Committed

False financial statements are used to make a company's earnings look better on paper. False statements sometimes cover up the embezzlement of company funds. Financial statement fraud occurs through a variety of methods, such as valuation judgments and fine points of timing the recording of transactions. These more subtle types of fraud are often dismissed as either mistakes or errors in judgment and estimation. Some of the more common reasons why people commit financial statement fraud include:

• To encourage investment through the sale of stock
• To demonstrate increased earnings per share or partnership profit interests, thus allowing increased dividend and distribution payouts
• To dispel negative market perceptions
• To obtain financing, or to obtain more favorable terms on existing financing
• To receive higher purchase prices for acquisitions
• To demonstrate compliance with financing covenants
• To meet company goals and objectives
• To receive performance-related bonuses

Source: Fraud Examination for Managers and Auditors, Jack C. Robertson, PhD, CPA, CFE, http://www.jsrsys.com/fema/ 

Chapter News

Outstanding Achievement in Outreach/Community Service

Board of Regent, Bruce Dean, awarded Tampa Bay Chapter member, Wayne Boytim with the 2004 Achievement Award for Outreach & Community Service at the 15th Annual Fraud Conference in Las Vegas. The Association of Certified Fraud Examiners believes strongly that members should be active members of their community and committed to helping improve the quality of life where they live and work.

Four New Certified Fraud Examiners

Tampa Bay Chapter Associates, Steve Hooper, Internal Auditor, Clerk of the Circuit Court, Hillsborough County, Robert Stewart, Supervisor, Internal Audit - Americas, Jacqueline Maltry, Owner, Jacqueline R. Maltry, LLC, and Dan Katsiyiannis, OMB Administrator, City of Pinellas Park, FL, recently passed the Certified Fraud Examiner exam. Steve is also the Tampa Bay Chapter's current vice-president. Congratulations to all of you.

ACFE Examination Prep Course

The reduced rate ACFE examination Prep Course offer is still available. The offer is 25% off the member rate for the course and $100 off the exam fee. The exam fee is not payable until the certification test is applied for. Using the offer, the Prep course would cost $536 and the exam fee $150.

There is a minimum of 5 individuals on the application list for the course before the ACFE will honor it. The Prep Course is the best study guide to prepare for the CFE certification test. Our four new CFE’s (Jacqueline Maltry, Robert Stewart, Dan Katsiyiannis and Steve Hooper) used Prep Course to prepare for the examination and all passed on the first attempt. The ACFE will not commit to how long the offer will be available. If certification is on your mind, it would be wise to act promptly to take advantage of it. Contact Wayne Boytim, Chapter Training Director, for more information.

Fraud Information and Articles

Visit the ACFE's new online resource for fraud articles and information. You will find a wealth of information about your most pressing fraud-related topics. There are FOUR easy ways to find the information you seek. You may choose a category to view articles related to that subject, do a keyword search to find information related to a specific area of interest, search by article date or search alphabetically. Please note that some articles are only available to members of the ACFE. Access to these articles will require your Members Only user name and password.

Access the new online database of fraud-related articles covering topics A-Z by visiting: Fraud Information & Articles

Fraud Costs, Detection Increase

Toby Bishop, ACFE president & CEO, interprets 2004 Report to the Nation statistics for Business Travel News. Use the following link to the article: Fraud Costs, Detection Increase

Dinner Meeting News

September 14th Dinner Meeting

Mark Kolman, CFE, will be our first speaker this year. Mark is a General Audit Manager at the Clerk of the Circuit Court, Hillsborough County. Mark's topic will be "Auditing for Financial Fraud." Mark is a recognized instructor on training auditors, accountants and business groups in fraud issues. Since 1984, he has designed and presented courses on auditing and fraud for professional and business organizations.

Mark's experience includes private accounting as a chief accountant, public accounting, non-profit and governmental auditing and audit supervision for large entities within the agricultural, financial services and utility industries.  He has supervised risk-based audits that facilitated fraud detection and prevention, risk mitigation, and corporate and regulatory compliance for a Fortune 500 utility with energy, telecommunication, and logistical service subdivisions. In this capacity, he served as an additional resource for his corporation's security and investigations department and performed work assignments with that group. These experiences have given him analytical and detection skills relating to defalcation schemes, contractor fraud, embezzlements, kickbacks and misappropriation of funds and other assets.

Presentation Overview

When Certified Public Accountants talk about fraud, they are concerned with two main issues, the misappropriation of assets and fraudulent financial reporting. CPAs, other auditors and government regulators have been highly criticized for not detecting fraud or for not properly handling fraud when they have found it.

During this session we will talk about:

• Some of the reasons fraud goes undetected or detected but not reported.
• Detection best practices 
• Developing the top exposures to fraudulent financial reporting 
• Factors contributing to fraud and what to do about them 

The dinner meeting will be held at the Park Plaza Tampa Airport Westshore, located at 5303 West Kennedy Blvd., 11th Floor. The hotel is just west of Westshore Plaza on the north side of Kennedy Blvd. Evenings will begin with a social at 6:00 P.M., followed by a buffet dinner at 6:30 and a presentation at 7:00. The Board of Directors is pleased to announce that the price for one hour of continuing professional education and the dinner buffet will remain only $15 during our 2004 - 2005 meeting season.

To make your reservation, please use the following link Chapter Meeting Reservation and complete the form at the bottom of the page.  You can also make your reservation by emailing Wayne Boytim or calling him at (813) 274-7167 by the Friday before the meeting date. Reservations will be accepted after that date and walk-ups are always welcome. Please remember that cancellations are accepted up to the afternoon of the meeting. No shows will be billed after the second missed meeting. Please help us keep our costs down by letting us know if you are unable to attend.

Four Steps to Prevent Financial Statement Fraud

1. Conduct fraud vulnerability reviews and implement hotlines that both insiders and sources outside the company can use to report fraudulent activities. Establish a whistle-blowing policy and turn to forensic accounting techniques when appropriate.

2. Use "gamesmanship reviews" to assess top managers' philosophies, attitudes, operating styles and ethical values related to the financial reporting process. Also, Rezaee suggests, conduct a "continuous review of management's financial reporting relationships with analysts, internal auditors, external auditors, the board of directors and the audit committee."

3. Implement a fraud-prevention program by establishing appropriate policies and procedures, communicating them to everyone within the organization, enforcing compliance, and periodically assessing the program's effectiveness in preventing and detecting financial statement fraud.

4. Follow the SEC's enforcement procedures by creating severe penalties for cooking the books. From top executives to line employees, everyone should understand that financial statement fraud is a crime that the company will prosecute. Those involved in fraud should be dismissed, and their stock options or bonuses should be canceled.

Although most fraud still goes undetected and unreported, regulators are turning up the heat on publicly traded companies to improve governance policies and the financial reporting process. The investing public is calling for the heads of senior executives of companies that perpetrate fraud. The old refrain "Where were the auditors?" is morphing into "Where were the executives?"

Source: From article originally printed in the November 2002 issue of Business Finance.

Red Flags of Financial Statement Fraud

The 1999 COSO study said that recognizing fictitious revenues was the most popular method of committing fraud and accounted for over one-half of the schemes in its analysis.  Fictitious sales can occur from false journal entries, false sales to existing customers and false sales to nonexistent customers.  Management fraud can often be detected by interviewing senior staff members and recently departed employees.  A simple question should be addressed to them: Do you suspect anyone in management who might be committing fraud or secretly stealing from the company?

Certain clues or red flags may suggest to a forensic accountant or investor that a company is engaging in financial shenanigans.

Earnings problem.  One of the most significant red flags is a downward trend in earnings.  Companies are required to disclose earnings for the last three years in the income statement, so do not just look at last year’s net income.

Reduced cash flow.  To a certain extent, management can exploit GAAP to produce the appearance of increased earnings.  Some popular shenanigans include booking sales on long-term contracts before the customer has paid up, delaying the recording of expenses (e.g., in 1998, 1999 and 2000 Xerox improperly used a $100 million reserve to offset related expenses), failing to recognize the obsolescence of inventory as an expense, and reducing advertising and research and development expenditures.  You can use the cash flow statement that firms are required to report to check the reliability of earnings.  If net income is moving up while cash flow from operations is drifting downward, something may be wrong.  (Over time, cash from operations should roughly parallel the changes in net income.)

Excessive debt.  Crucial to determining if a company can weather difficult times is the debt factor.  Companies burdened by too much debt lack the financial flexibility to respond to crises and to take advantage of opportunities.  Small companies with heavy debt are particularly vulnerable in economic downturns.  Professionals should pay special attention to a company’s debt-to-equity ratio, the total debt to stockholders’ or owners’ equity.  While the optimum ratio varies from industry to industry, the amount of stockholders’ or owners’ equity should significantly exceed the amount of debt.  This information is available on the balance sheet.

Overstated inventories and receivables.  Look at the ratio of accounts receivables to sales and the ratio of inventory to cost of goods sold.  If accounts receivables exceeds 15 percent of annual sales and inventory exceeds 25 percent of cost of goods sold, be careful.  If customers are not paying their bills and/or the company is saddled with aging merchandise, problems will eventually arise.  Overstated inventories and receivables are often at the heart of corporate fraud, resulting in future declines in profits.  As significant as the ratios are, trends over time are also important.  Although there may be good reasons for a company to have bloated or increasing inventory or receivables, it is important to determine if the condition is a symptom of financial difficulty.

Inventory plugging.  Inventory fraud is an easy way to produce instant earnings and improve the balance sheet.  Crazy Eddie, an electronic equipment retailer, allegedly recorded sales to other chains as if they were retail sales (rather than wholesale sales).

Balancing act.  Inventory, sales and receivables usually move in tandem because customers do not pay up front if they can avoid it.  Neither inventory nor accounts receivable should grow much faster than sales.  [For example, in 2000, Purchase Pro’s accounts receivable soared $13.2 million to $23.4 million, while its revenue during the same period was only $17.3 million.]  Furthermore, inventory normally moves in tandem with accounts payable since a healthy company does not often pay cash at the delivery dock as purchases are received.

CPA Switching.  Auditor switching and the financial condition of a company are correlated to a certain extent.  Firms in the midst of financial distress switch auditors more frequently than healthy companies.

Hyped Sales.  According to court documents, CEO Emanuel Pinez at Centennial used a form of trickery rarely seen:  He hyped sales by using his ample personal fortune to fund purchases.  “Any auditor would have had a hard time catching that,” says William Coyne, an accounting professor at Babson College.  Centennial Director John J. Shields, a former CEO of Computervision Corp., says in an affidavit that Pinez admitted to him that he altered inventory tags and recorded sales on products that were never shipped.  Pinez’s lawyer says that he is innocent.

Reducing Expenses.  In 2001, Rent-Way disclosed that their CEO had artificially reduced the company’s expenses--a reduction of $127 million.  Hiding or reducing many expenses, from automobile maintenance to insurance payments, accomplished the $127 million reduction.  The stock plummeted 72 percent, from $23.44 to $6.50.

Off-Balance Sheet Items. Enron had more than 880 offshore accounts and some special purpose entities. Enron created and capitalized four special purpose entities (SPEs) by issuing its own stock in exchange for about $800 million of notes receivables (thereby increasing shareholder equity by $800 million). GAAP requires such notes receivables to be presented as a reduction in shareholders’ equity (and not an asset). (EITF) SPEs are especially troublesome when a company officer is in charge and the company is engaging in transactions with the entities. Has the company given some sort of guarantee to the SPE?

Unconsolidated Entities. Apparently Enron did not tell Arthur Andersen that certain limited partnerships did not have enough outside equity and more than $700 million in debt should have been included on Enron’s statements. This oversight caused more than a $400 million reduction in prior period earnings.

Source: “The Accounting Profession and Financial Statement Fraud,” D. Larry Crumbley, CPA, Cr. FA and Nicholas Apostolou, CPA, Cr. FA; Forensic Examiner Jan/Feb 2003, Vol. 12 Numbers 1 & 2

A Message from our President

Well I guess the summer is officially over. And what a summer it was with the passing of President Ronald Regan, the victory of Lance Armstrong, and the devastation of Charley. It is hard to get back into the swing of things, but I guess it is time.

Before we look ahead at the coming year, I would like to acknowledge some of the accomplishments of our Chapter members over the summer.

• Congratulations to, Robert Stewart, Jacqueline Maltry, Dan Katsiyiannis and our Chapter Vice President, Steve Hooper. They are now CFEs. Good Job!!

• Our own Wayne Boytim received the 2004 award for Outstanding Achievement in Outreach/Community Service during the annual ACFE conference in Las Vegas and for a short while his mug shot was on National’s website. Way to go Wayne!

Next, let me extend a warm welcome to our latest Organizational Members. Six Detectives of the Polk County Sheriff's Office just joined the Tampa Bay Chapter. I look forward to meeting all of you.

The Board came together in June to discuss the activities for the coming year and some awesome ideas were suggested. We will bring you up to speed on our thoughts over the course of our dinner meetings throughout the year. So please come out for a night of tasty food, good company, and stimulating conversation.

See ya September 14^th.

Penny