Shaila Cullum - Corporate Fraud

Shaila Cullum

Professor Parsons

College Writing II

9 December 2010

Corporate Fraud

            Fraud has affected the economy greatly in the past, causing the creation of new laws and organizations in hopes of putting a stop to this crime. Fraud cases can small, as in asset misappropriation, or large, as in financial statement fraud. When fraud occurs within big companies it can cause their downfall, leading them to fall into bankruptcy. Fraud has been occurring on a larger scale in the past ten years, and new laws and organizations have been made in order to prevent fraud from happening within the U.S.          

Fraud is still a problem in the business world today and causes many people to question who they can trust. If employees don’t know if they can trust their boss with the company’s finances, who can they really trust? Fraud is an ongoing problem even though companies use many processes and check lists to prevent it. Many people find a way around the rules so laws, organizations, and even good accountants need to be at the top of their game to keep fraud at bay. Organizations are continuing their processes to detect fraud because it is an ongoing problem, technology is advancing and increasing the ways fraud can occur, and many businesses have been greatly affected by fraud.

            What is considered fraud in today’s society? Fraud, according to the legal dictionary, is a false representation of a matter of fact—whether by words or by conduct, by false or misleading allegations, or by concealment of what should have been disclosed—that deceives and is intended to deceive another so that the individual will act upon it to her or his legal injury. Three basic fraud types are asset misappropriation, bribery and corruption, and financial statement fraud. Most of the big fraud cases made public today are financial statement frauds, although they are the least common type of fraud.

            Asset misappropriation fraud involves third parties or employees in an organization who abuse their position to steal from it through fraudulent activity (Action Fraud). Asset misappropriation is the most common type of fraud; people hear it many times in the news from small businesses, or organizations, up to larger companies. Sometimes asset misappropriation can go on for long periods of time if finances are not properly monitored. When a business only has one accountant, they are the only ones that deal with where the money goes on the books. Many businesses trust that the money is going into the businesses bank account, but what they don’t know is that sometimes it goes into the accountant’s pocket. When only one person is dealing with the finances, how else would anyone know the money is being handled properly?

            Many businesses now have multiple accountants to check each other, or they have someone to watch over and make sure the money is going where it belongs. Asset misappropriations are commonly detected through employee monitoring, either via direct supervision by managers, or through indirect methods such as internal controls like segregation of duties, account reconciliation, and independent verification of data. A few tips on how to monitor, detect, and prevent asset misappropriation are: accounts to monitor the flow of cash, monitor employees, examine documentation, job rotation, surprise audits, security, and independent verification (Coenen).

            Bribery and corruption offences relate to the improper influencing of people in positions of trust (Hussey). Often people will find that many bribes are occurring through international business. Other countries are not as advanced as America, and any money offered to them will be taken advantage of. When an American company offers money to a country in order to let them do business that may be illegal in America, the country often allows it.

A recent study by Berlin-based Transparency International pegged 70 of 102 countries surveyed as likely places for executives to be hit up for bribes. TI's "Corruption Perception Index" incorporates data from surveys, polls and other ratings on the number of bribe requests perceived by business people who regularly conduct business in a given country. A score of 10 means people perceive that bribe requests are never made in a particular nation, while a zero indicates the perception that bribes are always requested.

In the 2002 index, Finland scored a 9.7, the United Kingdom came in at 8.7 and the U.S. earned a 7.7. With 70 of 102 countries scoring 5.0 or lower, however, the index shows that business people believe bribe requests are likely to be made in more than two-thirds of the nations examined. These countries include some of the world's biggest: China, which scored 3.5; India, 2.7; Indonesia, 1.9; and Pakistan, 2.6. Bangladesh had the lowest score of 1.2 (Knowledge@Wharton).

            Financial statement fraud is when a public company puts together a financial statement for the public; it wants to portray itself in the best possible light. That has led to fraudulent statements that have misled investors and others (Herrfeldt).

While most infrequent, it is this last category, financial statement fraud, that should receive the most attention from public company managers because it is by far the most expensive, in terms of both absolute dollars and long-term damage. According to the same ACFE report, the median loss of a fraudulent statement incident was $2 million, compared with $375,000 and $150,000 for corruption and asset misappropriation, respectively. When taking into account the loss of investor confidence, as well as reputational damage and potential fines and criminal actions, it is clear why financial misstatements should be every manager’s worst fraud-related nightmare (Ernst & Young).

Some of the most well-known cases of fraud are financial statement fraud cases and in some large companies which are perceived as a top company.

            One of the most well-known financial scandals today is the Enron scandal which involved Kenneth Lay and Jeffery Skilling. The company was a natural gas corporation and turned into an energy giant. It was estimated to be worth $68 million, but the financial statements were all based off of bad accounting practices and many losses of assets went unrecorded.

The six-week trial in Houston federal court stemmed from Enron's 1999 sale to Merrill of a $7 million stake in three energy-generating barges. Prosecutors said that the deal was a disguised loan because Enron promised to pay Merrill back and that the energy trader committed fraud when it booked the loan as a $12 million profit so it could meet earnings estimates (Calkins).

Kenneth Lay died of a heart attack before he could be convicted, and Jeffery Skilling received over twenty-four years in prison. There were many others that were accused and tried, but Lay and Skilling were the two that were be given the longest sentences.

            Another famous financial scandal is from the company WorldCom. WorldCom hid some expenses for long periods of time and tricked many people into believing they were doing very well around the recession that occurred in 2001. WorldCom, along with Enron, the very same year brought the SEC (Securities and Exchange Commission) to believe changes did need to be made.

The SEC said WorldCom had committed "accounting improprieties of unprecedented magnitude" -- proof, it said, of the need for reform in the regulation of corporate accounting.

To finance that reform, the House voted overwhelmingly Wednesday to authorize a 77 percent boost in the SEC's budget, raising it to $776 million for the fiscal year beginning October first (Chartier).

WorldCom CEO Bernie Ebbers was sentenced to twenty-five years in prison after the misstatements on WorldCom’s financial records. There is also evidence that Ebbers took out almost $370 million dollars in a personal loan from the company.

The chart shows the stock price of WorldCom and how low it became after the investigation was announced.

            Tyco International Ltd. Seemed to be a promising company and the CEO, Dennis Kozlowski, was even named one of the top 25 corporate managers of 2001. Who would have thought that four years later, the same man would be sentenced to prison for eight to twenty-five years? It was said that Kozlowski bought outlandish décor for his apartment with money from the company.

Tyco International is a diversified manufacturer that had a big ambition in the late 1990s: to become the next General Electric. And the fast-growing conglomerate was well on its way until its top executives were engulfed in accounting scandals, ultimately facing a white-collar criminal prosecution that came to symbolize an era of corporate greed.

That case culminated in June 2005 in the convictions of L. Dennis Kozlowski, the former chief executive, and his top lieutenant, Mark H. Swartz, on fraud, conspiracy and grand larceny charges. A Manhattan jury said the two men had defrauded shareholders of more than $400 million (Romero, and Atlas).

            Adelphia, once considered a reliable cable company, was put under investigation for very extensive fraud. The case included John Rigas, and three of his sons; Timothy Rigas, Michael Rigas, and James Rigas. The case also involved two executives; James Brown, and Michael Mulcahey. The Adelphia fraud case seemed to be done out of pure greed and was conducted by falsifying documents, misrepresentations, and misleading financial statements. Money was taken from Adelphia in order to pay personal Rigas family loans.

In the SEC’s complaint, the Commission charges that Adelphia, at the direction of the individual defendants: (1) fraudulently excluded billions of dollars in liabilities from its consolidated financial statements by hiding them on the books of off-balance sheet affiliates; (2) falsified operations statistics and inflated earnings to meet Wall Street's expectations; and (3) concealed rampant self-dealing by the Rigas Family, including the undisclosed use of corporate funds for Rigas Family stock purchases and the acquisition of luxury condominiums in New York and elsewhere. Also today, the United States Attorney's Office for the Southern District of New York filed related criminal charges against several of the same defendants (Securities and Exchange Commission).

John and Timothy Rigas could face up to thirty years in prison and the attorney general of the case even said the Adelphia fraud could be considered even bigger than the Enron fraud.

             Enron and WorldCom are just two of the cases that lead to the creation of The Sarbanes-Oxley Act, named after Senator Paul Sarbanes and Representative Michael Oxley, who created it (Sarbanes, and Oxley). It has eleven titles, which are often called sections. The Act was put into action in July of 2002 after the many financial scandals that occurred in 2002. The Sarbanes-Oxley Act was made to prevent fraud and also to protect the people that revealed the fraud. There have been many added items to help prevent fraud and to make sure companies are doing everything they can to detect any fraud that may occur. Since fraud occurs from some of the people at the top of the company, Sarbanes-Oxley added some check lists to make sure the finances are all set straight.

Fraud is most frequently perpetrated by senior executives in a company. According to a Wall Street Journal (July 8 th 2002), 70% of corporate frauds involved the CEO. The losses incurred were much lower, when an employee was involved instead of a senior executive of a company, by a factor of nearly fifteen. In the past, chief executives could override any dissent within a company to escape the consequences of their crimes.

Sarbanes Oxley has strengthened the hands of audit committees within the boards to ensure that report any management override. Fraud is also often reflected in unusual journal entries often at the time of close of accounts. Sarbanes Oxley Act, under its Section 404, requires reporting on control systems and their internal auditing so that shareholders know whether the company has the processes to detect such fraudulent activities (Sarbanes Oxley Compliance).

It is important to have certain deadlines for financial statements so companies cannot add revenue they have not actually earned yet. The Sarbanes-Oxley Act has added a step for many accountants to go through, but it is a very beneficial step for all businesses and companies.

            Another procedure to prevent fraud, GAAP, (Generally Accepted Accounting Principles) is the basic set of rules used in today’s accounting system. GAAP began because of the Great Depression.  

Many companies and businesses went bankrupt.  Upon closer examination and further scrutiny, it was discovered that these companies were not healthy, profitable companies.  The reported profits and healthy operations were bookkeeping tricks, and that basically, their financial statements were lies.  This was one of the lowest points in history for accountants (Money Instructor).

Many of these tricks are now prevented because GAAP tells people what they may still consider an asset to their company and other things they may need to get rid of and write off as waste. Although many businesses do not like to see items in inventory go to waste, sometimes there is no choice because the inventory is old and obsolete. The rules may not prevent every trick in the book accountants have, but it can prevent companies from making their business look like a palace when it is really a dungeon.

            FASB (Financial Accounting Standards Board) was created to create rules and regulations for accountants to go by and follow while creating financial statements. FASB creates standards for financial accounting and continues to improve them today.

The mission of the FASB is to establish and improve standards of financial accounting and reporting that foster financial reporting by nongovernmental entities that provides decision-useful information to investors and other users of financial reports. That mission is accomplished through a comprehensive and independent process that encourages broad participation, objectively considers all stakeholder views, and is subject to oversight by the Financial Accounting Foundation’s Board of Trustees (Financial Accounting Standards Advisory Board).

The SEC (Securities and Exchange Commission) was created to make sure financial statements are available to investors, the general public, employees, the stock market, etc. They also make sure that the information is not only available, but correct as well. This is why investors can find financial information on companies, because companies must disclose certain financial information to the public. The SEC believes investors and the public have the right to see how a company is doing in case of a future investment or because they are already investing in it. Why would anyone want to invest in a company they may know nothing about? Wouldn’t they want to make sure they are investing in a good company? “The mission of the U.S. Securities and Exchange Commission is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation” (Securities and Exchange Commission).

Currently, there are too many different financial systems. It would be much easier for countries to combine the rules they feel are most important and create some international accounting rules. The world will be coming to this sooner than later, there is an International Accounting Standards group that is working to create an internationally accepted way to do financial accounting. For these rules to come into play, they must allow a few alternative practices, be clearly stated, be comprehensive, be an effective system, provide full understandability, and be of high quality (Kieso, Weygrandt, and Warfield 1356-1361). Differences between the United States GAAP and the International GAAP (also known as iGAAP) are slowly being changed. In the future, the world will be able to communicate through financial statements from one country to another with no problem, and with international business always occurring and growing, this advancement is important.

Fraud is always going to occur. Even with all of the items available to prevent and detect it, someone will find a way to get around the new technology and rules. In order to continue preventing fraud, rules need to keep being added and employees need to be properly educated about fraud and how to detect it. There will always be someone pressuring someone else to do the wrong thing, even if they do not realize right away that it is wrong. The business world is always about making money and the pressure on some people in the finance department may prove to be too much. They may find themselves behind bars like a few others from the past.

            Prevention acts need to keep changing with the times, as well as the technology and knowledge with it. Classes need to cover these problems whether it is in an ethics class or in specific business classes. These problems will arise, but hopefully not as often as they did in 2002. The business world needs to be ready to try and stay a step ahead of those that are willing to do something they know is wrong in order to benefit themselves, family, or even the company. If it is ethically wrong, then there should not be a question of a doubt in their mind. It may be hard to distinguish whether some choices are ethical or not, but if it could be seen as unethical, it might be considered so. There are so many resources available now for anyone to research their dilemma and resolve any issues, so there is no excuse for unethical decisions.

            As technology advances so will knowledge, and if knowledge increases, rules and monitoring will have to increase as well. The business world must keep advancing along with everything else in the world. If advancements in our monitoring, rules, checks, and audits keep up with the rest of the technological advancements, there may be a way to keep preventing fraud in today’s business world. Businesses need to be educated, stay aware, and keep watching.

Works Cited

Action, Fraud. "Asset Misappropriation Fraud." Types of Fraud. Crown, 2010. Web. 30 Nov 2010. <http://www.actionfraud.org.uk/fraud_protection/asset_misappropriation>.

Calkins, Laurel. "Enron Fraud Trial Ends in 5 Convictions." The Washiington Post. Washington Post Company, 4 Nov 2004. Web. 8 Dec 2010. <http://www.washingtonpost.com/wp-dyn/articles/A23034-2004Nov3.html>.

Chartier, John. "Accounting fraud rising." CNN Money. Cable News Network, 11 Jan 2002. Web. 3 Dec 2010. <http://money.cnn.com/2002/01/11/companies/acct_scandals/>.

Coenen, Tracy. "Asset Misappropriation." Essentials of Corporate Fraud. John Wiley & Sons, Mar 2008. Web. 28 Nov 2010. <http://www.fraudessentials.com/index.php?option=com_content&view=article&id=8&Itemid=10>.

Ernst & Young, . "Detecting Financial Statement Fraud: What every manager needs to know." Ernst & Young LLP, n.d. Web. 8 Dec 2010. <http://www.ch.ey.com/Publication/vwLUAssets/Detecting_financial_statement_fraud:_what_every_manager_needs_to_know/$FILE/Industry_Oil_and_Gas_Detecting_financial_statement_fraud.pdf>.

Financial Accounting Standards Advisory Board, . "Generally Accepted Accounting Principles." FASAB. N.p., n.d. Web. 1 Dec 2010. <http://www.fasab.gov/accepted.html>.

Herrfeldt, Bill. "What Is Financial Statement Fraud?." eHow. eHow Inc., n.d. Web. 4 Dec 2010. <http://www.ehow.com/about_5061193_financial-statement-fraud.html>.

Hill, Gerald, and Kathleen Hill. "Fraud Legal Definition." Free Dictionary. N.p., n.d. Web. 1 Dec 2010. <http://legal-dictionary.thefreedictionary.com/fraud>.

Hussey, R. "A Dictionary of Accounting." High Beam Research. N.p., 1 Jan 1999. Web. 3 Dec 2010. <http://www.highbeam.com/doc/1O17-briberyandcorruption.html>.

Kieso, Donald, Jerry Weygandt, Terry Warfield. "Intermediate Accounting." Anna Melhorn. John Wiley & Sons, 2010. Print.

Knowledge@Wharton, . "How Bribery and Other Types of Corruption Threaten the Global Marketplace." Business Ethics. N.p., 23 Oct 2002. Web. 7 Dec 2010. <http://knowledge.wharton.upenn.edu/article.cfm?articleid=646>.

Money Instructor, . "Basic Accounting: What is GAAP?." MoneyInstructor.com. N.p., n.d. Web. 6 Dec 2010. <http://www.moneyinstructor.com/art/gaap.asp>.

Romero, Simon, and Riva Atlas. "WORLDCOM'S COLLAPSE: THE OVERVIEW; WORLDCOM FILES FOR BANKRUPTCY; LARGEST U.S. CASE." WORLDCOM'S COLLAPSE: THE OVERVIEW. The New York Times Company, 22 Jul 2002. Web. 5 Dec 2010. <http://www.nytimes.com/2002/07/22/us/worldcom-s-collapse-the-overview-worldcom-files-for-bankruptcy-largest-us-case.html>.

Sarbanes Oxley Compliance, . "Corporate Fraud." Sarbanes Oxley Informed Corporate Governance. N.p., n.d. Web. 1 Dec 2010. <http://www.sarbanes-oxley-compliance.us/edge/fraud.php>.

Sarbanes, Paul, and Michael Oxley. "The Sarbanes-Oxley Act Summary." A guide to the Sarbanes-Oxley Act. N.p., n.d. Web. 8 Dec 2010. <http://www.soxlaw.com/introduction.htm>.

Securities and Exchange Commission, . "SEC Charges Adelphia and Rigas Family With Massive Financial Fraud." U.S. Securities and Exchange Commission. SEC, 24 Jul 2002. Web. 2 Dec 2010. <http://www.sec.gov/news/press/2002-110.htm>.