January 28, 2012

Posts Comments

Solyndra: Financial Statement Fraud Revealed

October 5, 2011 By Sheila Leave a Comment

The FBI is investigating the now defunct Solyndra in connection with allegations of financial statement fraud.  Solyndra, which received over $500 million in government loans from the Department of Energy (DOE) as part of the stimulus package. When Solyndra filed bankruptcy at the end of August 2011, the government realized that Solyndra was not as healthy as it had presented itself in financial statements submitted to obtain and then renew government financing.

The primary focus of the financial statement fraud investigation for the moment is allegations of inflated sales backlog presented to the DOE to secure financing.  Regulators are also looking into allegations of corruption on the part of senior executive, who for the moment are asserting their fifth amendment rights and refusing to answer questions on bonus awarded to senior executives.

The Solyndra bankruptcy sheds a harsh light on government oversight of stimulus money.  Several red flags were overlooked when Solyndra’s financing was renewed at the end of 2010, including:

  • Ballooning inventory, specifically raw materials.  From the 2009 financial statements, the last set made available to the public, Solyndra reported an increase in inventory in the period between January and October 2009 from $3 million to $11 million.  Perhaps most concerning, finished goods inventory during that period was stagnant remaining in the $650,000-700,000 range.  While raw materials grew from $2 million to $9 million. One would hope that a DOE official would have asked by the cause for the increase in raw materials.  Reports that Solyndra suffered from unproven automated manufacturing process that ultimately failed, leaving an excess volume of raw materials.  To add to Solyndra’s problems, the built-to-suit manufacturing equipment was ultimately scrapped. In spite of all of this, Solyndra invested (taxpayer money) in building a second factory while inventory ballooned.
  • Revenue recognition was also suspect.  In Solyndra’s 2009 public filing, it defined its revenue recognition policy as recognized when “persuasive.”  Such loose terminology does not approach the preferred standards of transfer of ownership and minimal rights to return.
  • Sales backlog: if product sales required a deposit, the liability for customer deposit would grow.  An area investigators are likely to look at is the handling of such deposits to be sure advances were appropriately recorded as deferred revenue (a liability) rather than sales revenue.

In spite of these red flags and mounting operating losses and cash deficits, the DOE doubled down on its bet by agreeing to continue helping Solyndra going as far as to accept a secondary creditor position to new any money received after Dec. 2010 intended to save Solyndra.  The FBI investigation joins Congressional hearings set to explore the extent of fraud perpetrated by senior executives of Solyndra.

 

Filed Under: Uncategorized, Waste and Abuse Tagged With: , , , ,

It’s a New Day: Board Directors Must Devote Adequate Resources to Address Fraud

July 25, 2011 By Sheila Leave a Comment

As originally published at ACFE Insights:

James Murdoch, News Corporation’s deputy chief operating officer, found his career implode shortly after his testimony in front of Parliament was disputed by two high-level News Corp. executives. According to the executives, Murdoch knew that the hacking was a more pervasive problem as early as 2008. Perjury aside, the corporate governance concern has to be the lack of adequate investigation and response employed by Murdoch. Rather than launching a full investigation into the hacking as he had claimed, News Corp. underwrote only two limited-scope investigations. The first in 2006 was a preliminary investigation in the wake of the reporter’s arrest. The second investigation, supposedly more expansive, took place in 2007 in response to a wrongful termination lawsuit by the shady reporter; that investigation involved questions focused on just five staffers related to the terminated reporter.

Lack of adequate investigation into suspected fraud has been at the center of other recent board director woes; specifically, infoGroup Inc. and DHB Industries. For infoGroup, audit committee chairperson Vasant Raval was prosecuted for inadequately investigating fraud. In response to allegations of self-dealing by the CEO, Raval conducted a one-man investigation that lasted just 12 days. According to reports, the audit committee chairman did not look into the CEO’s expenses. With DHB Industries, the SEC charged three ex-directors who served on DHB Industries Inc.’s audit committee for being “willfully blind to numerous red flags” of fraud.

The SEC has come out and said that it does not wish to concern the majority of hard-working board directors: ”We will not second-guess the good-faith efforts of directors. But in stark contrast, Krantz, Chasin and Nadelman were [DHB Industries] directors and audit committee members who repeatedly turned a blind eye to warning signs of fraud and other misconduct by company officers,” said Robert Khuzami, director of the SEC’s Division of Enforcement.

What can be learned from these recent scandals involving News Corporation, infoGroup Inc. and DHB Industries is that board directors and audit committee members must be strident in their investigations into allegations of fraud and devote adequate resources to address fraud, known and unknown.

 

Filed Under: Board Directors, Fraud Deterrence Tagged With: , , , , , , ,

News of the World: ‘Everybody is Doing It’ is Not a Defense

July 20, 2011 By Sheila Leave a Comment

As originally published at ACFE Insights:

At the center of the News of the World scandal is the premise that violating the law is okay as long as it’s done consistently throughout the industry. To wit, as a rising star in tabloid journalism, Rebekah Brooks (then known as Rebekah Wade) stated to investigators in 2003 that she was sure that “we have paid the police for information in the past.”Upon further inquiry about specifics, Brooks declined to comment, implying that while she did not know of any specific bribes, she was indeed aware that payments to law enforcement were prevalent in the tabloid industry.

Even if we were to believe that Brooks did not know of any specific bribes, her statement in 2003 indicates that she was savvy enough about the tabloid journalism industry to know that juicy tidbits often come at a price. As Brooks ascended the, ranks in News of the World, one would reasonably assume that she knew darn well the origins of salacious details that would later bubble up from her staff that are at the center of the current hacking scandal.

Brooks has been arrested, without charges filed at the moment, and has resigned. Aside from the outcome of Brooks individually, the higher lesson of the News of the World case is that tone at the top dictates the course of an organization. News of the World follows in the embarrassing footsteps of other organizations that have previously enjoyed the public trust, specifically Hewlett-Packard and Berkshire Hathaway.

In the case of HP, board chairman Patricia Dunn worked through intermediaries to obtain phone recordings of other HP board members and nine journalists. This scandal was the first of many blunders HP shareholders had to endure, including the misguided ‘leadership’ of Carly Fiorina who questioned the very premise of the honored and revered ‘Bill and Dave Way’ that made HP a legend and, later, the ethical violations attributed to the now-departed Mark Hurd.

As for Berkshire Hathaway, this corporate scandal involved the use of insider information by heir-apparent David Sokol. While Warren Buffett had specifically prohibited the practice of inner circle management proposing investment in a particular company for which a senior staffer had an existing or imminent financial interest, Sokol just couldn’t help himself. He went right ahead and bought a stake in Lubrizol prior to Berkshire Hathaway taking a $9 billion stake in the company. While Sokol’s actions were shameful, Buffett took a share of the blame in the public eye when he was less than forthcoming in initial press dealings as to the reasons for Sokol’s unexpected departure.

Left unchecked, poor ethical practices are likely to recur in organizations that have suffered at least one ethical breach. As such, Rupert Murdoch must be tireless in the coming days, weeks and months to assert affirmative control over the ethical leadership of his many other enterprises to ensure that such shameful events do not recur.

 

Filed Under: Board Directors, Fraud Deterrence Tagged With: , , , , , , , ,

COVERING THE BASES: RISK ASSESSMENT & LEGAL ISSUES

July 11, 2011 By Sheila Leave a Comment

An excerpt from a presentation given at the ACFE 2011 Fraud Conference, San Diego, California (full text available at link):

AT A CROSSROADS: HOW RISK MANAGEMENT CAN SAVE CAPITALISM

Overview

The economic meltdown of late 2008, as well as repeated cycles of fraud, exorbitant compensation, and excessive risk-taking, took many by surprise and hurt millions. The United States, and indeed much of the world, is at a historical crossroad. While the opportunity, motives, and rationale to commit fraud will always exist, this seminar will put forth long-term solutions to effectively mitigate the risks leading to individual and widespread corporate failures. Corporate governance reform, including an effective fraud risk management program, serves an important role in addressing government regulations, including FCPA, Patriot Act, SOX, and Federal Sentencing Guidelines. Additionally, fraud risk management and other corporate governance reforms will help restore public trust, avoid SEC scrutiny, and help protect directors’ rights to receive benefits under D&O Insurance.  What’s Needed? Corporate Governance Reform  B1Corporate governance reform, including fraud risk management, is the job of all stakeholders. Key stakeholders include internal audit, management, board members, and employees.

Filed Under: Board Directors, Waste and Abuse

Found: Proof the Good Guys Finish First

July 11, 2011 By Sheila Leave a Comment

As originally published at ACFE Insights:

Growing evidence makes it clear that doing the wrong thing will cost companies dearly both in the marketplace and with law enforcement. Recent news shows that fraudulent business practices are bad for business. To wit,

At the same time, evidence is mounting that companies that do the right thing enjoy considerably higher returns. As reported by the Ethisphere Insitute, companies that qualified for the ‘ethics index’ outperformed the S&P 500 before, during and after the economic crisis of 2008.

Such data provides the necessary ammunition in the fight against fraud, starting with cultivating an ethical work environment. Techniques and strategies may vary among ethical companies; there are a handful of tenets, however, common to all ethical companies. Those tenets include:

  • Free information flow to board: organizations should strive to have their top compliance officer designated as a C-suite position. Board directors should ensure that direct lines of communication exist for the top compliance officer.
  • Anonymous reporting mechanisms:  Anonymous tips are the leading detection tool for fraud, with the 2010 Report to the Nations on Occupational Fraud and Abuse reporting that 40 percent of frauds are initially detected through tips.
  • Leadership by example: Employees watch top management very closely. When top management does not exemplify the highest ethical standards such conduct plants the seeds of rationalization for committing fraud.
  • Enforce superb ethics policies: Non-enforcement of known violations or inconsistent, seemingly surreptitious enforcement of company policies breeds confusion and possibly discontent strong enough to fuel rationalization for committing fraud.
  • Inspired training programs: Orientation and ongoing training programs educate, empower and motivate the workforce to report fraud.
  • Alignment of incentives with organizations values and goals: ‘buy-in’ mechanisms such as stock options and bonus pools can benefit organizations by reducing conflicts between personal gains and corporate success. However, incentives can illicit dysfunctional business processes and financial statement fraud. Organizations should look for ways to use incentives to reward acts of integrity as well as revenue-generating business activity.

As shown by the Ethisphere’s report that shows higher returns for ethical companies, creating a culture of shared success can help organizations reach both their economic and ethical goals. Add to that the penalties for fraudulent behavior dispensed by both law enforcement and the marketplace, it is clear that good guys do indeed finish first.

 

Filed Under: Fraud Deterrence, Waste and Abuse

Fool Me Once, Shame on You; Fool Me Twice…

July 11, 2011 By Sheila Leave a Comment

As published originally at ACFE Insights:

Lousy Tone at the Top Breeds Fraud

Pamrapo Savings Bank of New Jersey first made headlines last March when pleading guilty to conspiracy to commit Bank Secrecy Act (BSA) violations and forfeiting $5 million. Pamrapo admitted it had willfully violated the BSA to avoid the expenses associated with compliance (those pesky compliance expenses). It concealed its customers’ illegal or suspicious activities by failing to file Currency Transaction Reports (CTRs) and Suspicious Activity Reports (SARs) and willfully failed to maintain adequate anti-money laundering programs.

Per Assistant Attorney General Lanny A. Breuer, DOJ Criminal Division, “This case is a good example of how disregarding reporting and compliance can turn into a crime. [The] guilty plea by Pamrapo Savings Bank should remind financial institutions, large and small across the country, of the high price they will pay for ignoring the law.” Read the full article here.

Well, perhaps the DOJ enforcement action did remind other financial institutions of the importance of ethical business practices, but unfortunately for Pamrapo Savings Bank, the lessons were quickly forgotten. Within a year of the DOJ settlement, a Pamrapo Savings Bank affiliate, Pamrapo Service Corporation, was in the news when a former managing director embezzled more than $600,000 in commissions and was convicted of 33 counts of mail fraud.

Lousy tone-at-the-top was definitely the culprit with the Pamrapo Service Corporation embezzlement, with the ill-gotten gains in the form of ‘commissions’ approved by the bank founder and fraud perpetrator’s father. The ‘commission’ compensation arrangement was developed when the son went to the father seeking additional income in response to a pay cut.  The ‘commissions’ were deemed fraudulent because: (a) the commissions represented a change in accounting treatment for ongoing business activities for which the son had previous received no personal economic benefit and (b) no other officer or director of either the bank or the subsidiary was aware of the new arrangement.

Other organizations have suffered similar losses due to unreported conflicts-of-interest and improper related party transactions. It is notable with the Pamrapo organization because they had so recently been reprimanded and apparently made little effort to change their ways.  In the aftermath of a fraud detection, it is crucial that organizations take action to prevent additional fraud. Lousy tone-at-the-top can be especially difficult for companies to correct.  However, little can change without it.

 

Filed Under: Board Directors, Waste and Abuse

Audit Committees Should Be Worried

July 11, 2011 By Sheila Leave a Comment

An excerpt from the full length article, published by the ACFE Fraud Magazine:

How to Help Committee Members Maintain Their Integrity and Prevent Fraud

BY SHEILA KEEFE, CFE, CPA; AND RON KRAL, CPA, CMA

ACFE Fraud Magazine, July/August 2011

The U.S. Securities and Exchange Commission and other regulatory agencies are hotly targeting audit committees and directors. Here are ways CFEs can help them fulfill their responsibilities and prevent fraud in their organizations.

On Feb. 28, the U.S. Securities and Exchange Commission (SEC) charged three ex-directors and audit committee members of DHB Industries for failure to appropriately address a growing fraud in their organization.

Last September, a federal jury convicted DHB Industries CEO David Brooks and Chief Operating Officer Sandra Hatfields for, among other things, multiple counts of securities fraud, insider trading and obstruction of justice. The federal government had accused them of “manipulating financial records to boost earnings and profit margins, and thus inflate DHB’s stock price.”

Now, the SEC is prosecuting the ex-directors because their lack of oversight allowed senior management to manipulate results and to funnel millions of dollars to DHB’s founder and chief executive, David Brooks, to pay for luxury cars, costly vacations, art and prostitution services, according to a complaint filed in a Florida federal court. The SEC accused Jerome Krantz, Cary Chasin and Gary Nadelman of being “willfully blind to numerous red flags” of fraud, according to Robert Khuzami, director of the SEC’s Division of Enforcement.

“This massive accounting fraud permeated throughout an entire company,” said Eric Bustillo, director of the SEC regional office in Miami. “As the fraud swirled around them, Krantz, Chasin and Nadelman ignored the obvious.”

This SEC action is not the first time it has held directors responsible for poor oversight. Just last year, the SEC accepted a settlement from InfoGroup Inc. audit committee chairperson Vasant Raval.

The SEC concluded that Raval had conducted an inadequate investigation into allegations of the CEO’s improper related-party transactions. Raval accepted an injunction that included a $50,000 fine and a restriction against serving as a director or officer for five years.

The SEC has increased investigation and prosecution efforts directed at board members and audit committee members specifically. According to the SEC’s 2010 Performance and Accountability Report, the agency brought 681 enforcement cases covering a broad spectrum of financial wrongdoing in their 2010 fiscal year. Those enforcement cases have resulted in $2.8 billion in penalties and disgorgement, with many of the financial wrongdoings falling under the general oversight of audit committee activities.


Filed Under: Board Directors, Uncategorized

Global Corruption: Not a Victimless Crime

April 13, 2011 By Sheila Leave a Comment

Bribes and grease payments to foreign officials used to be considered standard operating procedure for many global enterprises. Much of that came to an end during the tenure of Mark Mendolsohn, former deputy chief of the fraud section at the U.S. Department of Justice. Mendolsohn’s zealous prosecution of corporate corruption, under the Foreign Corrupt Practices Act (FCPA), prompted many organizations to ramp up compliance budgets in order to be spared the multi-million dollar fines Mendolsohn managed to get.

Mendolsohn recently left the DOJ to focus on litigation in the private sector. In a recent interview with the Wall Street Journal (subscription only), Mendolsohn discussed how the DOJ’s campaign against foreign corruption paved the way for more broad, social, political and economic reforms in foreign countries doing business with United States. To wit, Mendolsohn stated, “People are more appreciating the connections to corruption and other issues of grave concern to people, such as democracy building and our efforts in Afghanistan and Iraq. It’s gone from being a taboo topic to a widely discussed topic.”

Looking forward, Mendolsohn suggested that the Dodd-Frank bill could act as a major accelerant to FCPA enforcement as whistleblowers look to profit from reporting violations. Additionally, Mendolsohn believes that increased cooperation between U.S. and foreign authorities, as well as increased funding to the DOJ and SEC, could create an environment of continued ardent FCPA prosecution by the DOJ.  Mendolsohn went on to predict that “the oil-and-gas industry and pharmaceutical industry, will continue to face challenges because of the nature of their businesses.”

The connection Mendolsohn makes between foreign corruption and democratic reform demonstrates the manner in which FCPA enforcement extends beyond the economic arena. Per Mendolsohn, “There is a growing recognition of what people commonly call the corrosive effects of corruption on development and democracy and democratic institutions. There is at some level a growing intolerance for corruption.”

Some may view bribes as a victimless crime, especially when there’s an attitude that ‘everybody’s doing it’ and bribes are ‘just a cost of doing business’ in certain foreign countries. The comments provided by Mendolsohn in the Wall Street Journal suggest a causal relationship between corruption enforcement and democratic reform, illustrating that foreign corruption is most definitely not a victimless crime.

This post has been cross-posted on the Association of Certified Fraud Examiner’s Insights blog.

Filed Under: Fraud Deterrence, Waste and Abuse Tagged With: , , , , , ,

Uh, Oh! What’s the SEC Done Now?

March 7, 2011 By Sheila 1 Comment

The Washington Post reported on March 4, 2011, that SEC inspector general probing agency’s handling of Madoff fraud.

This latest chapter in the Madoff affair has drawn additional scrutiny to the SEC at a time when the SEC is trying to ramp up its own investigative powers.  In this instance, the challenges the SEC faces are due to the possible conflict of interest of its own who had briefly held Madoff shares, received through an inheritance.  That former SEC official, David Becker, is now being charged by victims of Madoff’s fraud, the trustee, Irving Picard, for at least of portion of Becker’s proceeds.  The SEC, for its part, is not under investigation to determine who knew what and when with regards to Becker’s interest in the Madoff matter. [Read more...]

Filed Under: Waste and Abuse Tagged With: , ,

Worried? Who’s Worried? Board Directors That’s Who.

March 1, 2011 By Sheila Leave a Comment

The Chicago Tribune reported on February 28, 2011 that the SEC is charging three ex-directors for failure to appropriately address a growing fraud in their organization.  As reported by the Chicago Tribune:

Last September, a federal jury convicted DHB Industries CEO David Brooks and COO Sandra Hatfields for running a fraud, accusing the two of “manipulating financial records to boost earnings and profit margins, and thus inflate DHB’s stock price.”

Now, the SEC has its sights set on three of the ex-directors of DHB Industries for “their lack of oversight allowed senior management to manipulate results, and to funnel millions of dollars to DHB’s founder and chief executive, David Brooks, to pay for luxury cars, costly vacations, art and prostitution services.”  The U.S. Securities and Exchange Commission accused Jerome Krantz, Cary Chasin and Gary Nadelman of being “willfully blind to numerous red flags” of fraud.

“This massive accounting fraud permeated throughout an entire company,” Eric Bustillo, director of the SEC regional office in Miami, said in a statement. “As the fraud swirled around them, Krantz, Chasin and Nadelman ignored the obvious.”

[Read more...]

Filed Under: Board Directors Tagged With: , , ,
« Older Posts