I use this blog as an outlet for addressing fraud, fraud prevention, the value of controls in mitigating all types of business risk, and the critical nature of ethical managment behavior in all aspects of business life.
Today, however, a series of articles, courtesy of nakedcapitalism.com have moved my focus a bit. I don't think they are directly connected, any more than the fact that I'm addressing the local Chapter of the Association of Fraud Examiners this evening is connected...........
But, for me, it all fit together too perfectly.
The articles below, in the order they appear, are worthy of your time and thought.
Americans and Government (Joe Costello)
http://www.archein21.com/2010/04/americans-and-government.html
The T Word (Robert Cringely)
http://www.assetinternational.com/ASMW/PostDetail.aspx?id=876&blogid=226
and
GOP Seeks SEC Records on Goldman (Mike Allen)
http://www.assetinternational.com/ASMW/PostDetail.aspx?id=876&blogid=226
Joe Costello's item summarizes a recent Pew survey that looks at Americans' distrust of Government...and how it has grown over time....regardless of the political parties in power........as he says "The issue of disenfranchisement is essential to understanding America today."
After reading his, I stumbled onto Robert Cringely's brilliant article on the nature of Trust....empiricism and transparency. "Trust is present or it is absent. Grab a nerd and he’ll tell you that even the absence of trust is a measure of trust and that particular measure is zero. When trust is non-zero (which is better, believe me) it is based on one of two methodologies -- empiricism or transparency (the other T-word)."
His parallels between technology and current behaviors in the banking industry are frighteningly astute. For someone who addresses business ethics and fraud, I find his insights (depressingly) dead on.
The coup de grace of course was concluding my little sojourn into thoughts about political and leadership distrust with an article about Senators politicizing the regulators that are questioning Goldman's actions. Regardless of how you think you feel about the merits of the SEC's accusations (we all might want to question what we think at this point since so few facts of the case are yet known) the fact that a legal action is either seen as political, or has been turned into something political, only reinforces the first two articles.
So I'll talk about this to the fraud examiners tonight. I'll mention this to my peers and clients. I'll state again that regulating behavior is a failed hand....particularly without heavy investment in those who are supposed to regulate (something we have been consistently reluctant to do), though serious punishment can slow the perpetrators down. I'll hope that the 'facts' are uncovered without interference, in Goldman's case and others, and that we will judge the actions on their merits, not political agendas.
Tomorrow I will arise with the resigned cynicism of those who responded to the Pew survey...and go about trying to make my own small difference in the world....one deserving client at a time.
and wondering if we, as a people and a government, can ever learn that trust betrayed, is trust lost.
In closing I defer to a much smarter man than I, Peter Drucker:•
"Management is doing things right; leadership is doing the right things."
Wednesday, April 21, 2010
Friday, April 16, 2010
Goldman Sachs
I've been questioning why no fraud indictments have come out of the market meltdown that started two years ago. I mean, every bubble is fueled by greed, and greed has a tendency to fuel fraud. How could there not be fraud?
We seemed to think that Enron and Worldcom executives overstepped their ethical responsibilities enough to create indictments earlier in the decade. We even found the practice of option backdating heinous enough to require indictments of the perpetrators. So, I've been cynically curious as to why our leaders in the financial markets were being spared the same scrutiny.
Well, maybe the wait is over. As Yves Smith so nicely states:
"SEC Sues Goldman for Fraud
Oooh, things are starting to get interesting.
A number of journalists and commentators (yours truly included) have taken issue with the fact that some dealers (most notably Goldman and DeutscheBank) had programs of heavily subprime synthetic collateralized debt obligations which they used to take short positions. Needless to say, the firms have been presumed to have designed these CDOs so that their short would pay off, meaning that they designed the CDOs to fail. The reason this is problematic is that most investors would assume that a dealer selling a product it had underwritte was acting as a middleman, intermediating between the views of short and long investors. Having the firm act to design the deal to serve its own interests doesn’t pass the smell test (one benchmark: Bear Stearns refused to sell synthetic CDOs on behalf of John Paulson, who similarly wanted to use them to establish a short position. How often does trading oriented firm turn down a potentially profitable trade because they don’t like the ethics?)"
http://www.nakedcapitalism.com/2010/04/sec-sues-goldman-for-fraud.html
...so maybe, just maybe, we may see some people held accountable. Goldman, Lehman Brothers. Do we really think there were only two? It could be refreshing, for a short period, though as a fraud investigator, I can only figure that is it will be another footnote in capitalist history along a very long road.
But we need single out some of the worst each offenders each time a bubble creates these abuses. Without establishing some semblance of risk for the perpetrators, there really is no reason at all not to take advantage of the system
We seemed to think that Enron and Worldcom executives overstepped their ethical responsibilities enough to create indictments earlier in the decade. We even found the practice of option backdating heinous enough to require indictments of the perpetrators. So, I've been cynically curious as to why our leaders in the financial markets were being spared the same scrutiny.
Well, maybe the wait is over. As Yves Smith so nicely states:
"SEC Sues Goldman for Fraud
Oooh, things are starting to get interesting.
A number of journalists and commentators (yours truly included) have taken issue with the fact that some dealers (most notably Goldman and DeutscheBank) had programs of heavily subprime synthetic collateralized debt obligations which they used to take short positions. Needless to say, the firms have been presumed to have designed these CDOs so that their short would pay off, meaning that they designed the CDOs to fail. The reason this is problematic is that most investors would assume that a dealer selling a product it had underwritte was acting as a middleman, intermediating between the views of short and long investors. Having the firm act to design the deal to serve its own interests doesn’t pass the smell test (one benchmark: Bear Stearns refused to sell synthetic CDOs on behalf of John Paulson, who similarly wanted to use them to establish a short position. How often does trading oriented firm turn down a potentially profitable trade because they don’t like the ethics?)"
http://www.nakedcapitalism.com/2010/04/sec-sues-goldman-for-fraud.html
...so maybe, just maybe, we may see some people held accountable. Goldman, Lehman Brothers. Do we really think there were only two? It could be refreshing, for a short period, though as a fraud investigator, I can only figure that is it will be another footnote in capitalist history along a very long road.
But we need single out some of the worst each offenders each time a bubble creates these abuses. Without establishing some semblance of risk for the perpetrators, there really is no reason at all not to take advantage of the system
Wednesday, April 14, 2010
For more than thirty years I’ve been investigating fraud: figuring out how it happened, tabulating the costs, repairing the failed internal control systems and consoling the victims. Although the case studies vary, there is one constant: it is always a surprise! Even worse, Management’s response is invariably the same: “We never saw it happening. We never thought he/she could do something like that.”
The economic losses are often significant. The emotional and organizational impacts are always worse.
That’s the way it is with fraud. It is an act of betrayal by your own employee, and, unlike other losses, you can never fully shrug it off as “just part of the cost of doing business.” It is far too personal.
Yet in most of these cases, the company’s leaders had never implemented serious fraud prevention measures. They had addressed their other business risks, routinely scrutinizing business operations from a cost/benefit perspective and making control decisions accordingly. They bought property, liability and D&O insurance, even though they did not anticipate losses. But when it came to fraud protection, their standard evaluation methods were somehow forgotten, and they blithely plunged ahead without noticeable concern.
Why Does it Matter?
It matters because fraud risk is a constant in the marketplace. It matters because fraud’s impact on American business is staggering. It matters because I’ve seen the impact of these cases on my clients. It matters because Management can make an impact.
The statistics are sobering, if not downright scary. The Association of Certified Fraud Examiners (ACFE) estimates that U.S. organizations lose 7% of their annual revenues each year to fraud. That is approximately $994 billion, based on the ACFE’s estimates. In nonprofits, fraud accounts for $40 billion in losses each year—roughly 13% of all philanthropic giving! The median fraud loss is $175,000.That equates to over 5.7 million fraud incidents a year (228,000 in nonprofits alone)!
Who is at Risk?
Everyone. The median losses are approximately the same in all businesses: large corporations, small companies, governments and nonprofits. Of course, the impact of that $170,000 loss is much greater to the small company or nonprofit. In fact, if you are a small business with less than 100 employees, the news gets worse, as the median loss due to fraud is closer to $200,000 (look for check tampering and fraudulent billing schemes).
Who has Been Wreaking This Havoc?
The greatest losses are perpetrated by managers or officers who have been with the firm for more than five years. They are usually working alone and have no prior history of illegal activities. Accounting departments commit 29% of all fraud, executives another 18%. When the executives are involved, expect the median loss to exceed $850,000! If that isn’t bad enough, the average fraud usually covers an 18 to 30 month period before discovery, so the perpetrator may already be working his craft at your expense.
Why tell you this? Because your external auditors won’t find it for you. The police won’t find it for you. In fact, you’re as likely to discover fraud by accident as you are to discover it through internal audit. You can’t make it go away. If you haven’t taken action, tips are your best, and maybe only, hope.
Ways to Mitigate Risk
The sad truth is that no one has figured out how to eradicate fraud. As defined in Cressey’s “Fraud Triangle ,“ there are three elements that have to exist for fraud to be committed: Need, Opportunity, and Rationalization. So, how do you address these elements? As a manager, you have little control over a potential fraudster’s perceived need. You have some control over the rationalization process, but not a lot (it is harder to justify stealing from someone you like and respect than from someone you don’t). However, you do have a significant ability to control opportunity.
So if you want to reduce the risk of fraud loss, there are a couple of routes open to you. You can passively invest in dishonesty types of insurance policies and/or bond your employees. Or, you can actively spend a little bit of time improving your internal controls and internal auditing capabilities. Both solutions can reduce your financial risk. However, only the improvement in internal controls will reduce the likelihood of the fraud occurring at all, or at least allow you to detect it earlier.
Common Anti-Fraud Controls
In the fraud cases studied by the ACFE, lack of adequate internal controls was most commonly cited as the factor that allowed fraud to occur. In 78% of those cases, the victim organizations modified their anti-fraud controls after discovering that they had been defrauded.
There are fifteen common fraud-related controls that have proven effective at reducing the cost of fraud losses. Implementing job rotations and mandatory vacations, for example, reduced the median cost of fraud loss from $164,000 to only $64,000 which is a 61.0% decrease. You can review all of these in the ACFE's 2008 Report to the Nation.
Put some of these in place and it will make a difference. However, don’t confuse anti-fraud controls with SOX-related internal controls! Sarbanes-Oxley was passed in response to several large financial statement fraud schemes and is targeted toward preventing and detecting financial statement manipulation. Although those frauds are by far the most expensive, they are not the most prevalent. In fact, seven other categories of fraud (corruption, billing, skimming, non-cash, check tampering, expense reimbursements and cash on hand) are more frequent. If your goal is the reduction of all types of fraud, then the controls above will benefit you the most.
The Choice is Yours
You can buy insurance policies that will reduce the financial risk of a potential fraud. You pay a premium, take out a deductible and hope you are lucky. Or, you can invest some time (the labor premium) to strengthen your internal controls, and reduce both the likelihood of occurrence as well as the financial risk. Maybe if you do a little of both, you’ll rest easier and be better protected.
Prevention, deterrence and detection are the basis of risk management…and the basis of good business strategy. Don’t let fraud be the one risk you ignored.
The economic losses are often significant. The emotional and organizational impacts are always worse.
That’s the way it is with fraud. It is an act of betrayal by your own employee, and, unlike other losses, you can never fully shrug it off as “just part of the cost of doing business.” It is far too personal.
Yet in most of these cases, the company’s leaders had never implemented serious fraud prevention measures. They had addressed their other business risks, routinely scrutinizing business operations from a cost/benefit perspective and making control decisions accordingly. They bought property, liability and D&O insurance, even though they did not anticipate losses. But when it came to fraud protection, their standard evaluation methods were somehow forgotten, and they blithely plunged ahead without noticeable concern.
Why Does it Matter?
It matters because fraud risk is a constant in the marketplace. It matters because fraud’s impact on American business is staggering. It matters because I’ve seen the impact of these cases on my clients. It matters because Management can make an impact.
The statistics are sobering, if not downright scary. The Association of Certified Fraud Examiners (ACFE) estimates that U.S. organizations lose 7% of their annual revenues each year to fraud. That is approximately $994 billion, based on the ACFE’s estimates. In nonprofits, fraud accounts for $40 billion in losses each year—roughly 13% of all philanthropic giving! The median fraud loss is $175,000.That equates to over 5.7 million fraud incidents a year (228,000 in nonprofits alone)!
Who is at Risk?
Everyone. The median losses are approximately the same in all businesses: large corporations, small companies, governments and nonprofits. Of course, the impact of that $170,000 loss is much greater to the small company or nonprofit. In fact, if you are a small business with less than 100 employees, the news gets worse, as the median loss due to fraud is closer to $200,000 (look for check tampering and fraudulent billing schemes).
Who has Been Wreaking This Havoc?
The greatest losses are perpetrated by managers or officers who have been with the firm for more than five years. They are usually working alone and have no prior history of illegal activities. Accounting departments commit 29% of all fraud, executives another 18%. When the executives are involved, expect the median loss to exceed $850,000! If that isn’t bad enough, the average fraud usually covers an 18 to 30 month period before discovery, so the perpetrator may already be working his craft at your expense.
Why tell you this? Because your external auditors won’t find it for you. The police won’t find it for you. In fact, you’re as likely to discover fraud by accident as you are to discover it through internal audit. You can’t make it go away. If you haven’t taken action, tips are your best, and maybe only, hope.
Ways to Mitigate Risk
The sad truth is that no one has figured out how to eradicate fraud. As defined in Cressey’s “Fraud Triangle ,“ there are three elements that have to exist for fraud to be committed: Need, Opportunity, and Rationalization. So, how do you address these elements? As a manager, you have little control over a potential fraudster’s perceived need. You have some control over the rationalization process, but not a lot (it is harder to justify stealing from someone you like and respect than from someone you don’t). However, you do have a significant ability to control opportunity.
So if you want to reduce the risk of fraud loss, there are a couple of routes open to you. You can passively invest in dishonesty types of insurance policies and/or bond your employees. Or, you can actively spend a little bit of time improving your internal controls and internal auditing capabilities. Both solutions can reduce your financial risk. However, only the improvement in internal controls will reduce the likelihood of the fraud occurring at all, or at least allow you to detect it earlier.
Common Anti-Fraud Controls
In the fraud cases studied by the ACFE, lack of adequate internal controls was most commonly cited as the factor that allowed fraud to occur. In 78% of those cases, the victim organizations modified their anti-fraud controls after discovering that they had been defrauded.
There are fifteen common fraud-related controls that have proven effective at reducing the cost of fraud losses. Implementing job rotations and mandatory vacations, for example, reduced the median cost of fraud loss from $164,000 to only $64,000 which is a 61.0% decrease. You can review all of these in the ACFE's 2008 Report to the Nation.
Put some of these in place and it will make a difference. However, don’t confuse anti-fraud controls with SOX-related internal controls! Sarbanes-Oxley was passed in response to several large financial statement fraud schemes and is targeted toward preventing and detecting financial statement manipulation. Although those frauds are by far the most expensive, they are not the most prevalent. In fact, seven other categories of fraud (corruption, billing, skimming, non-cash, check tampering, expense reimbursements and cash on hand) are more frequent. If your goal is the reduction of all types of fraud, then the controls above will benefit you the most.
The Choice is Yours
You can buy insurance policies that will reduce the financial risk of a potential fraud. You pay a premium, take out a deductible and hope you are lucky. Or, you can invest some time (the labor premium) to strengthen your internal controls, and reduce both the likelihood of occurrence as well as the financial risk. Maybe if you do a little of both, you’ll rest easier and be better protected.
Prevention, deterrence and detection are the basis of risk management…and the basis of good business strategy. Don’t let fraud be the one risk you ignored.
Tuesday, April 6, 2010
PCAOB Fraud Director--Action or Lip Service
The PCAOB made the announcement below earlier today:
I have to ask? Is this a political response to the perceived audit failings at Lehman Brothers....or Koss....or Madoff? Seems odd that the recommendations from the Treasury Advisory Committee, which was established in 2007, are only coming to fruition now.........a year after the market meltdown. Why so long?
Is there going to be new regulation on the audit community to actually LOOK for fraud? Or, is this just lip-service so that we all know that our political leaders are concerned? When external auditors identify less than 13% of all frauds (and 80+% of discovered frauds had previously clean audits).......are we going to put the onus on the auditors? Will the market be willing to foot the cost?
Fraud keeps taking its toll on the market. But when protective regulation is expensive (think Sarbanes-Oxley) our capitalist society doesn't have much stomach for it. Of course, it doesn't help when we don't believe that regulation actually solves the problem. Still, sometimes doing something seems better than doing nothing.
Sadly, this announcement feels to me like doing nothing under the guise of 'doing something.'
Thoughts?
**************************************************************************************
Washington, D.C., April 6, 2010 -- The Public Company Accounting Oversight Board announced today that it is seeking to fill a newly created position of Director of the Financial Reporting Fraud Resource Center, which is being established in response to a recommendation from the Treasury Advisory Committee on the Auditing Profession.
The Treasury Advisory Committee was established in 2007 to consider and develop recommendations relating to the sustainability of a strong and vibrant auditing profession. One of the recommendations called for the creation by the PCAOB of a national center to facilitate the prevention and detection of financial fraud.
"The Center is intended to complement the work of the PCAOB in improving audit quality in this area, by identifying opportunities and incentives for fraudulent financial reporting," said Daniel L. Goelzer, PCAOB Acting Chairman. "We believe the Center’s work will raise the awareness of the investing public, other regulators and interested parties of financial reporting fraud."
Its primary objectives are to maintain and develop information related to financial reporting fraud, which can arise from a broad array of factors, including accounting and disclosure, auditing, corporate governance, insider trading, executive compensation, economic and other environmental circumstances, among other things. The Center will publish public reports on risks, and assist in developing educational materials, related to financial reporting fraud.
The Director will work with the Board and other senior PCAOB staff to set up the operations and activities of the new Center. Once the Center is established, the Director will be responsible for its day-to-day operations, including hiring and managing staff.
********************************************************************************
I have to ask? Is this a political response to the perceived audit failings at Lehman Brothers....or Koss....or Madoff? Seems odd that the recommendations from the Treasury Advisory Committee, which was established in 2007, are only coming to fruition now.........a year after the market meltdown. Why so long?
Is there going to be new regulation on the audit community to actually LOOK for fraud? Or, is this just lip-service so that we all know that our political leaders are concerned? When external auditors identify less than 13% of all frauds (and 80+% of discovered frauds had previously clean audits).......are we going to put the onus on the auditors? Will the market be willing to foot the cost?
Fraud keeps taking its toll on the market. But when protective regulation is expensive (think Sarbanes-Oxley) our capitalist society doesn't have much stomach for it. Of course, it doesn't help when we don't believe that regulation actually solves the problem. Still, sometimes doing something seems better than doing nothing.
Sadly, this announcement feels to me like doing nothing under the guise of 'doing something.'
Thoughts?
**************************************************************************************
Washington, D.C., April 6, 2010 -- The Public Company Accounting Oversight Board announced today that it is seeking to fill a newly created position of Director of the Financial Reporting Fraud Resource Center, which is being established in response to a recommendation from the Treasury Advisory Committee on the Auditing Profession.
The Treasury Advisory Committee was established in 2007 to consider and develop recommendations relating to the sustainability of a strong and vibrant auditing profession. One of the recommendations called for the creation by the PCAOB of a national center to facilitate the prevention and detection of financial fraud.
"The Center is intended to complement the work of the PCAOB in improving audit quality in this area, by identifying opportunities and incentives for fraudulent financial reporting," said Daniel L. Goelzer, PCAOB Acting Chairman. "We believe the Center’s work will raise the awareness of the investing public, other regulators and interested parties of financial reporting fraud."
Its primary objectives are to maintain and develop information related to financial reporting fraud, which can arise from a broad array of factors, including accounting and disclosure, auditing, corporate governance, insider trading, executive compensation, economic and other environmental circumstances, among other things. The Center will publish public reports on risks, and assist in developing educational materials, related to financial reporting fraud.
The Director will work with the Board and other senior PCAOB staff to set up the operations and activities of the new Center. Once the Center is established, the Director will be responsible for its day-to-day operations, including hiring and managing staff.
********************************************************************************
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