A Fraudster's Paradise

Sam Antar writes about society's vulnerability to fraud. Here are a few points that stood out to me.

On stiff punishments serving as a deterrent to fraud:

...white-collar criminals don't listen to the rhetoric of prosecutors. No white-collar criminal discovers ethical behavior and stops doing crime because another criminal ends up in prison. While white-collar criminals take precautions against failure, they do not plan on ever ending up in prison.

Sam implies that the expected punishment for fraudsters is no punishment. This suggests a need for stronger prevention and detection mechanisms. How about auditors?

Traditional financial statement audits of public and private companies are not designed to find fraud. What accounting firms call an “audit” of financial reports is really a compliance review designed to find unintentional material errors in financial reports by examining a limited sample of transactions.

In discussions I've had with auditors, I get the sense that most would like to do more to focus on fraud, but they feel like such a focus would be too expensive and would essentially price them out of the market. While I'm not completely satisfied with that explanation (e.g., firms could, at low cost, use computerized forensic tools to search for red flags), it suggests a need for either regulatory changes that require auditors to focus more on fraud or increased demand by investors for audits that specifically focus more on fraud. The latter is unlikely to occur as long as most investors continue to believe that audits are focused primarily on fraud.

In fairness to auditors, Sam's point about deficiencies identified via PCAOB inspections omits the fact that the PCAOB does not inspect audits randomly, but instead focuses primarily on the audits it believes have the highest risk of deficiencies. This means that even though 49% of E&Y's inspected audits had deficiencies, we would expect the actual rate at which deficiencies occur to be substantially lower. Even that lower overall deficiency rate may not be that informative about how effectively auditors conduct their audits. Still, that's primarily a distraction from Sam's main point, which is that audits primarily focus on unintentional errors rather than focusing on fraud.

If audits aren't particularly effective in preventing/detecting fraud, what about government agencies?

As a nation, we devote far more resources fighting blue-collar crime or street crime, than we do battling white-collar crime. For example, the NYC Police Department employs approximately 34,000 cops in uniform battling street crime. However, the FBI employs approximately 13,600 special agents, the IRS Criminal Investigative Division employs approximately 2,600 special agents, the SEC employs approximately 3,958 people, and the US Postal Inspectors Office employs approximately 1,500 postal inspectors. The NYC Police Department has more man power directly battling street crime than those four federal law enforcement agencies combined have fighting nationwide white-collar crime.

While it would be nice to have some estimates of the economic cost of white-collar vs. blue-collar crime, Sam's point still serves as a good illustration of the relative lack of funding oriented toward white-collar crime. Right now, the government seems to have outsourced most of the prevention and detection work to the private sector (e.g., auditors). Until standards or market forces change so that those parties increase their focus on fraud, we appear to be living in a fraudster's paradise.

BYU Radio Interview

Mark was interviewed on BYU Radio today and talked about Enron, auditing, Lance Armstrong, and other fraud-related topics.

The full show is here, with Mark's 27 minute interview starting just before the 31 minute point, or you can also listen to Mark's segment specifically here.

CBS Segment on Livestrong

Here's the video of a CBS segment where Mark was interviewed about Livestrong. The segment aired a little while ago, but this is the first time we've seen it available to view online. Mark's portion is less than half a minute starting around 6:15. Back up another 30 seconds before that to get the context of his comments.

Fraud in the Detroit Bankruptcy and the Role of Investment Banks

I read an interesting analysis of what's happening in the Detroit Bankruptcy proceedings. In a nutshell, it appears to be another case where the investment banks were able to take out millions of dollars in fees as they structured deals that ended up crippling the economy. In this case, the deals may be considered fraudulent according to this analysis. This seems to be business as usual in the investment banking world for about two decades or more.

Enron and WorldCom were frauds that were fueled by investment bankers and ended up becoming the largest bankruptcies in history. The mortgage meltdown was also fueled by investment bankers and that led to even larger bankruptcies and the world economy being brought to its knees in what is now known as the Great Recession. Now, the largest municipal bankruptcy in history also appears to have been fueled by some cleaver investment bankers who undoubtedly made out like bandits as it appears that they structured deals that gave them huge fees.

Lance Armstrong Investigation: I can't believe it's come to this....

Here we are, nearly three and a half years after Floyd Landis's first confession came out and I posted that I was 99.9% confident that pro cyclists had been doping for the past 15-20 years. I ended that first post by saying "Sadly, what would be surprising to me is if someone who is dominating pro cycling such as Alberto Contador was actually not doping!" Of course, soon after that, Alberto failed a doping test in the Tour de France and was suspended from racing.

Since that first post, there have been many posts to follow (this makes number 150 with the label of Lance Armstrong Investigation) and

Scientific Research Fraud is on the Rise--Especially in China

In accounting research, we had the first retraction in decades in the past year. Soon after the retraction, evidence was provided suggesting that the retracted article reported some very suspicious claims that were essentially impossible. The author(s) never provided a rebuttal to the claims and the author who claimed to obtain the amazing data for the article suddenly retired and is reportedly very hard (or impossible) to contact. While the retraction never stated that the article was a fraud, it all seems very suspicious...

In the harder sciences, The Economist reported this week that there has recently been a sudden uptick in fraudulent scientific research, especially in China. Here is a taste of the article:

Monitoring Matters

In a surprising development (to no one familiar with auditing or internal controls), it turns out that monitoring can actually make a difference in the way people behave!

Actually, a field study focused on monitoring and described in the NYT provides some interesting insights. While it isn't really surprising that monitoring focused on deterring theft actually deterred theft, what is less expected is that anti-theft monitoring actually increased productive efforts by employees. From the NYT article:

Fraudster gets Scammed

I always like it when I read about a fraudster who gets scammed. This reminds me of the groups who are dedicated to wasting time of the internet scammers. One group goes by ScamBaiter and another is 419 Eater. They basically waste time of scammers who send out the emails to people saying they're going to send them huge amounts of money if they will help them out. Well, I read about another scammer who got scammed today. This time, it involved a local power company in Utah. A scammer had notified a cookie company that they needed to pay their bill or their power would be turned off. You can read what happened next here....

Lance Armstrong Investigation: A Fitting Ending...

Check out this video from the Roopstigo website.

Enron CEO, Jeff Skilling, Received Shorter Jail Sentence

Various news agencies reported last week that a federal judge reduced Jeff Skilling's prison sentence by about ten years. If Skilling is found to be on good behavior and take a drug and alcohol rehabilitation course, he could be out of prison within four years. Part of the agreement is for Skilling to quit trying to get his conviction overturned. This new ruling also frees up some money from Skilling's estate that will be used to compensate victims of the fraud, including former Enron employees who lost their retirement when the company went bankrupt. Diana Peters is one of many former Enron employees who was at the latest trial and is quoted as follows:

"I pray that your decision is to give Jeff Skilling the maximum sentence for his crimes." 

Fraud always ends in a sad story as innocent victims deal with the aftermath by experiencing serious devastation, suffering and heartache. My heart goes out to these former Enron employees who had nothing to do with the crazy games Skilling, Fastow, Lay and others were playing...

Whistleblowing is Paying Off

The WSJ reported this week that the SEC has handed out it's second ever Dodd-Frank award for whistleblowing. the article says that the SEC expects more awards in the future. Here's a quote...

City Governments Committing Financial Statement Fraud

The Wall Street Journal reported recently that city governments in Pennsylvania, Florida, California, New Jersey and Illinois are increasingly being charged with financial statement fraud in their bond offerings. In the case of Harrisburg, Pennsylvania, the SEC stated that:

...this is the first time the (SEC) has "charged a municipality for misleading statements made outside of its securities disclosure documents."

According to "Anthony Figliola, a vice president at Empire Government Strategies, a Long Island-based consulting firm to local governments. 'Harrisburg is the tip of the iceberg.'"

Lance Armstrong Investigation: Betsy Andreu & Bill Bock Interviews

http://bit.ly/13f0ROw

This short video discusses some aspects of the fraud in pro cycling that was perpetuated by Lance Armstrong. Betsy Andreu and Bill Bock (USADA General Counsel) spoke at UT Austin recently and this video was produced. They speak of omertà, truth, and how one person with moral courage can make a difference. Check it out, it's worth the four minutes...

SEC to Focus more on Financial Reporting Fraud

According to the Wall Street Journal, the SEC is ready to get back to work looking for financial reporting fraud. After the mortgage meltdown, the article states that the SEC turned its attention to cases related to the financial crisis and took its eye off of fraudulent financial reporting. Interestingly, the article identifies one new tool that the SEC plans to use to identify fraudulent financial statements...