It’s the Most Wonderful Time of the Year… For Scammers Too

During the holiday season, many people choose to give and help others around them, but sometimes due to the spirit of giving that abounds, we tend to let our guard down. The Pittsburgh Post-Gazette recently published an article which outlines five popular scams to be sure to avoid this holiday season.

Fighting Fraud with Mathematical Weapons

According to a Wall Street Journal article, forensic accountants recently uncovered a several hundred thousand dollar fraud committed by employees at a national call center simply by “wielding mathematical weapons.” Using data analysis, they were able to identify a number of fraudulent refunds that call center employees were issuing. The find was critical to the company as it helped them discover where they were losing a lot of money.

Benford's Law

The forensic accountants who detected the fraud at the call center used a mathematical test known as Benford’s Law. Contrary to popular belief that there should be an even distribution in the starting digits of numbers, Benford’s Law says that “more numbers start with one than any other digit, followed by those that begin with two, then three, and so on,” and that “ones should account for 30% of leading digits, and each successive number should represent a progressively smaller proportion, with nines coming last, at under 5%.” In the case of the call center, the forensic team noticed an exceptionally large percentage of refund amounts where the starting digit was a four. It also happened to be that employees could issue refunds to customers up to $50 without needing additional supervision. By using Benford’s Law and investigating the transactions where the leading digit was a four, forensic accountants discovered a small number of operators at the call center “who had issued fraudulent refunds to themselves, friends and family totaling several hundred thousand dollars.”

Individuals Causing the 2008 Housing Crisis Receive No More Than a Slap on the Wrist

Following the 2008 housing crisis, several of the banks involved paid large settlement fines. JPMorgan Chase was one of those banks. The Justice Department used evidence from an anonymous whistleblower in the prosecution, but until recently the whistleblower remained anonymous. Matt Taibbi recently released an article in Rolling Stone describing why the whistleblower, Alayne Fleischmann, has gone public with what she knows. Ironically, the Justice Department wasn’t committed to bringing “justice” to those individuals who contributed to the fall of the economy through fraudulent activities. In fact, Attorney General Eric Holder said the following:

“I am concerned that the size of some of these institutions becomes so large that it does become difficult for us to prosecute them when we are hit with indications that if you do prosecute, if you do bring a criminal charge, it will have a negative impact on the national economy, perhaps even the world economy, and I think that is a function of the fact that some of these institutions have become too large.”

What is the Justice Department doing if they aren’t bringing justice to those responsible for major crimes? When Fleischmann realized that much of what she reported to the SEC and the Justice Department was not being fully pursued, she decided she had to go public with what she knew.

Research Study Suggests That the Culture in the Banking Industry Leads to Dishonesty

Financial Times recently printed an article about a study done by researchers at the University of Zurich which suggested that bankers have a tendency to lie for financial gain. The study used a control group and treatment group of bankers. The bankers in the control group were asked questions about their everyday life (for example, “How many hours of television do you watch per week?”). The bankers in the treatment group were asked questions relating to what they did at work as a banker. They then gave each group a coin, had them toss it ten times, and then had them self-report their results. The participants were told beforehand whether heads or tails would count as a success. If no cheating took place, the average amount of heads compared to tails should have been very close to 50/50 for each group. In the control group this was the case, but the group who had been primed with thinking about their profession as bankers reported 58.2% winning tosses. From these results, the researchers estimate that 26% of the bankers in the treatment group cheated.

Would You Break the Law for $1 Million?

A survey was recently conducted in Korea where participants were asked if they would break the law in order to gain the equivalent of $955,000 (USD). Surprisingly, nearly one in four responded that they would. The study showed that people in their twenties were even more likely to break the law for $1 million (nearly one in three respondents in their twenties said they would). If this holds true throughout the world, we could potentially see more frauds committed as the younger workforce reaches stages in their careers where they have the pressure and opportunity to commit fraud.

Check out the article in the Wall Street Journal and ask yourself the same question – would you break the law for $1 million? Hopefully the number of people who answer yes to this question gets smaller and smaller over time.

The Latest in Detecting Deception

I spend about two and a half weeks in my Fraud Examination class studying how we can detect when someone is being deceptive. I think it's a fascinating area that holds a lot of promise as one of the best things auditors could learn to utilize to detect fraud. If I was king of independent auditing for a day, I would change auditors' requirements to interview for fraud but that is the subject of a future post...

When I teach about detecting deception, I emphasize to my students that non-verbal cues are much less reliable than verbal cues. Some recent research shows that text analysis in verbal cues reveals four patterns in people who are lying. Check out the short, but informative, video below to learn more.

Lie Detector Could Help Stop Doping in Sports

They say a picture is worth a thousand words—and researchers have found a video can be worth even more. A recent article talks about research that was conducted using videos of Lance Armstrong where he denied doping, as well as the video where he finally confessed, taken from the Oprah Winfrey interview (see confession clip below). Researchers put the videos through a lie detector program to see the results.

The videos passed through the lie detector computer program and “revealed consistent patterns of behavior.” When Armstrong lied and denied allegations of doping, the computer detected patterns and revealed that Armstrong was lying. “Among the few, subtle patterns that Armstrong unwittingly repeated when lying were shaking his head, blinking and pressing his lips together.” When Armstrong confessed, the computer did not detect these same patterns.

Competitive Sports Leads to Academic Fraud at UNC

A report was recently released with findings of an investigation on academic fraud at the University of North Carolina. The report states that an office administrator, Deborah Crowder, established fake classes where students weren’t expected to do anything except submit a paper. The classes became known as “paper classes.” The investigative report revealed that “when Crowder graded the papers, she did so generously – typically with A’s or high B’s – and largely without regard to the quality of the papers.” A majority of the students enrolled in the “class” were student athletes (mainly football and basketball players) who needed a good grade to remain eligible to compete in their respective sport. Just like the frauds we have seen in cycling, competitive sports seems to have yet again created the perfect environment for fraud to occur, and it wasn’t just one person who knew about it.

Insider Trading: Employing Mob-like Tactics to Realize Tremendous Profits

An article from earlier this year on fortune.com said that “more than half of the best-known white-collar inmates… are in prison because of insider trading.” What causes people to risk being one of the next infamous white-collar inmates by committing insider trading? For most people it’s because of the unbelievably high profits. But just how profitable can insider trading be, and how do people get away with it?

Uncovering Pharmaceutical Fraud

In a previous post, I mentioned a research paper that was published in The Lancet that made claims that a certain vaccine caused autism. The idea went viral, and the amount of vaccinations decreased, which resulted in many children suffering needlessly with the measles and other preventable diseases. Claims in the paper were eventually proven false, and The Lancet retracted the paper. However, although there may not be a causal link between vaccines and autism, there does appear to be alleged fraudulent activity occurring on the side of the pharmaceutical companies to cover up and enhance the results of their vaccines.

A recent Huffington Post article discusses three court cases filed by whistleblowers against Merck, a pharmaceutical company, saying that they “fraudulently misled the government and omitted, concealed, and adulterated material information regarding the efficacy of its mumps vaccine in violation of the FCA [False Claims Act].” One of the court cases describes Merck’s misconduct as follows:

Doping in Sports and Financial Statement Fraud

I just read an interesting article titled: "Instead of punishing dirty cyclists, should we reward the clean?" The idea is to certify pro cyclists who are willing to be thoroughly tested for doping. The tests would go beyond what is currently used to look for drugs and involve many mechanisms to detect doping.

Connections Between the Big Banks and Holder's Justice Department: No Wonder There Aren't Criminal Cases

Eric Holder (from The Guardian)

A story in The Guardian discusses connections that Eric Holder and Lanny Breuer have with a law firm, Covington & Burling, that represents several big banks. The Guardian article gets key information from an NPR story including this connection between Holder and Breuer and the big banks:

How the Atlanta Teaching Scandal was Uncovered

A recent article in Business Insider shed some light on how a teaching scandal in Atlanta was uncovered. The scandal involved teachers who were changing their student’s answers on a standardized test so that their students could score higher and the school district and teacher could get better funding and bonuses. (See more about the scandal at these previous posts: Teaching by Example: Fraud in Public Schools and More on the Cheating Scandals in Public Schools.)

Don’t Get Scammed: Tips on Avoiding IRS Scam

I recently saw an email from someone who received a phone call from a woman claiming to be from the IRS. The woman claimed that she was calling because he (the person who received the call) was the target of a criminal investigation. She went on to say that he needed to give her the name of a lawyer that he wanted to represent him and that she could put him in touch with one if needed. Luckily, in large part because the woman on the phone didn’t speak very coherent English, he knew it was a scam. However, some people aren’t so lucky.

Should Legal Penalties for Research Misconduct be Similar to Those for Fraud?

Research misconduct (when research is falsified or plagiarized) has historically been dealt with internally, but Richard Smith thinks that should change. In The New Scientist, Smith argues that “Research misconduct degrades trust in science and causes real-world harm. As such, it should be a crime akin to fraud.” False research essentially causes people to believe in something that is incorrect, which can affect their actions—not unlike the way that financial statement fraud can change people’s investment decisions. Smith gives several reasons why research misconduct should be illegal and discusses how it should be treated in our society.

Reporting Fraud: An Uphill Battle, Especially in China

We often hope to see the people committing fraud receiving punishment. Unfortunately, this is not always the case. A recent New York Times article by Floyd Norris reports that Kun Huang spent two years in a Chinese prison – not because he committed fraud, but because he detected it. The consequences for reporting fraud are not generally quite as severe as they were for Mr. Huang, but they do often include ridicule and other challenges for many whistleblowers. While reporting fraud is an uphill battle, especially in China, it is definitely one that is worth fighting.

Lance Armstrong Investigation: Can A Tiger Change Its Stripes?

It has been about a year and a half since Lance Armstrong publicly admitted to doping.  In this article, Armstrong tells his side of the story and in the second installment, victims of Armstrong's lies tell their stories.

In the article, Armstrong tells about the slippery slope that he found himself on.  All of the fraud and issues that have come to light were spawned from one lie: the refusal to tell the truth about doping.  Regarding his adamant denials of ever doping, Armstrong reportedly said:

"I was good at playing the part," he admits now. "After the 850th time, it's not like I'm going to say, 'Matt, you seem like a nice guy, I'm going to be honest with you.' Once you say 'no' you have to keep saying 'no.'

"If this stuff hadn't taken place with the federal investigation, I'd probably still be saying 'no' with the same conviction and tone as before. But that gig is up."

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.