“Arresting Financial Fraud:The Inside Story From The FBI”

The views expressed by the presenters do not necessarily represent

the views, positions, or opinions of either the AICPA

or the presenter’s respective organization

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This program is designed to help you: Understand the U.S. Department of Justice’s

three-part definition of corporate fraud; Understand the scope of the problem; Identify common accounting schemes; Work effectively with law enforcement; and Better understand the impact of recently

enacted legislation

Course Objectives

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Today’s Speakers

Grant Ashley, CPA Assistant Director,

Criminal Investigative DivisionFederal Bureau of Investigation

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 Gary Dagan, CPAChief,

Economic Crimes UnitFederal Bureau of Investigation

Keith Slotter, CPAChief,

Financial Crimes SectionFederal Bureau of Investigation

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John F. Hudson, CPAModerator

Hudson Consulting Group, LLC

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Corporate Fraud - Background

Following the corporate scandals of 2002, the Department of Justice issued a three-part formal definition which describes the illegal activities that encompass corporate fraud.

These three parts are:

Accounting Fraud

Self-Dealing by Corporate Insiders

Obstructive Conduct

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Dept. of Justice Definition – Corporate Fraud

Part One – Accounting Fraud (“Cooking the Books”) The falsification of financial information, including

false accounting entries, bogus trades designed to inflate profits or hide losses, and false transactions designed to evade regulatory oversight.

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Restatements by Reason1997 - June 2002

37.9

15.714.1

8.9

5.9 5.4 5.13.6 3.0

0

5

10

15

20

25

30

35

40

Revenue

Cost/expense

Other

Restructuring/assets/inventory

Acquisition/merger

Securities-r

elated

Reclassifi

cationIPR&D

Related-party tra

nsactions

Reason

%

Per GAO Report on Financial Restatements

Figure 3

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Why is Revenue Recognition So Important?

In its October 2002 Report on Financial Statement Restatement, the GAO concluded that: Almost 38% of the 919 announced restatements

between 1997 and June 30, 2002 involved revenue recognition.

Revenue recognition was the primary reason for restatements in each year.

Over 50% of the immediate market losses following restatements were attributable to revenue recognition related restatements.

Approximately 50% of the SEC’s enforcement cases have involved revenue recognition issues.

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Why is Revenue Recognition So Important?

Restatements for improper revenue recognition also result in larger drops in market capitalization than any other type of restatement:8 out of the top 10 market value losses in 2000 related

to revenue problems.Of the 10 companies, the top 3 lost US$20 billion in

market value in just 3 days due to revenue recognition problems.

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Some Examples of Revenue Recognition Schemes

Phantom Sales Parked Inventory Sales Swap (i.e., “Round Trip”) Transactions Channel Stuffing Accelerated Revenue Undisclosed Side Deals Undisclosed Contingencies Backdated Contracts

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Some Examples of Expense & Liability Recognition Schemes

Capitalizing Expenses Deferring Expenses Unrecorded Expenses “Big Bath” Accounting “Cookie Jar” Reserves Creative Acquisition Accounting

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Cooking The Books– Selected Recipes

Parked Inventory Sales – Recording sales for goods shipped to a site (warehouse, parking lot) controlled by the seller to provide the appearance a valid sale occurred.

Swap Transactions – A scheme in which two conspiring companies exchange payments and services solely for the purpose of inflating revenues.

Channel Stuffing – Overselling products to customers with a hidden understanding that the customer will receive deep discounts on the full invoice price at a future date.

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Cooking The Books – Selected Recipes

Side Deals – An arrangement in which the buyer of goods is given the right to cancel the sales contract, return products or receive rebates in future periods. Although the sale is booked, the side deals are hidden from auditors.

Accelerated Revenue – Improperly recording revenues in the current fiscal period which are applicable to future periods. Examples are unshipped merchandise and percentage of completion contracts.

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Cooking The Books – Selected Recipes

Capitalizing Expenses – The improper reclassification of an expense to an asset. This scheme is typically conducted through a series of journal entries at the end of a fiscal period in order to inflate the financial statements.

Deferred Expenses – Recording expenses applicable to the current fiscal period at some date in the future. Typically, this scheme continues to perpetuate itself in future periods.

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Dept. of Justice Definition – Corporate Fraud

Part Two – Self-dealing by corporate insiders (“Me First”), including . . . Insider trading KickbacksMisuse of corporate property for personal gain Individual tax violations related to self-dealing

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The Fundamentals of Corporate Governance

Lessons often forgotten . . . A corporation is owned and controlled by the

individual shareholders.The corporation is NOT the personal property of

the individual executives of the company.Self-dealing places the greed of individual

executives ahead of the shareholders.

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Executive loans with no intentions to ever repay.

Extraordinary personal expenses charged to the company.

Failure to report forgiven loans or reimbursed personal expenses as taxable income.

Examples of Self-Dealing

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Awarding business contracts in return for personal compensation.

Receiving shares of stock in other companies in return for business transactions (shares are often placed in the name of another family member to avoid detection).

Examples of Self-Dealing

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Insider TradingBuying or selling personally owned shares of stock

prior to a major announcement that is expected to affect the stock price (i.e., positive or negative earnings, new products, change in management, mergers & acquisitions).

Examples of Self-Dealing

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Dept. of Justice Definition – Corporate Fraud

Part Three – Obstruction of Justice (“The Cover-up”)Obstruction of justice designed to conceal the

previously noted criminal conduct (accounting fraud & self-dealing), particularly when that obstruction impedes the regulatory inquiries of the Securities and Exchange Commission or other agencies.

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Obstructive Conduct

Shredding documents Erasing computer files Creating or altering documents to justify

illegal conduct Purposely failing to provide all documents

and files requested in a subpoena

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Providing false testimony in SEC depositions Lying to criminal investigators Influencing another witness Threatening another witness Failing to maintain records for a prescribed

period of time

Obstructive Conduct

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Record RetentionExpectations of the CPA

In 2002, a new criminal law (title 18, section 1520) was enacted which requires any accountant who conducts an audit of a public company to maintain all audit workpapers from this engagement for a period of five years.

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Corporate Fraud Victims

Individual shareholders Employee pension plans Mutual funds Financial institutions (lenders) Market stability & reliance

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Locations of Corporate Fraud Investigations

New York, NY

Chicago

Los Angeles

San Francisco

San Diego

Boston

Detroit

Houston

And …

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(Continued) Locations ofCorporate Fraud Investigations

Birmingham

Charleston (SC)

Anchorage

Columbus (OH)

Honolulu

Omaha

Erie (PA)

Johnson City (TN)

Oklahoma City

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