Chapter 6

Legal, Regulatory and

Professional Environment

Critical Thinking Exercise

A scientist has two buckets, one holds 4 gallons and the other holds 5 gallons as well as an unlimited water supply. By using nothing but the buckets and water, how can you accurately measure 3 gallons of water?

Introduction

• Fraud may be prosecuted criminally or civilly• Fear of getting caught• Fear of punishment• Most people are law abiding citizens• “Criminal justice funnel”• Regulatory agencies• Public Company Accounting Oversight Board

The Rights of Individuals

Amendment Protects •Fourth Against unreasonable searches

& seizures •Fifth Against self-incrimination •Sixth Right to an attorney •Fourteenth Due process and equal

protections

NOTE: Employees have less protections

The Rights of Individuals

• Interviews• Searches• Surveillance• Discharging a Suspected

Wrongdoer from Employment• Privileges

Interviews• Miranda warnings

– Right to remain silent– Answers can be used against him– Right to an attorney– If interviewee can’t afford an attorney, one will be

provided at no cost• Legal counsel• Private employers don’t have to offer due

process of law• Common law protections• Confessions

Searches• Unreasonable searches and seizures are

forbidden• When is a workplace search reasonable?

– Likely to reveal evidence of work-related misconduct

– Search is necessary to further investigation• Search limitations

– “Exclusive control”– “Fruit from the forbidden tree”

Surveillance• Types of surveillance

– Fixed point surveillance– Mobile surveillance– Videography– Audio or electronic surveillance

• Audio surveillance laws and regulations are more complicated– “One-party consent”

• Video surveillance generally permissible

Discharging a Suspected Wrongdoer from Employment

• Employment considered “at will”• Employer should document “good cause”

– Conduct against written policy– Conduct made for unsafe or inefficient operations– “Punishment fits the crime”– Evidence supports questionable act by employee

• Actions should be well documented• Nothing prevents employee from suing

employer in civil court

Privileges

• Protections against certain types of testimony• Attorney-client privilege• Attorney work-product privilege• Physician-patient privilege• Marital privileges• Miscellaneous privileges

Attorney-Client Privilege• The right to not disclose confidential

communication relating to professional relationship

• Client has right to compel nondisclosure• Applies only to communications intended to

be confidential• Does not permit attorney to conceal physical

evidence• Does not apply to future acts of crime or fraud

Attorney Work-Product Privilege

• Protects all materials prepared by an attorney in anticipation of litigation

• Shield materials that would disclose attorney’s theory of the case

• Any written materials directed toward preparation of a case

• Must be prepared in anticipation of litigation

Physician-Patient Privilege

• Confidential when obtaining treatment or being diagnosed

• When involved in litigation, privilege is waived– Court appointed physicians– Expert witnesses

Marital Privileges

• Spousal immunity– Protection from testifying against own spouse

• Spousal defendant– Protection from adverse testimony– Allowed in both civil and criminal cases– Covers statements made during marriage

• Neither applies to crimes or torts within family

Miscellaneous Privileges

• Confidential communications made to clergy• Government has privileges that protect the

disclosure of sensitive information• Trade secrets for businesses• No privilege for accountant-client

relationships

Probable CauseStandard used:• To make an arrest• To conduct a search • To obtain a warrant• By grand juries• Culpability scale

– Witness– Subject– Target

Probable Cause

• 4th Amendment• Terry v. Ohio

– “Terry Stop” (reasonable suspicion)• United States v. Matlock

– “Co-occupant consent rule”• Illinois v. Gates

– “Fair probability”

Probable Cause• Documentary evidence

– Voluntary consent– Subpoena– Search warrant

• Advantages of warrant over subpoena– Allows holder to decide which documents are

relevant– Avoids, but does not eliminate, possible

destruction of evidence– Interview key witnesses without opportunity to

prepare

Rules of Evidence

• Evidence must be relevant and trustworthy• Must be admissible• May be testimonial• Real • Demonstrative• Circumstantial• Direct• “Facts at issue”

Rules of Evidence

• Real evidence “speaks for itself”– Must be authenticated

• Demonstrative evidence purports to educate, summarize or amplify real evidence– Tells a story or complements other evidence– Must not create prejudice– Heart of most fraud and forensic accounting

investigations

Rules of Evidence• 5 considerations must be given to any piece of

documentary evidence– Document must not have been forged– Original documents are preferable

• “Best evidence rule”– Document must not be hearsay or

objectionable• “Statements against interest”

– Document needs to be authenticated– Document must be reliable

Criminal Justice System

• Most cases never end up in the criminal justice system

• 3 routes that a target may enter criminal justice system– Warrantless arrest by police based on probable

cause– Investigation that leads to the filing of an

“Information”– Grand jury proceeding that leads to an indictment

and subsequent arrest warrant by a judge• “Without unnecessary delay”

Criminal Justice System• Sufficient evidence exists to bring case to trial• Indictment stage

– Defendant is officially charged• Arraignment hearing

– Defendant is informed of the crime and charges against him

– Advised of rights– Asked to enter plea

• Guilty• Not guilty• Nolo Contendere

Criminal Justice System• Bench trial• Trial by jury

– Judge decides matters of law– Jury decides if evidence is sufficient

• “Mitigating circumstances”• After verdict, convicted person

may appeal verdict, sentence, or both

• Prison system– Community-based– Minimum security– Medium security– Maximum security

Criminal Justice System• Parole

– Reward for good behavior• Probation

– Alternative to prison• Recidivism• Discretion• Businesses and other

organizations may be prosecuted

Civil Justice System• Right a wrong or resolve a dispute• Recover losses and reap punitive damages• Cease and Desist Orders• How can fraud examiners and forensic

accountants be utilized?

Complaints and Pre-Trial Activity• Civil lawsuits begin with complaint• Fraud civil complaints must be specific

– Fraud misrepresentations– The impacted victim– How misrepresentations were false

• Discovery– Interrogatories– “Requests to produce documents”– Depositions– “Requests for admission”

Negotiated Remedies• Out-of-court settlements

– Both sides come to settlement position– Attorneys negotiate

• Mediation– Independent 3rd party with no authority to decide

case– Assists both sides– Work for mutually agreeable resolution

• Arbitration– Independent 3rd party acts as judge and jury– Authority to determine outcome of case– Binding or non-binding verdict

Pre-Trial Motions and the Civil Trial• If attempts to settle case fail, pre-trial motions

follow• Differences between civil and criminal trials

– Jury 6 persons– If opposing attorneys agree, unanimous verdict

not required– Requires preponderance of evidence rather than

“beyond a reasonable doubt”• Post-judgment discovery

Regulatory System• Basic Accounting Principles – a Survivor’s Guide to

Accounting• The AICPA and Statement on Auditing Standards No.

99• The Sarbanes-Oxley Act of 2002• The Public Company Accounting Oversight Board

(PCAOB)• COSO’s Enterprise Risk Management Framework

(ERM)• PCAOB’s Auditing Standards Nos. 3 and 5• IIA Practice Advisories 1210.A2-1 and 1210.A2-2

Basic Accounting Principles – A Survivor’s Guide to Accounting

• Balance Sheet• Income Statement• Statement of Cash

Flows• Accrual Accounting

The AICPA and Statement on Auditing Standards No. 99

• Auditing standards for non-public companies– Reasonable assurance– Professional skepticism

• Compilation and review standards• Other attestation standards• Consulting standards• Code of professional conduct

Fraudster’s Perspective

• Criminals exploit your humanity• “Trust, but verify”• White collar crime is a crime of deceit• White collar criminals are artful liars

The Sarbanes-Oxley Act of 2002

• Higher standards for corporate governance and accountability

• Independent regulatory framework• Enhance quality and transparency of financial

reports• Severe civil and criminal penalties for

corporate wrongdoers• New protections for corporate whistleblowers

Public Company Accounting Oversight Board (PCAOB)

• Registration with the board• Auditing, quality control, and independence

standards and rules• Inspections of registered public accounting

firms• Investigations and disciplinary proceedings

COCO’s Enterprise Risk Management Framework (ERM)

• Principles and components of effective risk management processes

• How risks should be identified, assessed and addressed

• Create anti-fraud environment• Help entities achieve operational and financial

objectives and goals

PCAOB’s Auditing Standards Nos. 3 and 5

• AS3 – Audit documentation• AS5 – Integrated Audit• Anti-fraud controls

– Control activities– Risk assessment– Control activities– Information and communication– Monitoring

The Role of Corporate Governance

• Protect investors• Create long-term shareholder value• Restore investor confidence• Support strong and efficient capital markets• Committee must ensure its independence• “Tone at the top”