Lessons Learned from Fraud Cases

1. Lessons Learned from Fraud Cases Can Better International Accounting and Auditing Standards Mitigate Fraud? Professor Paul Sheldon Foote California State University, Fullerton ACCOUNTING ACADEMICIANS’ COLLABORATION FOUNDATION MUHASEBE ÖĞRETİM ÜYELERİ BİLİM VE DAYANIŞMA VAKFI 4th International Accounting Conference, Istanbul, Turkey Lessons Learned From Fraud Cases

2. PricewaterhouseCoopers • Global Economic Crime Survey, 2007 Turkey Report • Larger frauds: $3.9 million average • Turkish fraudsters: 31 to 40 year old males, high school educated, less than 5 years on job • Only 21% of 105 companies brought criminal charges. Lessons Learned From Fraud Cases

3. SmarTalk TeleServices Fraud • 2003: PwC agreed to pay SEC $1 million for improper professional conduct • Approved $25 million restructuring reserve to reduce expenses • Revised, corrected, or discarded audit work papers Lessons Learned From Fraud Cases

4. KPMG • Typical fraudster: long-time employee, top management, acting alone, many frauds, over many years, large amounts • Whistle blowers catch far more than internal controls • Theft, fraudulent financial reports, embezzlement, kickbacks Lessons Learned From Fraud Cases

5. KPMG: Xerox Audit Fraud • 2003: SEC charged KPMG with fraud in Xerox audits (1997- 2000) • KPMG approval of accounting errors inflated revenues by $3 billion and pre-tax earnings by $1.2 billion Lessons Learned From Fraud Cases

6. Deloitte • Financial institutions • External: organized crime rings, sophisticated threats • Internal financial fraud increased 19% • Disaster recovery: Business Continuity Management (BCM) Lessons Learned From Fraud Cases

7. Adelphia Sued Deloitte • 2002: disclosed $2.3 billion off-balance-sheet debt, declared bankruptcy • November 2002: Adelphia Communications Corporation sued Deloitte & Touche for “professional negligence, breach of contract, fraud and other wrongful conduct.” Lessons Learned From Fraud Cases

8. Ernst & Young • 20% of respondents would not invest in some countries because of fraud risk, especially bribes and kickbacks. • “The move towards International Financial Reporting Standards (IFRS) will drive changes to accounting practices, particularly in emerging market countries. Where these standards negatively impact financial results, the risk of financial statement fraud may increase.” Lessons Learned From Fraud Cases

9. Manhattan Investment Fund • Phony financial statements certified by Deloitte (Bermuda, a tax haven) hiding $300 million short sale losses of $400 million hedge fund • Ernst & Young (Bermuda) fund administrator • Settled with investors, 2001 Lessons Learned From Fraud Cases

10. Association of Certified Fraud Examiners (ACFE) • “According to research conducted by the Association of Certified Fraud Examiners (ACFE), U.S. organizations lose an estimated 5 percent of annual revenues to fraud. Based on the estimated U.S. Gross Domestic Product for 2006 – $13.037 trillion – this percentage indicates a staggering estimate of losses around $638 billion among organizations, despite increased emphasis on anti-fraud controls and recent legislation to combat fraud.” Lessons Learned From Fraud Cases

11. United States Army, Vietnam • Army lieutenant, 1968 -1969 • False Claims Act (1863) because American government fails to prosecute many fraud cases • Qui Tam provision: 15% – 25% of recoveries to whistleblowers Lessons Learned From Fraud Cases

12. Iraq War (2003 – present) • Ali Allawi, nephew of Ahmad Chalabi and my Harvard Business School classmate, has written a book describing massive fraud cases in the Iraq War. A single fraud case involved $1 billion. Lessons Learned From Fraud Cases

13. War Fraud Lessons • Massive increases in fraud and corruption • Whistleblower (informer) system is weak • Vietnam War: military draft • Iraq War: all volunteers; more private contractors than American military service members • Corporate media can distract voters from important issues Lessons Learned From Fraud Cases

14. Citibank--Lebanon • 1972: Of more than 200 employees, few Muslim employees • Foreign exchange trader frauds resulted in millions of dollars of losses in branches including: Lebanon, Holland (The Netherlands), and in Hong Kong. Lessons Learned From Fraud Cases

15. Citibank—Lebanon Lessons • Not hiring based upon merit leads to incompetent work and audits and to fraud. • Management training program included only one week of reading about and observing foreign exchange trading. • Employees understand quickly that most managers are untrained and unfit to serve as managers. Lessons Learned From Fraud Cases

16. Citibank--India • 1972-1974: Reserve Bank of India (central bank) policy on bank auditor rotation • Reserve Bank of India and Citibank’s international internal audit team could find only 10% of internal control failures. Lessons Learned From Fraud Cases

17. Citibank—India Lessons • 2007: Reserve Bank of India and Institute of Chartered Accountants of India (ICAI), having failed to mandate audit firm rotation, are attempting to mandate audit partner rotation every 7 years. • External auditors and international internal audit teams cannot find most fraud. • If there is fraud in one activity, there is likely to be fraud in other activities. Lessons Learned From Fraud Cases

18. Singer Sewing Machine--Turkey • 1974: Store Manager fraud—fictitious deposits, non-Singer repair parts • Singer accountant in Istanbul reported concerns to marketing manager. • Store Manager fled from Turkey. Lessons Learned From Fraud Cases

19. Singer—Turkey-- Lessons • Even accountants who understand internal control procedures might permit personal, political, or cultural considerations to be more important that fraud losses. Lessons Learned From Fraud Cases

20. Singer Sewing Machine--Lebanon • Nearly all employees were Christians • Employees reported to me that they were paying 10% of their salaries each month to Lebanese officer who had hired them. • Incompetent employees Lessons Learned From Fraud Cases

21. Singer Sewing Machine--Morocco • Moroccan government fine for bad accounting • Paying all employees in cash • Accounting employees with high school bookkeeping or no training Lessons Learned From Fraud Cases

22. Singer—Morocco--Lessons • In spite of a French general manager with a business school degree, accountants were copying from marketing reports. • Imposition of voucher system revealed fake monthly reports to New York. • Imposition of imprest payroll account revealed illegal workers using false names. Lessons Learned From Fraud Cases

23. Gulf Investment Services (GIS) • 1998: fraud audit in Muscat, Sultanate of Oman Lessons Learned From Fraud Cases

24. GIS—Ernst & Young • Following financial audits, Ernst & Young did not detect any fraud. Lessons Learned From Fraud Cases

25. GIS—Best Brokerage • GIS: first brokerage company in Oman to receive the coveted "Best Brokerage" award instituted by the Muscat Securities Market Lessons Learned From Fraud Cases

26. GIS—ISO 9002 Certification • GIS: first to be an ISO 9002 certified financial services company in Oman • 1998: ISO representative had no clue there were frauds at GIS. Lessons Learned From Fraud Cases

27. GIS—Andersen Consulting • GIS used a special software system developed by Andersen Consulting (now Accenture) able to serve speakers of Arabic and English. • System default: all users can access entire system! Lessons Learned From Fraud Cases

28. GIS--Omanization • Since 1988, Oman has had a policy of Omanization, an attempt to increase percentage of Omani workers. • GIS employees: India, Jordan, United Kingdom, Oman Lessons Learned From Fraud Cases

29. GIS--Fraud • Focus of my fraud audit: fraud involving British and Omani collaborators • Collaborators included a manager with internal audit experience and an accountant with a CPA. Lessons Learned From Fraud Cases

30. If you discover one fraud … • Like discovering a cockroach, if you discover one fraud in an organization, there are likely to be other frauds. • Sometimes, you discover frauds your client or employer did not want you to discover. Lessons Learned From Fraud Cases