Archives for posts with tag: Fraud

The Wall Street Journal recently ran a story about the government’s watchdog, the SEC, having concerns about the quality of audit reports issued by one of the Big Four CPA firms, KPMG. This resulted in an indictment of several people. What the government noted was poor audit quality based on their review. Big 4 CPA firms have also been charged with fraud in other high-profile cases. In fact, government test audits of all the Big Four firm’s work show that about 25% of all audits were what they call, “deficient”.

The issue is that investors rely on the outside auditors to check the accuracy of a firm’s financial reports. The SEC and the federal government has focused on this since the bankruptcies and accounting scandals involving Enron and World-Com in the early 2000s. And the Big Four CPA firms audit almost all the public firms in the Standard and Poor’s 500. So, this is not a good thing, no matter how you look at it.

As a former CPA in public accounting and a former CFO who worked with auditors for  decades, I have some thoughts for the Big Four CPA firms.

Training is first. Accounting firms send their new staff to a couple week training program. This is nowhere near enough. When I was an entry level staff person, I understood very little about internal controls, proper procedures, and really the whole auditing process. It took into my third or fourth year before I felt comfortable. More hands on training ever few months would have helped even though this is expensive.

Supervision is next. CPA firms have a very clear hierarchy of command where each layer above supervises and reviews the work of those below. The Senior on an audit might have a handful of staff reporting to them which does not sound unreasonable. But the Senior auditor also has work only they can do, like taxes, and rarely has enough time to supervise and help train their staff. Managers supervise Seniors but a bunch of them at once on often very different types of audits. More time needs to be allocated for review and supervision so that audit quality can improve.

Finally, we need a clear and mutually agreed understanding of what an audit is and what it is not. Audits are not meant to detect fraud yet many people believe they are. If fraud is found, however, it must be reported. As the government completes all these test audits perhaps the expectations versus the deliverables of an audit can become less fuzzy.  We also have whole new issues these days with technology,  cyber crimes and data security that did not exist that long ago. The responsibility of the auditor needs to be re-defined.

All of these items will take more audit time and thus audits will cost more. That will  become a reality. Historically, audit clients put constant pressure on their auditors to lower their fee. Going forward, if we want to improve audit quality and significantly reduce deficient work, audits will cost more. The investing public deserves it.

The Journal of Accountancy (yes, there really is such a publication) had an article about the Securities and Exchange Commission (SEC) bringing and enforcing fraud cases over the last decade. The largest cases involved either improper financial reporting or violations of the Foreign Corrupt Practice Act which deals with bribes to international officials. Not surprisingly the financial services industry had, by far, the most cases and fines followed by natural resource and energy firms (think mining and oil and gas).

But what was very surprising, and more than a bit disturbing to me, was who the SEC prosecuted and fined.  Corporations themselves were at the top of the list which made sense. But, what did not, was that Chief Financial Officers (CFOs) were second followed by a firm’s Chief Executive Officer (CEOs) as a far distant third. Worst of all was that the Board of Directors were barely fined at all! Now, I know I was a practicing (and never indicted CFO) and I know CFOs certainly play a major role in a fraud of any kind. But, let me tell you this: nine times out of ten when a CFO does something bad, his or her CEO not only knows about it but probably pressured the CFO to cook the books in the first place! I could understand if CFOs were fined a bit more than CEOs, but not ten times as much in this study. CEOs are always responsible and often behind what goes on, period.

And, the Directors in these firms should have know something was going on! I have written on several occasions about the often limited involvement or usefulness of many members of Boards of Directors. But remember the corporate officers from the CEO to the CFO all report to and are responsible to the Board. The buck, and on average, $250,000 per year of bucks for large company directors, stops with the Board.

As many readers know, I hate fraud and especially fraud committed by senior managers who are paid a lot of money. So I am all for prosecuting and fining those who commit fraud. But if the SEC and the U.S. Government focus the bulk of their efforts on CFOs and almost ignore CEOs and their Boards, the occurrence and magnitude of fraud will only continue and probably get worse.

Think of this like a National League Football team. When a team, like my Cleveland Browns go winless, they fire the coach. When the team only wins a few games in several years, you fire the General Manager, the Director of Player Personnel and everyone but the Owners. So, in corporate terms, when major fraud occurs, fire the Board. This is how you send a message and how things might have a chance to improve in the future.

The unusual title of this blog post is from a new book called The Chickenshit Club by Jesse Eisinger. The book’s subtitled is “Why the Justice Department Fails to Prosecutes Executives.”  The writer cites several reasons why this is happening.  First, U.S. Attorneys are concerned about their conviction record and shy away from tough corporate cases they could lose, thus the nickname chickenshit. The second reason is even worse. The belief is that a far too cozy of a relationship exists between the government attorneys and the white collar defense lawyers who defend the corporate executives. The issue is that many government attorneys end up working, for far higher salaries later in their careers,  for the very laws firms they have been fighting against.

I have written before that corporate Boards of Directors and senior management are reluctant or afraid to prosecute fellow executives who commit crimes.This is true whether it is internal fraud, breaking security laws or even violating the firm’s ethics or morality code such as with sexual harassment.   Firms are reluctant because it often involves going after one of their own. Firms are afraid because to bring criminal charges because they have to follow through and maybe even testify in court!

So, when you combine the U.S. Government’s unwillingness to charge and try corporate executives and the corporations own reluctance to even report issues to the authorities, what do we have? To paraphrase James Bond, it is a license to steal and commitment securities fraud!

I Hate fraud and especially Management Fraud by those who get paid a lot already. So what is to be done? The federal government is hard to change as we all know. But, if these issues become more known they could end up being debated in law schools and maybe the next group of U.S. Attorneys will handle themselves and their responsibilities better. The corporate problem gets back to another one of my pet peeves, corporate boards.  Board of Directors have to step up and show courage and leadership in properly discipling and prosecuting executives who behave badly. None of this is easy but the present lax attitude to corporate misdoing needs to change.

To paraphrase the Nike logo, Just Do the Right Thing! People’s view of business and government may actually improve.


The Wall Street Journal recently ran an article about the engine emission crisis at Volkswagon (VW). Senior executives of VW acknowledged that their firm had a “culture of tolerance for rule breaking” that lead to this “chain of mistakes”. Although the article did not name exactly who ordered their engineers to install the software to fool the tests, the article did state that it found no evidence that “VW executive or supervisory Boards were involved in the fraud”.

Yeh. Heard that one before. After British Petroleum (BP) had the disastrous oil spill in the Gulf, a top writer from Fortune magazine stated that BP’s long time focus on cost cutting versus safety goes back directly to the Board of Directors. The Gulf spill was proceeded by several major safety events including a huge explosion in Texas that killed a dozen workers. All organizations look for guidance or direction from the top and a Board is the ultimate top. It appears that maximizing profits through cost cutting was a top priority over safety for BP and its Board.

At my old firm, USG Corporation, every meeting, even the Board meetings, started with a review of safety. This goes back to when USG started as a gypsum mining firm. Major accidents, especially deaths, are reviewed in often grisly details. Senior people, including myself, would attend safety dinners when a plant reached an accident free milestone. Safety was a core value at USG Corporation.

Sadly in most of these disasters like BP and VW often a few, token senior people are fired but with huge severance packages. But a lot of staff or line engineers at these firms lose their job and often their livelihoods because of their presumed role.

At VW, the Board and the senior executives looked the other way or showed a tolerance for rule breaking or it would not have occurred. And  German car companies are known for their excellence in their engineering and engines. That makes this all the more unbelievable to me.

In my view, senior executives and Board members must be held to higher standards than they are and at times, they need to bear the blame and responsibility for not focusing on what is right.  Read the rest of this entry »

Those who have followed this blog know that one of my favorite subjects is Fraud. Mainly the type committed by those who make the most and need the money the least: Management Fraud. But there exists, of course, a million other types of fraud, from con men to tax evaders. Which brings us to this tale of two famous or infamous fraudsters in the news recently.

Dennis Kozlowski was the CEO of a conglomerate called Tyco. Through acquisitions, Kozlowski grew Tyco into a giant public firm which was very successful and respected by Wall Street. He also managed to get paid tens of hundreds of millions in compensation from salary, bonuses and stock awards. But somehow this may not have been enough. Kozlowski was convicted of “stealing” from his company with an elaborate compensation package and outlandish expenses. These included a $30 million company owned NYC condo with, among other things, $6,000 in shower curtains and over $10million in artwork. You would want your luxury condo to look good after all. And let’s not forget the birthday party for his then second wife on the coast of Italy for which Tyco paid half of the $2 million cost. For all of this he was sentenced and just completed serving over 8 years in prison. One of the harshest sentences ever for a corporate executive. Kozlowski reported to a Board of Directors who were supposed to monitor his compensation and certainly understood much of what was going on. None of the Board were charged. Many business writers believed that Kozlowski’s punishment exceeded the crime in these circumstances.

Ty Warner, of Chicago, invented Beanie Babies and has been listed as having over $5 billion in net worth. But what does Ty do? He puts a mere $100 million or so of it into hidden Swiss bank accounts. Over a decade he uses different names including a foundation to evade U.S. income taxes. He has now paid our government over $70 million in back taxes, penalties and interest. The criminal trial just wrapped up. His lawyers argued that this tax evasion was the only mark on his lifelong business and charity record. Seems like a pretty big stain to me. The federal prosecutors argued for at least a year in prison as an example to others. The Chicago judge ignored federal guidelines of up to five years in prison and sentenced Warner to two years of probation and community service.

It was tax evasion that finally got Al Capone, also of Chicago. Tax criminals and corporate criminals should be treated the same. Ironically those who perpetuate most of these Frauds have the most money and the least reason to do so. It is very often more of a second thought or a game to them. So when caught and convicted, they should pay.

So what should we learn from all this? Individuals who commit fraud should be prosecuted with a criminal trial not just an out of court settlement. So often public corporations are afraid to deal with this type of unpleasantness and just announce that someone has left to pursue other interests. If those who commit fraud are not properly dealt with, it sets a terrible example for those who remain. It also allows corporate criminals to go off to some other organization and perhaps act in the same fashion. And it should not matter if the fraud involves expense accounts, kickbacks or tax evasion. Corporate America went through a rough patch with companies like Tyco and Enron grabbing headlines for all the wrong reasons. Some of the punishment was excessive in comparison to earlier times or similar crimes. What we need is consistent sentences based on federal or state guidelines. And even those with records as otherwise model citizens or major charitable donors should do prison time if that is the norm. Criminal Fraud should be followed with criminal punishment.

I was reminded recently that I had not written in awhile about one of my favorite topics, Management Fraud. Our focus here and in my book, The Business Zoo will concentrate primarily on those people who should know better, people who already make excellent money and who often believe they never did anything really wrong. This is called Management Fraud. Sometimes this can take on giant proportions like kickbacks from suppliers and sometimes it can seem almost like petty cash when it involves travel and entertainment expenses.

As is my practice with potential crimes, we will leave the company and person’s name out to protect their families any further embarrassment. We call this tale: Grooming a Senior Corporate Executive’s Expenses.

As individuals rise to the top of the senior corporate ranks, they get many benefits and privileges. Besides higher pay, bonuses, and stock options, they often are awarded private lunch club memberships, and in the old days, golf country clubs, company cars etc. But this is not enough for some people. For whatever reasons, a certain Senior Corporate Executive working with this company needed more. So the Executive started charging some personal expenses like hair stylists. To make matters worse, the same Executive spread over several expense reports, the cost of a holiday party at their home for their staff. That was against company policy as well. The sum total of all this was very minor compared to the Executive’s salary and bonus. What is also interesting is that the people who dream up and do things like this, are never someone you would expect even if you knew something about Management Fraud.

Expense accounts for senior executives at public companies would make exciting reading, if published in the Wall Street Journal. This actually happened to the, now imprisoned, former chairman of Tyco who charged the infamous thousands of dollars shower curtain. Sadly, senior executives’ expense accounts are often prone to these types of vulgarities. Why? Because for some the higher up in a firm they get, and the more they get, the more they actually believe they deserve.

Pushing your expenses seems like an easy way to get what you believe you deserve. Compounding the problem is this little understood fact: the expense reports for senior executives are reviewed and approved internally by other senior executives! Now some senior people actually do review each other’s expense reports as though they were important; others well, not so much. Sometimes very senior people like a Chairman or CEO, by necessity, have lower level executives review their reports. As CFO at one of my public companies, I reviewed and approved my boss’s expenses. But what should be common knowledge to the Executives at large public companies is that Internal Audit will review or spot check all the senior executives‘ expense reports. And every year or so someone gets caught. And usually for something stupid.

Our Senior Corporate Executive’s improper grooming and party expenses turned a spot check into a multi-year full blown review of all expense reports and departmental spending for the person and their staff. The Senior Corporate Executive and a direct report abruptly left the company “to pursue other interests.” This dreaded corporate jargon phrase usually means they were fired and had to go pursue something else.

Perhaps they learned a lesson and went straight on their expenses. But nowadays with less goodies, like country clubs, I doubt it.

The moral here is simple. Everyone in business and life needs a type of “moral compass” to tell themselves what is right versus wrong. You need to develop this when you are young and starting out and, by the time you are a Senior Corporate Executive, you won’t cheat on your expenses!

Fraud, like Grease and several other kinds of bad behavior, that we cover in The Business Zoo, goes back to the beginning of time. The word Fraud has century old roots in both England and France and basically means “to deceive or inflict a loss on others while seeking a personal gain.”

Fraud is a dirty daily business to some although it has often been made glamorous or even acceptable in movies like The Sting, with Newman and Redford deceiving the nasty and deserving Robert Shaw.

But the Fraud I focus on occurs in business and often by people who should know better and already are paid excellent money. This is called Management Fraud. It is so popular an activity that we dedicate a whole Section or Chapter about it in my book.

Big, public corporations like to think they can deal with and often prevent or quickly detect Fraud. To do this these firms put in place elaborate procedures and policies which employees must review and sign. And then to enforce all of this the big companies turn to their version of the police, their Internal Audit group.

There are a million stories about Management Fraud and many involve Internal Audit. Sometimes Internal Audit comes out as a hero and sometimes not.  Here is one short story which I hope you find to be both tender and amusing and yet informative.

Internal Audit and the Dead Cat:

Manufacturing plants are like small cities. They have Mayors (Plant Managers), Councils (Heads of H.R., Finance etc.), Citizens (hourly workers), and a Pest Control Department (A Feral Cat). The Cat is not a normal hire but a walk-in and not a pet but a worker which helps with the local pests (rats). Often the Cat becomes a beloved member of the plant community.

But when Cats age they do not have the same medical coverage or retirement plans as the Mayor, the Council or the Citizens.

At one plant, their beloved cat is old and dying so the Mayor asks his Human Resource person to deal with it. Human Resources people are often called in to deal with the dying of workers or their careers, so this was not unusual. The H.R. person does the humane thing and has the Humane society come out, trap and humanely dispose of the Cat, all for a small fixed fee of $25 which comes out of the Plant’s Petty Cash.

This is not the end of the story since, a few months later, this Petty Cash slip happened to get chosen in a random test conducted by the company’s Internal Auditors. They needed to speak with the H.R. person because in all the sorrow and the funeral that followed for the Cat, the Petty Cash slip was not properly filled out. For the week long Internal Audit at the Plant, the head Auditor kept trying to find the Human Resource person to get the paperwork in order. The meeting never occurred and it was listed as an Exception in the Plant’s Internal Audit report.

The H.R. person for this generous act and general good and humane conduct was later promoted to headquarters.

The moral of this story is that Internal Audit can help a business in many ways including Fraud but they need to focus on what is important and not pursue Dead Cats.

I Won’t Cheat!  is the official motto of the Little League, whose annual World Series is on TV each August, from Williamsport, PA. The words are on a patch on each uniform. If you’ve ever watched the Little League World Series, you might agree that it is far superior to watching the multi millionaire divas who play most of our professional sports. This past year, Uganda became the first African team to qualify even though most of the boys had only played baseball for two years- usually without shoes until they had to wear them in the tournament!  With no family able to afford to come with them, the Uganda team became the favorite of all the other players and fans. That’s sportsmanship. You can also sense how much all these kids just love playing the game. True they are only 10-12 (or 13 before May 1), but I really believe most of the Little Leaguers would never cheat.

Yet every few years, there is a major scandal at the LLWS, as its called, about the age of a player or something. Almost all of these scandals can be traced to the kid’s parents or coaches. The kids just love to play.

So when and how do we go from non cheating kids to adults with issues?

Especially adults in business (including sports) with issues on morality and ethics?

When I left the  corporate world for the second time, I had an interesting conversation with a very astute, retired guy in Florida. Upon asking what I had done, I replied “I was a Chief Financial Officer for two big public firms” then I playfully added, “and I am proud to say I was never investigated, charged or convicted of any crimes by the Securities Exchange Commission or any state Attorney Generals!”

The older, astute, long time business guy, then smiled and not as jokingly said, “ Then you must have gotten out in time.”  What a sad commentary. But ethics and morality should matter in business, sports and life and not just in the Little League.

So what about Lance. His “interview” with Oprah speaks for itself. He stated he did not feel he was cheating at the time. Yet he also sued or denounced many sources and fellow competitors who dared to suggest he had cheated.

In my forthcoming book, The Business Zoo, we look at ethics, morality and fraud using both actual stories from my career and today’s headlines. Then we summarize some lessons we can learn from them.

It’s never too late in business, sports or life to learn something!