Corporate Financial Fraud: How to Find It, How to Prevent It

Below we have outlined a synopsis of some of the common frauds that have lately, and are typically, a bane to directors. We trust that this overview will assist you in being able to ascertain these scenarios before they become both a financial and/or personal liability for you, your company, and your executive board. While we do not want to instill a cynical, distrusting attitude, we do feel that much of what has occurred recently in the American Corporate Markets is a direct result of a deficiency of knowledge in detecting the “red flags” of accounting fraud.

Unauthorized Compensation

DEFINITION: This is pay given to a company’s executives that haven’t been approved by its board.

EXAMPLE: In the case of TYCO International LTD., a SEC filing shows that former Chief Executive L. Dennis Kozlowski pushed through $100 million of bonuses for employees to forgive residence-relocation loans from the company, but its board hadn’t approved the program. According to an investigation by the Wall Street Journal, Mr. Kozlowski alone appears to have taken at least $77 million from the company that wasn’t previously disclosed to the board.

RED FLAG: When one firm acts as both accounting and auditing firm for one company, there may be potential for deception on behalf of the auditor due to conflicts of interest. In other words, two separate entities should fulfill duties of accounting and auditing, and consider changing your accounting and auditing relationships on a 5-year rotating schedule.

Capitalizing Business Expenses

DEFINITION: The unorthodox technique of earmarking operating expenses as capital expenditures in order to turn corporate loss into corporate profit.

EXAMPLE: WorldCom Inc. designated a large portion of its long distance and local telephone expenses as capital expenditures, a maneuver that was worth hundreds of millions of dollars to WorldCom’s bottom line, rather than allocating the monies as a normal business expense.

RED FLAG: When assessment of company’s normal business expenses reveals drastic changes for basic “utility-type” expenses as well as an increase in capital expenditures.

Spinning

DEFINITION: The practice of brokerage houses exchanging IPO shares with top executives for reciprocating business from their companies. A lucrative means of enticing the business of large companies. By swaying the decision of the top executives, investment brokerage houses can secure a quid pro quo type of arrangement.

EXAMPLE: Executives of a technology company select a brokerage firm to manage the company’s IPO. Then, the company’s top executives open accounts with the brokerage firm, which directs other IPO shares into these accounts. The shares can then be sold quickly and at a profit.

RED FLAG: Upon examination of accounting, noticeable changes in executive “perks” and quickly developing relationships with underwriting brokerage firms and/or other largely traded companies.

Continued Casey Letter

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