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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

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


Course Objectives

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

Slide 2

Grant Ashley, CPA

Assistant Director,

Criminal Investigative Division

Federal Bureau of Investigation


 Gary Dagan, CPA


Economic Crimes Unit

Federal Bureau of Investigation

Keith Slotter, CPA


Financial Crimes Section

Federal Bureau of Investigation


John F. Hudson, CPA


Hudson Consulting Group, LLC

Today’s Speakers

Slide 3

corporate fraud background
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

Slide 4

dept of justice definition corporate fraud
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.

Slide 5

restatements by reason 1997 june 2002
Restatements by Reason1997 - June 2002

Per GAO Report

on Financial RestatementsFigure 3

Slide 6

why is revenue recognition so important
In its October 2002 Report on Financial Statement Restatement, the GAO concluded that:Why is Revenue Recognition So Important?
  • 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.

Slide 7

why is revenue recognition so important8
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.

Slide 8

some examples of revenue recognition schemes
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

Slide 9

some examples of expense liability recognition schemes
Some Examples of Expense & Liability Recognition Schemes
  • Capitalizing Expenses
  • Deferring Expenses
  • Unrecorded Expenses
  • “Big Bath” Accounting
  • “Cookie Jar” Reserves
  • Creative Acquisition Accounting

Slide 10

cooking the books selected recipes
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.

Slide 11

cooking the books selected recipes12
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.

Slide 12

cooking the books selected recipes13
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.

Slide 13

dept of justice definition corporate fraud14
Dept. of Justice Definition – Corporate Fraud
  • Part Two – Self-dealing by corporate insiders (“Me First”), including . . .
    • Insider trading
    • Kickbacks
    • Misuse of corporate property for personal gain
    • Individual tax violations related to self-dealing

Slide 14

the fundamentals of corporate governance
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.

Slide 15

examples of self dealing
Examples of Self-Dealing
  • 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.

Slide 16

examples of self dealing17
Examples of Self-Dealing
  • 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).

Slide 17

examples of self dealing18
Examples of Self-Dealing
  • Insider Trading
    • Buying 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).

Slide 18

dept of justice definition corporate fraud19
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.

Slide 19

obstructive conduct
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

Slide 20

obstructive conduct21
Obstructive Conduct
  • 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

Slide 21

record retention expectations of the cpa
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.

Slide 22

corporate fraud victims
Corporate Fraud Victims
  • Individual shareholders
  • Employee pension plans
  • Mutual funds
  • Financial institutions (lenders)
  • Market stability & reliance

Slide 23

locations of corporate fraud investigations
New York, NY


Los Angeles

San Francisco

San Diego




And …

Locations of Corporate Fraud Investigations

Slide 24

continued locations of corporate fraud investigations

Charleston (SC)


Columbus (OH)



Erie (PA)

Johnson City (TN)

Oklahoma City

(Continued) Locations ofCorporate Fraud Investigations

Slide 25


Corporate Fraud …

Is A National Problem

Slide 26

industry trends in current investigations








Cable TV


Industry TrendsIn Current Investigations

Slide 27

typical scenario
Typical Scenario
  • In far too many cases, accounting fraud began as a “one time act” to help meet the quarterly revenue targets.
  • However, the “just one time” syndrome perpetuates itself into future quarters until the fraud becomes out of control.

Slide 28

case study example
Case Study Example

Corporate Fraud:

Walter Pavlo’s Insider Perspective . . .

Slide 29


Case Study Example

Let’s look at an interview with Walter Pavlo . . .

Slide 30

  • Some corporate executives have compared accounting fraud to a gambling or drug addiction. Although they believe it can be stopped at any time, their circumstances dictate otherwise.
  • Phony accounting from prior periods combined with current losses has a snowball effect.

Slide 31

motives for corporate fraud
Motives For Corporate Fraud
  • Executive bonuses are tied to profits.
  • Executives maintain their prominent positions within the corporation.
  • Stock value remains artificially inflated based on phony financial performance indicators.
  • Personal greed is the underlying factor.

Slide 32

  • Corporate fraud has negatively impacted the financial services sector. Its effect on the banking, insurance, and securities industries undermines the fundamental core of the United States economy.

Slide 33

overall scope of corporate fraud
Overall Scope of Corporate Fraud
  • Not limited to any geographic area or market segment.
  • Despite media attention on several select companies, the FBI is currently pursuing 139 cases of corporate fraud.
  • Many companies are lesser known but effect on shareholders is the same.

Slide 34

corporate fraud investigations
Corporate Fraud Investigations
  • At least 16 cases with losses > $1 Billion
  • 50 cases with losses > $100 Million
  • Since January 2002 – 187 executives charged with corporate fraud violations.
  • 3-6 new cases opened each month

Slide 35

participants in corporate fraud vary but may include
Participants In Corporate Fraud Vary But May Include . . .
  • Chief Executive Officer
  • Chief Financial Officer
  • Line Accountants
  • Sales Personnel
  • Shipping Personnel
  • Corporate Attorneys
  • Collusive Customers

Slide 36

a common myth
A Common Myth
  • I work in a small local CPA firm. Corporate fraud is only a concern for the big, national accounting firms.
  • I have very few (or no) publicly-traded audit clients. Therefore, the issue of corporate fraud has no effect on my practice.

Slide 37

a common myth38
A Common Myth
  • Should You Be Concerned About Corporate Fraud . . .
    • Do you conduct audits?
    • Do your clients have employees?
    • Do you prepare tax returns?
    • Do you conduct forensic examinations?
    • Do outside parties rely on your client’s financial statements?
    • Do your clients transact business with other companies?

Slide 38

a common myth39
A Common Myth

If you answered “Yes” to any of these questions, you can be affected by corporate fraud.

Because . . .

Slide 39

why you should be concerned
Why You Should Be Concerned . . .
  • As you certainly know, audited financial statements have end users, like investors and creditors, who rely on them.
  • Employee theft and self-dealing is a corporate fraud violation.
  • Individual tax violations from self-dealing is corporate fraud.
  • One company may assist another company in committing accounting fraud if there’s an incentive.

Slide 40

role of the cpa
Role of the CPA
  • Independence remains a crucial element In conducting effective audits
    • Objectivity and professional skepticism are also important
  • CPAs must avoid placing themselves in the position of “protecting” a client under investigation.

Slide 41

role of the cpa42
Role of the CPA
  • A major public misperception of the CPA is that if a CPA performs a financial statement audit, he or she will detect any fraud that may exist.
  • While an auditor does have responsibilities for detecting material fraud, audits are conducted to issue an opinion on the fairness of the financial statements.

Slide 42


Statement on Auditing Standards No. 99:

“Consideration of Fraud

in a Financial Statement Audit”

what s new in the auditor s fraud detection responsibilities
What’s New in the Auditor’s Fraud Detection Responsibilities?
  • Evaluating how the entity responds to identified fraud risks
  • More emphasis on professional skepticism
  • Discussions among engagement personnel
  • Expanded inquiries of management and others within the entity.
  • Reorganized and modified fraud risk factor examples (the “Fraud Triangle”).
  • Expanded fraud risk assessment approach

Slide 45


What’s New in the Auditor’s Fraud Detection Responsibilities?

  • Expanded guidance on revenue recognition as a likely risk.
  • Linkage between identified risks and the auditor’s response.
  • Responses to address the risk of management override of controls.
  • Documentation (expanded requirements).

Slide 46

the sarbanes oxley act why how
The Sarbanes-Oxley Act: Why & How
  • Focused on restoring investor confidence by:
    • Placing greater accountability on corporate officers;
    • Forcing timely flow of information (both good new and bad news);
    • Forcing greater separation of duties between auditors, consulting, and management; and
    • Limiting self-regulation of the accounting profession and standards-setting process.

Slide 48

the sarbanes oxley act why how49
The Sarbanes-Oxley Act: Why & How
  • Pursues these goals by amending existing laws, or creating new ones, which:
    • Requires officers, under possible civil and/or criminal penalty, to certify accuracy and representation of its financial conditions, disclosure controls and procedures, and assess its effectiveness on internal control structure and procedures over financial reporting;
    • Requires quarterly review of internal controls;
    • Places limitations on audit firm’s ability to provide some services and requires board approval of all non-audit services; and
    • Brings PCAOB into existence.

Slide 49

the sarbanes oxley act why how50
The Sarbanes-Oxley Act: Why & How

In essence, it endeavors to restore investor confidence by changing the corporate mind-set and actions towards controls and disclosures.

Slide 50

the sarbanes oxley act of 2002
The Sarbanes-Oxley Act of 2002
  • Major Provisions
      • Creates a new criminal violation (18 USC 1348) for securities fraud schemes.
      • CEOs and CFOs must provide a Statement of Certification that the financial statements fairly present the financial condition of the company.
      • Provides increased jail sentences for executives who engage in corporate fraud.

Slide 51

the sarbanes oxley act of 200252
The Sarbanes-Oxley Act of 2002
  • Major Provisions
      • CPAs must retain audit workpapers for 5 years. Failure to do so is a criminal violation (18 USC 1520).
      • Several new amendments added to obstructive conduct.

Slide 52

the fbi response
The FBI Response
  • Corporate Fraud Hotline
      • Initiated February 2003: 888-622-0117
      • 2,000 calls logged to date
      • Callers can be anonymous
      • Several new cases opened based on caller information
      • Several existing cases were enhanced
      • Public cooperation is essential

Slide 53

the fbi response54
The FBI Response
  • Reserve Team
      • Consists of special agents and financial analysts with accounting skills.
      • Temporarily assigned to corporate fraud cases across the country to efficiently conduct investigation.
      • Emphasizes timely results through the use of seasoned investigators with strong interview & interrogation skills.

Slide 54

the fbi response55
The FBI Response
  • Accountants Are Essential
      • Currently 1,334 FBI Special Agent Accountants
      • 501 are Certified Public Accountants
      • 336 are FBI Financial Analysts
      • In the upcoming year, 15% of all new special agents hired will be accountants. Since its inception, the FBI has continuously hired accountants for diverse investigative roles.

Slide 55

the fbi response56
The FBI Response
  • Corporate Fraud Investigative Partnerships
      • Securities and Exchange Commission (SEC)
      • National Association of Securities Dealers (NASD)
      • U.S. Postal Inspection Service (USPIS)
      • U.S. Department of Labor
      • Internal Revenue Service
      • Commodity Futures Trading Commission (CFTC)
      • Federal Energy Regulatory Commission (FERC)
      • Defense Criminal Investigative Service (DCIS)

Slide 56

the fbi response57
The FBI Response
  • These investigative partnerships were formed to capitalize on agency expertise in areas like:
    • Securities;
    • Pensions;
    • Taxation;
    • Energy regulation; and
    • Government contracts

Slide 57

my client is under investigation
My Client Is Under Investigation
  • What you should know . . .
    • CPA firms of all sizes are affected.
    • FBI – CPA roles are NOT adversarial.
    • Expect subpoenas for workpapers.
    • Expect interviews of audit personnel.

Slide 58

continued my client is under investigation
(Continued) My Client Is Under Investigation
  • What You Should Know . . .
    • Client offices may be searched.
    • These are normal investigative procedures.
    • It is not the CPA’s role to protect a client in a criminal investigation.
    • Remember – independence still applies.

Slide 59

criminal justice and the cpa
Criminal Justice and the CPA
  • CPAs are hired by the government in accounting fraud cases. Their findings are important in identifying the extent of the fraud.
  • CPAs are hired by the government as expert witnesses in criminal trials.

Slide 60

criminal justice and the cpa61
Criminal Justice and the CPA
  • When providing assistance to the Government:
    • How did you document answers from key personnel during the audit?
    • Audit workpapers are valuable pieces of evidence. CPAs often document statements by corporate executives during an audit. These statements may later contradict the position of these executives in criminal cases.

Slide 61

Cooperatively . . .

The FBI and the CPA Profession can tackle corporate fraud. It’s in everyone’s best interest.

Slide 62


Upcoming Webcasts

General Audit Risk Alert Update

  • November 20, 2003 [1pm Eastern Time]
  • Join your fellow CPAs for this live, interactive Webcast that will help you gear-up for the changes that will impact your 2003-2004 audit engagements. This invaluable webcast is directly relevant to this year’s audit engagements and will explain how to:
  • More effectively plan and perform 2003/2004 year-end audits.
  • Identify emerging practice issues and information about current accounting, auditing, and professional developments.
  • Achieve a more robust understanding of the impact of the current business and economic environment on audit engagements.
  • Identify the significant risks that may result in the material misstatement of an organization’s financial statements.
  • Auditors currently planning and executing year-end audits will find this program timely and directly relevant to this year’s engagements.Learn about the key issues that lie ahead and get your most important questions answered by leading authorities . . . all just in time for the year-end audit season!
  • Check it out at

Slide 65


Upcoming Webcasts

Compilation & Review Risk Alert – Strategic Briefing

  • December 3, 2003 [1pm Eastern Time]
  • Led by recognized experts on Compilation and Review engagements, Russell Madray, CPA, and Kurt Oestriecher, CPA, this 2-hour LIVE webcast will cover these topics:
  • Unique issues related to this year's Compilation & Review engagements
  • New SAARS Interpretations, including Business Valuation, Reporting on Omissions of Comprehensive Income and Financial Statement Disclosures as well as Reporting on Financial Statement Elements.
  • SSARS 9 & SSARS 8 and the "Management Use Only" compilation
  • Controllership services
  • Engagement communication requirements
  • Effect of recently issued audit standards
  • Other accounting and reporting issues
  • Peer review issues
  • Management Representation letter for review engagements
  • Join the thousands of CPAs who already have participated in an AICPA webcast and you’ll see why they are a TERRIFIC way to stay current on today’s professional issues.
  • Check it out at

Slide 66


Upcoming Webcasts

SEC Quarterly Update Webcast Series

Sponsored by the AICPA and

  • December 17, 2003
  • March 16, 2004
  • June 17, 2004
  • September 21, 2004

For a complete listing and description, check out:

Slide 67


Upcoming Webcasts

CFO Roundtable Webcast Series

Sponsored by the AICPA and

  • February 12, 2004
  • May 18, 2004
  • August 12, 2004
  • November 18, 2004

For a complete listing and description, check out:

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