The news keeps getting worse at embattled stereo-headphone maker Koss Corp. The Milwaukee company now fears that the amount that disappeared from its coffers is closer to $31 million, according to a filing by CEO Michael Koss with the U.S. Securities Exchange Commission. The company last month fired Vice President of Finance Sujata "Sue" Sachdeva after a federal court alleged she embezzled Koss funds to cover credit-card charges for furs and jewelry, among other items. The losses that go back to at least 2005 were initially estimated at $4.5 million a couple of weeks ago. No one is saying if the company is even close to uncovering all of the alleged wrongdoing.%%DynaPub-Enhancement class="enhancement contentType-HTML Content fragmentId-1 payloadId-61603 alignment-right size-small"%% The board of directors at Koss fired the company's auditors, Grant Thornton, in the wake of this scandal. It is quite common for companies to change auditors once a situation like this is discovered, so this action doesn't necessarily indicate that the company thinks GT did anything wrong.
Is The Company Blame-Shifting?
However, a move like firing the auditors often has a side benefit to management, giving the impression that the auditors are at least partly responsible for the losses. This subtle blame-shifting may certainly be an effective PR tactic, but investors and other interested parties should not be lulled into thinking the problems are over. GT is trying to clear their name by pointing out that they were never hired to evaluate the company's internal controls, and it is a deficiency in those controls, which is to blame for the alleged embezzlement.
It is important to understand what a financial statement audit is and is not. The general public, and even sophisticated investors, are often mistaken about what an independent audit is supposed to do. The auditors are simply there to check the math and make sure that the accounting rules have been properly applied. They are not there to uncover fraud, and the truth is that financial statement audits rarely do uncover fraud.
An audit involves testing transactions to see if the company is following the accounting rules. A relatively small sample of transactions is tested by the auditors, and if the sample checks out, the rest of the transactions are assumed to be proper as well.
Firing Grant Thornton Does Little Good
It should be obvious how an embezzlement or financial statement fraud can slip past the auditors. Manipulations are not found if they are carefully (or sometimes not so carefully) hidden within the books and records. Audits tend to become standardized from year to year, so the accounting personnel at the company often know exactly what to expect.
They're well aware of the types of transactions the auditors will be testing. The goal of the person committing fraud is to hide the fraud in transactions and accounts that won't be scrutinized by the auditors. And if the auditors do happen to question a transaction related to the fraud, accounting personnel often know what kinds of answers and documentation will throw them off the scent.
Firing the auditors at Koss really does nothing other than get a new set of auditors in, and sometimes a fresh set of eyes can find problems and opportunities. It does nothing to correct the problem of the fraud itself, however.
The Danger of Too Much Autonomy
In the case of Koss, it appears that Sachdeva was a highly trusted employee. She had been with the company for 17 years, and was likely given a lot of autonomy in her function as the head of the company's finance team. Too much autonomy is dangerous for an executive at any company. Checks and balances (called "internal controls" in accounting-speak) need to be in place so that other executives and the board of directors are involved in the accounting function on some level. If there had been greater oversight, it's likely that any alleged fraud would have been uncovered much sooner.
Maybe the alleged fraud wouldn't have happened at all. With the current estimate of $31 million allegedly stolen over a five-year period, that's an average of more than $500,000 a month that was allegedly being wired from the company's bank account to pay Sachdeva's personal credit-card bills. Anyone conducting alleged transfers of this size would have to be awfully confident that no one else was looking at the bank records, as transfers so large typically would be noticed.
I expect the total loss from this fraud to go higher than the most recent report. It's just the nature of the beast.
Tracy L. Coenen, CPA, MBA, CFE is a fraud examiner and forensic accountant who investigates corporate fraud and consumers scams, and is the author of Essentials of Corporate Fraud and Expert Fraud Investigation: A Step-by-Step Guide.
Introduction to Value Investing
Are you the next Warren Buffett?View Course »