Koss Corp: Anatomy of an Alleged $31 Million Fraud
Jan 18th 2010 11:00AM
Updated Jan 18th 2010 2:14PM
Who is to blame for the fraud allegations rocking Koss Corp (KOSS). Well, obviously the people who allegedly misappropriated millions from the stereo-headphone maker's bank accounts or helped them in the scheme. Sujata "Sue" Sachdeva, the company's former vice president of finance and secretary, was arrested on Dec. 21 for allegedly using interstate wire communications to defraud Koss. Beyond that, the blame should be cast on the other executives at Koss who should have been paying more attention to the company's finances.
How does an alleged $31 million fraud at a company, with sales in the range of $40 million to $45 million, go undetected for years? As I explain in this news report, Sachdeva likely had far too much autonomy in the finance function. She was likely well aware of what the other executives and the auditors were (or were not) looking at, and allegedly perpetrated her scheme accordingly.
Still, many people seem to think that Grant Thornton, the independent auditors at Koss, should have found this alleged fraud long ago. That might sound good, but that opinion doesn't really reflect the reality of auditing financial statements.
A financial statement audit is not designed to detect fraud. If the auditors come across information that leads them to suspect fraud, they're required to follow up on that issue. But their work is not primarily directed at finding fraud. Their job is to check the math and the application of accounting rules only.Holding The Auditors Responsible
Many people have asked, "Why don't auditors change their audits so that they do find fraud?" They could. They might do that in the future. But that's not the reality today, and executives of companies know this is not the purpose of an audit.
If management is serious about finding fraud, they're free to hire the auditors to do work above and beyond the audit. They're free to hire other professionals such as fraud investigators to do other work at the company to manage the risk of fraud. Koss didn't do that, and neither do many, many companies.
So the blame needs to be put squarely on the shoulders of company management. Much has been written about internal controls and how better controls at Koss would have led to an earlier discovery of Sachdeva's alleged fraud. Under the current Sarbanes-Oxley rules, Koss was not required to have Grant Thornton examine their internal controls. But they could have voluntarily done so, and they did not.
Is Legislation The Answer?
Believe me, Sarbanes-Oxley is not the wonderful piece of legislation many would have you think it is. It really does not attack fraud head on. It merely serves as window-dressing to make the public believe that our government is serious about eradicating fraud at public companies.
Sarbanes-Oxley hasn't actually reduced fraud. The Association of Certified Fraud Examiners reported the following in their 2008 Report to the Nation on Occupational Fraud and Abuse (bold added by me):
Sarbanes-Oxley was passed in response to several large financial statement fraud schemes, and, as such, the Act mandates the implementation of specific controls targeted toward preventing and detecting financial statement manipulation. Accordingly, we analyzed the impact of SOX-related controls in all reported cases of financial statement fraud in our study. We found that the presence of these controls was not correlated to a decrease in the median loss for financial statement fraud schemes; in fact, for all controls except hotlines, the converse was true. Organizations with these controls in place experienced greater fraudulent financial statement manipulations than organizations lacking these controls. Additionally, organizations that had independent audit committees and those whose management certified the financial statements actually took longer to detect the fraudulent financial misstatements than their counterparts without such controls.
Concealing The Fraud
But let's get back to the fraud charge at hand. How does someone allegedly steal $31 million from a company the size of Koss without anyone noticing? Again, it is Sachdeva's familiarity to the level of oversight of her that would allow her to conceal her alleged fraud effectively.
And as with most frauds, allegedly Sachdeva started relatively small and increased her alleged theft over the years. Koss reported the following alleged theft figures for each fiscal year:
2005 - $2,195,477
2006 - $2,227,669
2007 - $3,160,310
2008 - $5,040,968
2009 - $8,485,937
2010 - $10,243,310 (two quarters)
I've been saying all along that it's likely she hid the alleged theft in the cost of goods sold. It is relatively easy to explain rising material costs, and the auditors wouldn't know enough about the industry to question that contention. So each year the alleged theft (buried in expense accounts) goes up by an amount that doesn't raise a lot of suspicions for the auditors, but the other executives should have been curious enough to look further.
The auditors' work is based on the representations of the CFO or VP of Finance and finance department, who are often the ones committing the fraud. The auditors really have no choice. Who else would they turn to with financial questions? And the finance personnel know exactly what answers will pacify the auditors or point them away from the fraud.
Blame management at Koss Corp. for not having a better handle on what their VP of Finance was allegedly doing.
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.