DailyFinance.comhttp://www.dailyfinance.comDailyFinance.comhttp://o.aolcdn.com/os/df/2013/img/2-dailyfinance_logo_m.pngDailyFinance.comhttp://www.dailyfinance.comen-usCopyright 2013 Weblogs, Inc. The contents of this feed are available for non-commercial use only.Blogsmith http://www.blogsmith.com/Fraud Files: Plenty of Blame to Go Around in the Madoff Casehttp://www.dailyfinance.com/2011/02/23/fraud-files-plenty-of-blame-to-go-around-in-madoff-case/http://www.dailyfinance.com/2011/02/23/fraud-files-plenty-of-blame-to-go-around-in-madoff-case/http://www.dailyfinance.com/2011/02/23/fraud-files-plenty-of-blame-to-go-around-in-madoff-case/#commentsFiled under: ,

Although it has been more than two years since Bernie Madoff's gigantic Ponzi scheme collapsed, the case is still making headlines. And it seems there's plenty of blame to go around. The only question is who will be left standing in this game of musical chairs? Many of the players are jockeying for position, hoping to recover some money from other parties who might be deemed partly responsible for the fraud.

One target is JPMorgan Chase. It had money invested in hedge funds that had ties to Madoff, and Madoff bankruptcy trustee Irving Picard has sued the bank for $6 billion. The lawsuit against Chase (JPM) says warning signs existed, but the executives just ignored them while earning hundreds of millions of dollars. Chase employees notified regulators of their concerns in late 2008, but it's thought that company personnel knew about issues much earlier than that. Madoff himself says banks and hedge funds were "complicit" in his fraud. I doubt anyone takes anything Madoff says seriously these days because the world knows him only as a conman.

Swiss bank UBS AG is being sued by the Madoff bankruptcy trustee for $2.5 billion. It is alleged UBS (UBS) "capitalized on the Ponzi scheme in the face of clear indications of fraud." The bank put $1 billion into Madoff's fraud, and allegedly received extraordinary returns on those funds. HSBC Holdings Plc is being sued for $6 billion, with Picard claiming HSBC knew about fraud concerns surrounding Madoff but did nothing to protect investors. The trustee adds that HSBC saw "warnings and other obvious badges of fraud" that should have caused them to act.

Estates and Individuals Sued, Too

The estate of Norman F. Levy settled with Picard for $220 million last year. Levy was reportedly a "surrogate father" to Madoff, and allegedly deposited and withdrew money from Madoff's funds in a much larger volume than anyone else. More than $83 billion allegedly went in and out of Levy's account with Madoff, and some say Madoff's access to this cash flow allowed the Ponzi scheme to flourish for so long. A settlement of $7.2 billion was secured from the estate of Jeffry Picower, representing the profits Picower received from his investments with Madoff. Of that amount, $5 billion will go to the bankruptcy trustee, while the remainder will go to the U.S. Attorney's Office in Manhattan.

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Sonja Kohn, head of Bank Medici in Austria, is accused of sending $9.1 billion of investors' money to the Madoff funds, participating in what a lawsuit calls a "criminal relationship" with Madoff. Carl Shapiro reached a $625 million settlement with the Madoff trustee, although it was alleged he profited more than $1 billion from his investments with Madoff.

The New York Mets and its owner Fred Wipon were drawn into the battle over the Madoff fraud. A lawsuits alleges the Mets Limited Partnership invested $523 million with Madoff, but later withdrew $571 million. That $48 million profit is now being targeted. In total over 100 lawsuits now seek recovery of funds from many Madoff investors.

Who Really Missed the Fraud?

What's the funniest part of all these allegations? Many of the victims are finger-pointing, saying each of these parties should have known Madoff was committing fraud. Meanwhile, the Securities and Exchange Commission -- the supposed watchdog for investors -- was ignoring all the evidence it had of the fraud. Harry Markopolous notified the SEC of his concerns about Madoff several times, providing detailed narratives that supported his allegations of fraud. He offered to help the SEC understand his allegations and verify what he was saying. The agency summarily rejected him -- either through incompetence, corruption or both.

I have a hard time accepting the idea that the SEC is going to "get tough" on swindling of investors. Its track record is poor, and it often seems like there's no rhyme or reason to who the SEC decides to pursue. The agency couldn't catch a fraud that was happening on a grand scale right in front of it, even when it had someone (Markopolous) who did all the hard work and analysis proving that Madoff couldn't possibly be legitimately generating the investment returns he claimed.

It has been said that government agencies are even considering criminal action against some of the Madoff investors. Apparently, they're being accused of knowing they were involved in a Ponzi scheme, such that their continued deposits of cash might make them criminally liable for the fraud.

Don't Hold Your Breath

I've got an idea: How about if the people at the SEC who rejected Markopolous's analysis and evidence are prosecuted criminally? They had at least as much information as the Madoff investors, and probably more. Let's hold them accountable for the failure to stop the fraud scheme years before it finally collapsed.

But something tells me the SEC won't be too keen to prosecute its own people and that other law-enforcement agencies won't want to take them on, either.


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]]>bernie madoffColumnscorruptioncrimeinvestment scandalponzi schemeTracy CoenenWed, 23 Feb 2011 10:00:00 ESTFraud Files: Is Ernst & Young to Blame in Lehman Bros. Fraud?http://www.dailyfinance.com/2010/12/23/fraud-files-is-ernst-and-young-to-blame-in-lehman-bros-fraud/http://www.dailyfinance.com/2010/12/23/fraud-files-is-ernst-and-young-to-blame-in-lehman-bros-fraud/http://www.dailyfinance.com/2010/12/23/fraud-files-is-ernst-and-young-to-blame-in-lehman-bros-fraud/#commentsFiled under: ,

New York Attorney General Andrew Cuomo has slapped Big Four audit firm Ernst & Young with civil fraud charges for its alleged role in the collapse of Lehman Brothers. The theory is simple: Lehman Brothers committed a massive accounting fraud, and E&Y went along with it when they signed clean audit opinions.

The press release from the Attorney General's office puts it nicely, saying that E&Y helped " . . . Lehman Brothers Holding, Inc. ('Lehman') engage in an accounting fraud involving the surreptitious removal of tens of billions of dollars of fixed income securities from Lehman's balance sheet in order to deceive the public about Lehman's true liquidity condition."

The clean audit opinions were a longstanding tradition, as E&Y audited Lehman brothers from 2001 until its bankruptcy filing in 2008. During that time, E&Y reportedly earned more than $150 million in fees from Lehman Brothers. The suit is asking for those fees to be returned, plus damages.

Too Big to Fail?

There is no shortage of opinions about the case. Those on the side of the attorney general say that E&Y should be held responsible, at least civilly, for not blowing the whistle on shady accounting practices at Lehman Brothers. It is alleged that E&Y helped cover up the ailing financial condition of the company by sitting by while Lehman used "Repo 105" transactions to improperly make its balance sheet look better.

And those on the side of Ernst & Young are suggesting that the audit firm shouldn't be held responsible for the bad actions of Lehman Brothers. Some people are even saying that E&Y should be considered "too big to fail," saying that if we lose one of the Big Four, all hell could break loose because there just won't be enough large audit firms. (Let me assure those who subscribe to this notion that indeed, there are plenty of audit firms willing and able to step up and take on new clients.)

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E&Y's defense is straightforward. They say that the transactions in question were recorded in accordance with Generally Accepted Accounting Principles (GAAP), and the clean audit opinion was therefore justified. E&Y's attorneys will likely argue that when the Repo 105 transactions happened, the firm was not required under the accounting rules to disclose them. The auditors contend they did nothing wrong, and the collapse of Lehman was not their fault. They say the financial statements properly showed that Lehman Brothers was highly leveraged and operating in a very volatile and risky industry.

The truth behind the Repo 105 transactions might not be as simple as everyone wants to make it seem. Apparently, Lehman had to route Repo 105 transactions through a British affiliate because no law firm in the United States would offer a legal opinion on the accounting treatment Lehman wanted to use. A British law firm, however, approved Lehman's accounting treatment under English law.

Dig further, and you find that E&Y did not actually audit any of these Repo 105 transactions, according to the bankruptcy examiner's report. Even worse, E&Y told the examiner that it didn't even look at whether the volume of Repo 105 transactions was material to Lehman's balance sheet and net leverage ratio. E&Y personnel claimed that they only agreed to the accounting treatment applied to the transactions, but didn't actually look at the transactions themselves, their overall impact on the financial statements, and the real reason why they were used.

An "Accounting Gimmick"

According to the bankruptcy examiner, a strong argument can be made that the only reason Lehman Brothers used Repo 105 transactions was to manipulate the balance sheet. Internally, Lehman employees apparently referred to these transactions as an "accounting gimmick" and a way to manage the balance sheet. And that trick was apparently a house of cards that would inevitably fall.

Should the auditors be held responsible for the bad actions of Lehman Brothers? It's not an easy question to answer, but based on the above, my gut reaction is that E&Y didn't do enough.

Simply signing off on a theoretical accounting treatment, and not examining any of the transactions or their materiality to the financial statements doesn't seem to meet the professional standards to which auditors must adhere. Auditors must have sufficient, competent evidence to support their audit opinions, and that seems to be lacking in the Lehman Brothers case.

Audits offer a relatively low level of assurance on the financial statements. Put kindly, audit reports are of limited usefulness for a whole slew of reasons, and they're only useful in any respect when the audit is done right. The investing public really can't rely on auditors' reports to give them much comfort, and the case of Lehman Brothers is a prime example of why.

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]]>accounting fraudAndrew CuomoauditorsBig FourColumnsErnst YoungfraudlawsuitLehman BrothersNew York Attorney GeneralRepo 105Tracy CoenenThu, 23 Dec 2010 09:00:00 ESTFraud Files: FCPA Enforcement Will Continue to Be Costly ... and Unpredictablehttp://www.dailyfinance.com/2010/11/26/fraud-files-fcpa-enforcement-will-continue-to-be-costly-and/http://www.dailyfinance.com/2010/11/26/fraud-files-fcpa-enforcement-will-continue-to-be-costly-and/http://www.dailyfinance.com/2010/11/26/fraud-files-fcpa-enforcement-will-continue-to-be-costly-and/#commentsFiled under:

One major worry for American companies doing business overseas is the Foreign Corrupt Practices Act (FCPA), a 1977 federal law that prohibits the bribing of foreign officials. Those familiar with this regulation know it has many pitfalls, and even the most careful companies can run afoul of the law due to the actions of their employees.

FCPA enforcement isn't new, but in recent years, such corporate misbehavior is receiving more attention and increased enforcement, which is making executives nervous. Violations can mean both civil and criminal penalties for companies and their executives, and the monetary costs can be huge. Beyond the price of defending itself against a government investigation, a company with FCPA violations will pay penalties and incur ongoing costs for remediation and monitoring of activities.

It's not a stretch to suggest that the federal government may have increased its vigilance on the corporate bribery front lately due to the possibility of bringing in billions of dollars through FCPA enforcement. Or perhaps the Obama administration is just more interested in ensuring good, clean business operations by U.S. companies. Either way, Lanny Breuer, assistant attorney general for the Criminal Division of the Justice Department, has declared publicly that FCPA enforcement is a priority.

In a recent speech, Breuer said: "One year later, I'm proud to say that our FCPA enforcement is stronger than it's ever been - and getting stronger. To give you just one metric, in the past year, we've imposed the most criminal penalties in FCPA-related cases in any single 12-month period - ever. Well over $1 billion." In 2009 and 2010 alone, the Department of Justice charged more than 50 individuals with FCPA violations and collected almost $2 billion.

Recent Settlements Make the FCPA a Bit More Predictable

The government is encouraging violators of the law to self-report, saying that cooperation by defendants earns them lighter sanctions, and the DOJ is going out of its way to prove that self-reporting is rewarded. However, it has been hard to find clear-cut evidence that cooperation with the government actually results in a measurable positive impact on the violators.

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A big worry for businesses regarding the FCPA is its unpredictability: Many contend that enforcement is inconsistent. Butler University business law professor Mike Koehler (known as the "FCPA Professor") recently published an article titled The Facade of FCPA Enforcement. He says that while this law is very important in terms of what can happen to companies, because the outcomes are unpredictable and the legal theories used in the enforcement process are inconsistent, companies often end up at the mercy of the government with no way to determine what the outcome may be.

Simply put, Koehler says, FCPA enforcement isn't transparent because so much of it has developed based on privately-negotiated agreements between the government and the violators. As a result, companies are uncertain about whether their compliance efforts are sufficient, and tend to overspend in order to mitigate the unknown risk.

The government's recent settlements with Panalpina and six other companies for FCPA violations took a step in the right direction toward transparency. Each settlement included documents detailing best practices for corporate compliance programs. Finally, the government is giving American companies a better idea of what it's looking for in terms of internal corporate controls and procedures related to FCPA compliance.

Beyond those best practices guidelines, about the only thing that companies can count on in the FCPA realm is that enforcement will continue to be a focus for the Justice Department. Whether that's because the Obama administration desires more ethical business dealings on the part of American corporations, or because the government is in need of the cash it can bring in by penalizing the offenders hardly matters: The DOJ is watching -- carefully.

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]]>best practicesbriberyColumnscompliancecorruptionDOJenforcementfcpaFCPA complianceforeign corrupt practices actfraud filesJustice DepartmentLanny BreuerMike KoehlerObamaObama AdministrationTracy CoenenTracy CoenenFri, 26 Nov 2010 12:00:00 ESTFraud Files: When 'Immaterial' Financial Errors Hide Real Problemshttp://www.dailyfinance.com/2010/10/04/fraud-files-immaterial-financial-errors-hide-real-problem/http://www.dailyfinance.com/2010/10/04/fraud-files-immaterial-financial-errors-hide-real-problem/http://www.dailyfinance.com/2010/10/04/fraud-files-immaterial-financial-errors-hide-real-problem/#commentsFiled under: , , ,

Fraud Files: When 'Immaterial' Financial Errors Hide Real ProblemsPick a random handful of SEC filings in which public companies disclose errors or irregularities in their previously reported numbers, and it's a good bet that you'll see the word "immaterial" more than once. When companies use that word, what they're trying to say is that their numbers were wrong by such relatively small amounts that the errors don't really matter.

But there's a big problem on Wall Street: Many times, companies improperly label their errors immaterial when they aren't. Sure, the numbers involved might be small in relation to the overall revenues of the company, but the size of an error isn't all that counts when it comes to determining what is -- or is not -- material.

Take, for example, our friends at Citigroup (C). In July, Citigroup disclosed that it "misclassified" $9 billion of its debt as sales. Doing so made the bank's balance sheet look better, and it's not uncommon for banks to shift around debt just prior to a reporting period to make things seem rosier. But Citigroup says what it did was unintentional, and notes that "[t]he impact of these transactions was never large enough to have a material impact on Citigroup's financial statements or our published regulatory capital ratios, including our leverage ratios."

I don't disagree that $9 billion may be a small figure relative to Citigroup's overall financials, but I can argue that the substance behind the booking of the transactions likely makes them material. The SEC makes it clear that materiality cannot be addressed only in numeric terms. The qualitative aspects of the situation must also be considered. The SEC says:
"But quantifying, in percentage terms, the magnitude of a misstatement is only the beginning of an analysis of materiality; it cannot appropriately be used as a substitute for a full analysis of all relevant considerations. Materiality concerns the significance of an item to users of a registrant's financial statements. A matter is "material" if there is a substantial likelihood that a reasonable person would consider it important."
For example, suppose the CFO of a company gets caught stealing $10,000 via his expense reports. The company's annual revenue is $1 billion, so in comparison, this theft is a minuscule amount. However, the situation must be analyzed further. The fact that a company's head of finance is committing theft is certainly important, and likely has implications for the finance and accounting functions within the company as a whole. If an executive is dishonest with $10,000, isn't there a high likelihood of dishonesty in other financial matters? That alone makes the situation material to the company.

Small Shifts Can Turn a Loss Into a Profit

If we look again at the situation at Citigroup, we see that we cannot only consider the dollars at stake in their alleged accounting mistake, but we must also evaluate other factors surrounding the financial statements before making a sweeping generalization that the error was immaterial.

Two of the points that the SEC says must be considered in evaluating materiality are:
  • whether the misstatement masks a change in earnings or other trends, and;
  • whether the misstatement hides a failure to meet analysts' consensus expectations for the enterprise.
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This aspect of the test is where companies often make a mistake in their claims that an error or irregularity is immaterial. A dollar figure may be relatively small, but when it's large enough to "help" a company beat expectations or change the trend from a series of quarterly losses into a quarterly profit, then it becomes material.

Companies have relied too long on the excuse that a transaction was too small to matter. Look at the case of Overstock.com (OSTK). There is a lengthy, documented history of accounting irregularities at the company since 2000. In the fourth quarter of 2008, Overstock improperly reported revenue, and therefore overstated earnings by a relatively tiny amount. However, that small overstatement was large enough to cause Overstock to report a profit, rather than the loss that should have been reported.

More recently, Green Mountain Coffee Roasters (GMCR) disclosed an accounting error that caused the company to overstate its net income by a cumulative $4.4 million or $0.03 per share since 2007. The company says that this amount is not material, but when you consider that the SEC recently opened in inquiry that the company believes is related to its revenue recognition practices, it might not be so immaterial after all.

What is the lesson to be learned from this? Don't rely on public companies' assertions that their accounting shenanigans ... er, "errors" ... don't matter. Don't automatically believe management when they say those so-called mistakes are immaterial. Evaluate all of the information surrounding the errors and adjustments, and make your own call about whether a given financial misstatement really matters. Many times, it does.

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]]>accountinganalyst expectationsanalystsanalysts expectationsCFoColumnscorrectionCorrectionsfinancial statementsfraudfraud filesimmateriallossesprofitsquarterly earningsquarterly reportsquarterly resultsrevenuerevenuessecSEC FilingSEC filingsSecurities and Exchange Commissiontracey coenenTracy CoenenMon, 04 Oct 2010 14:00:00 ESTFraud Files: HP's Culture of Corruption Lives Onhttp://www.dailyfinance.com/2010/08/09/fraud-files-hps-culture-of-corruption-lives-on/http://www.dailyfinance.com/2010/08/09/fraud-files-hps-culture-of-corruption-lives-on/http://www.dailyfinance.com/2010/08/09/fraud-files-hps-culture-of-corruption-lives-on/#commentsFiled under: , , ,

If the scandal surrounding former Hewlett-Packard (HPQ) CEO Mark Hurd's resignation has taught us anything, it's this: Dishonesty pays at HP -- if you hold a high enough position, that is.

On Friday, the company announced that Hurd resigned following an independent investigation regarding a sexual harassment complaint involving an independent contractor. But then, the story got much juicier.

It turns out that HP's press release, which said Hurd merely violated HP's Standards of Business Conduct, was misleading. What the release didn't tell us is that the sexual harassment complaint wasn't the real reason Hurd was resigning, nor that he was going to receive almost $28 million for the noble act of stepping down. (Apparently, that is HP's idea of a punishment. After all, it's far less than the $100 million contract Hurd was in the process of negotiating.)

Meanwhile, even more details have emerged about Hurd's infractions. It appears that he lied on his expense reports to get HP to pay for personal dinners with a lady friend named Jodie Fisher. He also got the company to pay Fisher for work she didn't do. That, my friends, is fraud.

Does anyone want to guess whether there is even more to this story? The fact that the "victim" of the sexual harassment complaint, is a D-list actress, has been paid off by Hurd, and has hired attorney-to-the-mistresses Gloria Allred leads me to believe there is even more drama to come.

A Culture of Corruption

This situation isn't the only public scandal HP has endured. In 2006, HP's chairman of the board, Patricia Dunn, resigned after it was discovered that she hired outside contractors to spy on board members and journalists. HP can't seem to escape big headlines about scandals, and it would do investors and the public well to pay attention.

As a forensic accountant and fraud investigator, I've seen fraud at hundreds of companies, ranging from small family-owned businesses to large public companies. Fraud is never pretty. But it's even uglier when companies are doing things that create a culture of corruption, opening the door for fraud to occur over and over again.

The propensity of employees to commit fraud is dictated by the tone at the top. Whether we like it or not, employees look to those above them for cues about appropriate workplace behavior, and that includes fraud. When everyone knows that the boss does personal business on company time, it makes it easier for them to justify doing the same thing. If managers are stealing equipment, their in-the-know subordinates are likely to do the same. Monkey see, monkey do.

Rewarding Bad Behavior

In this case, when the head of the company steals via expense reports, and the company pays him millions on his way out the door, the message it sends to the employees is that stealing is okay. How could it send any other message?

Of course, lower level employees know that if they're caught stealing, they might get unceremoniously shown the door without a penny in severance. They aren't delusional enough to think that they merit millions of dollars as a parting gift. But they still realize that the company is going to allow a certain amount of fraud. So long as they stay under that limit, they are almost assured of keeping their jobs and fitting right in.

Rewarding bad behavior has consequences. And those watching the HP scandal unfold ought to heed this warning: The culture of corruption at HP is alive and well. This is neither the first, nor the last scandal for HPs management, I'm sure. I've seen enough fraud to know that when the company condones and rewards such behavior, the behavior grows in frequency and in magnitude.

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]]>business conductBusinessConductColumnsexpense reportfraudgloria allredhewlett-packardhphp scandalHurd expense reportjodie fishermark hurdTracy CoenenMon, 09 Aug 2010 12:30:00 ESTFraud Files: As FCPA Enforcement Grows, Let the Briber Bewarehttp://www.dailyfinance.com/2010/07/30/fraud-files-fcpa-enforcement-bribery/http://www.dailyfinance.com/2010/07/30/fraud-files-fcpa-enforcement-bribery/http://www.dailyfinance.com/2010/07/30/fraud-files-fcpa-enforcement-bribery/#commentsFiled under: ,

Fraud Files: FCPA Enforcement BriberyThe federal government has been cracking down on fraud and corruption, and one of the better weapons in its arsenal is the Foreign Corrupt Practices Act (FCPA), which makes it illegal for companies to pay foreign officials to get or retain business.

The government has been stepping up FCPA enforcement actions: More than three times as many FCPA cases were brought in 2009 than were filed in 2005. The Securities and Exchange Commission has created a dedicated FCPA unit, and added attorneys and supervisors accordingly.

It's fairly straightforward to say that bribing foreign officials to seal deals is strictly prohibited, but the application of the law to everyday business abroad isn't necessarily as simple as it sounds. Companies must carefully analyze how they are doing business in foreign countries and ensure that nothing resembling a bribe is allowed to happen.

In that vein, companies are spending lots of money on FCPA compliance, not only to monitor their own activities overseas, but also to ensure that they have good internal controls that allow them to maintain accurate accounting records.

Meanwhile, some big companies have been making headlines with their settlements of FCPA investigations and massive monetary penalties. Among them:

Why Worry About Bribes? Follow the Money

Why does our government even care if companies are engaging in bribery and corrupt activities outside the U.S.? In 1977, when the FCPA became law, the goal was to bring integrity back to business by stopping the bribery of foreign officials. In keeping with that tradition, the recent increase in FCPA enforcement actions could be because of a suspected increase in corrupt activities related to more global businesses.

But some now are suggesting that our government is so keen on pursuing allegations of bribery overseas because it is so lucrative. Companies are generally responsible for doing their own investigations and reporting the results to the government. Those investigations are done on the company's dime, and if malfeasance is found, the government gets to impose large monetary sanctions. This means little investment is required on the part of the government to net it huge returns via fines and disgorgements of earnings.

Companies can't afford to ignore this issue, from either a financial or public relations perspective. So, how can they avoid the many landmines surrounding FCPA compliance? The first step is to accept that the law is tricky and recognize that the government is on the warpath. If executives don't want FCPA issues to keep them awake at night, they must be willing to focus time, efforts, and money on compliance.

Compliance programs to educate employees about the FCPA are important -- and not just when they succeed in preventing wrongdoing: Having such a program can help a company get a reduced penalty if it's found to be in violation of the FCPA. Companies must also proactively search for violations of FCPA, and the use of independent legal counsel to conduct investigations can mitigate penalties as well.

At this point, it would be foolish to hope that the federal government will back off on FCPA enforcement actions; in fact, they are likely to escalate further. The Dodd-Frank Wall Street Reform and Consumer Protection Act creates a whistle-blower program offering 10% to 30% of fines collected in order to encourage people to report FCPA violations.

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]]>bribebriberyColumnsDaimlerdieboldDisgorgefcpaFCPA compliancefinesforeign corrupt practices actforeign governmentsgeneral electricTracy CoenenFri, 30 Jul 2010 11:00:00 ESTFraud Files: How Well Does Sarbanes-Oxley Reduce Fraud Risk?http://www.dailyfinance.com/2010/07/16/fraud-files-how-well-does-sarbanes-oxley-reduce-fraud-risk/http://www.dailyfinance.com/2010/07/16/fraud-files-how-well-does-sarbanes-oxley-reduce-fraud-risk/http://www.dailyfinance.com/2010/07/16/fraud-files-how-well-does-sarbanes-oxley-reduce-fraud-risk/#commentsFiled under:

The 2002 Sarbanes-Oxley law was supposed to protect investors from fraud.For most Americans with an interest in the business world happenings, the story of the $31 million fraud allegedly perpetrated by Koss Corp.'s vice president of finance, Sujata Sachdeva, was of interest for only a brief period. The story was sexy because the company's annual sales average between $40 million and $45 million. Clearly, a $31 million fraud is huge in comparison to annual revenue, even if the fraud was perpetrated over a period of more than five years.

Beyond the initial shock value, however, little interest remained in the story unless you live in the metro Milwaukee area, where Koss is located. I urged executives to learn some lessons from the situation and tighten up controls at their companies. Do I really think many of them did so? Of course not.

Can't Happen Here

Executives often have the mentality that the "bad stuff" doesn't happen at their company. Averages apply to other companies, and the typical corporate theft or embezzlement happens elsewhere. My work is living proof that this is not the case, and companies find out all too late that a little more diligence on the front end could have prevented a large theft.

In steps Sarbanes-Oxley, the 2002 legislation that was supposed to protect investors from fraud by requiring companies to be more diligent in creating and maintaining internal controls and by forcing public company auditors to work harder. Tangible benefits from the legislation are elusive. People would like to think that the legislation has forced companies to have better internal controls, and therefore fraud risks are reduced. Yet there is no real evidence that fraud risk or actual fraud has been reduced because of Sarbanes-Oxley.

The news this week surrounds Section 404 of the Sarbanes-Oxley Act of 2002. This section dictates what companies must do relative to assessing their internal controls. Until now, public companies with a market capitalization under $75 million (referred to as non-accelerated filers) don't have to comply with this section of the legislation. This exemption was created because of the costs of complying with Section 404. Documenting the internal controls process and having the company's outside auditors examine those controls is extremely expensive, and was thought to be disproportionately expensive for smaller companies.

Small-Company Exemption

It looks as if smaller public companies will continue to be exempt from this portion of Sarbanes-Oxley, and of course, there is a debate about whether this is wise. I can't argue against the idea that more focus on controls probably leads to more reliable financials and a decreased risk of fraud, but I can argue that more legislation isn't the answer to this problem.

Companies with dishonest or incompetent executives will have fraud problems no matter what the legislation says. Would Koss have been spared a $31 million fraud if they were subject to more regulations? Maybe. But I'd suggest that a company with executives asleep at the wheel (and to an extreme degree at Koss) will always have fraud problems no matter what the legislation says.

A civil suit filed against Sachdeva and the company's auditors, Grant Thornton, details how the former VP of finance perpetrated and concealed her fraud. Better internal controls could have decreased the fraud risk, but a properly motivated executive still would have found a way to steal and conceal. No matter how good the internal controls are, there are still ways around them, and the top finance official in a company is in the best position to know how to circumvent them.

Check the Checks

For goodness' sakes, the management at Koss didn't even bother to look at the checks being signed by Sachdeva for purchases at department stores and local boutiques. Do you think a silly piece of legislation would have made such a basic control a priority for anyone at Koss? Of course not.

So if regulation isn't the answer to decreasing the fraud risk at companies, what is the answer? It is proactive fraud prevention initiated by company management. It is a company culture that doesn't tolerate dishonesty and works diligently to prevent and detect it. It is an across-the-board better approach to fraud prevention, with the involvement of multiple executives who provide checks and balances against one another, thereby reducing the chances that one or two dishonest executives can bleed a company dry.

Bad management will be bad management no matter what the regulations say. Good management will be good in spite of regulations as well. Invest in companies in which honesty is at the forefront of their business model and is demonstrated each day as they conduct business.

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]]>Columnsinternal controlskoss corpsarbanes oxleysoxTracy CoenenFri, 16 Jul 2010 08:00:00 ESTFraud Files: Koss Corp. Sues Its Auditor for Failing to Detect Fraudhttp://www.dailyfinance.com/2010/06/25/koss-sues-auditor-failing-detect-f/http://www.dailyfinance.com/2010/06/25/koss-sues-auditor-failing-detect-f/http://www.dailyfinance.com/2010/06/25/koss-sues-auditor-failing-detect-f/#commentsFiled under: ,

moneyYou knew it was coming. Koss Corporation has sued its auditors Grant Thornton for failing to find the alleged $31 million fraud perpetrated by the company's VP of Finance over at least five years. The company is also suing the accused fraudster, Sue Sachdeva, but it's not clear what money the company could ever hope to collect from her.

Instead, it's much better to go after the auditors, who have assets and a large professional liability insurance policy backing them. It probably doesn't even matter to Koss whether or not Grant Thornton is at fault for not finding the fraud. Never mind that the company had little to no controls in place to stop such a fraud. Or that accusations are flying about the Koss family doing fancy footwork of their own when it came to personal expenses and the company's funds.

This lawsuit was expected. Whenever there's a sizable fraud, the independent auditors often get blamed. It never seems to matter that the entire process of financial statement auditing is not designed to detect fraud, and companies are regularly reminded of this fact. Audits have a very limited purpose -- to check the math and make sure the company is following the accounting rules.

The Narrow Scope of Audits

It's easy to say the auditors should have found the fraud. Accountants and auditors can probably think of plenty of procedures that might have uncovered the fraud. But this does not necessarily mean that the auditors should have done any of these. Audits have a very narrow purpose and scope, and if Grant Thornton carried out those duties competently, they may not be to blame for missing the fraud.

Wanting auditors to find fraud, and engaging them to do more procedures that increase the likelihood of finding fraud are two separate issues. Koss could have asked Grant Thornton to do more. They could have asked for a more in-depth financial statement audit, an internal controls review, or any additional procedures specifically designed to detect fraud. The company did none of that.

The lawsuit against Grant Thornton isn't surprising, but what a Koss press release said about the case is:

The Complaint further alleges that Grant Thornton, the company's auditor during those same years, failed to properly perform audits of the company's financial statements and failed to properly assess the company's internal controls, thus allowing the embezzlement to continue and the damage to the company to escalate. In particular, the lawsuit claims that Grant Thornton repeatedly assured Koss' management and its board that the company's internal controls were effective and that Koss could rely on those same internal controls and Grant Thornton's work.


These statements about the company's internal controls are in contrast with what Koss has previously said. In a 10-Q filed for Dec. 31, 2009, following the discovery of the fraud, Koss said there were no formal changes or material affects to the company's internal controls over financial reporting.

Yet in its press release about the lawsuit, Koss blames Grant Thornton for not telling them that their internal controls were ineffective. If the controls were so ineffective, why did the company say in December that it didn't make formal changes or do anything to materially affect the controls?

Where the Blame Lies

Even more curious is Koss' allegation the auditor told the board that its internal controls were effective, despite the most recent audit opinion by Grant Thornton stating the following

The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting.

Under the auditing standards, Grant Thornton was required to assess internal controls and use the results in designing effective audit procedures. But that analysis for the purpose of designing audit tests does not automatically create liability for the ineffective internal controls that the company itself was responsible for creating and maintaining.

This lawsuit is going to cost a lot of money and take much time and effort. How different this story would be if Koss' board and executives had put forth an equal amount of money and effort toward properly managing the finance function. The blame for this embezzlement still rests with the management of Koss, no matter how much finger-pointing the company does.


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]]>AuditColumnsfraudGrant ThorntonKossTracy CoenenFri, 25 Jun 2010 16:30:00 ESTNew Tax Rule Will Bury Small Businesses in a Blizzard of 1099shttp://www.dailyfinance.com/2010/06/18/new-tax-rule-small-businesses-1099/http://www.dailyfinance.com/2010/06/18/new-tax-rule-small-businesses-1099/http://www.dailyfinance.com/2010/06/18/new-tax-rule-small-businesses-1099/#commentsFiled under: ,

You might not have noticed, but a sneaky new tax rule was slipped into the recently passed federal health care reform law. It's a change that piles a ton of new paperwork on companies, and it will probably hit small companies harder than their larger counterparts.

Under the current tax code, businesses are required to send 1099s to people receiving payments of $600 or more from them for services rendered.

For the most part, 1099s currently don't need to be sent to companies. The 1099 has been focused on individuals receiving payments for services: The requirement was put in place to make sure that individuals being paid for work would report the income on their taxes.

That all changes in 2012, when businesses will be required to send 1099s to anyone and everyone -- individuals and companies, alike -- that are paid $600 or more for products or services. Maybe that means nothing to you. But it sure means a lot to small business owners. Companies will now have to send 1099s for virtually every product or service they purchase.

Making Sure Everyone Pays Their Fair Share

As a small business owner, I typically send three or four 1099s per year. It is an annoying paperwork exercise done every January, but it's manageable. Under the new rules, I'll have to collect a tax identification number from every person or company I pay. Then in January, I'll have to send them all 1099s. That will end up being 30 to 40 forms, making 10 times as much paperwork for me.

Of course, those who inserted this new rule into the health care law can easily fall back on the fairness argument to defend their actions: "We just want everyone paying their fair share of taxes, and this rule forces people and companies to report all their income."

I don't disagree that taxpayers should honestly report their income and pay the taxes due under the law, and I know that lots of people cheat on their taxes. But this new rule is not the answer. It creates a mountain of paperwork that hurts small businesses disproportionately. It's simply too much work, and experts say that the cost of complying will be far higher than any additional taxes the IRS might collect because of this procedure.

Tax Policy Discourages Entrepreneurship

It's also not the only tax hit small businesses are likely to take in the next couple of years. One proposed change is to levy additional payroll taxes on S-Corporations if their primary asset is the skill and reputation of three or fewer employees. My small business would have to pay this additional tax, but larger companies that provide the same services would be exempt because they have more employees. How's that for unfair to the small business owner?

Politicians far and wide have adopted the stance that more taxes are better for us. Instead of cutting spending appropriately, the politicians spend more and penalize those people and businesses that are perceived as having or making too much money: They can theoretically "afford" to pay more taxes, so let's make them pay more.

The unfortunate result of such a policy is that it discourages people from taking chances on starting new companies. Entrepreneurship is a risky venture, and even if you're one of the few successful business owners, count on the government to target you and take away an ever-increasing portion of your profits. An accounting firm with three employees may be expendable to the politicians, but to those three employees, the jobs are likely priceless.

If the desire is greater tax collections, the best way for our government to achieve that is by lowering the tax burden in a way that encourages entrepreneurship and risk-taking. If we have more businesses generating more income, the tax collections will increase overall. As it stands, every attempt to stick it to business owners hurts the chances of new job creation for enterprising entrepreneurs.

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]]>1099Columnsemployeesirspaperworks-corporationsmall businesstax codetaxesTracy CoenenFri, 18 Jun 2010 09:42:00 ESTFraud Files: Mountain of Evidence That LifeLock's Services Are Worthlesshttp://www.dailyfinance.com/2010/06/05/fraud-files-evidence-lifelock-services-worthless/http://www.dailyfinance.com/2010/06/05/fraud-files-evidence-lifelock-services-worthless/http://www.dailyfinance.com/2010/06/05/fraud-files-evidence-lifelock-services-worthless/#commentsFiled under: ,

credit cardsFor several years, LifeLock has been boasting that it can help protect you from identity theft. And if you do become a victim of identity theft, the company claims it will help you get back your good name. Neither of these claims are true.

In March, LifeLock settled a 35-state Federal Trade Commission lawsuit over its misleading advertising and had to pay $12 million. The FTC ordered LifeLock to stop lying to its customers about its services. The company tried to spin its punishment as a good thing because it puts standards in place to protect consumers. I guess they're hoping customers don't realize that LifeLock is the very company consumers needed protection from.

Multiple Failures

I started writing about the troubled company back in 2008 for AOL personal finance site WalletPop. My chief complaint about LifeLock was that the "fraud alerts" the company putting on consumerss credit reports weren't all that helpful. And consumers don't need to pay LifeLock a monthly fee for this -- they need only make a simple phone call to each credit reporting agency. More recent services developed by LifeLock seem to provide little value, but have catchy names to draw your attention. Still, these don't seem worth much.

My other beef with LifeLock is that you're very unlikely to get assistance from the company if your identity is stolen. While the company touts its "million-dollar guarantee," a careful reading of the fine print details exclusions that let LifeLock off the hook. It says it'll help you if your identity was stolen because of a defect in their services -- this would let LifeLock wriggle free from helping in just about every instance.

The most convincing piece of evidence about the worthlessness of the LifeLock services came a couple of weeks ago. Back in May 2008, I reported that LifeLock CEO Todd Davis himself had become a victim of identity theft after telling the world his Social Security number in advertisements for the services. The company copped to the fact that there had been one instance of a thief successfully using Davis's data to obtain credit and at least 100 other attempts to do so.

That was only the tip of the iceberg, however. It has now been revealed that Davis has had his identity stolen and used to fraudulently obtain credit at least 13 different times, beginning in 2007. If the company failed -- multiple times -- to protect its own CEO from identity theft, how on earth will they protect their lowly customers?

Seeing LifeLock for What It Is

Davis, however, contends the services work: "Our service worked just the way it was supposed to. I haven't spent any time or money trying to repair my credit."

Sure, LifeLock would do everything to fix things for Davis, seeing as he's the CEO and the company's reputation depends on this being repaired. But if Davis had been a regular LifeLock customer, the fine print of its million-dollar guarantee (with more holes than swiss cheese) would absolve the company of responsibility in repairing his credit.

Here's the best part about my history with LifeLock: When I was writing about them in 2008, I got a call from one of its top executives inviting me to meet with CEO Todd Davis so he could explain their services to me. Because obviously I didn't really understand the services LifeLock provided.

Apparently, I understood all too well. The troubled company can't really stop you from becoming a victim of identity theft. It may reduce your risk level a tiny bit, but not enough to be meaningful -- and certainly not enough to pay for. What better proof is there than the company's CEO becoming an identity-theft victim at least 13 separate times?

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]]>ColumnsFederal Trade Commissionftcidentity theftlifelockTracy CoenenSat, 05 Jun 2010 09:00:00 ESTFacebook Is Not Satan's Spawnhttp://www.dailyfinance.com/2010/05/16/fraud-files-facebook-is-not-satans-spawn/http://www.dailyfinance.com/2010/05/16/fraud-files-facebook-is-not-satans-spawn/http://www.dailyfinance.com/2010/05/16/fraud-files-facebook-is-not-satans-spawn/#commentsFiled under: , ,

The Internet is all aflutter once again about the online social networking service Facebook, pictured here, and its privacy settingsThe Internet is all aflutter once again about the online social networking service Facebook and its privacy settings. I'm no fan of how Facebook seems to change everything just when you finally figured out the last set of changes, but frankly, too many people are complaining for no good reason.

Some Facebook privacy issues have been worthy of criticism. Late last year when the first major changes to its privacy settings went into effect, there was a fatal flaw: Even when users had their friend lists hidden, they could still be seen. That problem was fixed in short order.

Another problem was that users quickly agreed to new privacy settings without carefully looking at them. Many were unaware that they were making a ton of data public by default. Oops to Facebook for allowing this to happen. The default should have been all private to protect careless users. And oops to the Facebook users who didn't read before they clicked.

Don't Get Alarmed

While I'm not a huge fan of some of Facebook's current privacy options, there's really nothing to be all that alarmed about. I've decided to just accept the Facebook hand I've been dealt and not participate in things that don't have privacy options to my liking.

The anti-Facebook crowd's first false argument is that the new privacy options are very complicated. The New York Times calls them "bewildering." That seems to be based mostly on the fact that there are a ton of options: You can choose your preferred level of privacy for a bunch of different bits on information in your Facebook account.

What's so bad about that? A user might not have a problem with everyone seeing his or her workplace, but doesn't want people to see his or her email address. I actually give Facebook credit in this regard. Thanks for letting me choose! I guarantee you that if things were "less complicated," with one, big, all-or-nothing privacy option for a whole slew of data fields on your profile, the naysayers would then be complaining over the lack of control.

Too Many Choices?

Here at DailyFinance, Sam Gustin is peeved at Facebook for having so darn many choices regarding privacy. He's so mad that he quit Facebook (and his story includes a video in which Sam explains his position quite frankly). But he also admits that he wasn't really an active user anyway: "Facebook's privacy policies are alarming, to be sure. But the truth is I'm not really getting any value out of Facebook, anyway, and I don't think I will really miss it."

On how confusing Facebook now is, Sam writes, "The simple fact is that Facebook has created a bewildering situation for its users. For most people, it's next to impossible to decipher what all of its frequent policy changes mean for individual privacy."

The thing is that the Facebook privacy settings aren't the least bit confusing for anyone who can be bothered to take 10 or 20 minutes to look at them and use Facebook's "help" function when necessary. My privacy is important enough to make me spend 10 or 20 minutes looking at all of my settings each time Facebook makes a change. I submit that Sam and many others are simply too lazy to take a few minutes to learn about the privacy settings on Facebook. That would have been much easier (and quicker) than writing his "quitting Facebook" article.

True Privacy on Facebook?

The second myth perpetuated by the anti-Facebook crowd is that privacy on Facebook isn't really privacy at all, and the company is just looking for ways to exploit users. I used to believe this too, so I'm not giving myself a pass on this issue. But I've come around. Facebook is a business. The company needs to make money in order to stay alive. If users aren't willing to pay for the service (and I think it's pretty clear that they aren't), then Facebook needs to find other ways to earn income.

Being attractive to advertisers means opening things up on Facebook. More access to user data means more revenue for Facebook. Can you really begrudge it that? Did I mention that Facebook is a business?

I think Facebook's problem is in its transparency -- or the perception of its transparency. It has to be up-front about the privacy controls and make sure users can know (if they bother to look) who can access what data.

Still a Downside

I am a little nervous about how Facebook is going to allow non-Facebook sites to access your data. The "like" button is changing. Sites that become partners with Facebook can get access to your "likes," and when you go to those outside sites, they can customize your experience there.

A good example is the idea that if you "like" a particular band on Facebook, when you go to the Pandora customized music site, for instance, that band's music could automatically show up on a playlist for you. If you're concerned about how these outside sites are going to be using your Facebook data, then take steps to avoid that stuff.

I don't really care what Mark Zuckerberg said in an instant message exchange six years ago when he was still a teenager and Facebook wasn't really a business. How many of us are guilty of saying unflattering things in emails we think are private? His attitude back then was not about today's Facebook. It was about a pet project of a college student. Big deal.

Remember that Facebook is a business. It needs to make money because of the cost to provide its service. If users aren't willing to pay any fees for Facebook, what's the alternative? The company is finding ways to incorporate advertising and applications, both of which can bring in money.

Facebook executives have to make judgment calls about what users want -- and will want years from now -- and execute their business strategy in a way that will appeal to people with money to spend. They've made their call. And of course, when talking to the media, they're going to talk in a way that supports their business model.

Admittedly, Facebook needs to achieve a delicate balance. It has to be able to give enough access to users' information to those willing to pay for it in order to make any money. But it has to allow some level of privacy that meets users' needs and desires if it wants to keep those users.

You Are Responsible

It's dangerous to believe that sites like Facebook are responsible for our privacy. We each have ultimate responsibility for our own privacy. Anything we put on the Internet, no matter how private we want it to be, is susceptible to being made public.

You thought your status updates and photos were private? They were until a friend let someone else use their account, or copied one of your photos and reposted it for public viewing. There are untold ways for our online data to become public, despite our best intentions. The only way to keep things truly private is by not posting them anywhere on the Internet.

Take the time to understand what is really private on Facebook and what is not. Deal with it, or don't be on Facebook. Users have every right to delete or deactivate their accounts, just like Sam did. You have the choice whether you participate and what you upload to your account. Choose wisely.


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]]>Columnsfacebookfacebook privacyprivacysocial mediasocial networkingZuckerbergTracy CoenenSun, 16 May 2010 14:45:00 ESTFraud Files: What the SEC Should Really Be Investigating About SpongeTechhttp://www.dailyfinance.com/2010/05/12/fraud-files-what-the-sec-should-really-be-investigating-about-s/http://www.dailyfinance.com/2010/05/12/fraud-files-what-the-sec-should-really-be-investigating-about-s/http://www.dailyfinance.com/2010/05/12/fraud-files-what-the-sec-should-really-be-investigating-about-s/#commentsFiled under:

SpongeTech has joined a long line of public companies who have retailiated against deserved criticism with personal attacks against reporters.Last week, the Securities and Exchange Commission charged SpongeTech Delivery Systems (SPNG), which makes a soap-filled SpongeBob sponge, with masterminding a pump-and-dump scheme. The SEC also named five individuals -- including executives Michael Metter and Steven Moskowitz -- in the civil complaint, which was accompanied by a criminal charge from the U.S. Attorney's Office for the Eastern District of New York.

The SEC claims the company made up customers and faked sales numbers, using fraudulent press releases and SEC filings to market the company's alleged success. These activities caused SpongeTech's stock price to rise, and the SEC says SpongeTech and its executives also flooded the market with unregistered shares of stock. When the investigation started, SpongeTech executives supposedly used phony documentation to try to substantiate its sales figures.

Reporters and bloggers grabbed their keyboards and started writing, calling the case a sign of a new, "tough" SEC. Hooray for the government finally paying attention to fraud and doing something about it, they said, suggesting SpongeTech might signal more enforcement cases to come. Market watchers also have been cheering about what they view as the SEC getting tough with Goldman Sachs (although I remain much more skeptical).

A Tiny Victory

The truth is that the SpongeTech case puts hardly a dent in the mountain of fraud that dishonest executives are committing every day. It's an interesting story and a case on which the SEC needed to act, based on the information it had. But it's way too small to be an indicator that the SEC is getting serious about corporate fraud.

To me, the real SpongeTech story is not the fact that the SEC is pursuing the company, but all the issuer retaliation that bubbled up when the company's problems were brought to light. Issuer retaliation is the special kind of revenge that public companies and their supporters exact on those who would dare to speak publicly about the wrongs they see, and this story is rife with it.

The victim is Kaja Whitehouse of the New York Post, who has been writing about SpongeTech since September 2009, when she reported the SEC's inquiry into SpongeTech's financials. She followed up with an article about attorney Joel Pensley, who said SpongeTech was fraudulently using his name on letters he hadn't written. Whitehouse then exposed the fact that five of the six largest customers SpongeTech cited in an SEC filing didn't appear to exist. The stories continued with SpongeTech's mounting legal woes, including lawsuits from Madison Square Garden, the New York Giants and CBS Radio.

SpongeTech Fires Back

And for her diligence, Whitehouse and her family were slammed with insults and accusations. Emails and message board postings have threatened "stock bashers" and their families with attacks. Whitehouse's personal information and photos have been posted on the Internet for the world to see.

While these attacks have never been linked directly to SpongeTech, the company has engaged in a bit of gameplay itself. In September, the company issued a press release, SpongeTech Delivery Systems, Inc. Sets The Record Straight, stating that press reports were inaccurate and based on forgeries. The company went even further in April, going after a critic at a competing company who questioned the company's sales figures and suing the New York Post, Whitehouse and several others.

Of course, I am well aware that this is only one of many examples of what the supporters of companies can do when someone attempts to ask serious questions about a business or expose red flags of fraud. One of the more colorful companies, when it comes to the smearing of critics, is Overstock.com (OSTK). The company's CEO Patrick Byrne has regularly retaliated against critics, not only with outrageous insults, but also with methods like cyberstalking and interfering in a divorce.

Felon-turned-corporate-watchdog Barry Minkow has been on the receiving end of attacks and lawsuits by companies he has criticized, as well. My colleagues and I (including Minkow) have been targeted in malicious anonymous attacks, and more recently, have been defending ourselves against a $270 million lawsuit from Medifast (MED).

Skeptics Wanted

I am not against the right of companies to defend themselves against false information and baseless attacks by critics, but I am against malicious personal attacks and lawsuits aimed at shutting down free speech. People have a right to ask questions about the financials and the dealings of public companies. If companies and executives don't want the public to scrutinize their activities, then they ought not be public companies.

If they are public, critics and supporters alike have a right to look at disclosures and public records and ask questions about them. Whitehouse was in the right: She was asking questions about things that didn't add up at SpongeTech. And apparently the SEC agrees with her.

In fact, the market needs critics to help examine public companies. Even if the SEC had the resources to conduct thorough investigations on a wide scale, its lack of competence means it would always be only marginally effective at reducing corporate fraud. Corporate executives have an inherent self-interest in inflating financials and engaging in positive public-relations campaigns. Public-company critics (including short sellers, fraud investigators, reporters and bloggers) help level the playing field and provide the skepticism and accountability necessary to keep those executives honest.

The SEC needs to take a serious look at issuer retaliation against those who ask questions and criticize public companies. The critics are providing a valuable public service and the SEC needs to take action to protect them from undeserved attacks by the public companies they're criticizing.

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]]>ColumnslawsuitlegalsalesstocksTracy CoenenWed, 12 May 2010 09:00:00 ESTFraud Files: As the SEC 'Gets Tough' on Goldman, Remember Madoffhttp://www.dailyfinance.com/2010/04/22/fraud-files-as-the-sec-gets-tough-on-goldman-remember-madoff/http://www.dailyfinance.com/2010/04/22/fraud-files-as-the-sec-gets-tough-on-goldman-remember-madoff/http://www.dailyfinance.com/2010/04/22/fraud-files-as-the-sec-gets-tough-on-goldman-remember-madoff/#commentsFiled under: , , , , ,

Fraud Files: As SEC 'Gets Tough' on Goldman, Remember Madoff There has never been such a masterful description of Securities and Exchange Commission incompetence as is given in No One Would Listen: A True Financial Thriller, the new book by the Bernie Madoff whistle-blower Harry Markopolos (pictured). You can debate about how thrilling the book itself is, but I suspect bean-counters like myself will get a thrill out of reading it. Even if the details of the Madoff Ponzi scheme and the way Markopolos and his team poked holes in it don't excite you, you should at least be able to revel in the blatant display of ineptitude by the financial industry's so-called regulators.

Last week's news of the SEC charges against Goldman Sachs (GS) got people buzzing about new "tough" enforcement by the SEC. An article published Wednesday on DailyFinance posed the question "Does a Revitalized SEC Have the Right Stuff to Tackle Goldman Sachs?" and answered with a tentative yes. I'm more skeptical. Maybe it's because I have read Markopolos's book, which plumbs the true depths of incompetence at the SEC. Maybe it's because I'm not the only one who suspects the SEC is pursuing Goldman just to look tough. I'm more than willing to take a "wait and see" approach as this enforcement action unfolds, but I'll be pleasantly surprised if the SEC follows through and brings the hammer down.

The reason I have so little faith in the SEC's ability to really get tough on corporate fraud is because it has such a bad track record. Granted, the agency has limited resources, so it can't investigate every complaint or tip it receives. But often, the SEC's decisions regarding whom to investigate (and more commonly, whom not to investigate) are made with no apparent rhyme or reason.

Reasons Why Markopolos Wasn't Viewed As 'Credible' Are Incredible

Markopolos couldn't have made it any easier for the agency to catch Bernie Madoff, and frankly, it has no excuse for not going after Madoff years before his scheme was exposed. The SEC received an easy-to-understand report that outlined the red flags pointing to the obvious conclusion that Madoff was running a scam.

As Markopolos put it in his book, "... Meaghan Cheung's team was incapable of winning a game of Clue if they were given all the answers." Of all the red flags Markopolos pointed out to the SEC, the only one that gave Doria Bachenheimer (the assistant director of enforcement) any heartburn was the fact that Madoff's "returns" were so consistent. Sadly, she publicly displayed her complete incompetence when she testified, "I was trying to come up with a theory of what he was doing, so I was thinking was this like an accounting case, is this like cookie cutter reserves, does he have some money somewhere else?"

First of all, it's not "cookie cutter reserves, " it's cookie jar reserves. And no, this is not "like an accounting case." This is an investment fraud case. Duh.

But it gets even better. The inspector general found that Bachenheimer didn't think Markopolos was credible because he had neither worked for Madoff nor invested with him. Really? That's the measure of credibility at the SEC -- whether a whistle-blower has been employed by the person committing the fraud or has given money to the person committing the fraud?

She further explained that the red flags were simply "theories" and the SEC couldn't bring a lawsuit against Madoff for them. They'd have to "... test it and substantiate it." Isn't that what "enforcement" means, Ms. Assistant Director of Enforcement? You couldn't make up excuses this ludicrous if you tried!

Madoff "Didn't Fit the Profile of a Ponzi Schemer"

And the madness continued. Markopolos was deemed unreliable because the SEC thought he was trying to collect a reward for turning Madoff in. It's certainly important to consider motive when looking at a whistle-blower report like this, but it's completely inappropriate to ignore the blatant red flags Markopolos pointed out simply because the SEC employees didn't like his perceived motive. (The SEC apparently didn't consider the fact that Markopolos wasn't even eligible for a reward for reporting this type of fraud.)

Employee after employee at the SEC dismissed the Markopolos allegations quickly, not even bothering to get a true understanding of the claims he made. SEC enforcement attorney Simona Suh even came to the brilliant conclusion that Madoff "didn't fit the profile of a Ponzi schemer." Well then. That settles it, doesn't it? I wonder if Suh could have even told anyone what the "profile" of a Ponzi schemer looked like. I seriously doubt it.

Markopolos wasn't suggesting that the SEC charge Madoff with anything without doing an investigation of their own. But he gave them all the evidence they needed to justify starting a real investigation. They had at least six serious red flags presented to them, but all they needed to justify an investigation was one of them: Madoff's claimed strategy of using options to hedge his investments couldn't possibly be true because there weren't enough options in existence to allow him to do that. How much more blatant did it need to get?

But there was more than just Markopolos to signal that the SEC should do more work on Madoff. There were other whistle-blowers who sent information to them. The SEC also caught Bernie Madoff lying to them several times. Any reasonably competent investigator knows that when you catch someone lying, you need to look even harder because, apparently, they have something to hide.

On Goldman Sachs Charges, The Timing Is Too Convenient

Forgive me for having no faith in the SEC's ability to get tough on corporate crimes. Their track record is dismal. And it's not like they just botched one part of a case. They botched huge cases, displaying their incompetence over and over in those cases. Employee after employee failed to understand the basics of investing or even simple math: These are the people who are supposed to enforce the financial laws?

It hasn't gone unnoticed that the SEC charges against Goldman Sachs had curious timing: The President had just publicly threatened to veto financial reform legislation if it failed to regulate of derivatives, and the Inspector General was ready to release a report criticizing the SEC's failure to to go after Allen Stanford four separate times after it had credible, serious information that he was running a Ponzi scheme.

I do not criticize the SEC for occasional incompetence. I criticize the agency for repeated incompetence in the face of serious allegations and evidence involving massive frauds. The agency needs to restore its own credibility, but how can we expect the SEC to do that when its history of massive failures is so clear?

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]]>ColumnsfraudGoldman Sachs fraudmadoffmarkopolosponziPonzi SchemeSECSecurities and Exchange CommissionTracy CoenenThu, 22 Apr 2010 15:50:00 ESTFraud Files: With Madoff, There Were Many Red Flagshttp://www.dailyfinance.com/2010/04/13/fraud-files-with-madoff-there-were-many-red-flags/http://www.dailyfinance.com/2010/04/13/fraud-files-with-madoff-there-were-many-red-flags/http://www.dailyfinance.com/2010/04/13/fraud-files-with-madoff-there-were-many-red-flags/#commentsFiled under: ,

If you want to know exactly why it was clear years ago that Bernard Madoff was running a Ponzi scheme, all you have to do is read No One Would Listen: A True Financial Thriller, the new book by whistleblower Harry Markopolos. As fraud investigation goes, Markopolos is a true hero. He took the time to dig deeper into a smelly situation, even when there was no apparent benefit to him personally. He put his reputation and his family's safety on the line to do the right thing. But no one would listen to him.

The magnitude of the investment scheme perpetrated by Bernie Madoff is difficult to pinpoint with any precision. There are likely many investors who will never come forward about their losses for a variety of reasons. We are left to speculate on the total losses, but $65 billion was the total showing on investor statements at the time the fraud was stopped. This number, however, includes the phony "gains" that had accumulated on the money. The $18 billion number is tagged as actual cash put into the Madoff scheme by investors, and ultimately the true total loss.

Markopolos was suspicious about Madoff from the first time he heard about the investment scheme based on the consistently high returns Madoff was supposedly generating. Even the best traders can't beat the market so consistently and by so much as Madoff claimed. He also knew that Madoff was constantly looking for new money from investors. This was even though he gave the appearance that the fund was "closed" to new investors and any opportunity for a new person to put money in was a special privilege offered just to them.

Markopolos couldn't have made investigating Madoff any easier for the Securities and Exchange Commission. Time and again, he identified red flags that made it clear Madoff was lying about his investment strategy and his returns. Obviously, he had no strategy and no returns. Markopolos identified convincing red flags for the SEC time and again.

1. Split-Strike Conversion - Madoff claimed to be purchasing baskets of stocks that were highly correlated to the general market. He supposedly knew which stocks were going up because of the amount of buying and selling that went through his brokerage. Madoff then supposedly hedged his investments with OEX index options.

Markopolos knew this couldn't be true because the number of options he'd have to buy to execute this strategy would be huge and would be easily seen in the market. Further, there were only $9 billion of OEX index put options on the Chicago Board Options Exchange. Yet Madoff would have needed $3 billion to $65 billion of the options to protect his investments. There simply weren't enough options available for Madoff to actually be using this strategy.

2. Market Timing - It was said that Madoff invested in the market only six to eight times a year, with the money staying in the market for a few days to a few weeks. Magically, he apparently knew exactly when the market was going up and only invested then. When Madoff thought the market was going to fall, he would supposedly put everything into cash. And he was always in cash at the year end, when the auditors were going to do their thing.

This explanation is absolutely preposterous to anyone with a grade school education. How finance professionals and the SEC could hear this (and often repeat it) without bursting into laughter is beyond me. Score another one for Markopolos for possessing the common sense that his colleagues and regulators apparently did not have.

3. Giving Up Profits - Madoff's claimed strategy cost him profits. The way he did business with the feeder funds, he only got paid with commissions on trades. This means he was earning less than the feeder funds (who were doing no work), while Madoff did all the work.

Had he run things as a hedge fund, he would have charged a 1% management fee plus 20% of the profit. This would have gotten Madoff about 4% on the assets he supposedly invested each year. Of course, we can now see that the reason Madoff operated this way was to incentivize the funds to keep raising money for him. He needed new cash on a continuous basis to keep the Ponzi afloat.

4. Cheaper to Borrow - It was expensive for Bernie to do business the way he claimed to be doing it. It took tons of time and effort, and the profits he supposedly returned to investors (something around 12% per year) were his cost of doing business. He could have borrowed money for much less and done whatever trading and investing he chose. This red flag is so simple, it's hard to believe everyone but Markopolos missed it!

5. Secrecy - The key to any long-term fraud scheme is secrecy on the part of those who participate. And Madoff demanded secrecy from his clients. He warned them that if they told anyone about investing with him, he'd kick them out of his club and give them their money back. No more consistent huge returns for them!

Anyone with a legitimate and successful business doesn't demand secrecy across the board. Even if they aren't publicity hounds, they certainly aren't going to forbid their clients to talk about how great they are. Secret clubs are for kids and college students. They have no place in legitimate business ventures. When an investor is commanded to remain quiet about the investment, you should know something is wrong.

6. Performance Line Had a 45-Degree Angle - When you plot legitimate investment returns on a graph, the only thing that can be guaranteed is that they will go up and down. But the graph for Madoff's Ponzi sloped upward at a beautiful 45-degree angle. This is simply impossible to do legitimately. Again, this is another red flag that is so in-your-face, it's tough to believe no one but Markopolos figured it out.

I would never discount all the time and effort Markopolos and his team put into investigating Bernie Madoff. But a quick look at these red flags shows that the warning signs were pretty apparent. People were investing millions or billions of dollars with Madoff, yet they didn't even take the time to critically analyze these points before investing?

It makes it harder to feel sorry for them when you see such obvious signs of problem. Even the most basic red flag - - unbelievably consistent and high returns - - should have tipped off everyone who wanted to invest. If it sounds too good to be true, it almost always is.

Next Week: The gross incompetence of the SEC regarding Bernie Madoff, and the Markopolos take on it.

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]]>Harry MarkopolosmadoffTracy CoenenTue, 13 Apr 2010 09:00:00 ESTFraud Files: Mark Cuban Fights Back Against the SEChttp://www.dailyfinance.com/2010/04/02/fraud-files-mark-cuban-fights-back-against-sec/http://www.dailyfinance.com/2010/04/02/fraud-files-mark-cuban-fights-back-against-sec/http://www.dailyfinance.com/2010/04/02/fraud-files-mark-cuban-fights-back-against-sec/#commentsFiled under: , ,

In late 2008, the Securities and Exchange Commission filed insider trading charges against Mark Cuban for selling 600,000 shares of Mamma.com stock.In late 2008, the Securities and Exchange Commission filed insider trading charges against Mark Cuban for selling 600,000 shares of search engine Mamma.com. The SEC said Cuban, owner of the Dallas Mavericks basketball team, sold his shares after receiving "material, non-public information concerning an impending stock offering."

He was allegedly given an invitation to participate in a stock offering and quickly sold the shares he already owned, because he knew the offering would dilute the value of shares outstanding.

Cuban fought these charges hard from the beginning, saying that he never agreed to keep any information about Mamma.com confidential. Therefore, Cuban contended, his sale of stock was not insider trading. He wasn't an insider.

It was an interesting defense from the start. After all, how can you stop someone from telling you important information, even if you don't necessarily want it and you don't agree to keep it secret?

No Case Against Cuban

It's one thing if Cuban had sought out the information about Mamma.com, but the fact that someone else voluntarily presented it to him (and received no promise of secrecy from him) threw a wrench into the SEC's case. Why should he be prohibited from selling a company's stock just because someone invited him to buy more?

Cuban, a billionaire high-tech entrepreneur, spent a ton of money on his defense in this case, and he prevailed. In July 2009, the SEC's case was dismissed in U.S. District Court. The judge went so far as to say that even if the SEC's facts were viewed in the most favorable light, there still wasn't a case against Cuban. The SEC would be required to prove that Cuban "... undertook a duty, expressly or implicitly, not to trade or other otherwise use material, nonpublic information" if they wanted to re-file the case against him.

Most defendants would have been happy just to be off the hook in an expensive and time-consuming legal case. Never one to back down from a good fight, Cuban turned the tables on the SEC and filed a lawsuit against them. The SEC clearly set out to embarrass Cuban, and he wasn't going to let the matter drop.

Cuban Goes After SEC

The suit, filed in May 2009, was an attempt to force the SEC to turn over documents Cuban had requested under the Freedom of Information Act (FOIA) and the Privacy Act of 1974. Cuban demanded a slew of documents in December 2008, including records relating to investigations of companies he owned and internal investigations of SEC employees. The SEC denied Cuban's request, and there were a number of subsequent requests, denials, and appeals in the matter.

Why did Cuban want these documents? He basically says that the SEC pursued their case against him in bad faith, and those documents were going to prove it.

But the SEC didn't want to play fair and turn over what they had, citing various exemptions from FOIA. Most people would throw up their hands in disgust, but feel powerless to do anything about it. But Cuban wasn't going to let them get off so easily.

Things Get Worse for the SEC

As if being sued by a guy with a ton of money weren't enough, now the agency looks even worse. Cuban has filed a motion to compel the SEC to produce more documents. His lawyers say the SEC produced very little documentation -- just 199 documents, including many that were originally provided to them by Cuban. They say an additional 602 documents exist for which the SEC is claiming various law enforcement and attorney-client privilege issues.

The lawyers raise an excellent point: How is Cuban to pursue his claim of bad faith against the SEC if he's not allowed to see most of the documentation relating to the investigation of him?

The motion gets even more interesting because it includes emails between SEC employees that show lack of professionalism at best, and bias against Cuban at worst. Cuban also alleges witness tampering by the SEC, for supposedly encouraging a lawyer for Mamma.com not to give Cuban access to a key witness related to the original investigation.

Cuban goes on to allege that at the time the case was filed against him, the SEC already knew there was no evidence that he agreed to keep information about Mamma.com confidential prior to selling his shares. Ouch.

Implications for Investors

These allegations are all rather serious, and it's no wonder that the SEC doesn't want its documentation to see the light of day. If nothing improper happened, why would the SEC object to turning over to Cuban information on their investigation into his business dealings? They can't claim their probe is none of his business, as clearly it was all about him and his businesses.

This case is interesting because the average American doesn't have the resources to go after a government agency like the SEC. But Cuban, No. 400 on the Forbes richest persons list, does. He can fight with the SEC practically into infinity, and we can live it vicariously.

It's no secret that the SEC has a history of gross incompetence and often chooses the wrong target. We should demand better from agencies funded with our tax dollars. Maybe Cuban's aggressive pursuit of the SEC will be a step in the right direction.

Troublemaker With Nothing to Lose

He has very little to lose. His livelihood isn't dependent on his reputation as it relates to the securities industry or any particular public company. There is no "career damage" he could sustain, no matter what the SEC does. In fact, his reputation as a bit of a troublemaker is likely to be enhanced by his pursuit of the SEC.

(No stranger to controversy or the limelight, Cuban has been fined by the NBA at least $1.6 million for 13 incidences of misconduct, according to ABC News, and has racked up a handful of TV and movie acting credits, often playing himself.)

The SEC got Cuban in their sights and wouldn't let go. Adding insult to injury, they want to prevent him from seeing the records that would show exactly how their vendetta against him played out. That's plain wrong, and I'm happy that someone with vast resources is standing up to incompetence and misguided prosecutions.

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]]>Columnsmamma.commark cubansecTracy CoenenFri, 02 Apr 2010 09:00:00 ESTFraud Files: LifeLock Barred From Lying to Consumershttp://www.dailyfinance.com/2010/03/19/fraud-files-lifelock-barred-from-lying-to-consumers/http://www.dailyfinance.com/2010/03/19/fraud-files-lifelock-barred-from-lying-to-consumers/http://www.dailyfinance.com/2010/03/19/fraud-files-lifelock-barred-from-lying-to-consumers/#commentsFiled under: ,

LifeLock is a company famous for advertising "identity theft protection services" and its "million dollar guarantee" by printing the Social Security number of its CEO Todd Davis all over the place. What the company failed to tell consumers was that Davis's identity wasn't as safe as they wanted you to believe, and there have been numerous attempts to steal his identity, at least one of which was successful.

This month, the Federal Trade Commission and LifeLock entered into a settlement agreement which required LifeLock to pay $12 million and quit lying about their services. What's funny is the difference in spin between LifeLock and the FTC. While LifeLock spins this as a good "agreement" between them and the agency, which will put in place advertising standards for their whole industry, the FTC makes it clear that this settlement is a result of LifeLock making false claims in its advertising. Specifically, the FTC says that LifeLock "... used false claims to promote its identity theft protection services, which it widely advertised by displaying the CEO's Social Security number on the side of a truck."

The company has had a checkered past: Robert Maynard, one of the co-founders, was at the heart of some sketchy dealings before starting LifeLock. The company eventually distanced itself from him in an effort to put those questions behind it. But everything has not been smooth sailing since then.

Promised "Protection" Has "Holes That You Could Drive a Truck Through"

I've written articles on the Fraud Files Blog and at DailyFinance's sister site, WalletPop, about my thoughts on LifeLock's so-called identity-theft protection services. I never really took issue with the core service the company provides: It will put fraud alerts on a consumer's credit profile with each of the credit reporting agencies for a small monthly fee. There is nothing inherently wrong with consumers paying for this service, so long as they realize this is something they could do themselves for free.

What I always took issue with were the promises the company was making. I've never liked the way LifeLock pretends your identity is safe because of its service. The company does little more than a consumer can do on her or his own. Beyond the fraud alerts, LifeLock now also goes through public records databases and tells customers of the postal addresses, dates of birth, and Social Security numbers on file in those public records. There's nothing revolutionary nor inherently valuable to consumers in providing this.

The FTC, too, is entirely unimpressed with LifeLock's ability to protect you from identity theft. "While LifeLock promised consumers complete protection against all types of identity theft, in truth, the protection it actually provided left enough holes that you could drive a truck through it," it said in its press release about the $12 million settlement. Now that's a ringing endorsement if I ever heard one.

And don't think that LifeLock was merely engaging in some creative wordsmithing in its advertising. The company got in trouble because it made absolutely outrageous and false claims like:
  • "By now you've heard about individuals whose identities have been stolen by identity thieves ... LifeLock protects against this ever happening to you. Guaranteed."
  • "Please know that we are the first company to prevent identity theft from occurring."
  • "Do you ever worry about identity theft? If so, it's time you got to know LifeLock. We work to stop identity theft before it happens."
Sure, the fraud alerts on your credit report can do some good, but there are all sorts of ways identity theft can happen which aren't addressed by LifeLock's services. The FTC says the company's services do nothing to prevent common types of identity theft like misuse of existing accounts, medical identity theft, and employment identity theft. The FTC also says LifeLock was lying when it said that a customer would always get a phone call before a new credit account was opened in their name, and that it would constantly monitor activity on its customers' credit reports.

Guarantee Is a Million Dollar "Maybe"

One thing not addressed by the FTC is the LifeLock "million dollar guarantee," which is essentially worthless to consumers, in my opinion. If you take a look at the details of this "guarantee," you'll see that all it really guarantees is that LifeLock probably won't have to help you repair your credit if your identity is stolen. The company posts the guarantee here, but then you need to click through to get to the page with even more exclusions and limitations.

Read carefully this statement about LifeLock's guarantee: "But if you become a victim of identity theft while you are a LifeLock member because of some failure or defect in our service, contact us and we will act on your behalf to repair any damage. We will spend up to $1 million to hire lawyers, investigators, consultants and whatever else it takes to restore your name and help you recover the direct losses from the identity theft."

I've boldfaced the most damning portion: LifeLock is only obligated to help you if your identity is stolen because of a "defect in their service." Can you think of any situation which would qualify? What if someone steals your wallet? Steals your mail out of your mailbox? Steals your credit card number while you're paying for your meal at a restaurant? None of these situations has anything to do with LifeLock and its service of putting fraud alerts on your credit files. If you can think of a situation which would qualify as a "defect in its service," I'm all ears, but I haven't thought of one yet. And if it's not LifeLock's fault, LifeLock isn't going to help you.

You should also carefully note that in the terms and conditions, LifeLock says it will help you recover your costs and losses related to the fraud. However, they will not actually repay you for any losses, per the fine print. So even if LifeLock agrees to help you with your identity theft, they won't actually pay you any money. Their "million dollar guarantee" is only good to the extent that it may help pay others to investigate or help you correct your credit report. (And again, that's if they even agree that you qualify under their guarantee.)

All in all, I find almost no redeeming qualities in LifeLock as a company or as a service for consumers. The FTC had some harsh words for the company, and that's saying a lot. There are tons of scams and questionable schemes out there which the FTC never gets around to looking at. They took their time on this one, and consumers ought to heed their warnings about the company.

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]]>ColumnsTracy CoenenFri, 19 Mar 2010 09:24:00 ESTFraud Files: Will an Extortion Plot Hurt Cindy Crawford's Brand?http://www.dailyfinance.com/2010/03/14/fraud-files-endorsements-after-cindy-crawford-extortion-plot/http://www.dailyfinance.com/2010/03/14/fraud-files-endorsements-after-cindy-crawford-extortion-plot/http://www.dailyfinance.com/2010/03/14/fraud-files-endorsements-after-cindy-crawford-extortion-plot/#commentsFiled under: ,

Edis "Eddie" Kayalar was sentenced March 9 to two years in prison for his attempt to extort 100,000 euros (about $137,000) from model Cindy Crawford and her husband Rande Gerber using a picture of their then 7-year-old daughter bound and gagged on a chair. The photo was allegedly shot by the girl's nanny while they were playing a game of "cops and robbers" and later stolen by Kayalar.

Gerber initially gave $1,000 to the former model Kayalar in exchange for the picture of his daughter, but when Kayalar began demanding more money and said he had copies of the picture, he was deported to Germany. He blamed Gerber for the deportation and began demanding 100,000 euros. He said if Gerber and Crawford didn't meet his demands, he'd sell the creepy picture of their daughter to the press, figuring he could get $500,000 for it. Kayalar reportedly planning to use the money to bring his American girlfriend to Germany.

The case was prosecuted by the German courts because the extortion attempt happened while he was there. Kayalar could have gotten up to five years for the attempted extortion, but got a reduced sentence of two years in prison because he confessed.

Beyond the Creepiness

As a fraud-fighter, just about any kind of scam bothers me, but blackmail involving innocent children is the worst imaginable. The child wasn't nude or in a suggestive position, but that won't stop some sickos from taking the bondage fascination to the next level in their minds, and I don't want anyone's child to be part of that. To try to make a buck (or a few thousand) from an unfortunate and embarrassing picture of a young child is disgusting.

Beyond the creepiness of such a photo and extortion plot, you have to wonder whether a weird story like this could damage Crawford's marketability and earning potential. We all know how Tiger Woods' sexual indiscretions have cost him endorsements and sponsorships. This is a bit different, and although there's something equally creepy about the stories, this was completely out of Crawford's control.

If you're a company looking to get the most bang for your marketing buck in a tight economy, do you want to take a chance that the face of your product is associated with creepy child bondage games in the minds of consumers? Perhaps it's a stretch, but it's possible some more conservative companies may shy away from Crawford at least temporarily as they exercise an abundance of caution.

For the sake of the little girl, I hope this is a case where consumers have short memories. Thankfully, I wasn't able to find any copies of the creepy picture on the Internet, and I hope it stays that way. Gossip site TMZ reported being offered the photo for sale in September of last year and turned it down. Let's hope that news of Kayalar's prison sentence deters the next creep who wants to try something like this.

Tracy L. Coenen, CPA, MBA, CFE, CFF is a fraud examiner and forensic accountant who investigates corporate fraud and consumer scams and is the author of Essentials of Corporate Fraud and Expert Fraud Investigation: A Step-by-Step Guide.

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]]>Cindy CrawfordColumnsextortion plotTracy CoenenSun, 14 Mar 2010 10:00:00 ESTFraud Files: Enron's Jeffrey Skilling Says We Shouldn't Expect Honest Execshttp://www.dailyfinance.com/2010/03/07/fraud-files-enrons-jeffrey-skilling-says-we-shouldnt-expect-e/http://www.dailyfinance.com/2010/03/07/fraud-files-enrons-jeffrey-skilling-says-we-shouldnt-expect-e/http://www.dailyfinance.com/2010/03/07/fraud-files-enrons-jeffrey-skilling-says-we-shouldnt-expect-e/#commentsFiled under:

Last week, the poster boy for executives committing fraud, Jeffrey Skilling, had his appeal of his criminal conviction heard before the U.S. Supreme Court. Skilling was convicted in 2006 on 19 counts of conspiracy, fraud, false statements and insider trading related to his work as the CEO of failed energy concern Enron. But even at sentencing, Skilling claimed he was innocent of all charges and Enron collapsed because of outside forces. (That still gives me a chuckle each time I read it.)

He'll be locked up for the next couple of decades and probably has nothing better to do than think about all the ways he can get out of prison early. And really, what does he have to lose by coming up with creative arguments to reduce his punishment?

Part of the argument his attorneys made in his appeal revolved around the inclusion of a juror who said she had lost $50,000 to $60,000 because of Enron's collapse. Can a juror who is essentially a victim of the crime Skilling is accused of committing be impartial? The defense tried to strike that juror, but she remained on the panel, raising questions about the impartiality of the jury.

Is Dishonesty at Work A Crime?

The more interesting issue that was raised, however, was the use of a law that makes it a crime to deprive someone of the right to honest services. Skilling's lawyers say this is unconstitutionally vague as it could literally turn any dishonesty at work into a federal crime. Yet such a law is important if prosecutors can't prove actual theft or other crimes, but can prove some sort of corruption or dishonesty in connection with the jobs of the accused.

Apparently Skilling isn't the only executive convicted of crimes who thinks it shouldn't be a crime to be a dishonest executive. Late last year, media mogul Conrad Black and Alaska legislator Bruce Weyhrauch appealed their criminal convictions, saying that the law making it illegal to deprive an employer of the right to honest services was "inherently vague."

It is hard to feel much pity for Skilling. Law enforcement and the courts use broad laws all the time to convict people of crimes. Consider someone believed to be involved in drug dealing. It's not always possible to prove that crime, so the Feds resort to using laws regarding tax evasion to convict them of felonies and get them off the streets. No one seems to mind broad laws in those cases, as sometimes they're the only way to stop the specific criminal acts, which are known but unable to be proven in court.

Wholesale Financial Statement Fraud

Skilling's main attorney, Daniel Petrocelli, wrote in his Supreme Court brief that the law has been used for "opportunistic and arbitrary prosecutions." Maybe that argument could go somewhere if Skilling hadn't been so dishonest and hadn't profited so handsomely from his frauds at Enron.

We're not talking about a guy who might have been involved in a little dishonesty as an executive at Enron. Skilling and the executive team engaged in wholesale financial statement fraud that propped up the company's stock price substantially. What's more, Skilling personally profited by unloading his stock while the company was still flying high and the fraud was undiscovered.

While I'm intrigued by the whole "don't expect me to be honest when our whole company is dishonest" defense, and it makes for good blog fodder, it's really all just crap.

Sarbanes-Oxley Hasn't Been Very Effective

This whole issue sounds silly to me. How can a criminal conviction for blatant dishonesty that created massive personal profits for Skilling (while simultaneously creating massive personal losses for thousands of others) be unfair to him? Yet it is not out of the realm of possibility that the Supreme Court could rule in his favor on this issue.

I don't believe that fraud can be legislated away. Executives behave honestly because it is demanded of them by the corporate culture and the owners of a company. Regulations like Sarbanes-Oxley are intended to reduce fraud, but haven't really been proven effective in doing so. Probably the biggest tangible benefit of Sarbanes-Oxley has been shining a bright light on the issue of fraud.

However, that doesn't mean that strong laws against dishonesty by executives shouldn't exist. Those deceiving and manipulating our financial markets must be penalized. If no other law fits the bill, I'm more than happy to have lying executives nailed to the wall for not providing their employers -- and all the stakeholders -- with honest services.

Tracy L. Coenen, CPA, MBA, CFE, CFF 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.

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]]>appealcorporate fraudenronjeffrey skillinglawTracy CoenenSun, 07 Mar 2010 10:00:00 ESTFraud Files: Does a Tough Economy Lead to More Fraud?http://www.dailyfinance.com/2010/02/27/fraud-files-does-a-tough-economy-leads-to-more-fraud/http://www.dailyfinance.com/2010/02/27/fraud-files-does-a-tough-economy-leads-to-more-fraud/http://www.dailyfinance.com/2010/02/27/fraud-files-does-a-tough-economy-leads-to-more-fraud/#commentsFiled under: ,

There is always a spirited debate about how much fraud is really going on. Fraud is a hidden crime, and so we only know about the frauds we actually discover. There are plenty of frauds that go undiscovered for years and fraud investigation professionals are left to speculate about how much secret fraud exists.

Forensic accountants and fraud investigators estimated that 7% of the average company's revenue is lost to fraud, in the 2008 edition of the Report to the Nation on Occupational Fraud and Abuse published by the Association of Certified Fraud Examiners. This would equal nearly $1 trillion per year in the United States alone.

I'm a dissenter. I think the real figure for fraud is about half of that. Fraud controls at many companies are bad, but I doubt that they are quite this bad.

Investment Frauds Increasing

There are also the frauds that are unrelated to employment, which include investment fraud and Ponzi schemes. These are the types of scams that Bernie Madoff helped make famous recently. We are hearing about more and more investment frauds around the country, including a $162 million fraud by a Florida money manager.

Even forensic accountants are getting into the business of committing fraud, with Lewis Freeman (referred to as Miami's "go-to" forensic accountant) being charged with embezzling $2.6 million from his clients.

The actual figure for the various types of fraud losses is neither here nor there. The fact is that individuals and companies lose a lot of money to fraud, through the direct theft, as well as the cost of investigating, prosecuting, and preventing future frauds. With a lagging economy, investors and business executives are left asking whether their fraud costs are even higher now.

Is The Economy A Factor?

It is reasonable to wonder whether a difficult economy causes more people to turn to fraud to pay their bills, feed their families or support an addiction. Indeed, a real or perceived financial need is a fraud risk factor for employee theft, as outlined in my book Essentials of Corporate Fraud. Many factors can make an employee more or less likely to commit fraud. Some of the most common personal red flags of fraud include:
  • Lifestyle issues -- Living beyond ones means, having excessive debt, or child support or alimony issues all require cash to resolve.
  • Personal problems -- An addiction, criminal background, chronic legal problems or infidelity can also require a steady inflow of money.
A quick look at news headlines related to fraud indicates that new frauds are being uncovered daily. Locally, it seems that each night on the news, a new business or organization has reported a large theft by an employee. Every time we turn around, we hear of a new Ponzi scheme bilking investors out of millions of dollars. Is fraud on the rise because of the economy, or is something else at play?

Likelier To Be Uncovered

Anecdotally, I'd have to say that fraud is not on the rise. Yes, we're hearing more about fraud, but that doesn't necessarily mean employees are stealing more often from their employers or money managers are swindling more investors. I don't believe the economy is causing more fraud, but I do believe that tighter finances are making it more likely that existing frauds will be uncovered.

Look at the frauds being reported in the news. These are not new fraud schemes. Most often, they are schemes that have been ongoing for at least several years. That in itself disproves the theory that the fraud is related to a flagging economy. These frauds started while the economy was flying high.

We are hearing more about fraud because companies have much less cash to play around with. They are looking to cut corners, and they are worried about inefficiencies. As belts are tightened, it is more likely that a fraud scheme will be uncovered. Business owners and executives are simply taking a better look at their finances. (Which is something that headphone maker Koss Corp. executives might have considered doing, rather than relying on American Express to bring a $31 million alleged fraud to their attention.)

Withdrawals Expose Ponzis

In the case of investment frauds and Ponzi schemes, these too are more likely to be uncovered during difficult economic times. Ponzi schemes require continual infusions of cash to stay afloat. With the economy tightening, investors are more likely to want to pull money out of these investments (rather than put money in), and this almost guarantees the collapse of a fraudulent investment scheme.

Fraud is a serious issue no matter what the economy is doing, but the economy does not necessarily cause more fraud. The difficult financial situations of many individuals and businesses have simply shined a brighter light on fraudulent activities. Fraudsters can run and they can hide, but now more than ever, they're likely to be discovered.

Tracy L. Coenen, CPA, MBA, CFE, CFF 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.

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]]>ColumnsembezzlementfraudponziPonzi SchemeTracy CoenenSat, 27 Feb 2010 09:00:00 ESTBanks and Card Issuers Find Clever Ways Around CARD Act Ruleshttp://www.dailyfinance.com/2010/02/22/banks-and-credit-card-companies-finding-clever-ways-around-card/http://www.dailyfinance.com/2010/02/22/banks-and-credit-card-companies-finding-clever-ways-around-card/http://www.dailyfinance.com/2010/02/22/banks-and-credit-card-companies-finding-clever-ways-around-card/#commentsFiled under: ,

Consumers should have seen it coming a mile away. In May, Congress passed the Credit Card Accountability, Responsibility, and Disclosure (CARD) Act of 2009, which included lots of new rules designed to protect consumers from predatory practices by banks and credit card companies, such as hidden fees and sky-high interest rates. The new rules, which go into full effect on Feb. 22, threaten to take a big bite out of the $15 billion in penalties and fees that the industry collects each year.

So what have banks and card issuers done? They've come up with new fees.

Continue reading Banks and Card Issuers Find Clever Ways Around CARD Act Rules


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]]>banksCARD Actconsumerfeesinterest ratespenaltiespersonal financeregulationTracy CoenenMon, 22 Feb 2010 09:30:00 EST