Deconstructing Business Fraud

By October 6, 2018 No Comments

How you handle this situation can be the difference between survival, and dissolution.

When a fraudulent business situation is discovered, it is generally necessary to deconstruct how it was perpetrated. If there was an effective control structure in place, designed to prevent, or detect, errors and irregularities, as well as to control the initiation of transactions, record transactions and maintain the custody of assets, it is possible that collusion may have undermined those controls, or processes. Frauds many times are perpetrated by advisors, family members, or long-standing employees, whom you have confidence, trust, and would never suspect. Your outside accounting firm is a key player in your control structure, therefore their potential role in the malfeasance should be considered.

The corporate landscape is littered with accounting fraud. All these firms had outside accounting firms supposedly watching over the books. Even the most sophisticated organizations, with astute Boards of Directors, can be a casualty to accounting malfeasance. AOL, Adelphia, Computer Associates, Enron, Global Crossing, Reliant Energy, Tyco International, Waste Management, Inc., and WorldCom are but a few of the companies that have been devestated by accounting fraud. How you handle this situation can be the difference between survival, and dissolution.

Handling fraud, without further damaging your business, requires a certain strategic, and usually delicate approach. Independent outside professionals can employ fraud investigation techniques that minimize many of the negative effects of such an investigation.

There is also the potential that your accounting firm may be held liable if a member of their firm participated in the fraud, or were grossly negligent in the performance of their professional duties. Therefore, it is advisable to have an independent professional, other than your traditional accounting firm, review what transpired.

The Fifth Amendment to the U.S. Constitution states that “[no person] shall be compelled in any criminal case to be a witness against himself.” This privilege against self-incrimination applies not only to individuals, but to your CPA as well. Your CPA may legally refuse to provide evidence that may prove they are criminally, and or professionally liable, or were complicit in the carrying out of a crime.

When the existence of fraud is indicated, evidence collection becomes paramount. Therefore conflicts of interest may profoundly affect the expediency, and effectiveness, of the investigation. The existing accounting firm may have a real, or perceived, conflicts of interest, and therefore it is beneficial to have a truly independent entity perform the fraud investigation. Very often, as a function of familiarity, and relationships that developed over many years, an atmosphere of complacency, or dwindling compliance, within the control environment, may have developed. Misplaced loyalties may have also affected the performance of these functions.

Statement on Auditing Standards No. 99 (SAS 99), Consideration of Fraud in a Financial Statement Audit, was issued by the Auditing Standards Board of the American Institute of Certified Public Accountants. Even non public companies can take some suggestions from this directive. SAS 99 discusses two types of fraud: misstatements arising from fraudulent financial reporting (eg. falsification of accounting records) and misstatements arising from misappropriation of assets (eg. theft of assets or fraudulent expenditures). Either can be devastating to your business. One of the most interesting, and productive, aspects of SAS 99 is the requirement for “brainstorming” sessions to discuss how and where the entity’s financial statements might be susceptible to material misstatement due to fraud. The Turnaround Professional is in a great position to conduct this function.

Finally SAS 99 requires the linking of audit procedures to identified risks of material misstatements due to fraud. There are three elements to a fraud. First there is the incentive or pressure to commit the crime. Then there is the opportunity. Lastly there is the attitude, or ability to rationalize why it is appropriate to behave in this manner. The Turnaround Specialist once again has a great vantage point in which to identify these sorts of problems. Therefore using your Turnaround Specialist/Independent Professional, to ferret out fraud is a good practice.

Our thanks to this article’s author, Bart Siegel, CPA, CFE, FCPA, MBA, Owner of Siegel Forensic Accounting and Consulting, LLC ( Siegel Forensic Accounting and Consulting is a forensic accounting firm located in the Tampa, FL area and specializes in assisting victims of investment fraud, detecting fraud and theft, detecting material misrepresentations, and other forensic investigative services. Mr. Siegel is a Forensic Certified Public Accountant (FCPA), Certified Fraud Examiner (CFE), and Personal Financial Specialist (PFS). Bart can be e-mailed through his web sites or contacted by telephone at (813) 831-3849.

DISCLAIMER: This Corporate Governance article is provided as an informational resource and does not constitute legal advice. The information provided in this article is based on the laws in effect at the time the article was published. Laws related to this article’s topics may change over the course of time. Visitors to this website should not rely upon or act upon this information without seeking professional legal counsel.