Most of us have heard of Bernie Madoff, Allen Stanford, and Raj Rajaratnam because of the significant financial frauds that each was alleged to be a part of in recent years. At the writing of this article, Stanford and Raj have not been convicted of any charges while Madoff was sentenced to 150 years in 2009. We heard about these incidents primarily because of the large dollar amounts involved, but what about other incidents? Are these isolated incidents or just the tip of the iceberg?
Each year, there are thousands upon thousands of smaller incidents that we never hear about because the dollar amounts are smaller and because companies quietly sweep these incidents under the rug to prevent the bad publicity and negative stigma that would ensue. In August 2009, KPMG, one of the “Big 4” accounting firms, released the results of its fraud survey. http://www.us.kpmg.com/RutUS_prod/Documents/8/AcrobatDocument.pdf If you are standing, please sit down. I don’t want to be responsible for any injuries that may occur after you read what I am about to tell you.
About 1/3 of the respondents believe fraud will increase in their companies. Well, maybe that shouldn’t come as a surprise given the economic climate we are enduring. More importantly, the responding executives believe that fraud occurs because of inadequate controls (66%) and management’s ability to override controls (47%). Let me see if I understand this. Executives believe that fraud is mostly like to occur because of poor controls, which management implements, or because of management’s hanky-panky with those very controls (using George Bush’s fuzzy math that’s 113% of the time).
Bottom line: management is the problem. So who’s watching management? That would be the Board of Directors. Whew! What a relief! I was beginning to worry. Thank goodness there is an independent group to look out for the best interests of the various stakeholders in the company. All hail the Board of Directors!
Now there’s a good old-boys club if I ever heard of one. Okay, ladies, I apologize for the male-dominated reference. I realize there are several women who sit on boards and hold C-level positions. My point is that board members ask each other to sit on various boards. This is an exclusive club where the theme is “you scratch my back and I’ll scratch yours.” Sort-of reminds me of politics. Who loses? We all pay the price when boards fall asleep at the wheel.
And that’s not all. When budgets are reduced, where do you think some of those cuts occur? Usually, in business operations that are deemed to be less significant, such as internal audit and compliance departments. Even with the existence of the Sarbanes-Oxley Act (SOX) and its requirements related to controls, companies have been looking for ways to reduce compliance spending since collectively shelling out $4-$6 billion in the early years of SOX. And yet the executives at these same companies are worried about increasing incidents of fraud.
As the saying goes, you can’t have your cake and eat it too. The best way to prevent fraud is to implement the appropriate controls and monitor them. Like any business process, controls need to be analyzed for their effectiveness. As business operations and risks change, so too should the controls. And by the way, it’s not the external auditor’s responsibility to detect fraud. It’s management’s.
Unfortunately, I think many companies have thrown in the towel and declared “No mas.” No more spending on prevention and detection. If something happens, let the insurance settlement take care of things. After all, that’s what the premiums are for. I say “fight the good fight” and “don’t ever give up!” It’s okay to lose now and again, but not okay to give in. The price to pay will be far greater if management can act without oversight. Spoken like a true fraud examiner.
Lou Arellano, CPA, CFE