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Volume 7: Issue 2, July–December, 2015

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Volume 7: Issue 2, July–December, 2015
 
Table of Contents
 

The Role of Special Masters in Federal Tax Cases | Full Article (PDF)
Brigitte W. Muehlmann
Priscilla A. Burnaby

Abstract: The role of a special master is to aid a court in complex civil trial or appeals proceedings. The court appoints a special master and establishes the allocation of the master’s compensation to the parties in the case. This study is the first to analyze the use of special masters in federal tax litigation as disclosed in 79 court opinions through 2012. Utilizing the case survey archival research method, this paper provides insights into the use of special masters in federal tax cases. Beginning in 1924, District Courts were the first to disclose the use of special masters and their roles. Magistrate judges and lawyers have been most frequently disclosed as special masters. Since 2001, accountants have been disclosed as special masters in two federal tax cases. They have acted as post-trial and consent special masters. Both assignments included auditing financial data. Some assignments performed by unidentified special masters were also within the scope of forensic accounting. Appeals courts overturned only a few decisions that were based on errors made by special masters and when a judge either did not give due regard to a special master’s fact finding or applied a clearly erroneous standard. As accounting is one of the recognized special master subject areas, the authors suggest that forensic accountants could help courts with additional assignments in fact-driven complex civil tax cases.
 
Keywords: Special master; Special trial judge; Tax Case; Complexity Factors.

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Tax Aggressiveness and the Effects of Potential Detection for Uncertain Tax Position Reporting | Full Article (PDF)
Robert Lee
Anthony P. Curatola
 
Abstract: This article introduces risk-based capital analyses as a new methodology for forensic accountants to consider when hired in punitive damages cases.  In addition, it performs a study to determine whether this analysis would be appropriate.  In this non-experimental quantitative study, the full population of insurance companies rated by A.M. Best Company and the full population of depository institutions operating from 2007 through 2011 were selected to examine.  Data was collected for the five year review period covering 2007 through 2011.  Logistic regression was used with archived data to determine whether insolvency rates or financial strength ratings are significantly related to an organization's risk-based capital position.  We show a significant relationship exists in each year between risk-based capital ratios and the insolvency status of property/casualty insurance companies, life/health insurance companies, and depository institutions as evidenced by a p-value in each analysis < 0.01.  We also report there is a significant relationship in each year between the risk-based capital ratios and the financial strength ratings of property/casualty and life/health insurance companies as evidenced by a p-value in each analysis < 0.01.  This study concludes that risk-based capital levels are a reliable foundation upon which to offer an opinion. 
 
Keywords: Risk-Based Capital; Punitive Damages; Forensic Accounting; Excessive Award; Award Calculation; Expert Testimony.

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Independent auditors’ responsibilities for violations of anti-bribery provisions under the U.S. Foreign Corrupt Practices Act: Auditing for bribes | Full Article (PDF)
Ricardo Colon
 
Abstract:  Numerous disclosures about payments of bribes to foreign government officials continue to undermine the public’s trust in corporate governance. Therefore, enforcement of the U.S. Foreign Corrupt Practices Act, which prohibits bribing foreign government officials, has become a priority for the U.S. Securities and Exchange Commission and the U.S. Department of Justice. Auditors cannot simply ignore bribery risks when auditing financial statements. Bribery is an illegal act that triggers numerous responsibilities for auditors, including potential civil and criminal liability. To assist auditors’ with meeting their professional obligations, this study discusses methods to audit for bribes, emphasizing forensic accounting procedures specifically designed to detect illegal payments. Finally, this study calls upon the Public Company Accounting Oversight Board to issue additional guidance in two areas: first, addressing auditors’ responsibility with respect to fraud, bribery, and other illegal acts and second, clarifying the role of forensic accountants and the use of forensic accounting procedures in audits of financial statements.
 
Keywords: FCPA; Bribes; Forensic Accounting; Illegal Acts; Audit Procedures.

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Challenges Facing Auditors in Detecting Financial Statement Fraud: Insights from Fraud Investigations | Full Article (PDF)
Stephen K. Asare
Arnie Wright
Mark F. Zimbelman
 
Abstract: Based on interviews with four fraud experts and a review of the literature, we develop a framework comprised of four broad factors (and elements within these factors) that can affect auditors’ ability to detect fraudulent financial reporting (fraud): (1) the audit process, (2) auditor knowledge, training, and experience (KTE), (3) auditor incentives, and (4) institutional forces. We then ask 65 fraud examiners to rate the importance of these factors and elements in explaining why auditors did not detect the fraud on a recent fraud engagement. The fraud examiners rate the audit process, KTE and incentives as the most important inhibitors, while institutional forces are considered of lower importance. They also indicate that failure to effectively assess managements’ incentives and opportunities and to modify audit tests are the primary audit process drivers of failure. With respect to KTE, the primary drivers include lack of skepticism (i.e., auditors put undue trust in management), limited knowledge of fraud schemes, and a lack of appropriate fraud-detection training. The fraud examiners also note that GAAS audits are not designed to detect fraud and current auditing standards do not provide adequate guidance on how auditors should fulfill their fraud detection responsibilities. Our results suggest the need to reexamine and reengineer the audit process, auditors’ training and audit standards to better equip 
auditors to carry out this critical function.
 
Keywords: Fraud; Audit Process; Audit Test; Fraud Detection

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What is the Value of Multiple Certifications in Forensic Accounting? | Full Article (PDF)
Wm. Dennis Huber
 
Abstract:  In the forensic accounting profession there are many who hold multiple certifications. However, as a sociological phenomenon, there is a paucity of research on what are either actual or perceived benefits of holding multiple accountingcertifications, and research on the benefits of holding multiple ertifications in the forensic accounting profession is non-existent. This paper reports the results of a recent survey of forensic accountants who hold multiple certifications in forensic accounting. The results reveal that the perceived benefit consists principally of symbolic capital rather than economic benefit.
 
Keywords: Forensic Accounting; Certifications; Symbolic Capital
 

A Comparison of U.S. Forensic Accounting Programs with the National Institute of Justice Funded Model Curriculum | Full Article (PDF)
Mike Seda
Bonita K. Peterson Kramer
 
Abstract:  In late 2003, the National Institute of Justice (NIJ) funded a proposal by the West Virginia University Division of Accounting in the College of Business and Economics to develop a model curriculum for forensic accounting and fraud investigation. This model was developed over the subsequent two years with input from forensic accounting experts representing a variety of professional organizations.  This article examines the extent to which existing forensic accounting programs in the United States emulate the NIJ model curriculum.  We reviewed websites of 900 colleges and universities in the United States to determine the forensic accounting education offered and compared each institution’s program of study to that recommended by the NIJ-funded model curriculum.  Our results find that while the availability and variety of forensic accounting education has increased tremendously over the past decade, very few colleges and universities currently provide forensic accounting education similar to the curriculum developed with the NIJ grant. The results of this study will help accounting educators with forensic accounting programs determine how typical it is to have one that conforms to the NIJ funded model curriculum, as they continue to make their own curriculum choices.
 
Keywords:  Forensic Accounting; Fraud Investigation; Accounting Curriculum; Model Curriculum; National Institute of Justice
 
The Impact of Technology and Regulatory Changes on the Relationship between a Firm’s External Governance Index and its Financial Performance and Earnings Management | Full Article (PDF)
Sung S. Kwon
Haiping Wang
Taslima Nasreen
 
Abstract: This paper examines the conditions when stronger firm-level corporate governance (CG) is associated with higher firm valuation and less accrual-based earnings management. Specifically, we investigate whether the above associations differ significantly between high-tech (HT) and non-high-tech (NHT) firms, and between pre-Sarbanes-Oxley Act (SOX) and SOX periods. We find that 1) the impact of corporate governance on firm valuation is significantly greater for HT firms vis-à-vis NHT firms and is greater in the post-SOX period than in the pre-SOX period; 2) the impact of corporate governance on earnings management is significantly greater for HT firms vis-à-vis NHT firms and is greater in the post-SOX period than in the pre-SOX period. Our findings are robust to a number of sensitivity tests.
 
Keywords: External Governance Index; Firm Valuation; Earnings Management; High-Tech Firms; Sarbanes-Oxley Act (SOX)

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The Effects of Mianzi and Professional Relationship Guanxi on Auditor Fraud Detection | Full Article (PDF)
Siew H. Chan
Qian Song
Arnold M. Wright
Sally Wright
 
Abstract: Financial reporting fraud entails intentional misrepresentation by management of the performance and health of a company, and, thus, auditors have great difficulties in detecting fraud. Two cultural factors that have promise in enhancing auditors’ abilities to detect fraud are guanxi (a network of relationships) and mianzi (face or image). Although these factors are widely recognized in Asia, prior research has not examined how they influence the audit process. Guanxi relationships may allow auditors to gather information from a network of individuals within the company to facilitate fraud risk assessments. Based on the literature, we design two scales specifically for the audit environment to measure the auditor use of guanxi and the expected benefits of guanxi in auditing. In addition, we develop a more comprehensive mianzi scale than prior research for use in a variety of settings including auditing. We posit that mianzi strengthens the beneficial effects of auditor use of guanxi, and that these benefits explain the perceived value of guanxi in aiding auditors to detect fraud. Analyses of the responses obtained from 126 auditors indicate that guanxi and mianzi are seen as valuable in helping auditors gain evidence to detect fraud.
 
Keywords: Auditor Use of Guanxi; Expected Benefits of Guanxi; Fraud Detection; Guanxi; Mianzi

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The Fraud at High Flying Corporation:  Developing Audit Interview Skills | Full Article (PDF)
Diane M. Matson
Kristine M. Sharockman
Janice M. Raffield
 
Abstract: This instructional case is designed to simulate a real world audit situation where red flags, primarily related to the existence assertion and related party transactions, have been uncovered and additional information must be obtained from the client, High Flying Corporation. Each student individually interviews a client official who is portrayed by a practicing accountant from the business community. This case provides students with an opportunity to make real-time judgments regarding the validity and reasonableness of information provided by a client and to determine an appropriate course of action, while simultaneously dealing with client behaviors intended to evoke negative emotional reactions and to undermine their confidence. This case is appropriate for advanced auditing at the undergraduate level, forensic accounting at the undergraduate or graduate level, or introductory or advanced auditing at the graduate level.
 
Keywords: Fraudulent Outcomes, Mindfulness, Online Auction Markets

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Eluding the Lemons: Buyer Mindfulness and Seller Deception in Online Auctions | Full Article (PDF)
Alexey Nikitkov
Dan N. Stone
 
Abstract: This paper proposes buyer mindfulness as one means to address quality uncertainty and seller deception in the online auction market. Mindful information processing includes: (1) the creation of new categories by parsing streams of information and activity, (2) active refinement and differentiation of existing categories, and, (3) flexible and nuanced attention to context and detail (Langer 1989, Weick and Putnam 2006). This paper synthesizes research related to mindfulness and deception, assesses the seller deception strategies evident in publicly reported online auction deceptions from 1995-2008, proposes a model of the “mindful"? online auction buyer, contrasts more versus less “mindful"? buyer approaches to evaluating an online auction listing, and explores the importance and implications of increasing buyer mindfulness in the online auction market. Its contributions include integrating the construct of mindfulness into market quality research, reporting updated data on the attributes and strategies of online auction deceptions, and, contrasting mindful and unmindful buyer market evaluation processes. Increased understanding of the role and effects of a more mindful online auction market will aid stakeholders, including market facilitators, regulators, and law enforcement, in designing and implementing more effective mechanisms for nudging buyer attention in ways that reduce fraudulent outcomes, and increase trust, in online auction markets.
 
Keywords: Fraudulent Outcomes; Mindfulness; Online Auction Markets

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More Evidence of the Nevada Effect: SEC, DOJ, FBI, and IRS Regulatory Enforcement Actions | Full Article (PDF)
A.J. Cataldo II
Lori Fuller
Thomas Miller
 
Abstract: Cataldo, Fuller and Miller (2014) examined a published sample of Securities and Exchange Commission (SEC) and Public Company Accounting Oversight Board Engagement Quality Reviewer violations (Messier, Kozloski and Kochetova-Kozloski 2010) and the entire population of 2012 SEC trading suspensions. They found that Nevada firms disproportionately consume scarce Federal regulatory resources. Their results support what has been characterized as the Nevada Effect. Additional evidence in support of the Nevada Effect is presented in the current research. In this extension, regulatory enforcement actions by the SEC, Department of Justice, Federal Bureau of Investigation and Internal Revenues Service during 2011 and 2013 are examined. Additionally, measures associated with related stock promoters and promotional schemes are identified. Our methodology used a forensic approach and examined publicly available information not previously executed or explored in the literature. Publicly traded Nevada corporations dominated our analysis of this information at a variety of detectible levels. We discuss our findings, in the clontext of information asymmetry, hidden and private information.
 
Keywords: Securities and Exchange Commission (SEC); Information Asymmetry; Hidden Information; Private Information

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Case: Asset Misappropriation Schemes: Short Cases for Use in the Classroom | Full Article (PDF)
Constance M. Lehmann
 
Abstract:  The purpose of these short cases is to provide instructors with realistic cases illustrating situations where fraudulent activity could occur. One or more of these cases can be used in classes where fraud deterrence and detection is discussed (e.g., IT auditing, accounting information systems, internal auditing, fraud auditing/accounting, MBA accounting). All four of these cases were field tested in the classroom and during a CPA CPE course taught by a non-author instructor. The ability to analyze a situation and develop a response to present to a client who suspects or is trying to minimize the opportunity for asset misappropriation in his/her business is an essential skill for future auditors and business owners. The cases presented here address the following Asset Misappropriation categories under the ACFE Occupational Fraud and Abuse Classification System (ACFE, 2012): 1) Billing Schemes/Personal Purchases (retail business), 2) Theft of Cash on Hand/Theft of Cash Receipts (banking industry), 3) Fraudulent Disbursement: Improper/Personal Purchases and Reimbursements, Payroll Schemes (construction business), and 4) Inventory, Accounts Receivable, and Accounts Payable (small business—body shop). The cases were field tested in the classroom and during a CPA CPE class. These cases can be used in small group or individual settings, and implementation guidance is included.
 
Keywords: Fraud Detection: Asset Misappropriation; Risk Assessment; Case Studies; Problem-Based Learning; Internal Controls.

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Books Reviews
Book
Hackers, Hoaxer, Whistleblower, Spy:  The Many Faces of Anonymous
Gabriella Coleman, 2014, 452 pp.Verso
20 Jay Street, Suite 1010
Brooklyn, N.Y. 11201      
 
The author provides the ultimate book on the worldwide movement of hackers, pranksters, and activists that operate under the no-name anonymous.  The book is filled with insights into the meaning of digital activism and the little understood facets of culture in the Internet age, including the history of “trolling"? and the ethics and metaphysics of hacking.

 

Book
Data and Goliath: The Hidden Battles to Collect Your Data and Control Your Worlds
Bruce Schneier, 2015, 384 pp.
W. W. Norton & Company,
500 Fifth Avenue,
New York, N.Y. 10110
 
Your cell phone provider tracks your location and knows who is with you.  Your online and in-store purchasing patterns are recorded and reveals if you are unemployed, sick, or pregnant.  Google knows what you are thinking, because it saves your private searches.  Facebook can reveal a great deal of information.  Forensic accountants can use this information.
 

Book
Qualifying & Attacking Expert Witnesses
Robert C. Clifford, Revision
James Publishing, Inc.,
3505 Cadillac Avenue,
Costa Mesa, CA 92626
www.JamesPublishing.com
 
This excellent manual is written for lawyers.  Starting with the selection of an expert, the book covers preparation, testimony of the expert, and the cross-examination of the expert.  The author has an excellent discussion of compensation of experts, discovery on the Internet, cumulative experts, choosing between an economist and an accountant, and experts relating to white collar crime. 
 
 Mr. Clifford provides dozens of high-potential attacks such as:
  • Failure to consider other causes
  • Subjective testing
  • Insufficient sample
  • Anecdotal evidence
  • Temporal relationship
  • Erroneous extrapolation
  • Research prepared for litigation

Book
Too Big to Fail
Andrew R. Sorkin, 2009, 600 pp.
Penguin Group, Inc.,
75 Hudson Street,
NewYork, NY 10014
 
 
On a mid-September morning in 2008, Americans awoke to discover the unthinkable: the nation’s financial system was in free fall.  One of Wall Street’s most prestigious investment banks, Lehman Brothers, had filed for bankruptcy, and the equally illustrious Merrill Lynch was forced to sell itself in a fire sale to Bank of America.  Within days the world’s largest insurance firm AIG, would be nationalized while Goldman Sachs and Morgan Stanley, following their own near-death experiences, voluntarily turned themselves into highly regulated banks, seemingly surrendering their ability to take big risks—the very risks that made them rich.
 
This true story is not only a look at banks that were too big to fail, but also a humbling human drama about a cast of bold-faced names who thought they themselves were too big to fail.

Book
Everyday Ethics: Making Wise Choices in a Complex World
Catharyn A. Baird, 2nd Edition, 2011
 Ethics Game Press
 2186 South Holly, Suite 206
Denver, CO 80222
 
This text is designed to be used with the Ethics Game Core Values or Hot Topics simulations, which are web-based ethics simulations that allow participants to assume leadership roles in a fictitious organization or company. Participants have the opportunity to solve ethical dilemmas that are typical of those facing people in management structures in the United States and around the world. These choices have both intended and unintended financial and social consequences, mirroring the sometime randomness of our lives.
 
The thesis of this book is that the vast majority of people want to become effective ethical decision makers, but they are rarely given either the opportunity to examine their beliefs or training in how to develop their ethical skills. The pedagogy of the simulations is based on educational research that demonstrates that with imagination, thought, training, and practice, we can avoid ethical pitfalls and learn to make better decisions.

Book
Understanding Business Valuation:
A Practical Guide to Valuating Small to Medium Businesses, 4th  Edition.
Gary R. Trugman, 2013, 1146 pp.
AICPA
220 Leigh Farm Road
Durham, NC 27707-8110
 
This mammoth book provides guidance on the theory, as well as how to apply it in a meaningful way. Although the author believes in the “keep it simple, stupid"? concept, the reading can be complex and difficult. For accountants, Mr. Trugman says this subject is not like accounting where the debits equal the credits. There is no black and white answer, but there are a million shades of gray. There are 26 long chapters, and 17 appendices, a CDROM, and 6 sample reports. Happy reading!

Book
Expert Fraud Investigation:
A Step-by-Step Guide
Tracey L. Coenen, 2009, 219 pp.
John Wiley & Sons, Inc.
Hoboken, N. J.
 
As suggested by the title, the author provides a who, where, and why of financial frauds. Some chapters include:
  • Finding Fraud
  • Beginning the Investigation
  • Managing the Case
  • Searching for Fraud
  • Investigative Techniques
  • Reporting and Litigation
What is interesting is that the first person to praise the book is Barry Minkow of the infamous ZZZZ Best fraud. Barry was able to talk himself out of prison early, become a pastor, wrote a book, was to appear in the 2015 movie, “Minkow,"? drove down the price of a home builder’s stock (while selling short), received a five-year prison sentence, and then pled guilty of converting around $3.1 million of funds from his church to his own use. A judge said that Barry Minkow had “no moral compass that says stop."? Five more years was add to his five years’ sentence.

Book
Earnings Management and Earnings Quality:
Evidence from Japan
Masumi Nakashima, 2015, 186 pp.
Hakuto Shobo Publishing
Japan 5-1-15, Sotokanda
Chiyoda-Ku
Tokyo, Japan 101-0021
 
The author documents whether U.S. GAAP works for the Japanese firms as corporate governance by analyzing both SEC-registered firms and Japanese public firms. She clarifies the content of internal control deficiencies for the Japanese public firms, and she focuses on earnings management and earnings quality by comparing the material weakness disclosing firms and control firms.
 

Book
A Guide to Forensic Accounting Investigation, 2nd
S. L. Skalak, et al., 2011, 622 pp.
John Wiley & Sons, Inc.
111 River Street
Hoboken, New Jersey 07030-5775
 
This book had 30 chapters often written by different authors who are partners or employees of PWC. There are no exercises, problems, or cases. Just some of the chapters include:
  • Psychology of the Fraudster
  • The Role of the Auditor/Forensic Accounting Investigator
  • Internal Audit: The Second Line of Defense
  • Building a Case
  • Potential Missteps
  • Potential Red Flags and Fraud Detection Techniques
  • Investigative Techniques
  • The Art of the Interview
  • Data Mining

Book
A Quantitative Approach to Commercial Damages: Applying Statistics to the Measurement of Lost Profits
Mark G. Filler and J.A. DiGabriele, 2012, 323 pp.
John Wiley & Sons
Hoboken, New Jersey   
 
Accurately estimating damages in business interruption cases is a make-or-break formula for companies who need to be compensated for their loss of income. Make a mistake, and those doors may never reopen. With this book you will have the analytical tools and step-by-step instructions you need to prepare an accurate damage claim.
 
Authors Mark Filler and James DiGabriele apply their forensic and valuation expertise to explain the complicated process of measuring business interruption damages, whether the losses are from natural or man-made disasters, or whether the performance of one company adversely affects the performance of another. More than 250 screenshots, sixteen case studies, key cell formulas, Excel spreadsheet applications, and a companion website provide clear instructions to help one construct their own formula and spreadsheets.
 
Expertly demonstrating the various methods that can use to estimate business interruption losses during a specified loss period, the book includes:
  • The three big statistical ideas
  • What is regression analysis, and where have I seen it before
  • Accounting for seasonality, trend, and interventions
  • The defendant’s expert’s report and the plaintiff’s expert’s report
  • Skeptical analysis using the fraud theory approach
  • Testing for seasonality and trend with a regression model
  • Prediction errors and their measurement
  • Double exponential smoothing (Holt’s Method)
  • The next frontier in the application of statistics

Book
Essentials of Forensic Accounting
M.A. Cain, W.S. Hopwood, C. Pacini, and G.R. Young, 2015
AICPA
220 Leigh Farm Road
Durham, N.C. 27707-8110
 
This paperback book is an authoritative resource covering a comprehensive range of forensic accounting topics. As a foundation review, a reference book, or as preparation for the Certification in Financial Forensics (CFF) exam, this publication will provide thoughtful and insightful examination of the key themes in this field, including:
 
  • Professional responsibilities and practice management
  • Fundamental forensic knowledge including laws, courts, and dispute resolution
  • Specialized forensic knowledge such as bankruptcy, insolvency, reorganization, and valuation
Through illustrative examples, cases, and explanations, this book provides abstract concepts to help one understand and successfully navigate this complex area.

Book
Taxes and Value: The Ongoing Research and Analysis Relating to the S Corporation Valuation Puzzle
N.J. Fannon and K.F. Sellers, 2015, 154 pp.
BVR
1000 SW Broadway
Suite 1200
Portland, OR 97205
www.bvrresources.com    
 
The authors present evidence of the effect of taxes on value. They suggest how analysts might consider this evidence in their valuation of closely-held organizations.

Book
Financial Shenanigans: How to Detect Accounting Gimmicks & Fraud in Financial Reports, 3rd
H. M. Schilit & Jeremy Perler, 2010, 320 pp.
McGraw Hill
1221 Avenue of the Americas
New York, NY 10020-1095    
 
The third edition of this classic written in 1993 is a must for all forensic accountants and professors. Howard Schilit has been called the Sherlock Holmes of accounting. He and Perler take you into the corporate bags of tricks, exposing new levels of accounting tricks and gimmickry. Chapters 14 and 15 are worth the price of the book.
 
What are the best metrics of that specific company’s performance, and does management highlight, ignore, distort, or even make up its own version of these metrics?
What are the best metrics that would reveal a specific company’s deteriorating economic health, and does management highlight, ignore, distort, or even make up its own version of these metrics?

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