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Volume 5: Issue 1, January–June, 2013
Table of Contents
- Summary Witness Testimony in Federal Tax Litigation Cases as Identified in Court Opinions
- Validating Early Fraud Prediction Using Narrative Disclosures
- Fraudsters and the Form 1099 Technique
- Influence of Leadership Positions on Internal Controls and Reported Fraud In Religious Organizations
- Effects of Alternative Short-Session Training Methods on Fraud Detection: A Performance and Efficiency Assessment
- Using Forensic Analytics to Evaluate the Reliability of Fair Value Reporting
- Forensic Accountant, Forensic Accounting Certifications, and Due Diligence
- Auditors' Responsibility for Fraud Detection: New Wine in Old Bottles?
- Compensatory Damages for Patent Infringement: TEXAHOMA HIGHWAY CONSTRUCTION CASE
- Announcements, Correspondence, and Book Reviews
Summary Witness Testimony in Federal Tax Litigation Cases as Identified in Court Opinions | Full Article (PDF)
Brigitte W. Muehlmann
Abstract: In U.S. tax litigation, there are three types of summary witnesses that may be called by both parties in a case. Their use provides insights into how large volumes of evidence and empirical research complex issues are presented in tax cases. To determine how witnesses are used during tax trials, this is the first to review the 109 tax opinions published through 2010 that disclose the use of summary witnesses. This paper first discusses the Federal Rules of Evidence related to summary witnesses: Rule 1006 primary evidence, Rule 611 pedagogical device and hybrid or secondary-device summary witnesses. Then the court cases are surveyed to determine: the trends in the use of summary witnesses; who presents the summary witness; how many cases are Rule of evidence 1006 versus Rule 611; the demographics of the summary witnesses; if they serve as more than one type of expert during the trial; and the reasons for which their testimony was challenged in courts of appeals. A detailed review of the opinions led to the master list of 109 cases. The majority of the summary witnesses (57.1%) presented Rule 611 pedagogical-device summaries, 26.5% presented Rule 1006 primary-evidence summaries, and only10.2% provided the hybrid 1006 and 611 secondary-evidence summaries. The vast majority of the summary witnesses (65.3%) were IRS revenue agents or IRS special agents (10.2%). Fifty percent of the summary witnesses served dual roles before the introduction of the Daubert standard, but only one summary witness did so after the standard was introduced. The summary witnesses' testimony was challenged in 22 court cases and six verdicts were overturned due to problems with their testimony.
Keywords: Tax, summary witness, expert witness, primary evidence summary, pedagogical-device summaries, secondary-evidence summaries.
Validating Early Fraud Prediction Using Narrative Disclosures | Full Article (PDF)
Natalie Tatiana Churyk
B. Douglas Clinton
Abstract: This study documents a model building and validation process for the purpose of early fraud prediction based on asynchronous communication contained in the narrative disclosures of annual reports. Following Churyk et al. (2009), we apply content analysis to the management discussion and analysis section of the annual report to determine and examine significant qualitative fraud risk factors. Using both discriminant analysis and a holdout sample, we confirm the accuracy of a robust, early fraud prediction model. Our model provides two significant contributions to fraud prediction. First, the model can be applied earlier than conventional models (i.e., potentially prior to the incidence of catastrophic consequences as a result of the fraud); and second, the model provided an overall fraud/non-fraud prediction rate of 64.8 percent using a cross validation method and 55.9 percent using holdout sample. This overall classification accuracy compares to conventional model accuracy of only 30 to 40 percent (Skousen and Wright 2008).
Keywords: Fraud, prediction, content analysis.
Fraudsters and the Form 1099 Technique | Full Article (PDF)
Christine Crawford Cheng
D. Larry Crumbley
Abstract: This paper discusses a technique employed by firms to recoup money and property stolen from a business by employees. Under the Form 1099 technique the firm supposedly uses the threat of filing a Form 1099 with the IRS for the amount stolen, unless the fraudster signs an installment note agreeing to a payback. This article discusses various aspects of this Form 1099 technique, including anecdotal evidence regarding the use of this technique, and the incentives of the firm, the employee who committed the fraud, and the IRS perspective of this technique.
In general, a company prefers the Form 1099 technique as a recoupment method when the probable amount collected from the employee exceeds the amount the firm would receive through insurance and tax recoupment. The employee should prefer to have the amount stolen reported to the IRS, unless the employee's potential tax liability exceed the amount stolen from the firm. The IRS should prefer delayed reporting of the fraud when the company has sufficient net income to offset the amount of the fraud. The IRS should prefer the immediate reporting of the fraud when the company does not have sufficient net income to offset the amount of the fraud. Based upon our discussions and the unlikelihood of full repayment by a fraudster, the Form 1099 technique may not be a valuable approach. However there are instances where the Form 1099 technique is preferable to immediate tax reporting. Congress may wish to consider a tax rule which would protect a firm's ability to use this technique for these instances.
Keywords: Form 1099, fraud, incentives, illegal income, embezzlement.
Influence of Leadership Positions on Internal Controls and Reported Fraud In Religious Organizations | Full Article (PDF)
Robert M. Cornell
Carol B. Johnson
William C. Schwartz, Jr.
Abstract: This study examines the extent to which particular leadership positions and governance bodies within churches are associated with the presence of internal controls and/or the absence of fraud. Our study is motivated by Marquet's (2011) chronicle of 21 high-profile church embezzlements in the first half of 2011; Ventura and Daniel's (2010) finding that church members tend to trust their leaders in spite of the absence of internal controls; and discoveries by Booth (1993) and Conway (1999) that clergy tend to be ill-disposed to utilize secular accounting and internal control practices. We surveyed 131 individuals who were responsible for financial management within their respective churches. The survey was conducted through in-person, structured interviews. After removing duplicate interviews, we analyzed a sample of 129 responses. The subjects were affiliated with churches that varied widely in size, age, and denomination. Our results indicate that the leadership position most closely associated with the presence of internal controls in the church is a financial expert on the board of directors. Consistent with the findings of Booth (1993) and Conway (1999), paid clergy tend to traverse in the opposite direction. We fail to find any indication that presence of the leadership positions or governance bodies we examined are associated with a reduced incidence of reported fraud. These results suggest that future research should go beyond simply looking for internal controls in churches and should establish whether there are characteristics or viable practices of churches (internal controls or otherwise) that can indeed reduce the incidence of fraud.
Keywords: Fraud, governance, internal audit, internal control, nonprofits, religious organizations.
Effects of Alternative Short-Session Training Methods on Fraud Detection: A Performance and Efficiency Assessment | Full Article (PDF)
W. Eric Lee
Abstract: Many novice accounting professionals and current accounting students receive limited training in fraud detection, often restricted to a short CPE course or a short module in an accounting course. Therefore, it is important to investigate the effects of alternative short-session training methods on fraud detection. This study reports the results of a short-session experiment that employed two widely used training methods: lecture and experiential. By comparing to a control group who received no training, we assess the relative performance effectiveness of the two training methods with respect to both fraud cue identification and fraud cue justification. We also assess efficiency, in terms of effort and time, relative to performance. Except for the experiential group, with no significant identification performance improvement, we find that either training method increases performance and efficiency compared to no training. Regarding both performance and efficiency for fraud cue identification, we observe slightly better results for lecture training over experiential training, but no significant difference between the two methods. With respect to both performance and efficiency for fraud cue justification, we find significant support for experiential training over lecture training. Our results should help accounting educators decide which approach to use when designing a short-session fraud detection training module.
Keywords: Fraud detection training, fraud cue identification, fraud cue justification, efficiency.
Using Forensic Analytics to Evaluate the Reliability of Fair Value Reporting | Full Article (PDF)
Abstract: A fundamental argument that has persisted throughout the modern history of accounting concerns whether the primary measurement basis in financial reporting should be input-based (historical cost) or outcome-based (fair value). The key issue hinges on the trade-off between the relevance and reliability of the numbers reported under these two measurement bases, with fair value measures viewed as more relevant, but historical cost measures considered more reliable. This article provides a background and discussion of these two measurement bases and explains the FASB's gradual shift from historical cost toward fair value reporting. More importantly, though, through the application of Benford's Law, which has become an important forensic analytical tool for detecting earnings management and other forms of fraudulent financial reporting, the study provides an empirical examination of the reliability of all three levels of fair value disclosures required by SFAS No. 157. The findings suggest a significant amount of manipulation occurs in each of the three levels of fair value disclosure, including Level 1, which should be based on objectively determined external marketplace data. Thus, the results of the forensic procedures performed in this study call into question the reliability and credibility of the fair value information currently reported in the financial statements.
Keywords: Fair value reporting, SFAS No. 157, reliability, manipulation, Benford's Law.
Forensic Accountant, Forensic Accounting Certifications, and Due Diligence | Full Article (PDF)
Wm. Dennis Huber
Abstract: Previous research has established that some corporations that issue certifications in forensic accounting fail to disclose their legal status and the qualifications of their Officers and Board of Directors. Previous research also established that a significant number of forensic accountants have inaccurate beliefs about the legal status of the corporations and the qualifications their Officers and Directors. This study investigates whether forensic accountants exercised due diligence in investigating the corporations that issued their certifications prior to obtaining their certifications. The results of a survey show that forensic accountants failed to exercise due diligence in their investigation of the corporations that issued their certifications. The failure of forensic accounting corporations to disclose important information coupled with the failure of forensic accountants to exercise due diligence in investigating the corporations suggests there is a need for reform within the forensic accounting profession.
Keywords: Forensic accountants, forensic accounting certifications, due diligence, forensic accounting corporations.
Auditors' Responsibility for Fraud Detection: New Wine in Old Bottles? | Full Article (PDF)
Abstract: We observe a historical trend that standard setters often resort to issuing additional auditing standards as a response to restore public trust after widely publicized fraud. Despite the standard setters' intention, auditors are generally poor at fraud detection. Auditors are not fraud examiners. We contend the failure of auditors to detect fraud is attributable to the differences in skill sets and task objectives between financial statement audits and fraud auditing. Our paper provides a brief overview of the changes in auditors' responsibility for fraud detection over the years. We highlight the differences between auditors and forensic specialists based on prior literature and an expert panel. Without proper and adequate forensic training, expecting auditors to detect fraud is similar to pouring new wine into old bottles. We conclude by identifying changes in the current audit model and research opportunities that can be used to improve auditors' fraud detection performances.
Keywords: Auditors' responsibility, fraud detection, forensic specialists, audit standards, expert panel.
Compensatory Damages for Patent Infringement: TEXAHOMA HIGHWAY CONSTRUCTION CASE | Full Article (PDF)
Abstract: This case involves damages for the infringement of two patents owned by Salsa, Inc. The patents are for (a) the design and (b) the method of manufacture of concrete walls for containing construction noise caused by the building or widening of highways. By containing this noise, the state highway construction authority saves on the cost of compensation paid to nearby business owners and homeowners disturbed by the noise of highway construction. This patent has been infringed by other highway construction companies. Therefore Salsa has sued the infringing companies in order to recover compensatory damages for its lost profits due to patent infringement. The case requires students to calculate compensatory damages for lost profits from lost sales, lost profits from margin erosion, lost profits (if any) from convoyed sales, and interest on all lost profits.
Keywords: Patent, infringement, compensatory, damages, lost profits, lost sales, margin erosion, convoyed sales
Advocacy v. Objectivity
As provided by Rule 702 of the Federal Rules of Evidence, an individual qualified as expert by knowledge, skill, experience, training or education (e.g., the forensic accountant), may offer "expert testimony" to assist the trier of fact (judge or jury or arbitrator) to understand the evidence. The court, of course, needs assurance of the expert's objectivity. This assurance may be a problem for an expert because the court, as well as the opposing attorney, may assume that advocacy has supplanted the expert's objectivity.
Consider, for example, the following characterization of forensic accounting experts (FA) testifying in a business valuation case by Judge David Schwartz, of the U.S. Court of Claims: "The trier must first judge the qualifications of the opposing experts, then try to understand their presentations, pass on their sincerity and credibility, and finally choose between opposing conclusions. Throughout, there is the uneasy doubt as to an appropriate discount for partisanship. Have the witnesses ... anticipated a discount by the trier and hiked their opinions twice, once for discount and once for loyalty to their client, or only once, or even not at all?"
Sometimes, the FA must deal not only with the court's and the opponent's assumptions about their advocacy, but also with the real difficulty of maintaining objectivity that is posed in some cases. Conclusions about technical and professional issues are sometimes based on probability rather than certainty. The determination of the value of closely held stock, for example, is a matter of judgment, rather than just mathematics. In such instances, the FA needs to be particularly careful to maintain objectivity and avoid becoming an advocate for an unwarranted position or conclusion.
A testifying expert's role (and duty) should be qualified during the engagement interview. At this point, the FA needs to clarify the nature and scope of the engagement and proposed limitations. Because of time and monetary constraints, for example, counsel may wish to limit the scope of' the expert's involvement or make that involvement conditional in anticipation of expanding or curtailing the scope of the expert's involvement. As the case progresses, the expert's scope of involvement may change from providing services as a consultant to testifying as expert witness. The FA needs to ensure that the scope of the engagement, including any changes, is documented in the case file and that all expert opinions offered fall within the scope of the engagement.
Each of the six segments of a litigation services engagement (engagement interview, investigation process, attorney communications, reporting, depositions, and testimony) is a progression built upon the prior segment. However, the investigation process is perhaps the key to keeping the expert an objective witness. A strong, thoroughly executed investigation gives the support needed to withstand the pressures and outright manipulations inherent in the rest of the litigation process.
As the investigation progresses, certain issues can arise that make it difficult for the FA expert to keep the investigative process objective. Attorneys and clients come to the FA with their own view of the facts. Inadvertently or deliberately, they may provide inaccurate information, or they may withhold information. This problem creates an opportunity for opposing counsel upon cross examination to compromise or discredit even the most seasoned expert witness. To avoid such impeachment, the FA needs to recognize that attorneys and their clients are biased. The FA needs to keep an open mind and avoid reaching conclusions prematurely. For example, the FA may use the scientific method of forming a hypothesis. Then the FA carefully follows well established investigative steps and develops forms, procedures, and processes that will ensure proving or disproving the hypothesis and that he or she will not neglect or overlook critical data, or be taken in by inaccurate data.
Even after the FA has thoroughly investigated the facts of the case and has objectively reached a supportable conclusion, he or she is still vulnerable to subtly shifting from objective expert to advocate. Sometimes, the expert's conclusion can fall within a range on a continuum of conclusions that at one end support the client-attorney's goals and at the other end support the opponent's goals. Wherever the FA expert's conclusion falls on that continuum, he or she needs to return to the data to be sure that the results, in fact, is supported by the data.
Communications between the attorney and the FA expert are necessary to ensure that everyone on the team is aware of all facts and the direction of the case. Such communications also provide opportunities for the expert to learn of new or contradictory data (e.g. alternative explanations) and to assess challenges to the conclusions he or she has reached.
At this point, the expert needs to avoid becoming attached to the original conclusion if it is attacked by the attorney or other team members. Understandably, an expert who has invested considerable time and effort in reaching this conclusion may be reluctant to change it. That said, the expert must maintain an objective point of view, realistically assessing challenges to opinions and remaining open to the possibility of flaws in the initial approach. A change may or may not be warranted, depending on the supporting data. Again, the expert needs to return to the data to see which conclusion it best supports.
An investigation that fails the mandates of Rule 702 (sufficient facts /data and the application of reliable methods) puts the expert's opinion in jeopardy. The FA expert needs to be careful, for example, when using a purchased software program (such as valuation and economic damage software) as part of the investigation to reach a conclusion. The conclusion may be subject to many variables unaccounted for by the software, making the expert's credibility vulnerable.
In general, the FA expert can help to avoid having testimony discredited by reviewing the investigation carefully before testifying. The FA should review records of time and research to make sure they agree with the case file reports. The FA also should review the files to make sure his or her conclusions are supported with documentation.
Although the FA expert can advocate his or her position based on the findings of an investigation, as an expert witness, he or she must be objective whether or not those findings support the goals being advocated by the attorney. This objectivity is required not only to provide services ethically, but also to ensure attracting the right kind of referral sources and clients.
*Bill Barrett, CPA/CFF/ABV, has investigated fraud and misfeasance in governments, corporations, boards of directors and professional practices; and has directed federal teams investigating multi-defendant money laundering, illegal income, tax evasion and white-collar fraud. He is the current vice president of practice for the American Accounting Association Forensic and Investigative Section. Contact him at firstname.lastname@example.org
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A. J. Marcella, Jr., F. Guillossoi, 2012, $80
The authors begin by explaining the origins of data. From there, the authors address concepts related to data storage, boot records, partitions, volumes, and file systems and how each of these is interrelated and essential in a cyber forensic investigation. They then analyze the roles these concepts play in an investigation and what type of evidential data may be identified within each of these areas.
Ronelle Sawyer and Jose McCarthy, two fictional characters, are used throughout the book to illuminate specific IT and cyber forensic concepts and discuss critical cyber forensic processes. Their activities and actions bring cyber forensic concepts to life by providing you with specific examples of the applications. Cyber Forensics also examines endianness and time - two important yet often overlooked topics that drastically impact almost every cyber-based investigation.
Providing a through foundation to this emerging field, this step-by-step reference covers:
Essentials of the Reid Technique Criminal Interrogation and Confessions
F.E. Inbau et al., 2005
Jones and Bartlett Publishers
40 Tall Pine Drive
Sudbury, MA 01776
This book teaches readers how to identify and interpret verbal and nonverbal behaviors of deceptive or truthful people, and how to move toward obtaining solid confessions from guilty persons using the Reid Technique. The Reid Technique is built around basic psychological principles and presents interrogation as an easily understood nine-step process. Separated into two parts, What you Need to Know About Interrogation and Employing the Reid Nine Steps of Interrogation, this book will help readers understand the effective and proper way that a suspect should be interrogated and the safeguards that should be in place to ensure the integrity of the confession.
Safeguarding Critical E-Documents
Robert F. Smallwood, 2012,
John Wiley & Sons
The author identifies the sources of electronic document leakage in terms non-techies can understand, as well as the many threats to confidential e-documents across a wide range of digital platforms, including e-mail, instant messaging, mobile devices, cloud computing, and social networks. Then he offers proven solutions for proactively defending against each of those threats.
While Smallwood describes proven technological fixes that can be implemented right away, he is careful to explain why technology alone cannot fix the problem. Real e-document security, the author explains, begins at the top, with clear, rigorously enforced Information Governance (IG) policies. Drawing upon his more than a quarter-century of experience, Smallwood provides step-by-step guidance on how to establish a set of IG protocols appropriate to your organization and for developing an organization-wide program of total life-cycle security for critical electronic documents, from their creation to their eventual archiving or destruction.