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Volume 3: No. 3, July–December, 2011

JFIA

Volume 3: No. 3, July–December, 2011

Table of Contents:

 

Conducting Effective Ponzi Scheme Investigations | Full Article (PDF)
Thomas A. Buckhoff
Bonita K. Peterson Kramer
 
Abstract: Subsequent to the 17-year span encompassed by Bernard Madoff’s Ponzi scheme and the billions in investors’ losses resulting from it, the Chairman of the Securities and Exchange Commission (SEC) directed the SEC Office of Inspector General to investigate the failure of the SEC to uncover Madoff’s Ponzi scheme. Although the SEC had received several complaints concerning Madoff’s hedge fund operations, the SEC investigators responsible for following up on the complaints did not have a sufficient understanding of the following three issues critical to effectively investigating Ponzi schemes: 1) understanding what a Ponzi scheme is and how it works; 2) detecting the red flags of a Ponzi scheme; and 3) conducting an effective Ponzi scheme investigation. It is impossible to effectively investigate a Ponzi scheme or any other fraud scheme without first developing a thorough understanding of each of the above three issues. Accordingly, we explore in detail each of these issues in order to enhance the effectiveness of future Ponzi scheme investigations.
 
Keywords: Ponzi schemes, detection, red flags, investigation, forensic accounting.

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An Effective and Efficient Analytic Technique: A Bootstrap Regression Procedure and Benford's Law | Full Article (PDF)
Ik Seon Suh
Todd C. Headrick
Sandra Minaburo
 
Abstract: Previous studies in auditing have proposed statistical analytic techniques to determine the presence of unusual fluctuations in financial data. However, these techniques use past financial data and/or other explanatory variables to compute expectation parameters. If past data were contaminated with errors or fraud, then the precision of developed expectations is questionable and this leads to an increase in Type II error. The current study introduces a new analytic technique known as the bootstrap regression (BREG) procedure in the context of Benford’s Law. The BREG procedure mitigates Type II error based on Benford parameters and exact confidence intervals to assess for the presence of unusual fluctuations in financial data sets. These parameters and confidence intervals are derived independently from the financial data subject to audit. In addition, the BREG procedure mitigates Type I error and the excessive power problem. The BREG procedure was applied to a wide range of data sets such as non-fraudulent, fabricated, allegedly fraudulent, and fraudulent data sets. The overall results demonstrate that the BREG procedure effectively and efficiently identifies the presence of data anomalies. Unlike the BREG procedure, other commonly used analytic techniques were either difficult to implement or yielded inconsistent results in the context of the fraudulent data.
 
Keywords: Analytic procedure, Confidence Intervals, Fraud, Misstatements, Power, Regression Analysis, Type I and Type II errors, Unexpected Fluctuations.

Data Availability: The fraudulent data are bound by a confidentiality agreement with the Mexican Retail Company.

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The Uncertain Liability of Accountants and Other Professionals in Securities Fraud Cases: The Shifting Sands of Central Bank | Full Article (PDF)
Carl Pacini
Jeff Paterson
Salar Ghahramani
 
Abstract: We analyze various federal court decisions that demonstrate varying legal standards used to determine whether the conduct of accountants, lawyers, investment bankers and others amounts to a primary violation of federal securities fraud laws. Although the Central Bank of Denver ruling eliminated aider-and-abettor liability for accountants and other professionals, the case shifted debate to when secondary actor conduct rises to a primary violation of section 10b of the Securities Exchange Act of 1934. The rising number of securities fraud lawsuits, increasing damage settlement amounts, and the application of different legal tests for section 10b liability show a rising level of legal uncertainty in the securities fraud area. Our analysis enhances understanding of evolving Rule 10b-5(b) legal standards to hold secondary actors liable for federal securities fraud so interested parties can better assess legal exposure.
 
Keywords: Securities fraud, auditor liability, Section 10b liability, Rule 10b-5. 
 
Data Availability: Federal court decisions are available on Lexis-Nexis and WestLaw.

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One Hundred Years of Disappointed Expectations: A Quantitative Content Analysis of the Auditor’s Responsibility to Discover Fraud Traced through Montgomery’s Auditing, 1912-1998 | Full Article (PDF)
Stephanie D. Moussalli 
O. Ronald Gray
Gokhan Karahan
 
Abstract: We use the authoritative Montgomery’s Auditing reference series from 1912 to 1998 as a proxy for the U.S. auditing profession’s stance towards fraud detection as an audit goal and its attention to the implementation of this goal. A quantitative content analysis of the editions finds that the amount of text expressing a position on the auditor’s fraud detection responsibility, whether affirmative, negative, or ambivalent, was very high in the early 20th century, low from 1916-1975, and high in the last decades. In contrast, text explaining how to detect fraud lagged the three positions variables (affirmation, denial, ambivalence); how-to text was voluminous until mid-century, plummeted after 1949, and stayed low thereafter despite the appearance of new standards acknowledging fraud detection as a goal and despite the series’ stated support of the new standards.
 
Keywords: Fraud, fraud detection, history of auditing, Montgomery, auditing standards, auditing procedures, content analysis.
 
Data Availability: The data series developed for this paper appears in an appendix. Its development required substantial effort, and we ask that any who uses it in the future acknowledge its source.

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Fraud Risks in Local Government: An Analysis of Audit Findings | Full Article (PDF)
Ronald J. Huefner
 
Abstract: Internal controls are a primary means to deter fraud. Failure to establish or to follow a strong program of controls provides opportunities for fraud to occur. Fraud occurs in all types of organizations. This article considers fraud risks in local government. Over 87,000 municipal governments exist in the United States, ranging from the smallest villages and special districts to the largest cities and counties. Smaller municipal units are often likely to suffer from control deficiencies, due to lack of financial and personnel resources and limited oversight. 
 
This research examines the findings of 234 audits of town and village governments in New York State, as conducted by the State Comptroller’s Office over the period 2003-09. The audits focused on governance and internal control issues, not financial statement issues. The audits presented numerous recommendations for improvements in controls. We analyze the content of 1,387 control recommendations from a fraud prevention perspective. The findings suggest locations of the greatest areas of weakness in the ongoing battle against governmental fraud.
 
Keywords: Fraud, internal controls, local government, towns and villages.
 
Data Availability: The data used in this study are publicly available.

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Where Did the Money Go? A Forensic Analysis of the Cash Position of General Motors Following the Bailout | Full Article (PDF)
Mariah C. Webinger
 
Abstract: GM received $20 billion in bailout funds from the United States government but was unable to avoid bankruptcy. This paper examines the possible ways in which the bailout funds were spent. Specifically, it examines the first $10 billion loaned that GM spent in a matter of three months. The study finds that GM spent this money on normal operating expenses, and further that these expenses created a cash burden because GM was not collecting their receivables as well as they had in the past, that the cost of sales was higher than it had been in the past, and that suppliers were unwilling to extend GM credit like they had done in the past. There is weak evidence that GM spent an abnormally high amount of cash on other post-retirement benefits, but no support for the popular allegations that GM used the cash to buy property in Brazil, paid excessive executive compensation, and little support for the theory that GM propped up their pension funds with the cash from the bailout.
 
Keywords: Forensic accounting, Funds tracing, Bailout, General Motors.

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Fraud Prevention and Detection in the United States: A Macro Perspective | Full Article (PDF)
Sara Aliabadi
Alireza Dorestani
Mohammed Qadri
 
Abstract: The collapse of Enron and other high profiled corporations such as WorldCom and Xerox in the beginning of the new century sheds light on the weakness of our auditing and accounting profession to prevent or detect fraud. It is shown that only a small portion of revealed frauds in the United States is detected by auditors. In this paper we introduce the Fraud Deterrence Triangle and show that for preventing or detecting fraud, we need to invest in: a) providing programs for educating and training for fraud prevention/detection, b) providing a set of corporate governance characteristics, and c) providing programs for educating and promoting ethical values. We argue that the literature on corporate governance is rich; however, less work is done on ethics and fraud related education. In this study we select a random sample of 201 universities in the United States and focus on programs for fraud prevention/detection education. Using a content analysis method, we show that more than 95% of business schools in the United States do not offer any fraud/related programs/courses and none offers any courses in ethics. We conclude that the inability of auditors to effectively detect frauds comes from the fact that neither universities nor audit firms provide programs that provide the required fraud and ethics related education.
 
Keywords: Fraud; Auditing; Fraud Avoidance; Fraud Detection; Fraud Avoidance/Detection Education.

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A Corruption Primer: The Role of Culture, Religion, Wealth, and Governance | Full Article (PDF)
Marinilka Barros Kimbro
 
Abstract: Drawing on macro and micro-economic theory, this paper expands the literature by examining the role of culture, religion, wealth, rule of law, governance and accounting on corruption. Using a panel of 75 countries, I find evidence that countries with Civil German law have better control of corruption and better governance, than countries with Civil French and Common Law. I also find that the relationship of individualism and corruption is mediated by the positive effect of GNI. Economically and institutionally mature countries with high individualism tend to have more corruption than countries with intermediate levels, indicating a non-monotonic, non-linear relationship between individualism, wealth and corruption. Even though Protestant countries are less corrupt than Catholic and Muslim countries, I find that this association is mediated by the level of institutional and regulatory development. Specifically, an efficient rule of law, moderate growth rates, as well as better governance and accounting is directly associated with countries that have controlled corruption.
 
Keywords: Corruption, culture, religion, legal origin, governance and accounting, individualism.

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The Effects of a Charismatic Leader’s Actions in a Public Community College | Full Article (PDF)
Kathy S. Pollock
Kent D. Kauffman
Janet C. Papiernik
 
Abstract: The purpose of this case is to introduce students to a real-life example of how organizations respond to activities of high level employees that appear to be inappropriate. At the same time the case engages the student since it sounds like the plotline for a TV sitcom: a college chancellor not only lived in a secret apartment in the university-owned building, but periodically hosted overnight guests. This case is unique in that rather than focusing on how the possible fraud was uncovered, it asks students to evaluate through their understanding of the fraud triangle, forms of power, and stages of crisis the impact of an employee’s actions on an organization and its constituents. To complete the case, students conduct some minimal online research.
 
Keywords: Fraud triangle, stages of crisis, forms of power, ethics.

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Employee Fraud at Miami Rehabilitation Services | Full Article (PDF)
Jeffrey E. Michelman
Bobby E. Waldrup
Alex Bird
 
Abstract: This case exposes students to internal control and fraud and their related impacts on small business. Although the issues of internal control and fraud are involved in almost every discussion of accounting, only recently has this concept received increased discussion specific to small business organizations. In particular, the case provides clear evidence how professional owners can often lose sight of the business side of ‘running a business’ as they get involved in their myriad professional responsibilities. Further, the case illustrates the importance of the CPA in both preventing and detecting fraud, particularly in small business. Finally, the case highlights the importance of human resource policies and procedures on internal control and fraud prevention.
 
Keywords: Small business, internal control, fraud detection, human resource policies, the fraud triangle.

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U.S. Foodservice: A Case Study in Fraud and Forensic Accounting | Full Article (PDF)
Maria H. Sanchez
Christopher P. Agoglia
 
Abstract: The Dutch company Ahold NV, parent company of U.S. Foodservice, announced a large earnings restatement for current and prior years. The restatement was largely because of fraud related to vendor rebates at U.S. Foodservice. They announced that an extensive forensic accounting investigation would be launched. It was later discovered that in an effort to boost earnings, the company had booked vendor rebates that had not yet been earned and in some cases, were entirely fictitious. It was also discovered that several vendors had provided misleading or false third party confirmations to the external auditors. In this case, students will gain insight into the proper accounting for and disclosure of vendor rebates, improving the auditors’ understanding of the clients’ business, maintaining professional skepticism, and guarding against over-reliance on third party confirmations.
 
Keywords: Fraud, forensic accounting, earnings restatements, vendor rebates, confirmations.