Volume 16: Issue 1, January–June 2024

Table of Contents

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Fraud and Unethical Behavior in Cryptoassets: Strategies and Recommendations for Improved Forensic Accounting | Full Article (PDF)
Stacey Ferris
Josh McGown
Julie Ravenscraft
Sean Stein Smith

Abstract: The digital asset sector has rapidly advanced from a fringe concept and novel idea to an asset class squarely at the forefront of mainstream financial markets. Alongside this rapid rise and corresponding rapid attraction of capital, the frequency and severity of frauds and unethical actors have continued to increase. While the collapse of FTX and the allegations leveled against the organization have attracted the majority of headlines, this incident has sparked intense debate over the valuation of crypto and its fundamental validity as a reserve asset. Facing these challenges, coupled with the lack of authoritative guidance for either accounting or auditing from applicable standard setters, the profession sought to develop workarounds in the form of proof-of-reserve engagements until FASB issued its first direct accounting standards on December 13, 2023. This article, written for both practitioners and academics alike, evaluates the crypto environment and crypto fraud through the FTX lens, analyzes the current state of proof of reserves engagements, and lays out best practices for working with risky crypto clients.

Keywords: Cryptoasset; cryptocurrencies; digital assets; audit; attestation; forensics; FTX

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Understanding the Role of Memory in Interviews Undertaken by Auditors: Pitfalls and Solutions | Full Article (PDF)
Joan Fico
Dave Walsh

Abstract: Auditors and forensic accountants regularly undertake interviews with clients and stakeholders to obtain detailed and reliable information. There are numerous references within the PCAOB auditing standards that require auditors to make inquiries. This article presents introductory coverage as to how interviewee memory functions in such interviews. Increased awareness concerning the functioning of memory is as important in the context of auditing and accounting interviews as in other domains. Psychological literature chronicles the many challenges which exist when conducting interviews. This article introduces the role of memory in accounting interviews, exploring how the interviewee’s memory can be influenced, potentially causing adverse effects. Additionally, the study includes three in-class exercises based on seminal research in psychology concerning memory.

Keywords: Audit interview; memory; oral evidence; internal audit; forensic and investigative interview

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Detecting Financial Statement Fraud: An Alternative Evaluation of Automated Tools Using Portfolio Performance | Full Article (PDF)
Amanda Yee
Adrian Gepp
Kuldeep Kumar
James Todd
Bruce James Vanstone

Abstract: This article investigates the effect of using financial statement fraud detection models in constructing investment portfolios. Three financial statement fraud detection models are recreated and used to inform portfolio construction. Portfolio performance is compared between two strategies investing in companies on the S&P 500 predicted to have the highest (lowest) likelihood of financial statement fraud according to three models. Investment performance under the two strategies and across the three models are assessed using Fama-French regressions over a trading period from 2003 to 2021 and during market shocks. The portfolio of companies with the highest likelihood of fraud underperforms, characterized by inadequate returns relative to risk exposures. In the case of low-likelihood firms, results are consistent with risk-reward expectations. Financial results were consistent across all three fraud models, indicating that each model effectively discriminates between companies predicted to exhibit financial statement fraud. This research investigates the effect of financial statement fraud risk on investment performance and provides an alternative evaluation of financial statement fraud detection models, complementing the traditional accounting analysis of such models.

Keywords: Financial statement fraud; accounting fraud models; fraud detection; investment performance

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Unveiling Financial Fraud in Divorce: Types, Taxes, Red Flags, and Investigative Steps | Full Article (PDF)
Nicole Forbes Stowell
Martina K. Schmidt
Irwin Katz
Sharon L. Segrest
Carl Pacini

Abstract: Approximately 40 to 50 percent of marriages in the United States terminate through divorce. Financial infidelity and the unique blend of financial and emotional pressures during divorce can contribute to the occurrence of fraudulent activities. Not surprisingly, divorce fraud allegations are estimated to arise in around half of all divorces; however, the discovery of evidence is scarce. Divorce fraud exhibits distinct characteristics, such as its diversity and complexity, its time-compression, the onset of suspicious actions prior to divorce filings, the involvement of tax-related aspects, and the considerable challenges and expenses associated with its detection process. This article aims to assist divorce fraud investigators in solving the puzzle of identifying and preventing such fraudulent behavior. The article explains four main types of divorce fraud (concealing assets, hiding income, improperly valuing assets, and dissipating funds), explores the interplay of taxes, highlights red flags for potential fraud, and outlines steps to further investigate suspicious activities.

Keywords: Divorce fraud; red flags; detecting divorce fraud; taxes in divorce fraud; finding assets

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Whistleblowing in Accounting: A Meta-Analytic Review | Full Article (PDF)
Mackenzie M. Festa
Kevin G. Knotts
Megan M. Jones

Abstract: Whistleblowing is generally understood as the disclosure of actions taken by an organization or the members therein that are potentially illegal or unethical. Forensic accountants must understand the impacts and reasons individuals choose to engage in whistleblowing as it is a key process for preventing and detecting accounting misconduct. Using meta-analytic techniques, we quantitatively explore the relationships that exist between various antecedents and whistleblowing. This meta-analysis empirically analyzes relationships for both internal and external whistleblowing channels. Our findings show personal responsibility and perceived seriousness are positively related to whistleblowing for both internal and external whistleblowing, while a negative relationship is found between perceived cost and internal whistleblowing. Mixed results are found for age and gender. This review adds to previous whistleblowing reviews by quantitatively summarizing existing research and providing avenues for future research.

Keywords: Meta-analysis; perceived cost; perceived seriousness; perceived responsibility; whistleblowing

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Improving the Efficacy of the Securities Fraud Lawsuit Against Catalent, Inc. | Full Article (PDF)
D. Larry Crumbley
Amanda M. Grossman
Steven D. Grossman

Abstract: Through detailed discussion of the proper application of accounting standards involving revenue recognition principles on contracts, this study aims to demonstrate how the arguments set forth in a securities fraud lawsuit against Catalent, a vaccine manufacturer, may be strengthened. This article articulates the revenue recognition requirements of both United States Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS), as they relate to Catalent products and the manner in which the company apparently violated the accounting rules. Next, the study discusses key sources that shed light on the company’s inappropriate practices, including Securities and Exchange Commission (SEC) statements and the reporting of Glasshouse Research analysts. Finally, the particulars of the subsequent, and currently pending, lawsuit filed by the City of Warwick Retirement System against Catalent is presented. The plaintiff’s case hinges on the claim of improper revenue recognition and channel stuffing schemes perpetrated by the company in an effort to deceive investors; however, incorporating the particulars of contract revenue recognition violations should reinforce evidence against the defendant.

Keywords: Securities fraud; Catalent, GAAP; IFRS, SEC, Warwick Retirement System; recognition requirement

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The Visible Hand of Lawyers: Attorneys’ Selection, White-Collar Fraud, and Criminal Sentences | Full Article (PDF)
Jesus Rodolfo Jimenez-Andrade

Abstract: In the American white-collar fraud prosecution system, attorneys stand between fraudsters and criminal justice. Based on the theory of access literature, this manuscript explores whether attorneys’ selection moderates the relationship between severity of crime and criminal sentence. Collected data from 1,872 white-collar crimes between 2002 and 2020 prosecuted in San Antonio, Texas tests this hypothesis. Findings evidence that attorneys’ selection influences up to 10 percent of the criminal sentence (+,- 64 days). Socioeconomic control variables result in statistical significance, while demographics lack this condition. These findings suggest that fraudsters have incentives to maximize the defrauded amount to gain higher-quality legal access to maintain the ambiguity of the legitimacy of the sources, while minimizing criminal sentences if any. A supplementary statistical analysis enhances the reliability of the findings.

Keywords: Attorneys; white-collar fraud; criminal sentences; theory of access

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The Perfect Tax Storm of 2026: Letting U.S. Gift and Estate Tax Exemptions Sunset Combined with the Proposals to Eliminate the Stepped-Up Basis | Full Article (PDF)
Rossen Petkov

Abstract: We discuss the perfect tax storm and the potential tax fraud implications by letting the U.S. gift and estate tax exemptions sunset in 2026, combined with proposals to eliminate the stepped-up basis to fair value at the time of death, in a controlled predetermined example. The discussion is twofold by looking at the gift/estate exemption expirations and recent proposals to remove the stepped-up basis to set the narrative for the perfect tax storm. The combination of these two events could result in unprecedented shifts of wealth across generations. Such changes contribute to an increase of the fraud risks associated, specifically related to the incentives for individuals to be involved in tax evasive activities to avoid paying their taxes. Proper regulatory planning can significantly reduce or eliminate the contributing factors mentioned. However, this study should serve as a warning of the potential fraudulent implications if appropriate and timely actions are not taken. To assess these implications, we develop and analyze a (preset) proposed model that involves reducing exemptions and eliminating the stepped-up basis, which serves as a control variable. This analysis aims to determine the potential implications of these proposed changes, so we provide potential steps taxpayers can undertake to mitigate the effect, if these changes occur. These steps include, but are not limited to, creating Qualified Terminable Interest Property Trusts to act as insurance against the proposed changes. In addition, taxpayers could combine these actions by taking advantage of the current exemption amounts prior to their sunset dates in 2026.

Keywords: U.S. gift and estate tax; stepped-up basis; stepped-down basis; exemptions; tax fraud

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The Audit Fee Implications of Change in Accounting Estimate Disclosures | Full Article (PDF)
David Hurt
Jason MacGregor
Melanie Millar 

Abstract: Estimates pervade the financial statements, and auditors must provide reasonable assurance that management has properly updated these estimates every period. If there is a material change in an estimate, then management must make a separate disclosure, and the auditor may need to conduct additional testing. The auditor must consider whether the change in estimate is the result of a change in economic circumstances, managerial opportunism, or fraud. We use the Audit Analytics Changes in Estimates database, which tracks all material changes in accounting estimates (ASC 250-10-50-4) disclosed by SEC registrants, to investigate whether these disclosures affect audit fees. We find that, at the mean, clients pay approximately seven percent higher audit fees when they report a change in estimate than when they do not. Additionally, we find that the fee increase is more severe when the client has reported a control problem or has high inherent risk (possible fraud). We also find that new auditors increase their fees more for a change in estimate than tenured auditors do, and we find that an integrated audit reduces the fee impact of a change in estimate. We find evidence that auditors do, in fact, respond to the risk of companies changing accounting estimates, and further, that they exhibit a nuanced response based on the particulars of the change in estimates and the context in which it is disclosed.

Keywords: Audit fees; financial reporting quality; change in accounting estimate disclosure

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How Remote Work is Affecting the New Generation of Auditors and Audit Quality: Recent Research and its Implications | Full Article (PDF)
Gillian Rose Barnes
Dana R. Hermanson
Margaret E. Knight
Valerie Simmons

Abstract: In March 2020, auditing practice changed overnight, from face-to-face to largely remote work, due to the COVID-19 pandemic. Although remote work offers many advantages, it is essential for audit firm leaders to understand the unique remote work challenges faced by auditors who are relatively new to the profession. In this article, we review selected recent studies and develop implications for audit firm leaders regarding the new generation of auditors working in a remote environment. Specifically, we examine the effects of remote work on (a) auditors’ socialization and professional development, (b) auditors’ mental health and burnout, and (c) audit quality. The study discusses several implications for audit firm leaders.

Keywords: Remote work; auditors; socialization; burnout; audit quality

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Book Reviews

Breaking Twitter Ben Mezrich, 2023, 322 pp. Grand Central Publishing Hachette Book Group 1290 Avenue of the Americas New York, NY 10104    Elon Musk acquired the Twitter platform using a leveraged buyout in October 2022 for $44 billion, using $13 billion of borrowed money. Using the borrowed money means Twitter is on the hook, not Musk, because a smaller amount of capital is required by the acquiring company. Employees fled, revenue fell, and Musk changed the name of the platform to “X.” Reports indicate that Musk lost $25 billion on the Twitter acquisition within a year. By the end of 2023, supposedly the X platform is worth 71.5% less than when Musk acquired it. Author Mezrich in his nonfiction book asserts that Elon Musk did not break Twitter, but Twitter broke Musk. Through interviews with employees and Musk’s confidants, the author indicates that Musk ran a chainsaw through the company before he stepped down as CEO, and the blowback has tarnished his reputation, perhaps irrevocably. In December 2022, Musk asked Twitter users to determine if he should step down. Around 57.5% of the users voted for him to step down. A Kirkus review indicates that this book is significantly flawed but has some important things to say about business in the social media age.

Among the Bros: A Fraternity Crime Story Max Marshall, 2023, 291 pp. Harper Collins Publishers 195 Broadway New York, NY 10007    Is Greek life a major breeding ground for American power? Well, 80 percent of Fortune 500 executives, 85 percent of Supreme Court Justices, and all but four U.S. presidents since 1825 have been fraternity members. Max Marshall, an investigative journalist, goes to the College of Charleston in South Carolina to investigate a “small-time” fraternity Xanax trafficking ring. However, he found a homicide, several student deaths, and millions of dollars after interviewing more than 120 people. The main character in this crime story is 5-foot-7 Mikey Schmidt who joins Kappa Alpha at the 253 years old historic public College of Charleston with almost 11,000 students. Eventually, he brought cocaine by the pound from cartel-connected sources in Atlanta to the Charleston campus to help pay his annual $18,400 tuition and board costs. Eventually, he gets a 10-year sentence plea deal, serving his time at Wateree River Correction Institute for operating a sizeable three-person drug ring. Another student of a wealthy builder of expensive homes that was dealing drugs is murdered with a Chipotle napkin on his chest covering the bullet wound, surrounded by 100s of GG 249 Xanax pills. The dark web has helped the college drug dealers by allowing them to stay in the dorm, order the drugs, receive the shipments, and sell massive amounts of drugs at less risk. This nonfiction book paints an addictive and devastating portrait of tomorrow’s American business and political establishments if all fraternities are like College of Charleston.

Big Liars: What Psychological Science Tells Us About Lying and How You Can Avoid Being Duped Christian L. Hart and Drew A. Curtis, 2023, 361 pp. American Psychological Association www.apa.org/pubs/books/big-liars    Big Liars, written by psychologists Christian L. Hart and Drew A. Curtis, investigates the science behind “big liars”—those rare people who use lies as their principal way of navigating life. Fortunately, most people are mostly honest, most of the time. And there are not that many big, pants-on-fire liars in the population overall. But just a few big liars can have an outsized impact on the people around them—ruining personal relationships, bankrupting businesses, and even, when they attain political power, undermining the fabric of society. Big Liars explores this small but dangerous group through the lens of psychological science. Fascinating new research gives us insight into the nature of dishonesty and dishonest people, explaining who lies, what types of people lie a lot, how often people lie, how big liars are created, how they operate, how we can recognize them, and how we can avoid being victimized by them. This book has crucial implications for mental health treatment, as well as our efforts to grapple with the effects of big liars—and their big lies—on social movements and society as a whole.

How to Make a Killing: Death and Dollars in American Medicine Tom Mueller, 2023, 277 pp. W. W. Norton & Co. 500 Fifth Avenue New York, NY 10110    The first dialysis machine was developed in Europe using a bathtub, sausage skins, and a sewing machine motor. The author lays out the corruption, fraud, and profit-making in the kidney dialysis business. Kidney disease was deadly in the mid-20th century. The author, based upon hundreds of interviews, maintains that doctors, huge corporations, and Beltway lobbyists turn the kidney miracle into one of U.S. worst health-care catastrophes because of a single focus on profits. Mueller introduces heroic patients who risked their lives to blow the whistle on how they were mistreated. He asserts that private dialysis centers in the U.S. followed a quicker, more aggressive and lethal methods that were more cost effective but with higher profits. By getting patients out too quickly during a treatment, “dialysis may shorten patients’ lives by stripping off bodily fluids too fast, triggering sudden drops in blood pressure that can damage the heart, brain, gut, and lungs, and leads to stroke, congestive heart failure, and cardiac arrest.” Europe and other countries followed a slower home treatment. Mueller shows “dialysis as a microcosm of American medicine and poses a vital challenge: find a way to fix dialysis, and we’ll have a fighting chance of fixing our country’s dysfunctional healthcare system as a whole, restoring patients, not profits, as its true purpose.”

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Events
NACVA and the CTI’s 2024 Business Valuation & Financial Litigation Super Conference
December 12–13, 2024 | MGM Grand, Las Vegas, NV | https://www.nacva.com/conferences