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Volume 8: Issue 1, January–June, 2016

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Volume 8: Issue 1, January–June, 2016
Table of Contents

Measuring Damages in Federal Securities Fraud Cases: A Herculean Task | Full Article (PDF)
D. Larry Crumbley
Christine Crawford-Cheng
Abstract:  With the huge amount of damages in securities fraud cases, accountants have opportunities to provide consulting and expert witness testimony for either the defense or plaintiff.  In this article, we discuss the commonly accepted methods available to accountants seeking to provide expert witness testimony with respect to measuring damages in securities fraud cases.  The event study method, which is becoming increasingly accepted in these types of court disputes, has been used extensively in accounting research.  The benefit of the event study method is that, when used properly, experts can isolate the damages caused by fraud from other factors, such as industry or market wide shocks, that may have impacted the stock price (but are unrelated to the fraud).  We also note that experts should be prepared to provide sound justification for the model and the assumptions to avoid losing a Daubert challenge which could cause their report and testimony with respect to the dispute to be disallowed.
Keywords: Securities fraud; litigation; expert witness; event study method; Daubert challenge.

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Commercial Crime Insurance for Coverage of Employee Fraud | Full Article (PDF)
Edmund D. Fenton, Jr.  
Siwei Gao
Abstract: Employee fraud continues to exist for many businesses even with numerous preventive measures in place.  Forensic accountants and financial statement auditors assess the potential risks faced by clients and recommend internal control procedures to help prevent fraud losses.  But with annual losses from employee fraud rising each year, totaling billions of dollars, and possibly trillions world-wide, it is quite evident that while internal controls may reduce potential losses, actual losses will occur for a large number of businesses.  After the internal controls fail and losses from employee actions occur, attention turns to recovery: either from the employee who caused the loss, or from the insurance carrier if a policy covering employee theft is in place.  Typical business insurance policies cover losses from liability claims, outsider theft, and property damage from fire, lightning, and windstorm.  Losses from employee theft, however, are covered by insurers under specialized policies called “commercial crime insurance,” and this coverage is not part of a typical property policy.  This paper discusses three important aspects of insurance coverage related to employee theft.  These aspects are the definitions of “employee,” “occurrence,” and “discovery” for insurance contract purposes.  For example, a dominant shareholder may not be considered an employee for insurance purposes; one occurrence could be a series of theft acts over a several-year period; and loss discovery must be made and reported to the insurer within certain time frames.  While having the appropriate coverage will help mitigate losses when well-designed internal controls fail, not understanding the definitions of certain commercial crime insurance terms may result in less than expected, or possibly no, insurance coverage.
Keywords: Fraud; employee; crime; insurance.

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Microinsurance, Fraud, and Fraud Controls | Full Article (PDF)
Deborah L. Lindberg
Deborah L. Seifert
Abstract: Microinsurance is the protection of low-income people against specific perils in exchange for regular premium payments proportionate to the likelihood and cost of the risk involved (International Association of Insurance Supervisors [IAIS] 2007).  Microinsurance is not necessarily a separate type of insurance, but rather viewed as insurance available in small amounts to poor people.  Since microinsurance is aimed at providing insurance coverage to low-income people, generally a relatively more “enabling” regulatory environment is required for the development and provision of microinsurance products (IAIS 2007).  Accordingly, when a more relaxed regulatory environment for microinsurance is considered, along with the somewhat unique marketing channels used for microinsurance products, the opportunity for fraud in the microinsurance industry is rampant.  However, steps can be taken to prevent fraud associated with microinsurance.  For instance, moral hazard and fraud can be limited by promoting awareness of the fraud issues related to microinsurance and by implementing controls to prevent or detect such fraud.  This article discusses specific threats of fraud in the microinsurance industry; but more importantly, we recommend controls to combat fraudulent microinsurance practices by providers and/or bogus claims by policyholders.
Keywords: Microinsurance; low-income people; moral hazard; fraud; controls.  

Countering Mobile Device Threats: A Mobile Device Security Model | Full Article (PDF)
Grover S. Kearns
Abstract: The use of mobile devices in business is increasing as employees use them for communications, creating, and editing documents, storage and retrieval of data files, and browsing the Internet.  Mobile device purchases now exceed personal computers.  While mobile increases worker agility and allows them to work remotely, the pervasiveness and evolution of these devices creates a special threat because existing policies and controls are not sufficiently broad to cover the new threats these devices pose.  Most organizations have failed to address these security issues through formal policies or create specific controls to reduce their likelihood.  This article argues for the importance of enhanced mobile device policies and controls, suggests specific policies and controls, and presents a mobile device security model.
Keywords: Mobile devices; mobile device security; mobile device policies; information systems security.

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Free Cash Flow and Debt Monitoring Hypothesis: Evidence from Material Internal Control Weakness Disclosure | Full Article (PDF)
Sheela Thiruvadi
Huang Hua-Wei
Clark M. Wheatley
Shiyaamsundar Thiruvadi
Abstract: This study investigates whether auditors are more conservative when assessing the internal control systems of low-growth firms that have high free cash flows (FCF) when compared to high-growth firms having high FCF.  Managers of firms with high FCFs are likely to opportunistically engage in value-declining activities, such as over-investment or misusing capital (Jensen 1986).  A weak internal control system may further facilitate such activities.  
Given that Section 404 of the Sarbanes-Oxley Act (SOX) was designed to strengthen the responsibilities of managers to maintain adequate internal controls and of auditors in assessing those controls, it is likely that, in the post-SOX era, auditors will be more conservative in their judgment of internal control weakness (ICW) for firms with high FCF.  Our results indicate that auditors are, indeed, more likely to report ICW for low-growth firms with high FCFs when compared to high-growth firms having FCFs.  In addition, our results indicate that ICW problems are mitigated by increased debt monitoring for firms with high FCF.  Furthermore, our results indicate that there are increased risk implications for low-growth firms having high FCF when managers engage in risky capital expenditure activities.
Keywords: Sarbanes-Oxley Act Section 404; agency theory; free cash flows; debt monitoring; material internal control weakness.

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Electronic Audit Confirmations: Leveraging Technology to Reduce the Risk of Fraud | Full Article (PDF)
Steven A. Solieri
Joan Hodowanitz
Abstract: Auditors are taught that the confirmation process provides reliable third-party evidence with regard to a client’s financial statement assertions.   However, several egregious frauds in the past twenty years were the direct result of the failure of the traditional, paper-based confirmation process.  Fortunately, that system is slowly giving way to more efficient and accurate electronic processes.  In fact, some recent cash confirmation frauds were actually uncovered using the service.  Although the auditing profession acknowledges the obvious advantages of electronic confirmation, only the National Futures Association (NFA), the self-regulatory organization of the Commodity Futures Trading Commission (CFTC), has mandated its use for companies in the futures industry.  The American Institute of Certified Public Accountants (AICPA) and the Public Company Accounting Oversight Board (PCAOB) approved the use of electronic confirmations in 2007, but they do not yet require private and public companies to use them as part of Generally Accepted Auditing Standards (GAAS).  Considering the ongoing risk of confirmation fraud, this requirement is the next logical step if the auditing profession is to perform its role as a public watchdog in the twenty-first century.   
Keywords: Audit confirmation; confirmation fraud; electronic confirmation process; auditor training.   

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Attitudes of Activist Shareholders, Securities Fraud, and Stock Market Reactions | Full Article (PDF)
Yi-Hong Lin
Hua-Wei Huang
Sheela Thiruvadi
Abstract: The purpose of this study is to examine the attitudes (hostile versus friendly) of activist shareholders with regard to, (1) the incidence of securities fraud, and (2) the market reaction around the filing date of securities fraud litigation.  Using a final securities fraud sample consisting of 996 observations, we find that the activist shareholders with hostile attitudes (hostile activist shareholders) have preventive and/or deterrent effects on the financial statement fraud and other types of securities fraud.  However, activist shareholders with friendly attitudes (friendly activist shareholders) do not show any effective monitoring on the securities fraud.  In addition, we find that hostile activist shareholders help reduce negative stock returns while friendly activist shareholders tend to aggravate negative stock returns around the filing date of the securities fraud litigation.  We also find that firms having friendly activist shareholders are more likely to manipulate earnings by increasing positive discretionary accruals.  Our study suggests that the attitudes of activist shareholders may influence the ethical behavior of top management and the responses of market investors.  
Keywords: Securities fraud; activist shareholders; stock market reactions; earnings management; corporate governance.

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Forensic Accounting Education and Practice: Insights From China | Full Article (PDF)
Zabihollah Rezaee
Daniel Lo
Michael Ha
Alexis Suen
Abstract: The forensic accounting practice has emerged in the areas of litigation support, consulting, expert witnessing, and fraud investigation.  About half of all business organizations are affected by fraud worldwide, and accountants can play an important role in combating fraud.  Although forensic accounting practice is viewed as one of the most rewarding and secure career choices, there is a gap between forensic accounting practice and education.  Furthermore, the evidence of forensic accounting practice and education from the global perspective is rare.  Thus, this study examines forensic accounting practice in China and gathers opinions from Chinese students regarding the importance, demand, relevance, benefits, coverage, and delivery of forensic accounting education in China.  Results indicate that: (1) the demand for and interest in forensic accounting education and practice will continue to increase in China; (2) forensic accounting can be integrated into the business curriculum by either offering a stand-alone forensic accounting course or through infusion into several accounting and business courses; and (3) many of the suggested forensic accounting topics should be integrated into business and accounting curricula in universities in China.  The findings can be of great benefit to business colleges and accounting schools worldwide in redesigning their curricula by providing coverage of the emerging area of forensic accounting.  
Keywords: Forensic accounting practice and education in China; business and accounting curricula; financial statement fraud.

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Foxes in the Henhouse: An Exploratory Inquiry Into Financial Markets Fraud | Full Article (PDF)
Joseph Wall
Timothy J. Fogarty
Abstract: Conventional understandings of fraud are organized around the fraud triangle first developed in the 1950s by Cressey.  This conceptual device remains central in our pedagogy and research on this especially timely topic.  As long as fraud is imagined to be not much different than a stereotypical act by a single individual out of financial desperation and impulsiveness, the fraud triangle provides a reasonably powerful conceptual organization.  However, when applied to abuses that occur in highly organized financial markets, its application takes on new meanings that push the boundaries of its usefulness.  Using interviews with traders and other securities market participants, this paper concludes that the prospects for ill-gotten gain are much more systematic and the product of incomplete regulation.
Keywords: Financial markets fraud; fraud triangle; traders; regulations; greed.

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Reporting Truthfully: Assessing Ethical Behavior of Accounting Students | Full Article (PDF)
Akhilesh Chandra
Thomas G. Calderon
Mark M. Welfley
George W. Daverio
Abstract: In an active engagement exercise, we assess the ethical behavior of accounting students by comparing digital logs of their actual work, done as part of a due diligence task, with the work they claimed to complete.  Students who participated had the prerequisite background to complete the task and to make an appropriate recommendation.  Students completed the due diligence task and kept a checklist of all work that they claimed to complete.  
We operationalized unethical behavior in two ways by examining students’ truthfulness in reporting their work: first, documenting in their checklist (working papers) that they completed activities which they actually did not complete; and second, certifying the introduction of a new product when, in fact, the numbers warrant rejection of the product.  Our results suggest that students struggle to report their due diligence work truthfully, and that thirty-five percent reported untruthfully.  In the context of the accounting profession, which relies on truthful reporting, we interpret this as an ethical issue.  We observe that students tend to be ethical in documenting the first half of their work but tend to become increasingly unethical as they progress.  We refer to this phenomenon as a midway sign-off strategy.
Keywords: Due-diligence task; ethical behavior; truthful reporting; midway sign-off strategy.

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The Incremental Benefit of a Forensic Accounting Course to Creativity | Full Article (PDF)
Chih-Chen Lee
Meghann Cefaratti
Ena Rose-Green
Abstract: This study examines the impact of a forensic accounting course on participants' creativity.  Extant research suggests that creativity is linked to the ability to generate ideas and solve problems.  Creativity is therefore an essential skill for auditors and forensic accountants to develop.  Using the Remote Associates Test, a word association task developed to measure creativity, we compare: (1) the creativity of participants who have taken a course in forensic accounting with the creativity of participants who have not taken a course in forensic accounting, and (2) the creativity of participants before and after taking a forensic accounting course.  After controlling for personality traits shown by prior research to impact creativity, we find that a forensic accounting course has an incremental positive effect on creativity.  Specifically, we find that participants who have taken a forensic accounting course are more creative than those who have not taken a forensic accounting course and participants exhibit higher levels of creativity after taking a forensic accounting course.  Because of the link between creativity and problem-solving, we conclude that including a forensic accounting course as part of the accounting curriculum supports the AICPA's Core Competency of problem-solving.  
Keywords: Creativity; forensic accounting; fraud; problem solving.  

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Books Reviews
White Collar Crime BookWhite Collar Crime: Core Concepts for Consultants and Expert Witnesses
D.K. Thompson and R. Wolverton, 2012, 314 pp.
New York, NY 10036-8775
The two editors and twenty contributors provide fourteen chapters to equip a practitioner to deal with a fraud investigation in the real world by following a flexible approach and relying on the authors’ valuable fraud investigation and FBI forensics experience in dealing with the prosecution of white-collar criminals.  
Many small-to-mid-sized entities and nonprofits do not have all of the resources or knowledge necessary to manage a fraud investigation.  Complex investigative processes need to be conducted and pursued in a clear and concise manner; the practical issues covered in this book by the McGladrey team of experts can make the difference in the outcome.
Presented in a user-friendly manner, covering core concepts and decisions that determine the outcome of a fraud investigation, this book provides a reader with the knowledge needed before the investigation begins and shows the person how to conduct solid interviews that can withstand legal challenge.  In addition, this book covers:
  • An overview of the “perfect” fraud investigation
  • Practical differences between a “perfect” investigation and real investigation
  • Gathering useful information quickly
  • Quickly addressing the pertinent facts—fraud triage
  • Interviewing witnesses
  • Understanding prosecution/defense tactics
  • Identifying fraudster assets
  • Antifraud tactics
  • Fraud prevention and detection measures

Financial Reporting FraudFinancial Reporting Fraud: A Practical Guide to Detection and Internal Control
Charles R. Lundelius, 2nd ed., 2011, 309 pp.
New York, NY 10036-8775
This author believes that principles-based International Financial Reporting (IFRS) may provide more discretion to management than the more detailed and rules-based U.S. GAAP.  When operating on the edge of GAAP or IFRSs permissibility, internal controls are stretched heavily, and one mistake in a seemingly small area can result in significant and drastic consequences.
COSO’s Fraudulent Financial Reporting analysis of U.S. public companies found that when it came to executing financial reporting fraud, the most common kinds of fraud methods were:
  1. Fictitious revenues
  2. Premature revenues
  3. Understatement of expenses and liabilities
  4. Overstatement of assets
  5. Fictitious assets
  6. Capitalized expenditures that should be expensed
  7. Misappropriation of assets
This book examines the SEC’s criteria for determining critical accounting policies and estimates, building upon the actual examples used in the SEC’s proposed rules, and discusses the role of senior management during an investigation and in the prevention of financial reporting fraud.

Inside IFRSInside IFRS: Accounting and Financial Reporting Fundamentals
AICPA, 2013, 334 pp.
220 Leigh Farm Road
Durham, NC 27707-8110

This book provides readers with an understanding of the accounting and reporting requirements as prescribed by IFRS.  The chapters are laid out in a topical format with a narrowed focus on specific IFRS pronouncements including IFRS, International Accounting Standards, International Financial Reporting Interpretations Committee, and Standing Interpretation Committee topics.  The content includes recognition, measurement, presentation, and disclosure requirements by accounting topic, which allows the reader to gain an understanding of the respective accounting and disclosure requirements as prescribed by the IASB.  

Forensic AccountingForensic Accounting
R.J. Rufus et al., 2015, 418 pp.
Pearson Education, Inc.
One Lake Street
Upper Saddle River, NJ 07458

This forensic accounting textbook uses a case-based instructional approach by using a case that highlights key issues in each chapter.  The authors emphasize the scientific approach.  

The book is broken into these chapters:
  • Introduction to the World of Forensic Accounting
  • The Legal Environment of Forensic Accounting
  • Screening and Staging Engagements
  • Gathering Evidence—Interviews and Observations
  • Financial Statement—Reading Between the Lines
  • Fraud and White-Collar Crime
  • Conducting a Fraud Investigation
  • Transforming Data into Evidence (Part 1)
  • Transforming Data into Evidence (Part 2)
  • Professional Responsibilities
  • Fundamentals of Business Valuation
  • Special Topics

Cost RecoveryCost Recovery
Richard B. Lanza, 2009, 243 pp.
John Wiley & Sons
Hoboken, NJ
The author provides step-by-step guidance for completing a cost recovery effort of any company’s spending.  He explains how to utilize free services offered by cost recovery consultants as well as how to assess risk based on the company’s control issues to identify the top areas of likelihood for recovery and process improvements.  This book looks at cost recovery from every angle, with in-depth coverage of areas including telecommunications, utilities, healthcare, advertising, media, freight, tax reduction, project fraud, and more.

Audit ToolkitThe AICPA Audit Committee Tool Kit, 3rd ed.
Public Company Audit Committee Toolkit Task Force, 2014, 170 pp.
New York, NY 10036-8775
The Audit Committee Toolkit focuses solely on public companies, and is designed for use by the following groups:
  • All public companies, regardless of size.
  • Board and audit committee members of public companies.
  • CEO, CFO, chief audit executives, and other key staff positions of public companies.
  • External and internal auditors.

The edition features updates and revisions that reflect significant changes to SEC and Public Company Accounting Oversight Board (PCAOB) regulations and standards that have occurred since the last edition, as well as an International Financial Reporting Standards (IFRS) implementation tool.  
This toolkit is organized into the following subgroups:
  • Audit Committee Administration.
  • Audit Committee Performance Evaluations.
  • Audit Committee Other Tools (risk management, SEC, resources, IFRS).

The 2016 LSU Annual Fraud and Forensic Accounting Conference                                                      
The LSU Fraud and Forensic Accounting Conference will be held July 25–26, 2016, in Baton Rouge, Louisiana, at the Crowne Plaza Hotel.
Some of the speakers will be: Brian Vaughn, Eileen Leslie, Richard B. Lanza, David Woodcock, Jonathan E. Turner, Tim Louwers, Scott McHore, Daryl Purpera, and other interesting speakers.
Registration for the 2016 Conference is not open yet.
The mid-year meeting of the Forensic Accounting section of the AAA will meet on March 4–5, 2016, in Charlotte, North Carolina.  New President Les Heitger hopes interested practitioners will attend the mid-year meeting.
The next NACVA and the CTI's Annual Consultants' Conference will be held June 8–11, 2016 in San Diego, California at The Hotel del Coronado.