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Volume 8: Issue 2, Special Issue, 2016

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Volume 8: Issue 2, Special Issue, 2016
Table of Contents

Which Fraud Investigation Procedures Are Most Often Performed? An Exploratory Study | Full Article (PDF)
Dr. Lynn H. Clements
Dr. Michael Knudstrup, PhD

ABSTRACT: Is there such a thing as a “typical fraud investigation”?  Perhaps not—each fraud has distinctive characteristics, so each investigation might be unique.  The fraud investigation procedures applied will depend upon a myriad of variables including the size of the organization, the industry, nepotism, and employee turnover.  That said, if patterns or commonalities to fraud investigations could be discovered, such discovery could help to determine fraud protocol and fraud training.

This paper explores fraud investigation procedures that are currently employed by fraud investigators in the search for fraud and to search for such commonality.  This study uses a survey completed by fraud investigators in order to identify: 1) fraud investigation procedures normally performed; 2) those procedures that are always performed; and 3) those procedures that are considered to be the “most important.”  The implications of our findings may be useful to experienced fraud investigators, in the training of new fraud investigators, and in supplementing the curriculum of college and university courses.

Keywords:Fraud; investigation procedures; fraud investigation; fraud detection

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SEC Comment Letters: An Unlikely Secret Weapon for Forensic Accountants, Short Sellers, and Other Financial Statement Users | Full Article (PDF)
Hugh Grove
Tommi Johnsen
Pei Lung

ABSTRACT: This paper is the first study to demonstrate strong informational content and economic significance associated with the issuance of SEC comment letters.  Access to comment letters, for forensic accountants and investors, is a relatively recent phenomenon, and little research has focused on the impact the letters have on security pricing.  We construct a “red flag” forensic metric to examine the information content in SEC comment letters and analyze market performance surrounding the issuance event.  The metric consists of five models that are developed to screen for and identify financial reporting problems.  We document that SEC comment letters contain salient information about a firm’s financial condition, valuation, and future performance that is not only consistent with “red flags” but is apparently overlooked by investors and other financial statement users.  Although the letters themselves do not evaluate the merits or investment potential associated with any reported transaction, they do reflect significant industry, accounting, and disclosure expertise.  We conclude that comment letters are a useful but unrecognized source of independent expert opinion regarding the quality of a firm’s financial reports.   

Keywords: SEC comment letters; information content; financial fraud models

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Securities Class Actions Compared to Derivative Lawsuits: Evidence from the Stock Option Backdating Litigation on their Relative Disciplining of Fraudster Executives | Full Article (PDF)
Ross D. Fuerman

ABSTRACT: This article is a comprehensive examination of the stock option backdating litigation.  It is important to study the stock option backdating litigation because it was a blend of financial reporting fraud and executive misappropriation of assets.  Sometimes the executive’s misappropriation of assets did not result in materially misstated financial statements under the federal securities laws, even if they did under accounting or auditing standards.  This scenario is unique and thus provides a unique research opportunity, since typical financial reporting litigation usually results in materially misstated financial statements under the federal securities laws. 

Another reason to study stock option backdating litigation is that about thirty-five percent of it included securities class actions, while the remainder was comprised solely of derivative lawsuits.  This aspect provides another unique research opportunity, as most litigation is comprised almost entirely of only securities class actions or only derivative lawsuits.  Thus, a researcher can compare and contrast securities class actions with derivative lawsuits.  This comparison is particularly useful because some question the value of securities class actions.  This part of the research is in a sense an extension of the work of Choi and Pritchard (2014), who found evidence that securities class actions are more effective than SEC enforcement actions at forcing out fraudster executives.

Using the empirical archival research method, the comparison of stock option backdating litigation to typical financial reporting litigation revealed that the stock option backdating litigation is negatively associated with auditor defendants, bankruptcy, and the amount of the settlement with the stockholders.  It is positively associated with U.S. companies, companies in the computer industry sectors, and restatements for stock option backdating.

Keywords: Stock option backdating; accountability; fraud deterrence; securities class actions; derivative lawsuits

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Independent Studies in Forensic Accounting:  Some Practical Ideas | Full Article (PDF)
Diane M. Matson

ABSTRACT:Forensic accounting is a growing area of accounting.  Students may want to study forensic accounting because they plan to become forensic accountants, or because they want to obtain some of the knowledge used by forensic accountants.  Forensic accounting knowledge is useful to accountants working in independent or internal auditing, tax accounting, or financial reporting.  Some colleges and universities require a course or courses in forensic accounting, or they offer one or more such courses as electives in their undergraduate or graduate programs.  Other colleges and universities find adding yet another course to be difficult, and instead provide forensic accounting as an independent study.  In this approach, students interested in the topic arrange to study with professors on an individualized basis.  This paper provides suggestions to professors who offer such independent studies, and it presents some sample materials.

Keywords:Forensic accounting; independent study; fraud

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Trust in Tax Software as an Antecedent to Intention to E-File | Full Article (PDF)
Barbara Apostolou
Jack W. Dorminey
Ludwig Christian Schaupp

ABSTRACT: We investigate the role of trust to understand an individual’s decision to e-file with tax software because of IRS emphasis on taxpayer e-file adoption.  We employ a theory of commitment and find evidence that trust is the critical underpinning in the intention to e-file.  Trust drives both calculative and affective commitment leading to the e-file choice.  Results derived from 121 individual U.S. taxpayers indicate that trust, affective commitment, calculative commitment, and quality of alternatives are significantly associated with an individual’s intention to e-file.  Our findings have implications about the role of trust and its effect on the IRS’s goal to increase e-file compliance.  The importance of trust may have an impact on taxpayer intention to e-file and regulatory goals in the wake of recent security breaches on individual state tax returns prepared with tax software. 

Keywords:Commitment; e-government; electronic tax filing (e-file); tax software, trust

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The Effects of Tipping and Losses on Insider Trading | Full Article (PDF)
Joseph D. Beams
Pongprot Chatraphorn

ABSTRACT: The U.S. government continues to increase efforts to stop illegal insider trading.  This study looks at how the source of insider information affects the likelihood of trading on it.  The results indicate that the greatest risk of insider trading is from “tipping” (or leaking) insider information to individuals outside the company.

Recent SEC and FBI investigations in the United States have identified widespread insider trading among top financial professionals.  Many of these cases involve exchanging insider tips for cash and other favors.  Criminals have become more careful to cover their tracks, and the government has responded by using wiretaps and other methods of surveillance.

This study finds that individuals perceive a lower likelihood of being caught when insider information is received as a “tip” from a friend than when it is acquired from direct knowledge through work.  Additionally, subjects are more willing to trade on insider information when it is a tip from a friend.
This study also finds that subjects are more inclined to trade based on insider information in situations where they are faced with the possibility of avoiding a loss on stock they currently own than when faced with the possibility of achieving an abnormal gain by purchasing a stock that they do not currently own.  While there will always be some individuals willing to use insider information to gain an unfair advantage in the stock markets, this study suggests that some individuals would use that information only if it were to avoid a loss on stock they currently own. 

Key Words: Insider trading; tipping; loss avoidance; prospect theory

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Occupational Fraud: A Comparison of Perceptions of Law Enforcement Majors, Accounting Majors, and Other Business Majors | Full Article (PDF)
Jane E. Baird
Robert C. Zelin II
Kate C. Olson

ABSTRACT: The financial impact of occupational frauds can be staggering, and yet research has shown that such frauds are viewed as less serious than other criminal activities.  Many of these studies included crimes of violence along with financial crimes.  Not surprisingly, the findings in these studies indicated that violent crimes were perceived as more harmful than nonviolent crimes.  The current study expands previous literature by comparing reactions to eight crime scenarios, all of which resulted in the same dollar amount of financial loss and none of which involved physical harm to the victims, thereby allowing for a more in depth analysis of financial crimes.  Of the eight crime scenarios, four described non-occupational crimes while the other four described occupational frauds.  Perceptions of law enforcement students were compared to perceptions of accounting students and other non-accounting business students. 

Our results indicate that the participants viewed the occupational frauds as less serious and less harmful than the crimes that took place outside of the workplace, even though the dollar amount of loss was the same across all scenarios.  Participants also indicated a greater likelihood for reporting the non-occupational crimes as compared to the occupational frauds.  The law enforcement and business majors did not perceive the occupational frauds to be as serious or as harmful as the accounting majors perceived them to be.  These results point to a need for more instruction on the impact of occupational frauds, particularly in law enforcement programs.

Key Words: Occupational fraud; crime seriousness; prosecution; whistleblowing.

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Tone at the Top and Shifts in Earnings Management: Evidence from Japan | Full Article (PDF)
Masumi Nakashima
David A. Ziebart

ABSTRACT: A firm that has a greater positive tone at the top (TATT) may provide a better internal control system and environment.  Since internal controls are a responsibility of the CEO, prior research finds a significant association between management involvement and internal controls (Okuda and Nakashima 2014).  We predict that this association between management involvement and internal controls results in higher earnings quality.  In this study, we examine whether the tone at the top is positively associated with earnings quality.  We use accruals quality, discretionary accruals, and the accuracy of cash flow predictions as surrogates for earnings quality.  We also investigate whether there is a significant positive association between TATT and internal controls.  Cohen et al., (2008) and Nakashima (2015) document that in response to improvements in internal controls, a manager shifts from accruals management to real management.  This shift improves cash flow prediction accuracy while accruals quality remains constant.  Second, since TATT relates to corporate governance, we investigate the determinants of TATT; including 1) top management's attributes, such as age or compensation; 2) corporate governance, such as stock structure and capital composition; and 3) audit quality.  TATT is important for the establishment, implementation, and promotion of a good internal controls system.  Third, this study examines the relation between the tone at the top and the trade-off between accruals and real management.  Since the internal control system is ultimately a responsibility of the CEO.  There should be a significant association between management involvement and internal controls effectiveness (Okuda and Nakashima 2014).

Key Words: Tone at the top; earnings quality; corporate governance; stock-holding structure; capital composition; trade-off between accruals and real management

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All Cash is not Equal: Detecting Fraudulent Cash Flows | Full Article (PDF)
Prakash Deo
Cathy Zishang Liu

ABSTRACT: Our study proposes a stepped-approach to reveal how a company may report fraudulent cash flows by masking-up the components of the statement of cash flows.  We demonstrate that though there is less flexibility than reporting of earnings, the financial reporting of cash flow also offers a surprising flexibility.  Some fraudsters may exploit this latitude to create intricate and sophisticated schemes designed to hoodwink investors on a company’s financial health and operational strength.  In the wake of Enron and WorldCom scandals, the investment community has lost faith in earnings-based metrics.  To that end, our study provides a timely tool to identify sustainable cash flows from operating and other activities.  By dispelling the myth of components of cash flows, our study contributes towards efforts to improve financial reporting transparency, and to satisfy the investment community’s ever increasing need for integrity in financial reporting.  A better understanding of cash flow will help forensic accountants to spot red flags and detect fraud.

Key Words: Cash flows; financial reporting transparency; integrity in financial reporting

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The Valuation of Economic Damages: A Case Study for the Forensic Accountant | Full Article (PDF)
James A. DiGabriele
Peter L. Lohrey

ABSTRACT:This article illustrates a teaching case study in estimating economic damages for use in a forensic accounting course.  The case study requires students to prepare a fundamental valuation of economic damages as the result of a personal injury.  The purpose is to restore the injured party to the position he or she would have otherwise occupied had the injury not occurred.  Readers obtain requisite necessary financial and qualitative information to complete a valuation of lost income that includes fringe benefits and compensation for household services due to a personal injury.

Key Words:  Forensic accounting; economic damages; valuation; discounting; income projection; risk

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Green Tech Manufacturing Company: Fraud and the Independent Auditor | Full Article (PDF)
Diane M. Matson
Lawrence Chui

ABSTRACT: This case, inspired by actual frauds, introduces students to fraud and forensic accounting.  Students assume the role of an independent auditor (or fraud auditor) at a small corporation.  Specifically, the auditor in this situation is assigned to checking income statement accounts.  Students learn about the activities of the organization and examine various accounting and bank records.  They are encouraged to apply analytical procedures in order to identify unusual changes in some expense accounts and to investigate these unusual changes by reviewing cancelled checks.  They also apply the fraud triangle, consider who the perpetrator might be, find potential fraud, and provide recommendations to the company.  The case is appropriate for use in introductory courses in auditing or forensic accounting.

Keywords: Fraud; embezzlement; S, G, and A expenses; consulting services

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Books Reviews
Chuck Wendig, 2015, 419 pp.
Harper Collins Publishers
195 Broadway
New York, N.Y. 10007

Five hackers—an Anonymous-style rabble-rouser, an Arab Spring hacktivist, a black hat hacker, an old-school cipherpunk, and an online troll—are detained by the U.S. government, forced to work as white-hat hackers for Uncle Sam in order to avoid federal prison.  At a secret complex known only as “ the Lodge,” where they will spend the next year working as an elite cyber-espionage team, these misfits dub themselves “the Zeroes.”

But once the Zeroes begin to work, they uncover secrets that would make even the most dedicated conspiracy theorist’s head spin.  Soon they are not just trying to serve their time, trying to perform the ultimate hack by burrowing deep into the U.S. government from the inside, and hoping they will get out alive.  Packed with electric wit and breakneck plot twists, Zeroes is an unforgettable, thrilling ride through the seedy underbelly of “progress.”

BookCook, the Crook, and the Real Estate Tycoon
Liu Zhenyun, 2015, 280 pp.
Arcade Publishing
307 West 36th Street, 11th Floor
New York, N.Y. 10018

Do you wish to read fiction that deals with fraud?  There is a novel published first in 2007, which has now been translated into English in 2015.

Liu Yuejin is a work-site cook and small-time thief whose pack is stolen.  In searching for it, he stumbles upon another bag, this one containing a flash disk that chronicles high-level corruption by some of China’s elite businessmen.  This discovery sets off an intense, convoluted chase through the streets and back alleys of Beijing that ensnares an ever-widening cast of businessmen, bent officials, and criminals obsessed with finding the disk—while Liu searches with growing desperation for his own money.

There are no heroes in this scathing, complex, and highly readable novel about the dark side of China’s predatory capitalism, corruption, and plight of the underclasses.  The novel reveals a microcosm of contemporary China, dealing with classes at two extremes: the super wealthy and the migrant workers who, along with a culture of deceit and official corruption make them rich.

Skills for Accounting Research: FASB Codification & eIFRS
Shelby Collins, 3rd edition, 2016, 462 pp
Cambridge Business Publishers
Accounting research and communication skills are being regarded as fundamental to success on the accounting profession.  Professionals who excel in these areas will likely experience a distinct competitive advantage relative to their peers.  At the same time, on today’s highly regulated business climate, the consequences of inadequately researching and documenting accounting judgments can be severe (e.g., PCAOB or SEC enforcement actions.)  Recognizing the importance of research skills, research simulations are now a key component of the national CPA exam.
In this book, students learn to confidently address and communicate accounting research issues, from start to finish.  Students will not only take away the ability to identify the accounting problems (the “researchable question”), but will gain experience locating and applying guidance within key research tools (including the FASB Codification and eIFRS), in a variety of accounting environments.  In learning to use these research tools, students will have the opportunity to apply guidance to a variety of actual accounting topics.
Recognizing that students cannot learn to research simply by reading about research, the textbook offers students numerous opportunities to actively apply chapter lessons, throughout each chapter.  Student come away from this book armed with the research and critical thinking skills necessary for success as accounting professionals.

Managerial Forensics
J.M. Munoz and D.H. Bivona, 2016, 276 pp.
Business Expert Press
222 East 46th Street
New York, N.Y. 10017
The editors define managerial forensics as an approach to diagnosing, framing, and solving problems.  It is the practice of gathering relevant corporate information for the purpose of analyzing and identifying reasons for managerial obstacles, mismanagement, bankruptcy, and corporate demise.  This book assembles a cast of seventeen leading academic and business expert and shares their views on the best practices in corporate analysis.  Following the notion that the past offers insights into the future, the book examines the maladies in contemporary business and offers strategies for corporate revival and turnaround.
Some chapters in this paperback book include:
  • From Problem to Cause
  • Trust and Legal Considerations in Managerial Forensics
  • Tools in Managerial Forensics
  • Developing Evidence—Based Data on Ethics and Culture
  • How to Perform an Autopsy on Marketing Strategy
  • Forensic Accounting:  Show Me the Money
  • Forensic Accounting for Governmental Entities
  • International Forensics
  • Executive Interview with Keith Cooper

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 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.