2. Fraud Prevention. NEED IT ASAP

(a) The Committee of Sponsoring Organizations of the Treadway Commission (COSO) Internal Control-Integrated Framework (updated May 2013, originally published in 1999) identifies three categories of objectives: (1) Operations, (2) Reporting, and (3) Compliance, According to COOSO (2013), the objectives represent "what an entity strives to achieve." Read the objectives found at the COSO website at: (the website is shown by the pictures plz read them and answer abcd). Identify the category of objectives that were not achieved, if the SEC complaints and criminal charges against Argo are true. Provide a justification for your response.

(b) Five components and 17 principles appear in the Integrated Framework (COSO 2013) as requirements for an effective system of internal control. Identify one principle from each component that was violated by SafeNet. Provide justification for your response. A complete response will list each of the five components, one principle for each component, and justification for your selection of principles,

(c) Describe the conditions at SafeNet, Inc. that allowed for the perpetuation of this fraud.

(d) Describe two specific internal control policies and/or procedures that would have helped to prevent the fraud described in the SafeNet case. Justify your response.

A Case of Fraudulent Financial Reporting Treasurer ARGO Secretary ARGO CEO CAPUTO Leisa L. Marshall and James Cali Chair. Board of CAPUTO ABSTRACT: This case focuses on fraudulent financial reporting as related to the tone at Directors the top, primarily the chief operating officer, Carole Argo, of SafeNet, Inc. (SafeNet). This case provides students a real-world example by which to apply basic fraud concepts including the fraud triangle, fraud prevention, and red flags (fraud symptoms). Students analyze SafeNet to identify deficiencies and prevention methods, from the perspective of The full-color version of Table I is available for download. please see Appendix B. COSO's (2013) Internal Control-Integrated Framework's internal control objectives, components, and principles. Students also analyze SafeNet's corporate governance structure by comparing SafeNet's Board of Directors and its subcommittees pre- and post-SOX. Students learn of stock options as a form of compensation. However, this selecting previous dates as the stock options grant dates. This procedure, in and of itself, does not case does not focus on the details of accounting for stock options. This case is violate any of the applicable accounting standards (see Appendix A for a basic description of stock appropriate for students with the financial accounting principles course background. This options and backdating). So what is the problem? Why did she resign? Why did she not stay with case was classroom tested in a basic fraud examination course and an internal auditing the company and fight her case? Why did the SEC and the U.S. Department of Justice (DOJ) press course. Students' responses in both courses support the use of the case as a learning charges? Where did she go wrong? Was she being unjustly targeted? tool. Keywords: fraud; fraud symptoms; fraud triangle; fraud prevention; fraud detection; red THE CASE flags; corporate governance; SOX; COSO Internal Control-Integrated In 2004, SafeNet, a publicly traded corporation whose mission it was to protect users (their Framework. customers) from computer fraud, boasted of higher than expected earnings for the year. They materially misstated their financial statements, proxy statements, registration statements, and press INTRODUCTION releases. SafeNet materially misstated their net income or loss for the years 2000 through 2005 by 4. 32, 25, 27, 400, and 200 percent, respectively (SEC 2007b). In an attempt to meet carings C arole Argo participated in the awarding of stock options at SafeNet and found herself in trouble. On one hand, it would appear that Carole Argo was simply following company expectations, SafeNet knowingly and willingly backdated stock options without reporting the policy with respect to the granting of stock options. It might appear that she was simply related compensation expense. As the chief operating officer (COO) and the interim chief financial maintaining the procedures of her superior, Anthony Caputo, Chair of the Board and CEO, by officer (CFO), Carole Argo was the first executive charged, and both civil and criminal charges were pressed (Schwankert 2007). Leisa L. Marshall is a Professor at Southeast Missouri State University and James Cali is the Carole Argo Director of Internal Audit at Bi-State Development Agency of Missouri and Illinois. Carole Argo, CPA. at 45 years old, was living the dream of most accountants. Prior to employment with SafeNet, Argo worked seven years in public accounting that included work with The authors acknowledge and appreciate the anonymous reviewers, associate editors, and the editor from Issues and one of the Big 4 as an audit manager. She also worked eight years as the VP of Finance and Accounting Education, the anonymous reviewers of the 2011 AAA Annual Conference, and the 2012 NACRA Annual Conference, as well as the NACRA round-table participants Jeff Michelman, Ingrid Splettstoesser, Lynn Ruggieri, Paul Controller for a privately held company, and one year as the CFO of a public company (SEC 2001- Thurston, Lisa Eshbach, and Nancy Levenburg. 2006, Proxy Statement 2005, 7). These 16 years of Argo's life were certainly successful, as she Supplemental materials can be accessed by clicking the links in Appendix B. continued to move up the corporate ladder. Argo went to work at SafeNet in 1999 and served five years as SafeNet's Senior VP and CFO Published Online: April 2015 (see Table 1). In January 2000, she was appointed to serve as the corporate treasurer and secretary.They Protect Us from Computer Fraud: Who Protects Us from Them? SafeNer, Inc. 355 356 Marshall and Call She concurrently served in these positions while serving as the Senior VP and CFO, In June 2004, In 2001, SafeNet's stock price remained steady while at the same time, most other tech stocks Argo was promoted to the position of President and COO of the company (Business Wire 2004). were "nose-diving" (Hughlett 2001). During a 2005 interview, Caputo was asked how they avoided She began serving as the interim CFO in April 2006. Argo's annual salary was $315,404 plus the technology bust of 2000-2001 (D'Onofrio 2003). Caputo replied that because they did not 50.000 stock options in 2005. She had unexercised stock options worth slightly more than believe the technology bubble would last forever. they did not overspend. He stated that with just a $3,000.000 as of December 31, 2005 (SEC 2001-2005, 2005 10-K, 10-11). couple of bad quarters, they merely had minor tweaking to get them back on track. In that same In May 2006, the SEC informed SafeNet. Inc. of the investigation into SafeNet's stock options interview, Caputo was asked to explain the losses of $9.6 and $2.2 million in the first and second policies (SEC 2001-2006. Proxy Statement. 9). Argo and her supervisor, CEO Anthony Caputo. quarters of 2003, respectively. He stated that net income is a function of generally accepted both resigned in October 2006 (Terry 2006). The SEC filed a complaint against Argo in August accounting principles (GAAP). The underlying implication was that GAAP does not always reflect 2007, citing several instances of fraudulent reporting (SEC 2007a). Concurrent to the civil suit filed actual operations. Caputo further stated that SafeNet's operating income "has been increasing very by the SEC, the U.S. Department of Justice (DOJ) filed criminal charges against Argo (Schwankert rapidly, essentially doubling" (D'Onofrio 2003). By the third quarter of 2004, SafeNet reported a 2007; Taub 2007). 242 percent increase in revenues over the third quarter of the previous year. Net income increased from $2.7 to $9.6 million (Baltimore Business Journal 2004). The Company SafeNet, Inc. (SafeNet) was founded and incorporated as Industrial Resource Engineering, Inc. Corporate Structure (SafeNet's Proxy Statement 2006) in 1983 by two security engineers in Timonium, Maryland. In 1988, the company reincorporated in SafeNet had nine members on their Board of Directors by 2006. Anthony Caputo was the Chair Delaware under the name of Information Resource Engineering (IRE). Although incorporated in of the Board. The board had three subcommittees (audit, compensation, and nominating), each Delaware. IRE maintained headquarters in Maryland. The company's stockholders voted to change comprised of members from the Board of Directors. the company name to SafeNet. Inc. in November 2000 (SEC 2001-2005, 10-K 2001, 2). As the CEO of the company, Caputo also headed up the management team (see Figure I). He SafeNet was a publicly traded corporation with a mission to protect users (their customers) had served as the CEO since 1987. Argo, as the President, served as the second in command behind from computer fraud. According to Anthony Caputo, Chair of the Board of Directors, CEO, and Caputo on the management team (executive officers), In 2006, Argo was also the COO and the President (during the time Argo was the CFO), "we [SafeNet] are a security company, We'll make interim CFO. Three senior VPs also served on the management team. our technology available in any form to meet the customer's needs" (D'Onofrio 2003). SafeNet's primary focus was "hardware and software information security products and Good Times-Stock and Stock Options services" (SEC 2001-2005, 10-K 2005, 2). A selection of their products included anti-piracy applications. biometrics, USB tokens/smart cards, virtual private network (VPN) hardware and SafeNet's common stock performed well in the early 2000s relative to the NASDAQ (see software, encryption (WAN. VPN, SSL, VPN, two-factor authentication, wireless VPN), and Figure 2). SafeNet's stock returns exceeded the market's returns from 2000 through 2004. communications security. They focused on securing identities, communications, and applications. Argo was well rewarded for SafeNet's performance. Argo's raises and bonuses increased by SafeNet's strategy included the acquisition of other organizations, both domestic and foreign. 150 percent from 2000 to 2003 (see Table 2). For this same period, the CFO of Juniper Networks (a that complemented their vision of providing computer security hardware and software. These competitor) received a 128 percent raise. Argo's compensation (salary and bonuses) for 2003 was 0.27 and 0.54 percent of total assets and total revenues, respectively. Competitor CFOs' acquisitions served to increase their customer base. product offerings, and/or proprietary rights. For example, in June 2005, the purchase of MediaSecurity, Inc. extended SafeNet's security services compensation was less than 0.10 percent of total assets and 0.20 percent of total revenues. In 2003, and products to the recording and motion picture industries (SEC 2001-2005, 10-K 2005). Argo's compensation of $355,000 was comparable to competitor Juniper Network's CFO of The company grew tremendously after its inception in 1983. "Information Resource $317,345. However, SafeNet's total assets and total revenues were less than 10 percent of Juniper's total assets and total revenues. Argo's stock options increased in market value by 267 percent. Engineering is now growing by leaps and bounds," stated analyst Steve Bronson (Kendall Argo's unexercised stock options had a market value of nearly $5 million by 2004 (see Table 3),' 1996), Bronson also stated that he expected "accelerated growth to continue" and forecasted As the President and OOO, Carole Argo focused most of her energies on SafeNet's global revenues to increase in 1996 by $19 to $21 million over the 1992 revenue of $3 million (Kendall 1996). By the year 2000, SafeNet reported gross revenues of $28.8 million. Gross revenues operations. Argo's primary focus was mergers and acquisitions. As the CFO, Argo was responsible for all accounting, finance, and treasury functions. These responsibilities included recommending increased to $66 million in 2003, and exceeded $260 million by 2005. The number of employees stock options awards to the Board of Directors' Compensation Committee. increased from 124 in 1999 to 1,043 in 2005. In addition, the number of employees working outside Argo (with Caputo) urged the Compensation Committee to produce a standardized stock of the U.S. increased by 20 percent. The number of shares outstanding increased to 25 million in options program, related to the FASB Interpretation No. 44 (effective July 1. 2000; FASB 2000). 2005, an increase from the 6.7 million shares outstanding in 1999 (SEC 2001-2005, 10-Ks 2000. 2003, and 2005). The market values of shares held by nonaffiliates was $166 million in 1999. More specifically. Argo (and Caputo) requested a program that would avoid charges to compensation expense (SEC 2007b). The Compensation Committee delegated the authority of compared to $713 million in 2005. SafeNet operated around the globe, with 44 subsidiaries in five the stock options award program for nonexecutive officers to the CFO, CEO, and secretary, The states and 15-20 other countries (SEC 2001-2005, 10-K 2005, Exhibit V21). executives were responsible for identifying recipients, the number of options, and the exercise SafeNet's markets in 2005 included financial institutions, U.S. federal government agencies price. The Compensation Committee maintained final approval. (Department of Defense, Homeland Security, Internal Revenue Service), and original equipment SafeNet provided secur Systemmarswere FIGURE 1 FIGURE 2 SafeNet, Inc. Organization Chart Stock Performance Chart as of June 2006 (adopted from SafeNet's proxy statement dated June 24, 2005) Board of Directors (with Subcommittees) 150 DOLLARS Anthony Caputo A Chair of Board & CBO 2001 5002 2004 Nasdaq Computer and Dais Total Alstom Index for Handing -0- The Company Carole D. Argo The full-color version of Figure 2 is available for download, please see Appendix B. President & COO An email message from Argo, to the new CFO, provides additional evidence of SafeNet's Chris Fredde Steve Lesem stock options backdating policy. Argo's message stated that their "past practice has been to ST. VP & Carole Argo Sr. VP of aggregate options .. . for the quarter .. . [and] pick the best price" (SEC 2007b). It appears the use GM Enterpose Interim CFO Worldwide of the earlier grant date, as the actual grant date, was standard operating procedure, In the same Security Division Services email message to the CFO, Argo justified the policy by stating, "Who wants to have an option priced ... and then have the option underwater" a month later" (SEC 2007b). She later stated that it The full-color version of Figure 1 is available for download, please see Appendix B. was not her intent to get rich. Argo was attempting to attract and reward employees (Bishop 2008). At the end of the quarter or during the next quarter, after selecting the lowest stock price date, the paperwork was sent to the Compensation Committee for approval. The top of the materials sent to the Compensation Committee contained the earlier date. with the "approval" date appearing to Actions by the Compensation Committee signaled the final step of the granting process for be the date selected in hindsight. The committee would approve the recommendations, despite the stock options awards to the executive officers and other senior officers (SEC 2007b). All differences between the dates at the top of the paperwork and the "approval" dates. recommendations were subject to change and not final until the Compensation Committee gave SafeNet's annual financial statements referred to the use of the intrinsic value method of the their approval. Evidence to this end appears in the recommendations for stock options awarded in Accounting Principles Board's (APB) Opinion No. 25. Accounting for Stock Issued to Employees 2001. (APB 1972) (see Appendix A) in the Notes to the Financial Statements. The company reported that In 2001, Caputo was awarded 50.000 options, contingent upon signing his employment because the exercise price and the market value of the stock were the same, compensation expense contract (SEC 2007b). Caputo refused to sign the contract unless he was awarded an additional was not recorded and did not appear as a reduction in net income. 100,000 options. Two months after the initial contract offer, the Compensation Committee agreed to add the extra 100,090 stock options. Caputo then signed the contract. SOX Certifications ($302 and $404, U.S. House of Representatives 2002) Argo selected a grant date for Caputo's stock options that was nearly three months prior to the During Argo's latter years as the CFO and later as the interim CFO, Argo certified that it was contract agreement date. The stock price on the signed contract date was $18.65 per share. The her responsibility (with the CEO, Anthony Caputo) to establish and maintain a system of internal carlier (backdated) "grant" date stock price was $5.85 per share. SafeNet reported in their financial controls. Argo certified the internal controls were designed to ensure all material information about statements, and other reports to the SEC, that the exercise price and the market price on the grant SafeNet would be revealed to her. Argo certified that she evaluated the effectiveness of SafeNet's date were the same ($5.85). Argo received an additional 25,000 stock options at the same time Caputo signed his contract. Again, $5.85 was reported as the exercise price and the market price on the grant date. "Underwater options" are those in which the market value is less than the exercise price.SEC Complaint and Litigation (SEC 20076, 2007a) TABLE 2 Argo's Salaries and Bonuses Argo allegedly was involved in assigning a "grant" date to stock options on a basis other than that allowed by the relevant GAAP. The relevant GAAP during the period of the fraud was APB Year Argu No. 25 Accounting for Stock Issued to Employees." APB No. 25 required the recording of Salary Bonus Total Compensation Expense for the excess of the market value on the actual" grant date over the exercise 2004 $ 271.957 $ 226,600 $ 498.537 price." See Appendix A for a basic explanation of stock options and accounting for stock options. 2003 8 180,000 $ 175,000 $ 355,000 The SEC Complaint (SEC 2007b) produced five cases that suggested fraudulent activity by 2002 8 153,000 $ 175,000 $ 328,000 Argo. In each case, the SEC provided evidence that Argo selected a grant date based on hindsight 2001 $ 166,000 $ 166,101 and determined the exercise price to be the same as the market value on the grant date. They alleged 2000 |$ 161,000 $ 75,000 $ 236.000 that she used the date during the quarter with the lowest or near lowest market price of SafeNet stock as the grant date, as opposed to the actual grant date. In each case cited by the SEC, the exercise price was less than the market value on the "actual" grant date. The full-cole version of Table 2 is available for download, please see Appendix B. The SEC charged Argo with-either knowingly or as reckless in not knowing-misleading investors, the SEC, auditors, and SafeNet's external auditors. She indicated the financial statements, registrations, and proxy statements were fairly presented and void of materially false and misleading statements or omissions. The SEC's overall charge was that by omitting the stock- options-related compensation expense. net income (loss) and earnings (loss) per share were internal controls and that the internal controls were working properly. Argo certified that she materially overstated (understated). disclosed any significant deficiencies and material weaknesses in the internal control system. Argo The SEC filed a civil injunctionction against Carole Argo on August 1, 2007, for backdating also certified that she disclosed any fraud involving management to SafeNet's auditors and Audit stock options and failing to record the related compensation expense. The injunctionaction Committee. Argo certified that, based on her knowledge, the annual reports submitted to the SEC specifically related to stock options that were "in-the-money"" during the period 2001 to 2006 did not contain any untrue or omitted information that would cause the report to be misleading (SEC 2007a). The SEC further charged Argo with backdating other documents to conceal the in- the money options grants, Argo was charged with (1) violating the antifraud provisions of the (SEC 2001-2005.10-Ks, Exhibits). As the corporate secretary. Argo also attested to the fair federal securities laws, (2) falsifying SafeNet's books and records, (3) circumventing SafeNet's presentation of SafeNet's proxy statements. internal controls. (4) misleading SafeNet's auditors, and (5) causing SafeNet to issue false and misleading financial reports. Criminal Charge TABLE 3 The U.S. Attorney, Michael J. Garcia, of the Southern District of New York and Ron Walker. Stock Options Awarded to Argo the Inspector-in-Charge of the U.S. Postal Inspection Service New York Division, filed criminal charges against Carole Argo. They alleged Argo committed eight counts of securities fraud and Weighted- Unexercised conspiracy for backdating stock options (Schwankent 2007) and failing to record the related Number of Average per Per Share Shares compensation expense. She faced a maximum sentence of 25 years in jail and a fine of $250,000 Year Stock Options Share Year-End Aggregated Awarded Exercise Price Market Value Year-End Market per count. Value 2004 100,000 $21.70 $36.74 $4,756,100 INSTRUCTIONS AND REQUIREMENTS 2003 50,000 $19.45 $30.67 $2,756,250 20:02 $25.35 $1.496,250 1. Fraud and the Fraud Triangle. 2001 62,000 $7.47 $18.9 $802.665 (a) Two major classification schemes of fraud types exist in the research literature. One 2000 13,000 $19.92 $47.00 $1.778.500 classification scheme identifies five types of fraud. The five types of fraud are (1) 1999 40.000 vendor, (2) customer, (3) management or financial statement, (4) investment scams, and Exercised 43,300 Total 236,500 Options APB No. 25 was superseded by ASC 718 (FASB 2014), which requires accounting for stock option compensation expense at fair value, Backdating can still result in fraudulent understatements of recorded compensation expense. "Actual" grant date is the date on which the recipients are identified, and the number of options and the exercise price are determined. Exercise price is the amount the hokler must pay to receive a share of stock. The full-color version of Table 3 is available for download, please see Appendix H. "In-the-money options exist when the market value on the actual grant date is greater than the exercise price of the option.They Protect Us from Computer Frand: Who Protects Us from Them? SafeNer, Inc. 361 (5) employee embezzlement. The second major classification scheme includes three types of fraud. These three types of fraud include (1) corruption, (2) asset misappropriation, and (3) financial statement. List the type(s) of fraud committed by Argo at SafeNet. Explain your response. (b) List and discuss the elements of the fraud triangle as they relate to Carole Argo. (c) Conduct a search for the Gramling and Hermanson (2007 ) article, "Rationalizing Stock Options Backdating and Spring-Loading, " published in Internal Auditing 22 (3): 38 41. This article should be available through your library. List the rationalizations that apply to SafeNet. 2. Fraud Prevention. (a) The Committee of Sponsoring Organizations of the Treadway Commission (COSO) Internal Control-Integrated Framework (updated May 2013, originally published in 1999) identifies three categories of objectives: (1) Operations. (2) Reporting, and (3) Compliance. According to COSO (2013), the objectives represent "what an entity strives to achieve." Read the objectives found at the COSO website at: http:/www.cosxorg/documents/ 990025P_Executive_Summary_final_may20_e.pdf (you may need to cut and paste the URL). Identify the category of objectives that was nov achieved, if the SEC complaints and criminal charges against Argo are true. Provide a justification for your response. (b) Five components and 17 principles appear in the Integrated Framework (COSO 2013) as requirements for an effective system of internal control. Identify one principle from each component that was violated by SafeNet. Provide justification for your response, A complete response will list each of the five components, one principle for each component, and justification for your selection of principles. (c) Describe the conditions at SafeNet. Inc. that allowed for the perpetration of this fraud. (d) Describe two specific internal control policies and/or procedures that would have helped to prevent the fraud described in the SafeNet case. Justify your response