I have attached the case fraud to read. Need answers/comments from question 2,6,7,9, see questions at last page. My focus will be question 2.

Prepare notes prepare notes to answer case question 2, using the fraud diamond as an organizing framework. That is, think about incentive/pressure, opportunity, rationalization/attitude, and capability at DHB Industries, Inc.

Thanks

ISSUES IN ACCOUNTING EDUCATION Vol. 28, No. 1 2013 pp. 131-152 American Accounting Association DOI: 10.2308/iace-50297 Of Hurricanes and Harness Racing: The Accounting Fraud at DHB Industries, Inc. Michael C. Knapp and Carol A. Knapp ABSTRACT: This instructional case focuses on an accounting and financial reporting fraud involving DHB Industries, Inc., the nation's largest manufacturer of bullet-resistant vests. Three executives of this Securities and Exchange Commission (SEC) registrant, including its founder and CEO, masterminded a large-scale fraud that grossly misrepresented DHB's financial statements. The three executives colluded to conceal their misdeeds from the four accounting firms that served as the company's independent auditors over the course of the fraud. In late 2010, a federal jury convicted DHB's former CEO and COO of multiple counts of fraud and related charges. This case addresses a wide range of auditing issues raised by the DHB fraud, including the identification of fraud risk factors, auditing of related-party transactions, the impact of frequent auditor changes on audit quality, and the internal control reporting responsibilities of auditors. Keywords: auditor changes; fraud; internal control over nancial reporting; materiality; related-party transactions. You can't make up a story like this. Andrew Cohen, Senior Legal Analyst, CBS News INTRODUCTION A s a small child, Brooklyn native David Brooks loved horses. In 1969, when he was 14 years old, Brooks went to work at a local racetrack as a groom to help support his family. Brooks loved the tough job, which involved arriving at the racetrack in the wee hours of the morning, wiping down sweaty horses, wrestling large bales of hay, and ''mucking'' (cleaning out) horse stalls. Although he wanted to spend his life working in the horseracing industry, Brooks' family encouraged him to pursue a more stable and pragmatic career after he graduated from high school. Because he was intrigued by the stock market, David Brooks eventually decided to major in Michael C. Knapp is a Professor and Carol A. Knapp is an Assistant Professor, both at The University of Oklahoma. We thank Glen McLaughlin for his generous and continuing support of efforts to develop instructional cases that highlight important ethical issues for use in accounting and auditing courses. We also gratefully acknowledge the editor, the anonymous associate editor, and the two anonymous reviewers for their constructive comments. Published Online: September 2012 131 Knapp and Knapp 132 business at one of New York City's prominent universities. The young extrovert relied on a variety of part-time jobs to nance an undergraduate business degree with a concentration in accounting at New York University. Ironically, Brooks' successful business career provided the path for him to return to his rst love. More than three decades after having worked at one of the lowest ranking jobs in horseracing, David Brooks quickly rose to the pinnacle of that sport by spending tens of millions of dollars to establish his own stable, Bulletproof Enterprises. At its height, Brooks' stable included more than 400 racehorses. In 2004, one of Brooks' horses, Timesareachanging, won the Little Brown Jug, which is the equivalent of the Kentucky Derby for standardbred horses that specialize in pacing.1 The Brooks Brothers Tangle with the SEC In the mid-1980s, Jeffrey Brooks, David Brooks' brother and best friend, founded a small brokerage rm, Jeffrey Brooks Securities. Jeffrey recruited David to join the rm and become his right-hand man. Several years later, in 1992, the two brothers ran afoul of the Securities and Exchange Commission (SEC) when one of their subordinates was charged with insider trading. The SEC alleged that the Brooks brothers had failed to establish proper control procedures to prevent their subordinates from improperly using material non-public information obtained from their clients. In addition to a $405,000 ne, the SEC led separate injunctions against the brothers. The SEC banned David Brooks from serving as a director, ofcer, or employee of a brokerage rm or an investment company for ve years. The injunction did not prohibit him from serving as an executive of an SEC registrant that was other than a brokerage or investment company. A few months before the SEC sanctioned the Brooks brothers, David, with the nancial backing of his brother, organized a small company based in Westbury, New York, a Long Island suburb of New York City. That company, DHB Capital Group, Inc., which was subsequently renamed DHB Industries, Inc. (DHB is David Brooks' initials), was intended to serve as the umbrella organization for a corporate conglomerate that Brooks hoped to build. Brooks' goal was to identify and then purchase small, underperforming companies and convert them into protable operations by retooling their business models. In 1994, Brooks attempted to register DHB on the NASDAQ stock exchange to provide it greater access to the nation's capital markets. The NASDAQ denied Brooks' application because of the sanctions that had been levied against him by the SEC. In defending that decision, the NASDAQ observed that ''given the extremely serious nature of the SEC allegations made against Brooks, and the fact that he was only recently enjoined'' it was necessary to exclude his company from the NASDAQ ''to protect investors and the public interest and to maintain public condence'' (SEC 1996) in that market. Brooks appealed the NASDAQ's decision to the SEC. After reviewing the matter, the SEC ruled in favor of the NASDAQ: The facts remain that Brooks has a history of serious securities laws violations and a signicant ownership interest in DHB, and proposes to retain his position as a DHB director. We do not nd it unreasonable that the NASD2 reviewing both Brooks' past conduct and his proposed level of involvement in DHB, remains uneasy about the potential for illicit conduct in connection with the operation of DHB or the market for its securities, and unwilling to expose public investors to that possibility. (SEC 1996) 1 2 Standardbreds are a breed of horses developed in North America that dominates harness racing. There are two types of harness races: trotting and pacing races. At the time, the National Association of Securities Dealers (NASD) oversaw the operations of the NASDAQ. Issues in Accounting Education Volume 28, No. 1, 2013 Of Hurricanes and Harness Racing: The Accounting Fraud at DHB Industries, Inc. 133 Despite being rejected by the NASDAQ, the strong-willed Brooks persevered in his effort to have DHB's securities listed on a national stock exchange. A few years later, he nally accomplished that goal when those securities were registered on the American Stock Exchange. Timing is Everything Brooks used the initial nancing provided to him by his brother and the capital that DHB raised through a public stock offering to acquire ve small rms during the 1990s. DHB's principal operating unit would become Point Blank Body Armor, a Florida-based rm purchased out of bankruptcy for a cash payment of $2 million. Throughout the existence of DHB, the Point Blank subsidiary accounted for upward of 95 percent of its annual consolidated revenues. Point Blank's primary product was the Interceptor Vest, a bullet-resistant vest used by all branches of the U.S. military and by law enforcement agencies. Brooks' acquisition of Point Blank was a timely decision. The small company had struggled for decades, but three circumstances ultimately triggered a surge in the demand for bullet-resistant vests after Point Blank was acquired by DHB. First, the September 11, 2001, terrorist attacks convinced law enforcement agencies throughout the nation to increase their budgets for weaponry and protective equipment for their personnel. Second, in early 2003, President George W. Bush's launching of Operation Iraqi Freedom, commonly referred to by the press as the Second Gulf War, prompted the U.S. Army and U.S. Marine Corps to purchase large quantities of bullet-resistant vests. Finally, one of Point Blank's primary competitors, Second Chance Body Armor, was forced into bankruptcy in 2004 after being sued repeatedly by law enforcement agencies for allegedly manufacturing a large number of defective protective vests. Brooks relied on his outgoing personality, persistent manner, and, most importantly, three Washington, DC-based political lobbyists to outmaneuver his competitors when vying for protective vest contracts put up for competitive bids by the U.S. military. Between 2001 and 2005, the U.S. military purchased nearly one million protective vests from DHB, accounting for the majority of the company's revenues during that time frame. In a period of only six months in 2004, Brooks landed three large contracts for body armor from the Pentagon totaling nearly $500 million. By comparison, DHB's total revenues in 2000 had been only $70 million, while the company's total stockholders' equity at the end of that year had been a negative $5 million due to a retained earnings decit of more than $29 million. The rapid expansion of DHB's Point Blank subsidiary caused the company's revenues and prots to soar. By 2004, DHB's annual revenues were approaching $350 million, and the company's net income had topped $30 million. Despite those impressive gures, some analysts were concerned by the company's weak operating cash ows. In 2004, for example, the company had a negative net operating cash ow of $10 million despite reporting the $30 million prot. Exhibit 1 presents the audited income statements and balance sheets included in DHB's 2004 Form 10-K, led with the SEC in early 2005. Patriot or Proteer? DHB's sudden nancial success focused considerable attention on David Brooks, the company's chairman of the board and chief executive ofcer (CEO). The Industrial College of the Armed Forces, a military agency administered by the Joint Chiefs of Staff, lauded Brooks for developing life-saving body armor technology for hundreds of thousands of U.S. soldiers. Military ofcials also praised Brooks for establishing a charitable foundation that provided nancial assistance for wounded veterans. Not all of the attention focused on Brooks and his company was favorable. In 2003, a group of DHB employees maintained that the company's protective vests suffered from aws similar to Issues in Accounting Education Volume 28, No. 1, 2013 Knapp and Knapp 134 EXHIBIT 1 (continued on next page) Issues in Accounting Education Volume 28, No. 1, 2013 Of Hurricanes and Harness Racing: The Accounting Fraud at DHB Industries, Inc. 135 EXHIBIT 1 (continued) those evident in the products of Second Chance Body Armor. In November 2004, Brooks and his two top subordinates, Sandra Hateld, DHB's chief operating ofcer (COO), and Dawn Schlegel, DHB's chief nancial ofcer CFO), were disparaged by the press when they received nancial windfalls upon selling most of their DHB stock. Brooks, alone, received more than $180 million from the sale of the majority of his DHB stock, an amount that was six times greater than DHB's net income for 2004. News reports of Brooks' huge stock market gain caused one organization to label him a ''body armor proteer'' (O'Brien 2006). A DHB spokesperson responded by defending Brooks' sale of his stock. ''The American economic system rewards those who take great risks with commensurate benets. The compensation Mr. Brooks received is directly attributable to the risk he undertook in aiding the capitalization of DHB and achieving extraordinary results for the company'' (O'Brien 2006). Issues in Accounting Education Volume 28, No. 1, 2013 Knapp and Knapp 136 The large stock sales by Brooks, Hateld, and Schlegel were followed by a sharp decline in DHB's stock price. More bad news was soon to follow for the company. Within a few months, additional allegations surfaced that a large number of Point Blank vests being used by military personnel in Iraq had ''critical, life-threatening aws'' (O'Brien 2006). Those allegations were followed by the U.S. military recalling more than 20,000 Point Blank vests. Then, in April 2005, DHB's audit rm resigned, citing ''deciencies'' (Bernstein 2005) in the method used by the company to value its inventory. The announcement was particularly unsettling to investors because it was the third time since 2001 that a DHB audit rm had resigned after commenting on major problems involving the company's internal controls. David Brooks' public image was sullied even more in November 2005, when several major publications reported that he had spent more than $10 million on a bat mitzvah party for his 13year-old daughter in the elegant Rainbow Room in midtown Manhattan. Brooks used DHB's corporate jet to y several famous musicians to the party to serenade invited guests, including 50 Cent, Aerosmith, Kenny G, Stevie Nicks, and Tom Petty. Brooks, who was decked out in a hot pink suede bodysuit during the affair, also handed out party bags to the bat mitzvah guests that contained a wide range of merchandise, including a digital camera and an Apple iPod, allegedly purchased with DHB corporate funds. ''Hurricane Brooks'' In July 2006, amid growing concerns regarding the reliability of DHB's accounting records, the company's board dismissed David Brooks and hired a team of forensic accountants to investigate those records. That investigation revealed that Brooks and his two top subordinates, Sandra Hateld and Dawn Schlegel, had orchestrated a large-scale accounting fraud that had grossly inated DHB's reported operating results and nancial condition.3 In addition to uncovering the massive fraud, the year-long forensic investigation yielded disturbing insights into the company's corporate culture during David Brooks' reign: Brooks exercised absolute control over every aspect of DHB's business, using the company's weak corporate governance and almost nonexistent internal controls to facilitate and hide the nancial fraud he directed through Schlegel and Hateld . . . Brooks' control extended to DHB's board of directors, which consisted of Brooks' friends and neighbors and Schlegel. At all times, Brooks had a chokehold over DHB's board which exercised no real oversight . . . Brooks also controlled the ow of information with DHB's outside auditors, who regarded Brooks as the key decision-maker. (SEC 2007) Brooks used threats of physical harm to enforce his policies and directives. ''When anyone questioned the accounting and nancial reporting practices underlying the fraud at DHB, Brooks became furious and threatening'' (SEC 2007). During one board meeting, Brooks told a board member who questioned one of his decisions, ''You know what we do to outsiders . . . you know what we do to people that are not on the team'' (SEC 2007). A primary target of Brooks' anger and threats was the company's independent auditor. When DHB's audit engagement partner questioned the authenticity of certain journal entries, Brooks told another company ofcial that ''if she [the audit partner] were not careful, she would be wearing cement blocks on her feet in the Atlantic Ocean'' (SEC 2007). Later, during that same audit, the 3 Hateld had worked for Brooks in several capacities after he organized the company in 1992. Brooks eventually appointed her as DHB's COO in December 2000. Schlegel's rst connection with DHB was as an independent auditor. In late 1999, Brooks hired her to serve as DHB's CFO. Schlegel, who was a CPA, also served on the company's board of directors. Issues in Accounting Education Volume 28, No. 1, 2013 Of Hurricanes and Harness Racing: The Accounting Fraud at DHB Industries, Inc. 137 audit engagement partner questioned Brooks directly regarding circumstances that took place during the company's prior audit, which was performed by a different accounting rm. During this conversation, Brooks stated that ''someone should . . . put a bullet'' (SEC 2007) in the brain of the previous year's audit engagement partner. Brooks also routinely withheld critical information from DHB's auditors, including information regarding signicant related-party transactions. DHB purchased many of the components used to manufacture its protective vests from Tactical Armor Products (TAP), a privately owned company based in Florida. In early 2003, after discovering that Brooks' wife was TAP's CEO, DHB's auditors insisted that the company issue an amended Form 10-K for scal 2002 to disclose that fact. In truth, Brooks exercised total control over TAP's operations, a fact that was not divulged to the auditors nor disclosed in the amended Form 10-K.4 In addition to repeatedly failing to disclose that TAP was a related-party entity, Brooks also failed to disclose in DHB's SEC registration statements that he had been sanctioned by the federal agency in 1992. This information was allegedly a material fact that would have been of signicant interest to DHB's stockholders, prospective investors, and a wide range of other parties involved with the company. According to a federal prosecutor, a principal goal of Brooks' accounting fraud ''was to ensure that DHB consistently reported gross prot margins of 27 percent or more and increased earnings, to correspond to the expectations of professional stock analysts'' (Broward Bulldog 2010). One facet of the fraud was a series of bogus journal entries. From 2003 through 2005, Dawn Schlegel instructed her subordinates on DHB's accounting staff to record multimillion-dollar entries that reclassied components of cost of goods sold as operating expenses. Although these reclassication entries did not improve the company's ''bottom line'' prots, they did serve the purpose of signicantly inating DHB's gross prot ratio each period. The major focus of the DHB fraud was the company's inventory accounts. From 2003 through 2005, DHB's period-ending inventories were consistently and materially inated. Throughout that three-year period, ''Hateld was responsible for assigning values to inventory and Schlegel was responsible for reviewing and approving the inventory valuation before incorporating it into the company's consolidated nancial statements'' (SEC 2007). Brooks ''directly supervised Schlegel and Hateld in performing all their duties, and demanded to review all nancial statements and disclosures DHB included in its [SEC] lings'' (SEC 2007). Near the end of scal 2004, Hateld realized that DHB would fall well short of the 27 percent gross prot margin that Brooks believed was necessary to satisfy nancial analysts tracking the company's stock. To solve this problem, Hateld increased the already overstated value of the company's year-end inventory by several million dollars through various ''pricing manipulations'' (SEC 2007). The offsetting reduction of cost of goods sold allowed DHB to reach the 27 percent threshold for gross prot margin and to inate its reported net income. When DHB's controller reviewed the company's year-end inventory values for 2004, he immediately realized that they were overstated. After preparing schedules documenting the inventory overstatements, the controller went to Hateld and Schlegel, who ''acknowledged that the inventory was overstated'' (SEC 2007). Despite that acknowledgment, the two executives refused to correct the inventory values. ''Troubled by concerns over the company's inated inventory values, the controller turned in his resignation'' (SEC 2007). Before leaving DHB, the controller informed the company's independent auditors that he believed the year-end inventory values were overstated. The auditors then raised this matter directly 4 Brooks used his control of both companies to funnel millions of dollars from DHB to himself via TAP. Issues in Accounting Education Volume 28, No. 1, 2013 138 Knapp and Knapp with Brooks. ''Brooks and Hateld told the auditors that the controller's inventory analysis was incorrect and that there were 'no real problems in the inventory''' (SEC 2007). After meeting with the auditors, Brooks stormed into the controller's ofce. During Brooks' subsequent trial, the controller testied that an ''enraged'' Brooks called him a ''___ snake'' and ''ung . . . water all over me'' (Kessler 2010). While an unidentied man blocked the door to the controller's ofce, Brooks shouted ''I am going to kick your ___'' (Kessler 2010). Brooks then ''conscated the controller's inventory analysis and violently ejected him from the premises'' (SEC 2007). When DHB's auditors subsequently questioned Brooks regarding the controller's ejection from the company's headquarters, Brooks responded that the controller ''had violated . . . internal policies and procedures'' (SEC 2007) when he had told them of his concerns regarding the valuation of inventory. The circumstances surrounding the resignation of DHB's controller served to heighten the auditors' concern regarding the valuation of year-end inventory. Making matters worse, Brooks instructed his subordinates to le the company's 2004 Form 10-K with the SEC before the auditors had concluded their investigation of DHB's inventory, a decision that deeply troubled the auditors. To placate the auditors, Brooks amended the company's 2004 Form 10-K. This amendment disclosed a material weakness in DHB's inventory valuation process.5 DHB's ''Management Report on Internal Control over Financial Reporting'' in the amended 2004 Form 10-K noted that ''there existed certain signicant deciencies in the Company's systems of inventory valuation rendering it inadequate to accurately capture cost of materials and labor components of certain work in progress and nished goods inventory'' (SEC 2005). The report went on to observe, however, that the material weakness ''did not affect the Company's nancial statements or require any adjustment to the valuation of its inventory or any other item in its nancial statements'' (SEC 2005). DHB's auditors insisted on including an updated version of their report on the company's internal controls in the amended Form 10-K. This updated report identied two additional material weaknesses in internal controls that were not documented in DHB's management report on internal controls. Exhibit 2 contains excerpts from the auditors' updated internal control report that described these two items. The rst item involved DHB's decision to le its original 2004 Form 10K prior to the auditors completing their nal review of key nancial statement amounts in that document. The second of the two additional material weaknesses indicated that DHB's audit committee did not have a proper understanding of its important oversight role for the company's nancial reporting process. To mitigate the damage caused by the reporting of these two additional material weaknesses, Brooks took the unusual step of including an insert in the amended 2004 Form 10-K that challenged the auditors' updated internal control report. In this insert, DHB maintained that the two additional material weaknesses identied by the auditors were not, in fact, true material weaknesses. (See Exhibit 3.) DHB's auditors resigned shortly after this contentious disagreement was aired in the company's SEC lings. DHB's Form 10-Q for the rst quarter of scal 2005 reported a net income of $7.6 million the company's net operating cash ow for that period was a negative $5.0 million. The company's gross prot margin for that quarter was 27.4 percent, a gure that was almost identical to the gross prot margins realized by the company for scal 2003 and 2004. DHB surpassed the ''magic'' 27 percent gross prot threshold for the rst quarter of 2005 because Hateld and Schlegel had inated 5 The amended Form 10-K was led with the SEC prior to the date that the original 2004 Form 10-K was released to the public. Issues in Accounting Education Volume 28, No. 1, 2013 Of Hurricanes and Harness Racing: The Accounting Fraud at DHB Industries, Inc. EXHIBIT 2 EXHIBIT 3 Issues in Accounting Education Volume 28, No. 1, 2013 139 140 Knapp and Knapp the quarter-ending inventory by adding 63,000 nonexistent vest components to the company's inventory accounting records. The decision to add ctitious items to DHB's inventory posed a vexing problem for the coconspirators that they had not anticipated; namely, how to conceal that fact from the company's new auditors, the company's fourth audit rm in four years. (In prior periods, the three executives had overstated DHB's inventory values by increasing the cost-per-unit assigned to individual inventory items rather than by adding ctitious items to the accounting records.) Near the end of 2005, Brooks came up with a plan for solving the problem posed by the ctitious inventory. Brooks told Schlegel to include the cost of the $7 million of bogus vest components in a large write-off entry that was necessary for a line of business that DHB was discontinuing.6 A few months later, during the scal 2005 audit, DHB's auditors questioned Brooks regarding the inventory included in the loss from discontinued operations. Brooks told the auditors that the $7 million of vest components had to be written off because the U.S. military had changed its color requirements for the vests in which those components were to be incorporated. When asked where the obsolete vest components were, the quick-thinking Brooks replied that they no longer existed because the warehouse in which they had been stored had been destroyed by a hurricane a few months earlier. Brooks later relayed this bogus explanation to Schlegel so that she would be prepared to corroborate it with the auditors. ''In exasperation, Schlegel asked Brooks why he had told that story, since they had nothing to support it, and the auditors would want support and details'' (SEC 2007). Despite her concern, Schlegel did as she was instructed and conrmed the story when DHB's auditors queried her regarding the $7 million inventory item. When the auditors continued to press for additional details regarding the written-off inventory, a ummoxed Brooks altered his story. He told the auditors that the ''hurricane'' explanation was a lie made up by his subordinates, which he had not known when he passed that information to the auditors. This troubling about-face and the inability of Brooks or his subordinates to account for the mysterious $7 million of inventory caused DHB's auditors to begin seriously questioning whether they could issue an opinion on the company's 2005 nancial statements. In early March 2006, the auditors told Brooks that they would not be able to release their audit report on DHB's 2005 nancial statements in time for the company to meet the SEC ling deadline for its 2005 Form 10-K. Law enforcement authorities subsequently discovered that Brooks attempted to ''shop for a favorable audit opinion'' (SEC 2007) by replacing those auditors with another audit rm that he had secretly contacted. That effort proved unsuccessful. A few months later, in July 2006, Brooks' turbulent tenure as DHB's founder and top executive came to an end when he was dismissed by the company's board. The following month, DHB recalled its audited nancial statements for 2003 and 2004 and warned third parties that they should no longer rely on them. DHB issued restated nancial statements for those two years that radically altered the company's previously reported operating results. DHB's restated income statement for 2004, for example, reported a $9.5 million net loss, compared to the $30 million net income the company had originally reported for that year. Exhibit 4 presents DHB's restated income statements and balances sheets for 2003 and 2004. The SEC led a civil complaint against Hateld and Schlegel on August 18, 2006. The SEC alleged that the two individuals had participated in an accounting fraud that had grossly inated DHB's reported operating results and nancial condition. Law enforcement authorities subsequently led criminal fraud charges against both Hateld and Schlegel. 6 In August 2005, a government agency ''decertied'' the bullet-resistant material being used in the manufacture of a certain product line of DHB's vests, which caused DHB to discontinue that product line. Issues in Accounting Education Volume 28, No. 1, 2013 Of Hurricanes and Harness Racing: The Accounting Fraud at DHB Industries, Inc. 141 EXHIBIT 4 (continued on next page) Issues in Accounting Education Volume 28, No. 1, 2013 Knapp and Knapp 142 EXHIBIT 4 (continued) On October 25, 2007, the SEC led a civil complaint against David Brooks that alleged he was the master architect of the DHB fraud. Later that morning, federal law enforcement authorities arrested Brooks in his lavish home on Long Island, and then led more than one dozen criminal charges against him during his arraignment. Two days prior to Brooks' arrest, his former close friend and condante, Dawn Schlegel, had pleaded guilty to two criminal charges, conspiracy to defraud the government, and conspiracy to conceal tax information. In exchange for sentencing considerations, Schlegel agreed to serve as the government's ''star witness'' (Gardiner and Hurtado 2010) during the criminal trial of Brooks and Hateld. Circus Trial The criminal trial of David Brooks and his co-defendant Sandra Hateld commenced in late January 2010. Brooks faced a 17-count federal indictment that included allegations of corporate fraud, insider trading, conspiracy, and obstruction of justice. Hateld faced similar charges in the 16-count federal indictment led against her. Issues in Accounting Education Volume 28, No. 1, 2013 Of Hurricanes and Harness Racing: The Accounting Fraud at DHB Industries, Inc. 143 Throughout the trial, jurors were pelted with an unrelenting stream of evidence that documented how Brooks had used ''DHB as his personal piggy bank'' (SEC 2007). Personal expenditures paid with corporate funds included purchases of luxury automobiles, expensive art, jewelry, designer clothing, and real estate. Court testimony revealed that the largest benefactor of Brooks' embezzlement scheme was his beloved harness racing operation. Brooks reportedly diverted nearly $15 million of DHB funds through TAP to help nance his expensive hobby. Other testimony during the long criminal trial documented how Brooks had repeatedly lied to DHB's independent auditors to conceal his fraudulent scams. Schlegel's testimony laid out in minute detail the extreme lengths to which she, Brooks, and Hateld had gone to mislead the auditors. The most elaborate hoaxes were required to conceal the large overstatements of inventory from the curious and persistent teams of auditors. Throughout the eight-month trial, the presiding federal magistrate, Judge Joanna Seybert, faced the daunting task of maintaining a sense of civility and decorum in her Long Island courtroom. The rst drama involved the revocation of David Brooks' bail. In January 2008, three months after his initial arrest, Brooks' attorneys secured his release on bail. Because Judge Seybert believed that Brooks posed a signicant ight risk, she required him to post a $400 million bail bond that included cash and other collateral of nearly $50 million. The bail terms also required Brooks to retain a security rm at an estimated cost of $3,500 per day to monitor him around the clock. ABC News (2008) reported that Brooks' bail terms were more stringent than those imposed years earlier by a federal judge on the infamous mobster John Gotti. Just as Brooks' trial was beginning, Judge Seybert revoked his bail and remanded him to jail because of two reports given to her by the FBI. An undercover video forwarded to the FBI by Scotland Yard detectives allegedly showed Jeffrey Brooks and one of his subordinates transferring millions of euros to a large safety deposit box in a London bank. The FBI was convinced that the funds belonged to David Brooks. The FBI also informed Judge Seybert that they had discovered evidence suggesting that Brooks had secretly transferred tens of millions of dollars to bank accounts in the tiny European nation of San Marino. Judge Seybert revoked Brooks' bail because the two incidents violated the conditions of his bail agreement that mandated that all of his nancial assets be ''frozen.'' Midway through the trial, Judge Seybert threatened to have David Brooks removed from the courtroom after he was discovered attempting to smuggle anxiety-suppression medication into his jail cell. The anti-anxiety pills were hidden in a ballpoint pen that had been placed at Brooks' desk during a break in the courtroom proceedings. Following this incident, Judge Seybert barred Jeffrey Brooks and one of David Brooks' close friends from the courtroom. Brooks' personal psychiatrist subsequently testied that the psychiatrist at the correctional facility where Brooks was being held had prescribed him an insufcient dosage of the anti-anxiety medication. Brooks reportedly needed larger than normal dosages of that medication to ward off the panic attacks that he frequently experienced. Later in the trial, federal prosecutors revealed that several months earlier, David Brooks had allegedly asked a veterinarian who worked in his harness racing operation to obtain a medication administered to horses. If taken by a human, this medication would supposedly wipe out his or her memory. According to the veterinarian, Brooks hoped to somehow administer the medication to Dawn Schlegel, the prosecution's principal witness, prior to the beginning of his criminal trial. This revelation and Brooks' other antics during the trial caused Comedy Central's Stephen Colbert to name Brooks his ''Alpha Dog of the Week'' during the August 2, 2010, airing of the popular television program The Colbert Report. Andrew Cohen, a senior legal analyst for CBS News who monitored Brooks' trial, observed that many of its details were so salacious that major publications, such as The New York Times, Issues in Accounting Education Volume 28, No. 1, 2013 Knapp and Knapp 144 would not report them (Cohen 2010). One veteran reporter summarized some of the more outrageous events and testimony that took place during the trial: It's not an everyday federal trial in which an FBI agent walks into the courtroom in the middle of a trial and seizes the contents of a defendant's wastebasket as part of a still ongoing investigation into whether Brooks tampered with the jury. Or in which the defense asserts that the payment of company money to prostitutes might be an acceptable technique to motivate employees. Or in which a defendant says he is entitled to have his company pay for the grave of his mother, camp tuition for his children, a $60,000 sculpture of a Wall Street bull, family trips to St. Barts and St. Tropez, or allegedly drains millions of dollars off through a shell company to pay for the upkeep of harness stables. (Cohen 2010) After spending two months studying the massive amount of evidence that prosecutors had presented to prove their allegations, a federal jury convicted Brooks on all 17 counts that had been led against him. Sandra Hateld, Brooks' former colleague and co-defendant, was found guilty on 14 of the 16 counts included in her federal indictment. Epilogue In April 2010, near the midpoint of David Brooks' criminal trial, Point Blank Solutions, the successor to DHB Industries, Inc., led for protection from its creditors in U.S. Bankruptcy Court. To date, a reorganization plan for the company has not been approved by the federal judge presiding over the company's bankruptcy ling. Point Blank remains an operating entity and continues to claim that it is the world's leading manufacturer of body armor. Following the completion of Brooks' trial, his attorneys immediately appealed his conviction. Among other arguments, the attorneys maintained that Brooks was incompetent and unable to contribute to his defense during much of the trial because of the anti-anxiety medication that he was taking. With his appeal still pending, Brooks has yet to be sentenced. Shortly after his criminal trial ended, Brooks pled guilty to tax evasion charges that had been pending against him for several years. Brooks is yet to stand trial on contempt charges led against him as a result of his behavior during his criminal trial. In February 2011, the SEC led a civil complaint against three former members of DHB's audit committee. The federal agency charged the three individuals with being ''willfully blind to numerous red ags signaling accounting fraud, reporting violations, and misappropriation at DHB'' (SEC 2011). The civil complaint went on to allege that the three former audit committee members ''merely rubber-stamped the decisions of DHB's senior management while making substantial sums from sales of DHB's securities'' (SEC 2011). QUESTIONS 1. Exhibits 1 and 4 present DHB's original 2003-2004 balance sheets and income statements and the restated balance sheets and income statements for those two years, respectively. Review the original and restated nancial statements for 2004 and identify the ''material'' differences between them. (Note: You are not required to identify the sources of these differences.) Defend your choices. 2. Identify the fraud risk factors posed by DHB for its independent auditors. Which of these factors, in your opinion, should have been of primary concern to those auditors? 3. During the 2004 DHB audit, the company's independent auditors had considerable difculty obtaining reliable audit evidence regarding the $7 million of obsolete vest components that allegedly had been destroyed by a hurricane. What responsibility do Issues in Accounting Education Volume 28, No. 1, 2013 Of Hurricanes and Harness Racing: The Accounting Fraud at DHB Industries, Inc. 4. 5. 6. 7. 8. 9. 145 auditors have when the client cannot provide the evidence they need to complete one or more audit tests or procedures? What responsibility, if any, do auditors have to search for related-party transactions? If auditors discover that a client has engaged in related-party transactions, what audit procedures should be applied to them? Compare and contrast the internal control reporting responsibilities of the management and independent auditors of public companies. What potential consequences do frequent changes in auditors have for the quality of a given entity's independent audits? Identify professional standards or other rules and regulations that are intended to discourage auditor changes or provide disclosure of the circumstances surrounding them. David Brooks apparently made threatening remarks to certain of his company's independent auditors. What actions should auditors take when they are the target of hostile statements or actions by client executives or employees? Does the SEC have a responsibility to protect the investing public from self-interested corporate executives? Do professional auditing standards or other rules or regulations impose such a responsibility on independent auditors? The audit committee of DHB Industries was criticized for failing to carry out its oversight responsibilities. What are the primary responsibilities of a public company's audit committee? REFERENCES ABC News. 2008. ''War proteer'' gets ''bulletproof'' bail terms: Released on $400 million bond. Available at: http://abcnews.go.com/blogs/headlines/2008/01/war-proteer-g/ Bernstein, J. 2005. DHB accountant resigns. Newsday (April 16): A14. Broward Bulldog. 2010. Update: Former Pompano Beach body armor tycoon convicted in huge fraud trial. Available at: http://www.Browardbulldog.org/2010/09/former-pompano-beach-body-armor-tycoonunder-the-gun-in-huge-fraud-trial/ Cohen, A. 2010. Hurricane Brooks: The trial of the century (nally) ends. The Atlantic. Available at: http:// www.theatlantic.comational/archive/2010/09/hurricane-brooks-the-trial-of-the-century-nally-ends/ 62951/ Gardiner, S., and P. Hurtado. 2010. DHB Industries ex-chief David Brooks looted company, jury told. Available at: http://www.bloomberg.com/appsews?pidnewsarchive&sidaQw6hgpgZ9rE Kessler, R. 2010. Ex-controller: Brooks threatened me. Newsday. Available at: http://www.lexisnexis.com. ezproxy.lib.ou.edu/hottopics/lnacademic/ O'Brien, T. 2006. All's not quiet on the military supply front. The New York Times. Available at: http:// www.nytimes.com/2006/01/22/business/22vests.html?pagewantedprint Securities and Exchange Commission (SEC). 1996. In the Matter of the Application of DHB Capital Group, Inc. for Review of Action Taken by the National Association of Securities Dealers, Inc. Release No. 34-37069. Available at: http://www.sec.gov/litigation/opinions/34-37069.txt Securities and Exchange Commission (SEC). 2005. DHB Industries Inc. Form 10-K/A (Amendment No. 2) led March 17, 2005. Available at: http://www.sec.gov/Archives/edgar/data/899166/ 000109230605000129/dhbform10ka.txt Securities and Exchange Commission (SEC). 2007. Securities and Exchange Commission v. David H. Brooks, U.S. District Court, Southern District of Florida, Case No. 07-61526. Available at: http:// www.sec.gov/litigation/complaints/2007/comp20345.pdf Securities and Exchange Commission (SEC). 2011. Securities and Exchange Commission v. Jerome Krantz, Cary Chasin, and Gary Nadelman, U.S. District Court, Southern District of Florida, Case No. 0:11-cv-60432. Available at: http://www.sec.gov/litigation/complaints/2011/comp21867directors.pdf Issues in Accounting Education Volume 28, No. 1, 2013