Koss Corporation: How $34 Million Disappeared?

Koss Corporation is a publicly traded company that designs and sells stereo headphones. The Koss family controls most of the Companys stock. On November 17, 2010, Sujata Sue Sachdeva, the former Vice-President of Finance was sentence to 11 years in prison for embezzling $35 million from the Company. Her attorney claimed that she was shopaholic. From 1992 to 2009, Sachdeva was the Principal Accounting Officer, Secretary, and Vice-President of Finance at Koss. As a result of the embezzlement, Koss Corporation was required to restate its financial statements for 2008, 2009 and the first quarter of 2010.

Sachdeva used the embezzled funds to sustain a lavish lifestyle including purchasing a vacation ownership interest on Hawaii, a Mercedes Benz, and other automobiles. She also used the proceeds to pay for luxury travel and numerous personal items, including luxury clothing, furs, design shoes, jewelry, and art. One neighbor stated that packages delivered to her front porch would sometimes reach 6 feet high! Sachdeva also maintained a large household staff. Such purchases were well beyond her Koss salary (approximately $175,000). She explained her life style by stating that her husband earned a couple of million dollars a year and that they both came from a wealthy family.

The massive misappropriation was ultimately discovered when American Express notified the Company that funds were being wire from a Company bank account to pay for Sachdevas personal credit card. According to the SEC, Sachdeva authorized at least 206 wire transfers of funds from Koss bank accounts to pay for her American Express credit card bills and issued more than 500 cashiers checks from company accounts to pay for personal expenses. Sachdeva used the cashiers check to make direct payments to retailers, such as Neiman Marcus and Saks Fifth Avenue. Sachdeva attempted to conceal the identities of the checks by using acronyms on the checks such as S.F.A. Inc. for Saks Fifth Avenue, N.M. Inc. for Neiman Marcus, and others. Sachdeva was able to conceal the fraud by directing other Koss employees to make numerous fraudulent entries in Kosss books and records. Julie Mulvaney, the Companys senior accountant who was responsible for making the journal entries, reconcile accounts receivable, reconcile the Companys bank statements, ordering cashiers checks, processing wire funds transfers, and checking the daily bank accounts balance assisted Sachdeva in covering up the fraud.

Other information about the Company:

• Michael Koss simultaneously held 5 senior management positions: Vice Chairman, Chief Executive, Chief Operating Officer, President, and Chief Financial Officer. Koss had little or no educational background or experience in the areas of accounting of finance and allegedly delegated important responsibilities typically performed by the CFO to Sachdeva on a regular basis.
• Koss did not have internal audit function.
• Koss Corporations control environment appears to have been remarkably relaxed and its corporate board rarely change. Excluding a member added in 2006 and founder John Koss, board members had an average tenure of 27 years.
• Unlike the proxy statement of typical public companies, Koss made no mention of any accounting expertise among audit committee members.
• Because it was a small company, Koss was not subject to a section of the Sarbanes-Oxley Act that requires outside auditors to evaluate a companys internal control over financial reporting.
• During the embezzlement, Kosss audit fees were reduced by half from $114,900 in 2007 to $63,600 in 2008.
• In 2006, Sachdeva co-chaired a fundraising gala for Big Brothers Big Sisters with one Kosss outside auditors.

Required:

1. Assume that you are a member of the audit team. Identify the fraud risk factors for misappropriation of assets that were present at Koss Corporation.

2. Is it appropriate for one individual to hold 5 significant senior management positions all at the same time in a publicly traded company? Why or why not? Explain your answer

2. Koss Corporation: Where were the internal controls?