need help for Question 1 and 2 of the assignment fir ACCT 221 FORENSIC BUSINESS INVESTIGATION. Pertains to WorldCom scandal.

QAssuming WorldCom was a company operating in Australia at the time of the fraud. select one of the events only and prove if the selected event represents false accounting pursuant to section 83 of the crimes act; you must cosdier relevant accounting principles and speciafically consider the elements that make up the fraud offence of false accounting to provide the necessary proof. - 1000 words - 1200 words

Second question - using theories of fraud, analyse how the behavior of Bernie Ebbers contributed to the collapse of WorldCom - 800 words - 1000 words

ACCT 2211 Forensic Business Investigation Spring 2016 Group Assignment: 35% Submission Due Date: 2 December, 2016 by 6pm. Objective: The purpose of this assignment is to assist students understand the challenges facing accountants when working in a forensic capacity with limited financial and nonfinancial information. Brief Background The WorldCom scandal which involved a $US3.85 billion accounting fraud during the FY2000 and FY2001, wiped out the value of shareholder investments and created significant public outcry. By late 2003, WorldCom had engaged 1,500 people to work on correcting (i.e. restating) its financial statements at a total cost of $US365 million (McCafferty, 2004). The accounting fraud essentially involved the capitalisation of expenses, creation of fictitious assets, the use of balance sheet reserves to write off costs including uncollectible debtors, litigation costs, company acquisition related costs and overvaluing goodwill. This accounting fraud was concealed and was not discovered by the market until 25 June 2002 when WorldCom announced that it was restating its financial statements by $US3.85 billion. Instructions 1. The folder 'Group Assignment WorldCom' contains several articles. The first article is titled 'Behind Closed Doors At WorldCom: 2001'. The second article is titled 'Accounting Spot-Check Unearthed A Scandal In WorldCom's Books' and includes the fraudulent WorldCom financial statements for FY2000 and FY2001. The third article is the amended Complaint filed by the U.S. Securities and Exchange Commission ('SEC') against WorldCom in 2002. These articles provide you with specific insights into the WorldCom fraud. WorldCom financial statements for FY1999 (including FY1998 comparative year) are also included in this folder. 2. You must read these articles and conduct your own research to answer the assignment questions below. Failure to conduct your own research limits the quality of responses to assignment questions. 3. There is no need for an executive summary or conclusion as you are not writing a 'report'. Simply answer the assignment questions. 4. The maximum length of the assignment is 4,000 words, excluding appendices, and attachments. 5. Format is Arial 11 point, 1.5 spacing, paginated, use a separate page to answer each question. Answers to questions must be clearly identified. 6. The assignment will be marked out of 60 marks, scaled to 35% of the final mark in this course. Please refer to the Assignment Rubric on Blackboard. 1 Assignment Questions 1. Using theories of fraud, analyse how the behaviour of Bernie Ebbers contributed to the collapse of WorldCom (10 marks). 2. The following events feature in the WorldCom fraud: Event 1 WorldCom employees Dan Renfroe and Angela Walter ma d e journal entries in the amount of $150 million and $771 million, respectively, without detailed support. Event 2 A journal entry was made to recognize $35 million of revenue in 2001 from the EDS contract based on performance projections. Required: Assuming WorldCom was a company operating in Australia at the time of the fraud, select ONE of the above Events only and prove if the selected event represents 'false accounting' pursuant to Section 83 of the Crimes Act. Your must consider relevant accounting principles and specifically consider the elements that make up the fraud offence of false accounting, as discussed in lectures, to provide the necessary proof. (15 marks). 3. Assume that you are part of the SEC team investigating the financial statement fraud committed by WorldCom, prepare a witness list and describe the evidence these witnesses are likely to provide to support the investigation of Event 1 or Event 2 above (5 marks). 4. Analyse the F Y 2 0 0 0 a n d F Y 2 0 0 1 WorldCom Consolidated Balance Sheets and Consolidated Statement of Operations1 using the following analytical methods, and justify any material red flags identified by each analytical method. Please show all calculations (25 marks) (a) Horizontal Analysis (b) Vertical Analysis. (c) Ratio Analysis (justify and select five key ratios only to perform your ratio analysis) (d) Beneish ratios. ( e ) M-scores using both the five variable and eight variable models. 5. Up to a maximum of 5 marks will be awarded for quality. That means the assignment is formatted appropriately, no spelling errors and no grammatical errors. Please note that RMIT University Academic Integrity policy applies to all written work, including this assignment. The policy can be viewed here http://www1.rmit.edu.au/students/academic-integrity. (Total 10 + 15 + 5+ 25 + 5 = 60 marks) 1 The Consolidated Statement of Cashflows has been provided for information purposes and is not required to be analysed. 2 1 ACCT 2211 Forensic Business Investigation Spring 2016 Group Assignment: 35% Submission Due Date: 2 December, 2016 by 6pm. Objective: The purpose of this assignment is to assist students understand the challenges facing accountants when working in a forensic capacity with limited financial and nonfinancial information. Brief Background The WorldCom scandal which involved a $US3.85 billion accounting fraud during the FY2000 and FY2001, wiped out the value of shareholder investments and created significant public outcry. By late 2003, WorldCom had engaged 1,500 people to work on correcting (i.e. restating) its financial statements at a total cost of $US365 million (McCafferty, 2004). The accounting fraud essentially involved the capitalisation of expenses, creation of fictitious assets, the use of balance sheet reserves to write off costs including uncollectible debtors, litigation costs, company acquisition related costs and overvaluing goodwill. This accounting fraud was concealed and was not discovered by the market until 25 June 2002 when WorldCom announced that it was restating its financial statements by $US3.85 billion. Instructions 1. The folder 'Group Assignment WorldCom' contains several articles. The first article is titled 'Behind Closed Doors At WorldCom: 2001'. The second article is titled 'Accounting Spot-Check Unearthed A Scandal In WorldCom's Books' and includes the fraudulent WorldCom financial statements for FY2000 and FY2001. The third article is the amended Complaint filed by the U.S. Securities and Exchange Commission ('SEC') against WorldCom in 2002. These articles provide you with specific insights into the WorldCom fraud. WorldCom financial statements for FY1999 (including FY1998 comparative year) are also included in this folder. 2. You must read these articles and conduct your own research to answer the assignment questions below. Failure to conduct your own research limits the quality of responses to assignment questions. 3. There is no need for an executive summary or conclusion as you are not writing a 'report'. Simply answer the assignment questions. 4. The maximum length of the assignment is 4,000 words, excluding appendices, and attachments. 5. Format is Arial 11 point, 1.5 spacing, paginated, use a separate page to answer each question. Answers to questions must be clearly identified. 6. The assignment will be marked out of 60 marks, scaled to 35% of the final mark in this course. Please refer to the Assignment Rubric on Blackboard. 2 Assignment Questions Q1. Using theories of fraud, analyse how the behaviour of Bernie Ebbers contributed to the collapse of WorldCom (10 marks). Q2. The following events feature in the WorldCom fraud: Event 1 WorldCom employees Dan Renfroe and Angela Walter made journal entries in the amount of $150 million and $771 million, respectively, without detailed support. Event 2 A journal entry was made to recognize $35 million of revenue in 2001 from the EDS contract based on performance projections. Required: Assuming WorldCom was a company operating in Australia at the time of the fraud, select ONE of the above Events only and prove if the selected event represents 'false accounting' pursuant to Section 83 of the Crimes Act. Your must consider relevant accounting principles and specifically consider the elements that make up the fraud offence of false accounting, as discussed in lectures, to provide the necessary proof. (15 marks). Q3. Assume that you are part of the SEC team investigating the financial statement fraud committed by WorldCom, prepare a witness list and describe the evidence these witnesses are likely to provide to support the investigation of Event 1 or Event 2 above (5 marks). Q4. Analyse the F Y 2 0 0 0 a n d F Y 2 0 0 1 WorldCom Consolidated Balance Sheets and Consolidated Statement of Operations1 using the following analytical methods, and justify any material red flags identified by each analytical method. Please show all calculations (25 marks) (a) Horizontal Analysis (b) Vertical Analysis. (c) Ratio Analysis (justify and select five key ratios only to perform your ratio analysis) (d) Beneish ratios. (e) M-scores using both the five variable and eight variable models. Q5. Up to a maximum of 5 marks will be awarded for quality. That means the assignment is formatted appropriately, no spelling errors and no grammatical errors. Please note that RMIT University Academic Integrity policy applies to all written work, including this assignment. The policy can be viewed here http://www1.rmit.edu.au/students/academic-integrity. (Total 10 + 15 + 5+ 25 + 5 = 60 marks) The Consolidated Statement of Cashflows has been provided for information purposes and is not required to be analysed. 1 Behind Closed Doors at WorldCom: 2001 Zekany, Kay E;Braun, Lucas W;Warder, Zachary T Issues in Accounting Education; Feb 2004; 19, 1; ProQuest Central pg. 101 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. Name Group Assignment Rubric Spring 2016 Description The purpose of this rubric is to (1) guide students with the preparation of the group assignment, and (2) provide feedback after submission of the group assignment. Rubric Detail Levels of Achievement Criteria Highly Competent Competent Satisfactory Unsatisfactory Question 1 8 to 10 points 6 to 7 points 4 to 5 points 0 to 3 points Fraud Triangle and Fraud Scale theories clearly discussed and applied in the context of Ebbers supported by research (at least five additional references) which identifies additional information about Ebbers. Fraud Triangle and Fraud Scale theories clearly discussed and applied in the context of Ebbers supported by research (at least three additional references) which identifies additional information about Ebbers. Fraud Triangle and Fraud Scale theories clearly discussed and applied most of the time in the context of Ebbers. Research limited to information provided. Ambiguous discussion and application of Fraud Triangle and Fraud Scale in the context of Ebbers. Very limited use of research to support analysis. 12 to 15 points 9 to 11 points 6 to 8 points 0 to 5 points Specifically identifies and clearly all discusses definition and recognition principles relating to ONE of the events (can use IFRS or US GAAP). Fully explains in plain English whether the event reflects a misinterpretation of GAAP or error or whether event was fraudulent by identifying and discussing all elements of the fraud offence 'false accounting'. Specifically identifies and clearly discusses most definition and recognition principles relating to ONE of the events (can use IFRS or US GAAP). Fully explains in plain English whether the action reflects a misinterpretation of GAAP or error or whether event was fraudulent by identifying and discussing most elements of the fraud offence 'false accounting'. Specifically identifies and clearly discusses some definition and recognition principles relating to ONE of the events (can use IFRS or US GAAP). Clearly explains in plain English whether the action reflects a misinterpretation of GAAP or error or whether event was fraudulent by identifying and discussing most elements of the fraud offence 'false accounting'. Ambiguously identifies and discusses definition and recognition principles relating to ONE of the events (can use IFRS or US GAAP). Ambiguously explains whether journal entry reflects a misinterpretation of GAAP or whether journal entry was fraudulent. Ambiguously identifies and discuss the elements of the fraud offence 'false accounting'. Question 2 Levels of Achievement Criteria Highly Competent Competent Satisfactory Unsatisfactory Question 3 4 to 5 points 0 to 0 points 2 to 3 points 0 to 1 points Witness list details the names of all witnesses and the evidence they are likely to provide to support the investigation. Not applicable Witness list details the names of most witnesses and the evidence they are likely to provide to support the investigation. Witness list not provided or does not clearly identify the names of witnesses and/or the evidence they are likely to provide to support the investigation. 20 to 25 points 15 to 19 points 10 to 14 points 0 to 9 points Performs horizontal, vertical and key ratio analysis for FY 2000 and FY2001 (requires FY1999).Clearly justifies ratio selection. Calculates all Beneish ratios and M scores for FY2000 and FY2001 under both the 5 variable model and 8 variable model. Calculations contain no errors. Critically explains Horizontal, Vertical and ratio analysis, Beneish ratios and M score results for FY2000 and FY2001. Clearly explains if analysis identifies red flags. Performs horizontal, vertical and key ratio analysis for FY 2000 and FY2001 (requires FY1999).Clearly justifies ratio selection. Calculates all Beneish ratios and M scores for FY2000 and FY2001 under both the 5 variable model and 8 variable model. Calculations contain minimal errors. Some critical explanation of Horizontal, Vertical and ratio analysis, Beneish ratios and M score results for FY2000 and FY2001. Some explanation if analysis identifies red flags. Performs most horizontal, vertical and key ratio analysis for FY 2000 and FY2001 (requires FY1999). Vaguely justifies ratio selection. Calculates most Beneish ratios and M scores for FY2000 and FY2001 under both the 5 variable model and 8 variable model. Calculations contain several errors. Broadley explains Horizontal, Vertical and ratio analysis, Beneish ratios and M score results for FY2000 and FY2001. Broadly explains if analysis identifies red flags. Does not significantly perform horizontal, vertical and/or key ratio analysis for FY 2000 and FY2001 (requires FY1999). Does not justify ratio selection. Does not calculate all Beneish ratios and M scores for FY2000 and FY2001 under both the 5 variable model and 8 variable model. Calculations contain several errors. Broadly explains Horizontal, Vertical and ratio analysis, Beneish ratios and M score results for FY2000 and FY2001. Ambiguous or no explanation about identification of red flags. Question 4 Levels of Achievement Criteria Highly Competent Competent Satisfactory Unsatisfactory Assignment Quality 5 to 5 points 0 to 0 points 2 to 4 points 0 to 1 points Correct format. No grammatical and typographical errors. Not Applicable Some formatting, grammatical and/or typographical errors. Several formatting, grammatical and/or typographical errors. View Associated Items Print Close Window Complaint: SEC v. WorldCom, Inc. Page 1 of 10 Home | Previous Page UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK : : SECURITIES AND EXCHANGE COMMISSION, : : Plaintiff, : Civ No. 02-CV-4963 (JSR) : FIRST AMENDED v. : COMPLAINT : (SECURITIES WORLDCOM, INC., : FRAUD) : Defendant. : : The Securities and Exchange Commission ("the Commission") alleges for its First Amended Complaint as follows: 1. From at least as early as 1999 through the first quarter of 2002, defendant WorldCom Inc. ("WorldCom") misled investors. Defendant WorldCom has acknowledged that during this period, as a result of undisclosed and improper accounting, it materially overstated the income it reported in its financial statements by approximately $9 billion. 2. In general, WorldCom manipulated its financial results in two ways. First, WorldCom reduced its operating expenses by improperly releasing certain reserves held against operating expenses. Second, WorldCom improperly reduced its operating expenses by recharacterizing certain expenses as capital assets. Neither practice was in conformity with generally accepted accounting principles ("GAAP"). Neither practice was disclosed to WorldCom's investors, despite the fact that both practices constituted changes from WorldCom's previous accounting practices. Both practices falsely reduced WorldCom's expenses and, accordingly, had the effect of artificially inflating the income WorldCom reported to the public on its financial statements from 1999 through the first quarter of 2002. As a result of, among other things, WorldCom's chronic and pervasive failures to follow GAAP standards, and to mandate and institute appropriate internal controls, the exact amount and extent of WorldCom's overstatement of its income has not yet been quantified. 3. Certain of the improper accounting entries were made with respect to WorldCom's so-called "line costs," which were among WorldCom's major operating expenses. From at least the third quarter of 2000 through the first quarter of 2002, in a scheme directed and approved by members of senior management, WorldCom concealed the true extent of its "line costs." By improperly reducing reserves held against "line costs" and by transferring certain "line costs" to its capital asset accounts, WorldCom falsely portrayed itself as a profitable business when it was not, and concealed large losses http://www.sec.gov/litigation/complaints/comp17829.htm 8/07/2014 Complaint: SEC v. WorldCom, Inc. Page 2 of 10 WorldCom suffered. WorldCom's fraudulent accounting practices with respect to "line costs" were designed to and did falsely and fraudulently inflate its income to correspond with estimates by Wall Street analysts and to support the price of WorldCom's common stock in the market. 4. While engaging in accounting manipulations with respect to line costs to fraudulently and falsely inflate its income, defendant WorldCom continued to offer and sell additional WorldCom securities, using fraudulent and materially false financial statements and financial information in the course of those offers and sales. 5. By engaging in such improper conduct, WorldCom violated the antifraud, reporting, record-keeping, and internal controls provisions of the federal securities laws. The Commission requests, among other things, that this Court enjoin WorldCom from committing further violations of the federal securities laws as alleged herein, and order WorldCom to pay a monetary penalty based on its violations of the federal securities laws. JURISDICTION 6. The Commission brings this action pursuant to Section 20(b) and 20 (d) of the Securities Act of 1933 ("Securities Act") [15 U.S.C. 77 (b) and 77(d)], and Section 21(d) of the Securities Exchange Act of 1934 ("Exchange Act") [15 U.S.C. 78u(d)]. 7. This Court has jurisdiction over this action pursuant to Section 22(a) of the Securities Act [15 U.S.C. 77v(a)] and pursuant to Section 27 of the Exchange Act [15 U.S.C. 78aa]. 8. The defendant, directly and indirectly, has engaged in, and unless restrained and enjoined by this Court will continue to engage in, transactions, acts, practices, and courses of business that violate Section 17(a) of the Securities Act [15 U.S.C. 77q(a)], Sections 10 (b), 13(a), 13(b)(2)(A), 13(b)(2)(B) of the Exchange Act [15 U.S.C. 78m(a) and 78m(b)(A)] of the Exchange Act [15 U.S.C. 78j(b), 78m(a), 78m(b)(A) and 78m(b)(B)] and Rules 10b-5, 12b-20, 13a-1, and 13a-13 thereunder [17 C.F.R. 240.10b-5, 240.12b-20, 240.13a-1, and 240.13a-13]. THE FRAUDULENT SCHEME REGARDING WORLDCOM'S LINE COSTS A. The Defendant 9. WorldCom is a Clinton, Mississippi-based company incorporated in Georgia which provides a broad range of communications services to businesses and consumers in more than 65 countries. WorldCom provides data transmission and Internet services for businesses, and, through its MCI unit, provides telecommunications services for businesses and consumers. WorldCom is a public company whose securities are registered with the Commission pursuant to Section 12 (b) of the Exchange Act and it is required to file periodic reports with the Commission pursuant to Section 13 of the Act. WorldCom's common stock was, at all times relevant hereto, listed and traded on the NASDAQ National Market System under the symbol "WCOM," and its stock was covered by Wall Street analysts who routinely issued quarterly and annual earnings estimates. B. Relevant Accounting Principles http://www.sec.gov/litigation/complaints/comp17829.htm 8/07/2014 Complaint: SEC v. WorldCom, Inc. Page 3 of 10 10. Public companies, such as WorldCom, typically report the financial results of their operations in financial statements that include both an income statement and a balance sheet. A company's income statement reports, among other things, revenue recognized, expenses incurred, and income earned during a stated period of time -- usually for a fiscal quarter or a fiscal year. Within an income statement, expenses are generally subtracted from revenues to calculate income. A company's balance sheet reports, among other things, the assets and liabilities of a company at a point in time, usually as of the end of the company's fiscal quarter or fiscal year. 11. When companies spend money or incur costs, those expenditures can be accounted for in a variety of ways depending on the nature of the transaction. Some types of expenditures, most commonly those incurred by a company in its normal operations, are treated as current period costs or "operating expenses." Examples of operating expenses include recurring costs such as salaries and wages, insurance, equipment rental, electricity, and maintenance contracts. Generally, almost all routine expenditures that a company makes are operating expenses. Other types of expenditures, most commonly those which result in the acquisition of, or improvement to, the company's assets, are treated as "capital expenditures." Examples of capital expenditures include purchases of real estate, manufacturing equipment, and computer equipment. 12. Operating expenses and capital expenditures generally receive different accounting treatment. Operating expenses are generally reported on a company's income statement and subtracted from revenues in the period in which the expense is incurred or paid, resulting in the company's net income for that period. Generally, capital expenditures, by contrast, are not subtracted from revenues and are not reflected on the income statement. Instead, capital expenditures are reported as capital assets on a company's balance sheet. 13. If a company makes entries in its accounts that effectively reclassify or transfer a given expenditure from an "operating expense" to a "capital asset," that action will have the following effects on the company's financial statements: (a) the reclassification or transfer will reduce the company's operating expenses, and the company's pre-tax net income consequently will increase by the amount reclassified or transferred; (b) the value of the company's capital assets and total assets will increase by the amount reclassified or transferred; and (c) the value of the company's net worth will increase. 14. One of WorldCom's major operating expenses reported on its income statements which were periodically filed with the Commission was its so-called "line costs." "Line costs" represented the various fees WorldCom paid to third-party telecommunications carriers for WorldCom's right to access the third-party's network facilities in order to serve customers. Under GAAP, these fees must be reported as an expense on a company's income statement. 15. From time to time, WorldCom established liabilities or "reserves" on its balance sheet for various future payments for goods or services it had previously received or incurred. Among the reserves WorldCom established were reserves for line costs and income taxes. Line cost reserves and income tax reserves were listed on WorldCom's balance sheet as liabilities. http://www.sec.gov/litigation/complaints/comp17829.htm 8/07/2014 Complaint: SEC v. WorldCom, Inc. Page 4 of 10 C. WorldCom Changes its Accounting to Fraudulently Inflate Its Income 16. Anticipating unabated growth in telecommunications services, WorldCom entered into a number of long-term lease agreements with various third-party telecommunication carriers to gain the right to access these networks in the late 1990s. Many of these leases required WorldCom to pay a fixed sum to the third-party carrier over the full term of the lease regardless of whether WorldCom actually made use of all or part of the capacity of the leased facilities. Before any improper entries to WorldCom's books and records were made at the corporate level, these fees were recorded by WorldCom employees on its books and records as "line costs," current expenses which would be reported as part of WorldCom's operating expenses on its income statements. 17. Beginning in or around July 2000, WorldCom's expenses as a percentage of its total revenue began to increase, resulting in a decline in the rate of growth of WorldCom's income. This decline in income created a substantial risk that WorldCom's publicly reported income would fail to meet the expectations of Wall Street analysts and that the market price of WorldCom's securities would therefore decline. 18. Starting at least as early as the third quarter of 2000, WorldCom, in a scheme directed and approved by members of senior management, engaged in a continuing series of improper and fraudulent accounting manipulations designed to inflate artificially WorldCom's publicly reported income by falsely reducing WorldCom's reported line cost expenses. As a result of this scheme, WorldCom materially understated its expenses, and materially overstated its income, thereby defrauding investors. 19. In or around October 2000, WorldCom officers and employees fraudulently made and caused the making of certain entries in its general ledger intended to increase WorldCom's publicly reported income and conceal the true extent of its expenses; specifically, fraudulent and false entries were made in WorldCom's general ledger reducing its line cost expense accounts, and reducing -- in amounts corresponding to the fraudulent and false line cost expense amounts -- various reserve accounts. There was no documentation supporting, nor was there any proper business rationale for, the false and fraudulent entries. These entries had the effect of reducing the third quarter 2000 line costs by approximately $828 million, thereby increasing WorldCom's publically reported income for the third quarter of 2000. 20. In or around February 2001, WorldCom officers and employees fraudulently made and caused the making of certain entries in its general ledgers intended to increase its publicly reported income and conceal the true extent of its expenses; specifically, fraudulent and false entries were made in WorldCom's general ledger reducing its line cost expense accounts, and reducing -- in amounts corresponding to the fraudulent and false line cost expense amounts -- various reserve accounts. There was no documentation supporting, nor was there any proper business rationale for, the fraudulent and false entries. These entries had the effect of reducing the fourth quarter 2000 line costs by approximately $407 million, thereby increasing WorldCom's publicly reported income in the year which ended December 31, 2000. http://www.sec.gov/litigation/complaints/comp17829.htm 8/07/2014 Complaint: SEC v. WorldCom, Inc. Page 5 of 10 21. In or around April 2001, because WorldCom could not continue to draw down its reserve accounts to hide the true extent of its line cost expenses, members of WorldCom's senior management effected a change in the method of making false accounting entries to fraudulently inflate WorldCom's income and to conceal the true extent of its expenses. Now, in addition to reducing WorldCom's line cost expenses with improper releases from reserve accounts, WorldCom officers and employees fraudulently made and caused the making of false and fictitious entries in WorldCom's general ledger which effectively "transferred" a significant portion of its line cost expenses to a variety of capital asset accounts, thereby effectively recharacterizing, without any supporting documentation, and in a manner inconsistent with GAAP, the operating expenses it had incurred for access to third party networks as "assets." In accordance with the directions and approval of members of WorldCom's senior management, WorldCom officers and employees made, and continued to make and cause the making of false and fraudulent entries in WorldCom's general ledger which were necessary to effect this scheme from the first quarter of 2001 through and including the first quarter of 2002. There was no documentation supporting, nor was there any proper business or accounting rationale for, the fraudulent and false entries. 22. Specifically, in or around April 2001, WorldCom officers and employees fraudulently made and caused the making of false entries in WorldCom's general ledger reducing its line cost expenses and correspondingly increasing its capital asset accounts. These manipulations resulted in the fraudulent concealment of approximately $771 million in WorldCom's line cost expenses for that quarter. In or around July 2001, WorldCom officers and employees fraudulently made and caused the making of entries in WorldCom's general ledger which effectively erased approximately $560 million from its line cost expenses for the second quarter of 2001 and correspondingly increased capital asset accounts. In or around October 2001, WorldCom officers and employees fraudulently made and caused the making of entries in WorldCom's general ledger which effectively erased approximately $743 million from its line cost expenses for the third quarter of 2001 and correspondingly increased capital asset accounts. In or around February 2002, WorldCom officers and employees fraudulently made and caused the making of entries in WorldCom's general ledger which effectively erased approximately $941 million from its line cost expenses for the fourth quarter of 2001 and correspondingly increased capital asset accounts. And, in and around April 2002, WorldCom officers and employees fraudulently made and caused the making of entries in WorldCom's general ledger which effectively erased approximately $818 million from its line cost expenses for the first quarter of 2002 and correspondingly increased capital asset accounts. 23. WorldCom's fraudulent, false and improper treatment of its line cost expenses, described above, was not disclosed to its investors, nor did WorldCom disclose to its investors, or elsewhere, that it had implemented such changes in its methods of accounting for line cost expenses. 24. As a result of these fraudulent, false and improper accounting manipulations, WorldCom materially overstated its earnings as well as its assets and materially understated its expenses in its filings with the Commission, specifically, on its Forms 10-Q for each quarter from the third quarter of 2000 through and including the first quarter of http://www.sec.gov/litigation/complaints/comp17829.htm 8/07/2014 Complaint: SEC v. WorldCom, Inc. Page 6 of 10 2002, and on its Forms 10-K for the fiscal years which ended on December 31, 2000 and December 31, 2001. 25. The effects of WorldCom's fraudulent accounting scheme on WorldCom's filings with the Commission, which scheme resulted in material misstatements therein, are summarized on the following table: WorldCom's False Statements in Filings With Commission Form Filed With the Commission Reported Line Cost Expenses Reported Income (before Taxes Actual Line and Minority Cost Interests) Expenses 10-Q, 3rd Q. 2000 $3.867 billion $1.736 billion $4.695 billion $908 million 10-K, 2000 $15.462 billion $7.568 billion $16.697 billion $6.333 billion 10-Q, 1st Q. 2001 $4.108 billion $988 million $217 million 10-Q, 2nd Q. 2001 $3.73 billion $159 million $4.29 billion $401 million loss 10-Q, 3rd Q. 2001 $3.745 billion $845 million $4.488 billion 10-K, 2001 $14.739 billion $2.393 billion $17.754 billion $622 million loss 10-Q, 1st Q. 2002 $3.479 billion $240 million $578 million loss $4.879 billion $4.297 billion Actual Income (before Taxes and Minority Interests) $102 million 26. WorldCom's disclosures in its Forms 10-K and in its Forms 10-Q failed to include material facts necessary to make the statements made in light of the circumstances in which they were made not misleading. Significantly, these filings failed to disclose the company's accounting treatment of its line cost expenses, that such treatment had changed from prior periods, and that the company's line cost expenses were actually increasing substantially as a percentage of its revenues. 27. While WorldCom was engaged in the fraudulent accounting scheme described above, WorldCom filed numerous registration statements for the issuance of new stock, and related amendments thereto, which statements and amendments incorporated or contained WorldCom's fraudulent financial statements and financial information. CLAIMS FOR RELIEF FIRST CLAIM Violation of Exchange Act Section 10(b) and Exchange Act Rule 10b-5 28. Paragraphs 1 through 27 above are incorporated herein by this reference. 29. Defendant WorldCom, directly or indirectly, by use of the means or instruments of interstate commerce, or of the mails, or of a facility of a national securities exchange, knowingly or recklessly (a) employed devices, schemes and artifices to defraud; (b) made untrue statements of material fact or omitted to state material facts necessary in order to make the statements made, in light of the http://www.sec.gov/litigation/complaints/comp17829.htm 8/07/2014 Complaint: SEC v. WorldCom, Inc. Page 7 of 10 circumstances under which they were made, not misleading; and (c) engaged in acts, transactions, practices, and courses of business which operated or would operate as a fraud or deceit upon the purchasers of securities and upon other persons, in connection with the purchase or sale of a security. 30. In connection with the above described acts and omissions, defendant WorldCom, and members of WorldCom's senior management, acted knowingly or recklessly. They knew, or were reckless in not knowing, that WorldCom's Forms 10-Q for the periods commencing the third quarter of 2000 through the first quarter of 2002, inclusive, and that its Forms 10-K for 2000 and 2001, including the financial statements contained therein, as filed with the Commission, contained material misstatements and omissions. 31. By reason of the foregoing, WorldCom violated Section 10(b) of the Exchange Act and Exchange Act Rule 10b-5. SECOND CLAIM Violation of Securities Act Section 17(a) 32. Paragraphs 1 through 27 above are incorporated herein by this reference. 33. On or about April 26, 2001, defendant WorldCom filed with the Commission a Form 425, a written communication deemed to be a prospectus under Rule 425. The Form 425, containing WorldCom's first quarter 2001 earnings, was filed in connection with a registration related to the offering of two types of tracking stock filed on a Form S-4 registration statement. Defendant stated in this Form 425 that its first quarter 2001 consolidated net income was $729 million. This reported consolidated net income figure was materially overstated as a result of WorldCom's manipulations of its accounts to fraudulently understate its line cost expenses by approximately $771 million for that quarter. 34. On or about May 1, 2001, defendant WorldCom filed with the Commission a Rule 424(b)(5) prospectus for a previously filed registration statement on Form S-3, wherein defendant stated that its first quarter 2001 consolidated pre-tax net income was $594 million. This reported consolidated net income figure was materially overstated as a result of WorldCom's manipulations of its accounts to fraudulently understate its line cost expenses by approximately $771 million for that quarter. Defendant WorldCom subsequently filed the following documents on or about the dates listed below which incorporated and thereby repeated this materially false overstatement of its first quarter 2001 consolidated pre-tax net income: Form Description Date Filed Form S-4 Tracking Stock Registration Statement May 9, 2001 Form 424(b) (5) Amendment to Prospectus for Debt Offering May 11, 2001 Form S-4/A Amendment to Tracking Stock Registration Statement May 14, 2001 35. On or about May 15, 2001, defendant WorldCom filed its Form 10-Q with the Commission for the first quarter of 2001, wherein it reported in its Consolidated Statement of Operations that its consolidated pre- http://www.sec.gov/litigation/complaints/comp17829.htm 8/07/2014 Complaint: SEC v. WorldCom, Inc. Page 8 of 10 tax net income was $610 million. This reported consolidated net income figure was materially overstated as a result of WorldCom's manipulations of its accounts to fraudulently understate its line cost expenses by approximately $771 million for that quarter. Defendant WorldCom subsequently filed the following documents on or about the dates listed below which incorporated and thereby repeated this materially false overstatement of its first quarter 2001 consolidated pre-tax net income: Form Description Date Filed S-8 WorldCom 1997 Stock Option Plan June 1, 2001 S-8 MCI Group 2001 Employee Stock Purchase June 13, 2001 Plan S-8 POS Post-Effective Amendment to Tracking Stock S-4 July 2, 2001 S-8 POS Post-Effective Amendment to Tracking Stock S-4 July 5, 2001 36. As a consequence of the foregoing, defendant WorldCom, in the offer or sale of the securities described above, among others, by the use of means or instruments of transportation or communication in interstate commerce, or by the use of the mails, directly or indirectly: (a) employed devices, schemes or artifices to defraud; (b) obtained money or property by means of untrue statements of material facts or omissions to state material facts necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading; or (c) engaged in transactions, practices or courses of business which operated or would operate as a fraud or deceit upon purchasers of securities. 37. In connection with the above described acts and omissions, defendant WorldCom, and members of WorldCom's senior management, acted knowingly, recklessly, or negligently. They knew, or were reckless in not knowing, or should have known, that the above mentioned filings with the Commission contained material misstatements and omissions. By reason of the foregoing, WorldCom violated Section 17 (a) of the Securities Act. THIRD CLAIM Violation of Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) and Exchange Act Rules 13a-1, 13a-13, and 12b-20 38. Paragraphs 1 through 27 are incorporated herein by this reference. 39. Section 13(a) of the Exchange Act and Rules 13a-1 and 13a-13 thereunder require issuers of registered securities to file with the Commission factually accurate annual and quarterly reports. Exchange Act Rule 12b-20 provides that in addition to the information expressly required to be included in a statement or report, there shall be added such further material information, if any, as may be necessary to make the required statements, in the light of the circumstances under which they are made, not misleading. 40. Section 13(b)(2)(A) of the Exchange Act requires issuers of registered securities to make and keep books, records, and accounts which, in reasonable detail, accurately and fairly reflect the transactions and http://www.sec.gov/litigation/complaints/comp17829.htm 8/07/2014 Complaint: SEC v. WorldCom, Inc. Page 9 of 10 dispositions of the assets of the issuer. Section 13(b)(2)(B) of the Exchange Act requires such issuers to, among other things, devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that the Company's transactions were recorded as necessary to permit preparation of financial statements in conformity with generally accepted accounting principles. 41. As a result of the conduct set forth above, WorldCom violated Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act and Exchange Act Rules 13a-1, 13a-13, and 12b-20. PRAYER FOR RELIEF WHEREFORE, the Commission respectfully requests that this Court: Enter Orders: A. Permanently restraining and enjoining WorldCom from violating Section 10(b) of the Exchange Act and Rule 10b-5 thereunder; B. Permanently restraining and enjoining WorldCom from violating Section 17(a) of the Securities Act; C. Permanently restraining and enjoining WorldCom from violating Section 13(a) of the Exchange Act and Rules 12b-20, 13a-1, and 13a13 thereunder; D. Permanently restraining and enjoining WorldCom from violating Sections 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act; E. Imposing civil monetary penalties on WorldCom pursuant to Section 20(d) of the Securities Act and Section 21(d) of the Exchange Act; F. Prohibiting WorldCom and its affiliates, officers, directors, employees, and agents, from destroying, altering, or removing from the court's jurisdiction any documents relevant to the matters alleged herein; G. Prohibiting WorldCom and its affiliates from making any extraordinary payments to any present or former affiliate, or officer, director, or employee of WorldCom, or its affiliates, including but not limited to any severance payments, bonus payments, or indemnification payments; H. Appointing a corporate monitor to ensure compliance with items F and G, above; and I. Granting such other and additional relief as this Court may deem just and proper. Respectfully submitted, /S Robert B. Blackburn (RB 1545) Local Counsel for Plaintiff Securities and Exchange Commission Woolworth Building, 13th Floor 233 Broadway New York, New York 10279 (646) 428-1610 (646) 428-1980 (fax) http://www.sec.gov/litigation/complaints/comp17829.htm /S Stephen M. Cutler William R. Baker III Charles D. Niemeier Peter H. Bresnan (PB 9168) Arthur S. Lowry (AL 9541) Lawrence A. West Gerald W. Hodgkins Jose Rodriguez 8/07/2014 Complaint: SEC v. WorldCom, Inc. Page 10 of 10 Louis A. Randazzo Counsel for the Plaintiff Securities and Exchange Commission Stop 9-11 450 Fifth St., N.W. Washington, D.C. 20549 (202) 942-4868 (Lowry) (202) 942-9581 (Fax) Dated: November 5, 2002 http://www.sec.gov/litigation/complaints/comp17829.htm Home | Previous Page http://www.sec.gov/litigation/complaints/comp17829.htm Modified: 11/05/2002 8/07/2014 Topic 2 The Fraud Problem Fraud - What Is it? In previous topic we introduced a generic definition of fraud as - \"Fraud is deception that includes the following elements 1. A representation 2. About a material point 3. Which is false 4. And intentionally or recklessly so, 5. Which is believed 6. And acted upon by the victim 7. To the victim's damage (Ref: Albrecht et al, Chapter 1, page 7) 2 1 Fraud - What is it? The generic definition provides a general insight about what fraud is In this course we address specific fraud offences : -Theft -Obtaining property By Deception -Obtaining Financial Advantage By Deception -False Accounting 3 Fraud Offences - An Overview Fraud offences in Australia are covered by the Crimes Act 1958 Note that fraud offences also exist under various Commonwealth legislation, including the Corporations Act that relate to corporate governance and the Trade Practices Act that relate to the conduct of business affairs. These fraud offences are beyond the scope of this course. Each fraud offence is made up of elements that must be proven. 4 2 Theft S 72. Basic definition of theft (1) A person steals if he dishonestly appropriates property belonging to another with the intention of permanently depriving the other of it. To establish the offence of theft the following elements must be proven: Person Z acted dishonestly Person Z appropriated property; The property belonged to another; Person Z intended to permanently deprive the owner of the property; Liable to 5 years imprisonment (10 years maximum) 5 Definitions 'property' is defined in s. 71(1) of the Crimes Act and includes money and all other property, real or personal, including things in action (for example, bank cheques) and other intangible property. Interestingly, the Act does not use the word 'asset' in the definition of 'property'. 'appropriates' includes any assumption by a person of the rights of an owner. See s. 73(4) of the Crimes Act. 6 3 Dishonesty Case law established the test of dishonesty. The test is based on whether or not the accused believed that she had the legal right to obtain the property (or financial advantage) in the circumstances of the case. It has been established by the courts that a person obtains property or a financial advantage dishonestly if they obtain it without any belief that they had a legal right to obtain it. In deciding this question, a jury may have regard to the 'the standards of ordinary decent people' and then consider whether the accused's belief was totally unreasonable or that no reasonable person could hold such a belief in the circumstances. Proving 'dishonesty' depends on whether the jury considers that the accused had the knowledge, belief or intent which is alleged to make the act dishonest. How transactions are authorised, how the bookkeeping is performed and how money is transferred between accounts can provide forensic accountants with circumstantial evidence of dishonesty. 7 Dishonesty Under s. 73(2)(a) of the Crimes Act, an accused's appropriation of property will not be regarded as dishonest if the accused appropriated the property in the belief that they had the lawful right to deprive the owner of fit. The section in effect provides a defence based on a reasonable claim of legal right. E.g it is arguable that company director/shareholder can appropriate company funds if the company is indebted to him and the company has failed to repay the loan. The forensic accountant will need to establish whether a directors/shareholder loan account exists and loan transactions between the company and the director/shareholder. 8 4 Obtaining Property By Deception S81. (1) A person who by any deception dishonestly obtains property belonging to another, with the intention of permanently depriving the other of it, is guilty of an indictable offence and liable to level 5 imprisonment (10 years maximum). 9 Obtaining Property By Deception To establish the offence of obtaining property by deception contrary to s. 81 of the Crimes Act 1958 (Vic), must prove the elements of the offence: Person Z engaged in a deception; Person Z acted dishonestly; Person Z obtained ownership, possession or control of property or obtained ownership, possession or control of property for another; The property was obtained as a result of the deception; The property belonged to a third party; and Person Z intended to permanently deprive the owner of the property. 10 5 Obtaining Property By Deception Must prove that Person Z engaged in a deception. Section 81(4)(a) of the Crimes Act provides that a deception, (a) means any deception (whether deliberate or reckless) by words or conduct as to fact or as to law, including a deception as to the present intentions of the person using the deception or any other person; and (b) includes an act or thing done or omitted to be done with the intention of causing(i) a computer system; or (ii) a machine that is designed to operate by means of payment or identification- to make a response that the person doing or omitting to do the act or thing is not authorised to cause the computer system or machine to make. 11 Obtaining Property By Deception Section 81(4) of the Crimes Act provides that a deception must relate to fact. If the facts show that Person Z failed to honour a representation based on existing fact or agreement , then the matter is a contractual dispute between Person Z and Person A. If, however, it can be shown that Person Z never intended to honour the representation or agreement in the first place, then criminal liability may arise. 12 6 Obtaining Property By Deception must prove that Person Z obtained the property as a result of the deception. There must be a link between the deception and the obtaining. No offence is committed if the property is obtained without any deception. Forensic accounting can identify deception in the form of missing or unexplained journal entries; a double set of books or convoluted journal entries designed to conceal the substance of fraudulent transactions. In some cases, these acts are performed by the alleged offender. In other cases, unsuspecting parties act upon instructions received from the alleged offender to carry out the deception. Care needs to be exercised: is this evidence of 'mistakes' or 'deception'? 13 Obtaining A Financial Advantage By Deception S.82 (1) A person who by any deception dishonestly obtains for himself or another any financial advantage is guilty of an indictable offence and liable to level 5 imprisonment (10 years maximum). To establish the offence of obtaining a financial advantage by deception must prove that: Person Z, engaged in a deception; Person Z did so dishonestly; Person Z obtained a financial advantage or obtained a financial advantage for another; and The financial advantage was obtained as a result of the deception. 14 7 Obtaining A Financial Advantage By Deception Financial advantage Court cases have established that the words 'financial advantage' are to be given their plain meaning and that there is no limitation upon the scope of the words. This has wide application, for example, obtaining a loan or a credit facility ( the financial advantage) by providing false information (hence the dishonesty) to the lender Forensic accounting can uncover false information provided by an alleged offender, such as declaring false sources of income, overstated or non-existent assets or understated or undisclosed liabilities when applying for loans or other forms of finance, such as trade finance. 15 False accounting S83. (1) Where a person dishonestly, with a view to gain for himself or another or with intent to cause loss to another(a) destroys, defaces, conceals or falsifies any account or any record or document made or required for any accounting purpose; or (b) in furnishing information for any purpose produces or makes use of any account, or any such record or document as aforesaid, which to his knowledge is or may be misleading, false or deceptive in a material particular(c) he is guilty of an indictable offence and liable to level 5 imprisonment (10 years maximum). (d) Note that there are two alternative offences, i.e. s83(1)(a) and s83(1)(b) 16 8 False Accounting S.83(2) For purposes of this section a person who makes or concurs in making in an account or other document an entry which is or may be misleading, false or deceptive in a material particular, or who omits or concurs in omitting a material particular from an account or other document, is to be treated as falsifying the account or document 17 False Accounting To establish an offence against s.83(1)(a) of the Crimes Act, must prove that: Person Z destroyed, or defaced, or concealed, or falsified a record, account or document; The record, account or document was required or made for an accounting purpose; The record, account or document was destroyed, or defaced, or concealed, or falsified with a view to gain for Person Z or another or with intent to cause loss to another; and Person Z acted dishonestly. 18 9 False Accounting To establish an offence against s.83(1)(b) of the Crimes Act, must prove that Person Z: Furnished information; Produced or made use of any record, account or document required or made for an accounting purpose; Was aware that the record, account or document was or might be misleading, false or deceptive in a material particular; Furnished the information with a view to gain for Person Z or another or with intent to cause loss to another; and Person Z acted dishonestly. 19 Who commits fraud? The Code of Ethics For Professional Accountants defines integrity 'to be straightforward and honest in all professional and business relationships' (APES 110) Anyone can commit fraud once they loose their integrity, that is, become dishonest. So, what is it that leads to dishonest behaviour. -People's dishonest behaviour can go unnoticed, hence unpunished by society for substantial periods of time 20 10 Who commits fraud? Impossible to predict in advance or identify who is likely to become dishonest or who is dishonest -Which of your employees has a gambling problem -Which of your employees is currently facing a financial crises -Which of your employees is currently battling a drug addiction -Which of your customers is using a false identity to open a false account in your business to launder cash -Which of your suppliers is providing \"incentives\" to key employees 21 What is the impact? See Topic 1 to review economic impact Consider the following: Sales: $1,000 COGS: $ 500 Gross Profit $ 500 Expenses $ 400 Profit $ 100 Included in expenses is $200 loss as a result of a fraud. How much additional sales need to be generated to recover losses from the fraud? 22 11 What is the impact? Firstly determine profit margin Profit / Sales = 0.10 or 10% Next discount fraud loss by the profit margin to arrive at the extra sales that need to be generated to recover the fraud loss: $200/0.10 = $2,000 additional sales What are the implications for a business suffering a fraud loss? What if the profit margin was lower, say 5% $200/0.05 = $4,000 additional sales 23 Why is fraud committed Understanding why a fraud has been committed contributes to the forensic accountant's understanding of the offender's motivation to commit the fraud Understanding motivation can provide clues about prospective avenues of enquiry (to be discussed in Topic 5) which can be investigated for documentary evidence: -A gambling addict can have betting accounts with the Casino or a Betting account to sustain gambling addiction. -Maintaining a high lifestyle, can have a high limit credit card and paid of by fees derived directly or indirectly from the fraud. 24 12 Why is fraud committed A combination of the following (Fraud Triangle): -Pressure (motivation) -Opportunity (indictor of poor control systems) -Rationalization (justification) KPMG identify an additional three factors: - leadership - role of significant others (family, friends) - organisational culture 25 Why is fraud committed The fraud gets larger and larger as confidence in the fraud or pressure to sustain the fraud gets higher and higher. This is not always the case. The 'human conscience' can breakdown the pressure to sustain the fraud as it happened to Aaron Beam, the CFO of HealthSouth. http://www.youtube.com/watch?v=_Z9y3qRh5xw&fe ature=related Aaron Beam identifies various pressures that led him to commit the fraud. Do you believe Aaron Beam's story? 26 13 The Fraud Triangle Source: Albrecht et al, 2012 27 The Fraud Scale Source: Albrecht et al, 2012 28 14 1st Element: Perceived Pressure Divided into four main groups: -Financial pressures -Vices -Work-related pressures -Other pressures Approximately 95 percent of all frauds involve either financial or vice-related pressures 29 1st Element: Perceived Pressure Common Financial Pressures: 1. Greed 2. Living beyond one's means 3. High bills or personal debt 4. Poor credit 5. Personal financial losses 6. Unexpected financial needs 30 15 1st Element: Perceived Pressure Vice Pressures Worse kind of pressures to commit fraud Examples include: -Gambling -Drugs -Alcohol -Expensive extramarital relationships. This is very common. 31 1st Element: Perceived Pressure : Example 1 Business owner has extramarital relationship with bookkeeper. Both withdraw cash out of the business to support lifestyle and relationship. This cash is not recorded or disclosed in the financial reports. The bookkeeper withdraws additional cash unbeknown to the business owner. The business owner discovers the additional withdrawals, terminates the extramarital affair, sacks the bookeeper and sees a lawyer to sue the bookkeeper and recover cash that was withdrawn without her knowledge. (i) Has a fraud been committed? (ii) If so, what makes up the value of the fraud? If there is no fraud, no need to involve a forensic accountant to quanifty the loss! 32 16 1st Element: Perceived Pressure Vice Pressures Real-life examples: -Executive embezzled company funds to fund gambling -Women who stole money to fund her lifestyle -Man that used company money to fund his drug addiction -There are many other stories..... Forensic accounting evidence can be presented to show that had the fraud not been committed, their vices could not have been satisfied 33 1st Element: Perceived Pressure Work-Related Pressures \"Get even with the employer\" Motivated by these factors: -Getting little recognition -Feeling job dissatisfaction -Fear of losing one's job -Being overlooked for a promotion -Feeling underpaid 34 17 1st Element: Perceived Pressure Other Pressures Spouse Pressures -Spouse's lifestyle demands Life Pressures -Family crisis Social Pressures -\"Being successful\" 35 2nd Element: Perceived Opportunity Six major factors that increase opportunity: 1. 2. 3. 4. 5. 6. Lack of controls Inability to judge performance quality Failure to discipline fraudsters Lack of access to information Ignorance, apathy and incapacity Lack of audit trail 36 18 Controls to Detect / Prevent Fraud Fraud prevention will be covered in Topic 8. For the time being an awareness of prevention mechanisms highlights the areas that need to be tightened up to mitigate the fraud problem Internal Control Framework -From Committee of Sponsoring Organizations (COSO) -Control Environment -The Accounting System -Control Activities 37 Controls to Detect / Prevent Fraud Control Environment -Management's Role and Example -Management Communication -Appropriate Hiring -Clear Organizational Structure -Effective Internal Audit Department 38 19 Controls to Detect / Prevent Fraud Accounting System - - - - - - - - Transactions are... Valid Properly authorized Complete Properly classified Reported in the proper period Properly valued Summarized correctly 39 Controls to Detect / Prevent Fraud Control Activities or Procedures: - - - - - Segregation of duties, or dual custody System of authorizations Independent checks Physical safeguards Documents and records 40 20 3nd Element: Rationalisation Common rationalizations by perpetrators -I deserve more -I am only borrowing the money and will pay it back -Nobody will get hurt -It's for a good purpose -I pay more than my fair share of taxes -The government wastes money 41 Case Study - Drug addiction problem Employee of the Family Court of Australia was a heroin addict who stole a significant sum of money to fund her addiction (Need). Took advantage of weak internal control systems to steal money (Opportunity) and keep herself and her boyfriend happy (Rationalisation: maintain relationship) Devised a plan. She stole the $300 application fee paid in cash from those who filed for a divorce over the counter. This involved falsification of the receipts book and inwards remittances book. A receipt was issued to the person paying cash over the counter but left out the carbon-paper , thus leaving the duplicate receipt (went to cashier) and triplicate receipt (retained in receipt book as proof of payment) in the receipt book, blank. The effect of this is that as far as the family court was concerned, no cash was received! The employee kept the cash. She completed the duplicate and triplicate receipts payment details by using cheque details received from divorce filers who submitted their divorce application by mail. The cheques were banked in the name of the person who paid cash as if that person paid by cheque. Accounting records showed that the cheque was returned to the person who lodged his/her divorce application by mail when in fact this was not the case. 42 21 Impact of forensic accounting evidence The forensic accounting evidence led in court connected the offender to the theft. Multitude of false entries provided grounds for suspicion. This was more than mere mistakes! Original receipt was obtained from Person 1 to show that cash was in fact paid by Person 1. What is the problem with relying only on the copy of the original receipt in the Receipts Book? Cheque details obtained from the Inwards Remittances book and/or duplicate/triplicate receipt enabled the tracing and obtaining original cheque from payees' banks to identify Person 2. Person 2 was not always contactable to confirm the cheque payment. Argued that not totally at fault because influenced and wanted to keep boyfriend happy i.e. she was 'recruited' 43 Fraud 'Recruitment' One of the current fraud problems There are frauds which are committed by more than one person The majority of fraudsespecially financial statement fraudsare collusive CFO survey results: -67 percent received requests to misrepresent corporate results -55 percent fought off the requests -12 percent yielded and were sucked in 44 22 Fraud 'Recruitment' Types of Power -Reward Power -A's ability to provide benefits to B -Coercive Power -A's ability to punish B if B does not comply with A -Expert Power -A's possession of special knowledge or expertise -Legitimate Power -A's legitimate right to prescribe behavior for B -Referent Power -The extent to which B identifies with A 45 Fraud 'Recruitment' Source: Albrecht et al, 2012 46 23 Fraud 'Recruitment' 'Nigerian 419' scams? (source: http://www.scamwatch.gov.au/content/index.phtml/tag/Nige rian419Scams A 'Nigerian' scam is a form of upfront payment or money transfer scam. They are called Nigerian scams because the first wave of them came from Nigeria, but they can come from anywhere in the world. The '4-1-9' part of the name comes from the section of Nigeria's Criminal Code which outlaws the practice. The scammers usually contact you by email or letter and offer you a share in a large sum of money that they want to transfer out of their country. They may tell you about money trapped in central banks during civil wars or coups, often in countries currently in the news. Or they may tell you about massive inheritances that are difficult to access because of government restrictions or taxes in the scammer's country. 47 Fraud 'Recruitment' Scammers ask you to pay money or give them your bank account details to help them transfer the money. You are then asked to pay fees, charges or taxes to help release or transfer the money out of the country through your bank. These 'fees' may even start out as quite small amounts. If paid, the scammer make up new fees that require payment before you can receive your 'reward'. They will