Lessons for theft of $31MM by Principal accounting officer

http://www.acfe.com/newsletters/fraud-examiner.asp?copy=july10-internal-control

General

• "These days there's a higher standard of fiduciary conduct for managers and board directors," said Sheila Keefe, CFE, CPA, a principal of Access Resource Management, a business advisory consultancy in Lake Geneva, Wis. "When shareholders lose money — whether stolen or lost through inefficiency — it's gone."
• A growing body of empirical research indicates that companies with good corporate governance — as evidenced by strong internal control over financial reporting — are less likely to have incidences of fraud and are able to obtain capital at a lower cost than firms with weak corporate governance.

Case specific

• The scheme was astonishing in its scale, with proceeds approximating three-quarters of Koss's total market value. The brazen fraud ended when American Express alerted Koss management that Sachdeva had allegedly been using company wire transfers, cashier's checks, and traveler's checks to pay her personal credit card bills.

Best Practices for Fraud Detection and Ethical Profitability

Create, disseminate, and enforce a strong code of ethics and set up an ethics hot-line.

• According to the 2010 ACFE Report to the Nations, 40.2 percent of occupational frauds are initially detected through tips … Many would-be whistle-blowers fear retaliation, a fact borne out in the Report's findings. In organizations that had hot-lines, 47 percent of frauds were detected by tips, but that measure dropped to 34 percent where there was no hot-line … As a model, Keefe cited Best Buy's code of ethics, a 31-page document that includes phone numbers of staff who can answer questions about ethics and an anonymous hot-line for reporting unethical practices. In contrast, she noted that Koss's two-page code of ethics contains no contact phone numbers and doesn't mention an ethics hot-line.

Financial statements

• Monitor key performance indicators, such as financial ratios and analytics. Looking back on Koss's financial statements, Keefe identified red flags of potential fraud. Keefe said Koss' shrinking gross profit and gross profit margin suggest that revenues fell faster than expenses. "If a senior manager had blamed higher raw material prices for the greater-than-expected cost of sales," Keefe said, "someone on the board of directors — preferably a member of the audit committee — should have confirmed that explanation with the purchasing manager. It is conceivable that a better handle on gross profit and the drivers of change would have warned the board of directors of the growing fraud at Koss."
  Keefe also recommended these key performance indicators (acceptable values vary by industry):
  • Significant inconsistencies between reported earnings and cash flows from operations
  • Unusual relationships between recorded sales volume and production statistics
  • Inventory turnover, both for individual parts and in the aggregate
  • Concentrations of vendors and customers
  • Profit by customer and product line
  • Rapid growth, especially in comparison to other companies in the same industry

Board packets

• Present board members with concise information packets. "I like to give them a dashboard with a half-dozen useful key performance indicators," Keefe said. "If certain board members need a lot of additional data, give it to them. But on top, put a one-page abstract that zeroes in on the highlights."

Best practices

• Stay abreast of research findings that demonstrate how good corporate governance — including strong internal control — lowers costs for all the organization's stakeholders and reduces fraudsters' ability to misappropriate assets and resources.

"The Effects of Corporate Governance on Firms' Credit Ratings," published in 2008 and authored by Skaife, Daniel W. Collins and Ryan LaFond, found correlations between firms' cost of credit, the transparency of their financial statements, and the expertise of their boards of directors.In the Koss fraud, the company's falsified financial statements, and the board's inattentiveness to troubling trends in the company's performance reports, together suggest that its cost of credit may rise.