Fraud & Forensic Accounting

Fraud & Forensic Accounting

New England Graduate Accounting Studies Conference

June 20, 2014

Agenda

► What is EY FIDS and what do we do?

► What is forensic accounting?

► Why forensic accounting?

► Fraud and financial restatement statistics

► Description of investigative process

► Case examples

Tony Jordan - Bio

Tony Jordan

Partner

Forensic Investigation & Dispute Services

Tel: + 1 617 585 1951 Mobile: +1 617 413 5736Fax: +1 866 780 9736 Email: [email protected]

Tony Jordan is a Partner in the Fraud Investigation & Dispute Services (FIDS) practice of Ernst & Young LLP (EY). Tony’s areas of focus include forensic accounting investigations, issues surrounds Generally Accepted Accounting Principles and general business-related disputes. He has extensive litigation consulting, forensic accounting and auditing experience, is a certified public accountant, and has been providing financial consulting advice to clients for over 18 years. Tony has been involved in a variety of investigations, working on behalf of Special Committees formed by Boards of Directors, named directors and officers and / or senior management. These investigations have involved analyses of various Securities and Exchange Commission (SEC) reporting matters, including revenue recognition (for software companies, as well as for various manufacturers, distributors, retailers and healthcare providers), and accounting for promotional marketing allowances, derivative transactions, and for stock options. He has also been involved in several matters assessing the adequacy of reserves and dealing with inventory manipulations, along with various other issues around the interpretation and application of GAAP. In addition, he has participated in a variety of other litigation matters, including purchase price disputes, valuations, the preparation and analysis of damage claims, the investigation of employee improprieties and / or defalcations, and royalty audits. Prior to joining EY, Tony was a partner at StoneTurn Group LLP, a boutique litigation support firm. Before that, he held the position of Accounting Branch Chief in the Boston District Office of the SEC where he oversaw and performed numerous investigations into violations of the securities laws relating to accounting and financial fraud matters.

Dawn Aiello - Bio

Dawn E. Aiello, CPA

Manager

Forensic Investigation & Dispute Services

Tel: + 1 617 425 7309Mobile: +1 978 852 3556Fax: +1 866 633 2172 Email: [email protected]

Dawn is a Manager in EY’s Fraud Investigation & Dispute Services (“FIDS”) Practice in Boston, Massachusetts. Dawn has extensive litigation consulting experience, which includes assisting clients in various industries and geographies with forensic accounting investigations, issues surrounding Generally Accepted Accounting Principles (GAAP), and general business-related disputes. Dawn has been involved in a variety of forensic accounting investigations, which have involved analyses of Securities and Exchange Commission matters, including software revenue recognition, and accounting for stock options. She has also been involved in matters dealing with issues around interpretation and application of GAAP. In addition, she has participated in other litigation matters, including purchase price disputes, and the preparation and analysis of damage claims. Prior to joining EY, Dawn was a Forensic Accountant at the Federal Bureau of Investigation. Before that, she was a Manager at StoneTurn Group LLP, a boutique litigation support firm. Her professional history also includes serving as a Forensic Accountant at Berman DeValerio, LLP and an Associate in the Financial and Economic Consulting practice at Huron Consulting Group.

EY Fraud Investigation & Dispute Services

► Anti-Fraud► Corporate Compliance► Dispute Services

► Damage Analyses► Purchase Price Disputes

► Forensic Technology and Discovery Services► Cyber Security► Data Analytics

► Fraud Investigations► Financial Statement/Occupational Fraud Investigations► Shadow Investigations► FCPA

Who are our clients?

► Lawyers and their clients

► Companies

► Individuals

► EY Audit Teams

Who are we?

► CPAs and other Accountants

► Certified in Financial Forensics (CFF)

► Certified Fraud Examiners (CFE)

► Finance Professionals

► Economists

► Information Technology Specialists

► Criminal Justice / Former Law Enforcement

What is Forensic Accounting?

Merriam Webster Online Dictionary – “forensic”► 1 : belonging to, used in, or suitable to courts of judicature or to

public discussion and debate► 2 : ARGUMENTATIVE, RHETORICAL► 3 : relating to or dealing with the application of scientific

knowledge to legal problems (i.e. forensic medicine, forensic science, forensic pathologist, forensic expert)

Forensic Accounting is the application of accounting to legal problems.

Why Forensic Accounting?

Types of Fraud

Former Microsoft Accountant Sentenced to 2 Years in Prison for Stealing $1.1M

FINANCIAL STATEMENT FRAUD

OCCUPATIONAL FRAUD

ACFE 2014 Report to the Nations

► What is the impact of Fraud?► Typical organization loses 5% of its revenues to fraud each year.

Equates to a potential projected global fraud loss of more than $3.7 trillion annually

► The median loss caused by occupational fraud cases is $145,000. 22% of the time losses are at least $1 million

► Detection► Frauds schemes typically last an average of 18 months before

being detected.► Occupational fraud is more likely to be detected by a tip than by

any other method. The majority of tips reporting fraud come from employees of the victim organization.

ACFE 2014 Report to the Nations (cont.)

► Who performs fraud?► The median loss among frauds committed by owner/executives was

$500,000; managers was $130,000; and employees was $75,000.► 77% of all frauds were committed by individuals working in accounting,

operations, sales, executive/upper management, customer service and purchasing.

► Most occupational fraudsters are first-time offenders with clean employment histories. ► 95% never previously convicted of a fraud-related offense► 82% never previously punished or terminated for fraud-related conduct

► Red Flags► In 92% of cases, one or more behavioral red flags exist

► Living beyond means (44% of cases), ► Financial difficulties (33%), ► Unusually close association with vendors or customers (22%) ► Control issues/Unwillingness to Share Duties (21%)

Where does fraud occur?

Restatements: Where have we been?

2001 to 2006 Restatements► Dramatic increase in the number and size of restatements – 2001 = 617

restatements and 2006 = 1,849 restatements (a 200% increase during the period and an average of 26.2% per year)

► Data showed an increase in issuers filing multiple restatements► Rising trend in number of periods contained in each restatement (in 2004,

40% contained at least 3 years of restated financials)► 75% of restatements reported by companies w/ revenues > $500 million► Increase in the # of issues per restatement (peak of 2.43 issues per

restatement in 2005)

2007 to 2013 Restatements► Steady decrease in the number of restatements from ‘07 to’09 (avg. decrease

of 25.8% per year)► Decrease in the number of periods restated (average of 1.5 years in 2013)► Amount of time to restate has decreased (avg. of approximately 30 days in

2007, which dropped to a low of 4.4 days in 2010 and 5.5 days in 2013)► Decrease in the # of issues per restatement from 2007 through 2012 (only

1.38 issues per restatement in 2012; up to 1.61 in 2013)

Restatement Statistics – Total Restatements

Source: “2013 Financial Restatements: A Thirteen Year Comparison”, Audit Analytics, April 2014

Restatement Statistics – Largest Restatements

Source: “2013 Financial Restatements: A Thirteen Year Comparison”, Audit Analytics, April 2014

SEC Enforcement Actions

Source: “Floyd Advisory: Summary of Accounting and Auditing Releases for the Year Ended December 31, 2013”

AAER Trends – Where are the issues?

Impro

per Rev

enue R

ecogn

ition

Balance

Sheet M

anipulation

Intentional

Mist

atemen

t of E

xpen

ses

Man

ipulation of R

eserve

s

Options Bac

kdati

ng

Defalca

tions0

5

10

15

20

25

30

35

40

45

2011 2013

Source: “Floyd Advisory: Summary of Accounting and Auditing Releases for the Year Ended December 31, 2013”

Forensic Investigation Tools

► Accounting discipline

► Forensic technology tools► E-Discovery► Data analytics

► Interview skills

► Use of industry specialists as required

Forensic Investigations - Where do we start?

► Start with the allegation – what is it?► Who’s your audience?► What are the controls and processes around the area?► Who’s involved in the controls and processes?► Where are the potential breakdowns?► What would it look like?► What other information is available for me to analyze?

► Business Intelligence► Email► Accounting Records► Other data from the accounting system► Data from third parties

► Trending of performance metrics► Based on internal and external metrics► Identification of anomalies that may suggest further review

required

► Anomaly Detection► Targeted Analyses► Additional testing (manual or electronic) used to follow up

on anomalies identified from trending and data analytics► Sometimes simple frauds require simple analysis

Data Analysis

Stages of an Investigation

Scoping

Data Gathering

Investigation

Preliminary FindingsInterviews

Additional Investigation

Summary of Investigation

23

Building the Information

Financial Statement Fraud Example

CUST

Product

$

ETS

ETS - What did they do?

ETS CUST

Product

$

Investment $

ETS - What did they do?

DIST

ETS CUSTInvestment $

Investment Certificate

Pro

duct

ProductPa

ymen

t

Paym

ent

Financial Statement Fraud Example:ETS - Timeline

► Friday, February 2, 2002 – announce they are being investigated by the SEC and they initiated an internal review

► Closing Price of Stock = $10.75/share► Market Capitalization = $2.1 Billion► Quarterly sales = $150-$200 million

► Monday, February 5, 2002 ► Closing Price of Stock = $4.13/share► Market Capitalization = $816 Million► Loss to Investors = 61% or $1.3 Billion in one day

► Tuesday, March 22, 2005► Closing Price of Stock = $1.46/share► Market Capitalization = $307 Million► Quarterly sales = $80-$90 million

Enterasys Networks - Timeline (cont.)

► 2/27/02 – 3 executives in Asia fired► 3/2002 – 2 sales people and 3 executives in U.S. fired

(including CEO)► 8/12/02 – Announce sale of Aprisma (sub.) for $7.4

Million► 11/26/02 – File restated financials for past 2 yrs

► reduction of revenue and net loss of over $200 Million► Fall 2002 – CFO fired► December 2002 – Mgr. Financial reporting fired► 2001 – 2002 = 730 people laid off► October 2003 – pay $50 Million to settle class action

Enterasys Networks – Timeline (cont.)

► May 2004 – 7 executives charged by US Attorney’s office (3 plead guilty)

► November 2004 – Former exec, Hor Chang Boey, arrested in Atlanta while attempting to enter US for family vacation

► January 2005 – pay $10.5 Million to settle class action► March 2006 – Acquired by two private equity firms for

$386 million. No longer a public company► April 2007 – 3 of 4 executives found guilty of securities

fraud and sentenced to 5 – 14 years in federal prison

Example:Fannie Mae (FM) – Key Players

► Roger Barnes - Accounting Manager & Whistleblower

► Franklin Delano Raines – Chairman & CEO

► Tim Howard – Vice Chairman & CFO

► Leanne Spencer – Senior Vice President & Controller

Example:Fannie Mae (FM) – Timeline

► August 2003 – Barnes raises concerns to OFHEO re: accounting practices

► October 2003 – OFHEO initiated examination of FM

► January 2004 – Special Review Committee (SRC) formed

► September 2004 – ► OFHEO issues report and discloses certain accounting violations

at FM► SRC hires attorneys/forensic accountants to investigate OFHEO’s

claims

► February 2006 – Rudman report issued outlining accounting and other issues at FM

► December 2006 – FM issues restated financials ($6.3B reduction in RE)

Example:Fannie Mae (FM) – Procedures

► Over 4 million pages of hard copy & electronic documents reviewed

► Over 240 interviews conducted

► Financial modeling

► GAAP research and interpretation

► Preparation of internal report presented to BOD and Congress

Fannie Mae – Issues Identified

► SFAS 91 - Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases► 1998 – Catch-Up Adjustment (recorded only $240M of $439M)► 2000 – Development and implementation of amortization policy

► SFAS 133 - Accounting for Derivative Instruments and Hedging Activities

► Corporate Governance & Internal Controls

► Executive Compensation

► Other Accounting Issues

Example: Fannie Mae (FM) – Excerpts from Document Review► 1996 Email from Spencer to Howard:

► “What do I have up my sleeve to solve an earnings shortfall?”► “I recognize (and thought about it yesterday) that we might want to show

the board $2.48. I made the decision that I wanted to show you the real answer and the let you decide if you wanted me to make any adjustment.”

► ``KPMG has apparently forgotten about these transactions, and we have not brought the issues to their attention. They have experienced significant turnover since we originally adopted the `package' accounting, and, as a result, there is currently only one member of the audit team left from 1995.'' (undated memo from Howard's staff)

► “I have given serious thought to the many conflicts of conscience I have had over management decision-making. Again, over the past few weeks issues after issue have arisen regarding FAS133 compliance where scenarios were last month…rerun and changed multiple times until we got a result we liked.” (2002 email from Barnes)

Fannie Mae – Report Conclusions

► Accounting Methods Not GAAP-Compliant► $200M in expenses pushed to future periods allowing executives

to receive $27M in bonuses► Amortization policy designed to avoid audit differences

► Inadequate Accounting Systems

► Unqualified Staff

► Tone at the Top/Corporate Culture

Presentation title

Fannie Mae – Where are they now?

► Fannie Mae – Restated financials ($6.3B)

► Franklin D. Raines – ► Golden Parachute ($240M in benefits)

► Tim Howard – ► Golden Parachute ($20M in benefits)► Author – The Mortgage Wars (2013)

► Leanne Spencer – Independent Real Estate Professional?

1 January 2014

► Fact Pattern► Controller of a healthcare facility was fired for performance related

issues► Controller was in his position from January 2009 through July 2011► Upon review of his work management discovered some erroneous

entries around A/R write-offs in Q2 2011► Company reports revenue metrics to headquarters based on

revenue by healthcare program and expenses by financial statement ► Company reports expense metrics to headquarters based on

expenses by financial statement category.

► Our Task► Determine whether the errors were intentional or unintentional► Identify any other erroneous entries► Determine whether anyone else involved

Data Analytics Example

Financial Statement Fraud Example

► Fact Pattern► Controller of a healthcare facility was fired for performance related

issues► Controller was in his position from January 2009 through July 2011► Upon review of his work management discovered some erroneous

entries around A/R write-offs in Q2 2011► Company reports revenue metrics to headquarters based on

revenue by healthcare program and expenses by financial statement ► Company reports expense metrics to headquarters based on

expenses by financial statement category.

► Our Task► Determine whether the errors were intentional or unintentional► Identify any other erroneous entries► Determine whether anyone else involved

Trending of Performance Metrics

Jan-

09

Feb-0

9

Mar

-09

Apr-0

9

May

-09

Jun-

09

Jul-0

9

Aug-0

9

Sep-0

9

Oct-0

9

Nov-0

9

Dec-0

9

Jan-

10

Feb-1

0

Mar

-10

Apr-1

0

May

-10

Jun-

10

Jul-1

0

Aug-1

0

Sep-1

0

Oct-1

0

Nov-1

0

Dec-1

0

Jan-

11

Feb-1

1

Mar

-11

Apr-1

1

May

-11

Jun-

11

Jul-1

1

Aug-1

1

$(120,000)

$(100,000)

$(80,000)

$(60,000)

$(40,000)

$(20,000)

$-

$20,000

$40,000

$60,000 Accrued Expenses Trending (January 2009 - July 2011)

Accrued Expenses Note : data points represent balances at end of monthSource: 2009, 2010 and 2011 Trial Balance

Trending of Performance Metrics (cont.)

Jan-09

Mar-09

May-09

Jul-09

Sep-09

Nov-09

Jan-10

Mar-10

May-10

Jul-10

Sep-10

Nov-10

Jan-11

Mar-11

May-11

Jul-11

0

50,000

100,000

150,000

200,000

250,000

300,000 Monthly Product A Revenue Trending (January 2009 - July 2011)

Adult IOP/TLP Revenue ActualAdult IOP/TLP Revenue Budget

Source: Monthly Operating Revenue Schedules January 2009 - July 2011

Trending of Performance Metrics (cont.)

Jan-09

Feb-09

Mar-09

Apr-09

May-09

Jun-09Jul-0

9

Aug-09

Sep-09

Oct-09

Nov-09

Dec-09Jan

-10

Feb-10

Mar-10

Apr-10

May-10

Jun-10Jul-1

0

Aug-10

Sep-10

Oct-10

Nov-10

Dec-10Jan

-11

Feb-11

Mar-11

Apr-11

May-11

Jun-11Jul-1

10

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000 Monthly Other Program Revenue Trending (January 2009 - July 2011)

Other Programs Actual

Other Programs Budget

Source: Monthly Operating Revenue Schedules January 2009 - July 2011

Finding: Intentionally Inflated Rates

Rate Charged per Procedure Formula Used to Determine Rate

Example:Canopy Financial – Success Story?

► Developed software for banks and healthcare providers to manage health savings accounts

► As of 2009 was one of the fastest growing private companies in the U.S.

► Reported a cash balance of $9 million

► Raised $75 million from outside investors

► Reported that they had 1,012,002 customers

Canopy Financial - Fraud Uncovered

► Fraud identified through identification of a fake audit opinion

Canopy Financial - Reality

► Two co-founders engaged in fraud that resulted in theft of $93,125,918 over only a one year period

► Stole monies from investors and the health savings accounts of their customers

► Had only $800k in cash versus the $9 million reported► Had only 81,618 customers versus the 1 million reported► Funds were used to:

► Operate the company► Purchase of exotic automobiles► Use of a private jet► Purchase of a home for one of the co-founders’ parents► Home renovations► Sports tickets► Jewelry► Credit card purchases

Canopy Financial - Automobiles

► 20 Cars purchase in total, including:► 2010 Range Rovers (2)

► 2008 Lamborghini

► 2009 Rolls Royce Phantom

► 2009 Aston Martin DBS

► 2009 Bentley Continental

► 2009 Ferrari 430

http://www.mibz.com/wp-content/uploads/2010/02/07rangeroversportreview2010.jpg

http://www.netcarshow.com/rolls-royce/2009-phantom_coupe/800x600/wallpaper_01.htm

Canopy Financial - Where are they now???

► Anthony Banas – Chief Technology Officer► Sentenced to 13 years in federal prison

► Jeremy Blackburn – President and COO► Sentenced to 15 years in federal prison

► Both men ordered to pay restitution and forfeit assets totaling $93 million

Example: Occupational Fraud - Lars Bildman

► CEO of Astra Pharmaceutical USA► Salary = $1.1M per year► “Supplemental Income”

► $4 Million of construction on his homes► Family vacations► Prostitutes► Sexual harassment of numerous female employees

(cost company $10 million)► Sentenced to 21 months in prison for tax evasion

Example:Occupational Fraud – Bradford Bleidt

► Full-service investment advisor w/ businesses in Boston including a radio station

► Performed fraud over a period of 20 years

► Stole in excess of $30 million from clients

► Many clients elderly and their life savings were gone

► Currently serving a 13 year sentence in federal prison

Questions

Fraud & Forensic Accounting

Documents

Transcript of Fraud & Forensic Accounting