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Bad Bets Episode 6: Enron, Lies and Choices

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Bad Bets Episode 6: Enron, Lies and Choices

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This was a podcast episode about the Enron scandal that occurred in the late 90s to early 2000s. Enron was a company that committed fraud by misreporting their financial information. They said they had way more revenue than they actually did leading investors to think it was a great choice eventually leading the stock to a price of just over $90. But when people realized it was somewhat of a farce it had one of the most dramatic falls in stock market history going down to 26 cents. This fraud shook wall street and caused so many people financial damage.

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Enron CEO Ken Lay was practically the company’s founding father. But when federal authorities began investigating Enron after its collapse, prosecutors had a hard time connecting Lay to anything illegal - and Lay himself insisted that he was innocent. Until: prosecutor John Hueston joined the team,…

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This video shows us what the fraud triangle is which seeks to explain why fraud might happen or what needs to be there for it to occur. The first is pressure which basically means their motivation, maybe they need more money to buy a house or keep up with their gambling addiction. Next is opportunity which could be that someone has a company credit card or an accountant in charge of financial statements. Finally is rationalization the main highlight of this video. There are many ways someone can rationalize this criminal activity but some include that they are underpaid anyways or are going to stop as soon as they hit a certain mark or that the company isn't going to miss a couple thousand dollars. There are an endless amount of combinations of each side of the triangle which is why fraud may be so common and people want to do it.

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How people rationalize fraud - Kelly Richmond Pope

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If you ask people whether they think stealing is wrong, most of them would answer yes. And yet, in 2013, organizations all over the world lost an estimated total of $3.7 trillion to fraud. Kelly Richmond Pope explains how the fraud triangle, (developed by criminologist Donald Cressey) can help us understand how seemingly good people can make unethical decisions in their daily lives.

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1. What causes someone to want commit fraud and what causes them to get caught or not?
2. How many types of different fraud are there and how can you identify them before you're a victim?

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This book Is about Theranos a company started by Elizabeth Holmes in Silicon Valley in the 2010s. She committed fraud by promising a product which wasn’t what it was advertised as and garnered billions of dollars in support from donors and investors. The machine was supposed to revolutionize blood testing and make it much more efficient and quick but it didn’t actually work. If one person can convince people to invest billions into a product that just doesn’t work we can see why fraud may occur more often.

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This book is about maybe the most famous white collar criminal ever Bernie Madoff. He used a type of fraud called a Ponzi Scheme to finesse people out of over $50 billion. Before this he was one of the most well-respected traders on Wall Street. It shows that no matter how much money someone has they may still feel the need or urge to commit fraud.

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In the accounting industry you deal with the reporting and auditing of financial statements as well as dealing with the tac policy of a company. When doing this depending on the company you work for you can be in charge of lots and lots of money. With all this power comes great responsibility though and not everyone is up for the task. Some accountants commit fraud to either benefit themselves, their company, or some other reason. Fraud is defined by Oxford as "wrongful or criminal deception intended to result in financial or personal gain.". Accounting fraud is only one type of fraud but there are many others and they occur all around the globe. I wanted to take a dive into different types of fraud and understand why they happen and when does someone get caught.

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This movie follows the story of Jordan Belfort (Leo DiCaprio) one of the most famous white collar criminals of all time. Him and his partner Danny participated in a type of fraud called pump and dump for their investment firm Stratton Oakmont. They would invest all of their clients money into highly speculative and risky penny stocks but since they had such a low value a big investment would cause them to rise up and they would sell quickly after. He got caught and arrested but this movie highlights the lavish lifestyle of someone who commits fraud. You could see why some people would want to commit fraud based solely on the lifestyle, lots of money, drugs, women and fast cars.

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The Wolf of Wall Street Official Trailer

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People will try to rationalize fraud in any way possible. This meme is showing Drake saying no to fraud but yes to creative accounting. Accountants are in charge of a company's financial statements so if they find creative loopholes they can abuse the system. This is fraud but some will still rationalize it.

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Fraud is even becoming more of a topic in pop culture and the media. TeejayX6 is a newer rapper whose main topics in songs relate to scamming people, credit card fraud, and identity theft among other things. He claims he does it as a way to get money which greed is often the most common reason people commit fraud. Here is him describing the lyrics to one of his songs "Swipe Story" about credit card fraud.

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Teejayx6 "Swipe Story" Official Lyrics & Meaning | Verified

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This book goes into a very famous international fraud scheme and one that has to do with sports, more specifically FIFA or the Federation of International Football Association. It goes into how a country becomes the host of a world cup and how this while intended to be a fair process is tainted with lots of corruption. It started off as a simple audit of a MLS (American) soccer club but ended in individuals from tens of countries getting caught and jail time. Sports are a highly profitable part of the entertainment industry and where there is a lot of money you can be sure to find fraud somewhere there.

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This article talks about why it can be hard for accountants reviewing and auditing financial statements to actually catch fraud. One reason is the lack of volatility in audit tests, they usually use the same method to review financial statements and those committing fraud know this and are smart enough to try and hide it based on how they do the audit. Another is time and budget constraints, auditors are very busy with many projects so they may not be able to dedicate as much time to a single audit as they would hope. These and other factors make accounting fraud relatively easy to get away with sometimes and may be a reason it is so common.

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In today's world where corporate scandals often make front page news, fraud prevention and detection are becoming a priority for management and decision-makers. An alarming fact reported by the Association of Certified Fraud Examiners ("ACFE") stated that an average organisation loses an estimated 5% of its annual revenue to fraud, hence fraud is posed as one of the major risks facing an organisation (both financially and reputationally).

Typically, a large majority of midsize to large organisations consider their internal and external auditors as the pivotal tool for uncovering fraud and taking preventive measures to minimise the risk of loss incurred due to a fraud. However, this doesn't imply that independent auditors often identify fraud, in fact, the opposite is true in many cases. ACFE's Report to the Nations points out the fact that auditors rarely find fraud - internal audit detects fraud 15% of the time, while external audit merely 4%.

One reason auditors rarely find fraud is that audits are not designed to detect and/or prevent a fraud from occurring. Audit procedures and rules are more likely to determine whether a company's financial statements are fairly stated without any material discrepancies and whether appropriate internal controls are in place. They are not aimed at detecting and remediating a fraudulent occurrence. For instance, organisations exhibiting unethical culture and poor employee behaviour are often held responsible for data breaches, whereas there is no relationship between auditors and the conduct of employees as typical audit rules don't require auditors to consider qualitative and non-regulatory factors. Hence, auditors can't be held accountable for fraudulent incidents in most of the cases.

Knowing all this, fraudsters try to take advantage of the gap between an auditors' limited reach and the company's policies and procedures. This makes fraud prevention a mutual responsibility of the board, top-level management and auditors.

The following are some reasons why auditors rarely find fraud:

The audit universe has its limitations. During an audit engagement, auditors usually evaluate financial statements of the organisation or test internal controls that are in place. The majority of these audit procedures are aimed at detecting material facts and correcting material errors. Materiality, in this context, is a misstatement/weakness in internal controls over financial reporting that might affect decision-making and profitability of stakeholders. Hence, the audit universe captures transactions and controls that are at or above material level.

Lack of volatility in audit tests. Generally, auditors are not known for modifying their testing methods from one exercise to another; their focus remains set on the specific thresholds of controls and the transactions occurring. This makes audit testing predictable as employees are often aware of the scope of the audit and the opportunities that exist under the auditor's radar. Adding an element of surprise can be an effective method in detecting and preventing fraud, yet it is not commonly used by auditors.

Sampling is not enough to capture the whole story. Sampling is widely used for testing transactions in an audit. Auditors collect random samples of transactions to verify that they were correctly recorded and that the internal controls were in place and working at the time. An intrinsic limitation of sampling is that all transactions are not tested, therefore creating a high probability that a fraudulent transaction will not be captured in the auditors' sample, and therefore will go undetected.

Fraudsters might prove clever for inexperienced auditors. Today's business model for audit firms relies on relatively inexperienced auditors to perform a major component of field work. Young and inexperienced auditors often do not know what questions to ask and are usually reluctant to ask difficult questions or challenge management's decisions. On the other hand, fraudsters can produce fake documents or paperwork to pacify the busy auditor. Simply put, auditors without much experience might not be adept at recognising suspicious transactions and/or fraudulent documentation.

Time and budget constraints. Just like any other project or engagement, auditors are also required to meet certain periodic and monetary deadlines. Limitations of resources and tight project deadlines may lead to audits not being as thorough as planned.

Heavy dependence on internal controls. The scope of testing and the types of audit procedures used are heavily influenced by the assessment of internal controls. Auditors review the company's policies and procedures that help ensure accurate processes and financial statements. Internal control deficiencies are often repeated year after year even with increased auditing procedures, while the client continues without addressing those deficiencies.
Auditors' Role in Detecting Fraud
The Australian government's Auditing and Assurance Standards Board (AUASB) and The Institute of Internal Auditors (The IIA) have both issued professional standards that require auditors, when performing an audit, to identify the risks of fraud and to plan audits to address these risks. These include (The Auditor's Responsibilities Relating to Fraud in an Audit of a Financial Report) andThe IIA Standard 1200 (Proficiency and Due Professional Care). The AUASB is an independent, non-corporate Commonwealth entity of the Australian government, responsible for developing, issuing and maintaining auditing and assurance standards. The AUASB standards are legally enforceable for audits or reviews of financial reports required under the Corporations Act 2001.

The AUASB requires auditors to maintain professional skepticism throughout the audit and recognise the possibility that a material misstatement due to fraud exists. Auditors cannot rely upon past experiences of honesty and integrity of management and employees. Auditors should re-assess any document which is believed to be non-authentic.

ASA 240 standard is similar to the International Auditing and Assurance Standards Board (IAASB) standard 240, which is about the auditor's responsibilities relating to fraud in an audit of financial statements. ISA 240 states that the primary responsibility for the prevention and detection of fraud rests both with those charged with governance of the entity and with management. Thus, auditors' responsibilities are confined to obtaining reasonable assurance that the financial statements are free from material misstatement, whether caused by fraud or error.

Per The IIA Standard 1200 - Proficiency and Due Professional Care, "Internal auditors must possess the knowledge, skills, and other competencies needed to perform their individual responsibilities." Sub-section 1210.A2 further specifies an auditor's role toward fraud detection: "Internal Auditors must have sufficient knowledge to evaluate the risk of fraud and the manner in which it is managed by the organisation but are not expected to have the expertise of a person whose primary responsibility is detecting and investigating fraud."

Hence, most of the professional standards around an auditor's role in fraud detection are confined to material misstatement. Also, auditors might be qualified in assessing risks and identifying where a fraud may occur, but they might not know how to recognise (i.e., identify) the indicators of fraud. Auditors must look at their audit evidence and identify where a fraud might have already occurred or might be occurring - these are the anomalies, or red flags, of fraud. Unlike certified fraud examiners, most auditors have never seen a fraud scheme or are unaware of common red flags.
The Way Ahead for Organisations and Auditors
Management and governance functions, and risk and compliance departments need to understand these inherent limitations in the auditing process. It is understandable that audit procedures have never been designed to detect fraud. It is difficult for auditors to detect fraud at a meaningful rate, unless there is a massive change in the business of auditing.

Nevertheless, there are a few ways that can enhance the role of an auditor in fraud detection and prevention:

Audits should use basic techniques, like the element of surprise, for example. Auditors should vary their procedures and scopes from year to year, and surprise procedures should be conducted throughout the year as well as during the audit. More time needs to be spent on assessing high-risk areas where fraud could be committed at the company.

Inexperienced auditors should be provided with better training and supervision that includes actual experience in the field.

Along with complying with professional standards, auditors can conduct fraud examinations for transactions/controls where the level of risk is significant.

Auditors can play a key role in developing a system of fraud indicators, so that suspicious activities are flagged and investigated.

Auditors should exercise professional skepticism when considering the risk of fraud. External auditors in particular must conduct their work with a mindset that recognises the possibility that a material misstatement due to fraud could be present, regardless of any past experience with the company and the auditor's belief about management's integrity. Auditors should never be satisfied with less-than-persuasive evidence because of a belief that management is honest.

Finally, internal auditors should be concerned with violations of the organisation's policies and procedures even when they do not involve fraud.
Fraud in the APAC Region
In this period of economic uncertainty and heightening regulations, efforts are being undertaken to detect red flags within the APAC region. The ACFE identified areas related to fraud in its "Report to the Nations - Asia Pacific Edition." Highlighted below are some findings from that report:

On average, median loss caused by a fraud incident in APAC is US$236,000, and the median duration of a fraud scheme is 18 months.

In terms of percentages globally, asset misappropriation (89%) is the most common fraud incident; however, in the APAC region, corruption (51%) is the most common incident. In monetary terms, financial statement fraud leads the way, with a median loss of US$236,000.

The role of audit in fraud detection is not so different in Asia-Pacific organisations compared to rest of the world. Internal audit is the second most common fraud detection avenue with 15% of fraud cases initially being detected by independent auditors.

External audit is not as effective, detecting only 4% of fraud cases.

In terms of victim organisations, private companies incur more monetary losses compared to public companies, and entities with less than 100 employees are sometimes at greater risk of fraud.

The manufacturing industry by far is the largest industry impacted by fraud in the Asia-Pacific region with 17% of cases identified and the highest median loss of US$500,000. The financial services sector and government agencies were the second and third most impacted, respectively.

Companies in the Asia-Pacific region rely significantly on audit as an anti-fraud control. External audit of financial statements is considered as an anti-fraud control in 93% of cases, while in 80% of cases companies relied on their internal audit department to prevent fraud.

External audit of internal controls over financial reporting systems was identified as reducing incidents of fraud in 28% of cases, and assisting in faster detection of fraud in 38% of the cases.

Formal fraud risk assessments can decrease the probability of fraud in 34% of cases and lead to faster detection of fraud in 17% of cases.

These are specific and informative findings. APAC entities need to be cognisant to the risk of a fraud occurring within their environment and ensure that appropriate controls are in place to mitigate the likelihood of a fraud or corruption event. This assertion applies to companies in other regions as well.

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Why Auditors Rarely Find Fraud - The Protiviti View

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In today's world where corporate scandals often make front page news, fraud prevention and detection are becoming a priority for management and decision-makers. An alarming fact reported by the Association of Certified Fraud Examiners ("ACFE") stated that an average organisation loses an estimated 5% of its annual revenue to fraud, hence fraud is posed as [...]

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This Youtube video set in London details a police raid on a gang of fraudsters participating in a type of fraud where they steal people's bank accounts. Whether it is in the US, the UK here, or anywhere else in the world, fraud is an international issue and exists everywhere. This video delves into how the police go about finding people committing these crimes and actually trying to go out and make the arrest.

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Executing A Police Raid On A Fraud Gang | Fraud: How They Steal Your Bank Account | ITV