Chapter 6
Legal, Regulatory and
Professional Environment
Critical Thinking Exercise
A scientist has two buckets,
one holds 4 gallons and the
other holds 5 gallons as well
as an unlimited water supply.
By using nothing but the
buckets and water, how can
you accurately measure 3
gallons of water?
Introduction
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Fraud may be prosecuted criminally or civilly
Fear of getting caught
Fear of punishment
Most people are law abiding citizens
“Criminal justice funnel”
Regulatory agencies
Public Company Accounting Oversight Board
The Rights of Individuals
Amendment
•Fourth
•Fifth
•Sixth
•Fourteenth
Protects
Against unreasonable searches
& seizures
Against self-incrimination
Right to an attorney
Due process and equal
protections
NOTE: Employees have less protections
The Rights of Individuals
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Interviews
Searches
Surveillance
Discharging a Suspected
Wrongdoer from Employment
• Privileges
Interviews
• Miranda warnings
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Right to remain silent
Answers can be used against him
Right to an attorney
If interviewee can’t afford an attorney, one will be
provided at no cost
• Legal counsel
• Private employers don’t have to offer due
process of law
• Common law protections
• Confessions
Searches
• Unreasonable searches and seizures are
forbidden
• When is a workplace search reasonable?
– Likely to reveal evidence of work-related
misconduct
– Search is necessary to further investigation
• Search limitations
– “Exclusive control”
– “Fruit from the forbidden tree”
Surveillance
• Types of surveillance
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Fixed point surveillance
Mobile surveillance
Videography
Audio or electronic surveillance
• Audio surveillance laws and regulations are
more complicated
– “One-party consent”
• Video surveillance generally permissible
Discharging a Suspected
Wrongdoer from Employment
• Employment considered “at will”
• Employer should document “good cause”
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Conduct against written policy
Conduct made for unsafe or inefficient operations
“Punishment fits the crime”
Evidence supports questionable act by employee
• Actions should be well documented
• Nothing prevents employee from suing
employer in civil court
Privileges
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Protections against certain types of testimony
Attorney-client privilege
Attorney work-product privilege
Physician-patient privilege
Marital privileges
Miscellaneous privileges
Attorney-Client Privilege
• The right to not disclose confidential
communication relating to professional
relationship
• Client has right to compel nondisclosure
• Applies only to communications intended to
be confidential
• Does not permit attorney to conceal physical
evidence
• Does not apply to future acts of crime or fraud
Attorney Work-Product Privilege
• Protects all materials prepared by an attorney
in anticipation of litigation
• Shield materials that would disclose
attorney’s theory of the case
• Any written materials directed toward
preparation of a case
• Must be prepared in anticipation of litigation
Physician-Patient Privilege
• Confidential when obtaining treatment or
being diagnosed
• When involved in litigation, privilege is waived
– Court appointed physicians
– Expert witnesses
Marital Privileges
• Spousal immunity
– Protection from testifying against own spouse
• Spousal defendant
– Protection from adverse testimony
– Allowed in both civil and criminal cases
– Covers statements made during marriage
• Neither applies to crimes or torts within
family
Miscellaneous Privileges
• Confidential communications made to clergy
• Government has privileges that protect the
disclosure of sensitive information
• Trade secrets for businesses
• No privilege for accountant-client
relationships
Probable Cause
Standard used:
• To make an arrest
• To conduct a search
• To obtain a warrant
• By grand juries
• Culpability scale
– Witness
– Subject
– Target
Probable Cause
• 4th Amendment
• Terry v. Ohio
– “Terry Stop” (reasonable suspicion)
• United States v. Matlock
– “Co-occupant consent rule”
• Illinois v. Gates
– “Fair probability”
Probable Cause
• Documentary evidence
– Voluntary consent
– Subpoena
– Search warrant
• Advantages of warrant over subpoena
– Allows holder to decide which documents are
relevant
– Avoids, but does not eliminate, possible
destruction of evidence
– Interview key witnesses without opportunity to
prepare
Rules of Evidence
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Evidence must be relevant and trustworthy
Must be admissible
May be testimonial
Real
Demonstrative
Circumstantial
Direct
“Facts at issue”
Rules of Evidence
• Real evidence “speaks for itself”
– Must be authenticated
• Demonstrative evidence purports to educate,
summarize or amplify real evidence
– Tells a story or complements other evidence
– Must not create prejudice
– Heart of most fraud and forensic accounting
investigations
Rules of Evidence
• 5 considerations must be given to any piece of
documentary evidence
– Document must not have been forged
– Original documents are preferable
• “Best evidence rule”
– Document must not be hearsay or
objectionable
• “Statements against interest”
– Document needs to be authenticated
– Document must be reliable
Criminal Justice System
• Most cases never end up in the criminal
justice system
• 3 routes that a target may enter criminal
justice system
– Warrantless arrest by police based on probable
cause
– Investigation that leads to the filing of an
“Information”
– Grand jury proceeding that leads to an indictment
and subsequent arrest warrant by a judge
• “Without unnecessary delay”
Criminal Justice System
• Sufficient evidence exists to bring case to trial
• Indictment stage
– Defendant is officially charged
• Arraignment hearing
– Defendant is informed of the crime and charges
against him
– Advised of rights
– Asked to enter plea
• Guilty
• Not guilty
• Nolo Contendere
Criminal Justice System
• Bench trial
• Trial by jury
– Judge decides matters of law
– Jury decides if evidence is sufficient
• “Mitigating circumstances”
• After verdict, convicted person
may appeal verdict, sentence, or
both
• Prison system
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Community-based
Minimum security
Medium security
Maximum security
Criminal Justice System
• Parole
– Reward for good behavior
• Probation
– Alternative to prison
• Recidivism
• Discretion
• Businesses and other
organizations may be
prosecuted
Civil Justice System
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Right a wrong or resolve a dispute
Recover losses and reap punitive damages
Cease and Desist Orders
How can fraud examiners and forensic
accountants be utilized?
Complaints and Pre-Trial Activity
• Civil lawsuits begin with complaint
• Fraud civil complaints must be specific
– Fraud misrepresentations
– The impacted victim
– How misrepresentations were false
• Discovery
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Interrogatories
“Requests to produce documents”
Depositions
“Requests for admission”
Negotiated Remedies
• Out-of-court settlements
– Both sides come to settlement position
– Attorneys negotiate
• Mediation
– Independent 3rd party with no authority to decide
case
– Assists both sides
– Work for mutually agreeable resolution
• Arbitration
– Independent 3rd party acts as judge and jury
– Authority to determine outcome of case
– Binding or non-binding verdict
Pre-Trial Motions and the Civil Trial
• If attempts to settle case fail, pre-trial motions
follow
• Differences between civil and criminal trials
– Jury 6 persons
– If opposing attorneys agree, unanimous verdict
not required
– Requires preponderance of evidence rather than
“beyond a reasonable doubt”
• Post-judgment discovery
Regulatory System
• Basic Accounting Principles – a Survivor’s Guide to
Accounting
• The AICPA and Statement on Auditing Standards No.
99
• The Sarbanes-Oxley Act of 2002
• The Public Company Accounting Oversight Board
(PCAOB)
• COSO’s Enterprise Risk Management Framework (ERM)
• PCAOB’s Auditing Standards Nos. 3 and 5
• IIA Practice Advisories 1210.A2-1 and 1210.A2-2
Basic Accounting Principles – A
Survivor’s Guide to Accounting
• Balance Sheet
• Income Statement
• Statement of Cash
Flows
• Accrual Accounting
The AICPA and Statement on Auditing
Standards No. 99
• Auditing standards for non-public companies
– Reasonable assurance
– Professional skepticism
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Compilation and review standards
Other attestation standards
Consulting standards
Code of professional conduct
Fraudster’s Perspective
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Criminals exploit your humanity
“Trust, but verify”
White collar crime is a crime of deceit
White collar criminals are artful liars
The Sarbanes-Oxley Act of 2002
• Higher standards for corporate governance
and accountability
• Independent regulatory framework
• Enhance quality and transparency of financial
reports
• Severe civil and criminal penalties for
corporate wrongdoers
• New protections for corporate whistleblowers
Public Company Accounting Oversight
Board (PCAOB)
• Registration with the board
• Auditing, quality control, and independence
standards and rules
• Inspections of registered public accounting
firms
• Investigations and disciplinary proceedings
COCO’s Enterprise Risk Management
Framework (ERM)
• Principles and components of effective risk
management processes
• How risks should be identified, assessed and
addressed
• Create anti-fraud environment
• Help entities achieve operational and financial
objectives and goals
PCAOB’s Auditing Standards Nos. 3
and 5
• AS3 – Audit documentation
• AS5 – Integrated Audit
• Anti-fraud controls
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Control activities
Risk assessment
Control activities
Information and communication
Monitoring
The Role of Corporate Governance
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Protect investors
Create long-term shareholder value
Restore investor confidence
Support strong and efficient capital markets
Committee must ensure its independence
“Tone at the top”