Fraud & Forensic Accounting
New England Graduate Accounting Studies Conference
June 20, 2014
Agenda
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What is EY FIDS and what do we do?
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What is forensic accounting?
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Why forensic accounting?
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Fraud and financial restatement statistics
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Description of investigative process
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Case examples
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Tony Jordan - Bio
Tony Jordan
Partner
Forensic Investigation & Dispute Services
Tel: + 1 617 585 1951
Mobile: +1 617 413 5736
Fax: +1 866 780 9736
Email: tony.jordan@ey.com
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.
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Dawn Aiello - Bio
Dawn E. Aiello, CPA
Manager
Forensic Investigation & Dispute Services
Tel: + 1 617 425 7309
Mobile: +1 978 852 3556
Fax: +1 866 633 2172
Email: dawn.aiello@ey.com
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.
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EY Fraud Investigation & Dispute Services
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Anti-Fraud
Corporate Compliance
Dispute Services
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Forensic Technology and Discovery Services
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Damage Analyses
Purchase Price Disputes
Cyber Security
Data Analytics
Fraud Investigations
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Financial Statement/Occupational Fraud Investigations
Shadow Investigations
FCPA
Who are our clients?
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Lawyers and their clients
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Companies
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Individuals
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EY Audit Teams
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Who are we?
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CPAs and other Accountants
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Certified in Financial Forensics (CFF)
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Certified Fraud Examiners (CFE)
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Finance Professionals
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Economists
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Information Technology Specialists
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Criminal Justice / Former Law Enforcement
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What is Forensic Accounting?
Merriam Webster Online Dictionary – “forensic”
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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.
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Why Forensic Accounting?
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Types of Fraud
Former Microsoft Accountant Sentenced to 2 Years in
Prison for Stealing $1.1M
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ACFE 2014 Report to the Nations
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What is the impact of Fraud?
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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
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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.)
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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.
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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
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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?
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Restatements: Where have we been?
2001 to 2006 Restatements
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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
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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)
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Restatement Statistics – Total Restatements
Source: “2013 Financial Restatements: A Thirteen Year Comparison”, Audit Analytics, April 2014
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Restatement Statistics –
Largest Restatements
Source: “2013 Financial Restatements: A Thirteen Year Comparison”, Audit Analytics, April 2014
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SEC Enforcement Actions
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Source: “Floyd Advisory: Summary of Accounting and Auditing Releases for the Year Ended
December 31, 2013”
AAER Trends – Where are the issues?
45
40
35
30
25
20
15
10
5
0
Improper Revenue
Recognition
Balance Sheet
Manipulation
Intentional
Mistatement of
Expenses
2011
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Manipulation of
Reserves
Options Backdating
Defalcations
2013
Source: “Floyd Advisory: Summary of Accounting and Auditing Releases for the Year Ended
December 31, 2013”
Forensic Investigation Tools
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Accounting discipline
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Forensic technology tools
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E-Discovery
Data analytics
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Interview skills
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Use of industry specialists as required
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Forensic Investigations - Where do we start?
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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?
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Business Intelligence
Email
Accounting Records
Other data from the accounting system
Data from third parties
Data Analysis
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Trending of performance metrics
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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
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Sometimes simple frauds require simple analysis
Stages of an Investigation
Scoping
Summary of
Investigation
Data Gathering
Additional
Investigation
Investigation
Interviews
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Preliminary
Findings
Building the Information
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Financial Statement Fraud Example
Product
CUST
ETS
$
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ETS - What did they do?
Investment $
Product
ETS
CUST
$
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ETS - What did they do?
Investment $
CUST
ETS
Investment Certificate
DIST
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Financial Statement Fraud Example:
ETS - Timeline
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Friday, February 2, 2002 – announce they are being
investigated by the SEC and they initiated an internal review
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Monday, February 5, 2002
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Closing Price of Stock = $10.75/share
Market Capitalization = $2.1 Billion
Quarterly sales = $150-$200 million
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
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Closing Price of Stock = $1.46/share
Market Capitalization = $307 Million
Quarterly sales = $80-$90 million
Enterasys Networks - Timeline (cont.)
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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
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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.)
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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
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Example:
Fannie Mae (FM) – Key Players
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Roger Barnes - Accounting Manager & Whistleblower
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Franklin Delano Raines – Chairman & CEO
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Tim Howard – Vice Chairman & CFO
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Leanne Spencer – Senior Vice President & Controller
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Example:
Fannie Mae (FM) – Timeline
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August 2003 – Barnes raises concerns to OFHEO re: accounting
practices
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October 2003 – OFHEO initiated examination of FM
January 2004 – Special Review Committee (SRC) formed
September 2004 –
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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
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December 2006 – FM issues restated financials ($6.3B reduction
in RE)
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Example:
Fannie Mae (FM) – Procedures
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Over 4 million pages of hard copy & electronic documents
reviewed
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Over 240 interviews conducted
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Financial modeling
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GAAP research and interpretation
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Preparation of internal report presented to BOD and
Congress
Page 33
Fannie Mae – Issues Identified
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SFAS 91 - Accounting for Nonrefundable Fees and Costs Associated with
Originating or Acquiring Loans and Initial Direct Costs of Leases
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1998 – Catch-Up Adjustment (recorded only $240M of $439M)
2000 – Development and implementation of amortization policy
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SFAS 133 - Accounting for Derivative Instruments and Hedging Activities
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Corporate Governance & Internal Controls
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Executive Compensation
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Other Accounting Issues
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Example: Fannie Mae (FM) –
Excerpts from Document Review
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1996 Email from Spencer to Howard:
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“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.”
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``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)
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“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)
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Fannie Mae – Report Conclusions
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Accounting Methods Not GAAP-Compliant
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$200M in expenses pushed to future periods allowing executives
to receive $27M in bonuses
Amortization policy designed to avoid audit differences
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Inadequate Accounting Systems
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Unqualified Staff
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Tone at the Top/Corporate Culture
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Fannie Mae – Where are they now?
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Fannie Mae – Restated financials ($6.3B)
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Franklin D. Raines –
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Tim Howard –
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Golden Parachute ($240M in benefits)
Golden Parachute ($20M in benefits)
Author – The Mortgage Wars (2013)
Leanne Spencer – Independent Real Estate Professional?
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1 January 2014
Presentation title
Data Analytics Example
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Fact Pattern
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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
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Determine whether the errors were intentional or unintentional
Identify any other erroneous entries
Determine whether anyone else involved
Financial Statement Fraud Example
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Fact Pattern
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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
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Determine whether the errors were intentional or unintentional
Identify any other erroneous entries
Determine whether anyone else involved
Trending of Performance Metrics
Accrued Expenses Trending (January 2009 - July 2011)
$60,000
$40,000
$20,000
Aug-11
Jul-11
Jun-11
May-11
Apr-11
Mar-11
Feb-11
Jan-11
Dec-10
Nov-10
Oct-10
Sep-10
Aug-10
Jul-10
Jun-10
May-10
Apr-10
Mar-10
Feb-10
Jan-10
Dec-09
Nov-09
Oct-09
Sep-09
Aug-09
Jul-09
Jun-09
May-09
Apr-09
Mar-09
Feb-09
$(20,000)
Jan-09
$-
$(40,000)
$(60,000)
$(80,000)
$(100,000)
$(120,000)
Source: 2009, 2010 and 2011 Trial Balance
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Accrued Expenses
Note : data points represent balances at end of month
Trending of Performance Metrics (cont.)
Monthly Product A Revenue Trending (January 2009 - July 2011)
300,000
250,000
200,000
150,000
Adult IOP/TLP Revenue Actual
Adult IOP/TLP Revenue Budget
100,000
50,000
0
Source: Monthly Operating Revenue Schedules January 2009 - July 2011
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Trending of Performance Metrics (cont.)
Monthly Other Program Revenue Trending (January 2009 - July 2011)
40,000
35,000
30,000
25,000
20,000
Other Programs Actual
Other Programs Budget
15,000
10,000
5,000
Source: Monthly Operating Revenue Schedules January 2009 - July 2011
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Jul-11
Jun-11
May-11
Apr-11
Mar-11
Feb-11
Jan-11
Dec-10
Nov-10
Oct-10
Sep-10
Aug-10
Jul-10
Jun-10
May-10
Apr-10
Mar-10
Feb-10
Jan-10
Dec-09
Oct-09
Nov-09
Sep-09
Aug-09
Jul-09
Jun-09
May-09
Apr-09
Mar-09
Feb-09
Jan-09
0
Finding: Intentionally Inflated Rates
Rate Charged per Procedure
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Formula Used to Determine Rate
Example:
Canopy Financial – Success Story?
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Developed software for banks and healthcare providers to
manage health savings accounts
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As of 2009 was one of the fastest growing private
companies in the U.S.
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Reported a cash balance of $9 million
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Raised $75 million from outside investors
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Reported that they had 1,012,002 customers
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Canopy Financial - Fraud Uncovered
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Fraud identified through identification of a fake audit
opinion
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Canopy Financial - Reality
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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:
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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
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20 Cars purchase in total, including:
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2010 Range Rovers (2)
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2008 Lamborghini
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2009 Rolls Royce Phantom
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2009 Aston Martin DBS
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2009 Bentley Continental
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2009 Ferrari 430
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Canopy Financial - Where are they now???
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Anthony Banas – Chief Technology Officer
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Jeremy Blackburn – President and COO
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Sentenced to 13 years in federal prison
Sentenced to 15 years in federal prison
Both men ordered to pay restitution and forfeit assets
totaling $93 million
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Example:
Occupational Fraud - Lars Bildman
CEO of Astra Pharmaceutical USA
► Salary = $1.1M per year
► “Supplemental Income”
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$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
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Example:
Occupational Fraud – Bradford Bleidt
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Full-service investment advisor w/ businesses in Boston
including a radio station
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Performed fraud over a period of 20 years
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Stole in excess of $30 million from clients
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Many clients elderly and their life savings were gone
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Currently serving a 13 year sentence in federal prison
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Questions
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