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The Challenges in Forensic Accounting

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Saurav K. Dutta introduces Statistical Techniques for Forensic Accounting: Understanding the Theory and Application of Data Analysis.
This chapter is from the book
  • I spent about ten years exposing corporate and financial fraud for Barron’s magazine, and I found a lot to write about.
  • Ben Stein

1.1. Introduction

Investigating corporate fraud cases is one of the highest priorities of the United States Federal Bureau of Investigation (FBI). At the end of 2011, 726 fraud cases were being actively investigated by various FBI field offices throughout the U.S.,1 which was an approximately 10% increase from the number of cases being pursued at the end of 2010 and a 37% increase over a five-year period. It is estimated that several of these cases resulted in losses to investors exceeding $1 billion.

In response to the growing importance of accounting investigative skills within the Agency, the FBI established a Forensic Accountant Unit in March 2009 to support FBI investigations requiring financial forensics. The creation of this program was the culmination of the FBI’s efforts to advance and professionalize its financial investigative capabilities. The mission of this unit is to develop, manage, and enhance the FBI’s Forensic Accounting and Financial Analysis programs.

Corporate fraud has been a persistent problem in the U.S. economy since the early days of the stock market. One of the oldest and most commonly known frauds is the Ponzi scheme, named after Charles Ponzi, who duped thousands of New England residents into investing in postage stamp speculation back in the 1920s. He promised his investors a 50% return in just 90 days at a time when the annual interest rate at banks was just 5%. He was able to fulfill his promise by using incoming funds to pay off early investors. His name is now synonymous with investment fraud schemes that involve attracting new investor money to fulfill the obligations owed to early investors. As long as the amount of incoming funds in the form of investment by new or existing investors exceeds the outgoing funds that are withdrawn by outgoing investors, the scheme thrives. However, it quickly unfolds in an economic downturn when investors have little excess funds to invest and more investors wish to cash out their investments. In the recent financial crisis of 2007, many investment funds, including that of Bernie Madoff and Stanford International, were found to have engaged in the decade-old Ponzi scheme to defraud investors. In the 1920s, Charles Ponzi’s investors lost upwards of $20 million. About a century later, in 2007 Bernie Madoff’s investors lost upwards of $20 billion.2Although there are obvious red flags to detect Ponzi schemes,3 these are often ignored by trusting investors who are sometimes in awe of the personality, success, and demeanor of the perpetrators.

Investment fund managers who perpetrate Ponzi schemes most often defraud investors by promising high returns. However, other businesses, though not directly engaging in Ponzi schemes, can still defraud investors by painting a false financial picture. By recording fictitious transactions or other accounting gimmicks, a business might inflate income or revenue or understate expenses to paint a rosier picture of its financial prospects. At times, senior officers of public companies with much personal wealth and reputation vested in the financial success of their companies resort to such means. In this chapter you learn about some of the recent well-publicized cases of corporate fraud.

Not all types of corporate fraud are committed by management to misinform investors and other third parties. A majority of occurrences and investigations of fraud involve acts by individuals committed against their organizations. One notable case prosecuted by the FBI in 2011 involved a former vice-president of Citigroup who embezzled more than $22 million from Citigroup over a period of eight years. The perpetrator transferred money from various Citigroup accounts to Citigroup’s cash account and then wired the money to his personal bank account at another bank. False accounting entries were created by the perpetrator to conceal the theft. In this chapter you read about common fraudulent schemes undertaken by employees to steal from the organization and the accounting cover-ups undertaken to conceal the crimes.

The remainder of this chapter discusses the nature of fraud schemes, presents the statistics of fraud investigations conducted by the FBI, and examines trends of various types of fraud. It then briefly covers the common management fraud schemes undertaken in recent years. Next is a discussion of common employee fraud schemes, which summarizes the results of a study conducted by the Association of Certified Fraud Examiners (ACFE). In recent years, with the Internet being so widely accessible, coupled with an immense growth in e-commerce, cyber-crime against businesses is rampant. The chapter concludes with an analysis of the ramifications and challenges imposed by this growing crime.

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