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Corporate Fraud Cases Decreasing?

March 26 2010

Today’s most recent reports of corporate fraud may pale in comparison to the Enron/WorldComonslaught of the early 2000s, but they’re still here—reminders that executive-wealth-inflating wrongdoings are not yet completely eradicated.

The most recent reminder? The stock-options backdating criminal trial of Bruce Karatz, who resigned as CEO of Los Angeles-based KB Home in 2006, taking place now in U.S. District Court in Los Angeles.

The Los Angeles Times offers a disturbing portrait of Karatz, 64, who faces 20 felony charges of fraud and making false statements about the company’s options practices between 1999 and 2006. In his opening statement to the jury, Assistant U.S. Attorney Alexander A. Bustamante described Karatz as a greedy man who made more than $6 million in “secret pay” by manipulating stock-option grant dates and then lying about it in regulatory filings and in interviews with lawyers and accountants.

“He stole without shareholders’ knowing about it and he used stock options to do it,” Bustamante said, according to the Times. “He lied within the company. He lied outside the company.”

Defense lawyers claim Karatz acted above board when questioned by the U.S. Securities and Exchange Commission, and even authorized an outside investigation into the allegations.

The scathing report issued by Anton Valukas, a U.S. bankruptcy-court examiner investigating the 2008 collapse of New York-based Lehman Brothers Holdings Inc., was another reminder. In it, he blamed senior executives and London-based auditing firm Ernst & Young “for serious ethical lapses that led to the largest bankruptcy in U.S. history and the worst financial crisis since the Great Depression,” according to the Wall Street Journal.

The document runs thousands of pages and contains fresh allegations—in particular, that Lehman executives manipulated the firm’s balance sheet, withheld information from the board and inflated the value of toxic real-estate assets, according to the Journal.

Lehman chose to “disregard or overrule the firm’s risk controls on a regular basis,” even as the credit and real-estate markets were showing signs of strain, Valukas’ report states.

Ernst & Young issued a statement that blamed Lehman’s collapse on “a series of unprecedented adverse events in the financial market,” noting that Lehman’s leverage ratios “were the responsibility of management, not the auditor.”

Nevertheless, Charles Perkins, E&Y’s director of public relations for the Americas, says the company “takes the criticisms included within the examiner’s report very seriously.”

While corporate fraud cases remain newsworthy, the latest Quarterly Corporate Fraud Index, issued this month by The Network Inc. in Norcross, Ga., shows fraud reports overall are starting to abate.

After a surge of in-house fraud reports in 2008, the numbers stopped climbing in 2009—even decreasing very slightly in the third and fourth quarters, according to the index.

More specifically, it states, in Q4 2009, fraud-incident reporting accounted for 20.3 percent of all compliance hotline-related activity from more than 1,000 organizations worldwide, down from 20.6 in Q1 2009.

“A leveling of the percentage of fraud reports,” says Luis Ramos, chief executive officer of The Network, “could be the sign of a rebounding economy, a strong compliance program, or, in contrast, could mean that employees are not aware of, or comfortable with, anonymous whistleblower-reporting systems.”

Also, says Ramos, for the past several years, “companies were increasingly focused on putting reporting systems into place and, in conjunction with that activity, were developing communication and awareness programs around those systems.

“Therefore, in 2009,” he says, “due to both a response to the current economic climate and to the high number of companies that have already put systems into place, a leveling off—of an increase in awareness programs and new systems—has occurred.”

According to a recent report by New York-based BDO, nine of 10 larger frauds are not even reported to authorities.

In contrast, however, a report from the Association of Certified Fraud Examiners, based in Austin, Texas, found that about half of fraud cases are discovered as a result of tips or complaints; it’s the No. 1 method for reporting fraud. The 2008 Report to the Nation by the ACFE concluded that hotlines typically reduce instances of fraud by 60 percent.

Regardless of the reporting percentages, Timothy Mohr, certified fraud examiner and partner at BDO Consulting, says, “companies need to ... build a stronger ethical foundation that will pay off for companies as the economy recovers.”

Some of the best resources an organization has for detecting fraud, says Jonathan Marks, partner-in-charge of the fraud and ethics group at Oak Brook, Ill.-based public accounting and consulting firm Crowe Horwath, “are a safe and anonymous tip line, a skilled internal audit function and internal controls that are appropriately designed and monitored for effectiveness.”

But just as key as installing hotline systems is knowing how to respond when a tip comes in, says Brenda Buetow, a senior manager in Crowe’s fraud and ethics group.

“When a whistleblower hotline is called, it’s important to act quickly and strategically,” she says. “Delaying an investigation could allow additional losses to occur or an organization’s reputation to be damaged.”

A fraud-response plan that designates responsibilities and outlines the steps to take “enables you to act quickly, prevents those additional losses and minimizes reputational damage,” she says.

Both Marks and Buetow suggest employers follow these steps if they suspect fraud may have occurred:

* Identify the investigation team and ensure that it has the expertise to conduct a thorough probe.

* Gather preliminary information. Evaluate and analyze it carefully; sometimes, suspicious circumstances may turn out to have reasonable explanations.

* Consult legal counsel for guidance in conducting the investigation, dealing with authorities and working with the investigation team to make sure evidence is properly gathered and preserved for possible prosecution.

* Secure data and files and establish a chain-of-custody protocol for all documents and information obtained.

* Define the investigation’s scope and objectives. For instance, is it your intent to work with law enforcement to prosecute the individuals? Do you believe funds are recoverable? Who else could have been involved?

* Determine who needs to be notified and consult with legal counsel to determine if and when you are required to alert outside parties.

* Make certain the investigation team has full access to all necessary data and people who could provide documentary support.

* Control data and communication, seeking legal and communications counsel to help decide when and how to share information with the public, if necessary.

* Strengthen your controls and revisit them to determine if a control was weak, broken or nonexistent.

First and foremost, says Ramos, “if a company does not have a hotline program in place, it needs to put one in place.”

Once that’s been done, it’s critical that a strong communications campaign be launched to promote it, he says.

“An advertising campaign needs to cut through the clutter to be effective,” Ramos says. “So does an internal employee-communications campaign. Multiple mediums—such as meetings, interactive e-mails and videos, texts and the use of social-networking sites—should be incorporated into a highly creative campaign that fits an organization’s employee demographics.”

Finally, “everything starts with a great corporate code of conduct,” he says. Not only should it be easy to read and understood, “it also needs to be the platform for an organization’s ethical behavior.”

Source: hreonline.com

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