Thursday, September 11, 2014

Reporting Fraud: An Uphill Battle, Especially in China

We often hope to see the people committing fraud receiving punishment. Unfortunately, this is not always the case. A recent New York Times article by Floyd Norris reports that Kun Huang spent two years in a Chinese prison – not because he committed fraud, but because he detected it. The consequences for reporting fraud are not generally quite as severe as they were for Mr. Huang, but they do often include ridicule and other challenges for many whistleblowers. While reporting fraud is an uphill battle, especially in China, it is definitely one that is worth fighting.

Mr. Huang researched companies that were newly listed on the United States’ and Canada’s stock markets. Over time, the company he worked for gained a reputation for detecting fraud in Chinese companies, and they published a list of those companies online. Mr. Huang researched Silvercorp, a mining company with its largest mine in China. They filmed trucks leaving the mine and sampled ore that fell off of the trucks, which led them to publish a report stating that Silvercorp couldn’t be doing as well as it had reported, due to the volume of trucks leaving the mine and percentage of silver in the rock.

Mr. Huang reported his findings, but instead of the Chinese government rewarding him for discovering fraud in a company, he was arrested and spent two years in prison. When Mr. Huang was originally arrested, the officers questioning him continually received phone calls and then demanded further information about his investigations.  Mr. Huang “believes [the calls] were from Silvercorp officials.” In China it appears that Silvercorp had a lot of influence over the judicial system and over what the punishment would be for people who tried to report fraud or anything negative about their company. If Silvercorp has this much power to manipulate the government to help them cover fraud, are there other companies in China doing the same thing? Can financial reports from Chinese companies be trusted? The SEC apparently has similar questions, because earlier this year it banned the Big 4 accounting firms from auditing U.S.-listed Chinese companies. By suspending firms from auditing U.S.-listed Chinese companies, this could lead to the companies not be able to trade because investors won’t have the data they need in order to trade. Perhaps the SEC does not want some of these companies’ stock to be listed in the United States. Floyd Norris said the following in another article about audits done in China:

“The board [The PCAOB] has found small American firms that were certifying Chinese audits that they basically did not do. And Chinese affiliates of the major firms have audited, and approved, financial statements of Chinese companies that turned out to be fraudulent. That does not prove their audits were badly done — good audits can miss frauds — but it does provide an indication that improvements may be necessary.”

It is clear from these accounts that there are definitely issues in the reporting and auditing of financial statements in China. As Floyd Norris said, “China has shown more hostility to those who found the frauds than to those who committed them.” And after the imprisonment of Mr. Huang, it appears as if the Chinese government would prefer to hide the problems rather than to fix them.

In the United States, the government does not punish the whistleblower for reporting fraud, and there are not nearly as severe of consequences as there can be in China, but there are still potential challenges for blowing the whistle on a company in the United States. A few years ago an airline pilot posted about security flaws he felt airports weren’t addressing, and “a team of six federal agents and Placer County sheriff's deputies arrived at the pilot's home to take the pilot's FFDO handgun and badge.” In another well-known instance, Sherron Watkins reported fraud at Enron, and because of the fraud that was committed thousands of employees at Enron lost their jobs. While she did the right thing, she was subsequently treated with hostility by many people within the company. Despite their good intentions, many whistleblowers lose their jobs and experience other negative social consequences.

Although the whistleblower is often treated with just as much animosity—if not more—as the fraudster themselves, it is worth it to report fraud. Even though Mr. Huang spent two years in prison, the reports that his company published led to seven companies being delisted from the United States stock market, three of which the S.E.C. has filed fraud suits against. Because those companies were delisted, investors around the world will be protected from relying on falsified financial statements. In addition to helping investors have reliable information, many whistleblowers are also compensated with large monetary awards.

If you have noticed fraud and are thinking about reporting it, have the courage to do the right thing, but be prepared and understand the potential challenges coming your way. Reporting fraud is an uphill battle, but it is definitely one worth fighting. Be grateful that in the United States reporting fraud is much easier than in China. Learn more about whistleblower protection programs in the United States and the rights you have by following this link.

Wednesday, August 20, 2014

Lance Armstrong Investigation: Can A Tiger Change Its Stripes?

It has been about a year and a half since Lance Armstrong publicly admitted to doping.  In this article, Armstrong tells his side of the story and in the second installment, victims of Armstrong's lies tell their stories.

In the article, Armstrong tells about the slippery slope that he found himself on.  All of the fraud and issues that have come to light were spawned from one lie: the refusal to tell the truth about doping.  Regarding his adamant denials of ever doping, Armstrong reportedly said:

"I was good at playing the part," he admits now. "After the 850th time, it's not like I'm going to say, 'Matt, you seem like a nice guy, I'm going to be honest with you.' Once you say 'no' you have to keep saying 'no.'

"If this stuff hadn't taken place with the federal investigation, I'd probably still be saying 'no' with the same conviction and tone as before. But that gig is up."

It seems that too often, the heart of a huge scandal such as this one is a small lie.  There is a lesson to be learned there.  We must live and act with integrity at all times, otherwise we might find ourselves on the same slippery slope that Armstrong and so many others have found themselves on.

Armstrong has promised to be completely transparent as he continues to reveal more about his doping scandal.  He even suggests that he will write another book detailing his demise.

Former teammate, Scott Mercier commented on the different reactions that Armstrong has received from fans, friends and onlookers:

"I think there are three camps in the U.S.: those that absolutely hate him and will never forgive him, those that overlook everything that he did and those that are a bit indifferent.

"I think he'll be forgiven but he needs to keep doing what he's doing. He's showing some humility, he needs to stop being [a jerk] and be nice. He has regrets. He's spoken about the bullying and I know he regrets that."

Although Armstrong has apologized, many of those who had been closest to him find those apologies hollow. (See image/quote below.)

Betsy Andreu, wife of former teammate-Frankie Andreu, has also found those apologies to be hollow.  She says:

"Everything that he's done, it's just the same Lance. He's talking about people and he's trying to deceive the public, and thinks that if he says sorry it's enough.

"But sorry is just a word. After everything he did to me, I extended an olive branch and he snapped it. That was a hard thing to do after all the lying and smearing of me."

So is he just the same Lance of always?

"I think he always will be," Betsy Andreu says. "He will fight and draw out the court cases as long as he possibly can.

"A tiger doesn't change its stripes. I really think he needs help and I hope he gets it. Maybe then he would stop the lying and could be on his way to healing. An authentic sorry means making amends, not just saying the words."


So the question remains, can a tiger change its stripes?  Can Armstrong really change and begin healing?

Wednesday, July 9, 2014

A Fraudster's Paradise

Sam Antar writes about society's vulnerability to fraud. Here are a few points that stood out to me.

On stiff punishments serving as a deterrent to fraud:
...white-collar criminals don't listen to the rhetoric of prosecutors. No white-collar criminal discovers ethical behavior and stops doing crime because another criminal ends up in prison. While white-collar criminals take precautions against failure, they do not plan on ever ending up in prison.
Sam implies that the expected punishment for fraudsters is no punishment. This suggests a need for stronger prevention and detection mechanisms. How about auditors?
Traditional financial statement audits of public and private companies are not designed to find fraud. What accounting firms call an “audit” of financial reports is really a compliance review designed to find unintentional material errors in financial reports by examining a limited sample of transactions.
In discussions I've had with auditors, I get the sense that most would like to do more to focus on fraud, but they feel like such a focus would be too expensive and would essentially price them out of the market. While I'm not completely satisfied with that explanation (e.g., firms could, at low cost, use computerized forensic tools to search for red flags), it suggests a need for either regulatory changes that require auditors to focus more on fraud or increased demand by investors for audits that specifically focus more on fraud. The latter is unlikely to occur as long as most investors continue to believe that audits are focused primarily on fraud.

In fairness to auditors, Sam's point about deficiencies identified via PCAOB inspections omits the fact that the PCAOB does not inspect audits randomly, but instead focuses primarily on the audits it believes have the highest risk of deficiencies. This means that even though 49% of E&Y's inspected audits had deficiencies, we would expect the actual rate at which deficiencies occur to be substantially lower. Even that lower overall deficiency rate may not be that informative about how effectively auditors conduct their audits. Still, that's primarily a distraction from Sam's main point, which is that audits primarily focus on unintentional errors rather than focusing on fraud.

If audits aren't particularly effective in preventing/detecting fraud, what about government agencies?
As a nation, we devote far more resources fighting blue-collar crime or street crime, than we do battling white-collar crime. For example, the NYC Police Department employs approximately 34,000 cops in uniform battling street crime. However, the FBI employs approximately 13,600 special agents, the IRS Criminal Investigative Division employs approximately 2,600 special agents, the SEC employs approximately 3,958 people, and the US Postal Inspectors Office employs approximately 1,500 postal inspectors. The NYC Police Department has more man power directly battling street crime than those four federal law enforcement agencies combined have fighting nationwide white-collar crime.
While it would be nice to have some estimates of the economic cost of white-collar vs. blue-collar crime, Sam's point still serves as a good illustration of the relative lack of funding oriented toward white-collar crime. Right now, the government seems to have outsourced most of the prevention and detection work to the private sector (e.g., auditors). Until standards or market forces change so that those parties increase their focus on fraud, we appear to be living in a fraudster's paradise.

Tuesday, May 27, 2014

BYU Radio Interview

Mark was interviewed on BYU Radio today and talked about Enron, auditing, Lance Armstrong, and other fraud-related topics.

The full show is here, with Mark's 27 minute interview starting just before the 31 minute point, or you can also listen to Mark's segment specifically here.

Friday, May 2, 2014

CBS Segment on Livestrong

Here's the video of a CBS segment where Mark was interviewed about Livestrong. The segment aired a little while ago, but this is the first time we've seen it available to view online. Mark's portion is less than half a minute starting around 6:15. Back up another 30 seconds before that to get the context of his comments.

Saturday, February 15, 2014

Fraud in the Detroit Bankruptcy and the Role of Investment Banks

I read an interesting analysis of what's happening in the Detroit Bankruptcy proceedings. In a nutshell, it appears to be another case where the investment banks were able to take out millions of dollars in fees as they structured deals that ended up crippling the economy. In this case, the deals may be considered fraudulent according to this analysis. This seems to be business as usual in the investment banking world for about two decades or more.

Enron and WorldCom were frauds that were fueled by investment bankers and ended up becoming the largest bankruptcies in history. The mortgage meltdown was also fueled by investment bankers and that led to even larger bankruptcies and the world economy being brought to its knees in what is now known as the Great Recession. Now, the largest municipal bankruptcy in history also appears to have been fueled by some cleaver investment bankers who undoubtedly made out like bandits as it appears that they structured deals that gave them huge fees.

Tuesday, October 1, 2013

Lance Armstrong Investigation: I can't believe it's come to this....

Here we are, nearly three and a half years after Floyd Landis's first confession came out and I posted that I was 99.9% confident that pro cyclists had been doping for the past 15-20 years. I ended that first post by saying "Sadly, what would be surprising to me is if someone who is dominating pro cycling such as Alberto Contador was actually not doping!" Of course, soon after that, Alberto failed a doping test in the Tour de France and was suspended from racing.

Since that first post, there have been many posts to follow (this makes number 150 with the label of Lance Armstrong Investigation) and

Saturday, September 28, 2013

Scientific Research Fraud is on the Rise--Especially in China

In accounting research, we had the first retraction in decades in the past year. Soon after the retraction, evidence was provided suggesting that the retracted article reported some very suspicious claims that were essentially impossible. The author(s) never provided a rebuttal to the claims and the author who claimed to obtain the amazing data for the article suddenly retired and is reportedly very hard (or impossible) to contact. While the retraction never stated that the article was a fraud, it all seems very suspicious...

In the harder sciences, The Economist reported this week that there has recently been a sudden uptick in fraudulent scientific research, especially in China. Here is a taste of the article:

Tuesday, August 27, 2013

Monitoring Matters

In a surprising development (to no one familiar with auditing or internal controls), it turns out that monitoring can actually make a difference in the way people behave!

Actually, a field study focused on monitoring and described in the NYT provides some interesting insights. While it isn't really surprising that monitoring focused on deterring theft actually deterred theft, what is less expected is that anti-theft monitoring actually increased productive efforts by employees. From the NYT article:

Monday, July 8, 2013

Fraudster gets Scammed

I always like it when I read about a fraudster who gets scammed. This reminds me of the groups who are dedicated to wasting time of the internet scammers. One group goes by ScamBaiter and another is 419 Eater. They basically waste time of scammers who send out the emails to people saying they're going to send them huge amounts of money if they will help them out. Well, I read about another scammer who got scammed today. This time, it involved a local power company in Utah. A scammer had notified a cookie company that they needed to pay their bill or their power would be turned off. You can read what happened next here....

Monday, June 24, 2013

Enron CEO, Jeff Skilling, Received Shorter Jail Sentence

Various news agencies reported last week that a federal judge reduced Jeff Skilling's prison sentence by about ten years. If Skilling is found to be on good behavior and take a drug and alcohol rehabilitation course, he could be out of prison within four years. Part of the agreement is for Skilling to quit trying to get his conviction overturned. This new ruling also frees up some money from Skilling's estate that will be used to compensate victims of the fraud, including former Enron employees who lost their retirement when the company went bankrupt. Diana Peters is one of many former Enron employees who was at the latest trial and is quoted as follows:
"I pray that your decision is to give Jeff Skilling the maximum sentence for his crimes." 
Fraud always ends in a sad story as innocent victims deal with the aftermath by experiencing serious devastation, suffering and heartache. My heart goes out to these former Enron employees who had nothing to do with the crazy games Skilling, Fastow, Lay and others were playing...

Monday, June 17, 2013

Whistleblowing is Paying Off

The WSJ reported this week that the SEC has handed out it's second ever Dodd-Frank award for whistleblowing. the article says that the SEC expects more awards in the future. Here's a quote...

Monday, June 3, 2013

City Governments Committing Financial Statement Fraud

The Wall Street Journal reported recently that city governments in Pennsylvania, Florida, California, New Jersey and Illinois are increasingly being charged with financial statement fraud in their bond offerings. In the case of Harrisburg, Pennsylvania, the SEC stated that:
...this is the first time the (SEC) has "charged a municipality for misleading statements made outside of its securities disclosure documents."
According to "Anthony Figliola, a vice president at Empire Government Strategies, a Long Island-based consulting firm to local governments. 'Harrisburg is the tip of the iceberg.'"