How Fraud Can Creep Into the Tiniest of Fractures During Change and Transition

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Comcast and Time Warner Cable. AT&T and DirecTV. Facebook and WhatsApp. In 2014, mergers and acquisitions were particularly prevalent, and these three deals made notable headlines. And for most corporations, organizational transformation enables adaptation to an ever-changing global business environment. However, change can also expose companies to significant financial, occupational and compliance fraud risks.

In the newest article on Fraud-Magazine.com, Chris Dogas, CFE, CPA, CRMA, explores the internal control structure of large corporations during a transition and how fraud can creep into even the tiniest of fractures. Using real-world case studies and the Fraud Triangle, Dogas provides valuable insight into how executives and employees find opportunities to commit fraud during times of change. He also outlines key steps that senior management and corporate boards can take to control risk.

Here are some points of action that management and boards in changing organizations should heed:

1. Maintain effective corporate governance and periodically communicate key governance activities to employees to remind them that despite the transition, the corporation continues to implement internal controls and it requires compliance with them. Governance activities could include audit committee meetings to review internal controls, including interactions with external and internal auditors.
2. Maintain strong company-level controls. This includes strong Tone at the Top, hiring practices (such as background checks), training and retaining clear policies and procedures.
3. Maintain and promote strong anti-fraud controls, including internal control risk assessments, fraud risk assessments and an incident hotline. The ACFE's 2014 Report to the Nations states that tips continue to be the primary method of fraud detection in 42 percent of incidents. When organizations identify violations, they should communicate to employees the nature of the incidents and the related disciplinary decisions and actions.
4. Perform monitoring activities, including internal control reviews, internal audits and segregation of duties reviews.
5. Most importantly, actively involve internal control and anti-fraud professionals during the integration process (i.e. planning, strategy integration meetings and discussions). These experts can perform risk assessments and identify leading indicators of weakening controls. They also can provide advice on remediation. Their involvement sends messages to the rest of the management team, and the whole organization overall, that the company continues to adhere to its internal control structure.

You can read more from Dogas in the full article on Fraud-Magazine.com.

Corporate Governance in Japan: Memories of the “Japanese Miracle”

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Roger Aradi, CFE 
ACFE Marketing Manager

It’s one thing to get a conservative culture to change; it’s quite another to get a successful conservative culture to change.

The Economist has been examining corporate governance in Japan in the aftermath of the Olympus scandal. In the article “Back to the Drawing Board,” they describe how Japan Inc. has resisted attempts to revise legal requirements for corporate boards and point out how Japanese requirements differ from the standards of other nations, including many of their Asian neighbors. And in “Olympian Depths,” they go on to say, “The refusal to embrace higher standards of corporate governance is a further sign of short-sightedness.”

I am certainly not going to argue in favor of a system of corporate governance that can be described as insular and opaque. Clearly any system of governance that does not include a truly independent audit committee is lacking a vital component, undermining any internal controls they may have in place. But to write off the resistance to change as mere “short-sightedness” is to overlook one key factor. Japanese leadership may be reluctant to change their system of governance in part because their current system has worked so well for them in the past.

Japan went from being a nation in ruins at the end of World War II to a global economic powerhouse in the span of a few decades, a feat often referred to as the “Japanese miracle.” While many have researched the factors that made this “miracle” possible (see, for example, “MITI and the Japanese Miracle”), the current system of tightly interlocked, opaque and insider boards governed the Japanese corporations that drove this economic growth. In fact, I’m old enough to remember a time when the Japanese model was held up as a positive example, their long-term focus praised as an alternative to the American system’s obsession with short-term numbers. So perhaps Japanese business leaders, many of whom rose through the ranks during the Japanese miracle, can be forgiven for being reluctant to overhaul a system that seems to have served them well.

Improving corporate governance is a crucial part of the fight against fraud – not just in Japan, but worldwide. As anti-fraud professionals push for systems that proactively prevent and deter fraud, it is important to keep in mind that resistance may not be a sign of greed or malice – your client or organization may, like Japanese business leaders, be held back by memories of their own past successes.

Even if it Ain’t Broke, Consider Fixing It

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Catherine Lofland, CPA
ACFE Research Specialist

The average person can name several corporate scandals off the top of their head. Once a fraud scandal becomes a household name, the victim organization may never recover from the damage to its reputation. The effects are far-reaching: employees, investors, creditors, vendors, customers and the community are among those who can suffer tremendously from fraud. The pervasive threat of corporate malfeasance indicates companies need to seriously consider whether they have effective systems in place to prevent such scandals. While strong internal controls, independent external audits, an ethics program and a whistleblower policy are effective fraud deterrents and detection methods, these measures succeed only when supported by a robust corporate governance system.

Corporate governance refers to the procedures and processes according to which an organization is controlled. It consists of the official policies promoting oversight and accountability in a variety of areas, including financial reporting, corporate strategy and risk management. You can think of corporate governance as a system of checks and balances similar to those outlined in the U.S. Constitution, which allows each branch of the government to regulate one another. An organization’s checks and balances are designed to protect the diverse interests of its stakeholder groups by keeping management and the board in line.

One of the biggest challenges in implementing a corporate governance system is that some companies, especially smaller organizations, don’t see any reason to change the status quo. This “if it ain’t broke, don’t fix it” attitude toward fraud prevention can be dangerous. Managers who exhibit this attitude aren’t concerned about fraud simply because they haven’t suffered from it yet. However, if an organization has a weak corporate governance structure, a devastating fraud might be just around the corner.

Our latest online self-study course, Corporate Governance for Fraud Prevention, describes the principles, functions and essential components of a corporate governance system. It addresses the controversy of CEO duality, the recommended committees any organization should have on its board of directors and how to set the appropriate tone at the top. The course discusses corporate governance best practices that you can tailor to your organization’s structure and needs, since there is no one-size-fits-all approach.

Many corporate governance programs are born from a crisis. But it is critical not to wait until disaster strikes at your organization to begin implementing an effective corporate governance system. While establishing preventive measures might seem costly and burdensome, they are vital to the success, reputation and longevity of your company.

Read more about the new course here.

Follow Up: It’s a New Dawn, It's a New Day in Corporate Governance

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Sheila Keefe, CFE, CPA
Principal, BDR Advisors LLC

FOLLOW UP: Board directors must devote adequate resources to address fraud

James Murdoch, News Corporation’s deputy chief operating officer, found his career implode shortly after his testimony in front of Parliament was disputed by two high-level News Corp. executives. According to the executives, Murdoch knew that the hacking was a more pervasive problem as early as 2008. Perjury aside, the corporate governance concern has to be the lack of adequate investigation and response employed by Murdoch. Rather than launching a full investigation into the hacking as he had claimed, News Corp. underwrote only two limited-scope investigations. The first in 2006 was a preliminary investigation in the wake of the reporter’s arrest. The second investigation, supposedly more expansive, took place in 2007 in response to a wrongful termination lawsuit by the shady reporter; that investigation involved questions focused on just five staffers related to the terminated reporter.

Lack of adequate investigation into suspected fraud has been at the center of other recent board director woes; specifically, infoGroup Inc. and DHB Industries. For infoGroup, audit committee chairperson Vasant Raval was prosecuted for inadequately investigating fraud. In response to allegations of self-dealing by the CEO, Raval conducted a one-man investigation that lasted just 12 days. According to reports, the audit committee chairman did not look into the CEO’s expenses. With DHB Industries, the SEC charged three ex-directors who served on DHB Industries Inc.'s audit committee for being "willfully blind to numerous red flags" of fraud.

The SEC has come out and said that it does not wish to concern the majority of hard-working board directors: "We will not second-guess the good-faith efforts of directors. But in stark contrast, Krantz, Chasin and Nadelman were [DHB Industries] directors and audit committee members who repeatedly turned a blind eye to warning signs of fraud and other misconduct by company officers," said Robert Khuzami, director of the SEC's Division of Enforcement.

What can be learned from these recent scandals involving News Corporation, infoGroup Inc. and DHB Industries is that board directors and audit committee members must be strident in their investigations into allegations of fraud and devote adequate resources to address fraud, known and unknown.

Corporate Governance: Who’s Getting It Right?

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Sheila Keefe, CFE
Principal, BDR Advisors, LLC
Lake Geneva, WI

Best Buy a Leader in Corporate Responsibility

Additional public scrutiny and shareholder activism have made ‘corporate governance’ the new buzz words, as many companies resolve to avoid repeating mistakes of the past. Even so, many struggle on how to implement corporate governance reform in an effective and efficient manner.

One of the companies that is getting it right is Best Buy. Best Buy has received numerous awards and appeared on several “best of” lists, including Corporate Responsibility Officer’s (CRO) list of the Best Corporate Citizens and Ethisphere’s list of the World’s Most Ethical Companies. 

Those kudos are well deserved. Best Buy has implemented many of the emerging best practices, which has allowed them to achieve an enviable “tone at the top,” necessary for true reform. Here are just a few of their achievements in corporate governance reform:

• Best Buy has assigned a C-level executive, Kathleen Edmond, as Chief Ethics Officer. Edmond is an attorney/MBA dynamo who has interjected a strong dose of candor and transparency.
• Best Buy uses an online chat room to air out ethical violations and pose interactive questions that fosters eager replies from team members, indicating a strong adoption of corporate ethics in workplace culture. Most recently, Edmond used her personal page to discuss the $40 million fraud perpetrated by a former Best Buy employee and a vendor, The Chip Factory. 
• Best Buy has a 52-page Code of Business Ethics. The document is beautifully laid out and easy to read. It starts with a list of questions to help team members tackle situational ethics, addressing head-on one of most difficult challenges to implementing a code of ethics.
• Best Buy takes its role as a corporate citizen seriously.  As evidenced by Best Buy’s Corporate Responsibility Report, it’s clear that Best Buy understands the importance of corporate consciousness as an essential business process. Specifically, Best Buy lays out corporate responsibility goals in their Corporate Responsibility Report.

Individually, any of these initiatives would be impressive and would signal to all of Best Buy’s trade partners that it takes corporate governance seriously. Taken together, they put Best Buy ahead of the pack.

You can find Sheila in Austin, Texas, this month teaching a new ACFE course entitled, "Fraud Risk Management." Read more.

Who have you seen getting corporate governance right? Leave us your comments below.