Financial Fraud (MGT 506)

The economic downturn and the corporate scandals of the recent years have drawn renewed attention to financial fraud in public and private organization. However, the dangers of financial fraud and the need for management, regulators and law enforcement to deal with this threat are always present.

Class members will gain an appreciation of the magnitude and impact of financial fraud, and its consequences; the respective roles of the audit committee, management and independent auditor, an overview of common fraud schemes and their linkages to various business functions and processes; the relevant legal, regulatory and accounting standards; management and mitigation of fraud through risk assessment, controls to deter and detect fraud, auditing, investigation, and remediation. The in-class segment of the course will cover fraud schemes involving revenue recognition, overstatement of assets and understatement of liabilities, concealment through off-balance sheet transactions and entities, internal and external misappropriation of assets, misconduct by senior management as well as fraud unrelated to financial statements (e.g., corruption).

Class members will gain an appreciation of the magnitude and impact of financial fraud, and its consequences; an overview of common fraud schemes and their linkages to various business functions and processes; the relevant legal, regulatory and accounting standards; management and mitigation of fraud through risk assessment, controls to deter and detect fraud, auditing, investigation, and remediation. The in-class segment of the course will cover fraud schemes involving revenue recognition, overstatement of assets and understatement of liabilities, concealment through off-balance sheet transactions and entities, internal and external misappropriation of assets, misconduct by senior management as well as fraud unrelated to financial statements (e.g., corruption).

Career Focus

This course will help future corporate, public and not-for-profit sector managers, in-house counsel, venture capitalists, business consultants, and board members assess, mitigate, detect, and remedy financial fraud and misconduct affecting their organizations. The course should also be useful to those planning careers in financial analysis and the investment community.

Prerequisites

MBA first year core classes

Course Requirements

Midterms Or Finals: There will be no midterm or final.

Case Participation and Reports

The course format includes lecture-discussion, readings, case analysis, class presentations and simulation exercises.

Students will be assigned to teams, which will conduct fraud exercises and prepare case reports based on the prior week’s lecture. Week One, for example, will cover assessing fraud risk, designing antifraud controls, and auditing for fraud. Week Two includes team exercises in these areas.

The case reports, which will be delivered verbally to the class, (and submitted in the form of a powerpoint or Word document for the restricted website of the course) will describe and evaluate:

· The fraud scheme and its resolution;

· How it was detected;

· What went wrong; and

· How it could have been prevented.

Outside Speakers

The course will include a few outside speakers, such as federal prosecutors, criminal defendants or their attorneys, regulators, policy makers, senior management and board members.

Grading

The final grade will be calculated as follows:

60% Papers and case reports

25% Class participation

15% Preparation for and discussion with the outside speakers

Course Meetings

Segment One includes 12 modules. We meet once a week in 6 three-hour sessions; each session has been divided into two 80-minute classes as listed in the following outline.

Availability of Course Materials

Lectures

PowerPoint lecture slides, when used, will be posted on this website following each lecture.

1. Lecture Slides for Modules 1 and 2.

2. Lecture Slides for Modules 7 and 8 (Internal investigations)

Readings

All required and suggested readings are available on the Internet or WebCT. A list of readings follows the syllabus.

Please note that many of the documents placed as readings for the course on WebCT are internal documents of PricewaterhouseCoopers, made available for the limited purpose of teaching and learning in this class. Please do not use or distribute this material outside this course.

Schedule

Module No.

Topic

24 January

Modules 1 & 2

Financial Fraud 101

· Course Overview

· Definition of Fraud

· Financial and Non-Financial Impact

· Roles, Responsibilities and Stakeholders

· Overview of Common Fraud Schemes

· Legal, Regulatory and Accounting Standards

· Antifraud Programs and Controls

· Fraud Risk Assessment

· Prevention & Detection

· Fraud Auditing

31 January

Module 3 and 4

Team Presentations: Complex Financial Fraud Cases

· Team 1: Computer Associates

· Team 2: Parmalat

· Team 3: Adelphia

· Team 4: Symbol Technologies

· Team 5: Enron

Readings:

o A. Vasilescu, Recent Enforcement Cases Involving Financial Fraud (on WebCT)

o Herbert S. Wander, Securities Law Disclosure After Sarbanes-Oxley I and II (on WebCT)

o Securities and Exchange Commission. Staff Accounting Bulletin 99: Materiality, 1999. http://www.sec.gov/interps/account/sab99.htm.

o Opacity Index

o Transparency International

o Jonny Frank, “Fraud risk assessments: audits focused on identifying fraud-related exposures can serve as the cornerstone of an effective antifraud program,”Internal Auditor, April 2004.

7 February

Modules 5 and 6

Fraud Risk Assessment

Assignment: Exercise 1 (on WebCT): Brainstorm about fraud risks, and consider industry specific issues in your chosen company. Use the following documents (on WebCT)

1. List of Generic Fraud Schemes

2. Asset Misappropriation

3. Revenue Recognition

4. Overstatement of Assets

5. Fraud_Cases

Use Fraud_Cases to conduct industry and sector research.

Deliverables:

1. Exercise 1 Worksheet

2. Powerpoint presentation (a) identifying fraud risks that are more than remote and more than inconsequential, (b) additional procedures that you would use, if the team had more time and resources, and (c) matching the frauds described in your 31 January presentation to the list of frauds.

14 February

Modules 7 and 8

Fraud Detection and Prevention

Assignment:

Exercise 2 (Designing Fraud Controls) and Exercise 3 (Evaluating fraud controls), both on WebCT.

Identify five fraud activities (preferably in your own designated section of the table), and prepare a design (Exercise 2) and evaluation (Exercise 3) presentation with respect to your chosen activities. Michael Carey, Partner and expert from PWC on fraud controls, and Joanne Liu will join us in the class to discuss fraud controls in the context of Exercises 2 and 3.

Resources: 13 documents under Business Process Control Matrices (on WebCT)

21 February

Modules 9 and 10

Assignment: Exercise 4 (available on WebCT). For the purposes of this exercise, select either:

The company that served the basis for Exercises 1 - 3; or

A company at which one of the team members was employed; or some other company or institution (e.g. Yale).
Using the research materials listed below as a guide:

Evaluate the design and operating effectiveness of the antifraud programs and controls of the entity you have selected using the template in Exercise 4.
Be prepared to discuss the methods that you might use to evaluate the proposed design and validate its operating effectiveness.
As before, please prepare your Powerpoint presentations for the class.

For an in-depth discussion of the requirements of antifraud programs, see the following documents, which are available in the unrestricted website of the course and Professional Publications and Documents:

· J. Frank, A New Audience for COSO—SEC & PCAOB Requirements for Anti-Fraud Programs & Control (BNA, May 2004)

· PwC, Key Elements of Antifraud Programs and Controls (December 2003)

· PwC, Emerging Role of Internal Audit in Mitigating Fraud and Reputation Risk (April 2004)

· PwC, Antifraud Programs and Controls in the Retail & Consumer Sector (September 2004)

28 February

Module 13

Module 14

Fraud Investigation

Each team will send to the instructors the names of their respective (virtual) clients and 3-5 fraud schemes each team has focused on.

Instructors shall send a "whistleblower" complaint involving one of those alleged frauds, including more detailed directions for the assignment.

See Exercise 6 and Exercise 6 Deliverable (due March 7) on Internal Website. Your final submission will be followed by a 30-minute conference call between each team and the instructors.

Reading:

J. Frank and M. Carey, “When Fraud Hits: Incident Investigationand Remediation.” (Available on the external website).

M. Carey & J. Frank, The Role of the Forensic Accountant in Corporate Internal Investigations(2000). (available on the internal website).

Incident Investigation and Remediation Methodology (on internal website)

The Feb 28 class will be devoted to an in-class group exercise to devise a fraud auditing plan and incident response and remediation plan.

Readings

Books:

1. Davia, Howard R. Fraud101: Techniques and Strategies for Detection. New York: John Wiley & Sons, 2000.

Written by a former audit executive of US General Accounting Office and General Services Administration. Detection and prevention strategies. Many summary cases of fraud, especially in government departments. Glossary and a detailed case from Congressional hearings.

2. Russell, Harold F. Foozles & Frauds. Institute of Internal Auditors, 1977.

Written by a former general auditor of Eastman Kodak Co. the book distinguished between fraud and foozles. The latter are “awkward, unskillful acts or bungles” while the former are “intentional deception to cause a person to give up property or some lawful right.” Foozles often lead people into predicaments from which they see no escape except by fraudulent means.

3. Mulford, Charles W. and Eugene E. Comiskey. The Financial Numbers Game: Detecting Creative Accounting Practices. New York: John Wiley & Sons, 2002.

Written by two professors of accounting and business, this book presents a comprehensive analysis of manipulation of financial reports through accounting practices.

Legal and Authoritative Sources

Securities and Exchange Commission. Staff Accounting Bulletin 99: Materiality, 1999. Full text available at: http://www.sec.gov/interps/account/sab99.htm.
Auditing Standards Board. Statement on Auditing Standards, SAS 99: Consideration of Fraud in a Financial Statement Audit. October 2002. Full Text.

3. Mail Fraud Statute, 18 U.S.C. §1341

4. RICO, 18 U.S.C. §§1961, 1962

5. Foreign Corrupt Practices Act, 1977.

6. Sarbanes-Oxley Act of 2002, http://www.law.uc.edu/CCL/SOact/soact.pdf,

7. SEC Rules Implementing Sarbanes-Oxley Act of 2002, http://www.sec.gov/spotlight/sarbanes-oxley.htm, http://www.sec.gov/rules/final/33-8177.htm, http://www.sec.gov/rules/final/34-47262.htm, http://www.sec.gov/rules/final/33-8177a.htm.

8. Public Company Accounting Oversight Board (PCAOB), Auditing Standard No. 2 – An Audit of Internal Control Over Financial Reporting Performed in Conjunction with An Audit of Financial Statements.

9. Thornburgh Report on WorldCom (Final). Third and Final Report of Dick Thornburgh, Bankruptcy Court Examiner, January 26, 2004. U.S. Bankruptcy Court, Southern District of New York (Chapter 11 Case No. 02-13533 (AJG)).

10. The BCCI Affair:A Report to the Committee on Foreign Relations,United States Senate, by Senator John Kerry and Senator Hank Brown, December 1992, 102d Congress 2d Session Senate Print 102-140.

Professional Publications and Documents

1. A. Vasilescu, Recent Enforcement Cases Involving Financial Fraud (on WebCT)

2. Herbert S. Wander, Securities Law Disclosure After Sarbanes-Oxley I and II (on WebCT)

3. Ahmad, J. David Jansen, and Jonny J. Frank, Common Financial Fraud Schemes (chapter in forthcoming Auditor’s Guide To Forensic Accounting).

Frank, J. “Financial Reporting Fraud Opportunities Checklist.”
Frank, J. “List of Potential Cases of Financial Fraud.”
Frank, J. “List of Recent Fraud Cases.”
Frank, J., and M. Carey. The Role of the Forensic Accountant In Internal Investigations. Litigation Services Handbook (2001).
Frank, Jonny. “Deeper and Broader: Performing Fraud and Reputation Risk Assessments,” Institute of Internal Auditors (Forthcoming, April 2004).
American Institute of Certified Public Accountants. AICPA Ethics and Fraud Cases.
Association of Certified Fraud Examiners. 2002 Report to the Nation: Occupational Fraud and Abuse.
Frank, Jonny, and Nancy Newman-Limata, “A New Audience for COSO—SEC and PCAOB Requirements for Anti-Fraud Programs and Control,” Prevention of Corporate Liability, BNA, Inc. April 19, 2004.
Bishop, Toby J. F. “Certified Fraud Examiner’s Fraud Prevention Check Up: An Introduction,” Association of Certified Fraud Examiners, 2002.
PricewaterhouseCoopers White Paper, Key Elements of Effective Antifraud Programs and Controls, December 2003.
PricewaterhouseCoopers. Economic Crime Survey 2003.
KPMG. Fraud Survey 2003.
Financial Executives International. Powerpoint Presentation of the study of financial restatements by public firms . News Story.
PricewaterhouseCoopers. The Emerging Role of Internal Audit in Mitigating Fraud and Reputation Risks. 2004.
PricewaterhouseCoopers. Anti-farud Programs and Controls in the Retail and Consumer Sector. 2004.
Jonny Frank and Michael Carey. When Fraud Hits: Incident Investigation and Remediation.

Periodical Literature

1. Sonnefield, Jeffrey. The CEO Blues, Wall Street Journal, 9 Dec. 2003.

2. Joann S. Lublin. Companies Seek To Recover Pay From Ex-CEOs. Wall Street Journal, 7 January 204.

3. Frieswick, Kris. How Audits Must Change: Auditors face more pressure to find fraud. CFO Magazine
July 01, 2003.

4. Martin, Roger. The Wrong Incentive. Barron’s, December 22, 2003.

5. Bryan-Low, Cassell. KPMG Probe Widens to Another Firm. Wall Street Journal, February 24, 2004.

6. Longstreth, Andrew, “Double Agent,” The American Lawyer February 1, 2005.

7. Longstreth, Andrew, “The Consequences of Cooperation,” The American Lawyer February 1, 2005.

8. Chorney, Jeff, “Ernst & Young Prevails in Rare Class Fraud Trial,” February 23, 2005. http://www.law.com/jsp/article.jsp?id=1108992917218.

9. Geller, Adam, “Judge Orders Reinstatement for First Sarbanes-Oxley Whistleblower,” February 23, 2005. http://www.law.com/jsp/article.jsp?id=1108992919634.

Class List

Group List

Group No.	Membership
1	Daina Druva, Seth Tutlis, Kevin Reed
2	Julia Lin, Rohini Sharma, Renato Vasconcelos
3	Colin Chung, Erick Flores, Al Cadena
4	Igor Gershenson, Joyce D’Addio
5	Melinda Delis, John Chen
Others	Julia Travers

Reports

Case Materials

Case	Documents
Ganim, Joseph P.	Docket	Bridgeport Scandal	Sullivan	Sentencing
Mutual Fund Fraud	Litigation and media files
Just for Feet	Langley Correspondence (Hyperlink to this material removed upon a phone “request” from a lawyer representing Deloitte & Touche (April 2, 2004, 4:35 PM)	Langley document on risk assessment at Just-for-Feet (Hyperlink to this material removed upon a phone “request” from a lawyer representing Deloitte & Touche (April 2, 2004, 4:35 PM)
Enron	Enron’s Values