Accounting and Reporting Fraud

Accounting and Reporting Fraud

By: Steve Y. Lehrer, CPA

October 2012

 

 As we continue our series on the topic of Fraud, this article is the second of ten topics, which will focus on the types of frauds that can be committed in accounting and reporting. 

 Accounting and Reporting Fraud

 Accounting fraud is any act or attempt to falsify accounting records for financial gain.   Over the past decade the financial world has experienced some of the largest frauds in history, all stemming from known, intentional and reckless falsification and misrepresentation of accounting records, and from the pursuit of personal financial gain and greed.  These frauds, some to the tune of billions of dollars, destroyed jobs, wiped out retirement accounts, shattered investor confidence and shook the global economy. 

 I.    Major Fraud Examples

 Examples of massive frauds of historical proportions that have rocked the accounting world over the past decade include: 

 

  • Enron

 Enron was a Houston-based energy giant that collapsed and declared bankruptcy in 2001.  The fraud involved hiding debts and inflating revenues.    After many years of global expansion through complex business deals, Enron found itself to be billions of dollars in debt.  The debt was not disclosed to shareholders and was concealed through partnerships with other companies, fraudulent accounting, and illegal loans.  Losses to shareholders were $74 billion, and employees’ losses were in the billions as well.  It also caused the unfortunate dissolution of Arthur Andersen, a Big 5 accounting firm.   This case subsequently became the catalyst behind the passage of the Sarbanes-Oxley Act of 2002.  

 

  • Tyco International  

Tyco was an international manufacturing company.  They were involved in a massive financial scandal, which erupted in 2002.   The source of the fraud was the improper use of company funds by the former CEO and ex-CFO.  Both were found guilty of stealing $120 million and taking part in inflating the firm’s financial condition by over $500 million.  Ultimately, both men were convicted of stealing hundreds of millions of dollars and using fraudulent accounting practices and falsifying records to conceal their crimes.

 

  • WorldCom

 WorldCom, the second largest of America’s long distance telephone companies, found itself in an $11 billion accounting fraud, which was exposed in 2002.   The company’s executive management perpetrated this fraud in masking the company’s failing profitability by inflating total assets through capitalization of operating costs and overstating cash flows by $3.8 billion.

 

  • AIG

 AIG, at the time, one of the world’s largest companies, was shaken by a $2.7 billion scandal in 2004. The improper accounting resulted from loans that were classified as revenue.  AIG was also accused of bid rigging of insurance contracts and received a $1.6 billion fine.  AIG subsequently received the largest government bailout of a private company in US history.

 

  • Satyam Computer Services

 In 2009, the company Chairman shocked India and the rest of the financial world by resigning and publicly announcing that he had fraudulently misrepresented the balance sheet.   He admitted to inflating cash and bank balances by $1.5 billion, overstating receivables by $100 million, and understating liabilities by $250 million.  The Chairman was quoted as saying that committing these frauds was “like riding a tiger, not knowing how to get off without being eaten”.  In 2011, the United States Securities and Exchange Commission (SEC) penalized the auditor of Satyam $7.5 million, charging that the auditor routinely failed to follow the most basic audit procedures.

 

  • Bernard Madoff

 In 2009, Bernard Madoff, the former NASDAQ chairman, pled guilty to 11 federal crimes and admitted to operating the largest Ponzi scheme in history.  Prosecutors estimated the size of the fraud to be approximately $65 billion.  Madoff and his accountant were charged with fraud and arrested as a result of preparing phony accounting records for the fictitious trading activity, which appeared on bogus investor account statements that were distributed periodically to unsuspecting investors.

 

  • Lehman Brothers

 Lehman Brothers was involved in the largest bankruptcy in American history, which caused a panic and brought the global economy to the brink of disaster.  In 2010 a bankruptcy examiner provided a 2,200 page report detailing exactly how Lehman had been cooking their books from as far back as 2007.  In short, Lehman entered into repurchase agreements with off shore banks.  Under the deal, Lehman would sell toxic assets to those banks and buy them back in a short time.   The effect was that Lehman had $50 billion more in cash on its books, and $50 billion less in toxic mortgage assets.  In practice, banks use these repo tactics all the time, except they have to disclose them as liabilities and not assets.

 Lehman was unable to find an American law firm that would write an opinion allowing this type of accounting treatment, and instead found an English law firm from London who found that this was acceptable under English law.  Further, the company’s auditor signed off on it as well.

 

 II.    Facilitators and Contributors

 The most common facilitators and contributors at the root of this type of fraud, which are all considered weaknesses in the internal control structure, though not a complete list, are: 

  • Lack of segregation of duties between the operations, accounting and monitoring functions
  • Transactions not recorded accurately or timely
  • Accounts not reconciled accurately or timely
  • Improper authorization levels especially when recording reserves an estimates
  • Lack of monitoring and oversight over non-routine transactions
  • No transparency to the Board or another independent objective body
  • Management override of established controls
  • Ineffective Board who may not understand the nature or complexity of the business
  • Lax or no internal audit procedures
  • Collusion among two or more fraudsters

 As previously discussed in my article titled “Occupational Fraud”, there are three elements that must be present in order for fraud to occur.  These elements combined are known as the fraud triangle. The three elements of the fraud triangle are (a) Incentive / Pressure, (b) Opportunity and (c) Rationalization / Attitude.  In the above major fraud examples, all three elements presented themselves and enabled the fraudsters to engage in their respective unlawful activities.

 

III.   Schemes and Outcomes

Accounting and reporting fraud typically occurs in larger corporations as a result of presenting false information usually for financial gain.   This type of fraud involves keeping inaccurate books. When a corporation keeps inaccurate books it means that they are not reporting all of the necessary and / or accurate information. Inaccurate books and presenting false information are two of the most common forms of accounting fraud that takes place in corporations today, and typically are the target of most SEC investigations.  In general, the frauds may come in the following forms:

 a)      Embezzlement

b)      Overstating or understating revenues and expenses,

c)       Overstating assets such as cash, receivables, inventories pre-paid assets, fixed assets, leases and capital improvement,

d)      Understating or concealing liabilities, both short term and / or long term, reserves and estimates, deferred revenue, tax liabilities, off Balance Sheet liabilities.

 Embezzlement is when a person misappropriates the assets entrusted to them. In essence, it is a breach of the fiduciary responsibilities placed upon a person.   In this type of fraud the assets are obtained lawfully, as in the case of Madoff, and the embezzler has the right to possess them, but the assets are then used for unintended purposes.  A recent example of embezzlement is Evelyn Reynolds, an assistant to the COO at a non-profit organization.  With access ranging from credit card purchases to purchase order requests, she perpetrated a multi-faceted fraud totaling more than $100,000 in less than ten months.  In large companies, embezzlement usually occurs when executives or other trusted employees falsely expense millions of dollars, transferring the funds into personal accounts. Embezzlement may be punishable by significant fines and a prison sentence.

A corporation may present false information to their financial advisors, employees, clients and other professionals when it comes to their accounting practices and other financial entities. Practices that fall into this category may include the delay of expenses, the acceleration of expected or deferred revenue, engaging in off balance sheet transactions or reporting and estimating inflated estimates of future earnings of the company. A corporation may also fail to report a segment of its income to the Internal Revenue Service in order to minimize the tax liability or overstating its income, thereby deceiving its investors and creditors.

 Overstating assets may produce falsely overstated cash flows, overstated revenues and a false sense of security for investors resulting from an increase in stock price.  They can also be fraudulently used as non-existent collateral to obtain financing and may also skew critical ratios and indicators used for financial planning and projection.  Understated liabilities will also result in overstated revenues, and may misrepresent the liquidity and solvency of a company, thereby fraudulently disguising and avoiding the potential of bankruptcy.

 

IV.    Fraud Detection

 Effective internal accounting controls will help minimize, detect and help prevent accounting fraud.   These controls are necessary both at the control activity level as well as at the entity level.  Some of these controls should include, but are not limited to: 

  • A positive tone at the top, which conveys a sense of honesty, integrity and cooperation
  • Adequately designed and effectively operating internal controls over accounting and reporting
  • Segregation of duties and adequate authorization levels
  • Complete transparency and accurate disclosures
  • Timely analytic review of the balance sheets, operating results, profit margins, cash flows, financial ratios and industry trends
  • An effective and skilled Board that participates and understands the complexities of the business
  • Ongoing monitoring of internal controls and mitigation of identified control weaknesses
  • An internal audit department that identifies areas of opportunity and has management’s support

 A comforting thought is that given adequate and effective internal controls in place, financial statement fraud will most likely not go undetected for an extended period of time.

 

V.    New Regulations

 New regulations have been introduced pertaining to accounting fraud.  These regulations include:

  •  Whistleblower Rules, which, given certain limitations and conditions, will compensate whistleblowers who provide the SEC with information regarding a securities laws violation, which leads to a successful enforcement of an action brought by the SEC, ultimately resulting in monetary penalties exceeding $1,000,000.  The amount of the award will be equal 10-30% of the monetary sanction.  
  • Mandatory Executive Compensation Clawback provision, which requires every public company to: (1) disclose incentive-based compensation that is based on financial information required to be reported, and (2) adopt a policy whereby, in the event of a restatement, the company will recover from current and former executives any incentive-based compensation, for the three years preceding the restatement, that would not have been awarded under the restated financial statements. Under the Act, a failure to do so will result in delisting.
  • Pay to Play rule, which is designed to prevent an adviser from seeking to influence government officials’ awards of advisory contracts through political contributions

 Given the new Accounting rules and reforms over the past decade, is the financial world now truly a safer place? The two major financial reforms are the Sarbanes-Oxley Act of 2002 (SOX), and the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.  Most regulations are mere knee jerk reactions to the schemes and frauds that have already been discovered.  We can only hope that regulators do a good job at poking holes at proposed regulations and make meaningful suggestions in anticipation of any new schemes that fraudsters may think of in lieu of the new regulation.  

SOX introduced a slew of new Accounting rules and criminal penalties, with a focus on greater levels of internal controls, making the CEO and CFO criminally liable for material misstatements on the Financial Statements.   Dodd –Frank was designed for protecting the consumer and investor, eliminating bailouts for certain systematically important financial institutions (SIFI) and too big to fail companies, identifying and mitigating systemic risk, providing transparency & accountability over exotic instruments, managing executive compensation, enforce existing regulations, and empowering the Federal Reserve.  In the case of Dodd-Frank however, it is yet unclear to what extent the provisions of this Act will ultimately be enforced.

         

VI.   The End of the Road

 Accounting and reporting fraud may occur anywhere anytime.  When discovered, the end results are usually stiff penalties coupled with criminal prosecution, which leads to a conviction and a long prison sentence. Civil lawsuits can also be brought not only on the corporation entangled in the fraud but also personally against the officers and other individuals behind the fraud as well.  

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Occupational Fraud

Occupational Fraud
By: Steve Y. Lehrer, CPA
March 2012

Occupational Fraud is defined by the Association of Certified Fraud Examiners (ACFE) as: “The use of one’s occupation for personal enrichment through the deliberate misuse or misapplication of the employing organization’s resources or assets.”

Over the past five years the economy has taken a noticeable downturn. This has resulted in, among many things, corporations being susceptible and vulnerable to fraud and has heightened management’s awareness to fraud risk. Fraud is in fact on the rise. Today’s fraudster is sophisticated, intelligent, operates globally and is well equipped with modern technology. The fraudster has by now built a callous to Sarbanes-Oxley and is most likely already developing workarounds to the new Dodd-Frank legislation.

A recent Global Fraud Study by the ACFE found that the median loss in companies caused by fraud cases was $160,000 in 2010. The ACFE also indicates that organizations lose about 5 percent of revenue each year as a result of fraud, translating to total losses worldwide of more than $2.9-trillion. They also noted that small businesses are more vulnerable to fraud than medium and large companies, and that approximately 40 percent of organizations ultimately do not recover any of their losses.

Periodically, a major fraud hits the headlines. Some organizations sit back, watch and think “it couldn’t happen here”. In reality, fraud can happen anywhere. While only few major frauds are ever disclosed in the media, tremendous sums are lost as a result of the high number of smaller frauds.

This article is the first in a ten part series focusing on the various areas that are closely related and in most cases may be susceptible to corporate fraud. The ten areas of focus will be as follows:

1. Root Causes and Remedies
2. Accounting / Reporting
3. Cash Receipts and Disbursements
4. Supply Chain
5. HR / Payroll
6. Banking
7. Information Technology
8. Travel and Entertainment
9. Forensics and Data Mining
10. Customer / Organized Retail Crime

This first article (Root Causes and Remedies) focuses on the root causes of fraud, particularly what causes someone to commit fraud, why they would do it, how they would be enabled, and what remedies should the organization consider in the ongoing battle against fraud.

Root Causes and Remedies

I. Fraud Triangle

There are three elements that must be present in order for fraud to occur. These elements combined are known as the fraud triangle.  The three elements of the fraud triangle are: (a) Incentive / Pressure, (b) Opportunity and (c) Rationalization / Attitude.

Incentive / Pressure – This element is what brings a person to consider and ultimately commit a fraud. Pressure may come in various forms and may include greed, high medical bills, gambling, a taste for the good life, drug addiction, etc. The recurring theme behind pressure is usually a significant financial issue. The fraudster will typically consider this private even secretive, believing that this issue has to be resolved with no one’s knowledge.

Opportunity – This element provides the ability to actually commit fraudulent activity. The fraudster wants to keep his activities undetected so as to no getting caught. A major contributor for committing fraud is a system of poorly designed or ineffective procedures and internal controls, inadequate management oversight, or abuse of one’s own position and authority. In this element, organizations have the most control. Organizations must be proactive in developing, implementing and monitoring processes, procedures and internal controls, which will serve to minimize the fraudster’s ability to commit fraud and will effectively detect fraudulent activity.

Rationalization / Attitude – Rationalization is the critical and psychological component of a fraud. This involves a fraudster’s reconciliation and justification of the fraudulent behavior with the commonly accepted notions of decency and trust.

II. Elements of Fraud

Fraud may be conducted by employees against the company or by individuals on behalf of the company. It encompasses an array of irregularities and illegal acts characterized by intentional deception. The five elements of fraud are:

1. A false representation about a material fact,
2. Made intentionally, knowingly, or recklessly,
3. Which is believed and relied upon by the victim,
4. And acted upon by the victim,
5. And where the victim suffers a financial loss.

Fraud may be perpetrated as a result of a lack of internal controls. Here is a partial list of common general factors that can contribute to fraud. This does not list all possible situations. Lack of internal controls may be a result of:
 Inappropriate tone at the top
 Lack of segregation of duties between authorization, custodianship, and record keeping.
 Lack of restriction
 Lack of accountability
 Unreconciled balance sheet accounts
 Unauthorized processing of transactions
 Unimplemented controls because of the lack of or unqualified personnel
 A lack of monitoring and oversight

As noted here, the organization plays a major role in either enabling or restricting the possibility of the potential for fraud to occur. Making it easier for the fraudster is essentially inviting this person to act on their urge.

III. Red Flags

In order to effectively detect fraud, it is critical to first identify and understand the symptoms of fraud.
In any given fraud situation, there may be symptoms or “red flags”, which can serve as indicators that fraudulent activity may exist. The red flags are not full proof, however should be considered and investigated so as to ensure that fraudulent activity is not present. The American Institute of Certified Public Accountants (AICPA) has issued a Statement on Auditing Standards (SAS) No. 99 – Consideration of Fraud in a Financial Statement Audit – that highlights the importance of fraud detection. This statement requires the auditor to specifically assess the risk of material misstatement due to fraud and it provides auditors with operational guidance on considering fraud when conducting a financial statement audit.

Here is partial list of potential, not all-encompassing, common red flags:

Employees
 New expensive cars, exotic vacations, jewelry, homes, clothes, etc.
 Significant personal debt and credit problems.
 Possible drug, alcohol, gambling, divorce, fear of losing a job.
 High employee turnover, especially in areas susceptible to fraud.
 Refusal to take vacation or time off.

Management
 Refusal to provide information to and continuous disputes with auditors.
 Decisions are dominated by an individual or small group.
 No clear organizational responsibilities.
 Discontent and general disrespect towards regulatory bodies.
 A weak internal control environment.
 Inexperienced or lax Accounting personnel.

IV. Detractors

Other factors may also contribute to a non-conducive / negative work environment. This may also provide employees and / or management a motive to commit Fraud. For instance, when good performance is not noticed or appreciated by executive management, or when employees consistently receive negative feedback and lack of recognition for job performance. Sometimes personnel may have perceived inequities in the organization or feel that they themselves are not treated fairly, have poor training or no promotional opportunities. Individuals may also feel that there are unreasonable budget expectations and fear delivering “bad news” to supervisors and/or management. Of course these examples are only partial list of potential detractors and are not all-encompassing.

V.  Fraud Prevention

An ounce of prevention is worth a pound of cure. A robust fraud prevention plan can support the organization’s initiative to mitigate losses resulting from occupational fraud. Understanding that in it of itself the plan may not stop fraud from occurring, an active plan which proactively identifies, assesses, monitors, and reviews fraud risks actively, and includes adequate anti-fraud controls, will result in timely detection of fraud, subsequent limited losses and retention of market confidence.

The plan comes down to the basics of a COSO-consistent approach, which can be applied to fraud risk management as follows:

 There has to be adequate oversight from and transparency to an independent objective body within the organization like a Board of Directors. The Board should be in the position to set a tone at the top, receive and evaluate reported fraud data, understand management’s approach to fraud prevention, and authorize necessary changes / updates to the ongoing initiative.

 A well prepared fraud risk assessment that provides an accurate presentation of the organization’s risks should be developed and utilized for identifying fraud and related red flags. Fraud risk assessments should be customized based on the company and specific industry.

 Assessing the design and operating effectiveness of controls in place is critical in order to ensure that the controls will address and mitigate identified key fraud risk factors. Any identified weakness in controls should be remediated, and action plans should be documented and implemented timely.

 There should be adequate periodic training / communication provided to employees on how to identify fraud and how to report it. A comprehensive fraud guidelines and employee handbook should be distributed to every employee. The literature should define ethical standards that employees are expected to adhere to and to state consequences for noncompliance. An anonymous whistleblower hotline should also be implemented and utilized. The ultimate goal of communication is to create a culture of zero tolerance for fraud throughout an organization.

 The plan should be monitored, periodically reviewed and updated as necessary to ensure that both preventive and detective controls are still effective, identified risks are still relevant and reflect any changes in newly identified frauds in the industry or changes in the environment. Information is available online, and the ACFE provides ample documentation and examples of all fraud schemes perpetrated domestically and abroad.

VI. Fraud Response

A strong fraud response plan for dealing with fraud can help a company deal with the identified threat or actual reported acts of fraud. A fraud response plan would have to include an investigation team that would gather and process information related to fraud, including performing the investigation itself, such as evaluating evidence, gathering and documenting corroborating statements from witnesses, and finally pursuing mandated disciplinary, civil or criminal actions.

Depending on the company, industry, location and other factors, each organization may have a different approach on division of responsibilities for managing fraud risk. A general consideration may include:

 An officer of the company (CFO, CEO, etc.,) having overall responsibility in the response to fraud. The officer should maintain an investigation log, detailing all reported suspicions, including those deemed high risk, low risk or not investigated. The log should also contain details of action steps taken and conclusions reached and provide an important tool for managing, reporting and evaluating lessons learned. The log should be presented to the Board as well.

 Internal audit investigating fraud claims, as they have the appropriate skills, knowledge of the control environment and company background to assume the task.

 Legal / outside counsel consulted immediately as fraud is reported. They can give advice on the level of litigation risk and would be knowledgeable in the civil, internal and criminal prosecution.

 IT staff providing technical advice on gathering evidence and pinpointing where the fraud originated, how it manifested, and what data was compromised, if the fraud was computer based.

 Board of directors / Audit Committee independent consideration and evaluation of any potentially damaging material frauds that may have been perpetrated and discovered.

 Fraud Officer and / or Human Resource investigating, coordinating and delegating duties based on expertise.

 Outside specialists such as forensic accountants providing a discreet investigation and / or asset recovery service.

Organizations should approach reported fraud with a sense of urgency, act timely and implement the necessary improvements to systems and procedures, in order to limit their loss and prevent it from happening again in the future. Management should learn from the experience and continue in their pursuit of building and enjoying a fraud-free environment. Having the proper plan in place will mean the difference between controlling the situation and suffering significant negative financial, operational and / or other consequences.

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Board Outlook and Challenges in 2011

Board Outlook and Challenges in 2011
By: Steve Y. Lehrer, CPA
April 2011

As companies wrap-up the year-end financial reporting process and SEC filings for 2010, Boards and Audit Committees are beginning to look ahead to emerging developments in 2011, to help steer their companies to a platform of stability and growth in 2011.

Events such as the devastating earthquake in Japan and political upheaval in the middle-east continue to cause great volatility and uncertainty in the global economy. As such, companies continue their efforts to adjust to the market uncertainties and pursue a risk-intelligent strategy. Shareholder expectations of Boards continue to increase. This is becoming more evident as Boards assume a larger role in organizational governance issues, with greater involvement in monitoring the development and execution of strategy, an ongoing focus on risk management oversight, and more involved interaction with the shareholders.

Based on our experience advising clients, below are some of the critical items that Boards are considering for 2011 and beyond:

Oversight of Strategic Direction

 Transitioning to a proactive focus on growth
 Exploring new opportunities, acquisitions, new markets and promoting innovation
 Evaluating the effects of global developments on existing operations
 Considering new investment strategies
 Realigning the workforce with company objectives

Regulation and Compliance

 The impact of the Dodd-Frank Wall Street Reform Act on public companies
 Shareholder’s “Say on Pay” relating to executive compensation and golden parachutes, intended to rationalize Director’s compensation based on merit and performance thereby protecting the interests of the corporation
 “Compensation Clawbacks” due to compensation paid to executives based on erroneous financial information
 Adoption of New Proxy Access rules, which will permit certain shareholders to nominate directors in the company’s proxy statement
 Consideration of whistleblower rules, anticorruption and antitrust compliance

Governance and Risk Management

 Collaborating with management on developing and strengthening relationships with shareholder
 Continuous improvement in the oversight of risk management
 Monitoring the adoption of social media and cloud computing while minimizing related risks.
 Fully assessing the impact and risk of the use of derivatives and other complex financing instruments to prevent large scale asset write downs, as witnessed during the financial crisis.

Financial Reporting

 Enhanced transparency in accounting and disclosures
 Transition to IFRS based financial reporting
 Effects of proposed changes in laws, regulations, accounting and audit standards

Board Performance Assessments

Proactive Boards should also self assess performance by conducting a periodic “health check-up”. These assessments are essential in ensuring that the Boards continue to enhance effectiveness as a strategic sounding board for management.. Boards can gauge how well they are positioned to address current conditions and future challenges. Assessments would need to be customized to the specific needs of the organization and timely action on results is critical. An example of what a typical Board assessment might include is given below:

 Does the Board have an appropriate mix of identified critical skills, experience and expertise — functional and industry related?
 Is there a process to create awareness of regulatory changes, and assess their risks and potential effect on the company?
 Are Board meetings timely, effective and appropriately managed to help fulfill the Board’s obligations?
 Given an economic recovery, how is the Board shifting its focus to a growth oriented strategy?
 Have the mandates for the Board and its various Committee been reviewed and updated as necessary, given the changes in economic climate?
 How does the Board balance “big picture” strategic considerations with current “hot button” issues?
 Is there a requirement for ongoing investment in formal learning, continuing professional education and certification?
 How does the Board composition, skills and experience and quality of ongoing Board education programs affect the Board / Director’s liability?

Finally, Board members should continue to explore new avenues in order to help them carry out their responsibilities. They may consider engaging outside experts on highly technical or complex issues, limit the number of Board positions to ensure adequate time and attention on the companies they serve and network among peers to share knowledge, insights and best practices.

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Fast Growing Companies – Challenges and Solutions

Fast Growing Companies – Challenges and Solutions

By: Steve Y. Lehrer, CPA

As your business begins to grow, your risks may begin to grow and evolve.  Investors and stakeholders will be comforted knowing that you understand the new risks and challenges facing your business, and that you have them under control.  Risks may manifest and change in a variety of ways.  Your future success will be driven by the way your business deals with these risks and challenges.

In order to identify and mitigate these risks, FGCs need to build the right foundation comprising of plans, objectives, policies, processes and performance indicators that can help the company fast track its growth in a stable manner. Rapid growth can be very challenging.  A major reason why fast-growing companies struggle is their inability to keep up with the many tasks required to facilitate such rapid expansion. 

Common performance challenges may include:

  • Lack of proper business planning
  • Unclear objectives and priorities leading to “Management by fire fighting”
  • Ad-hoc policies and processes
  • Cash Flow Management constraints
  • Lack of clear insight into business performance and profitability
  • Inadequate systems and controls

Here are some objectives that should be set by the owners and respective management, and monitored to ensure a healthy and productive growth:

 Administrative

  • A clearly defined mission, which is documented and conveyed to all employees
  • A written sales plan with an identified niche, pricing policy and targeted customers
  • An annual budget that is realistic and flexible, and is compared to actual results
  • Clear and concise job descriptions, employee training and ongoing evaluation

 Operational

  • A good relationship with suppliers and adequate contingency plans
  • A supply chain process with adequate inventory controls
  • Staying current with technological advances and safeguard assets / IT data
  • Knowledge of the industry, business, competitors and their locations
  • Documented policies and procedures and adequate internal controls
  • Focus on customer needs and conduct satisfaction surveys
  • Utilize effective advertising campaigns and participate in promotional events

 Financial

  • Accurate and timely accounting records and financial statements
  • Reconciled bank statements and balance sheet accounts monthly
  • Analyzed results of income and expenses
  • Timely and accurate tax filings and other regulatory requirements
  • Projected cash flow needs and proper financial planning

Parkview Risk Advisors (www.parkviewconsult.com)

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Dodd-Frank Wall Street Reform and Consumer Protection Act

By:  Steve Y. Lehrer,  CPA                                                                                                         

Faced with the biggest financial and economic crisis since the Great Depression, the President signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”) on July 21, 2010. This Act seeks to address some of the root causes and dire consequences of the financial meltdown – a lack of accountability on Wall Street, pyramid schemes of huge proportions, the collapse of major banks, mortgage crises, the loss of approximately eight million jobs, diminishing personal savings and the worst financial situation since the great depression. 

A diverse range of reactions to the Act has been seen from the financial services community, investors, consumers and tax payers. The question on every one’s mind is – Will this important legislation succeed in preventing the next financial crisis or is it just a knee jerk reaction to the present one? 

History tells us that financial crises and recessions have been occurring throughout the last century or so at regular intervals. Nearly a decade ago, we were faced with a number of history’s worst corporate financial reporting frauds. These frauds affected not only the investors, but also the respective company’s management, staff and the auditors.  The impacts were felt both domestically and globally. As a result, in 2002 our government passed the Sarbanes-Oxley Act (SOX), which was done in the hopes of rebuilding the public and investor confidence and trust. The jury is still out on whether SOX has been able to accomplish its objectives of preventing financial reporting frauds.

In the current scenario, the Act introduces, among many items, increased regulation of banks and other financial institutions, creation of a Financial Stability Oversight Council, attempts to address systemic risk and end “too big to fail” bailouts.

The following are highlights of the Act:

Protecting the consumer

The Act calls for the creation of a new independent watchdog.  This group will be housed at the Federal Reserve and is granted the authority to ensure that the American consumer is given complete and accurate information needed when shopping for mortgages, applying for credit cards, and other financial products.  The act also sets out to protect consumers from hidden fees, abusive terms, and deceptive practices.

 Eliminating Bailouts for Companies Considered “Too Big”

The Act ensure that taxpayers will no longer be forced to bail out financial firms that threaten the economy through the creation of a safe way to liquidate failed financial firms; imposing tough new capital and leverage requirements that make it undesirable to get too big; updating the Fed’s authority to allow system-wide support but no longer prop up individual firms; and establishing rigorous standards and supervision to protect the economy and American consumers, investors and businesses.

 Identifying and Mitigating Systemic Risk

A newly created Financial Stability Oversight Council will focus on identifying, monitoring and mitigating systemic risks posed by large, complex financial firms as well as products and activities that spread risk across firms. The council will make recommendations to regulators for increasingly stringent rules on companies that grow large and complex enough to pose a threat to the financial stability of the United States.

 Transparency & Accountability over Exotic Instruments

The SEC and the CFTC will regulate Exotic instruments.  Centralized clearing houses will play a larger role in clearing trades.  Regulators will monitor risk over this large and complex market.  Risky and abusive loopholes will be eliminated.

Executive Compensation

Compensation committees will achieve objectivity and independence as shareholders will be granted a say on compensation, proxy access and corporate affairs with a non-binding vote on executive compensation and golden parachutes.  Public companies will also be required to implement policies for retrieving executive compensation, which may be based on fraudulent, unreliable or inaccurate financial statements. 

Protecting the Investors

The Act provides tough new rules for transparency and accountability for credit rating agencies to protect investors and businesses.  Investor Protections will be enhanced through the encouragement of whistleblowers, SEC management reform, investment advice, new advocates for investors, and funding.

Enforce Existing Regulations

Regulators will be strengthened with adequate oversight and be empowered to aggressively pursue fraud, conflicts of interest and system manipulation, which benefits special interests, all at the expense of American families and businesses.

Empowering the Federal Reserve

The Federal Reserve will oversee the larger, more complex holding companies with assets over $50 billion and other systemically significant financial firms, where their expertise in capital markets will come into play.  This new role will come with new responsibilities, but also new transparency and efforts to eliminate conflicts of interest.

This reform is the most sweeping set of changes to America’s financial regulatory system since the 1930s.  The Act aims to restore American financial stability, shine a brighter light on some complex financial products, build a solid foundation for growing jobs, protect consumers, enhance oversight on Wall Street, and attempts to prevent another major financial crisis.

The Act is large and voluminous and covers the entire financial services industry including bank holding companies, insurance companies, investment banks, credit card issuers, broker-dealers, hedge funds and private equity funds. Despite this, some of the detailed and specific rulemaking has been left to the various regulatory bodies empowered by the Act to do so.

One thing is certain – the financial services industry in the US and globally will continue to evolve and create innovative products, services, business practices, even legal structures in a bid to gain competitive advantage and boost profits.  Ultimately, the success of the Act will depend on how effectively the regulatory agencies, especially the Financial Stability Oversight Council can keep pace with these innovations, understand the risks that they might represent and then act in concert to preempt and prevent the next financial crises or at least significantly reduce its magnitude and potential impact.

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