Attendees at the annual CFO Summit at the Massachusetts Institute of Technology on Nov. 19 heard from federal regulators promising no end to their fraud crackdown of recent years, as well as from other corporate executives offering their ideas on how to maintain ethical operations amid difficult economic circumstances.
Neil Power, a supervisory agent at the FBI, told the crowd that the FBI is currently investigating 592 corporate fraud cases—60 more than the caseload two years ago. Securities fraud, such as Ponzi schemes or other high-investment scams, have also seen “an alarming increase” from 1,200 cases in 2007 to roughly 1,500 cases today, he said.
To help its investigation efforts, the FBI works in parallel with the Securities and Exchange Commission, Power said. He stressed that neither agency has authority over the other: “They do not direct us. We do not direct them.” But given that fraud investigations can span across multiple locations and be “very document-intense,” the two do collaborate, he continued. The actual report of investigations, however, is written by only one to avoid conflicting viewpoints that could hinder civil or criminal proceedings in court.
The FBI is also looking to expand its sources of information to include hedge funds, private equity firms, and the Big 4 auditing firms to help the agency better address fraud before it happens, Power added.
Despite the current increase in fraud investigations, however, fraud itself is a constant threat, warned a panel of executives speaking at the event. “Fraud happens in good times, but it’s recovered in bad times,” said Frank Haydu, a chairman of the audit committee for retailer iParty. That means financial executives must treat fraud mitigation as an ongoing effort, he said.
To that end, Haydu said, he tries to “understand the business case” of a transaction or set of performance results, rather than look for specific types or incidents of fraud. That means investing the time so he can detect when something doesn’t make sense and try to figure out why it doesn’t. “To the extent that something is going on, you’ll find it if you understand what’s going on in the business,” he said.
Saparoff
Peter Saparoff, a partner at the law firm Mintz Levin, echoed Haydu’s advice. Too often, he said, he sees directors who clearly don’t understand a transaction, “but they’re afraid to ask and have it explained, because they don’t want to look stupid. In terms of risk control, that’s a problem.”
Understanding the culture of the business is also critical, Haydu added. “There’s nothing more important than the quality and the integrity of the people you are dealing with,” he said. “I’ve left companies because I didn’t trust the CEO or CFO. If I get a nervous feeling like that, that’s the one thing I will not ignore.”
John Tus, corporate treasurer of Honeywell, agreed. “There are no people in a company that are more well-positioned than the leaders of the company to drive that integrity in the organization,” he said. “One of the first rules you learn in accounting is that you can’t audit a company where management doesn’t have integrity.”
SOME BIG NAMES IN FRAUD
The following are some significant fraud cases pursued by the Federal Bureau of Investigation:
BROCADE COMMUNICATIONS SYSTEMS, INC. (SAN FRANCISCO): Brocade Communications Systems, Inc. (Brocade), a technology company based in San Jose, California, routinely used stock options to compensate its employees. In July 2006, former Chief Executive Officer (CEO) Gregory L. Reyes and former Vice-President of Human Resources Stephanie Jensen were charged in connection with a scheme to backdate stock option grants. The two executives made fraudulent entries into Brocade’s financial books and records, made false statements to auditors, and filed false financial statements with the SEC in furtherance of the scheme. After internal auditors restated earnings for the years 1999 through 2004, it was estimated that the cost to Brocade exceeded $400 million. On August 7, 2007, a jury convicted Reyes of ten counts of conspiracy and securities fraud. Reyes was the first person to be tried on charges related to stock options backdating and was sentenced to 21 months in prison. On December 5, 2007, a jury convicted Jensen of conspiracy to commit securities fraud and falsifying corporate records. Jensen is currently awaiting sentencing.
QWEST COMMUNICATIONS (DENVER): Qwest Communications (Qwest) is a Fortune 500 company and one of the largest providers of telecommunications services in the U.S. In 2000 and 2001, the company reported sales revenues of $16 billion and $19 billion, respectively, in its published financial statements. In 2002, Qwest issued a press release that acknowledged the company had improperly recorded $1.1 billion in revenue since 1999, and the FBI opened a criminal investigation. Five executives were indicted and either pled guilty or were convicted of securities fraud or insider trading. This included the former CEO Joseph Nacchio, who was convicted of insider trading on April 19, 2007. He was sentenced to six years in prison, ordered to forfeit $52 million gained as a result of his illegal stock sales, and fined $19 million.
HOLLINGER INTERNATIONAL, INC. (CHICAGO): Hollinger International (Hollinger) is an international newspaper holding company and owner of the Chicago Sun Times and The Daily Telegraph newspapers. This case was initiated based on allegations that $32 million in non-competition payments were made to CEO and Chairman of the Board Conrad Black and three other corporate executives in conjunction with newspaper sales without proper authority. It was also alleged that newspaper circulation numbers were overstated for the purpose of misleading advertising companies and causing them to pay more in advertising fees. In November 2005, Black and three others were indicted on 15 counts of racketeering, mail and wire fraud, money laundering, obstruction of justice, and tax fraud. On July 13, 2007, Black and the three other co-defendants were convicted after a four-month jury trial. On December 10, 2007, Black was sentenced to 78 months imprisonment.
BRITISH PETROLEUM, INC. (ANCHORAGE): On October 25, 2007, British Petroleum (BP) and several of its subsidiaries agreed to pay $373 million in fines and restitution for environmental violations stemming from a fatal explosion at a Texas refinery that occurred in March 2005 and from leaks of crude oil from pipelines in Alaska in March 2006, as well as for conspiring to manipulate the price of propane.
Source
Federal Bureau of Investigation.
Indeed, Power said, many cases come to the attention of the FBI thanks to “greedy executives who will do anything for a buck.” Usually the company is operating without checks and balances, or is extremely profit-driven from the executive-level down, where numbers are constantly being fudged whether it’s to increase revenue or hide losses, he said.
One attendee lamented that fraud whistleblowers often are the ones who suffer, since they are bucking the will of top executives and then face retaliation for making the right ethical decision.
Power agreed. “Each one is afraid to lose their job if they don’t go along with making money for the company,” he said. “These days in the recession, when there are not many jobs out there, it’s even more pressure on that follower.”
Haydu, however, put the choice for whistleblowers in more stark terms. “If you’re in a situation where people are breaking the law … you have to either leave, or you need to do something about it,” he said, “because you’ll not get another job eventually if it ever hits the light of day.”
Saparoff also warned that having a corporate compliance program in place isn’t always enough to please regulators. When facing an SEC probe, for example, companies will often tout their compliance programs as proof of their ethical attitudes, “but I don’t think the inquiry will stop there,” he said. “You can have the best compliance program in the world, but the SEC is still going to want to know why it was that this person was able to get around it.”
Saparoff said putting someone in charge of enforcing compliance is vital. If no clear enforcement person exists, the SEC will start to wonder: Was the compliance department not paying attention? Are its staffers underpaid? Is the compliance function itself not large enough to handle the challenges the company faces?
In summary, with all the headaches brought on by an FBI and SEC investigation, compliance with laws and regulations is critical, Tus said, and to invest in fraud mitigation is “money that’s very well spent.”
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