ACCT 601 Term Paper Topic: Financial Accounting FraudACCT 601 (GRADED A)

Accounting Fraud: Is It Still an Issue? Keller Graduate School of Management This report gives the reader information on accounting fraud. It also provides the reader wit h information on the proceedings by the SEC since the inception of the Sarbanes-Oxley Act of 2002. Table of Contents I. Executive Summary 1 II. Introduction 3 III. Review of Literature 4 IV. Analysis 6 V. Recommendations 13 VI. Summary 14 VII. Conclusion 16 VIII. References 19 I. Executive Summary Accounting Fraud This research paper is to discuss why there still continues to be accounting fraud happening after the inception of the Sarbanes-Oxley Act of 2002 and what the Securities Exchange Commission is doing about it. When discussing what needs to be done in order to curb this type of behavior, it all points to what the SEC should do in order to punish offenders. Is the punishment not severe enough for individuals who are performing these acts of deception? Does the SEC not have enough authority to give harsher punishments? What does the SEC need to do in order to ensure that the accounting principles and ethics are being followed? The information that was gathered for this report comes from the SEC, AICPA, and some sources which were obtained from the university library using key words and phrases like Corporate Fraud, Ethics for Accounting Professionals, Corporate Scandals, fraud, and ethics violations. What was found was that although the SOX Act started in 2002, the reality of the situation is that the number of corporate scandals has increased. One would think that with the U.S. Congress being at the foreground for reform of corporations would have the same information that I have for this research paper. I found it hard to believe, especially after all of the schooling, instructing, and previous research, that the number of corporate scandals has actually increased. I was completely flabbergasted by the research and immediately wanted to know what the SEC and other agencies were going to do to curb and stop this behavior. Research has shown that at the end of the first quarter of 2013, the SEC filed 85 legal proceedings. That is essentially thirty cases a month or one a day! How are these government agencies not angered over these statistics? And what gets me the most is the fact that these proceedings from the SEC are against the board of directors, accountants, auditors, and others. Isn’t this what SOX was supposed to stop? In today’s society, the public is uncertain about using the stock market to grow their retirement savings. The reason why investors don’t want to invest in the stock market is due to corporate scandals and fraud and are worried that their retirement savings will be taken to the cleaners much like Enron, WorldCom, and other various companies that no longer exist because of corporate fraud. Research shows that the public’s trust can be reclaimed if there is some assurance from the SEC and other governing bodies that they can take care of and eliminate accounting scandals. Research shows that with how vital accountants are to their organizations, accountants would have knowledge of any corporate schemes and the ability to end it and lower the number of corporate scandals. However, many accountants go along with the scandal due to several reasons. First, is pressure from upper management or managers which leads to concealing the scandal. Second, the accountant could feel that due to their loyalty to the company or management that they don’t want to go against either. And lastly, greed plays a part in which they go along with the scandal and profit from it. From the websites that have helped in the research phase of the paper, the AICPA and others accounting bodies have Code of Professional ethics for their memberships. These codes include how accountants should react when they find out or are presented with accounting scandals. For this topic, it would be recommended that the government agencies, such as the SEC, take a more forceful and authoritative approach to enforce policies, develop more suitable auditing standards to be followed, and to implement these changes in a way that would make the corporations think twice before deciding to do something like this. II. Fraud Introduction Accounting fraud in the U.S. has been as commonplace as everyday normal activities like eating breakfast or dinner. These scandals have stunned the American public and caused such a distrust in the accounting profession as a whole that it is going to take years of enforcing the laws to get the confidence back it once had. Because of how commonplace scandals are Americans are baffled by how that even after legislation has been enacted, that there continues to be scandals. As of March 29, 2016, the SEC has published sixty-three cases against culprits who commit criminal acts. These culprits include the board of directors of companies, accountants, and auditors. In recent years, the SEC has made numerous efforts to deter accounting fraud with the help of the PCAOB, ASB, and FASB. These accounting boards were originally created to protect investors but due to the increasing number of accounting frauds, the American people want the accounting standards and principles created to deter deceitful practices in favor of transparency and honesty. With that being said, FASB is working with IASB to help facilitate the adoption of the International Financial Reporting standards, or IFRS. It is believed that with the adoption of IFRS and moving away from U.S. GAAP, the accounting profession will be more in line with the rest of the world. Even with U.S. GAAP or the adoption of IFRS in the U.S., there is still the issue of unethical people in the corporate setting or accounting profession. Because of these unethical people, the number of accounting standards will continue to rise until something is done about them as well. One thing that the AICPA has done was issue a Code of Professional Conduct to its members to assist these professionals with situations that might come up and how to handle these situations. It could be something such as being pressured to do something unethical or just facing an unethical dilemma at work. Organizations such as the AICPA are trying to inform their members with rhetoric on how to handle situations, but the vast majority of accountants may not have access to that and with that being said, it should something that the SEC takes control of and disseminates it among the accountants and auditors. III. Review of Literature This research paper is determined to examine and hopefully solve two problems that stem from accounting fraud and corporate scandals. The first problem is that with the inception of the Sarbanes-Oxley Act of 2002, scandals are still common place to what was going on prior to 2002 and in some cases, worse than before. Scandals have stunned America, sent blows through the stock markets and has at times caused the American dollar to drop in value making other currencies stronger. The other problem that needs to be addressed and solved for is the need for accounting principles and standards to be updated. By updating the standards and principles that are the foundation of the accounting profession, these will in turn protect the interests of who this reform is needed for: creditors, investors, company employees, and anyone else who would have a hand in the pot with companies. By having updated standards and principles, investors should not have to worry about what corporations are doing with their money and public trust and positive perception of the accounting profession can be considered noble instead of being the forefront for all of the corporate scandals and accounting frauds. After some research and trying to find literature on scandals after the SOX Act, looking it up was easier than originally thought with the SEC litigation section on their website. It actually lists who the SEC is going after and by clicking into individual cases, one can see how much the dollar range of the fraud actually is. By observing this website, it shows that although the U.S. Congress helped pass the SOX Act, the number of corporate scandals are still growing and doesn’t seem to be slowly down at all. The website currently shows that through March 29th of 2016, that there were 63 cases opened this year alone (SEC, 2016). These dollar ranges for these cases are as little as $25,000 to multi-million dollar. In the article “The Role of Government in Corporate Governance”, the author confirms that there is a needed reform in the accounting standards and principles. The authors stated that in order for effective government action to be taken, there needs to be a reformed regulatory system, improved standards and principles, as well as law enforcement stepping up (Coglianese, 2012). To further support the claim that there needs to be a reform on the accounting standards and principles that are currently being used today, Mike Ng states that with the recent accounting and corporate scandals that have been happening, the faultfinders recommended that the U.S. adopt a principles based approach rather than the rules based one that we are using currently (Ng, 2004). By having multiple authors suggest that something like this needs to happen, that the accounting standards and principles need to be changed, means something. These authors wrote about this reform back in both 2004 and 2012. This was a couple of years after the SOX Act was passed and a decade after SOX. In that decade, it looks as though the cry for reform has fallen on deaf ears and that is something that needs to change if the U.S. wants the accounting profession to change for the better and to gain the trust of the American people back. The American Institute of Certified Public Accountants, or AICPA, website backs the theory that all accountants and auditors have the ability to stop the number of accounting frauds that are happening. The AICPA developed a Code of Professional Ethics which has been published and is located on their website. This Code has been provided to all of its members as a reference for all of the accountants who had to deal with a situation such as a corporate scandal (AICPA, 2016). With the AICPA giving literature to its members to ensure that the number of corporate or accounting scandals are brought down, then why are the numbers suggesting that they are increasing? The SEC publishes on their website who they are going to go after for these types of acts and yet the number of cases is increasing with minimal repercussions to the parties involved in the fraudulent activities. The AICPA is doing what they can to help out their members by providing guidance, but they are also trying to regain the public’s trust for the accounting profession as they are seen as the first people who could stop these scandals in the first place. Rendering to the AICPA website, the organization is calling for all of its accountants and auditors to have an “unswerving commitment to honorable behavior” even at the loss or sacrifice of having a personal advantage (AICPA, 2016). IV. Analysis Accounting and Corporate Scandals Based on when the data was pulled off of the SEC website, there has been sixty-three published cases opened this year as of March 29th, 2016 with more being updated daily. According to the SEC website, there has been 5,567 litigation complaints since the beginning of 2002 (SEC, 2016). The records of the SEC go all the way back to 1995 and shows by litigation release number, or LR, who the cases are against. Some of the cases are against one person companies, but there are corporations that are listed in these that have the “SEC Complaint” link for additional information. How is this broken down then? With 5,504 LR’s since 2002 to the end of 2015 (subtracting out the sixty-three from 5,567), that ends up being an average of 423 litigation complaints filed per year for the last 13 years. That ends up being 1.16 cases each and every single day! How is the federal government and SEC putting up with these statistics? One would think that if the number of cases decrease, then the SOX Act of 2002 did some good. However, the numbers have remained flat or increased since SOX has taken affect. It’s obvious that based on these numbers that the law isn’t working and that reform needs to happen. The perception of the accounting profession depends on the reform and the public is asking for it. What is also interesting to note about accounting fraud and corporate scandals is the rise of them. According to Patricia Galletta “… the 6% rise in fraud offenses from 2011 to 2012, and an additional 3% rise from 2012 to 2013, as reporting by the FBI’s National Incident-Based Reporting System” (Galletta, 2015). The rise in fraud cases year over year, can often revolves around civil law which only requires a misrepresentation of a material fact which the perpetrator knows to be false (Galletta, 2015). The author goes on to say that it’s not just one agency working together to detect fraud cases, but requires additional government agencies. For instance, in the cases of mail fraud, it requires the U.S. Postal Service to help detect the fraudulent activities. Most likely perpetrators know that if their fraud crosses over multiple agencies, that they have a better chance of getting away with it. This type of behavior needs to stop and the only way to stop fraud of this nature is to reform the accounting principles and standards and have more law enforcement power allocated to the different government agencies, not just the SEC. The question becomes, what is a corporate scheme and how is it defined. According to the research, a corporate scheme or fraud is defined as when “when there is hiding or twisting of financial information to seem strong and prosperous to employees, creditors, stockholders, and investors” (Evans, 2015). These schemes could include a few individuals or many individuals but depends on the extent to which these individuals are informed in the business practices of their company. These scandals, especially in the past with companies such as Enron, could include the auditors from the accounting firm there to audit the company or financial advisors and consultants. When companies commit fraudulent acts, it has shattering effects on everyone and everything. When companies such as Enron and WorldCom had their famous scandals become public, those companies were wiped out completely never to be heard from again (Giroux, 2008). These acts caused thousands of employees to lose their jobs as well as retirees to lose their pensions. Employees were investing their savings and retirement savings into company stock and when these companies went belly up, they lost everything. What is also devastating is the fact that billions of dollars were lost for investors in which they would never get their money back. The executives of these companies profited from these acts and ended up losing their livelihoods, but it doesn’t compare to the employees, retirees, and investors that lost everything due to the greed of the executives and their accounting firm Arthur Andersen. Effect of Scandals While researching for this topic, it was clear that the public had numerous debates on corporate governance to focus on how inadequate the accounting standards and principles were as well as the enforcement of them. There is a lot of talk about how employees lose their jobs and investors lose their money when the scandals become public and the companies cease to exist, but there is not a lot of mention about what the actual costs of a scandal were. In 2002, three authors of an article titled “Cooking the Books: The Cost to the Economy, set out to show the effects that corporate scandals have on the U.S. economy. In their article, they mentioned that since the 1960s, the public has been trusting their money more and more into the stock market, mutual funds, and other vehicles used for retirement accounts. In the report, almost 50% of households in the U.S. own some form of stock as opposed to 19% back in 1962. More than 21% of Americans placed their trust in mutual funds compared to 5% in 1990. “Mutual fund shares of 401(k) assets, were 44% percent of the total for 2001 compared to just 9% in 1990” (Graham, 2002). This is important to note because with all of that capital in companies’ 401(k) assets, if a scandal were to hit a prominent company, their employees would lose everything. Building the trust back up to the levels prior to the largest scandals on record in 2002, is going to take a serious undertaking to gain that trust back. Many people believe that scandals have caused the public to not trust accountants or auditors. There is also some considerable distrust with companies, especially with how public the executive suite’s salary, bonuses, and perks are. The SEC has attempted to deter scandals by collaborating with the Public Company Accounting Oversight Board or PCAOB, Auditing Standards Board or ASB, and the Financial Accounting Standards Board or FASB. These organizations were created to protect the interests of investors as well as employees and creditors. The U.S. are still looking for the adoption of a reformed accounting standards and principles that will put an end to the corporate corruption and greed. The American people still long for the adoption of accounting principles and standards that will deter corporate scandals. To quote Christopher Barker, the author of The $800 Trillion Scandal, “banking scandals have grown so common that perhaps folks have simply run out of outrage” (Barker, 2012). When Will There be Effective Accounting Principles and Standards? To reference back to the authors of The Role of Government in Corporate Governance, “The public outcry over the recent scandals has made it clear that the status quo is no longer acceptable: the public is demanding accountability and responsibility in corporate behavior” (Coglianese, 2012). To make this a reality, it is going to take more than just corporate management to reestablish public trust. In order to get this to happen, it will have to take strong legal action by the federal government to reform the accounting standards and principles, to improve auditing standards and procedures, and to bring up the law enforcement of this criminal acts. Although this somewhat happened back in 2002 with the passing of the Sarbanes-Oxley Act through Congress, in which it commanded new financial controls and reporting requests on publicly traded companies, it hasn’t had the desired effect that the public would have hoped. The Act was supposed to have the SEC become more of a self-regulated government administrator, but in essence, it created a lot of paperwork and not a lot of ability to prosecute offenders (Wilbanks, 2016). It seems as though with the quick passing of the Sarbanes-Oxley Act, it didn’t deter executives’ greed and it didn’t stop companies from committing fraud or cooking their books. What needs to be done are the accounting standards and principles to be reevaluated which is currently being done through the convergence process between FASB and IASB. This convergence process, since the early 2000s, is still going strong but there currently isn’t an end in sight on when the U.S. will adopt the new version of IFRS. In my opinion, this needs to happen sooner rather than later. As an investor and a registered voter, I would hope that there would be swift justice and punishment for offenders to the SOX Act. However, there doesn’t seem to be that effect and companies and litigation releases keep getting updated with more numbers. This needs to stop and reforming the current accounting standards and principles to IFRS would be a great first step. Are There Ethics in the Workplace? Since 2002, there have been almost 5,600 cases brought up on the SEC website which averages to be about 423 cases a year. With these numbers and with the SEC website that names the conspirators in these infractions or scandals, it shows that these cases are generally against an accounting professional in the form of either an accountant, executive board member, or an external auditor. Since the accountants and auditors make up the majority of the accounting professionals, it is sad to know that over 87% of the cases that the SEC publishes on their website name an accounting professional as a co-conspirator. That is almost 9 out of every 10 cases or roughly 368 cases a year. Where are ethics in the workplace? Apparently, they do not exist and ethics needs to be brought back into the business atmosphere and taught to the accounting profession. When it comes to accounting fraud or corporate scandals, auditors and accountants are the first ones to become aware that a scheme exist in the company. For example, we are going to go back to 2002 and discuss Enron and Arthur Andersen. In the article What Went Wrong by Giroux, Arthur Andersen knew the scheme was happening and didn’t do anything about it (Giroux, 2008). One would wonder why the outside auditing firm didn’t bring this to the attention of their management and prevent a company like Enron from going under. The simple answer was greed. Both Enron and Arthur Andersen executives were in on it and to bring that to light would have meant giving away the profits that they have made based on false information. Another reason as to why Arthur Andersen didn’t bring it up was revenue or market share. Arthur Andersen at the time was performing the audits for Enron as well as the consulting portion as well. This is a huge conflict of interest in which the auditors didn’t want to fault the consultants because it would mean less revenue coming into the company as a whole. So they decided to sweep it under the rug and essentially hope for the best. Arthur Andersen could have prevented the total collapse of Enron, but didn’t because they didn’t want to lose a valuable client. According to the AICPA website, “the principles call for an unswerving commitment to honorable behavior, even at the sacrifice of personal advantage” (AICPA, 2016). This means that the accountants and auditors should put their greed and power hungriness aside for the sake of performing their services for their clients in an honest way. By finding loopholes to save clients money on their taxes is not fraud in my opinion as anyone can go out and get a tax attorney to ensure that they are not overpaying on taxes. Finding a loophole, although some would say is morally wrong, it is not illegal by all means. When campaigners are running their negative ads on their opponents, they always have that they are not paying their fair share of taxes. But it’s not the opponent’s fault that they hired a great tax attorney to help them out and that is not illegal. There are way to help out your clients to save money on taxes or showing them the correct way to expense things to save them money. But doing it within the boundaries of how things should be done is the way that business should be conducted each and every single day. Ethics are the boundaries that define a person and a company’s character. Ethics should define the company as an organization and the message should be loud and clear: that the company will be ethical and will define the standards for the business and its employees to abide by. Where there is real skin in the game, such as employees and investors, the ethical standards that have been drafted and put in stone by the company should never be ignored and should never be broken. The point of establishing an ethical business is to not bend the rules for personal gain. Referring to the Code of Professional Conduct by the AICPA, accountants perform a vital role in society and business and have a responsibility to each other to maintain the public’s trust (AICPA, 2016). It is about time for accountants and auditors to seek the approval and trust of the public once again. After all of the scandals and all of the back office politics, it’s time to hatch out a plan and save the perception of what the public has of the accounting profession. A good start is to have individuals be certified in ethics and the accountants and auditors attend an ethics class to freshen up on subject matter. The accounting profession needs to do what they can to win back the trust and it’s not going to be done in one giant step but more likely in several steps over the course of several years to get the confidence back of the public. V. Recommendations Recommendations to go forward with would be to update and revise the current accounting standards and principles as the current ones are not working. This could be the opening that IFRS needs in order to obtain and maintain a foothold in the U.S. By having the same global standards as the rest of the world, the U.S. would have a better way to govern the accounting standards and principles. With all of the new cases coming on board from the SEC, there needs to be a clear cut way to prosecute offenders to deter this behavior. What also needs to happen is the SEC needs to have more authority when it comes to punishments and should be more than fines. Imprisonment is an option and something that would happen to normal citizens as oppose to the corporate suite that the executives have become accustomed to. Also recommended would be the AICPA and PCAOB to adopt rules that made it mandatory for its members to go to ethical classes annually and to develop a whistleblower policy to help end scandals in the accounting world. Something needs to be done to deter this behavior and by developing a more ethical base of accountants as well as developing an understanding for a whistleblower policy to help deter companies from scandals. By instilling these recommendations, the accounting profession can improve public trust and perceptions and lower the number of accounting scandals. VI. Summary Summary Within the obtained research, there was applicable information provided towards the topic of accounting fraud. The SEC publishes a website in which it lists out by defendants the number of litigation cases filed this year. As of the last date in which I looked it up, there were 63 cases and probably more have been added in the last 24 hours. In an economy that has passed the Sarbanes-Oxley Act, how can accounting fraud continue to happen? It’s been almost 15 years since the Act has been put into action and there seems to be more cases now then there were before. What needs to happen is change. There needs to be a change in the accounting standards and principles as they are not working, they are actually getting worse. After reading the Role of Government in Corporate Governance, it helped me shaped my opinion in which change needs to happen and change needs to happen soon. Corporations are continuing to do what they want and the articles and SEC website are proof that accounting fraud in corporations are still happening to this day. FASB needs to step up the convergence project with the IASB and make IFRS a reality for U.S. companies. Companies are following IFRS as it is currently, because of their entities overseas, and having a company file two different ways is not cost effective. The AICPA website has opened my eyes as well to how the accounting profession was supposed to go about their business. The AICPA published the responsibilities of the accounting profession as well as the Code of Professional ethics. The AICPA sees a need to inform its members that the scandalous accountants of the past need not apply to the future generations of accountants. That there needs to be a fresh start and that fresh start begins with ethics training and recurring ethics courses to keep the profession on task and to prevent future corruption and scandals. With these scandals still going and doesn’t show any light of them letting up, it is safe to say that the trust of the American people in the accounting profession has been dwindling at best. Since the beginning of 2002, the year in which the SOX Act was passed, the SEC’s list of litigations was up over 4,700 by the beginning of 2013. In the 12 years since the passing of the SOX Act, one would think that it would deter scandals, not heighten them up to almost 400 a year or 1.1 litigation cases a day! With these kinds of statistics, why would the American people have trust in the accounting profession? Due to previous accounting frauds, research has shown that these frauds don’t just impact the company. These frauds impact the employees, investors, creditors, and the economy as a whole. When companies go bankrupt, as most of the companies that have scandals do, the employees lose their job, their livelihoods, and pensions that they might have had for years until the scandal hit. To add to the employees losing everything, investors are impacted as well. The money that they put into the company is gone and could cause them to file for bankruptcy as well. And when corporate scandals happen, the economy feels the effects of it as well. The economy is affected by the unemployment rate rising, the American dollar decreases in value, stock markets drop as a reaction to the news, government spending is increased to bail out the corrupt actions of the few, and the public loses trust in accountants and auditors. To most investors, and the public at large, there have been petitions for a better principle based accounting system as well as better corporate governance to be had. Everyone wants a system that will protect their investments and interests and stop corporation corruption and scandals. These people want accountability of management and the accounting profession for the scandalous acts that they have done. They want the accounting standards and principles reformed, an improved auditing function, and increased law enforcement especially for ones that break the law. Many individuals believe that the corporate scandals and accounting fraud were committed by accountants and auditors. People believe that to be true because for the most part, accountants and auditors would be the first ones to uncover illegal schemes and be able to act on them. However, as the number of cases arise and the accounting profession taking bribes to produce numbers for a fee for management, the perception of the accounting profession is low. Accountants and auditors have the ability to become whistleblowers, but they decide to partake in the scandal and try to cover it up because they were either pressured to or paid to. The AICPA and other organizations have created for their members a Code of Professional Ethics to guide their members to do the right thing if they were to uncover these schemes. Although these codes have been created and dispersed to their members, it is up to the accountants and auditors to abide by them and help the SEC punish these culprits before it takes down the entire company. VII. Conclusion Conclusion To conclude on this topic, there are more than one way to skin a cat and believe that the SEC and other accounting authority bodies have better way to reduce, prevent, and eliminate accounting fraud as we know it today. It won’t happen overnight, but these agencies need to take a stand to ensure that corporations are doing their financial statements correctly to help elevate the growing concern that investors have. In the auditing world, accounting firms hold onto their auditors for extended periods of time because of possible relationships that have occurred between the client and auditor. By having auditors that the client is familiar with and trusts can increase the overall efficiency of the audit while the company continues to do what they need to do, grow their business. What could happen in these cases are conflicts of interest and when the auditors stick around a particular client and are offered a career at the company. These instances, although rare, is a conflict of interest as the auditor knows the firms policies and procedures and the client could exploit that for their own gain. Something that has happened numerous times for the course of history including Phar-Mor Inc. To get back to the topic of accounting fraud, but the auditor and client having this familiarity could cause the auditor to become unethical and accept bribes to keep their client pleased. Although the above scenario of the auditor and client should have been deterred from after the institution of Sarbanes-Oxley Act, it could still happen given that accounting fraud is still happening fourteen years after SOX was passed. What needs to happen is better accounting principles and standards. IFRS, something that the IASB and FASB have been working on for years, could be the answer, but only time will tell if the U.S. adopts it or not. With better accounting principles and standards, this could be a way to discourage accounting fraud. By reforming the regulatory system, providing better auditing standards and principles, and giving more authority to the SEC will not be the only way to deter accounting fraud. The people that perform these fraudulent acts will still need to go through some kind of ethics training as there are still very unethical people in the accounting profession as evident by the number of cases the SEC proceeds with annually. To add, in additional the updated standards, is the requirement that accountants should be required to take an annual ethical class. The hope is that with taking these annual classes that accountants will see ways to combat scandals and know exactly what to do when one presents itself to them. This in turn would lower the amount of SEC filings each year organically. Accountants need to win back the trust of the American people and investors worldwide. By regaining that trust in time would come some added benefits such as more clients for firms, better interactions between customers and accountants, as well as more trust in the system because it would be working. By decreasing the number of scandals and prosecuting the offenders to the highly degree will deter other corporations from doing something unethical. With time, the public will trust the stock market and the values that are being seen as well as more trust in the accounting profession and banks as a whole. VIII. References Bibliography AICPA American Institute of CPAs. (n.d.). Retrieved March 28, 2016, from ET Section 51-Preamble: