July 1999 Volume 68 Number 7 United States Department of Justice Federal Bureau of Investigation Washington, DC 20535-0001 Louis J. Freeh Director Features Contributors' opinions and statements should not be considered an endorsement by the FBI for any policy, program, or service. The CPA’s Role in CPA firms and law enforcement agencies can develop a liaison to detect The Attorney General has Detecting and Preventing Fraud 1 determined that the publication and prevent financial crimes. of this periodical is necessary in By Keith Slotter the transaction of the public business required by law. Use of funds for printing this periodical Drug Labs and Parents who manufacture has been approved by the Endangered Children methamphetamine place their children in Director of the Office of 10 grave danger and create great Management and Budget. By Tom Manning difficulties for law enforcement officers. The FBI Law Enforcement Bulletin (ISSN-0014-5688) is As more police departments move published monthly by the Police Training in Federal Bureau of Investigation, the 21st Century toward community policing, their training 935 Pennsylvania Avenue, 16 curricula and methods must keep pace. N.W., Washington, D.C. By Michael L. Birzer 20535-0001. Periodical postage paid at Washington, D.C., and additional mailing offices. Placing the Stockholm The development of relationships Postmaster: Send address changes to Editor, FBI Law Syndrome in Perspective between hostages and their captors is Enforcement Bulletin, FBI 22 not a common phenomenon. Academy, Madison Building, By G. Dwayne Fuselier Room 209, Quantico, VA 22135. Editor The Motor Vehicle Exception The motor vehicle exception is a John E. Ott By Lisa A. Regini powerful tool officers may use to search 26 a vehicle without a warrant provided Managing Editor Kim Waggoner they have probable cause. Associate Editors Glen Bartolomei Cynthia L. Lewis Bunny S. Morris Departments Art Director Brian K. Parnell Assistant Art Director 7 Police Practice 20 Bulletin Reports Denise K. Bennett Operation Linebacker Underage Drinking Staff Assistant Linda W. Szumilo Software for Local Surveys 15 Book Review Street Gang Survey Internet Address Crime in the Digital Age Youth Drug Abuse [email protected] Send article submissions to Editor, FBI Law Enforcement Bulletin, FBI Academy, Madison Building, Room 209, Quantico, VA 22135. ISSN 0014-5688 USPS 383-310 Investigative Assets The CPA’s Role in Detecting and Preventing Fraud By KEITH SLOTTER raud and abuse cost U.S. employers an average of $9 F a day per employee, totaling in excess of $400 billion in fraud loss to domestic organizations. Me- dian losses committed by execu- tives represent 16 times more dam- age than those committed by their employees, and the most costly abuses occur in companies with fewer than 100 employees.1 These statistics confirm what law enforce- ment authorities have known for years—companies lose billions of dollars to fraud annually, much of it perpetrated against corporate America. During the past decade, however, those in the financial community, particularly within the accounting profession, viewed this information with both interest and dismay. In fact, the level of fraud © PhotoDisc and, perhaps more important, pub- lic outcry compelled certified pub- THE TRADITIONAL company’s financial statements— lic accountants (CPAs) to alter the AUDITOR the auditors never specifically ad- way they conduct business and Historically, auditors mainly dressed the issue of fraud. Most au- make the search for fraud a speci- have reviewed financial statements dits resulted in a clean opinion of fic requirement in each audit en- to form an opinion concerning the the veracity of the client’s financial gagement. These changes present accuracy of a company’s repre- report. If auditors detected material new opportunities for law enforce- sented financial position. In order to problems and corporate manage- ment to work with the accounting render this opinion, auditors con- ment refused to take proper action, community in detecting, prevent- structed an audit plan to conduct the CPA firm simply withdrew from ing, and investigating a myriad of tests of company records and trans- the assignment. Subsequently, the financial crimes long before compa- actions. In the past, this plan out- company passed the job to another nies report such frauds for criminal lined procedures used to search firm that either did not conduct as investigation, if they report them at for possible errors and irregular- diligent an audit or employed a all. ities that materially impacted a “more creative” approach. July 1999 / 1 but only provided illusory assur- ance and offered little guidance as Fraud presents to the exact requirements of the “ a daunting CPA or how to detect errors or ir- challenge to regularities. In 1997, after consult- today’s ing with various law enforcement business and investigative agencies, the executives. AICPA deleted the phrase “errors and irregularities” from its auditing standards and finally used the term “fraud.” As a result, CPA firms now must plan their audits to detect and Special Agent Slotter serves in the FBI’s ” report material fraud to company New Haven, Connecticut, field office. management. Since the enactment of this statement on auditing standards, CPAs have discovered new client/ service opportunities, and many The failure of the Penn Square charges of negligence. The typical larger firms have established inves- Bank of Oklahoma City in 1982 large firm spent over 12 percent of tigative services divisions. These marked a new era in financial insti- its revenues on defense litigation.3 organizations often employ retired tution fraud. The severity of this The Big Six4 accounting firms be- law enforcement personnel, assist failure forever influenced the ac- gan dropping clients at a rate of 50 clients in preventing fraud, and counting profession and the way in to 100 per year. Despite implement- weigh options at the discovery of which auditors conduct financial re- ing lower risk strategies, the ac- an embezzlement. Additionally, views. As greedy bank officers used counting profession, as a whole, un- several of the Big Six accounting the banks they controlled as their derstood that for every firm that firms conduct periodic fraud sur- own treasure troves for personal en- dropped a client, 20 more firms veys to determine the current white- richment at the public’s expense, stood ready to step in and replace collar crime climate and future po- over 1,000 financial institutions that one. CPAs became inundated tential for fraud throughout various failed in the United States. The sav- with a barrage of lawsuits claiming industries. Of note, 75 percent of all ings and loan crisis rocked the negligent conduct and oversight. U.S. companies surveyed incur at United States and cost taxpayers The industry began to look for ways least one incident of fraud each over $200 billion, more than the to reduce risk and enhance law en- year, and nearly half sustain five or amount spent on the Vietnam war.2 forcement cooperation. more occurrences. The average After the dust cleared, the fin- fraud totals over $200,000 in losses gers of disgruntled investors, stock- SETTING NEW to the victim company. Interest- holders, and industry experts STANDARDS ingly, although 76 percent of man- pointed directly at CPAs across the Due to this unpredictable and agers believe that fraud has become nation and deemed them derelict in litigious economic climate, the a major problem in society today, their duties to both their clients and American Institute of Certified only 38 percent believe that fraud the public. How could failed institu- Public Accountants (AICPA) began represents a significant problem for tions have received clean bills of reviewing the changing role of the their companies.6 health just months prior to financial CPA. In 1989, the AICPA ad- In a recent international fraud collapse? CPA firms across the dressed the client’s expectations survey, 28 corporate respondents country found themselves in civil regarding the auditor’s responsibil- indicated that they each had lost court defending their reputations on ity to detect fraud during an audit5 over $25 million to fraud during the 2 / FBI Law Enforcement Bulletin last 5 years with 50 percent of that accounting personnel to testify. fraud matter, not just because of amount lost in the previous twelve Previously, only corporate man- client confidentiality issues, but months. Additionally, the report re- agement, pursuant to engaging an rather because they are unsure of vealed that employees committed independent auditor to perform how to proceed. The criminal inves- 84 percent of the most significant a specified fraud audit, made tigator usually initiates liaison with frauds. Almost half of those em- referrals to law enforcement local accountants to establish rap- ployees had been with the company agencies concerning material port and areas of commonality for over 5 years. Discouragingly, criminal misconduct. Today, how- where both professions can benefit. only 13 percent of all fraud losses ever, companies should establish For instance, although CPAs rarely were recovered, including insur- investigative guidelines for the refer suspected fraud to law en- ance recoveries.7 Regarding handling and reporting of fraud forcement without client consent, cyberfraud, fewer than 25 percent allegations. officers can encourage them to rec- of responding companies included a ommend this course of action to computer fraud vulnerability as- their clients based on the likelihood sessment in their year 2000 strate- of success, improved chances of re- gic plans. Only 1 in 10 respondents covering funds, and greater deter- believed adequate internal controls The savings and loan rence factors. In turn, law enforce- were in place to prevent computer ment offers assistance with training hacking.8 crisis rocked the public and private accountants in Fraud presents a daunting United States and fraud detection techniques, current challenge to today’s business “cost taxpayers over crime trends, and frauds to which executives.