Norwegian School of Economics and Business Administration Bergen June 2008 Master Thesis in the area of Business Analysis and Performance Management Greed at the Top: Fraud and the Failure of Oversight at Adelphia Communications Corporation and Tyco International Ltd By Therese Thoresen and Anita Rakstad Jakobsen Supervisor: Iris Stuart This thesis was written as a part of the masterprogram at NHH. Neither the institution, the advisor, nor the sensors are - through the approval of this thesis - responsible for neither the theories and methods used, nor results and conclusions drawn in this work. PREFACE This paper is a part of our “masterstudiet” on the Norwegian School of Economics and Business Administration. In the paper we examine the concept of fraud in relation to two contemporary business scandals. We focus on the scandals in Adelphia and Tyco to explore the concept of fraud. Accounting scandals like these have received major publicity in recent years. Because fraud persists as a threat to modern businesses it is important to study particular cases and explore how futures scandals may be prevented. We found this theme very interesting, and we chose to write our master thesis on these two major scandals. As we both start our careers in the same big audit firm, we chose to look at fraud from the auditor’s perspective. Many people may believe that the auditor has all the responsibility in discovering business fraud, but is this really the case? We ask: “What is the responsibility of the auditor, and who else shares the responsibility?” In writing our paper we have gathered information using several different sources including books, articles and the Internet. We thank our supervisor, Iris Stuart, for helping us with this paper. She has been a great help both in giving us ideas and giving us inspiration. We also thank Bruce Stuart for his help with this paper, especially with the English language. Bergen June 2008 Therese Thoresen Anita Rakstad Jakobsen 2 ABSTRACT In this paper we have taken a good look at the concept of fraud, using theory and examining frauds that have happened in two large companies. The main purpose of this paper was to gain insight on the concept of fraud, to see why fraud is committed and who has responsibility to prevent fraud. We have seriously considered the auditor’s job, to see what part he plays in preventing fraud. We have found that fraud is somewhat common in the business world and think it probably will continue to be a serious problem. In the beginning of this century several major accounting scandals were revealed. This publicity has prompted increased focus on the problem of business fraud. In response, a new regulatory framework is developed, we think that this framework is good, but it will likely not be sufficient to prevent fraud entirely. In this paper we have looked at fraud that involves management, thinking this kind of fraud is more difficult to prevent than fraud committed by employees. When management commits fraud, it is often committed by strong personalities. These persons are often very hard to stop with rules. If they have the desire to commit fraud, they can often find ways to break rules. The auditor has a certain responsibility to prevent fraud, but we have come to think that he can not be held responsible if he is doing his job properly. There are always many other people in position to detect fraud, employees and the Board of Directors. They can be good resources in the fight against fraud. We think that these parties can find support for their effort to prevent fraud, not only through formal structures of regulations but also from increased awareness of how to recognize circumstances that give opportunity for fraudulent actions. 3 TABLE OF CONTENTS PREFACE .............................................................................................................................................................. 1 ABSTRACT ........................................................................................................................................................... 3 TABLE OF CONTENTS ...................................................................................................................................... 4 INTRODUCTION ................................................................................................................................................. 6 ABOUT THE FRAUDS ........................................................................................................................................ 8 ADELPHIA COMMUNICATIONS CORPORATION ................................................................................................... 10 About the company ...................................................................................................................................... 10 About the fraud ............................................................................................................................................ 11 TYCO INTERNATIONAL LTD .............................................................................................................................. 14 About the company ...................................................................................................................................... 14 About the fraud ............................................................................................................................................ 15 FRAUD................................................................................................................................................................. 21 WHY STUDY FRAUD .......................................................................................................................................... 21 THE INTERNATIONAL STANDARDS ON AUDITING’S DEFINITION OF FRAUD ....................................................... 23 DIFFERENT TYPES OF FRAUD ............................................................................................................................. 23 “THE FRAUD TRIANGLE” ................................................................................................................................... 24 Perceived pressure ...................................................................................................................................... 25 Rationalization ............................................................................................................................................ 29 Opportunity.................................................................................................................................................. 30 PEOPLE WHO COMMIT FRAUD ............................................................................................................................ 34 THE FRAUD IN ADELPHIA AND TYCO ...................................................................................................... 35 THE FRAUD IN ADELPHIA .................................................................................................................................. 35 The fraud committed on behalf of the company ........................................................................................... 35 The fraud committed against the company .................................................................................................. 38 THE FRAUD IN TYCO ......................................................................................................................................... 42 THE PEOPLE BEHIND THE FRAUDS .......................................................................................................... 45 JOHN RIGAS ...................................................................................................................................................... 45 DENNIS KOZLOWSKI ......................................................................................................................................... 48 THE AUDITORS’ PLACE IN THE FRAUDS ................................................................................................ 53 THE AUDITOR’S RESPONSIBILITY ....................................................................................................................... 53 International Standards on Auditing 240 .................................................................................................... 54 General Accepted Auditing Standards ......................................................................................................... 59 ADELPHIA AND DELOITTE & TOUCHE ............................................................................................................... 60 TYCO AND PRICEWATERHOUSECOOPERS .......................................................................................................... 62 OTHER PEOPLE IN THE COMPANY ........................................................................................................... 66 THE BOARD OF DIRECTORS ............................................................................................................................... 68 The Board of Directors in Adelphia ............................................................................................................ 68 The Board of Directors in Tyco ................................................................................................................... 70 RISK AND THE CONFLICT OF INTEREST ...............................................................................................