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Page 1 a. A rogue employee can be any employee that defrauds the company and does not follow the rules and guidelines put in place. This type of employee defrauds the company by attacking from within, causing financial and reputational damage (Biegelman, M. T. & Bartow, J.T., 2006, p. 8). Typical rogue employees are CEO’s, CFO’s, and COO’s. Although chief operators are mostly portrayed in the media, a rogue employee may be anyone in the company. Rouge employees do not care about the success of their company. Their main agenda is to cheat the company out of a successful growing business by stealing and defrauding. A new defense strategy has emerged for the resulting prosecutions of responsible corporate executives called the “Chutzpah Defense” (Biegelman, M. T., 2006, p. 8). This strategy is mainly about trying to lessen the punishment for the corporate fraudster. The notion that these corporate executives have no clue as to what is going on at their companies is the challenge for juries to figure out. Many corporate executives that have tried to use this type of defense have not been successful. b. Thomas A. Sebastian was the former CFO of an internet advertising agency named L 90, Inc. Since then, the name has been changed to MaxWorldwide, Inc. Between July 1999 and March 2002, Mr. Sebastian purposely inflated the company’s stock by providing false and misleading public statements regarding the company and its financial results. Sebastian admitted to his role in a conspiracy to generate fraudulent revenues for L90 to meet securities analysts' revenue estimates (Fraud Digest, 2008). His penalties for this fraud include 18 months of imprisonment, 9 months of home confinement, and $400,000 in lawsuit settlements. Other executives were involved and admitted their parts in this scheme also. Page 2 c. Dr. Donald Cressey developed the Fraud Theory Triangle to explain why people commit fraud which included three necessary and interrelated elements that must be together in order for a person to actually commit a fraud (Biegelman, M. T., 2006, p. 33). The first element in the fraud triangle is motive. In this element, greed seems to be most usual motive, but it also explains how a person feels pressure to commit fraud. Financial debts such as high utility bills can contribute to a person committing fraud. It can be a desire for material goods, a revenge or ego factor, or just a desire to beat the system. Motives can come in many forms and cause a person to have an emotion or desire reaction. The second element is opportunity. When a person perceives an opportunity to commit fraud and get away with it, the fraudster usually possesses general information and technical skills in their workplace. Employees may have access to documents and records or other information that would allow them to commit fraud. The third element is rationalization. People like to justify their fraudulent behavior by convincing themselves that committing fraud is okay. They may feel like the money is owed to them or deserved. Some even convince themselves that they’re only borrowing the money with the intent of paying it back. d. The “Tip of the Iceberg Theory” is the first detection of fraud and usually just the beginning of something much larger. An example of this theory is an insurance fraud case. Anonymous tips lead to an investigation which started off with claims for $8,000 and ended up revealing more than $500 million in inflated homeowner insurance claims (Biegelman, M. T., 2006, p. 37). Page 3 The “Potato Chip Theory” happens when a fraudulent activity becomes increasingly addictive and the employee is unable to stop. This notion is strongly supported by fraudsters getting away with the scheme and gaining confidence along the way. If they are not caught, most likely the scheme will continue. The “Rotten Apple Theory” comes from employees copying the frauds that they see upper-level employees committing. Upper management is supposed to lead by setting a good example of ethical behavior in an organization. If upper management does not follow rules and policies themselves, the employees under them can be influenced in a negative manner. The “Low-Hanging Fruit Theory” is when one commits a fraud over duration of time that is minor and low-risk. These types of frauds are usually simple and do not take a significant amount of investigative time (Biegelman, M. T., 2006, p. 39). If the fraudsters are not caught in the beginning, the situation can escalate into something far more serious. The “Addiction by Subtraction Theory” is having zero tolerance for fraud in an organization. A company needs to set an example when an employee at any level has defrauded them. It is in the company’s best interest to remove the fraudster before he or she can move up within the company and cause more damage. The “Fraudster as Employee Theory” is an employee who once upheld the company’s interests begins to commit fraud. These employees find weaknesses in the internal controls and exploit them to commit fraud (Biegelman, M. T., 2006, p. 40). There is no interest to caring about the growth and success of the company with these fraudsters. e. Cynthia Cooper was former Vice-President of Internal Audit for WorldCom. Her investigation uncovered $500 million in fraudulent computer expenses and led to the arrests and Page 4 convictions of several WorldCom executives. Whistle blowers have gained popularity over the years. In 2002, Time Magazine recognized Cynthia Cooper and other women for “Persons of the Year” for their commitment to disclosing corporate fraud (Biegelman, M. T., 2006, p. 68). Some frauds go undetected because employees fear by reporting it; they will encounter some sort of retaliation or discrimination. Whistle blowing is protected by the Sarbanes-Oxley Act of 2002 and it encourages employees to report misconduct within an organization without the fear of being discriminated against. f. COSO’s framework consists of guiding executive management and governance entities toward the establishment of more effective, efficient, and ethical business operations on a global basis (COSO, 2010). The organization believes that internal controls are an important component of a robust fraud prevention program and if adopted by a company, the system would promote efficient and effective operations, accurate financial reporting, and compliance with laws and regulations (Biegelman, M. T., 2006, p. 53). The COSO internal control program consists of five elements: control environment, risk assessment, control activities, information and communication, and monitoring. This means that management must be able to identify and deal with situations that could potentially lead to fraud. There should be a number of qualified internal auditors in an organization to assure that fraudulent financial reporting will be detected quickly and handled appropriately. The SEC should have an active role in requiring top executives and the chairman of the audit committee to sign off on annual reports so that shareholders can see certain responsibilities and activities within the organization. g. SAS 99 requires auditors to apply professional skepticism when doing their audits to ensure that the truth is found by having a questioning mind at all times (Biegelman, M. T., 2006, Page 5 p. 81). Auditors have multiple steps when attempting to discover fraud. They must obtain, identify, and assess fraud risks pertaining to SAS 99. To obtain the necessary information, an auditor must identify risks of material misstatement by inquiring with management about the risks of fraud and considering any other relevant information. Once the information is gathered, it must be used to identify risks that may result in a material misstatement due to fraud. The auditor should assess the identified risks by evaluating the company’s controls that address fraud matters. Auditors do not view themselves as being totally responsible for discovering fraudulent activities. Before the new standard, the auditor’s role was to find errors and irregularities in financial statements. Auditors now have the responsibility to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud (Biegelman, M. T., 2006, p. 57). Many auditors do not want to be apart of detecting fraud. On top of that, SAS 82 does not require auditors to be trained fraud examiners. h. Listed companies must be in compliance with the audit committee’s requirements mandated by the SOX Act of 2002. Some of the listings required suggest that board members be accountable to stockholders and provide independent review and oversight of the financial reporting process, internal controls, and independent auditors (Biegelman, M. T., 2006, p. 90). The New York Stock Exchange (NYSE) and NASDAQ have similar requirements, with NASDAQ having a few more. Both corporate governance rules are there to protect the interests of stockholders and a company’s financial reporting system. A financial expert should have extensive experience and knowledge in the financial field. They should have an understanding of generally accepted accounting principles (GAAP), Page 6 financial statements, and audit committee functions. They should also have experience with internal accounting controls and preparation or auditing of financial statements. A financial expert’s knowledge and experience should display these qualities as a member of the company’s audit committee. i. The PCAOB was created by the Sarbanes-Oxley Act (SOX) to be a strong and independent oversight body of the auditing of public companies by external auditors (Biegelman, M. T., 2006, p. 94). This organization protects the interests of investors by making sure that no one is in violation of SOX. Sections 102 through 105 of SOX pertain to the PCAOB which assist auditors in detecting violations. Theses sections require PCAOB to establish and conduct effective fraud prevention methods. Both U.S. and non-U.S. accounting firms are required to register with the PCAOB in order to prepare and issue audit reports of issuers (PCAOB, 2010). The organization has also established a hotline accepting tips, complaints, and other information that may lead discovering violations in a public accounting firm. j. The Key Provisions of the Audit Standard No. 2 provides greater guidance on Section 404 of SOX because it requires auditors to independently test the effectiveness of a company’s internal controls, not just evaluate them. Some of the provisions require auditors to evaluate management’s assessment, obtaining an understanding of internal control over financial reporting, identifying account and relevant assertions, testing operating effectiveness and evaluating the effectiveness of the design controls, and evaluating the results of testing. These are just some of the provisions in place to assist auditors with detecting and deterring fraud. There is much more work required of auditors when evaluating and testing the internal controls of an organization. Auditors have to identify, inquire, and evaluate fraud of any magnitude on the Page 7 part of senior management of a company (Biegelman, M. T., 2006, p. 96). This can be extremely costly once all of the auditor’s fees are accumulated. Although many companies are reporting stronger internal control programs as a result of these provisions, they feel that the cost of compliance exceeds the benefits. References Biegelman, M. T. & Bartow, J.T. (2006). Executive roadmap to fraud prevention and internal control: Creating a culture of compliance. (1st). Hoboken, NJ: John Wiley & Sons, Inc. COSO. (2010). About us. Retrieved on September 27, 2010 at http://www.coso.org/ Fraud Digest. (2008). Securities and Investments. Retrieved on September 27, 2010 at http://www.frauddigest.com/fraud.php'ident=2318 PCAOB. (2010). Registration and reporting. Retrieved on September 28, 2010 at http://pcaobus.org/Registration/Pages/default.aspx