Financial Statement Fraud in the Katrina Aftermath

A Whirlwind of Opportunities

By Tracy L. Coenen, CFE, CPA

Hurricane Katrina has caused more than 1,300 deaths, destroyed thousands of homes, and scattered the populace of half of New Orleans throughout the country. And some have estimated that up to 50 percent affected by the storm will experience varying degrees of post-traumatic stress. Lives have been altered permanently.

The hurricane also has devastated thousands of companies and eliminated jobs. But for other firms it has created opportunities to enhance their financial statements. All too often, management feels a certain sort of market pressure that pulls them into financial statement fraud. What sometimes starts as aggressive accounting treatment to "fix" a quarter that fell short of expectations can quickly snowball into long-term, large-scale fraud.

Consider the situation of Waste Management Inc. The U.S. Securities and Exchange Commission (SEC) determined that from 1992 through 1997, management officials participated in a systematic scheme to falsify the company's financial results.

Their actions caused expenses to be underreported, which increased net income by $1.7 billion. Quarterly financial statements were adjusted to align Waste Management's results with predetermined earnings targets. By meeting earnings targets, management received performance-based bonuses and valuable stock options.

Financial statement frauds following the devastation created by Hurricane Katrina will be no different. While the underlying motive may be a bit different, the results will still be the same. Earnings will be "enhanced" or "managed" to temper the negative financial effects of the natural disaster.

The risk of fraud may be greatest in the industries that were hardest hit by Katrina: shipping, tourism, gambling, and fishing. The more obvious frauds will include those committed by contractors and insurance policyholders who overstate cleanup and repair costs. The less obvious situations, however, relate to financial statement manipulation following the hurricane.

The opportunities abound for financial statement fraud yet no obvious cases of this type of fraud have been publicized. Is this because it hasn't happened? Or could it be that auditors are more sympathetic to their clients as victims of natural disasters? Has the hardship of it all caused the financial watchdogs to take a softer approach to the business of auditing?




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