Hollywood Sparkles with 13th Annual Fraud Conference & Trade Show

Global fraud examiners learn the latest fraud examination techniques and theory, network with their peers, and cruise down the Sunset Strip. 

The stars were shining in Tinseltown as the ACFE presented the 13th Annual Fraud Conference & Trade Show Aug. 4-9 at the Renaissance Hollywood Hotel.

Attendees had a choice of 40 breakout sessions within 10 tracks. During a working lunch, special guest speaker Sherron Watkins described her efforts to warn Enron's top management of the impending disaster. During a general session, Regent J. Scott Newton, J.D., CFE, presented a legal update on new laws affecting fraud examiners. And during the second working lunch, former embezzler John Everroad Jr. described his crime and continuing rehabilitation.

Mary Jo White, partner in the law firm of Debevoise & Plimpton in New York City, and former U.S. attorney for the Southern District of New York, received the Donald R. Cressey Award.

Retiring ACFE President Gil Geis, Ph.D., CFE, one of the first Association leaders, was honored for his 10 years of service. Geis is professor emeritus of the Department of Criminology, Law and Society, School of Social Ecology at the University of California at Irvine.

Toby J.F. Bishop, CFE, CPA, FCA, the new ACFE President and CEO, presented four key areas of focus for the Association: 1) global membership growth; 2) enhancing the value of membership; 3) expanding fraud education outreach to university students and the business community; and 4) enhancing the infrastructure of the Association to better support members and chapters.

The Association presented the first annual Outstanding Achievement Awards to the CFE of the Year, Associate Member of the Year, and Outstanding International Member, as well as Chapter of the Year and Newsletter of the Year. Outstanding achievement was also recognized in Outreach/Community Service, Accounting, Anti-Fraud Education, Commerce, Government, and Law Enforcement.

Attendees visited a diverse group of fraud examination-related vendors during the accompanying trade show. Prior to the Main Conference, anti-fraud practitioners learned about the identification, investigation, and prevention of identity fraud during the Pre-Conference.

Joseph T. Wells, CFE, CPA, founder and Chairman of the Association, announced the pending establishment of the Institute for Fraud Studies (IFS) at the University of Texas at Austin.

"Through a combination of donations and grants, the ACFE and other organizations, including the American Institute of CPAs will be funding original research in fraud, looking for solutions to a dilemma that threatens all of us," Wells said.

At the end of the year, the ACFE will begin a four-hour, online anti-fraud education course for accountants worldwide at a nominal price. "There are currently about a half a million CPAs in the United States," he said. "I feel confident in guessing that at least 400,000 of them have never had any anti-fraud education at all."

Wells also updated the Association's higher education program, which provides free materials and support to any institution of higher learning if it agrees to offer a principles of fraud examination course.

"Twelve months ago, only 19 colleges out of nearly 900 provided any kind of dedicated anti-fraud education for their accounting students," Wells said. "Now nearly a third of all accounting schools have expressed an interest in offering a fraud examination course." He said more than 50 colleges were rushing to schedule a fraud examination course at the beginning of the fall semester.

Cressey Award Winner, Mary Jo White, says Rationalization Contributed to 1990s' Fraud 

The Roaring '90s was a decade of blind rationalization that led to excess and fraud, said 2002 Cressey Award winner Mary Jo White at the 13th Annual Fraud Conference & Trade Show.

"I would wager that, nearly to a person, each of the CEOs and CFOs who today find themselves in the SEC's and prosecutors' gun sights," White said during her acceptance speech, "would say and mean that they didn't think they had done anything fraudulent or criminal - they followed GAAP, their accountants okayed it, they were doing what they were doing for the benefit of the shareholders, for the price of their company's stock."

White said the executives at the companies that committed fraud, engaged in "group rationalization" - an extrapolation of the third leg of the renowned fraud triangle developed by Dr. Cressey. "The accountants would say they raised all the right questions and yes, the accounting may have been aggressive, but it was permitted under the rules as a technical matter. Blame it on the rules. Stock analysts and many investors bear responsibility too - they knew better than to believe the astronomically rosy numbers. …"

White said that many forgot the cardinal rules on transparency, basic honesty, and the level playing field. She said that financial statements can conform to every technical rule and be accompanied by clean audit opinions. "But if they don't paint a true and understandable picture of the actual financial condition of a company, they can be materially misleading and fraudulent," White said.

"We need companies and their executives to screw on that moral compass that must underlie and guide American capitalism," she said. "Only then can we address this epidemic of fraud, restore investor confidence, and learn the lessons we must learn from the current scandals."

She said that those who don't learn the lessons must be found, removed, and replaced by those who value good corporate governance and ethics, and state-of-the-art fraud detection and prevention programs. "Those we put and keep in charge need to understand, in the tradition of Donald Cressey, the frailty of the human nature of the white-collar employee or executive and to design the workplace and the incentives and disincentives (financial and otherwise) that will maximize - not impossibly tempt - the white-collar human nature on which we depend for honesty and trust," she said.

White, who has bachelor's and master's degrees in psychology, said it is critical to understand the psychology of the recent scandals if we are to learn from them. "We should not settle for any seemingly easy answers we hope to be supplied from the outside, by a dramatic arrest or two or a new SEC rule or piece of hastily passed legislation," she said.

White chairs the 150-lawyer litigation group of Debevoise & Plimpton of New York, N.Y. Her practice concentrates on internal investigations and defense of companies and individuals accused by the government of involvement in white-collar or corporate crime or civil securities law violations, and on other major business litigation disputes and crises.

From 1993 through January of 2002, she served as the U.S. attorney for the Southern District of New York. She was the first chairperson of Attorney General Janet Reno's Advisory Committee of United States Attorneys and was named to The National Law Journal's 2002 list of Top 10 Women Litigators.

Sherron Watkins Chides not Just Enron Management but Watchdog Entities 

Sherron Watkins, the Enron executive who tried to warn top management of the impending doom, said the collapse came not only from the company's dishonesty but the failure of watchdog entities that are in business to protect investors.

"The financial accounting system has become too rule-based and not principle-based," she said during her keynote address at the 13th Annual Fraud Conference & Trade Show. "Companies feel like they are justified in reporting results by finding a set of accounting rules that they think works … (and) applying those rules even if there is no resemblance to the financial condition of the company or to the operations of the company. The idea that a set of financial statements is supposed to fairly represent the condition of the company appears to have gone out the window."

She said the majority of investment analysts had ranked Enron as a "buy" as late as October 2001. "The analysts' glowing reports on Enron were clearly not objective," she said. "They appeared to be severely conflicted by the investment banking fees that their sister operations were receiving."

Watkins said a simple review of Enron's annual and quarterly reports would have highlighted some glaring problems. Enron's cash flow, she said, was incredibly spotty. "Enron was making approximately $250 million a quarter in net income in 2000," she said. "If you look at the quarterly filings, first quarter's cash flow from operations was generally negative; second would be slightly negative or break even; third quarter, there might be about $100 million positive cash flow from operations; fourth quarter, miraculously, $3 billion."

She said those figures show a strong indication of pre-pays, structured finance deals, and manipulated cash flow from operations. "For the six months of 2001, Enron had positive earnings of over $800 million and negative cash flow from operations of $1.3 billion. Now why weren't those analysts screaming about those financial statistics?"

Watkins' questions began in mid-2001 when she accepted a job working for Enron CFO Andrew Fastow after spending nearly eight years with the company. Her new job was to prioritize Enron's efforts at selling assets.

She found that a number of assets were hedged with an entity named Raptor. "Any assets that were hedged should have a locked-in sales value for Enron. But despite the fact that the market values for these investments had fallen significantly below book value, that should have been no consequence to Enron. Enron should have realized the hedge price that it had with Raptor," she said.

The Raptor special purpose entities were subsidiaries of the now infamous LJM partnership managed by Fastow. Watkins said she found certain losses that had been incurred by Raptor were actually coming back to Enron and being borne by the company. "The general explanation I received from the business units was that the Enron stock that had been used to capitalize the Raptor structures had declined in value such that Raptor was going to have a shortfall and was not going to have enough capital or cash to meet the hedging obligations with Enron," she said.

Watkins said she never heard reassuring answers when she asked about the outside capital that was invested in Raptor. "Basically, I couldn't find any outside capital," she said. "I was highly alarmed by this fact. My understanding from being an accountant 10 years prior to this was that a company could never directly generate a gain or in Enron's case directly avoid a loss by using its own stock. I just couldn't imagine that accounting rules had gotten that creative."

In an initial one-page, anonymous letter to CEO Kenneth Lay, who had stepped back into that position after Jeffrey Skilling's abrupt resignation, she said that Skilling had "looked down the road, knew that the Raptor stuff was unfixable and would rather abandon ship now than resign in shame in two to three years," she said.

Within a week she was talking face-to-face with Lay. "My main point to Ken Lay was that by this time these Raptor structures owed Enron in excess of $700 million," she said. "These Raptor entities had no other business except the hedges with Enron. Therefore they were not going to be gains anywhere else to offset this."

These Raptor entities basically had an unrealized accumulated loss of $700 million, she said, that was going to be paid out in the next year or two. She said she urged Lay to find out who had lost the money. "If it turns out that it's going to be borne by Enron shareholders from an issuance of shares in the future then I thought that we had a very, very large problem on our hands," she said.

After meeting with Lay, she believed that he would form an investigative body and a crisis management team. However, that didn't happen and no other top executives supported her, she said. In public they said they relied on Enron's accounting firm Arthur Andersen but "behind closed doors and around the water cooler they were whispering that it was very wrong but they did not say so to his (Lay's) face," Watkins said.

Enron and its team of investigative attorneys concluded that nothing was amiss, the accounting was completed appropriately, and the only problem was that the "optics" were not good right now, she said. "Well, they decided to 'unwind' these transactions in the third quarter of last year. That unwind caused about (after taxes) a $540 million hit to the income statement but it also reversed $1.2 billion of shareholders' equity," Watkins said. "That started Enron's free fall, which ended in bankruptcy just a scant six weeks after first announcing the unwinding of the Raptor transactions."

She said that some have argued that the capitalist system worked because Enron was caught in the act of representing less than honest financial results and they were punished. "But that doesn't quite hold water for me," she said. "We have laws and regulations in place that are supposed to stop abuses before they occur. We do need protection for the rank-and-file employees. For the average investors."

Enron laid off 4,000 employees without any severance just three weeks before Christmas, she said. Many more employees lost virtually all their retirement savings and overall investors lost more than $60 billion in less than two years. "Enron went bankrupt without ever declaring or having a poor quarter relative to recurring earnings," Watkins said.

"To report misleading financial results is dishonest and amounts to nothing less than theft," she said. "There can be no successful capitalistic system without trust. With very few exceptions - carnival games, some used-car salesmen - we do expect honesty in our everyday dealings. We have to have faith that our business leaders strive to be ethical. That they are trying to comply with existing laws and regulations in spirit and substance and not just form."

Watkins referred to a Washington Post column by E.J. Dionne in which he quoted James Madison from the Federalist Papers: "If men were angels, no government would be necessary."

"Dionne pointed out that if capitalists were angels we could deregulate everything," she said. "Clearly capitalists aren't angels. I don't think we ever thought they would be. But it's unfortunate that we have to put some teeth back into governmental oversight to restore confidence into the system and weed out the negative influence from the group. We must not lose this opportunity to ensure that appropriate safeguards are in place so that we can all feel comfortable investing our hard-earned dollars in this country's equity marketplace."

J. Scott Newton Reviews New Laws Regarding Terrorism, Identity Theft, Corporate Fraud 

Regent J. Scott Newton, J.D., CFE, said that laws regulating fraud have changed markedly since 9-11, and because of the recent burgeoning of identity theft, and the spate of large corporate collapses.

"The battleground on the war on terrorism is where we operate," Newton said during the 13th Annual Fraud Conference & Trade Show. "Terrorists operate on money, which we can trace, and they operate in hate, which can make them careless. Sometimes in this new war there will be moments of great excitement. But more often than not it will be won on the financial battlefields by people just like us. By those who follow the money."

He said the new USA Patriot Act addresses terrorism by making it easier for government agencies to share information among themselves and foreign governments. The act gives the U.S. government enhanced surveillance powers, nationwide search warrants, strengthened money laundering laws, and expanded FBI eavesdropping capabilities, among other provisions, Newton said.

The act also grants new authority to obtain private information from banks, employers, and universities about any suspected terrorist, he said, but it has generated controversy because of its new broad powers.

Terrorists have stolen or illegally obtained Social Security numbers to commit financial thefts, violate immigration laws, and to flee the criminal justice system, he said. "As unlikely as it may seem," Newton said, "an obscure fraud statute has emerged as a highly effective tool in the domestic was on terrorism. Since Sept. 11, federal prosecutors in several districts have used 42 USC 408 to charge and detain individuals suspected of engaging in or supporting terrorist activities or have misused or misrepresented a Social Security number." That statute makes it a crime to "willingly, and with an attempt to deceive, to falsely represent, or knowingly alter or counterfeit a Social Security card," he said.

"Identity theft is the fastest growing crime in America," Newton said. "The Federal Trade Commission estimates that 700,000 people a year are victims to identity theft. … The Aggravated Identity Theft statute was passed this year. The statute adds a two-year enhancement to any federal crime conviction and five years if it relates to terrorism."

Other bills related to identity theft include one that would establish a commission for the comprehensive study of privacy protection; another that would prohibit the display, sale, and purchase of Social Security numbers; and another that would provide for the disclosure of identities of individuals using another person's Social Security number to file tax returns, Newton said. The Privacy Act of 2001 requires consent of an individual prior to the sale and marketing of the individual's personally identifiable information, he said.

"The new Public Company Accounting Reform and Investor Protection Act … is indispensable though not by itself an insufficient step to restore consumer confidence in our markets," Newton said. "Among other things, it establishes a strong independent board overseen by the Securities and Exchange Commission to oversee auditors of public companies."

Newton also mentioned the White-Collar Criminal Enhancement Act, which increases the criminal penalties from five years to 20 years for securities fraud violations and the Corporate and Criminal Fraud Accountability Act, which involves the destruction of records.

"The role of the fraud examiner has never been more important," Newton said. "As we look to tomorrow we do so with optimism and pride. Optimism, because you are protecting the public trust. And pride, because you are the best in the world in what you do."

Convicted Embezzler says Most Commit Fraud not Because of Financial Difficulties but for 'Fun' 

Most people commit fraud not because they have financial needs but because they simply enjoy it, said convicted embezzler John Everroad Jr. during the 13th Annual Fraud Conference & Trade Show.

"It's fun to find a person whom you perceive to be stupid and if they are stupid they deserve to be robbed," Everroad said. "You can talk about all of your reasons … yes, there are people whose homes are going into foreclosure. There are people who have credit card debt running out of their ears and yes, they will take money to try and solve those problems. But I really believe the worst-case scenario is a person who simply has fun doing it. 'To hell with the money; let's look at their faces and stab them in the back.' "

Everroad described the fraudster's modus operandi: "You find those weak spots, you develop a plan, you strike, and then you put distance between the strike and the current time and then you disappear.

"You look for the person (in a company) who has absolute blind trust. It's a hunt. You operate with two personalities: the personality that you are and the personality you want people to think you are," he said. "And you know when you're on that hunt, you wait, you commit the crime, and then you go home and move on to the next hunt."

"Employment decisions that I have made in the past have been at times based upon where I thought a crime could be committed," Everroad said. "There actually is a seeking-out process by the criminal. If you know accounting it's fairly easy to walk into a business and do a quick scan of the inventory, the physical assets."

He said fraudsters look for businesses that use small auditing firms staffed with young, overworked employees. "These auditors run into the company they're auditing, grab this stuff, put it in their briefcases, bring it back to their office, and bring it back in worse shape than when they took it," he said.

As an accountant in Nebraska, Everroad embezzled $300,000 in the last part of 1998 from the company for which he worked, its bank, and his own bank. "It wasn't a real innovative crime," he said. "It was just a typical check kiting between company accounts and personal accounts. I wrote $1.5 million in checks to myself and about $1.2 million back to the company. Over that period I just pilfered the difference."

He said the company's healthy cash flow allowed him to take a good deal of money without notice. The fraud detection unit of the company's bank detected suspicious activity on certain transactions, began observing the account, and eventually contacted Everroad's company.

Everroad was charged, convicted of embezzlement, and sentenced to three to eight years in the Nebraska state penitentiary. He served 18 months and was on parole when he addressed the conference attendees. Everroad works as a night audit clerk at a Marriott hotel in Omaha, Neb. "I'm very grateful to them for hiring me," he said. "Obviously, a money crime is something that's very difficult to live down. … When someone comes to the front desk at the hotel and asks for me, the employees usually laugh and ask if they have a badge."