Financial Statement Fraud


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  • Financial Statement Fraud

    1. 1. FINANCIAL STATEMENT FRAUD 16 November 2013
    2. 2. About me • 17+ years in project appraisal, audit, financial due diligence, financial feasibility, valuation and real estate finance • 15 years in the Middle east- Oman, Bahrain and now Dubai • KPMG, Ernst & Young, Nakheel, Gulf Finance House • Teaching advanced finance and accounting courses since 1996 • Chartered Accountant and a CFA charterholder 2
    3. 3. Genesis • Market leader in CFA preparatory courses in the GCC • Largest prep provider for all levels of CFA in the Lower Gulf • Diverse product portfolio of Bespoke Training and Executive Education • Trained 2,000+ finance professionals till date 3
    5. 5. The “Fraud Triangle” Incentives or Pressures Three conditions that are present when accounting fraud occurs Opportunities Rationalization 5
    7. 7. Hall of Shame COMPANY YEAR 1998 ISSUES IMPACT (USD) Inflated revenue 550 Million over 3 years Treated lease as sales between 1997-2000 2000 1.5 Billion 1999-2001 Channel stuffing Restatement of P&L by 1.5 billion 1998-1999 Inflated revenue by double counting license fees from unrecognised portion of existing contracts& full on new contracts 500 million
    8. 8. Hall of Shame COMPANY YEAR ISSUES IMPACT(USD) 20002001 Inflated advertising revenue by booking banner deals & ads it sold on behalf of others as its own NA 2002 Improperly booked construction cost overruns as revenue before clients agreed to pay them NA 2002 Executed round trip deals by trading subsidiaries to artificially boost energy trading volume and revenue 5.2 billion 19992002 Inflated revenues with bogus accounting entries from corporate unallocated revenue accounts 3.3 billion
    9. 9. Hall of Shame COMPANY YEAR ISSUES IMPACT (USD) 2002 Engaged in network capacity swaps with other carriers to inflate revenue. Also, recorded revenue from long term IRU contracts immediately rather than over the term of the IRUs. NA 20012002 Booked higher promotional payments (provided by suppliers to promote their goods) than actually received at US subsidiary FoodService. 1.0 billion 19992002 Recognised revenue from services to patients by billing Medicare for reimbursements where patients were not pre-certified & payment was never got 2.64 billion
    10. 10. 10
    12. 12. Olympus • Major Japanese manufacturer of optical equipment • FYE 31 March 2011, sales of US$10.589 billion, and total equity of US$3.281 billion • Assets of US$13.295 billion • Employs 40,000 people globally CEO Michael Woodford suddenly removed from office on 14 Oct 2011, just 2 weeks after promotion 12
    13. 13. The Firing “Michael C. Woodford has largely diverted from the rest of the management team in regard to the management direction and method, and it is now causing problems for decision making by the management team. Hence, judging that realisation of the 2010 Corporate Strategic Plan with its slogan of "Advancing to the Next Stage of Globalisation" would be difficult to achieve by the management team led by Woodford, all the board directors attending today, except for Woodford himself who could not participate in the voting due to special interest, unanimously resolved the dismissal from his office of the representative director" — Olympus press release 13
    14. 14. Mr Woodford • • British born Woodford became COO and President in April 2011 On 1 Oct 2011 he was made CEO. This appointment was very unusual:  Non Japanese CEO, the first for Olynpus  Unlikely choice  25 other potential candidates were ignored So why was he elevated AND removed suddenly?? 14
    15. 15. History • In the 1980s, many Jap corporations relied on Investments to boost profits, as exports fell due to a strong yen • In 1991 Olympus had to take losses of ¥2.1 billion • In June 1998, Olympus was subject of rumours of sizeable trading losses on derivatives • In Oct 1999, Olympus disclosed that it had lost nearly ¥17 billion from interest rate and currency swaps • Olympus lost ¥2.9 billion in the Princeton Economics International Ponzi scheme 15
    16. 16. Why the promotion? • He asked questions on the $ 2.2 billion acquisition of Gyrus • AXAM (Advisors) were paid $ 687 million, 31% of the value! How?:  $ 67 million in cash  Olympus bought back preference shares for $ 620 million • Olympus paid $965 million when it acquired three "small venture firms“ • It wrote down $ 600 million in 2010 related to acquisitions • Woodford wrote to the Chairman, copying the Auditors (E & Y) • Woodford was promoted to CEO to shut him up! • He was a puppet COO and CEO. The real power was Tsuyoshi Kikukawa, Chairman 16
    17. 17. Timeline 17
    18. 18. Why did this happen? "Japan's corporate culture of denial, of ignoring problems and letting them fester, keeps running up against a globalized world that values agility, innovation and transparency. Olympus demonstrates all too painfully how much Old Japan tolerates a lack of accountability among senior executives; inadequate disclosure; a disinclination to challenge authority and absolute deference to corporate boards regardless of share performance” - Bloomberg View columnist William Pesek 18
    19. 19. TRUTH… AND UNTRUTH
    20. 20. Satyam Computers : The Rise • • • • • • • Annual revenue rose from $ 467 million to USD 2.1 bln Average Operating Earnings was 21%, a CAGR of 35% Earnings Per Share rose from $ 0.12 to $ 0.62, a CAGR of 40% Share price rose from INR 138 to INR 526, a 300% increase SCL was the first Indian company to publish IFRS financials SCL won the Golden Peacock award from the World Council for Corporate Governance for Best Governed Company (2007 and 2008) Ramalinga Raju was awarded Entrepreneur of the Year by Ernst & Young (2008) 20
    21. 21. Satyam Computers: The Fall • • • • • 16 Dec 2008: Shareholders oppose takeover of Maytas Properties by SCL. Stock falls 53% on NYSE 23 Dec 2008: World Bank bars SCL from doing any business due to bribery. Stock falls 14% 28 Dec 2008: Three Directors quit 7 Jan 2009: Ramalinga Raju resigns and admits fraud 11 Jan 2009: Govt of India steps in and forms a new board 21
    22. 22. Satyam Computers: The Fraud Cash $ 1.04 bln in cash that SCL claimed to own was non existent Liabilities Liabilities underreported on the balance sheet Revenue Revenue overstated in almost every quarter. Fake customer identities were created and fake invoices were raised by the SLC Head of Internal Audit to create revenue Profit Profit overstated by showing interest income from fake bank accounts 22
    23. 23. Satyam Computers: Red Flags Financial Red Flags • $ 1.04 billion in non interest bearing deposits • Large amount of accrued interest in deposits • 35% EPS growth over five years • With $1.2 billion of cash, Satyam closed 2007-08 with $56 million of debt • Insiders lowered ownership from 17.4% in 2004 to 8.7% in 2008 Non financial Red Flags • Ramalinga Raju was the Chairman. His brother, Rama Raju, was the CEO • No audit experts on the Audit Committee • The Rajus had a history of trying to siphon out funds from SCL companies • PwC was paid twice what other firms would charge for audit • Independent directors? Krishna Palepu was Director and Consultant, earring nearly $ 200K in 2007 23
    24. 24. The Dirty Dozen 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. Revenue recognition Non recurring gain as operating Understating expenses Understating depreciation Deferring expenses Operating expenses as non operating Big bath provisions Cookie jar accounting Off balance sheet liabilities Investments- equity accounting Investments- reclassifications Fair value accounting 24
    25. 25. Red Flags! 1. 2. 3. 4. 5. 6. Increasing Days Sales Outstanding Increasing sales as % of cash collected Receivables growing faster than revenues Revenue growing faster than industry average Falling ratio of CFO to Net Income Higher 4th quarter revenue not explained by seasonality 7. Decrease in provision for bad debts as % of receivables 8. 9. Decrease in provision for obsolete inventory as % of inventory Increasing Days Of stock in Hand 10. Sudden increase in Gross Profit or EBIT as % of Sales 11. Depreciation out of line with peers 12. “Mark to model” approach to fair value accounting 25
    26. 26. Z score model - 4.840 + SGI ( Sales Growth Index) X 0.892 + GMI (Gross Margin Index) X 0.528 + AQI (Asset Quality Index) X 0.404 + DSRI ( Days Sales in Receivables Index) X 0.920 + TATA ( Total Accruals to Total Assets) X 4.679 The red flag is a Z score greater than – 1.99. Enron had a Z score of 0.045 in its last year 26
    27. 27. “The truth may be puzzling. It may take some work to grapple with. It may be counterintuitive. It may contradict deeply held prejudices. It may not be consonant with what we desperately want to be true. But our preferences do not determine what's true.” ― Carl Sagan 27
    28. 28. Binod Shankar, CFA +971 50 558 2498 Genesis Institute Dubai | Abu Dhabi 28