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Deloitte Forensic Center

Ten things about financial statement fraud — third editionA review of SEC enforcement releases, 2000–2008

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Company officers were named in 81% of the enforcement releases the SEC issued in 2008 that we analyzed in our study.

Ten Things about Financial Statement Fraud — Third Edition 1

Ten things about financial statement fraud — third edition (updated through 2008)

Despite stringent legislation, such as the Foreign Corrupt Practices Act and the Sarbanes-Oxley Act aimed at combating fraud — and despite enforcement efforts by the Securities and Exchange Commission (SEC) and the Department of Justice — financial statement fraud remains a public concern.

But just what types of fraud is the SEC alleging in its enforcement actions? Are some industry sectors more prone to alleged fraud than others? Have alleged fraud scheme preferences and industry patterns changed over time? What were the roles of the individuals who were alleged by the SEC to have been involved in financial statement fraud?

To learn how alleged fraud schemes have evolved over the current decade, the Deloitte Forensic Center has analyzed hundreds of SEC enforcement releases issued from 2000 through 2008.

These findings may have significance for the global effort to develop more robust business processes for managing the risk of financial statement fraud — and mitigating it. The efficacy of such processes may be enhanced by understanding the alleged fraud schemes typically committed and the industry-specific patterns in the occurrence of those schemes.

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Methodology

The SEC reports on its administrative enforcement actions through its Accounting and Auditing Enforcement Releases (AAERs). The Deloitte Forensic Center’s staff reviewed more than 1,700 AAERs issued by the SEC from January 2000 through December 2008. For our analysis, we considered, where possible, the AAERs that most comprehensively addressed particular instances of alleged financial statement fraud at SEC-registered companies. This resulted in the inclusion of more than one AAER for some companies, when the SEC issued multiple AAERs detailing multiple, discreet alleged fraud schemes. We excluded releases that repeated alleged fraud schemes we had already identified, or which dealt with alleged insider trading, actions against vendors, or auditors. This filtering process resulted in the 430 AAERs relating to 392 companies that are the subject of this study.

We sorted companies into nine industries, using categories we developed, as well as noting subindustries as appropriate:

Aviation and Transport Services•

Consumer Business•

Energy and Resources•

Financial Services•

Life Sciences and Health Care•

Manufacturing•

Public Sector•

Real Estate•

Technology, Media, and Telecommunications•

We classified the alleged frauds identified into 12 categories and 61 subcategories based on how the alleged fraud was committed. AAERs typically describe more than one alleged fraud scheme active in a company in a given period. The 12 main categories are:

Aiding and Abetting•

Asset Misappropriation•

Bribery and Kickbacks•

Goodwill•

Improper Disclosures•

Investments•

Manipulation of Accounts Receivable•

Manipulation of Assets•

Manipulation of Expenses•

Manipulation of Liabilities•

Manipulation of Reserves•

Revenue Recognition•

We also compared the length and time between the first alleged commission of fraud to the issuance date of the latest related AAER included in our study.


1. How many enforcement releases alleging new financial statement fraud schemes has the SEC issued?

Using the filtering process in the methodology described •herein, we identified 430 Accounting and Auditing Enforcement Releases (AAERs) issued by the SEC from 2000 through 2008 relating to instances of alleged financial statement fraud schemes at SEC-registered companies.

In the years following the Enron and WorldCom •collapses, the number of AAERs issued by the SEC more than doubled, from 35 in 2000 to 75 in 2003.

The number of AAERs related to alleged financial •statement fraud schemes has since fallen to fewer than 50 per year beginning in 2005 and remained quite consistent through 2008.

Chart 1: AAERs issued by the SEC alleging financial statement fraud schemes, by year

35

24

57

75

5447 46 45 47

0

10

20

30

40

50

60

70

80

2000 2001 2002 2003 2004 2005 2006 2007 2008

4

2. What is the average duration, in years, from the start of the alleged fraud scheme to the latest related AAER in our study?

We determined the time between the start date of each •alleged fraud scheme, as described in the AAER, and the issuance date of the AAER. This is an approximate measure of the length of the time during which a business may be affected by the alleged fraud.

The average duration has been steadily increasing since •2004, reaching seven years in 2008, a record for this decade. This represents an increase of approximately 63% since 2004.

The seven-year average duration means that alleged •financial statement fraud reported in 2008 AAERs started, on average, in 2001. Of course, recent AAERs may not indicate future trends for alleged financial statement frauds.

Chart 2: Average duration, in years, from the first alleged commission of a fraud scheme to the issuance of the AAER included in our study

5 5.1

4.3 4.4 4.34.7

5.86.3

7

0

1

2

3

4

5

6

7

8

2000 2001 2002 2003 2004 2005 2006 2007 2008


101

87

5247

2919

11 10 10

26

0

20

40

60

80

100

120

1 2 3 4 5 6 7 8 9 10+

3. How many alleged fraud schemes were identified per company?

Of the 392 companies identified in the 430 AAERs in this •study, 74% had more than one alleged fraud scheme identified in the AAERs — with 26 companies (7%) having 10 or more.

Four of the 26 companies in the 10 plus group had 20 •or more alleged fraud schemes described in the SEC releases.

The average number of alleged fraud schemes identified •by the SEC per company declined by approximately 53% from 2007 to 2008, from 4.5 to 2.1.

Chart 3a: Number of companies with alleged fraud schemes

Chart 3b: Average number of alleged fraud schemes per company

Number of fraud schemes

Num

ber

of c

ompa

nies

2.7 2.9 3.1 2.9

5.0

4.0

5.0 4.5

2.1

0.0

1.0

2.0

3.0

4.0

5.0

6.0

2000 2001 2002 2003 2004 2005 2006 2007 2008

6

4. Was the subject of the SEC’s alleged financial statement fraud enforcement release a company, a company officer, or both?

The SEC issues enforcement releases, for example, •identifying a company, one or more officers of a company, and sometimes both.

Since 2001, the percentage of alleged financial •statement fraud AAER subjects who are company officers has increased. This may denote greater emphasis

by the SEC on holding company officers personally accountable for incidents of alleged financial statement fraud at their companies.

In 2008, company officers were named, either •individually or along with the company itself, in 81% of the AAERs included in our study.

Chart 4a: Distribution of AAERs with each category of subjects, by year

Chart 4b: Distribution of AAERs with each category of subjects, by year

0

5

10

15

20

25

30

35

2000 2001 2002 2003 2004 2005 2006 2007 2008

Company

Officer

Company and officer

Subjects

0%

10%

20%

30%

40%

50%

60%

2000 2001 2002 2003 2004 2005 2006 2007 2008

Company

Officer

Company and Officer

Subjects


5. What were the roles of the individual subjects of SEC alleged financial statement fraud enforcement releases in 2008?

Forty-four percent of the individuals identified in the •SEC's alleged financial statement fraud enforcement releases we analyzed for 2008 had the role of chief financial officer (CFO), chief accounting officer (CAO), or controller. Chief executive officers (CEOs) accounted for 24%.

Other members of management alleged by the SEC to •be involved in the financial statement frauds included those in sales, operations, and planning. Many held the title of vice president or senior vice president. Collectively, they represented 24% of individuals identified in the SEC’s enforcement releases in 2008 — the same proportion as CEOs.

Directors and general counsel were each identified •as subjects of 4% of the financial statement fraud enforcement releases we analyzed for 2008. This indicates a willingness of the SEC to pursue charges against parties allegedly involved in financial statement fraud, other than the traditional targets of CEOs and financial executives.

Chart 5: Roles of individual subjects of SEC alleged financial statement fraud AAERs issued in 2008

CEO24%

CFO, Controller, and CAO

44%

Director4%

General counsel

4%

Management24%

8

6. What were the most common financial statement fraud schemes alleged by the SEC?

Of the SEC enforcement releases in our study from •2000 to 2008, 38% identified alleged fraud schemes related to revenue recognition fraud, making this the most common alleged financial statement fraud scheme identified in AAERs. But for 2008 alone, just 30% of the enforcement releases related to revenue recognition, down from 33% in 2007. The change from 2007 to 2008 is part of a broader trend beginning in 2003, seen on Chart 8.

Improper disclosures formed the second most common •scheme alleged by the SEC for 2008, accounting for 18% of financial statement fraud schemes in 2008 enforcement releases, up from 13% in 2007.

Alleged manipulation of accounts receivable (A/R), •liabilities, and reserves decreased in 2008 from 2007, while alleged manipulation of expenses and goodwill increased.

Chart 6a: Proportion of financial statement fraud schemes represented by each alleged fraud scheme in AAERs from 2000 through 2008

Chart 6b: Proportion of alleged financial statement fraud schemes represented by each such fraud scheme in 2007 and 2008 AAERs

38%

12%12%

8%

7%

7%

4%

3%3%

2%

2%2%

Revenue Recognition (38%)

Manipulation of Expenses (12%)

Improper Disclosures (12%)

Manipulation of Liabilities (8%)

Manipulation of Assets (7%)

Manipulation of Reserves (7%)

Bribery & Kickbacks (4%)

Asset Misappropriation (3%)

Manipulation of A/R (3%)

Investments (2%)

Aiding and Abetting (2%)

Goodwill (2%)

33%

13%

12%

9%

9%

5%

4%

0%

3%

2%

4%

6%

30%

18%

16%

6%

6%

6%

6%

4%

3%

3%

2%

0%

0% 5% 10% 15% 20% 25% 30% 35%

Revenue recognition

Improper disclosures

Manipulation of expenses

Manipulation of liabilities

Manipulation of reserves

Bribery and kickbacks

Manipulation of assets

Goodwill

Aiding and abetting

Investments

Asset misappropriation

Manipulation of A/R

2008

2007


7. What were the most common types of revenue recognition fraud alleged by the SEC in 2007 and 2008?

The six types of revenue recognition schemes depicted •above account for 76% of all alleged revenue recognition schemes identified in the 2008 AAERs we analyzed and 66% of all alleged revenue recognition schemes in 2007 AAERs.

The most common alleged revenue recognition schemes •in the 2008 AAERs were recognition of fictitious revenue and recognition of revenue when products or services are not delivered, delivery is incomplete, or items are delivered without customer acceptance.

Recording of fictitious revenue was also the most •common type of revenue recognition fraud scheme alleged by the SEC in AAERs overall from 2000 through 2008, followed by recognizing inappropriate amounts of revenue from swaps, round-tripping, or barter arrangements.

Chart 7: Most common types of revenue recognition fraud alleged in 2007 and 2008 AAERs

12.2%

7.3%

19.5%

22.0%

17.0%

22.0%

9.1%

13.6%

13.6%

18.3%

22.7%

22.7%

0% 5% 10% 15% 20% 25%

Recognition of revenue in the inappropriate period eitherby holding the books open after period-end or by closing

the books prior to period-end

Recognition of revenue from sales transactions billed,but not shipped (“bill and hold”)

Recognition of revenue where there are contingenciesassociated with the transaction that have not yet

been resolved

Recognizing inappropriate amount of revenue fromswaps, round tripping, or barter arrangements

Recognition of revenue when products or services are not delivered, delivery is incomplete, or delivered without

customer acceptance

Recording of fictitious revenue

2008

2007

10

8. What are the trends for the “top” six alleged financial statement fraud types?

While revenue recognition fraud continues to be the •most common financial statement fraud scheme alleged by the SEC in AAERs from 2000 through 2008, the number of such schemes has declined in all but one year since 2003.

If alleged revenue recognition frauds continue to decline, •they could soon be at a level similar to that of other alleged financial statement fraud schemes, rather than

being several times more common as has been the case during most of this decade. This may have implications for corporate fraud risk assessments and for regulatory policy.

The remainder of the top six alleged financial statement •fraud schemes have fluctuated inconsistently during this period, making it harder to predict where future alleged financial statement frauds may lie.

Chart 8: Incidence of top six alleged fraud schemes, by AAER release date

0

20

40

60

80

100

120

2000 2001 2002 2003 2004 2005 2006 2007 2008

Improper disclosures

Manipulation of assets

Manipulation of expenses

Manipulation of liabilities

Manipulation of reserves

Revenue recognition


5

19

39

68

120

122

140

438

550

0 100 200 300 400 500 600

Public sector

Aviation and transport services

Real estate

Energy and resources

Financial services

Life science & health care

Manufacturing

Consumer business

TMT

9. How are alleged financial statement fraud schemes distributed across industries?

Of the 1,501 alleged fraud schemes identified in the •430 AAERs from 2000 to 2008 that we analyzed for this study, two-thirds were accounted for by two industries: TMT (technology, media, and telecommunications) had 37% and consumer business had 29%.

The consumer business, financial services and life science •and healthcare industries showed at least one-third growth in their share of alleged fraud schemes in 2008 AAERs as compared to 2007 AAERs. This may be in part due to growing regulatory attention being given to the financial services and life science and healthcare industries.

Chart 9a: Number of alleged fraud schemes by industry identified in AAERs from 2000 to 2008

Chart 9b: Proportion of alleged fraud schemes in each industry identified in AAERs in 2007 and 2008

2%

5%

5%

8%

10%

13%

21%

36%

2%

1%

6%

12%

2%

18%

29%

30%

0% 5% 10% 15% 20% 25% 30% 35% 40%

Energy and resources

Aviation and transport services

Real estate

Life science and health care

Manufacturing

Financial services

Consumer business

TMT

2008

2007

12

0 50 100 150 200 250 300 350

Investment management

Insurance

Securities

Banking and finance

Health plans

Tourism, hospitality, and leisure

Consumer products

Consumer services

Retail, wholesale, and distribution

Publishing, media, and entertainment

Telecommunications

Technology

TMT Consumer business Financial services

15

26

27

52

4

20

54

88

272

76

147

327

10. In the “top” three industries, how are the alleged schemes distributed across subindustries in 2007 and 2008?

From 2000 to 2008, alleged fraud schemes in the •TMT (technology, media and telecommunications) and consumer business industries as identified by the SEC in AAERs were predominantly in the technology subindustry. But in 2008, AAERs were more evenly distributed among subindustries.

In 2008, in the consumer business industry, 43% •of identified alleged fraud schemes occurred in the

consumer products subindustry, more than three times the level of 2007.

In 2008, in the financial services industry, 50% of •identified alleged fraud schemes occurred in the insurance subindustry, an increase from 17% in 2007. In contrast, the securities subindustry fell from 50% to 22% of alleged fraud schemes in this industry.

Chart 10a: Number of alleged financial statement fraud schemes in segments of each “top” industry identified in AAERs from 2000 to 2008

Chart 10b: Number of alleged financial statement fraud schemes in each “top” industry identified in AAERs in 2007 and 2008

8%

17%

50%

25%

8%

0%

13%

0%

79%

5%

38%

57%

0%

50%

22%

28%

0%

0%

43%

25%

32%

17%

45%

38%

0% 10% 20% 30% 40% 50% 60% 70% 80% 90%

Investment management

Insurance

Securities

Banking and finance

Health plans

Tourism, hospitality, and leisure

Consumer products

Consumer services

Retail, wholesale, and distribution

Publishing, media, and entertainment

Telecommunications

Technology

2008

2007

Con

sum

er b

usin

ess

Fina

ncia

l ser

vice

sTM

T


Deloitte Forensic Center

The following material is available on the Deloitte Forensic Center Web site: www.deloitte.com/forensiccenter or from [email protected].

Deloitte Forensic Center book:Corporate Resiliency: Managing the Growing Risk of •Fraud and Corruption

Chapter 1 available for download –

Deloitte Forensic Center ForThoughts newsletters and videos:

Ten Things about Financial Statement Fraud — Third •edition

The Expanded False Claims Act: FERA Creates New Risks•

Avoiding Fraud: It’s Not Always Easy Being Green•

Foreign Corrupt Practices Act (FCPA) Due Diligence in •M&A

The Fraud Enforcement and Recovery Act “FERA”•

Ten Things About Bankruptcy and Fraud •

Applying Six Degrees of Separation to Preventing Fraud•

India and the FCPA•

Helping to Prevent University Fraud•

Avoiding FCPA Risk While Doing Business in China•

The Shifting Landscape of Health Care Fraud and •Regulatory Compliance

Some of the Leading Practices in FCPA Compliance•

Monitoring Hospital - Physician Contractual •Arrangements to Comply with Changing Regulations

Managing Fraud Risk: Being Prepared•

Overview: Managing the Business Risk of Fraud –

Fraud Risk Governance –

Fraud Risk Assessment –

Hospital - Physician –

Fraud Prevention and Detection –

Fraud Investigation and Corrective Action –

Ten Things About Fraud Control•

Notable material in other publications:Mapping Your Fraud Risks, • Harvard Business Review, October 2009

Listen to Your Whistleblowers, • Corporate Board Member, Third Quarter, 2009

Use Heat Maps to Expose Rare but Dangerous Frauds, •HBR NOW, June 2009

Essentials of Fraud Detection Monitoring, • White-Collar Crime Fighter, May 2009

Bankruptcy and Fraud, • The Bankruptcy Strategist, April 2009

Bankruptcy and Fraud: The Ties That Bind?, • Business Crimes Bulletin, February 2009

The views expressed in this publication are solely those of the authors and not necessarily those of Deloitte Financial Advisory Services LLP.

This publication contains general information only and Deloitte Financial Advisory Services LLP, its affiliates and related entities are not, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. Deloitte Financial Advisory Services LLP, its affiliates and related entities shall not be responsible for any loss sustained by any person who relies on this publication.

Deloitte Forensic Center The Deloitte Forensic Center is a think tank aimed at exploring new approaches for mitigating the costs, risks and effects of fraud and corruption.

The Deloitte Forensic Center aims to advance the state of thinking in areas, such as fraud and corruption, by exploring issues from the perspective of forensic accountants, corporate leaders, and other professionals involved in forensic matters.

The Deloitte Forensic Center is sponsored by Deloitte Financial Advisory Services LLP. For more information, visit www.deloitte.com/forensiccenter.

About Deloitte As used in this document, “Deloitte” means Deloitte Financial Advisory Services LLP, a subsidiary of Deloitte LLP. Please see www.deloitte.com/us/about for a detailed description of the legal structure of Deloitte LLP and its subsidiaries.

Copyright © 2009 Deloitte Development LLC. All rights reserved. Member of Deloitte Touche Tohmatsu

This article was first published as ForThoughts, the Deloitte Forensic Center’s newsletter highlighting the trends and issues in fraud, corruption, and other complex business issues. To subscribe to ForThoughts, visit www.deloitte.com/forensiccenter or send an e-mail to [email protected].

Toby Bishop is the director of the Deloitte Forensic Center for Deloitte Financial Advisory Services LLP. Mr. Bishop can be reached at [email protected].

Frank Hydoski is the leader of the Analytic and Forensic Technology practice of Deloitte Financial Advisory Services LLP. Mr. Hydoski can be reached at [email protected].

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