CBI on how the Satyam fraud was pulled off

The financial fraud perpetrated by the founders of Satyam Computer Services was executed through a well-planned accounting system that used as many as 7,561 fraudulent invoices worth Rs 5,117 crore (Rs 51.17 billion) to inflate the company's sales, the Central Bureau of Investigation alleged Monday.

Using cyber forensic techniques, the CBI deciphered the modus operandi of the Satyam fraud: that is generating false invoices to show inflated sales by the IT company.

The accused had used an emergency option of feeding invoices directly to the company's inventory management software, which in normal circumstances would be routed and validated through several software systems.

Investigation conducted by the CBI into the Satyam scam revealed that Satyam Computer Services Ltd has got a regular application flow for the generation of invoices.

This regular flow has a series of applications like the Operational Real Time Management for creating and maintaining the projects, the Satyam Project Repository for generating the project ID, an application to key-in the main hours put in by the employees called Ontime, and a Project Bill Management System to generate billing advises from the data received from the Ontime and from the rates agreed upon with the customer.

Based on these billing advises generated by PBMS, the Invoice Management System generates the invoices.

Apart from the regular application flow, Satyam has another method of generating invoices through Excel Porting wherein the invoices can be generated directly in IMS bypassing the regular application flow by porting the data into the IMS.

This application has to be used sparingly for emergency requirements.

Investigation revealed that in order to perpetrate this fraud, the accused surreptitiously got a subroutine incorporated in the source code of the IMS application wherein a new user ID called 'Super User' was created and this Super User had the power to hide/show the invoices generated in IMS.

By logging in as Super User, the accused could hide some invoices that were generated through Excel Porting. Once an invoice is hidden the same could not be visible to other divisions within the company but would only be visible to the sales team in Satyam's finance division.

As a result, the concerned business circles would not be aware that such invoices exist.

These invoices are also not dispatched to the customers. Investigation revealed that all the invoices that were hidden using the Super User ID in the IMS server were found to be false and fabricated.

Investigation further revealed that these false and fabricated invoices were generated for the purpose of inflating the sales and the amounts pertaining to these false and fabricated invoices were shown as receivables in Satyam's books of accounts thereby dishonestly inflating the revenues of the company.

Some 7,561 invoices were found to be hidden in the IMS. These 7,561 invoices are collectively worth Rs 5,117 crore.

It was also revealed that the accused have already entered 6,603 out of these false and fabricated invoices amounting to Rs 4,746 crore (Rs 47.46 billion) into their books of accounts thereby inflating the revenues of the company to this tune.

During the course of the investigation, a detailed analysis of the computer logs pertaining to both the IMS application and the computer network of Satyam were analysed. This analysis was also matched with the Access control swipe card data of the company.

As a result of this analysis, the individuals who have generated and hidden these false and fabricated invoices have been identified. The computer server where these incriminating electronic records were stored has also been identified and the incriminating data was retrieved and the required computer forensic expert's opinions were also obtained.

As a result of this detection, the actual modus operandi as well as the individuals who have perpetrated the fraud have been identified. This will go a long way in unearthing the entire fraud and in the finalisation of the investigation pertaining to the falsification of accounts and forgery of documents by the accused in the Satyam scam.

The bail application of disgraced former chairman of Satyam B Ramalinga Raju, B Ramaraju and V Srinivas was dismissed by the trial court on April 25. Eight persons are in judicial custody including the above three persons.

The CBI has also obtained permission to conduct further investigations into the case pertaining to acquisition of assets by the accused and the diversion of funds.

Source: www.rediff.com 

Crimes suspected in 20 bailout cases -- for starters

The special inspector general says TARP is 'inherently vulnerable to fraud, waste and abuse.' The risk grows as the plan becomes more complex, he says.

Reporting from Washington and Los Angeles -- In the first major disclosure of corruption in the $750-billion financial bailout program, federal investigators said Monday they have opened 20 criminal probes into possible securities fraud, tax violations, insider trading and other crimes.

The cases represent only the first wave of investigations, and the total fraud could ultimately reach into the tens of billions of dollars, according to Neil Barofsky, the special inspector general overseeing the bailout program.

The disclosures reinforce fears that the hastily designed and rapidly changing bailout program run by the Treasury Department and Federal Reserve is going to carry a heavy price of fraud against taxpayers -- even as questions grow about its ability to stabilize the nation's financial system.

Barofsky said the complex nature of the bailout program makes it "inherently vulnerable to fraud, waste and abuse, including significant issues relating to conflicts of interest facing fund managers, collusion between participants, and vulnerabilities to money laundering."

The report said little about who is under investigation and how the fraudulent schemes work, but investigators are already on alert for a long list of potential scams. Such schemes could include obtaining bailout money under false pretenses, bilking the government with phony mortgage modifications, and cheating on taxes with fraudulent filings.

"You don't need an entirely corrupt institution to pull one of these schemes off," Barofsky said. "You only need a few corrupt managers whose compensation may be tied to the performance of these assets in order to effectively pull off a collusion or a kickback scheme."

The risk of fraud is only increasing as the bailout becomes "more complex and larger in scope," he said.

Indeed, much of the 247-page report released in Washington today by Barofsky's office focuses on a segment of the bailout that is only now being put into motion -- an effort to buy toxic securities from banks and other investment groups in which the federal government would provide up to 92.5% of the money. That effort could be the most vulnerable to fraud, Barofsky said, because investors would have so little at risk.

Among the toughest recommendations in the report is for the Treasury to abandon its planned structure for buying the toxic securities, which include intricate bundles of bad mortgages and loans, before it gets rolling.

Members of Congress and consumer advocates expressed outrage Monday when they heard about the findings of the report.

"It shouldn't be a big surprise that a huge pot of honey attracts a lot of flies," said Tom Coburn of Oklahoma, the senior Republican on the Senate Permanent Subcommittee on Investigations, which is also examining the program. "I would guess that 20 investigations, while a good start, is only the tip of the iceberg."

"That's an appalling record," Barbara Roper, director of investor protection for the Consumer Federation of America, said of the 20 criminal investigations. "In the midst of this crisis from which they are being bailed out, the same people who created this mess are apparently still breaking the law. What is it with these people?"

In a series of recommendations, Barofsky asked the Treasury Department for greater transparency and greater fraud protections.

The Treasury Department's bailout chief, Neel Kashkari, said in a letter dated April 14that the recommendations would be "considered."

The report underscores just how complicated the bailout program has become.

What started out in October as a $750-billion effort only to buy toxic securities has morphed into 12 separate programs that cover up to $3 trillion in direct spending, loans and loan guarantees -- an amount roughly equal to the annual federal budget.

Today, banks, insurers, brokerages, auto companies, car parts makers and homeowners are just some of the beneficiaries of the program, known formally as the Troubled Asset Relief Program, or TARP.

The report dedicated an entire section to what many experts believe is its most risky operation -- a toxic asset purchase plan under a broader program known as the Term Asset-Backed Securities Loan Facility, known as TALF. Originally, TALF was aimed at expanding consumer lending programs for autos, student loans and other types of credit.

But the Obama administration expanded TALF to include funding and federal loan guarantees to purchase toxic securities.

That program has at least two parts: one to buy up bad loans from banks and another to buy up bundled loans in the form of mortgage-backed securities from investment markets. The government would split any profits with the private investors it partnered with.

The latter has sparked greater concern because of the possibility that buyers could collude to manipulate prices and extract kickbacks, with the government taking virtually all of the risk.

"When you are buying from the market or the street, transparency comes into question," Barofsky, a former federal prosecutor, said. "The potential for pricing fixing and collusion becomes greater because the government doesn't have control or knowledge of who" all the players are.

Members of Congress, who were given Barofsky's report Monday, have already expressed concern over the plan.

House Financial Services Committee member Brad Sherman (D-Sherman Oaks), a certified public accountant, said that under the plan, taxpayers would take virtually all the risk, get zero control and only 50% of the profits.

"That doesn't sound like a good deal," he said.

"I can't imagine Warren Buffett signing something like that."

Source: www.latimes.com, By Ralph Vartabedian and Tom Hamburger 

India ranks 5th in illicit financial outflows: Global Financial Integrity

WASHINGTON : 

India ranks fifth globally among 127 developing countries for illicit financial outflows, according to a report released by the Global Financial Integrity (GFI).

The report "Illicit Financial Flows from Developing Countries: 2002-2006" estimates the total illegal capital flight from developing countries to be as high as $1 trillion per year. 

In 2006 around ten dollars were lost due to illicit outflows on every one dollar received as official development assistance (ODA), it said in a statement released through Asianet. 

"This massive loss of assets is the greatest impediment to economic development and poverty alleviation and should be a concern for all nations," Raymond Baker, director GFI said. 

According to the report, the total illicit financial outflows from India rose to $27.3 billion per year during the period 2002-2006. 

The illegal outflows involve activities such as corruption (bribery and embezzlement of national wealth), proceeds of illicit business that becomes illicit when transported across borders in violation of laws and regulatory frameworks.

Source : www.rediff.com 

Ponzi Schemer Bernie Madoff: Duped Inept SEC till the Very End

There’s an intriguing and very long piece in this week’s Fortune magazine by James Bandler and Nicholas Varchaver delving into the psyche of Bernie Madoff, one of the largest Ponzi scheme crooks in American history, asking the question of “How Bernie did it?” And more importantly how did such a blatant Ponzi scheme, amounting to an astonishing $65 billion (on the cooked books anyways), escape the notice of the Securities and Exchange Commission for 20 years?

 

The answers are at once surprising and mundane. Any good Ponzi scheme survives on secrecy and a continuous infusion of new cash, both of which Bernie had in spades. Bernie treated his investment scheme like a private club, only open to the very wealthy, extracting a promise of secrecy from each new investor.

 

Bernie was also able to charm his way through two major scrapes with incompetent SEC regulators over the years and despite glaring warning signs pointing to fraud, the SEC never went the extra mile to conduct a deeper investigation into Bernie’s operations, leaving dozens of investors unprotected, with their life savings in many instances wiped out.

Bernie’s giant “feeder funds” captured the attention of the SEC twice, but both investigations ended without an extensive investigation into his hedge fund operations. The feeder funds were a merged block of individual investors, an ingenious way to keep billions flowing into the Ponzi operation, using the new cash to pay off current investors.

Bernie Madoff’s hedge fund operation first appeared on the SEC’s radar in 1992, when it shut down one of Bernie’s original feeder funds, Avellino and Bienes, accusing it of operating an unregistered securities operation, promising returns of 13.5 to 20 percent. Such high returns were a sure sign of a Ponzi scheme. Bernie calmly paid all the money back and the SEC just let the matter drop, issuing a small civil penalty.

 

A few years later in 2006, another giant Madoff feeder fund, Fairfield Greenwich came under scrutiny by the SEC for failing to disclose to its investors all of its investments were with one entity, Bernie Madoff’s hedge fund. Like the previous SEC investigation, Bernie talked his way out of it, but this time escaped prosecution by lying through his teeth. Despite providing obvious misinformation and misdirection to SEC investigators, again the SEC took no further action, except requiring Madoff to register as an investment adviser.

In the end, the one event that finally brought Bernie down was the financial crisis. The toothless SEC had nothing to do with uncovering the massive Ponzi hedge fund. When the financial sector came crashing down last fall, investors started to ask for their money, in a sense starting a run on the Bernie bank. With very little new cash coming in to grease the wheels of his Ponzi enterprise, the gig was up and now Bernie Madoff will sit in a jail cell for the rest of his life, leaving dozens of bankrupt former investors and his family members to pick up the pieces.

 

Once Bernie knew his carefully cultivated fraudulent hedge fund was about to come crashing down, he went home to his penthouse and confessed all to his brother, sons and wife, with his two sons, Mark and Andy calling the feds to arrest their father. The SEC is now looking to expand the case and seeking out assets to repay duped investors who lost billions.

Bernie claims he ran the Ponzi scheme all by himself. But many wonder how much, if any, Bernie’s family knew of the Ponzi scheme. His brother Peter and two sons were important members of Bernie’s firm, but not with the infamous hedge fund. They all claim, including Bernie’s wife, to have been completely unaware of the scheme until Bernie confessed. It’s hard to believe not one of the family members, even had an inkling that something was amiss. Bernie laundered millions of his dirty hedge fund money through the legitimate trading operations run by his brother and sons.

 

However, Fortune reports suggest Frank DiPascali, Bernie’s “number 2,” an henchman with just an high school education, is about to strike a plea deal with the feds to reduce his jail sentence in return for information on the Ponzi scheme. Fortune indicates DiPascali has no evidence that Bernie family members were involved with the scheme or knew it was going on.

 

DiPascali is also expected to testify to a few select feeder investors, who were provided with false investment records by Bernie to give them either non existent losses or profits for a better tax return. DiPascali’s revelations, when he starts naming names are sure to be explosive.

Lurking behind the 2006 SEC investigation was a private whistleblower, Harry Markopolos, a 52-year-old former options trader now working to uncover securities fraud conducting forensic accounting analysis. Ten years ago while with the Boston firm, Rampart Investment Management he tried to reverse engineer Bernie Madoff’s hedge fund, which for years was the talk of the investment world with its unheard of double-digit returns, despite any downturns in the market.

After investigating any information on Bernie Madoff’s hedge fund Markopolos could get his hands on, he concluded Bernie’s high returns were a statistical impossibility and the enterprise had to be a giant Ponzi scheme, perhaps one of the largest in the world. Markopolos tried to sound the alarm for years; constantly alerting the SEC to any new evidence he uncovered pointing to fraud.

 

The SEC enacted its 2006 investigation, based on information provided by Markopolos, but stopped short of an in-depth investigation of Bernie’s entire hedge fund enterprise, allowing him to defraud investors for another two years. Markopolos, being a determined securities gumshoe, never gave up and continued to warn the SEC about Madoff’s fraudulent operation, but it fell on deaf ears.

 

Some credit Markopolos with Bernie’s arrest, but the SEC took little notice of his warnings that extended over a decade. At least Markopolos can say, “I told you so.” Markopolos has also become something of a financial fraud-busting legend, since the extent of the Madoff Ponzi scheme has finally come to light.

Since the financial crisis, more Ponzi schemes have been discovered as the schemers ran out of ways to manipulate investor’s funds when the fresh cash stopped rolling in. The frightening part of this whole mess, is that Bernie and others would still be in business, were it not for the financial crisis.

It’s past time for a serious investigation into the incompetence of the SEC and its inability to recognize and shut down fraudulent investment schemes. The Bush administration set the stage for Ponzi schemers like Madoff to flourish in an unregulated market. During the course of its two “investigations” of Madoff’s hedge fund, the SEC investigators didn’t even bother to subpoena the firm’s records, instead relying on Bernie’s cooked books.

Following doubts are being raised :

 

1. How could the SEC have failed so miserably in the Bernie Madoff case? 
   
2. Were its investigators cowered by Bernie’s legendary reputation on Wall Street? 
   
3. Was, is, the SEC institutionally inept? It’s time to clean house at the SEC, riding it of incompetent political appointees and get on with the business of protecting the public from fraudsters like Bernie Madoff

Source:  Fortune Magazine

6 biggest risks to your business

This latest brutal recession has reminded us all that what can happen in business will--and likely when you least expect it. The prepared win--the rest get mauled.

But preparing is hard--especially in heady times when the cash is flowing strong and in the right direction. (Yes, those days will come around again.) The trick to managing risk is not seeing the thunderheads gathering this week or even this month, but anticipating all the nasty weather one, three or even five years from now.

The first step is bothering to look for trouble in the first place. "Small-business owners are trying to do business and make money," says Jay Foley, executive director of San Diego-based Identity Theft Resource Center. Much of the time, "they're simply unaware of the risks."

While no one can consistently predict where the overall economy is going, understanding the drivers (interest rates, inflation, unemployment, consumer indebtedness, currency values) goes a long way toward making sound decisions about how manage your business. Reading a lot helps--ask any professional money manager.

Then there are a host of more specific risks to your company. Here are six very real ones, and some brief prescriptions for how to deal with them.

Credit Risk. The pain of the credit crunch persists. According to the Small Business Association, guaranteed loans were down 30 per cent in 2008.

Prescription: a pristine balance sheet. Just because you're given credit doesn't mean you should gorge on it. "Hold on to it like it's your last dollar," says Tod Coseland, chief executive of Utah-based Interbank FX, an online currency-trading brokerage. If traditional lenders are too skittish, canvass alternative (albeit expensive) financing options, such as factoring.

Legal Risk. Being sued for compromised data, faulty products or hazardous working conditions is a real possibility. In 2008, data breaches were up 69 per cent over the prior year, according to the Identity Theft Resource Center.

Prescription: Establish standards and protocols for everything from manufacturing to record keeping, and bone up on the necessary technology. If you can afford a consultant, hire one. "Our in-house staff uses a multilevel process of software verification and customer service review to verify the credit information for our orders on a daily basis," says Susan Barone, chief executive of AlwaysForMe.com, a New York-based lingerie maker. "Customers tell us they appreciate the extra precautions that we take to keep their credit information secure."

Regulatory Risk. Making products and delivering services while covering costs is hard enough. Anticipating how governments might change the rules of the game--and are they ever changing them now--is virtually impossible. But you have to try.

Prescription: Use the Web. Set up news feeds via Google or your favorite news source, using keywords tailored to your industry and the regulatory bodies that govern it.

Operational Hiccups. These in-the-trenches risks include inventory gluts and shortages, poor quality, unattractive product mix, ballooning overhead, culture clashes, overaggressive expansion, data breaches and fraud.

Prescription: Savvy managers and sound systems are the best defense here, but even the vigilant inevitably miss a few cracks.

Concentration Risk. Many small businesses double down on a few big customers--a dangerous strategy in a bad economy.

Prescription: Diversify. A good rule of thumb is that no one customer should constitute more than 10 per cent of your revenues. Also run credit checks to make sure the customers you do have are in paying shape; tier your credit terms based on credit risk. Beware, too, vendor concentration, lest you be left short on inventory--or stuck paying too much.

You. Entrepreneurs are eternal optimists. This keeps their energy and enthusiasm up, but it also can cloud their vision.

Prescription: Acknowledge and understand the worse-case scenario and prepare for it. For extra perspective, assemble a board of trusted advisers.

Source: Forbes, By Chavon Sutton & Brett Nelson

The Gauge of Innocence

Fraud takes many forms. Count on all of them to increase this year.

In tough times, companies face plenty of honest challenges, and most managers and staffers rise to the occasion. But inevitably, as pressures multiply, some will cave in and demonstrate poor judgment, or worse. They may blur the lines on revenue recognition, tinker with stock options, abuse reserves, or evade loan covenants. Petty favors from vendors or "innocent" side deals with customers snowball into grand larceny.

Pay cuts, layoffs, diminished morale, and fewer resources devoted to internal controls are among the specific pressures that "open the door to fraud in a down market," says Kerry Francis, chairman of Deloitte Financial Advisory Services, the accounting firm's U.S. fraud investigative arm.

She began emphasizing such concern in early 2009, after a Deloitte survey found that two-thirds of 1,280 financial-services and technology executives expected to see more instances of accounting fraud.

Since Francis first sounded that alert, the downturn has become vastly more severe. Stunning Ponzi schemes at Stanford Group (allegedly) and Madoff Securities have made fraud a key theme of the current economic morass.

CFOs can't be expected to peer into the souls of every employee or business partner, of course, but they do need to be more cognizant than ever of the three sides of the classic "fraud triangle": pressure, opportunity, and the capacity to rationalize. When those elements unite, fraud often erupts.

The perpetrators are frequently those you would least suspect, says Dan Ariely, author ofPredictably Irrational: The Hidden Forces that Shape Our Decisions. Repeated behavioral testing shows that people cheat if they can get away with it — even smart, Ivy League–educated people with relatively little to gain (see "Thou Shalt Not Commit Fraud" at the end of this article). "The moment you have a fuzzy environment," Ariely says, "the more this can happen." In finance, recessions are very fuzzy. "CFOs are on shaky ground," warns Ariely, "because they are [now] operating in very difficult conditions."

For every case that makes headlines and ends with prosecutions, thousands of garden-variety frauds quietly drain corporate assets. The costs can cripple small and large companies. According to one unscientific estimate — a 2007–2008 survey of certified fraud examiners by the Association of Certified Fraud Examiners (ACFE) — U.S. organizations may lose 7 percent of their annual revenues to fraud, including financial-statement fraud.

Some fraud is flagrant crime, of course, but in other cases it can be thought of as good intentions gone badly awry. "The pressure can be enormous," warns Michael Young, an attorney with Willkie Farr & Gallagher and editor of Accounting Irregularities and Financial Fraud: A Corporate Governance Guide. "Insiders don't have crystal balls. All they know is that business has turned south and that that is not what outsiders are expecting. It presents almost a petri dish of temptation to meet expectations through some kind of accounting adjustment." That's often fatal, Young notes, because prosecutors and plaintiffs' lawyers pay close attention to evidence that performance targets or objectives influenced reported results.

No Stop Signs
As outlined by the ACFE, fraud can be classified into three broad categories: asset misappropriation (such as false invoicing, payroll fraud, or skimming), corruption (bribes, extortion, conflicts of interest), and financial-statement fraud, which aims to make companies look healthier than they actually are.

The first category is the most common, but the least costly (averaging $150,000 per incident). Fraudulent statements are the least common form of fraud, but in the ACFE study they accounted for a stunning $2 million median loss (as measured by lost market capitalization in most cases). Perhaps of most concern to CFOs, statement fraud is the very kind that can begin with an employee trying to "help the team," but in a misguided way. "There is no stop sign that will tell you when you are going too far," warns fraud-prevention expert Geoffrey Kaiser of Navigant.

In fact, there have been times when "too far" was seen as a virtue. In his 2001 memoir, former General Electric CEO Jack Welch bragged that GE managers once volunteered to help plug an unexpected $350 million write-off after a quarter's books closed. "Some said they could find an extra $10 million, $20 million, and even $30 million from their businesses to offset the surprise," Welch wrote.

By 2002, a culture shift had made earnings management more likely to garner prosecution than praise, and by 2005, when Waste Management was hit with a $26.8 million fine, plus other penalties, for "fraudulently manipulat[ing] the company's financial results to meet predetermined earnings targets," the practice was widely condemned.

Today, "any company obsessing over analyst earnings expectations needs to have its head examined," says Willkie Farr attorney Young. "Now the temptation is not to try to maximize earnings or meet expectations," he says. "It is to avoid impairments or other asset write-downs that put companies in a downward spiral toward bankruptcy."

These days, with shareholder expectations decidedly lower, lenders are emerging as the entity that must be pleased — or deceived. How easy is it to justify a dubious accounting step that averts a technical violation of a loan covenant and keeps a crucial credit line open? Put it this way, says consultant Michael Mayer of CRA International: "Companies that are facing significant covenant violations, or that need to raise capital, are under more pressure than ever."

These days, those who seek to deceive must also contend with a Securities and Exchange Commission that, under new chairperson Mary Schapiro, has placed a renewed emphasis on fraud detection, no doubt stung by its failure to unmask Bernard Madoff despite ample warning. "Those who break the law and take advantage of investors," Schapiro warned in February, "need to know that they will face an unrelenting law-enforcement agency in the SEC." She promises her agency will pursue lawbreakers "until the full force of the law is the sure, certain, and sole reward of their wrongdoing."

Preventive Measures
Within the workplace, "occupational fraudsters are generally first-time offenders," cautions the ACFE. In its 2008 report, it found that a mere 7 percent of perpetrators had prior convictions, and only 12 percent were let go by previous employers because of charges related to fraud. This data reinforced similar results in 2006 and 2004.

Luckily, most first-time embezzlers do not cover their tracks very well. Many flaunt their illegal gains. In 39 percent of cases it reviewed, the ACFE found that perpetrators lived beyond their apparent means. A third of them had financial difficulties when they committed fraud. Thanks to such flagrant signals, whistle-blowers tipped off authorities to nearly half of all occupational frauds.

Not that companies can afford to simply wait for anonymous tips. Monitoring sensitive activities and enforcing well-communicated antifraud policies play an important role in preventing lapses from becoming crimes. The goal should be to arrest bad judgment before it becomes fraud, says fraud-prevention expert David Dixon of Norkom, and to use coaching as a way to keep certain employees on the right track. Such actions might have shut down unauthorized trading at Barings Bank, says Dixon, long before the once-venerable British financial institution was taken down in 1995 by the reckless actions of a single trader. But for want of a coach, Barings was lost.

"If you test the waters and see that nobody is watching, you will go ahead and pursue a fraud further," warns managing director Ken Yormark of LECG, a firm that conducts fraud investigations around the world. "If you have the right controls in place and someone says stop, you quell the urge. Stamping down that desire is the number-one way to prevent fraud."

Also key is continuous research into ways to ferret out fraud. One recent study used nonfinancial data to sniff out anomalies that may indicate fraud; for example, if growth in retail outlets, warehouse space, or employee head count doesn't map logically to growth in reported revenues, something may be afoot, particularly when one company's metrics don't seem to parallel its industry peers. "You'll see a ton of red flags at fraud companies," says Joe Brazel, an assistant professor at North Carolina State University who co-authored the study.

Some experts have applied game theory to assess the potential for financial-statement fraud. In one study, three levels of "strategic reasoning" consider widening circles of actors and motives and how added scrutiny may alter behavior.

But drop any thought of using personality tests to sound the alarm on future manipulators of financial statements, declares Richard Davis, a consultant with RHR International, a corporate-psychology firm. "They're easily faked," he says. "There is no psychometric way to measure integrity." He is more sanguine about new methods involving microexpressions, very brief facial expressions that may reveal a person's predisposition to fraud.

There is, however, at least one psychological trait that can be a useful indicator. Beware of perfectionists, Davis warns. "The classic example is Martha Stewart." Hiding the fact of a conversation with a broker, not the substance of the conversation, sent her to prison, says Davis. "She wanted to appear as if nothing was wrong, so she masked small things to appear perfect."

There may be a lesson there for CFOs: set realistic expectations. For all the new research into fraud prevention, experts are unanimous about one thing: "tone at the top" counts for a lot. That was a vital finding of the National Commission on Fraudulent Financial Reporting, aka the Treadway Commission, in 1987. "The tone set by top management," the commission concluded, "is the most important factor contributing to the integrity of the financial-reporting process."

Think of tone-at-the-top as a beacon that can help prevent employees who toil in gray areas from crossing over to the dark side. Nothing will eradicate fraud, and in this current climate the fraud triangle may loom as large as an Egyptian pyramid. But CFOs can help keep this risk in check through a combination of clear communication, leading by example, and maintaining a watchful eye across the entire organization.

Fraud Facts

• Average length of time from fraud start to detection: 2 years

• Frauds exposed by whistle-blowers: 46%

• Corporate-fraud victims that blamed lack of adequate controls: 35%

• Companies that modified controls after fraud was detected: 78%

• Frauds by persons in the accounting department: 29%

• Frauds by executives or upper management: 18%

• Frauds by perpetrators living beyond their means: 39%

• Frauds by perpetrators experiencing financial difficulty at the time of the fraud: 34%

Thou Shalt Not Commit Fraud
Employees can resist everything but temptation.

Who might cheat? Talk to Dan Ariely, author of Predictably Irrational: The Hidden Forces that Shape Our Decisions, and he'll tell you practically anyone. In a series of behavioral tests, Ariely and two colleagues tempted more than 2,000 people to cheat. Most did, despite Ivy League pedigrees and not much to gain.

Behavioral psychologists blame a trait called "reframing," in which someone about to cheat adjusts the definition of cheating to exclude his or her actions. "People who would never take $5 from petty cash have no problem paying for a drink for a stranger and putting it on the company tab," says Ariely, the James B. Duke Professor of Behavioral Economics at Duke University.

To measure the inclination to cheat, Ariely posed 10 questions about science and culture to groups of college students and paid them 10 cents per correct answer. Control groups gave their answer sheets to proctors. Subsequent groups had increasing leeway to cheat. One group could alter answers before turning them in, another could self-report the number of correct answers, and a third group could simply take 10 cents per correct answer from a jar without reporting results.

Control groups averaged 32.6 percent correct. Scores increased for the other groups, suggesting cheating, but not in strict accordance with increased opportunity. For example, the group allowed to change its answers had the highest scores, at 36.2 percent correct, while the group that paid itself directly cheated slightly less, and the group that self-reported to proctors cheated least.

Clear standards, Ariely says, provide a powerful deterrent. Prior to answering questions, one group was asked to name 10 books they had read, while a second was asked to name as many of the Ten Commandments as they could recall. Both had the opportunity to cheat; scores suggested that those who recalled the Ten Commandments did not. Likewise, no cheating was evident by MIT students who signed, in advance, a statement defining the study as falling within the university's honor system.

"What this means for CFOs," says Ariely, "is that they should think very carefully about the culture they want to create, and understand that it will have a big effect on what people will be willing, and not willing, to do." — S.L.M.

Source: www.CFO.com, By S.L. Mintz - S.L. Mintz is deputy editor of CFO.

To check telebanking fraud, lend your ear

New Technique To Detect Unique Sounds Made By Our Ears May Help In Identifying The Caller

Victims of identity theft may soon get another chance to save their cash. If the fraudster calls their bank to transfer money into their own account, bank officials would be able to know who is at the other end of the line simply by pressing a button that causes the phone to produce a series of clicks in the caller’s ear. A message would immediately alert the bank that the person is not who they are claiming to be, and the call ended. 
    

Such a safeguard could one day be commonplace, if a new biometric technique designed to identify the person on the other end of a phone line proves successful. The concept relies on the fact that the ear not only senses sound but also makes noises of its own, albeit at a level only detectable by supersensitive microphones. 
    

If those noises prove unique to each individual, it could boost the security of call-centre and telephone-banking transactions and reduce the need for people to remember numerous identification codes. Stolen cellphones could also be rendered useless by programming them to disable themselves if they detect that the user of the phone is not the legitimate owner. 
    

Called otoacoustic emissions (OAEs), the ear-generated sounds emanate from within the spiral-shaped cochlea in the inner ear. They are thought to be produced by the motion of hair cells within the outer part of the cochlea. Typically, sounds entering the ear cause these outer hair cells to vibrate, and these vibrations are converted to electrical signals which are transmitted along the auditory nerve, allowing the sound to be sensed. Crucially, these cells also create their own sounds as they expand and contract. 
    

That’s because “hearing is an active process — the ear actually puts energy into the incoming sound waves to replace energy lost as sound is absorbed by the ear’s structure”, says Stephen Beeby, an engineer at the University of Southampton, UK, who is leading the research. “This process helps us hear things we otherwise would not, but as a result some of the energy added by the hair cells escapes as OAEs.” 
    

Predicted in the 1940s but not detected until ultralow-noise microphones were made in the 1970s, OAEs can be provoked when a series of clicks is played into the ear. The returning sound emissionscomprise signals of between 0 and 5khz. 
    

What sparked the interest of Beeby is the fact that the power and frequency distribution in the OAEs provoked by specific series of clicks seem to be highly distinctive, driven by the internal shape of the person’s ear. “Anecdotally, audiologists say they can tell different people apart — men, women, even people of different ethnic origins — by the profile of the widely varying types of emissions the clicks evoke,” he says. So with funding from the UK’s Engineering and Physical Sciences Research Council, Beeby’s team is attempting to work out if OAE patterns can be used in biometry, like iris scans or fingerprints. 

Source : www.timesofindia.com; 14/04/09

Watch the Video - ATM Scam

Patterns in Governance Failures

Most cases of Corporate Fraud have the same heady mix of high profile Boards, reputed auditors, fantastic growth, and political contacts.

Selected Cases of Corporate Fraud :

Source: www.business-standard.com, 13/04/09

Corporate frauds - A shocking revelation

Taking immediate corrective action and lessons from the US experience would help in restoring investor confidence.

A study called “Early Warning Signals of Corporate Frauds” conducted by the Pune-based Indiaforensic Consultancy Services (ICS), a forensic accounting and education firm, from January 2008 to August 2008 has come out with shocking revelations about corporate frauds.

Study details
The study has revealed that at least 1,200 companies out of 4,867 companies listed on the Bombay Stock Exchange and 1,288 companies listed on the National Stock Exchange as on March 31, 2007, including 25-30 companies in the benchmark Sensex and Nifty indices, have massaged their financial statements.

The study investigated 11 sectors, viz. real estate, retail, banking, manufacturing, insurance, public sector undertakings, mutual funds, transport and warehousing, media and communications, oil and gas and information technology.

The manufacturing sector, which contributes about 28 per cent of India’s gross domestic product, is the one most ridden with fraud mainly due to the peculiar nature of the business and the procedural complexities inherent in this sector. Real estate and public sector undertakings came second.

The motive for committing accounting statement frauds, according to 73 per cent of 340 chartered accountants who were respondents to the findings of the study, was to exceed expectations of stock market analysts. Other reasons for the fraud include credit-hungry firms manipulating application data in order to qualify for credit.

The KPMG India Fraud Survey Report 2008 showed that more than 80 per cent of respondents recognise fraud is a problem and 70 per cent believe it will increase over the next two years.

Accounting fraud is the worst type of fraud, shattering as it does the very basis of investor confidence in financial statements. In fact, investors eagerly await corporate results quarter after quarter, and if these statements themselves are manipulated, the efficient market theory relating to price formation itself does not hold good. As such, frauds cannot continue to be committed for long, prices will ultimately find their own realistic levels.

The beneficiaries of the frauds are those responsible for the fraud, including the personnel in the accounts departments of companies, auditors and concerned directors of companies and others who are in the know of things, all at the cost of the ordinary investors. It is possible that the fraudsters and those in the know of fraud may be indulging in insider trading, committing yet another serious offence.

Clause 49
It is indeed sensational that accounting frauds of such a large number of listed companies have occurred, despite the fact that Clause 49 of the Listing Agreement has been in operation for the last few years.

Clause 49 of the Listing Agreement provides, inter alia, for the Board of Directors to have at least half the Board to be independent directors, and for a qualified and independent audit committee with two-thirds of the members being independent directors and the chairman of the committee also being an independent director.

The audit committee should have an oversight of the company’s financial reporting process and disclosure of its financial information “to ensure that the financial statement is correct, sufficient and credible.”

Besides, the chief executive officer, as also the chief financial officer of the company have to certify that the financial statements do not “contain any materially untrue statements or omit any material fact or contain statements that might be misleading”, “present a true and fair view of the company’s affairs” and that no transactions of the company “are fraudulent, illegal or violative of the company’s code of conduct.”

Over and above these are internal auditors, apart from and the statutory auditors who have to certify that “no material fraud on or by the company has been noted or reported during the year.”

With all of the above mentioned in-built checks and balances and the Department of Corporate Affairs of the Government of India overseeing the working of companies all over the country, it is amazing that about 20 per cent of the listed companies have successfully managed to come out with financial statements that are fraudulent.

Corrective action
What is needed is immediate corrective action. The Department of Company Affairs /Securities and Exchange Board of India (SEBI) should order immediate special audits of the relevant years of these companies where frauds have occurred.

Suitable penal action should then be initiated against the directors of the company and all others involved in cases where special audits reveal frauds. The Institute of Chartered Accountants on India should also take suitable penal action against the concerned chartered accountants. The role of independent directors need also to be ascertained; is it just negligible or connivance, neither of which is pardonable.

Not just that. In all cases where the fraud is of a serious nature, which if revealed in time would have had a significant influence on the movement of stock prices, SEBI should start investigations of transactions in the shares of these companies to detect cases of insider trading. Needless to say that penal action must follow all cases where insider trading is detected.

Besides all these, the proposal of the Ministry of Finance to make it mandatory for companies to publish their balance sheets every quarter (which is presently done once a year), along with the profit and loss account, which will help the investors to know the liquidity and solvency of the companies, needs to be implemented urgently. This will, incidentally, bring India closer to international disclosure standards.

Guidance
If the actual financial statements are incorrect, chances of knowingly manipulating the figures relating to subsequent quarters for guidance of investors are greater still, particularly in the context of the desire of most of managements to show better results in the short-term, which may not always be in the long-term interest of the company. Former chairman of SEBI, M Damodaran, had called for a public debate on this issue. Although a joint call to end quarterly EPS guidance was made recently by the CFA Centre for Market Integrity and by the Business Roundtable Institute for Corporate Ethics, the matter has not been pursued. It is time that the issue is revisited in the context of the revelations made by ICS.

Conclusion
Any relaxation towards the guilty will encourage the fraudsters to continue their fraudulent activities, affecting adversely not just the process of price formation on stock exchanges, but also the very basis of the functioning of the corporate world. It is relevant to note that several of the leading companies in the United States, including Enron Corporation, Imclone Systems, Tyco International as also the leading accounting firm, Arthur Anderson, who were all involved in huge corporate frauds in the 2002 financial scam are serving time in jail. Recently, Bernard Ebbers, CEO of WorldCom, who was involved in an $11 billion accounting fraud, was sentenced to 25 years of imprisonment, despite his heart condition and he being called “an angel to desperate charity causes.”

Indian authorities do need to take a lesson from the United States. Will they?

Source: www.business-standard.com, By M R Mayya, Mumbai, April 13, 2009 

The Rise and Fall of ‘Chinese Warren Buffett’

Four months ago, life was good for Weizhen Tang. It was December and the so-called “Chinese Warren Buffett” was welcomed at Beijing’s Diaoyutai State Guesthouse, a site traditionally reserved for visiting foreign officials. 
Mr. Tang was the toast of the occasion, rubbing elbows with Chinese officials and media. It was an event celebrating “wealthy and intelligent” Chinese, and the Toronto-based investor was honoured with the “Award for Best Credibility.” 
But that credibility was called into question recently after investigators with the Ontario Securities Commission accused Tang of defrauding his investors of as much as $60 million, allegedly part of a Ponzi scheme in which old investors were paid with new investors’ money. 

On March 17 the Ontario Securities Commission ordered that Tang and his companies cease trading so that investigators could probe the allegations further. 
On Wednesday, the commission extended that cease-trade order to Sept. 10. 

Mr. Tang declined an interview with anEpoch Times reporter who visited his house on Wednesday. No formal charges have been laid. However, upwards of 200 are said to have lost their investments, each at $150,000 or more. 
Tang’s rise to prominence was no less dramatic than his recent fall, according to a Chinese-language article on Tang’s corporate website titled “Why Is Weizhen Tang So Capable?”
Tang was born the son of peasants in Hunan Province, China. He entered South Central Forestry College in 1978 and nine years later was sent overseas as a visiting scholar of biochemistry at a university in Ohio. 
Tang came to Canada in 1990, continuing biochemistry studies at the University of Waterloo before taking up a job as a researcher at a Toronto hospital. 
It was in Toronto in 1995 that Tang is said to have discovered his knack for trading, first by managing mutual funds for family and friends.Two years later he formed what would later become the Weizhen Tang Corporation, one of three company’s run by Tang that have now been named in the security commission complaint. His wife and daughter are listed as directors and officers of one company, according to the OSC filing. 

If it sounds unlikely that a man with no formal training in economics would rise to be the investment “king,” with claims of one per cent weekly returns, it’s perhaps because Tang is an unlikely character. His role models include the world’s best-known investor Warren Buffet, as well as hard line communist ruler Mao Zedong and pragmatist Deng Xiaoping, according to Tang’s Chinese blog.   
Tang succeeded in earning trust from other ethnic Chinese by presenting himself as someone who could help them succeed in an unfamiliar world. His investors included ethnic Chinese in Canada, the U.S., and Mainland China. 
In an article on the Weizhen Tang Corporation website where Tang shares his “road to Buffettian wealth,” Tang argues that the fears shared by Chinese immigrants are barriers to their success in North America. 
“The majority of Chinese refrain from trusting others,” Tang wrote. “On the rare occasions when we must, however, we are ever plagued by feelings of worry and suspicion. Many of us fear that someone might covertly make profit from us, or even cheat us. What we do not seem to understand is that we ourselves will not be able to make money if we stop others from doing the same.”

As Tang’s wealth grew, so did his reputation and influence. He was among those invited to welcome Chinese leader Hu Jintao on his visit to Canada in 2005. He was also welcomed as a representative of overseas Chinese by Chinese officials at a 2007 meeting of the United Front, an important organization used by the Communist Party to expand influence abroad.
In Canada, Mr. Tang was also an advocate of the Chinese regime’s policies. When Chinese police cracked down violently on protesting monks in Tibet in 2008, Mr. Tang came forward with the funds for dozens of buses to bring Chinese to Ottawa for a rally supporting the Chinese government’s stance that Communist rule had liberated Tibetans, he boasts on his blog. 
For the event, Tang says he was prepared to spend up to $200,000. 
“My role was to set the goal, provide funds, instruct how the capital was to be used, shoulder the risk, and do things that others can’t and don’t dare to do,” he wrote. 
Tang also enjoyed close ties with the Chinese consulate in Toronto. In January 2009 alone he organized and funded two events at which the consul general was a guest speaker. 

And in February and March, he was recognized twice with an award for having organized the rally against the Tibetan cause last year. Both times the consul general was again in attendance. 
In its March 24 submission to the securities commission, investigators now say Mr. Tang admitted in an interview to losing $15 million in 2007 while reporting a profit to investors. 
The commission claims it has evidence that Tang was also paying old investors with funds from new investors. 
Tang and his companies are also accused of trading securities without being registered with the commission and without filing a prospectus. 
For Tang’s part, he has stressed that no formal charges have been laid against him to date. In a series of letters posted on the Weizhen Tang Corporation website, he has admitted to making mistakes, but has denied benefiting personally. 
“I did not steal everyone’s funds,” he said in the first of five letters. 
“I am not like Ponzi or Madoff, because even my car is a leased one,” he wrote in the latest, posted Monday. 
Tang has said that if given the chance, he would earn back the money he lost. And, it seems, many investors want him to have the chance. 

In a petition claiming to represent 116 investors that was posted by Tang to his company’s website on Sunday, the OSC was asked to lift the ban on Tang’s trading.  
“Most investor clients of Weizhen Tang believe that, as overseas Chinese and a minority in Canada, non-physical confrontations should be solved internally,” the letter read. 
It said failure to lift the ban would result in “total, unrecoverable loss of our investments. This is something that we cannot accept on any terms.”
Neither Tang’s lawyer nor the investors presented the petition to the committee on Wednesday. Tang’s lawyer instead stressed that his client was cooperating with investigators. 
But one investor was present on Wednesday, a man who identified himself as Mr. Liu, a former doctor from China now in his 60s and out of work.

Mr. Liu said he’d invested with Tang since 2002 and says he lost most of his life savings.

“The thing I most like to do now is to have my money back,” Liu said.

“I had seen my investments grow in the statements from Tang, but I’d never withdrawn any money.”

Tang never warned Mr. Liu that there was risk in the investment, Mr. Liu says.“I hope he can continue his job if the law allows. But if the law says he has to go to jail, so be it.”

Source : www.theepochtimes.com, By Masha Ma and Anna Yang.