The Fraud Busters
by
Robert Bryce
Call it fraud that occurs in plain view. At Italian dairy giant, Parmalat, the company kept fraudulent books for some three decades. The fraud became so blatant that some financial analysts have said that they knew the company’s books were nonsense. They were right. Parmalat’s books were hiding some $14 billion in bad deals.
At Enron, many of the fraudulent accounting scams, including an admission that a high-ranking company executive was doing business deals with the company, were disclosed—albeit obliquely—in the footnotes to Enron’s financial statements. The scams allowed Enron to hide liabilities that were two to three times the amounts shown on its balance sheet.
These frauds—along with the ones at Tyco, Adelphia, HealthSouth and dozens of other companies—have transformed the pages of The Wall Street Journal and other business publications into what frequently resembles a police blotter. Indeed, over the past few years, the business world has endured a tsunami of big-time frauds. And there are hundreds, perhaps thousands, of others that get less notoriety or go undiscovered, but are every bit as corrosive to our system of democratic capitalism.
Fraud costs businesses and investors enormous amounts of money—both in terms of losses due to the fraud itself and in the amounts needed to comply with new regulations like the Sarbanes-Oxley Act of 2002, which are intended to combat future fraudsters.
The price tag for all this fraud staggers the imagination. The Austin-based Association of Certified Fraud Examiners estimates that fraud of all kinds—embezzlement, misappropriation of funds, accounting fraud, consumer fraud, identity theft and other fraudulent activities—could be costing the U.S. $660 billion per year. Identity theft, alone, is among the most widespread. Last year, the Federal Trade Commission estimated that identity theft affects nearly five percent of all citizens and costs nearly $50 billion per year.
Although it’s impossible to accurately measure the impact of fraud across the entire economy, there’s anecdotal evidence to suggest that the association’s figure is at least in the ballpark.
In 2001, Enron filed for bankruptcy with $63.4 billion in assets. In 2002, phone giant WorldCom, went bankrupt with $107 billion in assets. However, the $170 billion in assets represented by those two bankruptcies will be only a fraction of their total cost. The lost market capitalization, combined with the lost wages, lost retirement benefits and litigation costs associated with the bankruptcies, will likely result in costs that are several multiples of that $170 billion figure.
Of course, fraud isn’t a new phenomenon. In the late 1800s, con artists like railroad magnate Jay Gould manipulated the stock market at their whim. In the late 1920s, stock fraud was so common that cheating was almost expected. But the advent of the Internet, combined with ever more complicated accounting rules and ever more sophisticated consumer databases, have given the bad guys many more opportunities to cheat.
The McCombs School has been dealing directly with the fraud problem for nearly a decade and a half. In 1990—at a time when only a handful of other universities were offering the class—the McCombs School began offering internal audit classes to students. In 1992, Jack Robertson, the Charles T. Zlatkovich Emeritus Professor of Accounting, began teaching a course on how to investigate fraud. According to Robertson, who retired from teaching last year, only two other major accounting programs in the country were instructing students on fraud detection methods when he began teaching his class.
Today, dozens of schools have courses on fraud examination—a
fact that may help reduce the number of Enron-like disasters in
the future. Given the recent surge in fraud and the McCombs
School’s history of
teaching students about fraud, this article focuses on two people
from the University of Texas community—Joe Wells and Bill
Black—who are on the front lines of the battle against fraud.
Showdown at the Bookkeeping Desk
Joe Wells is the Wyatt Earp of the fight against fraud. Like Earp, who gained fame and fortune thanks to his role in killing the Clantons during the gunfight at the OK Corral, Wells has become the lead sheriff in the world of fraud examination.
A certified public accountant who spent 10 years in the FBI, Wells is the founder and chairman of the Association of Certified Fraud Examiners (ACFE), a group dedicated to reducing the incidence of fraud and white-collar crime. Founded in 1988, the ACFE now includes some 30,000 members and it conducts dozens of classes every year on different aspects of fraud detection and prevention. The association also began distributing course materials—at no charge—to colleges that want to teach courses on fraud examination.
Wells believes that the recent corporate scandals indicate a
fundamental flaw in the way accountants have approached their
jobs. When auditors go into a company, “They assume there’s no
fraud. Auditors are supposed to be professionally skeptical,”
Wells says. “In today’s era, the standard of professional
skepticism isn’t really enough. Instead, it should be professional
suspicion.”
While Wells is pushing education to help control fraud—he’s been
teaching fraud examination at the McCombs School since 2001 as an
adjunct professor—he also believes that structural changes are
needed in how companies keep their books. And his solution is
fairly radical: require companies to report their financial
positions in real time.
Wells believes that if companies are required to report their financial positions every day, it would remove the pressure for CEOs to hit the quarterly earnings-per-share estimates put out by Wall Street analysts. Moving to a continuous reporting cycle, says Wells, would remove the “period that allows execs to sit around and scheme and cook the books.”
Remember the S&Ls
During the height of the savings and loan disaster, Bill Black was not a particularly popular fellow. During the late 1980s and early 1990s, Black was a senior regulator at several federal agencies that oversaw the savings and loan industry. And thanks to his aggressive push to shut down insolvent S&Ls and prosecute the professionals and individuals who were defrauding many of those institutions, Black won plenty of enemies, both in Congress and in the financial sector. But that experience—some 25 percent of $300 billion that was lost during the S&L disaster was due to fraud—has also made Black an expert.
An assistant professor at the LBJ School of Public Affairs, Black is the interim executive director of a fledgling entity called the UT Austin Institute of Fraud Studies. Teaming with Joe Wells and ACFE, Black established the institute to help make UT Austin a leader in the study of fraud. The ACFE and the American Institute of Certified Public Accountants are expected to provide initial financial backing for the institute. It is hoped that the institute will allow professors at the McCombs School who work in various disciplines—like internal auditing, risk management and accounting principles—to cooperate with people from other UT departments in scholarly research on fraud-related topics.
Although it has taken massive disruptions like the S&L meltdown and the failure of Enron and other companies to get the public’s attention, Black believes there has been a shift in perception regarding the deleterious effects of fraud.
“It’s now respectable to take fraud seriously,” says Black. “And we have lots of student interest in our classes. That’s a good thing.” This year, Black and his students will produce a report on fraud in the non-profit sector. Last year, he and his students produced a report for the Congressional Research Service on fraud and corporate governance.
While Black and Wells continue to fight various varieties of fraud, they both understand that the game won’t end anytime soon. The Internet, readily available consumer databases, increasingly complex accounting rules and high-speed communications have given fraudsters many more opportunities to cheat.
“This is an eternal struggle,” says Black, “and you have to think of it that way.”
For information on specific programs at the McCombs School, consult our contacts page. For media information, contact the Communications Director by phone at 512-471-3314 or by email at CommunicationsDirector@mccombs.utexas.edu.
