In the late 1990s, this was not a problem as the stock was continuing to climb to all-time highs. However, once the economy began to slow, is when this strategy backfired by forcing them to issues more stock to cover these losses. As shares were declining, many investors became weary of continuing to participate in these activities. (Healy, 2003)
In late 2001, these activities were brought to the attention of regulators and investors (which resulted in the eventual bankruptcy of the firm). This is illustrating how forensic accounts overlooked or ignored key areas that could have uncovered fraudulent activities. As a result, one could argue that the lack of ethics and the close relationship with company executives helped to perpetuate these abuses. (Healy, 2003)
Another type of fraud that is most prevalent is insider trading. This is when executives will have specific knowledge of the financial situation surrounding the firm and they will begin purchasing or selling the company's stock in advance. The basic idea is to take advantage of the price irregularities before the rest of the market has a chance to discover what happened. In forensic accounting any kind of large buys or sells could be a sign that executives are aware of this information. This is a violation of the Securities and Exchange Act of 1934. As the law, requires that executives must disclose (to the SEC) their intentions in advance of conducting the transaction. (Jagolizinnger, 2009) (Bettis, 2000)
However, most executives will often say one thing to: their employees, regulators and the general public. Yet, privately they will be engaging in activities that are in direct contradiction to what they are telling others. When this happens, these individuals will receive significant advantages at the expense of stakeholders. (Jagolizinnger, 2009) (Bettis, 2000)
A good example of this occurred with World Com. During the 1990s; the company was rapidly taking advantage of deregulation in the telecommunications industry. The idea is that they could use this as a way to become a major communications and Internet provider throughout the U.S. This resulted in the firm acquiring a number of assets that helped to increase their size and market share. (Jagolizinnger, 2009) (Bettis, 2000) (Albrecht, 2006)
To achieve these objectives, management would often use their common stock as currency and acquired significant amounts of debt. The problem with this approach is that World Com was purchasing firms with funds they did not have. This meant that these activities would normally have an adverse impact on their stock price under GAAP accounting standards. To deal with these challenges, the firm would take smaller write offs for the losses over a period of many years (versus right away). When the economy was strong, this helped World Com to grow exponentially. (Jagolizinnger, 2009) (Bettis, 2000) (Albrecht, 2006)
However, once a slowdown occurred, is when these issues became problematic for executives. This is because the company was having trouble growing their earnings through acquisition. Moreover, the previous purchases caused the debt load to cripple the firm's ability to obtain financing. This created a situation where World Com had trouble meeting their expenses. (Jagolizinnger, 2009) (Bettis, 2000) (Albrecht, 2006)
Bernard Ebbers (the CEO) realized what was happening and quickly began selling a large number of his holdings in the company. While at the same time, he was telling stakeholders and regulators that the firm was financially sound. To make matters worse, he approached the board of directors about them giving him loans to help complete his large purchases of different pieces of real estate around the country. This is a sign that Ebbers knew his company was in financial trouble and wanted to save his own investments at any cost. The fact that he did not disclose this to regulators or investors (until after these sales) is a sign that he intentionally wanted to protect himself. (Jagolizinnger, 2009) (Bettis, 2000) (Albrecht, 2006)
In this case, forensic accountants had a close relationship with the management and failed to reveal critical red flags of potential fraud. This is an indication there was a lack of ethics among actuaries. As they were willing to overlook these issues by: not questioning critical transactions, why they occurred or carefully scrutinizing the activities of executives. In many ways, one could argue that this close relationship is what allowed the fraud to continue (with the insider transactions serving as a tool to protect the net worth of unscrupulous company officials). (Jagolizinnger, 2009) (Bettis, 2000) (Albrecht, 2006)
Clearly, three areas where fraud is prevalent inside many corporations include: the misappropriation of company funds, inaccurately reporting information on financial statements and insider trading. What makes these issues so troubling; is the fact that forensic accountants often overlooked critical factors which could have identified and prevented these activities. However, because of their close relationship with company officials and a lack of ethics meant that these issues are often ignored. To deal with these challenges, all forensic accountants must have a sense of objectivity and a willingness to look out for the interests of stakeholders. If this can take place, it will be more difficult for these types of situations to develop. When this happens, stakeholders will have increased confidence in the company and the information that is provided. This should be the primary focus of forensic accountants at all times.
Albrecht, S. (2006). The Ethics Development Model. Australian Accounting Review, 16 (38), 30 -- 40.
Bettis, J. (2000). Corporate Policies. Journal of Financial Economics, 57…