Enforcement & Litigation
New Strategies for Reducing Corporate Fraud
By Jaclyn Jaeger
A ttendees at the annual CFO Sum-
mit at the Massachusetts Institute of
Technology in November heard from fed-
eral regulators promising no end to their
fraud crackdown of recent years, as well as
from other corporate executives offering
their ideas on how to maintain ethical op-
erations amid difficult economic circum-
stances.
Neil Power, a supervisory agent at the
FBI, told the crowd that the FBI is cur-
rently investigating 592 corporate fraud
cases—60 more than the caseload two
years ago. Securities fraud, such as Ponzi
schemes or other high-investment scams,
have also seen “an alarming increase” from
1,200 cases in 2007 to roughly 1,500 cases
today, he said.
To help its investigation efforts, the FBI
works in parallel with the Securities and
Exchange Commission, Power said. He
stressed that neither agency has authority
over the other: “They do not direct us. We
do not direct them.” But given that fraud
investigations can span across multiple lo-
cations and be “very document-intense,”
the two do collaborate, he continued. The
actual report of investigations, however,
is written by only one to avoid conflict-
ing viewpoints that could hinder civil or
criminal proceedings in court.
The FBI is also looking to expand its
sources of information to include hedge
funds, private equity firms, and the Big
4 auditing firms to help the agency bet-
ter address fraud before it happens, Power
added.
Despite the current increase in fraud in-
vestigations, however, fraud itself is a con-
stant threat, warned a panel of executives
speaking at the event. “Fraud happens in
good times, but it’s recovered in bad times,”
said Frank Haydu, a chairman of the audit
committee for retailer iParty. That means
financial executives must treat fraud miti-
gation as an ongoing effort, he said.
To that end, Haydu said, he tries to
“understand the business case” of a trans-
action or set of performance results, rather
than look for specific types or incidents of
fraud. That means investing the time so he
16
can detect when something doesn’t make ing on in the business,” he said.
sense and try to figure out why it doesn’t. Peter Saparoff, a partner at the law firm
“To the extent that something is going on,
you’ll find it if you understand what’s go-
Mintz Levin, echoed Haydu’s advice. Too
Continued on Page 71
SOME BIG NAMES IN FRAUD
The following are some significant fraud cases pursued by the FBI:
BROCADE COMMUNICATIONS SYSTEMS, INC. (SAN FRANCISCO): Brocade Communications
Systems, Inc. (Brocade), a technology company based in San Jose, California, routinely used stock
options to compensate its employees. In July 2006, former Chief Executive Officer (CEO) Gregory L.
Reyes and former Vice-President of Human Resources Stephanie Jensen were charged in connection
with a scheme to backdate stock option grants. The two executives made fraudulent entries into
Brocade’s financial books and records, made false statements to auditors, and filed false financial
statements with the SEC in furtherance of the scheme. After internal auditors restated earnings for the
years 1999 through 2004, it was estimated that the cost to Brocade exceeded $400 million. On August
7, 2007, a jury convicted Reyes of ten counts of conspiracy and securities fraud. Reyes was the first
person to be tried on charges related to stock options backdating and was sentenced to 21 months
in prison. On December 5, 2007, a jury convicted Jensen of conspiracy to commit securities fraud and
falsifying corporate records. Jensen is currently awaiting sentencing.
QWEST COMMUNICATIONS (DENVER): Qwest Communications (Qwest) is a Fortune 500 compa-
ny and one of the largest providers of telecommunications services in the U.S. In 2000 and 2001, the
company reported sales revenues of $16 billion and $19 billion, respectively, in its published financial
statements. In 2002, Qwest issued a press release that acknowledged the company had improperly
recorded $1.1 billion in revenue since 1999, and the FBI opened a criminal investigation. Five execu-
tives were indicted and either pled guilty or were convicted of securities fraud or insider trading. This
included the former CEO Joseph Nacchio, who was convicted of insider trading on April 19, 2007. He
was sentenced to six years in prison, ordered to forfeit $52 million gained as a result of his illegal stock
sales, and fined $19 million.
HOLLINGER INTERNATIONAL, INC. (CHICAGO): Hollinger International (Hollinger) is an inter-
national newspaper holding company and owner of the Chicago Sun Times and The Daily Telegraph
newspapers. This case was initiated based on allegations that $32 million in non-competition pay-
ments were made to CEO and Chairman of the Board Conrad Black and three other corporate execu-
tives in conjunction with newspaper sales without proper authority. It was also alleged that news-
paper circulation numbers were overstated for the purpose of misleading advertising companies and
causing them to pay more in advertising fees. In November 2005, Black and three others were indicted
on 15 counts of racketeering, mail and wire fraud, money laundering, obstruction of justice, and tax
fraud. On July 13, 2007, Black and the three other co-defendants were convicted after a four-month
jury trial. On December 10, 2007, Black was sentenced to 78 months imprisonment.
BRITISH PETROLEUM, INC. (ANCHORAGE): On October 25, 2007, British Petroleum (BP) and
several of its subsidiaries agreed to pay $373 million in fines and restitution for environmental viola-
tions stemming from a fatal explosion at a Texas refinery that occurred in March 2005 and from leaks
of crude oil from pipelines in Alaska in March 2006, as well as for conspiring to manipulate the price
of propane.
Source: Federal Bureau of Investigation. For additional information, go to www.complianceweek.com
and enter Print Reference Code: 011007.
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New Strategies for Reducing Corporate Fraud
Continued from Page 16
often, he said, he sees directors who clear-
ly don’t understand a transaction, “but
they’re afraid to ask and have it explained,
because they don’t want to look stupid. In
terms of risk control, that’s a problem.”
Understanding the culture of the busi-
ness is also critical, Haydu added. “There’s
nothing more important than the qual-
ity and the integrity of the people you are
dealing with,” he said. “I’ve left companies
because I didn’t trust the CEO or CFO. If
I get a nervous feeling like that, that’s the
one thing I will not ignore.”
John Tus, corporate treasurer of Hon-
eywell, agreed. “There are no people in a
company that are more well-positioned
than the leaders of the company to drive
that integrity in the organization,” he said.
“One of the first rules you learn in account-
ing is that you can’t audit a company where
management doesn’t have integrity.”
Indeed, Power said, many cases come to
the attention of the FBI thanks to “greedy
executives who will do anything for a
buck.” Usually the company is operating
Debt, Lease Restructurings Pose Fresh Challenges
Continued from Page 24
agreement would change the classification
of a lease from operating to capital or vice-
versa, says David Grubb, a partner with
regional accounting firm Plante & Moran.
An operating lease is reflected as an expense
as lease payments are made, with no asset
or liability appearing on the balance sheet;
a capital lease appears as an asset and a li-
ability over the life of the lease. ASC Topic
840 addresses lease accounting, and gener-
ally tells companies what to do if the terms
of a lease are modified. It’s also an area of
complexity, Grubb says.
Chris Montague, a managing part-
ner with Plante & Moran, says companies
should pay attention to whether a change in
lease terms could trip changes in metrics that
are important to other loan covenants, such
as debt-to-equity ratios or capital require-
ments, among others. “If you’ve not thought
that through, you could end up with an is-
JANUARY 2010
without checks and balances, or is ex-
tremely profit-driven from the executive-
level down, where numbers are constantly
being fudged whether it’s to increase rev-
enue or hide losses, he said.
One attendee lamented that fraud whis-
tleblowers often are the ones who suffer,
since they are bucking the will of top ex-
ecutives and then face retaliation for mak-
ing the right ethical decision.
Power agreed. “Each one is afraid to
lose their job if they don’t go along with
making money for the company,” he said.
“These days in the recession, when there
are not many jobs out there, it’s even more
pressure on that follower.”
Haydu, however, put the choice for whis-
tleblowers in more stark terms. “If you’re
in a situation where people are breaking the
law … you have to either leave, or you need
to do something about it,” he said, “be-
cause you’ll not get another job eventually
if it ever hits the light of day.”
Saparoff also warned that having a cor-
porate compliance program in place isn’t
always enough to please regulators. When
sue in your banking relationships that you
weren’t counting on,” Montague says.
John Hepp, a partner in the national
professional standards group at Grant
Thornton, says lease accounting has plenty
of complexity generally, and accounting for
modifications is no different. “If you mod-
ify a lease, some of the debits and credits
don’t work out intuitively,” he says. “You
need to be careful.”
Companies renegotiating leases now
would be wise to consider not only existing
rules, but also new lease standards that are
percolating in both the United States and
internationally, Hepp says. In a few years,
it’s won’t be so easy to keep leases off the
balance sheet, he says.
There may be good business reasons to
lease property or equipment rather than to
buy, “but if keeping the obligation off the
balance sheet is one of those, you have to
start anticipating that that will go away,”
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facing an SEC probe, for example, compa-
nies will often tout their compliance pro-
grams as proof of their ethical attitudes,
“but I don’t think the inquiry will stop
there,” he said. “You can have the best com-
pliance program in the world, but the SEC
is still going to want to know why it was
that this person was able to get around it.”
Saparoff said putting someone in charge
of enforcing compliance is vital. If no clear
enforcement person exists, the SEC will
start to wonder: Was the compliance de-
partment not paying attention? Are its
staffers underpaid? Is the compliance
function itself not large enough to handle
the challenges the company faces?
In summary, with all the headaches
brought on by an FBI and SEC investi-
gation, compliance with laws and regula-
tions is critical, Tus said, and to invest in
fraud mitigation is “money that’s very well
spent.”
For more information, including re-
lated coverage, please go to www.compli-
anceweek.com and enter Print Reference
Code: 011007. ■
Hepp says. “Even the whole decision of
whether to lease or buy may change. If it’s
going to be on the balance sheet, particu-
larly in today’s market, you may be able to
purchase that asset at relatively favorable
terms.”
According to Grubb, companies will
typically pursue lease modifications after
they’ve exhausted other debt modifica-
tions that might produce some cash relief.
“If the economic turnaround is slow, we’ll
see more” companies pursuing new leases,
he says.
Gary says retailers, who typically lease a
lot of property, likely will ride out the holi-
day shopping season and see how that im-
proves their situation before pursuing new
lease agreements.
For more information on lease and debt
accounting, please go to www.compliance-
week.com and enter Print Reference Code:
011009. ■
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