Write three brief paragraphs about what you found. Remember to include the Web sites where your information came from so that your friend can do some investigating of his or her own.

Assignment Question

CHAPTER 1: Your best friend wants to know why “on earth” you are taking a fraud examination class. He is curious about what careers this class prepares you for. Go to the Internet and find information about two different careers that you could pursue in the field of fraud examination.

• Write three brief paragraphs about what you found. Remember to include the Web sites where your information came from so that your friend can do some investigating of his or her own.

CHAPTER 2: The following describes an actual investment fraud that occurred. Mr. Amslong stands accused in a federal indictment for committing one of the most common frauds in the history of finance: making big promises to investors that he couldn’t deliver. Mr. Amslong is accused of securities fraud after allegedly trying to cover up millions of dollars in bets on the yen and other currencies and options that went horribly wrong. It is probably not the ending that the 49-year-old Mr. Amslong envisioned when he fell in love with business as a boy. It was a love that turned him into an active stamp dealer at just 13 years old, only to be kicked out of the stamp world’s most elite fraternity as a young man in 1972, amid accusations of selling extremely rare stamps that he didn’t own and couldn’t deliver. Undaunted, he fought back and became a stamp authority—and eventually an authority on the far more sophisticated financial markets on which he was widely quoted. His self-confident forecasting style made him a hit in Japan, where Mr. Amslong is now accused of bilking investors out of $950 million. Documents he used to sell his investments show that he promised buyers of his securities that a yield of 4 percent was guaranteed on the fixed-rate instrument, a strong selling point in a country where interest rates on government bonds are less than half that. Moreover, the securities were designed to offer further returns as high as 25 percent, depending on market conditions. Mr. Amslong’s bets on the markets increasingly began turning against him. The Securities and Exchange Commission says that from late 1997, Mr. Amslong began to rack up increasingly big losses on large investments he made in currencies and options. Between November 1997 and August 1999, for example, SEC officials say Mr. Amslong lost $295 million in trading the yen alone—all money that belonged to clients. “In the wake of the discovery of the fraud,” the SEC said in its civil complaint that was filed, “Amslong has transferred millions of dollars from Princeton Global accounts into foreign-bank accounts he controls.” SEC officials declined to disclose how much money Mr. Amslong allegedly transferred overseas, or to what countries. On two previous instances, Mr. Amslong did face commodities trading scrutiny. In 1985, the agency overseeing commodities trading in the United States lodged a complaint against him for allegedly not registering and maintaining proper investment records. Then in June 1987, the same agency fined Mr. Arm- strong $10,000 and suspended his trading privileges for a year for improper risk disclosure and misrepresentation of his trading returns. Part of the complaint was related to advertising in a Princeton newsletter.

• 1. How did trust contribute to Mr. Amslong’s fraud?
• 2. In the chapter, lack of access to, or asymmetrical, information was discussed as one of the factors that provide opportunities for fraud. If investors would have known Mr. Amslong’s background and had access to other information about him, how would it have affected the fraud? Why?

CHAPTER 3: Frank is a friend of yours and works with you at the same company. He is a well-respected and trusted employee. He has two young children and is a leader in his community. You have discovered that Frank has embezzled $3,000 over a period of several years. While this is not much money for such a large company, you suspect that if you don’t report him, the problem may get worse. On the other hand, he has young children, and he has done so much good in the company and the community. If you report him, he may go to prison because your company has an aggressive fraud prosecution policy.

• Should you report him or are there any other alternatives ways to deal with this problem available to you?

CHAPTER 4: You work for a small manufacturing firm, where it is clearly too expensive to have proper segregation of duties. Because of this lack of control, management knows that opportunities exist to perpetrate fraud within the company. Management is particularly concerned with possible collusion between purchasing agents and vendors because of the relatively small size of the company and the fact that a single purchasing agent is often solely responsible for a vendor’s account. Management knows now that a lot of money can be saved by proactively preventing fraud and not just acting on a reactionary or crisis basis. They have started to establish an open-door policy where all employees are encouraged to talk about pressures and opportunities faced while on the job. Management also wants to establish a hotline where employees can report suspicious activity. Questions:

• a. Is an employee hotline necessary?
• b. Is this sort of whistle-blowing ethical?
• c. What can management do as they establish this hotline to encourage employees to actually use it?

CHAPTER 5: In his own words, Daniel Jones was “The Dude.” With his waist-long dreadlocks, part-time rock band, and well-paid job managing a company’s onlinesearch directory—he seemed to have it all. Originally from Germany, Jones, now age 32, earned his doctorate and taught at the University of Munich before coming to the United States, where he started his career in computers. When Jones started working with the company as a director of operations for U.S.-Speech Engineering Service and Retrieval Technology—he was assigned to work on a new, closely guarded search engine tied to the company’s .net concept. The company allows employees to order an unlimited amount of software and hardware, at no cost, for business purposes. In one year’s time, Jones ordered or used his assistant and other employees (including a high school intern) to order nearly 1,700 pieces of software which had very low cost but were worth a lot on the street. He then resold them for reduced prices— reaping millions. When items with a cost of goods sold of more than $1,000 are ordered, an e-mail is sent to the employee’s direct supervisor, who must click on an “Approve” button before the order is filled. In no individual order was the cost of goods more than $1,000—he made sure none of the orders required a supervisor’s approval. The loosely controlled internal ordering system reflects the trust the company puts in its employees. During this time frame, FBI agents said they saw Jones exchanging a large box of software for cash in a department store parking lot. The FBI contacted the company’s security and began monitoring Jones’s bank accounts. Previously, one account with his bank had an average balance of $2,159. In a short time, however, the average balance ballooned to $129,775. Another account at another bank showed irregular deposits totaling $500,000—none of which appeared to be from any legitimate income or other source. Investigators also noted that Jones purchased a Ferrari, a Jaguar, and traded in lesser vehicles for a Hummer, a Mercedes, and a Harley-Davidson motorcycle. He also bought an $8,000 platinum diamond ring, a $2,230 wristwatch, and a $4,000 bracelet. “You figured that I like big boy’s toys by looking at some of my pictures,” Jones wrote on his personal Web page. “I just can’t resist.” The Dude’s Web page includes a camera for monitoring his cat and photos of his yacht, cars, and other treasures. For a relatively low-level manager, it was an impressive collection. But at his company, where teenage software engineers can earn more than company directors, no one noticed anything unusual. A neighbor across the street from Jones said that he was clearly wealthy, but not flamboyant with his money. He described Jones as an intelligent man who didn’t flaunt his education, would loan neighbors tools, and was always friendly. The neighbor was surprised to hear the accusations against someone he called his friend. All he knew about Jones was that he was a good neighbor who loved cars. “He was very, very helpful. The few times I had problems with my PC, he’d come and help straighten them out,” the neighbor said. “They are just ideal neighbors. I feel terrible for him and his wife.” Jones and his wife lived in a modest home. Jones also joined the city’s Rotary Club, “where he seemed more outgoing and personable than the stereotype techie,” said a local jeweler and immediate past president of the club. “He seemed like what I would expect a genius software developer to be.” Eventually, the fraud was discovered and Jones was fired. He was also charged with 15 counts of wire, mail, and computer fraud—with each count carrying a maximum of fives years in prison. He is expected to remain in custody until his preliminary hearing.

• 1. Describe the symptoms of fraud that might be evident to a fellow employee.
• 2. Recently, his employer has been putting more emphasis on controlling costs. With the slowing of overall technology spending, executives have ordered managers to closely monitor expenses and have given vice presidents greater responsibility for balance sheets. What positive or negative consequences might this pose to the company in future fraud prevention?
• 3. As discussed previously, all frauds involve the following key elements: perceived pressure, perceived opportunity, and rationalization. Describe two of the key elements of the Jones fraud— pressure and opportunity.
• 4. From the scenario, what measures has the company taken to prevent fraud? In what ways could the company improve?

CHAPTER 6: Chapter 6 discusses the fascinating theory called ‘Benford’s Law’. To see if Benford’s Law has merit, I experimented with the following data. You can find the results in the following spreadsheets. Benford’s Law Experiments Please find your own data set to experiment on. (Feel free to use my spreadsheets as a model.)

• Share your thoughts regarding this method of fraud detection. Did your experiment match Benford’s predictions? Please attach your sample data and results. (By the way, this website tests Benford’s Law on many datasets: http://testingbenfordslaw.com/)

CHAPTER 7: Jim is the owner and president of ZZZ Company. He and his close friend, Dan, graduated with MBAs. They always dreamed about being successful and making lots of money. They have worked in the same company for years, working their way up to senior management and eventually senior executive roles. ZZZ Company has been a success the entire time that Jim and Dan have worked for the company. Stock prices have increased every year, and revenues have grown by a compounded rate of 20 percent per year. Jim is becoming a little suspicious of the company’s results because the earnings per share are always equal to Wall Street’s projections. In the past couple of years, Jim has noticed that his friend’s personal life has become troubled. Dan has gotten a divorce and is continually struggling financially, even though Jim knows that Dan is making plenty of money to cover his bills.One night, Jim stopped by the office to respond to some e-mails he could not get to during the day. He noticed that Dan was working late as well. Dan was the CEO, and Jim just assumed that he was working late because it was close to the end of the quarter. However, after reviewing the quarter’s results, Jim is suspicious again because the results are exactly equal to Wall Street’s forecasts. Jim decides he needs to begin an investigation into financial reporting practices.

• Question: What issues must Jim consider in deciding how to investigate the financial results of the company?

CHAPTER 8: An excerpt from the Fourth Amendment reads: “The right of the people to be secure in their persons, houses, papers, and effects, against unreasonable searches and seizures, shall not be violated, and no Warrants shall issue, but upon probable cause, supported by Oath or affirmation, and particularly describing the place to be searched, and the persons or things to be seized.” Suspecting a Mr. Flammer of running an illegal gambling and loan sharking operation, the FBI obtained a federal search warrant. The FBI entered the residence of Mr. Flammer and searched through various records. Suspecting most of the records were contained on a personal computer, the FBI began attempting to access the computer’s various files. Unable to access the needed files because of password barriers, the FBI installed a system known as a key logger system (KLS). This system was able to determine the keystrokes made on a computer and thus allowed the FBI to discover the password needed to enter the incriminating files. The discovery led to the gathering of evidence linking Mr. Flammer to the suspected illegal operation

• Question: Were Mr. Flammer’s Fourth Amendment rights violated?

CHAPTER 9: Steve (Slick) Willy, 45, just got out of jail. As a reformed citizen on parole, Slick decides to go into business for himself. He starts a collections company to help companies collect debts. The terms of his parole stipulate that he pay restitution payments to the federal government of $400 a month, or 10 percent of his income, whichever is greater. As his parole officer, you notice that after a year out of jail, Slick makes some interesting purchases. First, he buys a new Jaguar, which he drives to parole meetings. Second, he moves into an expensive neighborhood on the north side of town and takes a cruise to Jamaica with his 19-year-old girlfriend. Yet, he has never been late making his $400 monthly payments to the federal government. After obtaining a subpoena for his bank records, you notice that he has only $1,000 in his account. About this time, you receive a call from a man who is making payments to Slick’s collection company. He states that Slick is threatening to break his legs and hurt his family if he doesn’t pay Slick’s company. The man says Slick demands the checks be made out to a woman, not a company. This complaint convinces you to investigate Mr. Willy and his girlfriend. A search of UCC filings in the county shows that Slick’s girlfriend owns three cars costing a total of $85,000, a $360,000 house, and a company called Tak’It From You. You check her bank account and see that more than $45,000 is moving through the account each month. You decide to dig through Slick and his girlfriend’s trash a few times each month. In these searches, you find evidence that supports the following: three car payments totaling $2,000 per month; a $2,600 monthly mortgage payment; a credit card balance of $6,500, with $200 monthly payments; a balance of $13,500 owed to Home Shopping Network, with $600 monthly payments; $350 food payments during the past two weeks; and a $3,650 payment to Jamaican Cruise Lines. After searching the girlfriend’s trash, you talk to her neighbors, friends, and co-workers and determine that she and Slick spend between $1,500 and $2,500 a month on miscellaneous items and trips. One neighbor tells you that Slick just gave his girlfriend a diamond ring that cost $4,500. Slick’s girlfriend works as a waitress at a small restaurant and makes only $16,500 a year. (Note: Assume that both Slick and his girlfriend’s net worth last year were zero.)

• Question: Use this information to prepare a net worth analysis of Slick’s girlfriend. (Ignore interest in your calculations.)

CHAPTER 10: It is early Monday morning, and Jake is preparing to conduct his first interview as a fraud examiner. He is to meet with Lin, a laborer in the factory his firm is investigating. She is neither a suspect nor thought to be connected with the fraud. Her name simply came up in another investigator’s interviews as someone who might be able to provide additional insight. They have arranged to meet at Jake’s office, so he is simply awaiting her arrival. “Hello,” he hears someone say through his partially open door. “I’m Lin.” “Come in,” he replies, remaining seated behind his large, oak desk. She enters and takes the empty seat across the desk from Jake. “Let me get right to the point,” are his next words. “Are you aware of any reasonably credible or plausible evidence that the allegations of embezzlement at your place of employment are tenable?” After a brief pause and a look of concern on Lin’s face, Jake asks, “Do you know what embezzlement means?” “Yes,” replies Lin. “Okay, then, do you know anyone who has embezzled from your employer?” “No.” Lin becomes nervous as she sees Jake begin to take notes on a pad. He continues, “Specifically, have you seen Tom perpetrating fraud?” “No.” “Are you sure? You know that this is a big deal,” he says as he stands and begins to pace around the room. “I can’t imagine why anyone would steal from his own company, but he deserves to be caught if he has. It’s wrong and bad, and only a horrible person would do something like this.” “I’m sure.” “Have you embezzled?” “No,” Lin states again. “Well, then, I don’t see any reason to continue. Goodbye.” Lin stands, excuses herself, and leaves the room.

• Question: What are some of the things Jake did wrong during this interview?

CHAPTER 11: After Enron, WorldCom, and other major corporate scandals that rocked America in the recent past, it seemed that nothing would surprise investors or regulators. However, almost everyone was shocked by revelations that as many as 20 percent of all public corporations may have allowed their officers and directors to “backdate” their stock option awards and account for the awards improperly. For a time, hardly a day went by without another public company’s fraudulent stock option practices being revealed. A stock option is an award granted under which key employees and directors may buy shares of the company’s stock at the market price of the stock at the date of the award. As an example, assume that Company A’s stock price is $15 per share on January 1, 2007. Further assume that the company’s CEO is awarded 200,000 stock options on that date. This means that after a certain holding (vesting) period, the CEO can buy 200,000 shares of the company’s stock at $15 per share, regard- less of what the stock price is on the day he or she buys the stock. If the stock price has risen to, say $35 per share, then the CEO can simultaneously buy the 200,000 shares at a total price of $3 million (200,000 times $15 per share) and sell them for $7 million ($35 per share times 200,000 shares), pocketing $4 million. Stock options are a way to provide incentives to executives to work as hard as they can to make their companies profitable and, therefore, have their stock price increase. Until 2006, if the option granting price ($15 in this case) were the same as the market price on the date the option was granted, the company reported no compensation expense on its income statement. (Under accounting rule FAS 123R, effective in 2006, the required accounting changed.) However, if the options were granted at a price lower than the market share price (referred to as “in-the-money” options) on the day the options were granted, say $10 in this example, then the $5 difference between the option granting price and the market price had to be reported as compensation expense by the company and represented taxable income to the recipient. The fraudulent stock option backdating practices involved corporations, by authority of their executives and/or boards of directors, awarding stock options to their officers and directors and dating those options as of a past date on which the share price of the company’s stock was unusually low.Dating the options in this post hoc manner ensured that the exercise price would be set well below market, thereby nearly guaranteeing that these options would be “in the money” when they vested and thus provided the recipients with windfall profits. In doing so, many companies violated accounting rules, tax laws, and SEC disclosure rules. Almost all companies that were investigated “backdated” their options so that they would appear to have been awarded on the low price date despite having actually been authorized months later.

• 1. Would a good system of internal controls have prevented these fraudulent backdating practices?
• 2. Why would executives and directors of so many companies have allowed this dishonest practice in their companies?
• 3. Would a whistle-blower system have helped to prevent or reveal these dishonest practices?

CHAPTER 12: After graduating from college with your MBA, you decide to take your grandma’s secret cinnamon roll recipe and open up a bakery. You grew up devouring your grandma’s rolls, and you have convinced her to give you the secret. You are confident that your bakery will be the next big hit in the fast-food business. You take out a business loan for the maximum amount your bank will give you, hire several employees, and open a beautiful store that is designed to look like your grandma’s home. After eight months of hard work and diligence, you are crushed when you realize that your store manager has been stealing from you. One of your recent hires tells you that during her last shift, the manager, Stephanie, voided a sale of two-dozen cinnamon rolls, stamped the receipt as a return, and pocketed the money. Stephanie warned the new hire not to say anything and told her she deserved the money because she didn’t get paid enough. Encouraged by your open- door policy, the employee confides in you.

• 1. Identify what symptoms this fraud will generate. In addition, identify how this fraud will directly affect your revenue and inventory accounts.
• 2. Explain the steps you should take to search for each symptom you identified in part (1). In particular, describe the computer queries and transactions that should be searched to find this fraud.
• 3. After you have identified several symptoms, do you have enough evidence to prove that she is guilty? What other evidence is required or useful in this case?
• 4. Besides searching for symptoms of the fraud, what other investigative steps can be taken to elicit a confession or otherwise prove the fraud?
• 5. What steps could have been taken to prevent this fraud from occurring in the first place?

CHAPTER 13: In its 2001 annual report, investors of Adelphia Communications were startled to find a footnote in its financial statements that reported the company had guaranteed as much as $2.7 billion in loans to a private entity owned by CEO John Rigas and his family. As a result of the footnote, Adelphia lost more than 50 per- cent of its market value in little more than a week.

• Question: Explain why you think the market value of Adelphia fell so dramatically with the footnote disclosure that the company had guaranteed loans to an entity owned by the company’s CEO and his family.

CHAPTER 14: For many large, international companies that do business in less developed countries, corruption is a part of everyday life. Without bribing public officials, their companies could never build a factory, hire employees, get permission to build infrastructure, or receive shipments from international vendors. Shipping merchandise out of these countries can be equally difficult, with customs agents demanding unofficial payments to allow the shipment to be made.

• 1. If you worked for one of these companies, how would you respond to being asked by your boss to pay a bribe?
• 2. Are such bribes a necessary part of doing business abroad?
• 3. Most importantly, explain this in the context of the FCPA laws.

CHAPTER 15: There have been some major data breaches in recent years – including Equifax, Capital One, Target, Home Depot, Facebook etc. [You can find a complete list here: https://en.wikipedia.org/wiki/List_of_data_breaches.] All of these breaches increase the likelihood of you or your friends becoming a victim of identity theft.

• Detail what actions you have taken or will take to protect yourself from this risk. Further, describe what you would advise a friend or client to do if their identity has been stolen.

CHAPTER 16: Colleen Matthews had just turned 22 when her hard work finally started to pay off. Six months earlier, Colleen had graduated from a state university with a master’s degree in accounting. Colleen graduated with honors and was one of the youngest in her class. Unlike most of the intellectuals she had studied with throughout her career, Colleen was extremely social and had great communication skills. After graduation, she took a job with a well-known regional accounting firm. The firm specialized in assisting companies with their technology problems. Colleen knew that the connections and knowledge she would gain working for the firm would be beneficial throughout her career. Now, six months after graduation, she has a full-time job offer with one of the firm’s strongest clients. Within a few days on her new job, Colleen had adapted to her new environment. Colleen and two other recent graduates were running the entire accounting department. However, it wasn’t long until Colleen began to notice that something wasn’t right. After a few weeks, Colleen realized that the firm’s executives were participating in illegal transactions. The company executives were importing expensive technological products from China and selling them under the table to contacts unknown to Colleen. Once the firm received the products at the shipping dock, the executives’ “personal employees” marked the products and took them to a separate location. The entire operation was done with little paperwork. The money received from the special products received special attention. Colleen was told to report this inflow of cash in an account called “Personal Executive Consulting Services.” This allowed the executives to personally use the money at their convenience.

• 1. Does Colleen have a responsibility to report the apparent fraud?
• 2. If so, to whom should she report the fraud?
• 3. Assuming that the fraud has been continuing for several years, what would be the tax ramifications to the executives of not reporting earnings on their tax returns?
• 4. Even though the money is from illegal sources, are the executives required to report the income on their annual tax returns?
• 5. Earlier in the book, we discussed the net worth method. How do you think the net worth method can help prosecutors determine the extent of these executives’ illegal income?

CHAPTER 17: A number of security/intrusion detection firms exist in the market. Research one of these firms and report on its services, costs, and benefits.

• 1. Would you hire a firm like this for a start-up company?
• 2. Would you hire one for an established, small company?
• 3. Would you hire one for a Fortune 1000 company? Why?

CHAPTER 18: Mr. Oaks has worked as the CEO of Turley Bank for the last three years. This past year, the outside auditor discovered some fraudulent loan activity in which Mr. Oaks was circumventing internal controls to lend money to friends and family. After a thorough investigation, the board of trustees concluded that Mr. Oaks had committed more than $10 million in loan fraud. Mr. Oaks denied any wrongdoing. Now, the board is contemplating pursuing a civil case against Mr. Oaks, seeking repayment of the $10 million.

• 1. What are some reasons why Turley Bank would not pursue a civil case against Mr. Oaks?
• 2. If Turley Bank decides to pursue a civil case against Mr. Oaks, what are some reasons why the bank would settle out of court before the actual trial?
• 3. If Turley Bank decides to pursue a civil case against Mr. Oaks, what are some reasons why Mr. Oaks would settle out of court before the actual trial?

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