How To Prevent Financial Statement Fraud

Transcription

1 Who are you looking at? PROFESSOR KAREN VAN PEURSEM PHD (WAIKATO), CA (NZ), CPA (U.S.)

2 Financial Statement Fraud: Governing Bodies and the Auditors CAN A CORPORATE GOVERNING BODY TAKE ACTIONS THAT MIGHT GIVE THEM A BETTER CHANCE OF PREVENTING MATERIAL FINANCIAL FRAUD?

3 What are their responsibilities? Governing bodies Auditors

4 According to New Zealand Statute... oversight, providing direction, conducting practices with due care, acting in good faith and in the best interests of the company (NZ Companies Act, 1993, S131)

5 According to New Zealand Listing Regulations keep the market... informed on matters that may affect the price of their securities restricts insider conduct But may rely on professional or expert advice given (CA, S138)

6 In comparison to U.S. Listings Regulation An emphasis on within-board skills and subcommittee involvement Foreign Corrupt Practices Act 1977 Sarbanes-Oxley (2002) : Audit Committee requirements Exchange provisions and requirements

7 The accounting professions and standards setting bodies may disagree... the accounting profession and standard setters express interest in ensuring the governing body and management have a strong role in fraud prevention

8 International Standard of Auditing The primary responsibility for the prevention and detection of fraud rests with both those charged with governance... and management (ISA (NZ) 240, para 4)

9 ... and It is important that management... governance, place a strong emphasis on fraud prevention... a commitment to creating a culture of honesty and ethical behaviour includes considering the potential for override of controls.. [and] earnings management (p4)

10 ... And therefore... identifying fraud within the organisation is viewed by the accounting profession as an important role of the governing body

11 The auditor s role......is to provide reasonable assurance that the financial statements are True and fair and that they are free from material misstatement (ISA (NZ) 240)

12 The auditor shall identify and assess the risks of material misstatement due to fraud...(isa (NZ) 240k p25)

13 That is, and according to the accounting profession, the role of the auditor is to... evaluate fraud potential... follow up suspicions of fraud... communicate issues appropriately

14 ... A view reluctantly (?) formed over time 1997: no requirement to look other than to take into consideration risk..., lower level of assurance on fraud 2003: Follow up suspicions emerging from normal audit evidence gathering procedures 2007: Plan, consider risks, discuss, design tests in response to known risks...

15 This is where the courts step in..

16 How can a board structure themselves as to best prevent corporate financial fraud?

17 Relationships between Corporate Governance and Fraud in U.S. Listed Companies NICOLA BURKE, KAREN VAN PEURSEM, IAN EGGLETON

18 Governance characteristics said to contribute toward corporate fraud protection... Independence Expertise Communication practices Their own relationships with the company By Board sub-committees Board member composition Board communication practices Shareholder representative characteristics

19 What was examined 519 U.S. Fraud-committing companies ( ) Data from SEC s Accounting Enforcement Releases, official sites, corporate reports Matched pairs reduces to refined sample of 152 fraud and no-fraud companies (76 each) Regression to identify governance characteristics associated with fraud

20 Board Sub-Committee Characteristics and Communication Practices Audit committee member numbers Independence financial expertise meeting frequency average tenure (other) directorships held Nominating Committee Existence Numbers

21 Board member composition characteristics Number of directors Number of independent directors Whether the chief executive officer is also a director Ownership share by inside (and outside) directors

22 Shareholder representative characteristics Outside blockholder ownership numbers and proportion * Auditor Tenure International firm (or not) * External to Board control

23 Tests applied: Companies matched by industry, size, leverage, age, growth... Univariate matched t-tests Validating tests Logistic regression What governance characteristics accompany the presence of fraud in these companies?

24 Findings 5 characteristics significantly associated with fraudulent corporate financial statements include: 1. Number of directorships held by (AC) directors 2. Smaller proportion of independent directors 3. Companies without a Nominating Committee 4. CEO who is also Chairman That is... Independence issues

25 Surprise finding #5 The only other significant correlation was between the percentage of company ownership held by outside blockholders and the presence of corporate financial fraud...

26 Findings as to the auditor? Neither the size of the firm nor their tenure proved to be significant to fraud practice. Limitation: We only examine select measures of auditor independence, other auditor independence studies may identify further issues

27 Implications Would be risky for the governing board to rely on the auditor alone to pick up instances of corporate fraud. Ambiguous guidance makes it difficult to anticipate responsibility, and the governing board may be in a stronger position to structure the company to help prevent corporate financial fraud

28 That is, while the auditors have a growing responsibility to look for material fraud, our findings suggest that potential for fraud prevention may lie in the structure (and independence) of the board.

29 Thank you!