Question

Discus the development of the fraud examiner/forensic accounting profession since the 2001 Enron fraud. Discuss applicable standards and the core foundation of the profession.

Answer 1

Forensic accounting has been pivotal in the corporate agenda after the financial reporting problems which took place in some companies around the world like Enron. These scandals resulted in the loss of public trust and huge amounts of money. In order to avoid fraud and theft, and to restore the badly needed public confidence, several companies took the step to improve the infrastructure of their internal control and accounting systems drastically. It was this development which increased the importance of accountants who have chosen to specialize in forensic accounting and who are consequently referred as “forensic accountants.”

Forensic accounting relies on the fraud triangle to identify weak points in the business systems and find possible suspects in cases of fraud. It consists of three core concepts which together create a situation ripe for fraud: incentive, opportunity, and rationalization. People must have the incentive and opportunity to commit financial fraud, as well as the ability to justify it. Recent analysis has suggested adding a fourth concept to make a diamond—capability. Just because someone has the opportunity or incentive to steal does not necessarily mean that they have the capability to do so. For example, if someone does not understand how to make journal or ledger entries in the books of accounts, they would not know how to manipulate numbers no matter what the incentive or opportunity is.

The accounting scandals involving Enron, WorldCom, Global Crossing, and other companies have put accountants in the public spotlight as never before in their history. After these accounting scandals, public confidence in the accounting profession has been seriously undermined. However, the scandals have created business for forensic accountants and developed opportunities for forensic and investigative accounting. Forensic accountants have been conducting these activities for quite some time in a quiet professional manner. New laws and regulations resulting from these scandals will make the role of forensic accountants more important than ever before in the business world.

Forensic accountants, also referred to as forensic auditors or investigative auditors, often have to give expert evidence at the eventual trial. All of the larger accounting firms as well as many medium-sized and boutique firms have specialist forensic accounting departments. Forensic accountants utilize an understanding of business information and financial reporting systems, accounting and auditing standards and procedures, evidence gathering and investigative techniques, and litigation processes and procedures to perform their work. Forensic accountants are also increasingly playing more proactive risk reduction roles by designing and performing extended procedures as part of statutory audit, acting as advisers to audit committees, fraud deterrence engagements, and assisting in investment analyst research. The skeptical mindset is something that has long been inherent in forensic accountants and other internal investigators when looking for evidence of fraud. The investigator historically has asked a set of questions different from those of conventional auditor, who is monitoring the financial statements to see whether they are in compliance with generally accepted accounting principles (GAAP) and thereby fairly represent the financial conditions of the company. Fraud auditing, forensic accounting, and/or fraud investigation (i.e., forensic accounting) put things together rather than take them apart, as is the case in financial classical auditing or modern method of systems analysis. The process of forensic accounting is also sometimes more intuitive than deductive, although both intuition and deduction play important parts.

Forensic accounting profession has some requirements. Certified fraud examiner (CFE) is a designation awarded by the ACFE. The ACFE is a 41,000 member-based global association dedicated to providing antifraud education and training. In order to become a CFE, one must meet the following requirements:

• Be an associate member of the ACFE in good standing

• Meet minimum academic and professional requirements

• Be of high moral character

• Agree to abide by laws and code of professional ethics of the ACFE

Professional Requirements

At the time of certification, at least 2 years of professional experience in a field either directly or indirectly related to the detection or deterrence of fraud is required. The ACFE recognizes the following areas as qualified professional experience:

• Accounting and auditing

• Criminology and sociology (sociology is acceptable only if it relates to fraud)

• Fraud investigation

• Loss prevention (experience as a security guard or equivalent is not acceptable)

• Law relating to fraud

SOX

On 30 July 2002, the landmark legislation known as the Sarbanes-Oxley Act (SOX Law) was enacted into the United States Law. The Act was named after its principal authors, Senator Paul D. Sarbanes (D-Md) and Rep. Michael G Oxley. The Act seeks to restore investor confidence in the US financial markets, corporate governance, and financial reporting. The Sarbanes-Oxley Act was passed by the US legislature in the wake of accounting scandals such as Enron. Through strictly United States legislation and its impact is far reaching on the accounting and financial markets. The Act applies to all Securities and Exchange Commission (SEC)-listed companies, and so extends to subsidiary and associated entities of SEC-listed companies outside the USA.

The impact of the requirements of Sarbanes-Oxley is that forensic practices must seek work outside such traditional sources as existing audit clients, although this potentially opens up avenues into other clients. In turn, clients may lose benefits of 2 Fraud Detection and Forensic Accounting 35 the inherent in-house knowledge and experience obtained from the audit engagement, but they may also benefit from a different expert, as perspective. However, in so far as the nature and performance of the audit engagement were seen to threaten the forensic accountant as independence, the Sarbanes-Oxley provisions go some way to enforcing and promoting objectivity and restoring the accounting professions’ reputation.

In the USA, forensic accountants have been employed by the Federal Bureau of Investigation (FBI), Central Intelligence Agency (CIA), Internal Revenue Service (IRS), Federal Trade Commission (FTC), Homeland Security, Bureau of Alcohol, Tobacco and Firearms, Governmental Accountability Office (GAO), and other government agencies. The focus is on what is referred to as white-collar crime, notably fraud. This is why financial and other skills are required. Outside of government employment, big employers of forensic accountants include financial intermediaries such as banks and insurance organizations plus divorce attorneys. Forensic accountants often testify in civil and criminal court hearings. In this capacity, they serve as expert witnesses. They do not testify as to whether fraud has occurred. This is the court’s decision. The expert witness presents evidence.

Conclusion-

In recent years, corruption in the US companies has attracted the attention on fraud in many US organizations. Detection and prevention of corruption have given rise to the profession of forensic accounting. Forensic accounting, which has been growing rapidly as a profession in the world and has been accepted as a profession in countries such as Canada, Australia, the USA, and the UK, is beginning to gain the importance that it deserves.

The traditional auditor was following a reactive approach during the audit process. Now we see that proactive approaches have begun to replace the reactive solutions. Once the loss has occurred, neither detection nor investigation could compensate the loss. In fact, these procedures would also cost business a large sum of money. Due to this fact, the most important thing companies have to do with regard to fraud is to prevent the crime from being committed. To prevent the crime, two concepts move to the top of the corporate agenda: deterrence and motivation. Rules, regulations, and legislation play deterrence role, while motivation is provided with education and training. The landmark legislation Sarbanes-Oxley Law has significantly contributed and consolidated the effectiveness of the code of ethics and moral standards in the organizations. Countries enact and adopt new regulations as the need arises as a result of corruptions, fraud, and bankruptcies due to unethical applications on the part of corporate entities.

Applicable standards and core foundation of the profession:-

Standards of professional conduct

1. Integrity and Objectivity- Certified Fraud Examiners shall conduct themselves with integrity, knowing that public trust is founded on integrity. CFEs shall not sacrifice integrity to serve the client, their employer or the public interest.

2. Professional Competence- Certified Fraud Examiners shall be competent and shall not accept assignments where competence is lacking. In some circumstances, it may be possible to meet the requirement for professional competence by use of consultation or referral.

3. Due Professional Care - Certified Fraud Examiners shall exercise due professional care in the performance of their services. Due professional care requires diligence, critical analysis and professional skepticism in discharging professional responsibilities.

4. Understanding with Client or Employer - At the beginning of a fraud examination, Certified Fraud Examiners shall reach an understanding with those retaining them (client or employer) about the scope and limitations of the fraud examination and the responsibilities of all parties involved.

5. Communication with Client or Employer - Certified Fraud Examiners shall communicate to those who retained them (client or employer) significant findings made during the normal course of the fraud examination.

6. Confidentiality- Certified Fraud Examiners shall not disclose confidential or privileged information obtained during the course of the fraud examination without the express permission of a proper authority or the lawful order of a court. This requirement does not preclude professional practice or investigative body reviews as long as the reviewing organization agrees to abide by the confidentiality restrictions.

Standards of Examination

1. Fraud Examinations- Fraud examinations shall be conducted in a legal, professional and thorough manner. The Certified Fraud Examiner's objective shall be to obtain evidence and information that is complete, reliable and relevant. Certified Fraud Examiners shall establish predication and scope priorities at the outset of a fraud examination and continuously reevaluate them as the examination proceeds. CFEs shall strive for efficiency in their examination. Certified Fraud Examiners shall be alert to the possibility of conjecture, unsubstantiated opinion and bias of witnesses and others. CFEs shall consider both exculpatory and inculpatory evidence.

2. Evidence- Certified Fraud Examiners shall endeavor to establish effective control and management procedures for documents, data and other evidence obtained during the course of an examination. CFEs shall be cognizant of the chain of custody including origin, possession and disposition of relevant evidence and material. CFEs shall strive to preserve the integrity of relevant evidence and material.

Standards of Reporting

1. General - Certified Fraud Examiners' reports may be oral or written, including fact witness and/or expert witness testimony, and may take many different forms. There is no single structure or format that is prescribed for a CFE's report; however, the report should not be misleading.
2. Report Content- Certified Fraud Examiners' reports shall be based on evidence that is sufficient and relevant to support the facts, conclusions, opinions and/or recommendations related to the fraud examination. The report shall be confined to subject matter, principles and methodologies within the member's area of knowledge, skill, experience, training or education. No opinion shall be expressed regarding the legal guilt or innocence of any person or party.