Forensic Accounting

Case 1

James Watkins, an ambitious 22-year-old, started an entertainment business called Best Club after he graduated from California State University. Best Club initially was a business failure because James ignored day-to-day operations and cost controls. One year later, James was heavily in debt. Despite his debt, James decided to open another location of Best Club. He was confident that Best Club would bring him financial success.

However, as his expenses increased, James could not meet his debts. He turned to insurance fraud to save his business. He would stage a break-in at a Best Club location and then claim a loss. In addition, he reported fictitious equipment to secure loans, falsified work order contracts to secure loans, stole money orders for cash, and added zeros to customers bills that were paid with credit cards. James was living the good life, with an expensive house and a new sports car.

Two years later, James decided to make Best Club a public corporation. He falsified financial statements to greatly improve the reported financial position of Best Club. In order to avoid the SECs scrutiny of his financial statements, he merged Best Club with Red House, an inactive New York computer firm, and acquired Red Houses publicly owned shares in exchange for stock in the newly formed corporation. The firm became known as Red House, and the Best Club name was dropped. James personally received 79 percent of the shares. He was now worth $24 million on paper. James was continually raising money from new investors to pay off debts. A few months later, Red Houses stock was selling for $21 a share, and the companys book value was $310 million. James was worth $190 million on paper. A short time later, he met John Gagne, president of AM Firm, an advertising service. Gagne agreed to raise $100 million, via junk bonds, for Red House to buy out Sun Society, a travel service.

Afterward, with television appearances, James became a hot figure and developed a reputation as an entrepreneurial genius. However, this reputation changed after an investigative report was published in a major newspaper. The report chronicled some of his early credit card frauds. Within two weeks, Red Houses stock plummeted from $21 to $5.

After an investigation, James was charged with insurance, bank, stock, and mail fraud; money laundering; and tax evasion; and Red Houses shares were selling for just pennies. A company once supposedly worth hundreds of millions of dollars dropped in value to only $48,000.

Questions
From this case, identify:

1-The pressures, opportunities, and rationalizations that led James to commit this fraud.

2-The signs that could signal a possible fraud.

3-Controls or actions that could have detected Jamess behavior.

Case 2

ABC satellite, a satellite television company, sells satellite television service contracts to customers, usually for a 24-month period. ABC satellite is a fast-growing, high-paced company created by aggressive salesmen. The companys success has made its owners very wealthy, many of them live a lavish lifestyle and drive luxury cars to work. The retention division of this company is responsible for contacting customers nearing the end of their contract and convincing the customer to renew their contract. Retention agents are paid a commission for each account that agrees to a new contract. The commission rate is considered by many employees to be below the industry standard. Over the past year, the retention division has undergone significant supervisor and manager turnover. The current manager has not had sufficient time or understanding to properly implement controls. Additionally, the new manager has been so busy playing catch up that he has yet to hold a training or orientation meeting for his department. The current process for paying commissions to retention agents on renewed accounts is as follows:

The phone system records the verbal contract extension commitment.

The retention agent attaches the audio recording to the customers account in the ABC customer contract system (CCS); this acts a legal proof of contract.

The retention agent then updates the customer contract date information in CCS.

Each retention agent has a spreadsheet he or she uses to keep track of the account renewals for the month.

The retention agent records the customer #, date of contract extension, and length of contract extension in his or her spreadsheet.

At the end of each month the retention supervisor receives each agents spreadsheet and multiplies the total retention renewals submitted by the agent by his or her commission rate in order to calculate the total monthly commission.

The spreadsheets are not maintained by the supervisors.

In order to get the payments processed quickly, the supervisors have less than four hours to receive all agents spreadsheets (usually each supervisor is responsible for 20+ agents) and submit the summary file to payroll.

The supervisor records the total commission earned by each agent on a summarized spreadsheet, which is sent directly to payroll for payment.

Questions
1-Part of avoiding fraud is to create a positive work environment. Describe a few conditions mentioned within the case that could contribute to a poor work environment.

2-What symptoms should an auditor look for to determine if fraud is occurring within the retention department?

3-There are five primary control procedures or activities. List and explain which two procedures you feel would be most effective in improving the control system of the retention department. Include in your explanation specific examples of controls that should be implemented.

 

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