Is there a common theme among financial statement fraud schemes? Maybe according to the Anti-Fraud Collaboration (AFC), which issued a study this month to classify common financial statement fraud schemes based on an analysis of Securities and Exchange Commission (SECO enforcement actions.

The SEC enforcement arm does keep itself busy focusing on a wide range of alleged misconduct, related but not limited to intentional and non-scienter frauds, issuer reporting and disclosures, auditor shortcomings, absent or insufficient internal controls, deficient disclosure controls, non-GAAP measures, the Foreign Corrupt Practices Act, securities offerings, insider trading, broker-dealer, and cyber-related misconduct.

Given the unique impact of financial statement frauds and relevance to companies, auditors, and investors, the AFC study classified common financial statement fraud schemes based on an analysis of SEC enforcement actions. It particularly focused on those involving accounting or auditing issues where the SEC has issued an Accounting and Auditing Enforcement Release (AAER).

Fraud by the numbers?

Of the 531 AAERs the SEC issued from January 1, 2014, through June 30, 2019, the AFC focused on 204 enforcement actions related to financial statement frauds from which researchers identified 140 fraud schemes. The goal was to determine which higher risk areas might be most susceptible and what companies might do to identify and mitigate these types of fraud effectively.

The most common fraud types included:

• improper revenue recognition,
• reserves manipulation,
• inventory misstatement, and
• impairment issues.

Of these, improper revenue recognition appeared to be the most common among fraud schemes. In nearly every year studied, improper revenue recognition was among the top two fraud schemes.

Of interest was that in all types of fraud, there rarely was a single root reason. Rather, a significant number of fraud schemes also included misleading or inaccurate financial statement disclosures, material weaknesses in internal controls, and unsupported journal entries.

What sectors were most at risk for fraud?

Top sectors included technology services, followed by finance, and then less and less to the energy, manufacturing, and healthcare industries. Most suffered from a variety of accounting and reporting issues.

The SEC often charged the issuer, but it also usually charged employees involved in the schemes. CFOs were most commonly charged, followed by an organization’s CEO.

Why did the CEOs and CFOs act badly?

According to the SEC reporting, bad actors frequently blamed a host of issues for their actions, including:

• tone at the top,
• high-pressure environments,
• business challenges, and
• a lack of adequately experienced personnel that could foster an environment or culture more conducive to fraud.

While the regulators suggest that a more attentive board or audit committee, management, internal and external auditors could have helped quash fraud, as Patrina often reports in this space, oversight alone is usually insufficient. Why is that? Because in many cases, the bad actors had gone to great lengths to circumvent existing controls.

Has technology changed the face of fraud?

Not necessarily. In recent years, the SEC enforcers report that the most common schemes and higher risk areas have not changed much over time. Instead, the regulators find that the kinds of business challenges frequently presented are eerily familiar:

• pressure to meet analyst expectations,
• increased supplier costs,
• slowing demand for products, and more.

According to the study, the key to protecting companies against fraud is vigilance. Companies, it recommends, should remain focused on the fundamentals—controls, processes, and environments that impact financial recordkeeping and decision-making—and company-specific risks by conducting regular risk assessments. And that’s where Patrina comes in.

For more than 25 years, Patrina has helped compliance professionals stay on the “straight and narrow” efficiently and cost-effectively. So, let’s talk. Call 212-233-1155 to ask about Patrina’s cost-effective, designated third-party services, comprehensive, 8-module compliance solution, compliant data capture, file storage, and records archiving specifically designed for the financial services community. Be smart. Be covered. Let’s talk.