Fraud In Governmental Programs - A Waste of Our Tax Dollars

            "The US Office of Management and Budget estimated that the government lost more than $125 billion in improper payments in fiscal year 2010," and it's the taxpayer who ends up paying this bill. Part of the improper payments is obviously due to fraud. The government should be held to at least the same standards as a publicly traded company because as taxpayers, we are America’s shareholders.

            The GAO, the Government Accountability Office,   is set up to investigate all matters relating to the receipt, disbursement, and application of public funds,. The GAO's auditors conduct not only financial audits, but also engage in performance audits.  The GAO has been referred to as "The Congressional Watchdog" and "The Taxpayers' Best Friend,”  for its audits and reports that have uncovered waste and inefficiency in government.  Despite its reputation and the billions of dollars in potential savings, the House and Senate are proposing a 7.6 percent cut from the GAO's 2011 budget.

            "The GAO publishes more than 1,000 reports and audits annually and provides an invaluable asset to the taxpayer."  The GAO has uncovered fraud in many of the government agencies.  They have found improper or fraudulent farm-subsidy payments as much as half a billion dollars a year.  In 2007, the GAO uncovered that the USDA paid $1.1 billion in subsidies over six years to 170,000 deceased individuals.   Program audits have also found that about one-quarter of those receiving free and reduced-cost lunches are not eligible. Reviews have also found that almost one-third of Earned Income Tax Credit payments of $12 billion annually are improper or fraudulent.   They have also found that more than $1 billion, of the payments made to people in the $30 billion Food Stamp Program were in excess of what they should receive.   

            Fraud in the two main federal health programs is extremely huge.  Medicare and Medicaid have as much as $60 billion a year in fraud, waste and overpayments.  The GAO estimates that there are about $17 billion of improper Medicare payments each year, including fraudulent and erroneous overpayments to health care providers.

            The Department of Housing and Urban Development (HUD) provides subsidies to state and local governments, real estate businesses, financial institutions, and nonprofit groups. The largest share of HUD’s budget goes toward rental subsidies for low-income tenants. According to the GAO, there are about $1 billion in erroneous and fraudulent overpayments to these subsidies each year.

            The federal budget has become victim to large-scale fraud and abuse.  Why cut the one agency looking to protect taxpayers from government waste, corruption and fraud?  This is one agency that monitors the spending of our government and saves tax dollars. The return on investment has been quite strong over the years as the GAO has detected fraud, abuse and waste in our governmental programs. There is a need for our tax dollars to be spent on an agency that reviews the "Governments Books."   Just as accounting firms review publicly traded corporations, government agencies and programs need to be reviewed, audited and held accountable; they are spending our money.

Calling All Auditors

             What is the problem?  When is the auditing profession going to get the message that if they are not performing their job adequately  with professionalism, knowledge and integrity there will be no use for their services.  We saw what happened to Arthur Andersen with the Enron scandal when they were destroyed. 

             An audit of financials is supposed to be the verification of the financial statements of a company with a view to express an audit opinion. The audit opinion is intended to provide reasonable assurance that the financial statements are presented fairly, in all material respects, and/or give a true and fair view in accordance with the financial reporting framework. The audit is designed to increase the possibility that a material misstatement is detected by audit procedures. The purpose of an audit is to increase the confidence of intended users of the financial statements.

            If there is one scandal after another the degree of confidence the auditing profession instills in its users will deteriorate.  The auditing profession obviously knows this, but it keeps happening. Why? Is money behind it?  Doesn’t the auditor realize that the immediate profits may be immaterial when their services are no longer required?

            Aside from the Enron scandal, just to mention some of the numerous scandals, Xerox would come to mind. In 2003, the SEC filed a complaint against Xerox's auditors, KPMG, alleging four partners in the "Big Five" accounting firm, permitted Xerox to "cook the books" to fill a $3 billion "gap" in revenue and $1.4 billion "gap" in pre-tax earnings.  The issue was when the revenue was recognized, not the validity of the revenue.   The SEC charged that the change in how Xerox applied accounting principles not only violated GAAP, but was intentionally designed to fool Wall Street into believing the new management team was working wonders.

            Another scandal worth mentioning, actually involved an accounting firm's own fraudulent activity. In 2005, KPMG admitted to setting up fake tax shelters for its wealthiest clients, which helped them evade paying $2.5 billion in tax dollars throughout the1990's.  KPMG agreed to pay $456 Million to avoid an indictment from the US Department of Justice.

            And now there is another scandal lurking!   In a stock market announcement, the company Olympus said it has been "engaging in deferring the posting of losses on investment securities."  The details disclosed could lead to one of the worst accounting scandals Japan has ever seen.  Olympus Corp's use of accounting tricks to hide big losses has obviously raised questions about its auditors, KPMG and Ernst & Young, both of which have audited Olympus in recent years.   KPMG stepped down in 2009 after a disagreement over how $687m (£427m) in advisory fees on an acquisition was being accounted for. The replacement of KPMG, after the dispute over how to account for the acquisitions was Ernst & Young. The reason for KPMG's resignation was never revealed to the market. Olympus told investors at the time that KPMG's audit contract had expired and it was hiring Ernst & Young. Why weren’t the reasons for the step down by KPMG made public?

            As a student of the accounting/auditing profession, it is very disturbing to constantly read about one scandal after another.  Whether it is intentional or careless really doesn't matter.  The accounting and auditing field is still a respected profession, as such we need to follow every procedure, policy, and standard necessary to continue to command that respect. 

Independence is an Asset to the Auditor

The auditing profession loses its value when independence is compromised. Independence is a standard that relates to the auditors organization and the individual auditor.  Independence includes both independence in fact and appearance.  Even when an auditor is acting with integrity, if there is reasonable cause for a third party to believe that the results of the audit may be compromised, then independence in appearance does not exist.  Auditors maintain independence so that their opinions have validity.

If a CEO told you that his company was rock solid and that it was going to continue to make a tremendous amount of money, would you believe him?  If a major investor in a corporation said that the corporation was definitely worth investing in, would you invest?  If you were a consulting business that offered advice to your client, would you be able to be impartial in your audit of that client? We know that if someone has a vested interest in the success or failure of a company, he may not be able to give an unbiased opinion. If in fact he does give an unbiased opinion, it may still not carry any weight because in appearance he is not independent.

The fee the auditor receives can actually be the vested interest an auditor has in his client. The fee can affect his independence as well as the threat of losing the client.  For example, a decade later we will still hear about the Enron scandal.  We know the scandal affected the employees and investors of Enron, but it also had a horrible impact on the auditing profession and obviously their auditors Arthur Andersen, which was put out of business.

Arthur Andersen was charged with shredding thousands of documents and deleting e-mails and company files that tied the firm to its audit of Enron. In investigating Arthur Andersen, the concept of independence entailed a big part of the picture.  Was Arthur Andersen independent?  Many feel they were not, so even if they acted independently, their appearance was compromised.

Arthur Andersen received some $27 million in consulting fees from Enron, compared to $25 million in audit fees. We know that the fees an accounting firm receives can affect his independence, but when the fees from consulting services outweigh the fees from auditing there is a bigger problem.  Consulting fees offer a temptation for an auditing firm to not be objective.  Arthur Andersen’s consulting fees from Enron outweighed its audit fees; independence was compromised. The Enron scandal may seem like history, but the concept of independence is a standard that the auditing profession must actively follow if their profession is to survive.  There were five big accounting firms before the Enron scandal. 

As a consequence of the scandal, new regulations and legislation were enacted to expand the accuracy of financial reporting for public companies. One piece of legislation, the Sarbanes-Oxley Act, expanded repercussions for destroying, altering, or fabricating records in federal investigations or for attempting to defraud shareholders. The act also increased the accountability of auditing firms to remain unbiased and independent of their clients.

Independence is a standard of the auditing profession that needs to be reviewed and evaluated constantly.  Independence is an asset to the auditor that earns the confidence of the public.  Without independence in fact or appearance the auditor’s findings are useless.

The Auditor and The Company Stock

            The auditing profession provides a valuable service to all stakeholders by ultimately instilling confidence in financial reports and management integrity.  The value of the auditor is extremely apparent when the auditor resigns.  The resignation of auditors can immediately devalue a company.

            When auditors resign, especially respected auditors such as PwC, Ernst & Young, Deloitte Touche Tohmatsu or KPMG, many investors head for the exits. The resignation of auditors often results in major stock dips.  For example, shares of Singapore-listed Sky China Petroleum Services Ltd, tumbled as much as 32 percent to an all-time low after it said its auditors, Ernst Young LLP had resigned.   China Media Express Holdings, Inc.,  had their shares fall 4.3% when they announced the resignation of independent auditor, Deloitte Touche Tohmatsu.   A couple years ago American Apparel Inc. had their shares fall by 25% in New York trading after saying Deloitte & Touche resigned as its accountants.  This past summer Nasdaq-listed SinoTech Energy Ltd. had their auditors   Ernst & Young's China resign as the company's auditor ultimately resulting in the company's stock suspended from trading. The impact the auditor has on the value of a company's stock is affected by his opinion on the financial statements, his inability to give an opinion and his resignation from an engagement.

            When an auditor resigns he will state his reasons for his resignation, however until the public becomes aware of the reasons, their first reaction is to sell.  Auditors can resign for many reasons such as an issue of independence, lack of profitability to their firm, or dissatisfaction with how their personnel are treated.  However, when auditors state they are no longer able to rely on the representations of management or that certain issues need to be looked at by an independent investigation, the integrity of the company is affected.  Moody's who puts out ratings on a company stock is obligated to understand the reason for an auditor's resignation because in many cases it  can wind up affecting a company's credit profile, which will affect stock value.

            According to a survey by the Chartered Certified Public Accountants, questioning the value of an auditor, 90% of respondents felt that the external audit brings value to them, 80% felt that audited financial statements were important to them in making investment decisions, 75% agreed that the scope of the audit should be extended to enhance the value of audit and 85% of respondents felt that the provision of non-financial information would serve their investment decision making purposes.  Based on the results of the survey and more importantly the impact on the stock of a company upon the resignation of the auditor, it is obvious the value the auditor provides to all its stakeholders.  The auditor has a huge responsibility and needs to constantly exhibit integrity, professionalism and competence.   The company that they are working for may be paying them but the confidence they instill in the public will ensure the value of their service.

Why Do We Need Auditors?

The need for auditors may be the same reason as to why we need law enforcement.  We need auditors to police the activities of business!

It appears that if people have the opportunity to prosper from illegal activities, they will.  It doesn't matter who they are cheating.  You hear about white collar crimes constantly.  "White-collar criminals are opportunists, who over time learn they can take advantage of their circumstances to accumulate financial gain."  Just recently a "white collar student-in-training,” was arrested for getting paid to take the SAT  for high school students.  A fellow student eventually informed officials and confirmed the report with an analysis of the handwriting on the exam; an arrest was made.

You would think that by now procedures would be in place that would entail two picture ID’s.  When I sat for the exam we were required to bring one picture ID- which was never even checked by the proctors.  Once again, you have policies to deter fraudulent behavior, but they are not being followed.  We need constant review and policing of company policies; we need to detect that procedures are followed.  How was one student able to sit for the exam of several other students? Doesn't CollegeBoard realize that this undermines ttheir reputation?

How about the recent activity from the New York City Department of Education?  The DOE was paying out an average of $13 million a year on a contract that was supposed to be about $3.6 million.  After an investigation, it showed that a high level employee of the DOE was romantically involved with the owner of the company they were paying.  Again, what procedures were in place that would detect over-budget disbursements at this level?  Who was responsible for monitoring and enforcing the procedures?  Why it was not detected sooner?

What about Medicare fraud- how many cases do we hear about that each year?  Last year, in Miami two companies were set up to provide mental health services.  These services were unnecessary or never provided.  The companies were set up for the purpose of scheming to bill the Medicare system.   The fraud operation netted about $83 million. The investigation showed that fake symptoms were documented, physician signatures were forged and treatments were never given. Employees who suspected fraudulent activities were terminated if they did not cooperate.  Obviously, if they needed the job they just cooperated.  What about the procedures and policies in the Medicare system?   Were their policies followed?  There needs to be a system in place that can detect bogus claims and those procedures need to be enforced.  There needs to be reports and reviews on the adherence of these procedures.

I can go on and on about exposure of illegal activity, but how many fraudulent schemes go on undetected? Obviously, recommendations for the necessary controls to keep a company operating efficiently and deterring fraudulent activities are time consuming and costly.  All businesses including governmental agencies need to know the importance of detecting non-compliance and enforcing the controls.  Governmental agencies,  have an obligation to the taxpayers and  they need to be held accountable.  Governmental Audits are a necessity and not a waste of our tax dollars.  Effective audits actually can save millions of dollars.  We need auditors just like we need any other law enforcement agency!

The Necessity of Stronger Internal Controls

The Necessity of Stronger Internal Controls- When are companies going to learn the detrimental effect of inadequate controls?

Once again UBS is in the headlines. Kweku Adoboli, a UBS trader was arrested and charged with fraud for unauthorized trading on September 15th.   Adoboli, a rogue trader, lost UBS 2 billion dollars.  The estimated $2 billion losses would list the UBS scandal among the world’s biggest rogue trading frauds. The sad part about it is that supposedly it was not UBS that detected the incident, but the employer himself that informed his colleagues of his actions.


UBS had minimal comments on the incident.  On their website of September 15th the media release stated, "UBS has discovered a loss due to unauthorized trading by a trader in its Investment Bank. The matter is still being investigated, but UBS's current estimate of the loss on the trades is in the range of USD 2 billion. It is possible that this could lead UBS to report a loss for the third quarter of 2011. No client positions were affected." The unauthorized trading is called "Rogue trading."  It is when an employee is making unauthorized trades on behalf of his employer. Banks encourage proprietary trading (usually within limits) and give traders bonuses for the amount of profit they make for the bank which provides an incentive to take risky bets. The problem is that this incentive can become even stronger if the trader made a bad bet and has big unreported loss.

Technically, they are not allowed to take big risk.  The banks require traders to remain within certain risk limits. What are the limits imposed on UBS traders?  What are the penalties for exceeding these limits?  What are the methods for detecting limits exceeded?   Aside from the limits, the trader is also supposed to log in all his trades by the end of each day.  Obviously if there are no mandatory procedures to follow or no one actually performing a check on daily transactions, the trader would attempt to hide huge losses hoping that it can turn around.  That logic prompts the trader to take riskier bets, which inevitably compounds his losses.

You would think that since a trader has opportunity to speculate that a bank would diligently employ internal controls.  Internal controls come at a cost, but the bigger costs can come when the internal controls are not implemented.

This incident will cost UBS and the banking industry their reputation which has been under scrutiny since the financial crisis. Customers and investors will lose any confidence they acquired toward the industry, especially toward UBS.  As a result of this incident, UBS is also likely to report a net loss in the third quarter.  In a time of economic crisis, how does a company like UBS permit such tarnish to the banking industry, I do say permit, because if adequate controls were employed 2 billion dollars in unauthorized losses would not exist.

In addition to their reputation and probable third quarter lose, the ratings agency Moody's placed UBS's credit grade on review for possible downgrade because of concern about the  future of its London-based investment unit.

Last month UBS announced 3,500 job losses due to poor trading figures. These job losses were estimated to save the company 2 billion dollars.  This rogue trader eliminated the savings to UBS.

This is not the first rogue trading scandal and it probably won't be the last but the bank’s credibility to customers could be at stake if it is found that internal controls were too weak to spot huge losses on its own accounts.  When are companies going to learn the detrimental effects of inadequate internal controls?  When are companies going to learn that it is worth to allocate sufficient funds for internal auditing and utilize their expertise and suggestions?