acfe.iia presentation - the shocking statistic you … legislation (cont.) • to receive an award,...

The Shocking Statistic You Don't Know About Hotlines

ACFE/IIA Fraud ConferenceMarch 23, 2012

Agenda

• The Shocking Statistic

• The Complication: Dodd-Frank Act Hotline Provisions

• Going Beyond Fraud

• Rewarding Employees: How Can You Afford Not To?

• A Tip Came in…Now What?

• Outsourcing Your Hotline: Pros and Cons

• Integrated Case Studies

The Shocking Statistic

Initial Detection of Frauds

Source: ACFE Report to the Nation 2010, page 16

Small Businesses are No Different


By Organization Type


Shock and Awe

If tips & whistleblowers seem to be the lead source of initial detection,

then why…

…are Rewards for Whistleblowers the LEAST used Anti-Fraud Control?


The Complication:

Dodd-Frank Act hotline provisions

Dodd-Frank Legislation

• Applies to:– All Securities and Exchange Commission

(“SEC”) registrants (e.g., public companies)– Entities regulated by the Commodities

Futures Trading Commission (“CFTC”)

• Permits whistleblower awards of 10-30% of the amount of monetary sanctions in cases where they exceed $1 million

Dodd-Frank Legislation (cont.)

• To receive an award, the information must be:– “Original” (e.g., must be derived from the

whistleblower’s independent knowledge or analysis only and not known to the Commission from any other source)

• “Securities law violation” includes:– Insider trading– Fraudulent financial reporting– Foreign Corrupt Practices Act (“FCPA”)

Dodd-Frank Legislation (cont.)• Awards for everyone!

– Employees– Vendors– Customers– Investors– Financial analysts– Short-sellers– Fund managers

• Increased whistleblower protection from retaliatory employers (e.g., penalties for retaliatory employers)

Dodd-Frank Legislation (cont.)

• SEC expects to receive approximately 30,000 tips, complaints and referral submissions each year

• SEC has launched a new Tips, Complaints, and Referrals Portal

– https://denebleo.sec.gov/TCRExternal/disclaimer.xhtml

The Challenge

So, the government is offering tremendous

rewards, yet…

…the Rewards for Whistleblowers are the LEASTused Anti-Fraud Control!


Potential Consequences for Companies

• If employee submits a false tip to SEC, the Company may:– Endure extensive legal fees– Endure an unnecessary

investigation/negative publicity

• If employee submits a true tip to SEC, the Company may:– Endure extensive legal fees– Be investigated by the SEC (and possibly

other federal authorities)

Source: Fraud Magazine, November/December 2011

All is not lost…

• The SEC allows whistleblowers to report a fraud within their company first and still be eligible for the financial award.

– The whistleblower would have to contact the SEC within 120 days after alerting the company in order to be eligible for the reward

Source: http://www.sec.gov/news/press/2011/2011-116.htm

Case Study #1: Whistleblower Perspectives

• Accounting employee at major public company– Worked for 31 years in Company’s accounts payable

department– Received high marks for his integrity, ethics and job

performance

• Employee objected to expenses from company events at vacation resorts

• Accounting employee refused to process these event expenditures because:– He considered them improper – Thought they violated tax laws

Source: DBR Article, “Federal judge limits definition of whistleblower”, August 1, 2011


• Company’s tax department later declared that some of the resort costs had been improperly categorized as business expenses

• Accounting employee was then target of internal investigation – Told to not bother with a scheduled performance

review– Went on medical leave until he was terminated

seven months later

• Accounting employee sued the company, alleging that the company retaliated against him



• Federal Judge ruled:– Accounting employee failed to qualify for SOX

protection because his complaint focused on:• How they should be treated for tax purposes, or • That they may have violated internal company

procedures

• The complaint never alleged it was a fraud that would harm investors

• Bottom line: Allegation must state the conduct amounts to shareholder fraud



The judge stated:

“A fair reading of [Accounting employee’s] e-mail demonstrates that he only recommends

that the tax department review the areas listed in the e-mail…it appears that his advice was indeed followed…nothing in the e-mail would

allow the court to draw a reasonable inference that [his] concern about proper tax and

accounting treatment was connected in any way to a concern about shareholder fraud.”


Case Study #1: Lessons for Consideration

• After learning of this case and the outcome:

– What is the perception of how companies treat whistleblowers?

– How will potential whistleblowers feel about coming forward?

– Are whistleblowers more inclined to report internally or go straight to the SEC?

– If the judge ruled in favor of the whistleblower, would that have possibly changed the perception of future whistleblowers?

– What can companies do differently to encourage employees to come forward with tips without fearing retaliation?

Going Beyond Fraud

Expansion of Use• COMMON PROBLEM: Employees are concerned about

being labeled "tattletale, snitch, or whistleblower”

• SUGGESTION: Expand use of hotline to include anonymous comments regarding:

– Process improvement– Safety issues– Quality control enhancements– Human Resource suggestions– Sexual harassment– Vendor comments– General complaints – General employee suggestions

Source: Fraud Magazine, July/August 2011

Positive Spin

• COMMON PROBLEM: Employees are psychologically intimidated by potential retaliation associated with being a whistleblower

• SUGGESTIONS:– Avoid using negative words in publicizing hotline

(e.g., fraud, corruption, bribery)

– Instead, use positive language. Examples:• Responsibility• Ethics• Transparency• Efficiency• Process improvement


Everyone Loves Free Stuff

• Consider giving out items with the hotline number printed on it, such as:– Mugs– Notepads– Key chains– Pens/pencils/markers– Squishy balls– Jelly bean containers

• Consider listing the hotline in other places, such as:– Pay stubs– Invoices– Training materials– New hire packages– Email signatures


Fundamental Message

Create positive tone, image,

and energysurrounding hotline

Rewarding Employees

How can you afford not to?

Monetary Rewards

• Consider offering monetary rewards for tips that lead the company to:– Saving money through process improvement– Identifying fraud, waste, and abuse

• Monetary rewards can a percentage of the savings

• Other reward ideas:– Extra days of vacation– Tickets to sporting/recreational events– Donations to charity of their choice


Rewarding Employees

Sr. management should consider publicly praising employees for performance-

improvement suggestions

– This sets the tone at the top in the organization

– More employees may be inclined to use it

– The negative stigma of a hotline will likely be minimized

– Employees may feel less intimidated when looking at the hotline posters in hallways

– Employees moral may be strengthened (e.g., they feel like their opinions are being heard)


Fundamental Message

Employees who call the hotline are respectedand not the subject of

retaliation

A Tip Came in…

Now What?

Who Should Be Involved?• Setting up the hotline:

– Internal/external legal counsel– Human resources department – Public relations

• Managing Hotline:– Investigators– Internal audit– Internal/external legal counsel– Process improvement personnel– Information systems divisions– Financial accounting– Forensic Accountants/Consultants

• Various departments should open lines of communications


After a Tip is Received

• For fraud related tips, consider:

– Information provided (e.g., the who, what, where, when, how, why)

– Have there been similar tips reported recently?

– Which departments need to be involved or intentionally excluded?


After a Tip is Received (cont.)

– Should outside forensic accountants be consulted?

– What is the cost to investigative the tip?

– What is the cost not to investigate the tip (e.g., potential risk and exposure to the company)?

– Sorting by commonalities• Originator• Allegation• Date• Suspect Name• Location (e.g., specific plant/branch)


After a Tip is Received (cont.)

• Have all departments shared tips?

• Does the suspect’s peers have similar metrics?

• Test your hotlines (e.g., report an allegation, and see what happens)

• Create a decision tree matrix– Differentiate between process improvement

and fraud tips


Same Decision Tree Matrix


Case Study #2:Whistleblower Allegations

• Barry Minkow founded “ZZZZ Best”– Carpet-cleaning and restoration company– Front for a Ponzi scheme– Collapsed in 1987, costing investors and

lenders $100

• After Minkow’s release from prison in 1995:– Became pastor in San Diego– Minkow began the Fraud Discovery Institute– Gained national media attention

Case Study #2: Whistleblower Allegations

• In 2009, Minkow issued a report accusing public company of fraud, including allegations:

– Irregularities in the company’s off-balance-sheet debt accounting, which he claimed was indicative of a Ponzi scheme

– Company not disclosing enough information regarding its off-balance-sheet debt to its shareholders

– Claiming that a Company executive took out a fraudulent personal loan

Case Study#2:Whistleblower Allegations

• Company’s stock plummeted after the allegations

• From January 9 (when Minkow first made his accusations) to January 22:

Company’s stock dropped from $11.57 a share to $6.55


• The Rest of the Story:– Minkow was contacted by a third party,

who had previously filed lawsuits against the Company for fraud

• Both lawsuits were ruled in the Company’s favor

– The Plan:• Drive down the Company stock

through fictitious allegations • Minkow sent his allegations to

the FBI, IRS, and SEC


• The Rest of the Story (cont.):– Minkow shorted the Company stock, buying

$20,000 of options (betting stock would fall)

– He also bought Company stock after his allegations were released

• Minkow was:– Sentenced to 5 years in prison– Ordered to pay the Company $583.5 million

in restitution


Guess who was the fraud specialist for the Company when Minkowhurled his allegations?


• Lessons to Consider:– Allegations alone do not mean there is

necessarily a fraud– After a tip/allegation comes in, it must

be treated seriously• Can not be discounted, even if the

accuser has a history of frauds– Mere allegations can cost a company

significant market share and reputational damage

– Are all tips/allegations treated equally?


“Where there is smoke, there is usually some sort

of fire.”

The question is: Where is the fire?

Outsourcing Your Hotline

Pros and Cons

Should you outsource your hotline or keep it in-house?

• Considerations:

– Confidentiality/data protection– Resources– Costs– Call volume– International audience– Time allocated for following up on a

tip– Industry-specific regulations/laws

Outsourcing the Hotline: Pros• No need to re-invent the wheel

• Resources trained to draw information from tipster

• Company is released from tedious burden of:– Receipt– Documentation– Retention

• Perception that company is unbiased in its evaluation of tips

• Employees may feel confident they are truly “anonymous”

• Possible reduction in cost/resources in running the hotline

• Multiple languages/jurisdictions may be supported

Outsourcing the Hotline: Cons

• Possible loss of attorney-client privilege

• If federal investigation, third party is not bound by company policy

• Third party may be unfamiliar with company culture (e.g., to eliminate false positives)

• Companies may not be able to monitor tips as closely as they may like

• May be a lengthy process to find the right third party for the company's needs and budget

Case Study #3: Olympus Olympus is a maker of cameras and medical equipment

Michael Woodford worked for Olympus for 30 years– Moved up in the rankings:

• Low-ranking salesman • President of Olympus European operations• CEO

– Woodford was only CEO for two weeks before he was fired

• Woodford became aware of articles published in FACTA– A little-known Japanese publication with only 9 staff

Case Study #3: Olympus

• July 2011: FACTA published an article questioning exorbitant fees Olympus paid consultants and extravagant purchase prices of three small companies

– Advisory fees of $687 million paid in 2008 for the purchase of Gyrus, a UK medical instruments firm

– $773 million paid for three small Japanese companies (each with fewer than 50 employees):

• Face cream maker• Plastic container maker• Recycling business

Case Study #3: Olympus

• Deceptive accounting practice is known as “tobashi” in Japan

– Companies hide losses by selling bad assets (e.g., investments that went bad) to other companies

– Buy them back in good times using “advisory fees”

– Losses were incorrectly reported (in wrong period) to hide the true nature of the losses

Case Study #3: Olympus• August 2011:

– Chairman Tsuyoshi Kikukawa:• Woodford questioned Chairman Tsuyoshi Kikukawa• Kikukawa said, “You are president, you are too

busy.”• Asked if the allegations in the article were true,

Woodford claims Kikukawa said: “Most of it -- but we've made some provisions.”

– Executive vice president Hisashi Mori:• Woodford asked Mori about the transactions. • Frustrated by the responses, Woodford says he

asked: “Mr. Mori, who do you work for?”• He said, “Michael, I work for Mr. Kikukawa, I'm

loyal to Mr. Kikukawa”

Case Study #3: Olympus September 2011: FACTA published new article alluding to

possible Japanese mafia involvement (the Yakuza)

Woodford wrote several emails of his concerns to: Kikukawa Mori Entire Board of Directors Outside auditors

Case Study #3: Olympus October 2011: Woodford asked for Kikukawa and Mori to

resign

Instead, the board of directors fired Woodford

Woodford was asked to: Turn over the keys to the company apartment Return his phones and computers Told he couldn't use the company car to get to

the airport – he would have to use the shuttle bus

Case Study #3: Olympus November 2011:

New president Shuichi Takayama admits: Company’s accounting practice was "inappropriate" Money had been used to cover losses on investments

dating to the 1990s (fraud was over 2 decades old!)

The company blamed the inappropriate accounting on: Former president Tsuyoshi Kikukawa Auditor Hideo Yamada Executive vice president Hisashi Mori

The stock price tumbled 70% in three weeks

Case Study #3: Olympus• Lessons to Consider:

– Tone at the top can make or break a company

– Who sets the tone at a company:• BOD? Audit committee? CEO? Anyone else?

– If the CEO can’t be an effective whistleblower, who can?

– If Olympus had a better tone at the top, is it likely this fraud would have emerged earlier?

– Are employers who don’t reward whistleblowers at a disadvantage?

What can CFE’s and Internal Audit department’s do?

– Ensure company hotline program is comprehensive • Available 24/7 and in all languages• Tips can be reported anonymously• Availability to report via phone/email/Internet

– Strong Tone at the Top • Sr. Management should want to hear from you!• If employees fear retaliation, something is wrong• Encourage company to create positive tone,

image, and energy surrounding hotline

– Swift Responses• Company responses should be timely/credible • Company should consider publicizing cases

where hotline was utilized and had success

SummaryTips are the lead source of fraud detection,

yet rewards for whistleblowers are the least used Anti-Fraud Control

• Dodd-Frank legislation complicates matters

• Suggestions to improve hotline:– Expand use to include process improvement– Create positive tone, image, and energy– Consider rewarding employees

• After a tip is received, consider all variables and situations

• Outsourcing your hotline has pros and cons; no one size fits all

• Tone at the top has the potential to make or break your company

Contact Information

Craig Hirsch, CPA, CFE, CAMSManager, Forensic & Regulatory Compliance Kaufman, Rossin & Co., P.A. Phone: 305-646-6067 Email: [email protected]

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