THE ACCOUNTANT AND FRAUD
By Professor Nessan Ronan
Corporate fraud is now a world-wide phenomenon. Both in the developed and the developing world we are confronted on a regular basis with incidences of fraud. These frauds involve considerable sums of money and adversely affect the economic functioning of companies and countries. Shareholders, management, employees, suppliers tax authorities and other stakeholders suffer when fraud occurs. The main elements in the fight against fraud are good corporate governance and a strong code of professional ethics together with adequate protection for those who blow the whistle on illegal activity. This paper briefly explores the phenomenon of corporate fraud and discusses the role which the accountant should play in reducing fraud.
RECENT FRAUD REPORTS
The recent UK government report into the collapse of the Maxwell group of companies, highlights once again, the role which auditors are expected to play in both combating and detecting fraud. You will recall that Robert Maxwelll was both the Chairman and CEO of the Maxwell group. In 1991 he fell off his yacht in the middle of the atlantic ocean and was drowned. Subsequent investigations revealed that he had been involved in massive frauds involving his companies. One of the most alarming activities was his raiding of the pensions fund to shore up his ailing enterprises.
The question that was asked at the time was where were the auditors? Coopers & Lybrand were the auditors and were criticised for their handling of the audit. They were fined a considerable sum of money, by the joint disciplinary committee. It was also pointed out that in• 1991 there was a government enquiry into how Maxwell was running his companies. That report stated inter alia that Maxwell was not a proper person to be in charge of a public company. He was forceful, domineering,
dictatorial to the point of bullying. He was secretive. He was impulsive, opportunistic and a heavy gambler
The report went on to catalogue a series of serious corporate offences committed by Maxwell. From the Maxwell case we can draw a few useful conclusions. Firstly, when major fraud occurs there is sufficient evidence available to arouse suspicion and put auditors on their guard. In the Maxwell case there was evidence going back over twenty years. Secondly, there can be a tendency by auditors to put commercial interests before ethical and professional duties. Thirdly, internal audit as an organizational function needs to be strengthened.
In the case of Botswana Housing Corporation2, the subject of a presidential enquiry the report stated that their internal audit function was very weak. This led to the senior management perpetrating serious fraud on the company. These frauds involved both top management and selected customers. In this country, there is some evidence from recent cases that the internal audit function needs to be strengthened. Both the Cadbury3 and King4 reports on good corporate governance have enunciated the principle that management are responsible for good governance.
Good governance rests on proper checks and balances in the financial system and adequate disclosure. Fraud thrives where concealment is successful. Thus management should strive to achieve a high degree of transparency and openness in their operations. This means that the corporate culture should be formed to operate in a democratic and transparent way.
KEY FINDINGS ON CORPORATE FRAUD Ernst & Y oung5 have produced biennial reports for some time on corporate fraud. Some of the important findings from the 1998 report are outlined below. Their reports are based on large scale global questionnaire surveys. Their findings on the nature of fraud are:
EXTENT AND NATURE OF FRAUD
• MORE THAN 50% OF THE SURVEYED FIRMS HAD SUFFERED FRAUD WITHIN THE LAST YEAR
• 84% OF THE WORST FRAUDS WERE COMMITTED BY EMPLOYEES
• MOST OF THE WORST FRAUDS WERE COMMITTED BY MANAGEMENT
• ONLY 13% OF FRAUD LOSSES HAD BEEN RECOVERED
• THE BETTER DIRECTORS UNDERSTAND THE BUSINESS, THE LOWER THE INCIDENCE OF FRAUD SUFFERED
These findings clearly point to the role of management in combating fraud. Of course this can prove elusive if top management are the ones perpetrating the fraud. Another key issue is that directors should have a very good understanding of the business. In the case of Botswana Housing Corporation, it was reported that the directors did not fully understand their role as directors. For example, some of them stated that they did not realize that they had to declare an interest in an agenda item and abstain from voting.
In the case of Barings bank, Nick Leeson in his book, ROGUE TRADER6 states that his directors did not understand what he was doing in trading in derivatives. Thus he was able to demand more and more money from Head Office and at the same time conceal his huge losses. The survey also points out that more than 50% of respondents reported that they had suffered fraud with the previous year. This statistic should shake us out of our complacency. In the United States it has been estimated that about 80% of the population will engage in fraudulent activity given the right motive and opportunity.
We next look at the best ways of preventing fraud. Here again we make use of then Ernst & Young report.
TABLE 1 PREVENTING & DETECTING FRAUD
Normal Internal Controls 1 1
Internal Audit 2 2
Security of Passwords 3 8
Management Review 4 3
Entry/Exit controls 5 11
External Audit 6 9
Change of Management 7 5
Internal Whistle Blower 8 4
P= Prevention D= Detection
Interestingly, we find that respondents rank normal internal controls as the best means of both preventing and detecting fraud. Clearly, this puts accountants and internal auditors at the forefront of combating corporate fraud. Accountants should ensure that as far as possible the system of internal control is functioning as intended. Proper checks and balances are of paramount concern in ensuring that corporate. fraud is more difficult to achieve. Accountants in large organizations should develop a systematic fraud auditing programme. This has the effect of creating a more security conscious environment and of detecting fraud if it is taking place.
At the same time, external audit is ranked sixth as a means of prevention and ninth in terms of detection. This indicates that it is a foolish expectation to rely on the external audit to either detect or prevent fraud. The Auditing Practices Board (UK/ in their paper Fraud and Audit:choices for society, express the considered view that external auditors, due to a variety of reasons are unlikely to discover fraud.
They also confirm that the investing public, still have the expectation that the external auditor will discover fraud. This is what has given rise to the expectations gap. The internal whistle blower is ranked only eight for prevention but fourth for detection.
In the UK, there is now statutory protection for whistle blowers. Of course it provides no protection for the person who is only seeking revenge through destructive allegations without substance. In Africa, there is an urgent need to protect the genuine whistle blower who can provide the vital lead in the detection of fraud. The institutes of accountants should take the lead to push for statutory enactment in this area.
I would suggest that there should also be statutory enactment for a code of good corporate governance and making it mandatory for public liability companies and commercial parastatals to have internal audit departments. The head of internal audit should report to the chairman of the audit committee and not to management.
Also, there is a role for organizations like the World Bank8 to provide some pressure on governments to enact statutory provisions to cover good corporate governance and professional ethics. Some argue why the state should legislate for the minority who are going to commit fraud. It is precisely because of deviant minorities that we have legislation. And the concept of voluntarism is seen not to be working.
For example, in South Africa they have an elegant code of corporate governance advanced by the King Committee. Yet, recently we witnessed NEDCOR’S9 appalling disregard of good governance principles in devising an executive incentive scheme, blatantly targeted at a select few executives. The fact that NEDCOR backed down on its proposal only in the face of journalistic pressure indicates that statutory force is necessary to encourage top management to act honestly and ethically.
In this article we have confronted a number of crucial corporate issues, which have a huge impact on the economic well-being of nations. Accountants have a crucial role to play in combating corporate fraud. But there is need to improve the institutional aspects of good governance. Some suggestions have been made that the Institutes of Accountants should
play a more active role in this area. For one they should push for statutory protection for whistleblowers. Secondly, the internal audit function should be given statutory recognition and the role and functions of the internal auditor should be strengthened. We have also called for the World Bank and other influential players to play a more active role in influencing governments to legislate for these areas. Perhaps, we are expecting too much from our external auditors in detecting fraud. Lets put responsibility back where it belongs-top management and in particular, the chief executive officer.
Finally, there is a need for on-going research on corporate fraud so as to be able to fully understand how it occurs and how preventive measures can be adopted. Combating fraud is like democracy, it requires eternal vigilance on the part of all of us.
1. Maxwell Industries – For details on this case see Tricker RI (1994) International Corporate Governance, Prentice- Hall. 2. Christie RH (1992) Report of the Presidential Commission of Inquiry into the operations of the Botswana Housing Corporation, Government Printer Gaborone.
3. The Report of the Cadbury Committee on the Financial Aspects of Corporate Governance.
4. King M (1994) Report on Corporate governance. Institute of Directors, Johannesburg
5. Ernst & Young (1998) Fraud-The unmanaged risk
6. Leeson Nick, (19%) Rogue Trader, Warner Books
7. ACCA (1999) Auditing Handbook 1999/2000. See Fraud and Audit: Choices for Society
8 .World Bank They have an interesting website at
9. The Sunday Times, Truly a sleazy scheme, May 30,2001
Professor Nessan J Ronan is the Bank of Zambia Professor of accountancy at the Copperbelt University , Kitwe, Zambia