FORENSIC ACCOUNTING

The primary participants in the capital markets are:

• Banks, including commercial banks, money center
banks, national or central banks, savings and loans,
credit unions, and mortgage bankers
• Investment banks—the primary underwriters of newly
issued securities in both the debt and equity markets
• Broker/dealers—that is, stock and bond brokers for
both institutional and retail (individual) customers,
foreign exchange traders, primary dealers in U.S.
Treasury securities, online or Internet stockbrokers,
and commodities brokers and traders
• Insurance companies
• Mutual funds and their advisers and sponsors
• Individual investors
Excluding individual investors for the moment, all of the
other participants may become victims of fraudulent
schemes in three fundamental ways: by being
(1) attacked from within, generally by a rogue employee
exceeding the scope of his or her authority for personal
gain;
(2) attacked from the outside through a wide variety of
schemes to obtain funds under false pretenses; or
(3) used as an unwitting participant to facilitate a
fraudulent scheme perpetrated on others or for the benefit
of others. Money laundering is the classic example of the
third category.

Some frauds involve the intentional mischaracterization

of the nature of trans-actions and misleading disclosures
dealing with the accounting policies and procedures used
to account for such transactions or events, the effects of
accounting changes, the classification of transactions, or
how such transactions affect reported results of
operations. Among the most common examples are:
• Failure to properly disclose the effects—on both
current and, possibly, future operations—of material
changes in accounting estimates
• Misclassification of operating expenses and costs or
losses as nonrecurring, when in fact such expenses
should be reflected as operating
 • Creation of reserves—most typically associated with
pre-acquisition liabilities, restructuring charges, and
other so-called onetime charges—intentionally
exceeding probable and estimable liabilities expected
to be incurred as well as subsequent release of such
reserves in order to offset expenses or increase
revenues for which such reserves were not provided.
In many cases, the provisions of such reserves are
reflected as non-operating charges, while their
subsequent release, in whole or in part, is reflected
improperly as results of continuing operations
incurred in the ordinary course of business.
• Misstatement of—or failure to include—key
accounting policies and/or their effect upon reported
results of operations

Fraud on Auditors
The purpose of an independent audit is to determine
whether financial statements do in fact present fairly the
financial condition and results of operations of a company
in accordance with GAAP. If reported results contain
accounting irregularities and do not comply with GAAP,
any intentional failure to disclose such a condition
represents a fraud perpetrated on the auditors. This type
of fraud has as its purposes obtaining from the auditors
an unqualified audit opinion and keeping the auditors from
knowing about and disclosing the accounting
irregularities. Fraud on auditors typically includes some
combination of the following elements:
• Misrepresentations by management and/or
employees concerning the nature of transactions, the
accounting applied, the absence of accounting
irregularities—when in fact such accounting
irregularities exist—and adequacy of disclosure
• Concealment of fraudulent transactions by means of
falsification, alteration, and manipulation of
documents and accounting records or in some
cases, by keeping a separate set of books and
records
• Subornation of collusion to defraud from among
management and/or employees, taking the form of
silence when in fact these persons have knowledge
 of the fraudulent activities but do not disclose their
knowledge to the auditors, active participation in the
fraud by corroborating misrepresentations and/or
assisting in the falsification of books and records,
and assistance in the circumvention of internal
controls designed to prevent or detect fraud
• Collusion with third parties or other employees of the
victim company, in which such parties are aware of
irregular transactions but do nothing to prevent them
and/or nothing to bring them to the attention of either
their auditors or the counterparty’s auditors
• Deceptions, including planning the fraud to take advantage of
known or anticipated patterns of auditing—such as scope of
testing or audit locations—and furnishing false information to
auditors in response to their audit inquiries
• Destruction of evidential matter and/or withholding key
documents such as side letters