Background

This chapter is based on our personal experiences as forensic financial investigators over the past 40-plus years. It summarizes actual situations where directors could have acted promptly but somehow did not. Not all of what is described was testified to in courts. Nevertheless, the available material should prove educational.

Frankly, some massive financial frauds have been so embarrassing to directors, officers, external auditors, and others that a credible defense was incapable of being assembled. Out-of-court settlements in the millions of dollars thus became required.

Ranking of a “top 10” had to be arbitrary and was primarily based on the number of times we encountered such a general scenario, and the dollars required to settle. Certainly, patterns of fraud repetition, or copycats, exist. For example, a too-common director “mistake,” or choice, is to assume that “someone else” was monitoring the at-issue situation and would have had the motivation to exert a thorough effort. External auditors, for instance, have tended to detect huge fraud schemes for only 1 in 15 to 20 discovered frauds. Internal auditors' results are better, unless they might be subjected to intimidation at a senior level. Thus, directors have to assume responsibility and not try to “buck-pass.”

The most costly frauds that we have investigated over the years have tended to involve swindles against stockholders and lenders, such as banks and pension funds. Settlements are too often for only a fraction of what the providers of cash had lost.

Some countries are much better than others in providing legislative protections for forms of white-collar crime. Needless to say, much room for improvement exists across the world. Simply, investors and lenders can lose their business, their life savings, their pension dollars, and even their life because of inept oversight legislation and non-prosecution of white-collar crime.

Fraud #1: Absent Board Independence

The fraud we are calling #1 is unfortunately commonplace, but is likely to be denied as being such, because it typically arises from an absence of sufficient board independence. Too often some corporate officers over time manage to place on the board of publicly owned entities a control group of rubber-stampers. Many are new to being directors and few have adequate financial literacy. Insurance companies typically have not checked into the backgrounds of board members and noted any weaknesses. As well, typically pension and money managers have not opposed appointments.

Sooner or later, situations arise where an entity's profits and cash flows drop for a variety of reasons. Competitors may have attracted some of the company's best previous customers. Bank covenants may have become violated or interest rates have become increased or a supposed new product does not sell well, and various other consequences arise.

Senior management then asks for breathing room, such as not recording various items as being expenses, but instead capitalizing them as assets. Sales become granted to entities with poor credit ratings and with much-reduced chances of collecting the receivables. In all, generous accounting methods become applied as part of a cover-up to growing reality of a downturn.

Suggestions are made that “normal” will return “next year,” so as a board member “just be patient” for a year. But, recovery does not occur the next year.

In financial reporting terms, what occurs next is that last year's accounting “generosity” or inflated results have to be repeated so as to cover up. But, such gets tricky, and more such faked revenue and decreased expense items have to be created in the second year so as to cover up a potentially worsening trend. A doubling-up of dollars of trickery becomes necessary.

As well, the company's external auditors have to be willing to go along with the reporting “generosity” if they should happen to discover it. Often, they do not discover the extent of problems because they too frequently are told fanciful tales, such as that receivables will be collected, and similar optimism. Differences in the extent of external auditors looking the other way seems to vary from country to country.

At some point, what ought to happen is that reality of unsupported financial reporting has to be seriously brought to a board level. Decisions have to be made to allow the company's stock price to fall, dividends to be reduced, and management bonuses to be canceled; more money has to be borrowed because cash inflows from operations have dropped, and similar. Insider trading needs close board attention, including offshore short-selling prior to financial announcements.

In brief, boards have to have advance planning sessions to think through likely consequences of various surprise events or variations in success and other unwanted events. Cover-up short-term actions must be contemplated and then detected by the board, using people with knowledge about financial disguises and possessing essential independence. Having been told countless times by board members “but the figures have already been audited” while they know that a scam has already occurred is discouraging to hear.

The comment “but it's been audited” should be interpreted as “these board members are not technically competent enough to be on an Audit Committee, and possibly a board, dependent upon their level of other skills.” They do not comprehend that external auditors use sampling and generally do not go into depth on much. In our experience, too many external auditors are not able to detect financial cover-ups; hence, looking elsewhere for detection is a common necessity for a board.

Circling back to our initial comment, a board that is under the strong influence of senior corporate management can be an accident waiting to happen. Such situations are far more common than people want to admit. Board members have to know about each other's skills and their willingness to act.

In our experience, a weak board is often a principal component for why losses in corporate financial failures became huge. Procrastination, hoping for a better tomorrow, seldom seems to pay off in our experience. Reality, unfortunately, is that, as investigators, we see large numbers of huge financial failures being closely linked to entities that had dominant CEOs and a pliable group of board members, who settled into believing fanciful financial reporting tales—likely not something a person would hope to read.

Fraud #2: Hiring “Rubber-stamp” Consultants

Closely related to Fraud #1 is the matter of board acceptance of a consultant's report that broadly defends a corporate management strategy that merely prolongs financial agony. Consultants cannot be chosen by a board just because “they are familiar with the company” (possible translation: being friends of senior management).

Canada especially has had a long history of situations where the following have been engaged inappropriately so as to support some form of senior management cover-up of a previous dubious decision:

• Real estate appraisers
• Pension asset valuators
• Marijuana plant growers
• Gold and silver vein geologists
• Compensation consultants
• Pollers of customer preferences
• Advertising designers
• Actuaries
• And much more

Obviously, competent independent people provide valuable services in each of these fields. But, to be honest, enough tricksters also exist that care must be exercised in choosing what a board requires to get to the bottom of issues.

Many of our huge losses in North America have involved property appraisals that have been grossly in excess of what is ultimately received on sales of the property. Loans can be made on the basis of an appraiser's collateral values being well in excess of the dollars that have been loaned. But when rental revenue drops and cash becomes squeezed, loan interest and principal cannot be repaid. The lender then has to absorb a large loan loss, perhaps across a wide group of loans, and too frequently could become bankrupt.

Unfortunately, we have seen this repeated “inflated value” pattern across our entire life as financial investigative accountants and auditors. Learning apparently is not taking place. Little to no risk of inflated numbers exists for appraisers, many of whom seem to have a bias of granting inflated dollars in their appraisal reports.

Hence, board members tend to face the repeated situation of how they can effectively oversee the choosing of “specialists” who will provide “honest answers.” Some boards are able to have their own group of consultants, which report directly to the board. Others have to pay especially close attention to situations where independence may not exist, and too much is at risk.

Overall, what we have to say on Fraud #2 is that the absence of independence among consultants has been a huge contributor to investor/lender losses of their investments, and over many years. Hence, with a high rank as a potential fraud, boards must give the choice of specialists extra attention. Otherwise, ugly losses await.

Fraud #3: Over-Ranked Financial Specialists

Once more, our ranking is based on the frequency with which we see certain types of financial trickery and the dollars of losses that we see involved in these types of cases. Boards have to face a reality that many lawyers and judges, among others, do not find financial collapses as being worthy of much attention. Short attention spans have to be tolerated.

Related thereto is that many lawmakers tend to be lawyers. In Canada, for example, can you name the Ministers of White-Collar Crime in the various jurisdictions? Correspondence with ministers is somewhat uniform: “It's not them; not their title; try elsewhere.” White-collar crime is largely ignored and “buck-passed.” (Incidentally, Canada does not seem to have any Ministers of White-Collar Crime.)

What can easily occur in board situations is where much reliance is being placed on an Audit Committee of the board. Such a committee too often did not have the necessary talent for the failed entity cases that we see. In case after case, the Audit Committee consulted with the company's external auditors, who failed to tell the whole story, thereby compounding consequences.

Reality too frequently is that the external auditors want to be reappointed to be the external auditors for next year. They do not want to offend management and others. Minutes of board/external auditor meetings tend to be boilerplate: “additional attention could be given to,” instead of something along the lines of “evidential support could not be located to defend the recordings.”

Similar misleading phrases in minutes and letters can be, “We received full cooperation from senior management throughout our audit.” Missing evidence is hardly full cooperation.

Our message to Audit Committees and boards for Fraud #3 is that there is not much wording difference that we have detected over the years between minutes of meetings with external auditors for companies that have financially collapsed versus those that are still in operation. Too much “going through the motions” wording has been occurring, and the full details needed by a board is not forthcoming. Procrastination has its limits. The title “auditor” has certainly diminished in the past 20 years.

No doubt some valuable meetings could occur between board/Audit Committee members and their external auditors. But, based on our principal sample base as forensic investigators of companies that have failed, warnings to board members have proved inadequate.

External auditors are inherently conflicted because of who engages them and pays them. A company that has not failed is sometimes labeled as being a “good audit” and therefore most such audits by definition become “good audits.” This reasoning does not make any sense, especially in industries such as marijuana and real estate investment trusts. When cash flow drags behind the reporting of profits, liquidity crises tend to arise.

In financial reporting terms, reported “profits” can actually be buried on balance sheets as receivables, long term or short term. Uncollected receivables mean that money may have to be borrowed to finance ongoing operations. Eventually, too much borrowed money leads to a liquidity crisis arising from violated debt covenants, and interest charges. Overstated revenue and receivables seem to exist in all fraud cases.

In our experience, boards that say that they consulted their external auditors, and that such is viewed as sufficient, are not doing themselves any favors. Incompetence could be being displayed, which hurts many people.

Fraud #4: Incentive Programs Gone Awry

Our experience has been that employee/manager incentive programs within public companies can become serious targets for manipulation when linked to financial reporting numbers. For example, bonuses could be based on a percentage of income before income tax (IBIT), or EBITDA (earnings before interest, taxes and depreciation or amortization), or adjusted or basic EBITDA, or a variety of other similar measures. Manipulation by senior executives therefore has to be monitored, including by boards. Likely weaknesses and trickery have to be identified in advance.

Countries that have adopted IFRS (International Financial Reporting Standards) are especially vulnerable to additional manipulation trickery games, because IFRS allows extensive management choice in valuing assets and liabilities, with their offsets arising in income-based figures and adjusted “cash flows” that are not cash.

A common type of example is where “cash flow from typical operating results arising from sales less expenses” is bloated by sales proceeds from disposals of long-term assets, such as excess buildings and land. Technically, a company's main sources of revenue would usually be unrelated to selling their long-lived assets. So, why should a bonus be paid on a transaction that has zero relationship to a manager's sales operation tasks?

Yet, we see these types of unwarranted manipulations because a financial person does not have instructions to exclude them but is influenced by others who may benefit from the bonus inflation trickery.

These types of misclassifications sadly are widely seen. Governments may sell land or investments that have been held for 50 to 100 years. What sometimes happens is that some or most of the sales proceeds become utilized to reduce a reported government “deficit.” The taxpayer then thinks, incorrectly, that the government is doing a good job with managing tax money. However, only deceptive accounting has occurred.

If a government sold all of its land and buildings, and rented space, a large gain on sale could arise, but for only one or two years. If so, the cash could be spent on a variety of weird election promises. However, what remains to be sold for the next year or so? Who pays the rent on the space that is thereby needed to operate the government? Obviously, it has to be next year's taxpayers.

In brief, ill-considered accounting treatments result in dysfunctional consequences. The financial tricksters are the winners and the taxpayers become the losers, unless tight controls exist.

Another popular, yet devastating, board-level decision occurs when approval is given to a “turnaround bonus” arrangement. That is, to motivate senior employees, boards have approved huge bonuses for showing a profit improvement year after a company has experienced a “loss” year or two.

Such schemes are loaded with opportunities for nasty financial trickery. For instance, the year prior to the implementation of the turnaround bonus year then becomes crammed with asset write-downs of all sorts to maximize the loss (in the base year before the bonus year). In essence, everything that could be expensed, so as to increase the loss year amount, occurs. Little is left to do anything other than to improve the numbers in the bonus year. “Optimism” can occur in the year of eligibility for bonuses, of course.

Court cases on such schemes get bogged down in arguments about professional judgment and available alternative treatments, as well as the intentions of people to deceive or not. Yet, the blame should be placed on a board when the court somehow accepts the faked bonuses. That is, the board chose to approve such a turnaround-incentive program that was loaded with opportunities for financial trickery.

An all-purpose solution to these incentive programs does not exist in our view. Accounting is loose across the world, especially IFRS. The more tightly defined becomes the terminology of what is included and what is not, the less will be the trickery. Hence, the board has to specify as precisely as possible what gets rewarded: all sales? sales less returns? only sales collected in cash within 60 days? only sales at regular prices that are collected in cash within 60 days?, and similar.

Throwing open the floodgates by widening who is eligible for a bonus and what gets counted as being a “success to be rewarded” is generally asking for grief. For example, we have seen bonuses awarded to shoe salespeople for sales over the next 90 days. What do the salespeople do? They ask customers to buy six pairs of shoes, and to return five pairs after the 90 days for credit. Sales of six pairs are then dated 10 days before the 90-day expiry period for bonuses.

Summed up, boards must clearly think out how individuals will try to obtain bonuses for free, and close the loopholes as much as possible. Perfection is not attainable in our experience. Foolish systems are too commonplace.

Fraud #5: Weak Financial Controls

Audit Committees and boards may not pay sufficient attention to the strength or weakness of “internal control systems” in a company. The quality, completeness, and other essential components of the internal control system may be deficient in several respects such that unreliable information is routinely being produced. Reports derived from the deficient control system can lead to considerable inappropriate decision-making.

An appearance that all is well when the opposite represents reality could mean that growing financial problems are addressed too late to correct at a reasonable cost. Fraud cover-up mechanisms that can be built into a weak control system are more common than most people want to admit.

Over the years we have seen many types of built-in fraud cover-ups, including the following (most of such entities with these mechanisms tend to struggle and then fail):

• Built-in arrangements that show current payments being made on receivables/loans due when no receipts have occurred for many months.
• Collateral listings pledged on loans that were fraudulently made and for which the collateral is nonexistent.
• Assets recorded on balance sheets that were never acquired, with the money for alleged purchase payment having been diverted to offshore accounts of specific employees.
• Refunds and cash received for scrap sales being diverted for personal use when the records show bad debt or inventory write-offs and various donations to charities.
• Uncollectible loans being shown as being current because a new loan was provided to pay off the old uncollectible one. Sometimes this situation has been ongoing for years.
• Spare parts for machinery and equipment being coded so that it is called inventory for sale.
• Widespread expense items being routinely coded as assets destined to be amortized over five or so years, thereby converting cash expenses into noncash, nonoperating investments.

Auditors are obliged to test the completeness of internal control systems that they intend to rely upon for audit evidence-gathering. Hence, extra attention needs to be paid by internal auditors to control matters that the external auditors usually do not evaluate. Boards in our experience unfortunately tend to assume inappropriately that external auditors investigate a variety of issues that are actually routinely being ignored.

Boards also have to give adequate attention to the longstanding problem whereby corporate management may try to override controls and succeed. Controllers who are fearful about their job security can be too timid to object to financial trickery, which also may be forced upon external auditors. Again, such a situation is far more common than is admitted.

Being able to trust corporate employees is certainly important for a multitude of reasons. Nevertheless, we have seen too many frauds in audited companies that have extended for 15 or 20 years or more. Then, the company may be quickly sold in whole or in part and new management becomes involved. Suddenly a multiple-year fraud becomes revealed.

Why was the fraud not caught earlier? Most such lengthy frauds that we have investigated are fairly simplistic with just one or two people involved. Nonsensical excuses from the trickster were accepted when a suspicion arose and no follow-up occurred.

Asking the company's external auditor for fraud evaluation help is usually not a wise decision. Too often the people who do the annual audit, and know the company, do not bring a fresh viewpoint and want to maintain their friendships. Frankness is needed for these control adequacy evaluations.

Last-minute financial statement manipulations could also be mentioned under a “Controls” topic heading. However, it can be too complex for this type of “Top 10” chapter. Meanwhile, those interested could consult our book, Easy Prey Investors (McGill-Queen's University Press).

Fraud #6: Non-Arm's-Length/Self-Dealing

A wide variety of costly frauds arise through self-dealing transactions. Directors have to be especially careful whenever scenarios such as the following arise:

• Subsidiary companies that are only partially owned could trade with the parent company, and an evidence-supported fair market value of the trading price has not been established; minority shareholders in the subsidiary company thus could be being defrauded.
• Companies that are owned individually by directors or officers trade with the company for which you are a director (how was “value” established?).
• Salaries, bonuses, and stock options for corporate officers and directors are granted at other than fair market value.
• Assets are acquired first by specific officers and directors and then later are sold to the company for which you are a director, at much higher, dubious “fair market values.”
• “Special arrangements” are made whereby money is granted to certain directors and officers on an interest-free deferred repayment basis.
• Bank and other loans are granted to specific officers and directors for usage by them, with the company guaranteeing the loan repayment.

In our experience some of the above can be harmless while others are troublesome because clarity is absent. For instance, minority shareholders in a subsidiary can sue for oppression of their rights if sales trading prices are below what a parent company should have paid.

Dollars at stake can add up rapidly in situations where applicable accounting guidance is vague. For example, IFRS is supposed to be based on the usage of “current values”; but exceptions and different definitions of “market value” are permitted. However, trades among partially owned companies are not seriously required to be at fair market values. Similarly, with historic-cost-based accounting systems, terms such as “exchange value” can be utilized to explain trading prices and they may not be close to fair market value.

Thus, directors can be seriously misled should they have assumed that accountants have recorded intercompany trading at a reasonable definition of “fair market value.” A company cannot bargain with itself so as to establish some fair “exchange value.” Hence, some accounting terms and note disclosure are inherently misleading. This leaves directors exposed to litigation unless steps have been taken to obtain adequate advice for the recording of fairly priced related-party transactions.

In an important sense, the entire arena of self-dealing can be scary for a director. All too often in many countries, the related-party arrangements are not being adequately monitored. We have seen many examples of potentially explosive scenarios. Some become exposed by taxation authorities in different countries, but others are best described as “ticking time-bombs.” Directors just have to give more attention to self-dealing, including the “back-dating” cover-ups that occur.

Fraud #7: Ponzi Schemes

Ponzi schemes are widespread. Annual losses are difficult to estimate. One person can steal over $1 million very easily and can continue to do so for periods of 10 years or more. The secret of longevity is finding more and more “contributors” to provide money so that chunks of cash can be paid to others (who inappropriately believe that their received interest came from wise investing by the Ponzi master). Also, some people may be convinced to reinvest their interest checks and thereby lose more and more.

Offered interest rates (or dividends) from fraudsters have to be sufficiently above the current market interest or dividend rate to attract donors. But, the rate cannot be so high that the rates are too good to be true and people thus become frightened. An “investment” name has to be chosen for the supposed recipient company that is a slight variation of a real-name company. As well, some directors may have to be appointed who are not financially skilled, along with a gullible accountant/bookkeeper. In sum, many innocent people can be dragged into one person's con game and lose much of their savings.

The scary part of Ponzi schemes is that the concept itself (i.e., “borrow from Peter to pay Paul”) can be, and is, applied to companies listed on stock exchanges. We had a case where the same $5 million was quickly circulated a total of nine times to give the appearance of $45 million of audited assets. (The company failed two years later when cash became exhausted and demands for repayment intensified.)

What directors have to especially watch out for is companies that do not track their cash flows closely. Who or what is providing the cash? Is the cash being generated by successful operations, such as from sales or services? Or, does cash have to be borrowed, thereby requiring interest and principal payments? How closely is the net cash received dollars to what is being reported as profits? Is borrowing replacing successful operating results?

For instance, much of IFRS separates in time the quick reporting of alleged profits from the much later receipt (if at all) of cash. Liquidity crunches accordingly can occur, which may require companies to sell their most valuable assets to try to stall the eventuality of bankruptcy.

Directors also have to be on guard for modifications of Ponzis. Some companies exaggerate their earnings through nasty accounting and then unwisely declare dividend rates to stockholders of perhaps 80 to 90 percent of the faked profit/income (perhaps being 150% or more of cash profit). High dividends attract investors, leading to higher stock prices, but for how long? Such tactics are mere variations of a basic Ponzi scheme because available cash is being circled and fresh sources of cash have vanished.

Money can be attracted for a while by selling more stock/shares at exaggerated prices. Then, a shortage of company cash tends to require the dividend rate to be cut. Reduced dividends lead to reduced stock prices and stockholders having to sell their shares at a capital loss.

By being more moderate, a “Perpetual Ponzi Scheme Company” can remain on a stock exchange for years. Dividend reinvestment arrangements can help to preserve cash temporarily. Lenders may be found for a while, by paying higher interest rates. But, once the company becomes forced to sell its better income-producing assets, its life is coming to an end.

Directors simply must monitor cash flow closely especially in relation to reported income/earnings (both fairly reported income and not). Accrual accounting, especially like extreme IFRS, tends to hide growing liquidity problems until a crisis arises. The scary combination of IFRS with maintaining a “too-high” dividend rate, designed to support an unwarranted high stock price, is simply dangerous. Yet, such is too frequently seen in public companies.

Summed up, directors may be the last set of available gatekeepers who are thereby required to contain short-term attempts to encourage a too-high stock price. Exercised stock option evidence has to be brought into the picture as well to measure whether too many short-term policy decisions are occurring. The expression “follow the money” cannot be downplayed.

Fraud #8: “Cooked Books”

The most common way of covering up some combination of frauds, bad management, and perhaps bad luck is to “cook the books” to disguise the potential appearance of a financial downside. Frequently, when we have been engaged to evaluate and quantify a specific suspicion of fraud, we observe financial cover-ups that lead to finding other frauds. That is, we uncover the cover-up first and then have to seek out the fraud(s) that are being covered up and which were not previously known. Stated bluntly, the accountant has been requested to change into the resident cosmetics artist.

Probably the most utilized cover-ups, or ways of dressing up a declining financial situation, are:

• Recording sales revenue at exaggerated amounts, or earlier than is realistic, or made to just plain imaginary customers; all of these mean that additional cover-ups have to be repeated in later periods so as to avoid write-downs of resulting receivables, because any cash eventually received would be less than the earlier recorded sales revenue.
• Calling expenses “long-term assets,” such as repair costs being labeled as building improvement assets.
• Recording goodwill and intangible assets at high levels when “too much” has been paid to acquire another company, for ego or other reasons; long-lived asset categories such as goodwill allow a financial trickster several years of breathing room before the lack of recoverability of the spent dollars becomes too obvious; excess freedom exists in accounting rules to delay write-downs of bloated goodwill.
• Mispricing of various derivative financial assets and liabilities also provides opportunities to avoid having to record some liabilities and losses; judgment choices are often too generous.
• Management's changing of desired interest rates that apply to pension assets and liabilities allow pension liabilities to be artificially reduced and pension assets to be overpriced; investments in illiquid infrastructure projects can be priced at imaginary “values,” and are rapidly becoming an embarrassing situation in many countries and for governments as well.
• Manipulation of the dollars of cash being generated by sales and service activities is out of control in some countries; items that are logically of a longer-term financing or investing nature are being inappropriately called a current-year “operating transaction.”
• Liability provisions for pending situations can be juggled to hide the reality of which dollars will be required to settle litigation; which year should be absorbing the costs?
• Timing of effective dates of contracts is often deliberately being chosen to downplay or enhance whether gains or losses are being included in a current period or will be shown in the next period.
• Similarly, the timing of recognition of loan and other asset losses can be procrastinated by various stall tactics (such as restructuring) that alter the likely dollars of losses in a current period and permit future “surprises.”
• Similarly, the basis of financial reporting that has been adopted by a company (e.g., U.S. GAAP, or otherwise).

To improve one's ability to detect ongoing financial trickery, it is helpful to read a few sets of different companies' notes to financial statements and observe when the common boilerplate wording is being chosen. Then, one company's changes in words become more noticeable and lead to asking “Why? What is the purpose underlying these particular words? Why is this specific comment necessary? Is something being hidden? What are the dollar consequences?” Out comes the magnifying glass.

Fraud #9: IFRS

Our experience with IFRS is that many directors, money managers, and investors still have not comprehended that IFRS is overly loose and is especially poorly conceptualized. IFRS is not a foundation that can be built upon in future years. Its “actuality” of today is far removed from what was advertised initially and is still surprisingly being claimed by external auditors. Investors have much to lose from the fraud potential that IFRS has opened up. Thus, the special dangers of IFRS merit extra attention in our listing of frauds.

IFRS allows considerable management flexibility but is supposedly based upon the use of “current market values.” Unfortunately, many countries do not have active trading markets in a wide range of assets, which would permit verification of current market values. For example, the latest selling price of various industrial buildings, infrastructure projects, specialized machinery, and much more is simply not available.

Accordingly, although the current value concept sounds good, in practice it is not workable. Often IFRS then lets corporate management decide on the reported “current value.” Thus, a major breakdown occurs from the traditional concept of why financial reporting exists in a country.

Traditional reporting was similar to scoring methods in sports such as baseball. Here is what “actually happened” in the game: number of different pitches, and by whom; what each batter and fielder did inning by inning, and so forth. The same concept of “what actually happened” is widely used in horse racing, weather forecasting, medical diagnosis and research, and on and on. Why? The past-results data could help in researching for an uncertain future.

But no; the IFRS supporters have chosen to permit corporate management to be able to seriously tamper excessively with the past-period data, and consequently have destroyed the “what actually happened” concept of reporting. Endless data interpretation problems thereby have arisen because past, present, and future activity are being combined into one period's audited, reported income and cash flow dollars. Consequently, recent unpleasant results in a company are permitted to be covered up by overly optimistic portrayals using future speculation by corporate management.

Trendlines under IFRS can easily be highly misleading because of the mix of past, present, and future as it was visualized by corporate management. Trying to pick out the actual past from the aggregated audited numbers can be impossible for directors and others.

Under IFRS, traditionally applied analytical techniques for financial interpretation are now fundamentally invalid for evaluating management's recent success, or otherwise. That is, corporate management has been permitted to write its own report cards and rate itself by utilizing data that it has been permitted to contaminate. IFRS promotes financial manipulation. What actually happened in an entity can be largely guesswork because receivables, inventories, revenues, expenses, and much more are largely biased under the IFRS rules of open management-choice behavior.

IFRS is fundamentally flawed as representing any form of what was previously advertised as a worldwide reporting system. Management choices obviously differ from manager to manager; prohibitions are few; interpreting the data is often not possible; trends are meaningless; and more.

IFRS is not based on actual, documented, third-party transactions where cash is received as a cross-check on previously reported extreme accrual accounting. Weak companies can be made to look very successful by management's optimistic fantasies. Directors must be especially careful with IFRS. Its usage encourages a variety of frauds.

Fraud #10: Corporate Reorganizations

This category can include corporate acquisitions, restructurings, divestitures, and similar material alterations to the previous nature of a business. Commonplace from time to time might be the acquisition of a cash-generating business at a high price, just so as to provide some operating cash flow to a previously cash-starved, long-operating entity. Included herein could be realignments of what constitutes a business segment so as to postpone having to write down goodwill and some intangibles.

Many such restructurings are usually attempting to buy time and avoid having to record losses on what may have been a supposedly widely promoted cure for a company's financial woes. Egos are at stake when a previous corporate acquisition turns out to be ineffective.

Acquisitions of other operating entities often provide opportunities to secretly revalue certain assets and liabilities and to renegotiate debt covenants. Excesses, including high purchase prices, can also be financially buried in illiquid goodwill and intangibles.

Overall, in these situations directors have to ask for a listing of what was financially moved, where, and why. Restructurings too easily can cover up financial manipulations.

Category #10 probably would require a separate book so as to describe all of the “what to watch for” financial reporting creativity that can arise. But, one nasty scenario that must be stressed is the reorganization that splits a company into separate public entities:

• Entity A: a viable going-concern operation
• Entity B: overvalued assets; understated liabilities; pension and union and environmental obligations; destined to fail

Do not volunteer to be a board member for Entity B.

Again, such “reorganizations” occur from time to time with some being better disguised than others. Most such situations become involved in serious litigation. Stockholders would have received shares in both A and B at the time of the company split. Those who quickly sold their shares in B fall into a different legal category than those who own a worthless stock certificate. But other complexities drag these cases out for many years. Be on guard. Much of what was described in the previous nine fraud categories can easily become part of Fraud #10.

About the Author

Rosen & Associates Ltd. is one of the premier independent litigation and investigative accounting firms in Canada. Our professionals possess a broad array of skills and expertise in the fields of forensic accounting, auditors' negligence, business valuations, damage quantification, shareholder disputes, financial and equity analysis, and due diligence.

Dr. Al Rosen has consulted or given independent opinions on over a thousand litigation-related engagements. He has provided expert testimony or affidavits in jurisdictions across Canada, including the Supreme Court of British Columbia and the Supreme Court of Canada. Al is the author or coauthor of several texts on accounting and hundreds of articles in numerous publications.

After heading the litigation accounting and business valuation division of a mid-sized accounting firm Dr. Rosen founded Rosen & Associates Limited. He has also been an instructor and professor of accounting at the University of British Columbia, the University of Washington, the University of Alberta, and York University, serving in many posts, including area coordinator and director of the Master of Business Administration program.

In addition to having his MBA and PhD, he is a Fellow of the Chartered Accountants of Ontario and Alberta (FCA), a Fellow of the Society of Management Accountants (FCMA), a Fellow of the Hong Kong Society of Accountants (FHKSA), a Certified Fraud Examiner (CFE), a Chartered Insurance Professional (CIP), a Certified Public Accountant (CPA), and a specialist, Investigative and Forensic Accounting (CA-IFA).