Oversight Systems Corporate Fraud Survey Finds Sarbanes-Oxley Effective in Identifying Financial Statement Fraud

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Few feel the heightened push for institutional integrity and fraud prevention by business leaders will continue in the long-run.

Oversight Systems Inc. today announced the findings of the 2005 Oversight Systems Report on Corporate Fraud, a survey of certified fraud examiners. The report explains that most fraud examiners view Sarbanes-Oxley (SOX) as an effective tool in fraud identification, though few think it will change the culture of business leaders.

The survey results (available as a free download at http://www.oversightsystems.com/survey) indicate that 65 percent of respondents feel SOX has been “somewhat effective” or “very effective” in identifying incidences of financial-statement fraud. Only 19 percent of those surveyed found SOX to be ineffective or serve to prevent fraud identification.

“This report is full of positive news but foreshadows a real need for continued vigilance among executives toward intuitional fraud,” said Patrick Taylor, CEO of Oversight Systems. “SOX legislation and the intense focus on corporate scandals have helped battle this type of white-collar crime, but professionals seem to be worried that the C-suite might quickly lose interest in policing corporate fraud.”

Although respondents agree that SOX serves to identify fraudulent activity, they do not feel the recent cultural change among U.S. business leaders toward institutional integrity and fraud prevention in the wake of account scandals will stick. Only 17 percent feel there will be a shift among business leaders to institutional integrity and fraud prevention for the foreseeable future. The remainder of respondents possess a more stark outlook, reporting that interest in such actions will fade in the next five years (39 percent); that vigilance has already begun to fade (32 percent); or that there has been no change among business leaders (12 percent).

“The pendulum of corporate culture and attitudes toward integrity swings back and forth,” said Dana Hermanson, Dinos Eminent Scholar Chair of Private Enterprise at Kennesaw State University. Hermanson is also an advisor to Oversight Systems and co-author of the COSO-sponsored research report Fraudulent Financial Reporting: 1987-1997. An analysis of U.S. Public Companies. “We could see very little corporate fraud in the next seven or eight years, but then another boom-and-bust economic period could ignite another wave of financial scandals, which would lead to further accounting and governance reforms.”

The State of Institutional Fraud

While corporate vigilance toward fraud prevention has increased at least temporarily, fraud examiners said fraud is a bigger problem today than in the bubble market of 2000. Two-thirds of respondents (67 percent) said institutional fraud is more prevalent today than five years ago. Only seven percent think fraud is less prevalent, while the remaining 26 percent of respondents feel there has been no change in the amount of fraud.

Participants were asked to select the three forms of institutional fraud that present the greatest risk to companies. Respondents identified conflicts of interest (63 percent), fraudulent financial statements (57 percent) and billing schemes (31 percent) as most threatening. Examples of fraud that garnered at least 20 percent support were expense and reimbursement schemes (29 percent), bribery/economic extortion (25 percent) and inventory and non-cash asset misuse (20 percent)

“The risk of financial statement fraud is real and not going away,” Hermanson said. “However, the perception of increased fraud may stem from Sarbanes-Oxley’s effectiveness in uncovering weaknesses in internal controls and the potential for fraud. SOX compliance gives auditors and executives a better position to evaluate a company’s financial reporting system. Instead of only inspecting the outcome, financial reports, SOX forces companies to understand the financial reporting process as well. And like the manufacturing quality movement of the past, SOX pushes companies toward monitoring each step in the process to drive out errors and weaknesses.”

Stopping Institutional Fraud

When asked to identify the measure most effective in preventing or deterrent institutional fraud, 41 percent of professional fraud examiners identified the need for a strong tone from the top of the organization. Visible prosecution was the next most popular response garnering 22 percent support, followed by internal controls and technology-enabled monitoring, each receiving support from 17 percent. Manual quarterly audits and government regulation received only minimal support, earning two and one percent, respectively.

However, when asked what single change would result in the greatest reduction of domestic institutional fraud, opinions were more mixed. An employer pressing charges against employees who commit fraud garnered the most support with 39 percent. The trend of prosecution continued with 32 percent of respondents identifying convictions and hefty sentencing as the next most popular response. Moreover, an additional seven percent would like stiffer laws to increase corporate transparency.

“Stiff penalties and thorough prosecution send a strong message to employees. First, employees are less likely to go along with rogue executives who orchestrate financial reporting schemes. Second, a company’s prosecution of fraudulent employees establishes the corporate attitude that fraud will not be tolerated,” Hermanson said.

The Role and Views of Fraud Examiners

Survey participants report that SOX has altered the role of fraud examiners. Nearly all participants (95 percent) explain that their duties have changed with the implementation of SOX legislation, with 47 percent reporting that fraud examiners play a major role in the management of corporate integrity. Additionally, nearly one-third (29 percent) of respondents felt their work in fraud detection has become secondary to SOX compliance.

In recent years it seems white-collar crime has been a staple of the evening news. Enron, WorldCom and Martha are just a few of the high-profile names with which Americans have become all too familiar. When asked, the majority of professional fraud experts felt these well-known defendants should have been found guilty of the charges against them. The percentage of respondents who thought the following executives are guilty of the charges against them is listed below:

  •     John Rigas, Adelphia Communications – 95 percent
  •     Jeffrey K. Skilling, Enron – 95 percent
  •     Kenneth L. Lay, Enron – 96 percent
  •     Richard Scrushy, HealthSouth – 93 percent
  •     Martha Stewart, Martha Stewart Living Omnimedia – 72 percent
  •     L. Dennis Kozlowski, Tyco International – 96 percent
  •     Bernard J. Ebbers, WorldCom – 97 percent

Identity Theft Update

Identity theft is one of the more prevalent forms of fraud known by the average American. A February 2005 Federal Trade Commission report states that for the year 2004, the commission received more than 635,000 reports of consumer fraud and identity theft, with identity theft accounting for 246,570 of the complaints (39 percent).

The 2005 Oversight Systems Report on Corporate Fraud reveals that 22 percent of respondents think the justice system must get tougher on the identification and prosecution of identity thieves. Additionally, 19 percent believe that the federal government needs to pass national identity-theft-protection legislation and another 19 percent feel regulators and consumers must work together to manage consumer information.

Some respondents believe that individuals are the first and most important line of defense. Taking ownership of one’s own personal information was identified by 16 percent of respondents as the best way to reduce identity theft.

About the 2005 Oversight Systems Report on Corporate Fraud

A total of 208 certified fraud examiners participated in this survey, conducted at the Association of Certified Fraud Examiners’ (ACFE) 16th Annual Fraud Conference and Exhibition. Dedicated to reducing business fraud world-wide, the more than 34,000 members ACFE make up the world's premier provider of anti-fraud training and education. Survey participants include anti-fraud professionals such as internal auditors, independent auditors, law enforcement officials, investigators and management consultants.

This study follows the August release of the 2005 Oversight Systems Financial Executive Report on Risk Management, which found that CEOs are placing a greater emphasis on risk management, although many companies are struggling to implement the necessary changes. Also recently released was the 2005 Oversight Systems Financial Executive Report on Sarbanes-Oxley, which found that nearly half of financial executives feel the biggest issue related to compliance is the need to maintain the morale of the employees responsible for compliance. All these research studies can be downloaded for free by visiting http://www.oversightsystems.com/survey.

About Oversight Systems, Inc.

Oversight Systems is the leading provider of independent, continuous monitoring solutions for real-time transaction inspection. By combining the expertise and experience of security, fraud, audit and enterprise software development professionals, Oversight Systems ensures the quality of financial processes, strengthens the control environment and automates controls for Sarbanes-Oxley compliance. For more information, visit http://www.oversightsystems.com.


Camera-ready charts and graphs of the findings from the 2005 Oversight Systems Financial Executive Report on Corporate Fraud are available by contacting Brian Moran by phone at 404-920-2039.


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Brian Moran