What Accounting Students Need to Know About Fraud
Part I
Joseph T. Wells
Introduction
Long ago and far away, I graduated with an accounting degree. In the days before Enron and WorldCom were infamous, I wasn't taught very much about fraud. But after two years in public accounting, I had concluded that auditing was definitely not my "forte". I found the long hours boring and tedious. In search of adventure, I became an FBI agent who specialized in the investigation of white-collar crime.
In nearly ten years I reckon I handled part or all of about two thousand cases. But for nearly four decades, my life's work has been in understanding fraud so that it can be prevented and detected. At the request of the Graduate Business School at the University of Texas at Austin, I started teaching a three-hour fraud course several years ago. It is one of the most popular courses at the college. That's because while traditional accounting courses teach how accounting systems are used, this one teaches how they are misused. Regularly, students say how it has opened their eyes to a whole new discipline.
This article is the first of three that details what accounting students need to know about fraud. As you will read, it is much more than debits and credits. As a matter of fact, some of the material has nothing to do with accounting at all. To begin, we will discuss two important predicates: the law as it relates to fraud and an understanding of criminal behavior. Both are critical to resolving fraud-related issues.
The Law as it Relates to Fraud
First, it is necessary to issue the standard disclaimer: I am not a lawyer. For legal advice, consult your attorney. But in general, there are four legal elements to fraud — no matter if it is financial statement fraud, embezzlement or corruption. My students know the elements of fraud by heart.
A Material False Statement
Not every false statement is material. The law doesn't address "white lies" nor does it address opinions as long as they are labeled as such. Materiality, of course, is a user-oriented concept.
Knowledge that the Statement is False
The difference between errors and fraud is intent or knowledge. There is no such thing as an "accidental fraud." The actor must have the intent to deceive. In the legal sense, intent is the most difficult element, because it requires proving someone's state of mind at the time of the material false statement.
Reliance by the Victim on the False Statement
Even if the actor made a material false statement with knowledge of its falsity, there is no fraud if the victim did not rely upon the statement. For example, when I was an FBI agent, banks would commonly claim fraud after a borrower defaulted on a note. But it became clear that some banks did not rely upon the puffed and unaudited financial statements of their borrowers, but on the underlying hard collateral. In those cases, the banks were unsuccessful in sustaining a fraud claim.
Damages
If the victim relied upon a material false statement and the actor knew it was false, there is no fraud unless there are damages (certain exceptions for this element exist with attempted fraud against the government). The important thing for students to understand is that all four elements must be present to prove fraud.
Accounting students also need to know what to do with evidence of fraud if discovered. Should documents be mishandled or misplaced, the chain of custody might not be proven, a critical element in the legal process.
Criminal Behavior
Were I to ask the average accountant or accounting student, "Why is fraud committed?" the standard response would be "inadequate internal controls." That answer is not only misleading; it ignores an understanding of human behavior. Fraud isn't committed by accounting systems but by people. Given outwardly identical circumstances, one person will turn to fraud while another will not. Why? The answers lie in the complex world of criminology.
There are numerous — indeed, almost countless — criminological theories. But accounting students need to be exposed to the principle ones: specific deterrence (how to deter someone individually from committing crime), general deterrence (the message others get by punishing another person), biological theories (that criminal behavior is inherited), anomie theories (that crime is caused by wanting more than we have), learning theories (that the tendency to commit crime is learned from observing criminal behavior) and psychological theories (that crime is caused by a dysfunctional early childhood environment).
Students also need to be exposed to the criminal justice system — the process that leads to arrest, indictment, trial, conviction and incarceration of fraud offenders. Only by doing so can the student place crime in its proper context. Fraud is not an accounting problem; it is a societal phenomenon and should be recognized as such. In the next issue, we will begin delving into the specific schemes that are used by dishonest employees and executives to defraud organizations.
Joseph T. Wells, CFE, CPA is founder and chairman of the 34,000-member Association of Certified Fraud Examiners. He is an adjunct professor of fraud examination at the University of Texas and the author of 11 books and scores of articles on fraud. For the last seven years in a row, Mr. Wells has been named to Accounting Today's list of "100 Most Influential People in Accounting." His email address is jwells@cfenet.com.
|
