Financial fraud red flags

Searching for the funnel clouds


By Cynthia Harrington, CFE, CFA

Fraud examiners, when looking backwards to the early stages of an investigation, report common patterns. Like tornado watches, these signals don't indicate the funnel clouds were sighted but that they might develop because of optimal conditions.  

In 2003, the firm, webMethods, was named the No. 1 fastest-growing software company in North America.

But slowing earnings cratered the stock price from $11 to $4 per share in mid-2004. In November of 2004, an employee of the company's Japanese subsidiary notified webMethods' management that he was concerned about certain transactions. The company swiftly acted. The audit committee investigated and found that the improper activities included, among other things, engaging in improper licensing and professional services transactions and misrepresenting the transactions to the company's management, which caused the Japanese subsidiary to engage in undisclosed and unauthorized borrowings. The committee also found that the subsidiary failed to record expenses, recorded improper expenses, and created false documents to support those bogus transactions. Based on the findings of the investigation, webMethods announced that it will restate its financials for most of 2004 and 2005, according to the firm's public statements.

Certainly no one expects that the management of every fast-growing company will commit financial statement fraud. But along with a handful of other red flags, slowing growth is one of the starter conditions for fraudulent actions. Fraud examiners, when looking backwards to the early stages of investigations, report common patterns. Like tornado watches, these signals don't indicate the funnel clouds were sighted but that they might develop because of optimal conditions.

 

 

 


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