FraudBytes

My Experience with Ariely's Modified Shredder: A Followup

noreply@blogger.com (MZ) — Mon, 30 Aug 2021 19:29:00 +0000

I mentioned in a prior FraudBytes post that I have some suspicions about a set of experiments that Professor Ariely claimed he ran using a shredder that he said was modified so it looked like it was shredding but really wasn't (see this link for more details). After purchasing several shredders in an attempt to modify them so we could do what he claimed he did, we emailed Professor Ariely to ask him how he did it. He provided a voicemail response where he stated that it was "quite simple" to convert a shredder by breaking the teeth in the middle with a screwdriver but that he doesn't use that method any longer. (You can listen to Dr. Ariely's explanation at this link.)

As I said in the earlier post, we were unable to break any teeth on the shredders we purchased but ended up finding a way to remove some of the teeth in the center by taking the shredder apart. Unfortunately, when we did this the papers would no longer go through the shredder without getting turned to one side or another and they inevitably got stuck because the shredder no longer had enough teeth to pull them straight through.

We concluded that it was impossible to modify any of the shredders we bought and I put an asterisk next to Dan Ariely's name as someone who made a claim regarding his research that seems very suspicious.

Since I posted about this almost two weeks ago, I did an extensive literature search (involving several others who helped out) looking for the research that he claims was done with the modified shredder. The end result is that I can't find any published paper that discusses using a modified shredder. I even called one of his co-authors and asked him if the experiment that they ran together used a modified shredder. He said the shredder in their study was not modified.

I did find a few papers that used a regular shredder but did not mention any modifications. I also found several statements (including this one and the one linked above) where he claims to use this mysterious modified shredder. Overall then, here's where we are with the shredder:

1. Dr. Ariely has made numerous claims to use a modified shredder in his matrix experiments.

2. I am unable to find any published papers by Dr. Ariely that use a modified shredder.

3. Modifying a shredder to do what he has claimed appears to be very unlikely.

So why would Dan Ariely make this claim? Perhaps he got confused about how his studies involving shredders were conducted. Or perhaps he never conducted the studies with a modified shredder.

Unfortunately, the more I dig into things, the more I find instances where Dr. Ariely has made statements that suggest a lack of integrity on his part. For example, this NPR interview about dentists is troubling to me. He also has a paper that was recently given an "Expression of Concern" by the journal that published it (see this for details). I hope Duke University gets to the bottom of these black marks on Ariely's work and if other published studies are based on fabricated data that they get retracted like the 2012 paper.

Unfortunately, at this point, I'm not sure what to think of the research he claims to have conducted on the psychology of dishonesty...I certainly will hesitate to cite any of his papers in my research.

Analysis Argues Ariely Retraction was a Sloppy Fraud

noreply@blogger.com (MZ) — Tue, 24 Aug 2021 03:44:00 +0000

An analysis by Jonatan Pallesen shows that the Ariely fabrication that I posted about a few days ago was extremely sloppy. The post concludes that "This is a case of fraud that is completely bungled by ineptitude." Well, let's not mince words here....

The original analysis on the Data Colada blog identified several inconsistencies in the data that showed it was fabricated data. For example, the data is a uniform distribution that goes from 0-50,000 and stops. This new analysis, raises additional questions about the data and asserts that the analysis shows how the fraudster was able to manipulate the data to support the hypotheses tested in the paper.

I recommend reading this analysis and deciding whether the author makes a compelling argument to support his claims. His ultimate claim is that the fraud had to be perpetrated by Ariely himself. He says: "Is it possible that someone at the car insurance company faked the data, and Dan Ariely simply received this fake data? I would say that it is not."

Bold claims require bold evidence. See what you think.

Top Honesty Researcher, Dan Ariely, Has Paper Retracted Due to Fraudulent Data

noreply@blogger.com (MZ) — Wed, 18 Aug 2021 15:26:00 +0000

Today, truth is on my mind after I read the following quote:

"(T)ruth is not what you want it to be; it is what it is, and you must bend to its power or live a lie."–Miyamoto Musashi

This reminded me of this, my favorite, quote about truth:

“When truth is buried underground it grows, it chokes, it gathers such an explosive force that on the day it bursts out, it blows up everything with it.”–Emile Zola

Over the years, I've found the latter quote to be very descriptive of the events that follow after the initial revelations that a fraud has taken place. For example, the explosion of truth that happened after Lance Armstrong was first accused by his former teammate, Floyd Landis, of doping. A few years later and Lance had been stripped of all his yellow jerseys and all sorts of revelations came out that exposed truth that was buried deep in the ground in hopes that it would never be revealed (this link chronicles about 150 blog posts about Lance's fraud coming to light).

Similarly, in accounting research, we had a researcher who, by many accounts, was considered accounting's most prolific academic, Jim Hunton, have a paper (ironically on auditor's detection of fraud) retracted in November 2012. Many of Professor Hunton's papers contained what he claimed was proprietary data that was obtained from confidential sources. A few years later, 37 of Jim Hunton's papers had been retracted (technically, 36.5 since one paper was partially retracted). He is currently listed as #14 on the RetractionWatch leaderboard (see this link for more information).

Over the past few days, a 2012 paper coauthored by someone who is arguably the most prolific psychology researcher on (ironically) honesty, Dan Ariely, was identified as containing fraudulent data and is being retracted (see this link for details on the investigation that led to the retraction; see this Twitter thread saying it is being retracted and giving other interesting context from one of the coauthors). Unfortunately, like Jim Hunton, Professor Ariely was in charge of the data and claims to have obtained it from a proprietary source. While it is too early to tell, this begs the question of what the future holds. Is this the early rumblings of the truth trying to free itself from its casket buried deep in the earth?

Sadly, I have had some suspicions about some experiments that Professor Ariely ran using a shredder that was modified so it looked like it was shredding but really wasn't (see this link for more details). After purchasing several shredders in an attempt to modify them so we could do what he claimed he did and even getting a BYU engineering student who was the lead TA in the Mechanical Engineering lab involved in the effort, we emailed Professor Ariely to ask him how he did it. He provided a voicemail response that was not satisfactory. He claimed it was "quite simple" to convert a shredder by breaking the teeth in the middle with a screwdriver but that he doesn't use that method any longer. (My TA found the file with Dr. Ariely's explanation; click this link if you want to hear it.)

(The photo on the left is one of the shredders we tried to modify. I'm confident that those teeth could not be broken with a screwdriver.)

We were unable to break any teeth on the shredders we purchased but ended up finding a way to remove some of the teeth in the center by taking the shredder apart. Unfortunately, when we did this the papers would no longer go through the shredder without getting turned to one side or another and they inevitably got stuck because the shredder no longer had enough teeth to pull them through. We concluded that it was impossible to modify any of the shredders we bought and I filed the entire experience in my mind by putting an asterisk next to Dan Ariely's name as someone who made a claim regarding his research that seems potentially suspicious.

Time will tell whether this retraction is the rumblings of a massive explosion or not. If there are other implications, I hope the truth comes out because, I believe, the world is always a better place when fraud has been exposed.

Finance Professor Exposes "Deeds of Darkness"

noreply@blogger.com (Bret) — Mon, 15 Oct 2018 17:15:00 +0000

A recent article in Bloomberg Businessweek highlighted the work of UT-Austin finance professor John Griffin, and his work in exposing the Bitcoin—Tether cryptocurrency connection. He found that when “Bitcoin fell to certain levels, purchases using Tether would flood in to stabilize prices” and this “fit a pattern consistent with someone, or a group of people, trying to manipulate Bitcoin prices.” Griffin also published a paper last year alleging a favorite benchmark of volatility in the finance industry, the XIV, was rigged. His work has drawn an “eager readership” among watchdogs, including the Department of Justice and the Commodity Futures Trading Commission.

Chinese Spies Infiltrate almost 30 U.S. Companies

noreply@blogger.com (Bret) — Mon, 15 Oct 2018 17:06:00 +0000

On October 4^th, Bloomberg published an article detailing how Chinese spies placed microchips on motherboards produced for Super Micro Computer Inc., one of the biggest supplies of motherboards in the world. Supermicro products are used by large tech companies such as Amazon and Apple. These microchips allow the servers they have been inserted into to be accessed remotely by those that put them there, and gather all the information they want. According to the article, "one government official says China’s goal was long-term access to high-value corporate secrets and sensitive government networks. No consumer data is known to have been stolen.” A link to the full article is provided below.

China infiltrated U.S. tech companies

NY Times Investigation digs into possible President Trump tax fraud

noreply@blogger.com (Bret) — Wed, 03 Oct 2018 19:54:00 +0000

On October 2^nd, the New York Times published a recent investigation into the President's taxes in the 1990s. The investigation states that "President Trump participated in dubious tax schemes during the 1990s, including instances of outright fraud, that greatly increased the fortune he received from his parents..." The investigation also concludes that, contrary to the President's claim that he is a "self-made billionaire," Trump owes his fortune to his father, who repeatedly bailed his son out of failed businesses. The article alleges that the President and his family engaged in tax fraud to avoid inheritance taxes as the father of the president passed his fortune on to his posterity.

Links to a summary article and the full investigation are included below.

11 Key Takeaways from Trump Investigation

Full Investigation

Auditors and Fraud: Interview with Going Concern

noreply@blogger.com (Aaron) — Wed, 31 Jan 2018 20:07:00 +0000

Mark was recently interviewed by Going Concern about auditors' responsibilities to detect fraud. Here are a few highlights:

On auditors' recognition of their responsibilities:

As I talk to auditors, I’ve found there is a lot of confusion in the profession when it comes to designing audits to detect fraud. I spoke with a new hire from PwC last week who had taken my class on fraud the year before. In my class, I make it very clear that the auditing standards specify that auditors are responsible for providing reasonable assurance that there are no material misstatements due to fraud. However, he was already confused and said he had read the firm’s communication about the Colonial case and thought auditors don’t have responsibility for detecting fraud. Needless to say, I was a bit disappointed that he had forgotten what he learned the year before in my class!

On the potential for changes to auditors' procedures in order to better detect fraud:

I personally think the skills needed to make these changes in audit procedures are not that hard to learn but someone needs to push the profession into widespread changes. The PCAOB is likely the best hope for this but the courts may beat them to it, as in the Colonial case.

The full interview is worth the read. Check it out here.

Moral Hypocrisy: The KPMG / PCAOB Scandal

noreply@blogger.com (MZ) — Wed, 24 Jan 2018 21:08:00 +0000

Auditors aren't that great at detecting fraud and sometimes claim their audits aren't designed to detect it. It looks like they may not be that great at committing it, either (though not for lack of effort).

The good news: the conspiracy was uncovered by someone within the firm who suspected that something wasn't right and spoke up, leading to quick and decisive action from the firm.

The bad news: several high-ranking officials within one of the largest accounting firms were allegedly involved in a conspiracy to defraud the federal government. These individuals are supposed to be examples of integrity to their firm and to the profession as a whole. If the allegations are true, this looks pretty bad for the firm and the profession.

The story: five KPMG employees have been charged with conspiracy and wire fraud; another employee pled guilty to conspiracy last week. These individuals were fired last year when the firm discovered that they were obtaining information about which of the firm's audit clients were going to be inspected by the PCAOB. Three of them were high-ranking KPMG partners, including David Middendorf, Thomas Whittle, and David Britt. The others were former PCAOB employees, two of whom had been hired by KPMG.

According to the sealed indictment of the case, there is evidence in emails and other written or sworn testimony that the top audit partners hired these individuals to help them get this information. It appears that they did this for three years until they were a little too helpful and raised the suspicions of another KPMG partner. That partner called the firm's in-house legal counsel and the resulting investigation uncovered the scheme. That's when the firm made the right choice in firing all involved employees and reporting the situation to the government.

Now, the government has brought charges and appears to have some pretty compelling evidence. One notable omission from the revealed charges is Scott Marcello, KPMG's former lead audit partner, who was also fired last year in relation to this scandal.

So why is this a big deal for KPMG? First, KPMG is in the business of performing independent audits of financial statements and to give an opinion that the statements are not materially misstated. When a KPMG audit client intentionally misstates their financial statements and violates accounting principles, they are committing fraud and investors usually lose a lot of money. This is how Enron and WorldCom and other major frauds take place.

So how does a smart fraudster conceal a fraud from their auditor? They often take one of two approaches: 1) they learn what the auditor is planning to test by either guessing based on prior years (auditors are often very predictable); or, 2) they hire former auditors and ask them what the audit plan is.

In this case, these KPMG partners appeared to be taking a page out of a fraudster's playbook and hiring former PCAOB employees to discover the PCAOB's audit plan. When top partners from an audit firm are acting like fraudsters, we know there are problems...

How does this all translate into the market for KPMG's audit services? Time will tell but if board members who hire auditors were to view this attitude as systemic at KPMG then those who want to send a signal to the market that their books are clean may be hesitant to hire KPMG.

To their credit, the firm appears to have done the right thing once it was brought to the attention of in-house counsel. The tough questions are how these partners got to the positions they were in and whether KPMG has done anything to ensure others like them have found the exit door. For example, were there other audit partners who were told to clean up their audits because the PCAOB had selected them for inspection but they didn't raise the issue?

Overall, I don't believe it's enough to just talk more about ethics in a situation like this. The firm needs to exonerate the partner who was uneasy and called legal counsel. That partner is, in my opinion, a hero! Also, the firm needs to clean house on any partners who have shown any sign of similar behavior. This also includes partners who were going along with the news to clean up their audits because the PCAOB would be looking without raising an eyebrow.

The value of auditing is largely contingent on public perception of auditor integrity. These partners' actions damaged a service and firm that is critical to the efficient operation of our capital markets. For that reason, they betrayed us all. As a professor of auditing, I am particularly disappointed that members of the audit profession stooped this low. I hope the firm takes action necessary to recover from this. Time will tell.

Is Bitcoin a Scam?

noreply@blogger.com (Aaron) — Tue, 09 Jan 2018 01:07:00 +0000

First, let's consider what bitcoin isn't.

Bitcoin is not a penny stock

Even high-risk investments like penny stocks have some intrinsic value. Stocks are valuable because they grant the owner the right to a share of company profits (either through dividends or liquidation). Bonds (and CDs and other similar financial instruments) pay interest. Real estate can be used for commerce or to provide shelter.

Bitcoin has none of those uses/attributes. What, then, is bitcoin's intrinsic value? I have yet to encounter a compelling argument that bitcoin has any intrinsic value. Bitcoin's underlying technology (blockchain) isn't proprietary (which is why there are so many alternative cryptocurrencies). It doesn't even function well as a currency (too volatile) or payment system (too slow). Others have done more in-depth analyses of bitcoin's intrinsic value and come to the same conclusion: bitcoin has no intrinsic value.

With no intrinsic value, bitcoin can't reasonably be considered a penny stock.

Bitcoin is not a lottery ticket

When people buy a lottery ticket, they know what they are getting into. They may be overly optimistic about their individual chances of winning, but they have a reasonable understanding of the mechanics (e.g., risks and payouts) that govern the outcome. Bitcoin's risks are unclear. This, coupled with the lack of intrinsic value leaves everyone in the dark about bitcoin's potential payoffs.

With so much uncertainty about bitcoin's potential payoffs, bitcoin can't reasonably be considered a lottery ticket.

Is Bitcoin a scam?

Let's be clear--bitcoin isn't your run-of-the-mill Ponzi or pyramid scheme. However, some of the discussion I've seen from bitcoin investors reminds me of the story involving one of my college roommates:

Doug (not his real name) was invited to participate in an amazing program called 12 Daily Pro that offered 12 percent daily returns! Doug came home and we talked about how absurd that sounded. We decided Doug should send an email to the person who had given him the flyer asking for more details. The response we got was amazing: this person candidly told us that 12 Daily Pro was essentially a Ponzi scheme, but that it was in its early stages and there was a good chance Doug could get paid before it collapsed. Hopefully it goes without saying that neither of us decided to jump on the 12 Daily Pro bandwagon...

Those who invest in bitcoin while knowing that it has no intrinsic value (or while believing the market to be in a bubble) remind me of the person who tried to recruit Doug. Both parties hope to profit at the expense of the ignorant or unlucky (those who invest too late in the case of 12 Daily Pro and those who sell too late in the case of bitcoin).

I don't believe bitcoin itself is a scam. However, the way in which individuals are most likely to profit from bitcoin has many of the hallmarks of a scam.

What about the other cryptocurrencies?

I believe my reasoning is equally applicable to the many other cryptocurrencies out there. As a result, I can't see a compelling argument for investing in any cryptocurrency (even though I think the underlying technology has a lot of potential).

PWC Held Responsible for Not Detecting Fraud

noreply@blogger.com (MZ) — Tue, 02 Jan 2018 20:28:00 +0000

The Wall Street Journal published an article explaining that PricewaterhouseCoopers (PWC) was held responsible for failing to detect fraud in their independent audits of Colonial Bank. Colonial Bank collapsed in 2009 and, according to the Tampa Bay Times, was the sixth largest bank failure in history. The articles estimate that PWC may be responsible for damages totaling hundreds of millions of dollars.

This is an interesting case because the audit firm has had some individuals claim, in court, that auditors are not responsible to detect fraud. The court rejected this claim and said auditors who don't design audits to detect fraud are not following their own auditing standards. Here are some details from the FDIC order related to the case:

“While there are numerous auditing standards that are implicated in this case,...the overarching standard that governed the PWC audits is that: “[t]he auditor has a responsibility to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatements, whether caused by error or fraud.” AU § 110.02; AU § 316. PCAOB Auditing Standard No. 2 states that “[a]lthough not absolute assurance, reasonable assurance is nevertheless a high level of assurance.” Id. at ¶ 17. To that end, a PCAOB 2007 release clarified that “[t]he auditor should, therefore, assess risks and apply procedures directed specifically to the detection of a material, fraudulent misstatement of the financial statements." (emphasis added). The Engagement Letters between PWC and CBG acknowledged this responsibility by stating that PWC would “design [the] audits to obtain reasonable, but not absolute, assurance of detecting errors or fraud.” See, e.g., A4 at 3. Indeed, Mr. Westbrook, one of the PWC audit partners, testified at trial that PWC had a duty to design audit procedures to detect fraud. Tr. 817:25-818:7 (Westbrook). He further testified that if PWC failed to design its audit procedures to detect fraud, it would be a violation of PCAOB standards. Tr. 822: 19-22 (Westbrook).

However, PWC voiced a very different tune just a few years ago with respect to another lawsuit that stemmed from this fraud. TBW’s bankruptcy trustee also filed suit against PWC, alleging that PWC breached its duties when it failed to detect the fraud. That lawsuit proceeded to trial in August 2016 before it settled mid-trial. As part of that lawsuit, many of the same PWC engagement partners, audit managers, and audit staff who are involved in this case gave deposition testimony under oath in the TBW trustee’s case. During that testimony, these individuals repeatedly admitted that PWC did not design its audits to detect fraud. For instance, Mr. Westbrook testified that PWC “audits are not designed to detect fraud.” Tr. 358:6-7 (Westbrook) (quoting Westbrook TBW Dep. at 23:7-12). Likewise, Mr. Jackson, the PWC engagement partner, testified that “I would point out that our audit procedures were not designed to detect fraud.” Tr. 1027:1-10 (TBW Dep. at 31:17-20). Similarly, Wes Kelly, PWC’s audit manager for the 2003-2005 and 2008 CBG audits, testified that PWC “did not design audit procedures to detect fraud.” W. Kelly TBW Dep. 45:608 (Ex. P3120). Finally, Mr. Rivers, a PWC audit associate assigned to the CBG audit, testified that PWC had no obligation to look for fraud. Rivers TBW Dep. at 66:17-23.

At trial, PWC attempted to explain away this testimony by arguing that these individuals simply meant that PWC was not a guarantor against the possibility of material fraud because the auditing standards recognize that “even a properly planned and performed audit may not detect a material misstatement resulting from fraud.” Ex. A400 at 7-8 (AU § 316.12); Tr. 821:25-822:24 (Westbrook stating that in order to provide a guarantee against fraud, auditors would “need a lot more tools like lie detector tests and subpoena power and guns and badges and all those kinds of things.”). This Court does not find this explanation credible, nor is it consistent with the previous testimony from the TBW trustee’s lawsuit. This Court heard Mr. Westbrook and Mr. Rivers testify for hours and is convinced that these gentlemen are more than capable of saying what they mean. If they had intended to say that PWC audits were not a guarantee against the possibility of material fraud, they would have testified accordingly. However, that was not their testimony. Instead, they clearly stated that PWC had no duty to detect fraud and did not design its audits to detect fraud. The Court concludes that PWC did not design its audits to detect fraud and PWC’s failure to do so constitutes a violation of the auditing standards.

What I find interesting is that practicing auditors admitted that they don’t design their audits to detect fraud even though auditing standards clearly say that auditors are responsible to provide reasonable assurance that there are no material misstatements due to (error or) fraud. Over the past decade, including as recently as 2016, I’ve asked several audiences of auditors to answer the following true-false question: “Auditors have the responsibility to provide reasonable assurance that there are no material misstatements due to fraud.” These auditors range from staff to partners and, on average, about 50% incorrectly answer false. This is pretty disheartening to me...

Unfortunately, my experience suggests that most auditors don’t put in a lot of effort to detect material fraud. Fraud may be discussed briefly in the required brainstorming session but then quickly forgotten as the audit team gets focused on ticking and tying and trying to get some sleep during busy season.

There are many things that auditors could do but, unfortunately, it's rare to find an auditor who is thinking beyond what they did last year. If I were king for a day, I would require auditors to do interviews with lower level people in an organization with the goal of discovering aggressive accounting or business practices. Combining interviews with strategic reasoning would potentially help auditors provide the reasonable assurance they are responsible for. For example, if strategic reasoning leads the auditors to believe revenue recognition and shipping cutoff is ripe for financial reporting fraud, auditors trained in interviewing could meet with shipping / warehouse personnel about the end of the year. Well designed questions could reveal information that could help identify control weaknesses and potential fraud.

In any case, this case and other experiences with auditors reminds me of the 1980s when auditors put it in their engagement letters that they weren’t responsible for providing assurance for fraud. Back then, and now, the courts don’t appear to share that view. In the end, both the auditing profession and audit users end up suffering when auditors are weak in fulfilling this responsibility.

Wells Fargo Incentives Lead to Fraud

noreply@blogger.com (Unknown) — Thu, 08 Dec 2016 19:22:00 +0000

Wells Fargo, one of the largest banks in America, was fined $185 million for the company’s fraudulent selling practices. A Wall Street Journal article¹ reports, “Federal regulators announced that Wells Fargo opened as many as two million deposit and credit-card accounts without customers’ knowledge.” Many former employees of the bank attribute the widespread fraud to the incentive structure and the pressure received from managers to reach the company’s ambitious sales targets.

Wells Fargo has been envied by its competitors for its high return on equity, with greater relative profits than other leading financial institutions such as J.P. Morgan. This success is a result of the focus on cross-selling more products (i.e. different financial services) per customer, a strategy it has faithfully followed since 1999.

However, some managers’ fierce dedication to this strategy led many lower level employees to create dummy accounts. Sales progress was closely monitored, requiring updated reports several times a day. Not meeting your targets was not something to be taken lightly, as many lower and mid-level managers lost their jobs due to their inability to consistently achieve their goals.

The account representatives and account managers also felt immense personal pressure to achieve sales goals due to the monetary incentives attached to their targets. With low base salaries those bonuses became very significant and highly desirable. A Harvard Business Review article³ explains how this type of incentive structure entices employees to make minor ethical compromises which then escalate and spread from there. The article reads:

“Consider the following sequence: A bank account manager, under pressure to make a sales goal to receive his bonus, pushes a customer to add a credit card, even though the account manager knows it’s not in the customer’s interest. Still short of the goal, the account manager asks his friends and family to open accounts. (The accounts are to be closed shortly thereafter.) With the goal still not achieved, the account manager opens accounts without asking customers and transfers a small amount of money. (The accounts are closed shortly thereafter and the money is transferred back.) As soon as the account manager gets away with the first unethical act, it’s not a big step to the fraudulent ones. The justification moves from ‘it’s legal’ to ‘no one is harmed’ to ‘no one will notice.’ When such practices are tolerated, they escalate in severity and spread throughout the organization.”

Wells Fargo’s CEO, John Stumpf, accepted full responsibility in his congressional hearing last week.²Over the past five years the bank has fired 5,300 employees for their involvement in fraudulent practices and has hired consultants from PriceWaterhouseCoopers and Accenture as well as several law firms to investigate the situation. However, it seems as though all that effort was too little, too late.

Mr. Stumpf has received a lot of heat for this scandal, including requests for his resignation and calls for top executive’s compensation to be paid back to those negatively affected. Some have even questioned his competency as the CEO of such a large bank. The WSJ article¹ previously mentioned goes on to state, “In the 2010 annual report, Mr. Stumpf said he often was asked why Wells Fargo had set a cross-selling goal of eight retail banking products per customer. “The answer is, it rhymed with ‘great,’ he wrote. ‘Perhaps our new cheer should be: ‘Let’s go again, for ten!’”

The bank said it will “scrap all product-based sales goals in its retail branches starting January 1.”¹ It is unclear why they are waiting until next year to implement this change aimed to alleviate the pressure experienced by employees that led them to these illegal practices. Hopefully this scandal will help other companies see more clearly that extreme commitments to aggressive goals can potentially lead to fraud.

1. http://www.wsj.com/articles/how-wells-fargos-high-pressure-sales-culture-spiraled-out-of-control-1474053044

2. http://www.wsj.com/articles/wells-fargo-ceo-stumpf-i-accept-full-responsibility-for-unethical-sales-practices-1474326173

3. https://hbr.org/2016/09/wells-fargo-and-the-slippery-slope-of-sales-incentives

Combating Cheating in the Classroom

noreply@blogger.com (Unknown) — Sun, 28 Aug 2016 02:47:00 +0000

Online resources students may use for cheating

Have you ever heard of websites such as Course Hero, Quizlet, or Koofers? If you have, you may know that while these websites can provide some advantages for honest students, they also provide an opportunity for some students to cheat. A recent presentation by a professor at Brigham Young University (BYU) highlighted several concerns about these study websites. After searching the websites, thousands of assignments, quizzes, and exams were discovered posted on the various sites. While it may be okay to post student notes, flash cards, or even class slides depending on professors’ instructions, posting assignments, quizzes, and exams is likely a violation of copyright laws.

When a student cheats they aren’t just affecting their own learning. One professor from South Dakota State University said in a Wall Street Journal article that he was essentially forced to drastically reduce the weight of homework because study websites had made it too easy for students to cheat on homework. Students who cheat are affecting others’ grades (by changing the curve), the university, future employers, and ultimately society as a whole. If cheating is commonplace among students in school, then why wouldn’t fraud become common place after those students graduate? So what can be done about it?

At BYU, faculty have communicated to a number of study websites and requested that specific assignments, quizzes, and exams be removed. Some faculty have proposed that the university create a new position at the university tasked with contacting the various study websites to request removal of material whenever an unauthorized document is uploaded. This position could also search uploaded materials by student name with the intent to take action against the student for uploading unauthorized material. Essentially, this new position would reduce both opportunity (less unauthorized material online) and rationalization for the students (students could no longer feel that nobody would care that they posted a quiz or exam).

It may seem like there are too many ways for students to cheat, and that tackling the problem is impossible. However, if every university, or even a majority of universities, hired someone to monitor websites that allow people to post unauthorized classroom material, cheating could decrease. In any case, we shouldn't quit trying to fight corruption and allow it to flourish simply because we will never stop all corruption.

Whose Job is it Anyway? Are Auditors Expected to Detect Fraud?

noreply@blogger.com (Unknown) — Mon, 15 Aug 2016 17:18:00 +0000

A recent article in The Wall Street Journal details what could be one of the only legal cases from the great recession to actually go to trial. Taylor Bean & Whitaker Mortgage Corp. is suing PriceWaterhouseCoopers LLP (PWC) for $5.5 billion dollars claiming that PWC was negligent in auditing one of their clients. While PWC didn’t audit Taylor Bean, they did audit a bank with which Taylor Bean did frequent business--Colonial Bank (Colonial). Taylor Bean overdrew its accounts with Colonial for several years to cover cash shortfalls, then sold fake pools of mortgages to Colonial in order to cover up the fraud. Taylor Bean claims PWC was negligent in auditing Colonial, and that the collapse of Colonial led to them losing billions of dollars. The real question is how liable should auditors be for detecting fraud?

Elizabeth Tanis, an attorney for PWC, said that PWC did its job correctly and should not be held liable. Further, she added that it is not even an auditor's job to detect fraud. In contrast, in 2007 Dennis Nally, who recently retired as PWC’s global chairman, said that “the audit profession has always had a responsibility for the detection of fraud.”

Unfortunately for Ms. Tanis and PWC, auditing standards have clearly stated that auditors are responsible for providing reasonable assurance that audited financial statements contain no material misstatements due to fraud (or error). Auditors have long wanted to be exempt from the responsibility of fraud detection.

However, in this case, the jury will decide if auditors are responsible for detecting a fraud perpetrated by a client's customer. At some point, if auditors don't provide adequate assurance that material misstatements due to fraud do not exist, the market will likely not value audit services much. In my opinion, this age-old question of whether and to what extent auditors are responsible for detecting fraud will be debated as long as auditors keep providing independent services.

HSBC Holdings Receives Nothing More Than a Slap on the Wrist

noreply@blogger.com (Unknown) — Fri, 12 Aug 2016 03:37:00 +0000

A recent article in The Wall Street Journal talks about the Justice Department’s decision to not pursue charges against HSBC for allegations made in 2012. HSBC is a major bank in the UK that admitted to neglecting to spot proceeds from drug trafficking in Mexico and also did not flag transactions by countries under economic sanctions. Rather than being prosecuted, the bank was allowed to admit guilt, improve its controls, and make a few other minor changes. Both Republican and Democrat lawmakers view the decision as a slap in the wrist for a company that admitted to engaging in extreme illegal activity. While former Attorney General Eric Holder says his remarks were misinterpreted (see below), the fact that HSBC is no longer being prosecuted lends credence to the idea that the government seems incapable of handling corruption within some of the world’s largest corporations.

See this previous post for a further discussion on companies being too big to fail.

Fraud Prevention in the Banking Industry

noreply@blogger.com (Unknown) — Fri, 05 Aug 2016 22:19:00 +0000

According to a recent article on Bloomberg, banks are considering using blockchain technology, the same platform used in bitcoin transactions. This change could prevent losses that are due to one particular type of fraud. Some companies are applying for and receiving financing from multiple banks, but are using the same invoice as proof of collateral for all of the banks. This allows the company to receive much more financing than they should be able to receive, and the banks lose a lot of money if the company defaults on their loan. This fraud is similar to if an individual were to receive several mortgages from various banks for a single house. If the individual were to default on their mortgage, they would keep a lot of cash, and the banks would each be left with only a portion of a house as collateral. The losses due to this financing fraud have been close to $700 million for banks such as Standard Chartered Plc and JPMorgan Chase.

The blockchain technology that the banks are considering using would create a unique hash value for each invoice, which would allow banks to know if that invoice has already been used as collateral for financing somewhere else. However, while this technology could help reduce fraud, it remains to be seen if it will actually be adopted. In order for the fraud prevention to work, the technology would need to be used universally among all banks, and historically banks have been less inclined to work cooperatively with one another. However, as this particular type of fraud continues to happen more frequently, perhaps this will be a collaborative project worth undertaking by the banking industry as a whole, leading to a reduction in fraud.

Expert Witnesses in the Armstrong Case: Are their Opinions Valid?

noreply@blogger.com (Unknown) — Sun, 24 Apr 2016 04:17:00 +0000

It’s been over three years since Lance Armstrong admitted to doping throughout his career, but the lawsuit between the United States Postal Service (USPS) and Armstrong continues. The main question that is still unresolved is whether or not the USPS actually suffered losses due to sponsoring Armstrong with more than $30 million between 1998 and 2004. If the USPS can prove they experienced losses due to sponsoring Armstrong and subsequently learning of Armstrong’s doping, then they will have strong evidence to win the case. On the other hand, if Armstrong can prove that the USPS didn’t experience any loss, he will have a better chance at winning the case. How is the dispute resolved? By hiring expert witnesses at $700 – 900 per hour.

Both sides hired expert witnesses to testify in their favor. Armstrong hired a brand consultant at $700 per hour while the USPS hired a marketing professor at his “discounted” rate of $900 per hour. Both sides say that the other side’s expert witness didn’t have all of the facts or failed to account for everything in determining if a loss was suffered. The real question, however, is whether or not the expert witnesses are essentially being paid to find whatever makes them the most money. For example, if the brand consultant that Armstrong hired found that the USPS actually did suffer a loss, would Armstrong actually pay him or continue to use his services? Probably not. The same is true for the marketing professor hired by the USPS. Overall, especially in high-profile cases, expert witnesses stand to make a lot of money by sharing their opinion. However, whose opinions are they actually sharing? That’s the question that needs to be considered in cases where an expert witness is involved.

See this article on USA Today for more information about the ongoing lawsuit between Armstrong and the USPS.

New Detection Method Could Have Caught Lance Armstrong

noreply@blogger.com (Unknown) — Mon, 18 Apr 2016 14:59:00 +0000

There are several articles on Fraudbytes discussing doping in professional sports, but is there a way to stop doping? A recent article on road.cc discusses research that claims it could have caught Lance Armstrong. The current methods for detecting drugs in an athlete’s system are extremely sophisticated (i.e., if there was a drop of drugs in an Olympic sized pool, they would detect that drop). However, they are only able to detect the drug if it was used in the last 48 hours. According to Yannis Pitsiladis, a professor of sport and exercise science with a particular interest in genetics, his new method can detect if the athlete has doped in the past several months and, potentially, even years.

Dr. Pitsiladis looks at the fluctuations of RNA in athletes and says that when an athlete dopes it leaves a footprint that is detectible for months or even years. The biggest concern is that other natural causes, such as travelling to higher elevations, might also produce a similar RNA pattern as doping does. In order to fully disentangle this, additional research needs to be done so that the drug test can become more accurate. In discussing the challenges of perfecting the research, Dr. Pitsiladis said, “It is very frustrating because the technology is there, the science is there but the research needs to be done and that costs money.” He calls for more funding for his research and more cooperation between scientists who are researching similar things. If Dr. Pitsiladis’s new method is tested and proven effective, then, as he says himself, “We can eradicate doping and change sport forever.”

See this article in The New York Times from 2014 which also discussed Dr. Pitsiladis’ research.

Financial Crime Registry: Will it Deter Fraud and Improve Restitutions?

noreply@blogger.com (Unknown) — Fri, 01 Apr 2016 15:31:00 +0000

Every state in the United States has a sex offender registry that is publicly available for everyone to see in order to identify people who have been convicted of a sex crime in the past. Could such an approach also prove effective at lowering financial crime rates? A recent article in The Wall Street Journal discusses the creation of a White Collar Crime Offender Registry in Utah. Utah is the first state to implement such a registry, making them, according to the article, the “most aggressive jurisdiction in the country when it comes to publicly shaming financial criminals.” The registry will list first time offenders of financial crime for five years, second time offenders for ten years, and third time offenders will never have the option of being removed. In addition, convicts who fully comply with court orders and pay their restitutions in full will not be added to the list.

While there is some debate about whether or not the financial crime registry is an invasion of privacy, it does appear to be a good solution to help potential future victims of fraud avoid getting involved with a fraudster in the first place. In addition, due to a low payment rate of financial crime restitutions, the new registry could substantially improve the amount of restitutions that get paid in full (because convicts can keep their names off the registry if they pay their restitutions). Utah is hopeful that other states across the country will adopt similar registries to help protect people from financial crime. Michael McKell, a member of Utah’s House of Representatives, said, “I know we're the first in the nation for doing it… I certainly don't think we will be the last.” While it remains to be seen how effective the new financial crime registry will be, hopefully it does prove to deter fraudsters, decrease financial crime rates, and improve restitution payment rates.

How to Avoid Being Asked to Commit Fraud

noreply@blogger.com (Unknown) — Fri, 25 Mar 2016 19:50:00 +0000

A recent article in The Economist discusses how to avoid being asked to commit fraud. It can be very uncomfortable if your manager asks you to alter the books or do anything that is unethical. Often there are not only repercussions for committing the fraud (i.e., fines or jail time), but also for not committing the fraud (21% of employees who reported unethical behavior at work said they experienced some form of punishment from their employer). If you refuse to commit a fraud, your manager may choose not to promote you or may even fire you. Rather than refusing to commit a fraud, the best scenario for an employee would be to never be asked to commit a fraud. A study that was done by Dr. Sreedhari Desai (professor at the University of North Carolina at Chapel Hill) found one approach that dissuades managers from asking employees to engage in unethical behavior.

The study done by Dr. Desai found that employees who either displayed a religious symbol at their desk or appended a moral quotation to their emails were less likely to be asked by managers to engage in unethical behavior. In addition, the study found that while the effect was strongest with the individual to whom the religious symbol or moral quotation belonged, managers who were exposed to either of these were less likely to ask anyone on their team to do anything unethical. Also interesting to note is that it didn’t appear to matter if the manager and the employee belonged to the same or different religions (i.e., Muslims respected the integrity of someone displaying a Christian cross more than someone who didn’t display any religious or moral symbol at all).

In summary, it appears that publicly displaying your moral character in some way will likely protect you and your entire team from being placed in the awkward situation of being asked to commit fraud. If your manager sees you as an ethical person who acts with integrity, it is more likely that they won’t ask you to do something unethical or illegal, and you’ll be spared the dilemma of determining what to do.

Doping and Match Fixing: Has Tennis Crossed the Line?

noreply@blogger.com (Unknown) — Wed, 23 Mar 2016 20:13:00 +0000

News of professional tennis player Maria Sharapova failing a drug test at the Australian Open has spread rapidly, especially since tennis is generally considered a more sophisticated sport, and people don’t usually think of tennis players when they think about athletes that are doping (see the video below of the press conference where Sharapova made the announcement). While Sharapova says that the drug she was taking was a medicine given to her for health reasons that was only just recently banned by WADA (World Anti-Doping Agency), she still takes responsibility for taking it after it became a banned substance. Additionally, this situation has brought to light other instances of potential fraud in professional tennis, including doping and fixing matches.

A recent article on independent.ie discusses the stance that tennis as a sport has taken against doping. The article points out that the main surprise about Sharapova admitting to using banned substances is that she made her situation and statement public. Historically, professional tennis has been criticized for quietly punishing players who use performance enhancing drugs. As Roselyne Bachelot, the former French minister for sport and health, stated, “We never hear about positive tests… we just learn that players pick up injuries that keep them off the courts for months.” Sharapova made a comment to fans on Facebook that corroborates this: “I won't pretend to be injured so I can hide the truth about my testing.” Whether or not Sharapova knew she wasn’t supposed to take the drug she was using, it is apparent that professional tennis as a whole likes to hide instances of substance abuse through lengthy recoveries and early retirements.

A joint investigation by BBC and Buzzfeed also raised awareness about allegations of match fixing in professional tennis (see the article here). Match fixing is when one or both players decide to play in such a way that a certain player either wins the match, a particular set, or a particular game. This allows for people betting on the matches to make a fortune. Tennis is more prone to match fixing than other sports because there are fewer players that need to be paid off in order to affect the results of the match. While all of the collecting bodies in tennis formed the Tennis Integrity Unit (TIU) in order to protect the integrity of tennis from match fixing, many allege that the TIU doesn’t actually pursue investigations in order to punish those who are involved in match fixing. One investigator says that after a 9-month investigation that identified about 10 players who had likely been involved in match fixing, the TIU did nothing to follow up with their investigation and none of the players were punished, at least not within the next two years.

BBC also conducted an interview with Daniel Koellerer, former professional tennis player who was banned for life for allegedly fixing matches (though he denies the claims), in which Koellerer stated that hundreds of professional tennis players are approached and offered amounts of $50,000 or more to purposefully lose a match (see the video of the interview below). When large amounts of money are involved, many people do things they wouldn’t normally do, and it is almost certain that some players have been involved in match fixing. And just as professional tennis organizations like to keep drug test failures quiet, with minimal punishments, it appears they take the same approach with match fixing.

I love tennis and hope to continue watching and playing the sport, but if there aren’t punishments enforced for cheating, then cheating will become rampant. Just as businesses would likely commit more fraud if there were not penalties assessed, athletes will fix matches and dope in order to maximize their income if there are no penalties. It is important that rule violations are made public and appropriate actions are taken to ensure that others don’t continue to cheat.

Advances in Technology for Auditing Firms: KPMG to Announce Deal with IBM Watson

noreply@blogger.com (Unknown) — Wed, 16 Mar 2016 04:41:00 +0000

A recent article in The Wall Street Journal discussed the technological improvements among auditing firms (KPMG in particular). KPMG is expected to announce an alliance with IBM to use their artificial-intelligence technology, IBM Watson, which will allow KPMG to audit all of the data for their clients rather than only samples of the data. The technology is not meant to replace human auditors, but will help them know where abnormalities may exist in the client’s books.

The other major accounting firms have also heavily invested in similar technology (some spending up to $400 million for an initial investment in the technology). The benefit of being able to audit 100% of the data is that nothing is missed due to sampling error. This allows auditors to see where problems may exist and “know exactly where to dig in and dive.” New technology has the potential to improve audits by making them both more effective and more efficient. While a managing partner at PwC correctly stated that “human intervention and judgment will always be the most valuable part of any audit,” it is also clear that technology will play a crucial role in audits going forward.

Ponzi Scheme in China: $7.6 Billion Lost

noreply@blogger.com (Unknown) — Tue, 16 Feb 2016 04:25:00 +0000

A recent article in The Economist elaborates on a massive Ponzi scheme that recently collapsed in China and caused 900,000 investors to lose about $7.6 billion.

Ponzi schemes are not new in China. In fact, China’s current lack of regulation in the peer-to-peer lending industry has created an environment ripe for fraud. This article points out how the lack of government regulation can lead to an economic environment where investors find it nearly impossible to distinguish between fraud schemes and legitimate businesses. We can also learn a few additional things from this Ponzi scheme that might help investors identify when something really is too good to be true.

The article mentions that “instead of paying investors out of revenues from business projects,” Ezubao was “paying long-standing investors with money deposited by new ones,” a structure that can’t last and is the key feature of a Ponzi scheme. Additionally, the founder of Ezubao spent millions of dollars on advertising, instructed employees to live lavish lifestyles, and even appeared on the government’s web portal during interviews. One fundamental principal that is true in nearly every fraud is that the fraudster generally does not quietly save their fraudulent earnings. Instead they live extravagant lifestyles, own nice cars, jewelry, and other luxurious items.

Every fraud eventually collapses, despite fraudsters’ best efforts to keep the details concealed. In the case of Ezubao, managers buried their accounting records underground, but after 20 hours of excavating, police were still able to retrieve the evidence.

As investors and consumers trying to not lose money in a fraudulent investment, it is important to understand how the company makes money, how lavish the lifestyles of management personnel are, and what fraud prevention regulations are in place (or lacking).

Dodd-Frank Whistleblower Program Makes its Annual Report to Congress

noreply@blogger.com (Unknown) — Tue, 05 Jan 2016 04:50:00 +0000

The Whistleblower Program was instituted in August of 2011 with the purpose of incentivizing people with inside, original information about potential securities law violations to come forward and share that information with the SEC. In order to incentivize whistleblowers, the Whistleblower Program may award whistleblowers an amount between 10% and 30% of the monetary sanctions collected. The Whistleblower Program recently released its 2015 annual report to Congress.

Some interesting things from the report are the following:

“The commission has paid more than $54 million to 22 whistleblowers since the Commission’s new whistleblower rules went into effect in August 2011.”
The number of tips received in 2015 represents a 30% increase from the amount received in 2012.
The Whistleblower Program takes legal action against companies who attempt to create contracts and other means that discourage or prohibit employees from blowing the whistle.
The largest award paid by the Whistleblower Program to date was more than $30 million.
“Award percentages are based on the particular facts and circumstances of each case, and are not based on any hardset mathematical formula.”
While whistleblower submissions have been received from every state and territory in the US, the states with the highest submissions are California, New York, Texas, Florida, and New Jersey (see map below).

Hopefully the Whistleblower Program is successful at helping uncover fraud early on. To learn more about what has happened during 2015 with the Whistleblower Program, read the full report to Congress at this link.

Martin Shkreli: The Downward Spiral of Fraud and Greed

noreply@blogger.com (Unknown) — Tue, 22 Dec 2015 04:18:00 +0000

Martin Shkreli, former CEO of a pharmaceutical company is known for buying up old drugs and immediately raising the price to consumers by as much as 5,000% overnight. He recently raised the price of one drug that treats a devastating infection in babies and people with AIDS from $13.50/pill to $750/pill. Mr. Shkreli has often spoken out against critics, and has become known as the “bad boy of pharmaceuticals,” portrayed by his excessive greed. On December 17^th, Mr. Shkreli was arrested for securities fraud and wire fraud charges, not because he raised prices so quickly in his current company, Turing Pharmaceuticals, but because of fraud he committed in two prior hedge funds and a previous biopharmaceutical company, Retrophin.

Mr. Shkreli lied to investors for both of his hedge funds while losing millions of dollars. He then paid them off by using funds from Retrophin without consent from the board of directors. Throughout the process, he and a partner fabricated consulting agreements so that external auditors would not be suspicious of the transactions taking place between Retrophin and the investors of the two hedge funds. This article from The New York Times and the video below (posted by the Associated Press) give more information about what Mr. Shkreli did and what he has been charged for.

I find it really interesting to note the behavior of Mr. Shkreli after the major frauds were committed in his hedge fund companies and at Retrophin. He has become more outspoken against critics, more greedy, and more self-centered (though currently offline, he has a live-streaming YouTube channel of himself talking in his apartment – https://www.youtube.com/watch?v=YCB6AybM4Cs). He has even said that his only mistake in raising drug prices by drastic amounts was not raising the prices more.

Greed often leads to fraud, but what is interesting is that as a fraud is carried out, the fraudster seems to become even greedier. This concept can be applied across all industries. As people exhibit more greed, not only is it possible that greed is leading them to commit a fraud, but it is also likely that they are already committing a fraud, and, in the process of attempting to cover it up, are displaying more greed. Greed leads to fraud and, as in a vicious circle, fraud also leads to greed.

Swisher Executives Charged with Fraud

noreply@blogger.com (Unknown) — Wed, 11 Nov 2015 01:24:00 +0000

In 2012, Swisher, a janitorial and cleaning-supply services company, was charged with allegations of financial wrongdoings. Now, three years later, Michael Kipp (former CFO) and Joanne Viard (former director of external reporting) face charges of conspiracy to defraud the United States, wire fraud, securities fraud, and obstruction of justice.

The fraud was carried out largely so that executives could meet earnings targets. While it may not have initially seemed like a big deal to Kipp and Viard to commit the fraud, the investing public was put at risk, and fraud is a crime that is punished. Jill Rose, the U.S. Attorney for the Western District of North Carolina, made it clear that whenever there is fraud it will be punished, and in this case the two executives may face up to 30 years in prison.

See this article from The Charlotte Observer for more information.