PowerPoint Presentation - UT Dallas

							        AIM 6377
   Corporate Governance

    Fraudulent Financial Reporting


Constantine Konstans, Ph.D., CPA, CMA, CIA, CFE
   Professor of Accounting and Information Management
          “Preparing Business Professionals for
 Leadership/Management Roles in a Globally-Competitive
                   Information Age”
    Session 2 Learning Objectives
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
         Securities Act of 1933
• Often referred to as “truth in securities” law
• Prompted by the stock market crash of 1929
• Lack of regulation to monitor financial status of
  publicly traded companies and sale of fraudulent
  stocks contributed to crash
• Part of the “new deal”, Franklin Roosevelt’s
  legislative agenda to rescue America from the
  depression
• Aims to prevent fraudulent transactions through
  registrations of of securities
       Securities Act of 1933
• Two basic objectives
  – require that investors receive financial and
    other significant information concerning
    securities being offered for public sale; and
  – prohibit deceit, misrepresentations, and other
    fraud in the sale of securities.
          Securities Act of 1933
• The information enables investors to make
  informed judgments about purchasing a company's
  securities
• Registration of securities includes information
  such as
  –   a description of the company's properties and business;
  –   a description of the security to be offered for sale;
  –   information about the management of the company; and
  –   financial statements certified by independent
      accountants.

                  http://www.sec.gov/answers/regis33.htm
         Securities Exempted
• private offerings to a limited number of
  persons or institutions;
• offerings of limited size;
• intrastate offerings; and
• securities of municipal, state, and federal
  governments.


                 http://sec.gov/about/laws.shtml
     Securities Exchange Act 1934
• Created to
  – Protect interstate commerce, the national credit, the
    Federal taxing power,
  – Protect and make more effective the national
    banking system and Federal Reserve System,
  – Ensure the maintenance of fair and honest markets
   Securities Exchange Act 1934
• Created the Securities Exchange Commission
  (SEC) that regulates commerce in stocks, bonds,
  and other securities
• Companies with more than $10 million in asset,
  500 stockholders
• Empowers the SEC with broad authority over all
  aspects of the securities industry including power
  to register, regulate, and oversee brokerage firms,
  transfer agents, and clearing agencies as well as
  the nation's securities self regulatory organizations
  (SROs)
                   http://sec.gov/about/laws.shtml
  Securities Exchange Act 1934
• Identifies and prohibits certain types of conduct in
  the markets and provides the Commission with
  disciplinary powers over regulated entities and
  persons associated with them
• Tries to increase information available to investors
  by ensuring companies make public information
  such as financial and managerial conditions of the
  firm


                   http://sec.gov/about/laws.shtml
     Securities And Exchange
           Commission
• Composed of five commissioners, four
  divisions and 18 offices
• Commissioners appointed by the president
  for a term of five years
• Primary mission is “to protect investors and
  maintain the integrity of the securities
  market”
Public Utility Holding Company
            Act 1935
• Regulates electric and gas utility companies
• Does not regulate utility rates
• Regulates structure of companies and inter
  company trade, acquisitions, financial
  reports and issue and sale of securities
• The SEC must approve any restructuring of
  utility companies
      Trust Indenture Act 1939
• Applies to debt securities offered for public
  sale
• Requires corporations to appoint a trustee
  for the benefit of bondholders
• Sets up qualifications for trustees
    Investment Company Act 1940
•    Defines the fiduciary duties, charges,
     financial reports of investment companies
•    Enacted after the Investment Trust Study
     found that investment companies were
     operated to further the interests of the
     company and not the shareholders
     interests
 Investment Company Act 1940
• To overcome any adverse effects due to
   – Investment companies not providing adequate
     information about the securities
   – Conflict of interest between management of such
     companies and investors
   – Investment companies issuing securities containing
     inequitable or discriminatory provisions
   – Investment companies operating without sufficient
     reserves or assets
  Investment Advisors Act 1940
• Requires investment advisors to register
  with SEC
• Requires registered advisors to keep records
  for specific periods which can be examined
  by the SEC
• Advisors shall have written policies and
  procedures to prevent misuse of non public
  information
   Foreign Corrupt Practices Act
              1977
• Prohibits corporate bribery of foreign officials
• Requires corporations to maintain accurate books
  and records
• Maintain internal accounting control systems
• Enacted after revelations of illegal payments to
  foreign officials by domestic corporations
• Provisions for criminal penalties
• Criticized for curbing foreign trade and exports
• Criminal penalties removed in the 1988 amendment
     National Commission on
  Fraudulent Financial Reporting
• Private sector initiative to study factors that lead to
  fraudulent financial reporting
• Sponsored by Commission of Sponsoring
  Organization (COSO) in 1985
• COSO Sponsored by American Accounting
  Association, the American Institute of Certified
  Public Accountants, the Financial Executives
  Institute, the Institute of Internal Auditors, and the
  National Association of Accountants (now the
  Institute of Management Accountants)
• Popularly known as the Treadway Commission
    National Commission on
 Fraudulent Financial Reporting
• Addresses internal control
• Recommendations for code of conduct,
  audit committees, control environment
      National Commission on
   Fraudulent Financial Reporting
• Recommendations for the Public Company
  – The Tone at the Top
     • top management must identify and assess the factors that could
       lead to fraudulent financial reporting: and set internal controls
  – Internal Accounting and Audit Functions
     • must be designed to fulfill the financial reporting responsibilities;
       companies must have an effective and objective internal audit
       function
  – The Audit Committee
     • Audit committees should be composed entirely of independent
       directors; have a written charter
   National Commission on
Fraudulent Financial Reporting
– Management and Audit Committee Reports
   • recommends a management report that acknowledges that the
     financial statements are the company's and that top
     management takes responsibility for the company's financial
     reporting process
– Seeking a Second Opinion and Quarterly Reporting
   • Management should advise the audit committee when it seeks
     a second opinion on a significant accounting issue;
     recommends additional public disclosure in the event of a
     change in independent public accountants; recommends audit
     committee oversight of the quarterly reporting process.
    National Commission on
 Fraudulent Financial Reporting
• Recommendations for the Independent Public
  Accountant
  – Responsibility for Detection and Improved Detection
    Capabilities
  – Audit Quality
  – Communications by the Independent Public Accountant
  – Change in the Process of Setting Auditing Standards
    National Commission on
 Fraudulent Financial Reporting
• Recommendations for the SEC
  – New SEC Sanctions and Greater Criminal Prosecution
  – Improved Regulation of the Public Accounting
    Profession
  – Adequate SEC Resources
  – Improved Federal Regulation of Financial Institutions
  – Improved Oversight by State Boards of Accountancy
  – Insurance and Liability Crises
Savings and Loans
            Federal Sentencing Guidelines
       • Set by the United States Sentencing Commission
       • To provide uniformity in dealing with federal
         crimes
       • Chapter eight added in 1991 deals with federal
         sentencing guidelines for organizations (FSGO)
       • Sentencing includes fines and organizational
         probation



THE FEDERAL SENTENCING GUIDELINES FOR ORGANIZATIONS , Rexroad, W. Max, Bishop, Toby J. F., Ostrosky, Joyce A., Leinicke,
                                               Linda M.,
            Federal Sentencing Guidelines
     • Holds companies liable for criminal acts of their
       employees and agents
     • Business crimes covered by FSGO
           –   fraud and deceit
           –    bribery
           –   bid-rigging, price-fixing, or market collusion
           –   money laundering
           –    tax evasion; evading import duties or restrictions
           –    embezzlement, larceny, and other forms of theft
           –   criminal infringement of a copyright or trademark
           –   insider trading.
THE FEDERAL SENTENCING GUIDELINES FOR ORGANIZATIONS , Rexroad, W. Max, Bishop, Toby J. F., Ostrosky, Joyce A., Leinicke,
                                               Linda M.,
            Federal Sentencing Guidelines
       • The sentencing places affirmative
         responsibility on the board of directors
       • Companies can minimize any potential
         sentencing by implementing compliance
         programs



THE FEDERAL SENTENCING GUIDELINES FOR ORGANIZATIONS , Rexroad, W. Max, Bishop, Toby J. F., Ostrosky, Joyce A., Leinicke,
                                               Linda M.,
Mutual Funds Regulating and
         Reporting