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Fraud Examiners Doubt SOX Will Change Culture

Nov. 10, 2005 (SmartPros) Most fraud examiners view Sarbanes-Oxley as an effective tool in fraud identification, though few think it will change the culture of business leaders, according to a corporate fraud report released by Oversight Systems.

The survey results of the report, "2005 Oversight Systems Report on Corporate Fraud," available as a free download, 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.

A total of 208 certified fraud examiners participated in this survey, conducted at the Association of Certified Fraud Examiners' 16th Annual Fraud Conference and Exhibition.

"This report is full of positive news but foreshadows a real need for continued vigilance among executives toward institutional 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 noncash 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."

When asked to identify the measure most effective in preventing or deterring institutional fraud, the respondents said:

Strong tone from the top


Visible prosecution


Internal controls


Technology-enabled monitoring


Manual quarterly audits


Government regulation


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) explained 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.

2005 SmartPros Ltd. All rights reserved.

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