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financial statement
fraud
A review of SEC enforcement releases,
2000-2006
Deloitte Forensic Center
June 2007
Deloitte Forensic Center
The Deloitte Forensic Center (DFC) is a think tank aimed at exploring new
approaches for mitigating the costs, risks and effects of fraud, corruption, and
other issues facing the global business community.
Unique to the marketplace, the DFC aims to advance the state of thinking in
areas such as fraud and corruption by exploring issues from the perspective
of forensic accountants, corporate leaders, and other professionals involved in
forensic matters. The DFC will strive to provide multidisciplinary analyses that
companies and official organizations will find practical and helpful.
But just what types of fraud is the SEC describing in its enforcement actions?
In what industries are frauds most prevalent? Have fraud types and industry
patterns changed over time?
To address these questions, and to learn how fraud schemes have evolved
since the Committee of Sponsoring Organizations of the Treadway Commission
produced its last comprehensive report on fraud in 1999, the Deloitte Forensic
Center has, in 2007, completed an analysis of hundreds of SEC enforcement
releases issued from 2000 through 2006.
This booklet provides snapshots of the data collected from the SEC’s
enforcement releases relating to frauds allegedly committed by companies,
officers, and employees. It reports the number of frauds by industry and type and
comments on the trends emerging in this millennium.
The Forensic Center will, in the future, update the study annually to provide
longer views of trends, and to broaden coverage by including restatements and
securities litigation in the analysis.
The findings may have significance for the global effort to develop more robust
business processes for managing the risk of fraud. The efficacy of such processes
will depend on knowing the fraud schemes typically committed and industry-by-
industry differences in those schemes.
Overview of Methodology
The SEC reports on its administrative enforcement actions through its Accounting
and Auditing Enforcement Releases (AAERs). The Deloitte Forensic Center’s staff
reviewed slightly more than 1300 AAERs that the SEC released from January
2000 through December 2006. For our analysis, we considered, where possible
but not in all cases, final AAERs that addressed financial statement fraud,
excluding releases that dealt with insider trading; actions against vendors, or
auditors. This filtering process resulted in the 344 AAERs that are the subject of
this study.
We classified the frauds identified into 12 categories based on how the fraud
was committed, and within them 57 sub-categories. AAERs typically describe
more than one fraud scheme active in a company in a given time period.
The 12 main categories are:
• Aiding & Abetting • Manipulation of A/R
• Asset Misappropriation • Manipulation of Assets
• Bribery & Kickbacks • Manipulation of Expenses
• Goodwill • Manipulation of Liabilities
• Improper Disclosures • Manipulation of Reserves
• Investments • Revenue Recognition
For each AAER, we also captured the date of the final release and, importantly,
the earliest date of evidence of each scheme.
- -1
How many financial statement fraud
AAERs has the SEC issued?
77
58
55
50
44
35
25
• From 2000 through 2006, the SEC issued 344 financial statement fraud
AAERs relating to its registrants.
• The flow hit its peak in 2003 at 77 releases.
• In 2002, the U.S. Government dedicated additional funding to the SEC and
charged it with increasing its scrutiny of financial statement fraud within
public companies.
• The SEC doubled the number of financial statement fraud AAERs from 2001
to 2002, and issued another 42% more in 2003. The annual rate has since
fallen to about 50 AAERs per year.
2
- -
What is the average time lag, in years, between
the initial fraud and the SEC
enforcement release?
5.6
5.0 5.0
4.7
4.2 4.3
4.1
252
183
98
74
83
64
47 47
25
22
13
10 9
3
1 2 3 4 5 6 7 8 9 10+
• This chart plots the number of companies that had one or more fraud
schemes identified in the SEC releases.
• Most companies (82%) had from one to five fraud schemes — but over 20
had 10 or more.
• Four of the 22 companies that had 10 or more fraud schemes under
investigation had over 20 fraud schemes.
- -5
What fraud schemes are most common?
Manipulation of
Reserves 7% Revenue
Recognition 41%
Manipulation of
Liabilities 7%
Manipulation of
Assets 8%
Manipulation of
Expenses 11% Improper Disclosures 12%
• Revenue recognition fraud schemes are by far the most prevalent, at 41% of
the total. This finding is consistent with earlier studies and reinforces the need
for focus on this area.
• Other fraud schemes involving manipulation of various financial statement
items account for more than a third of all fraud schemes identified.
6
- -
• The ‘top’ 6 fraud schemes, depicted above account for 70% of all revenue
recognition schemes identified.
• Recording fictional revenue is the most common type of revenue-recognition
fraud.
• Next was recognizing inappropriate revenue from swaps, “round-tripping,” or
barter arrangements.
• The remaining four subtypes were fairly evenly distributed.
7
- -
How are the fraud schemes distributed
over industries?
480
371
129
95
77
58
9 5 16
TMT
Manufacturing
Energy & Resources
Financial Services
Real Estate
Public Sector
• The 1,240 fraud schemes identified in the 344 AAERs in this study break
down by industry very unevenly.
• With 480 fraud schemes, the Technology, Media, & Telecommunications
industry was responsible for 39% of identified schemes.
• Consumer Business, with 371 fraud schemes, was second, at 30% of
identified schemes.
• Manufacturing companies had the third largest group of fraud schemes,
129 in total, amounting to 10% of the total.
- - 8
In the “top” 3 industries, how are the schemes
spread across sub-industries?
TMT
122
88 83
68
37
14 18 20
9 1
Aerospace Defense
Automotive
Health Plans
Consumer Products
Consumer Services
Telecommunications
Technology
Industrial Products
Process Industries
Manufacturing &
Entertainment
Distribution
Diversified
Leisure
Manipulation of Assests
Manipulation of Expenses
100
Manipulation of Liabilities
Manipulation of Reserves
80 Revenue Recognition
60
40
20
0
1996 1997 1998 1999 2000 2001
Manipulation of Assests
Manipulation of Expenses
100
Manipulation of Liabilities
Manipulation of Reserves
80 Revenue Recognition
60
40
20
0
2000 2001 2002 2003 2004 2005 2006
• These charts show the trends in the six most prevalent fraud schemes
measured first by the scheme initiation date and then by the date of the final
enforcement release.
• Revenue recognition frauds account for most of the change in fraud types
over time when measured by either method.
• For example, revenue recognition fraud increased almost 350% when
measured by the scheme date, jumping from 25 identified incidents in 1996
to 111 in 2000.
- 10a-
What are the fraud trends within the
Technology, Media, & Telecommunication
industry?
Chart 10a1: Incidence of top 6 fraud types in TMT industry,
by scheme date
70 Improper Disclosures
Manipulation of Assests
60
Manipulation of Expenses
Manipulation of Liabilities
50
Manipulation of Reserves
40 Revenue Recognition
30
20
10
0
1996 1997 1998 1999 2000 2001
Manipulation of Assests
60 Manipulation of Expenses
Manipulation of Liabilities
50 Manipulation of Reserves
Revenue Recognition
40
30
20
10
0
2000 2001 2002 2003 2004 2005 2006
Improper Disclosures
30 Manipulation of Assests
Manipulation of Expenses
Manipulation of Liabilities
25
Manipulation of Reserves
Revenue Recognition
20
15
10
0
1996 1997 1998 1999 2000 2001
Manipulation of Assests
30 Manipulation of Expenses
Manipulation of Liabilities
25 Manipulation of Reserves
Revenue Recognition
20
15
10
0
2000 2001 2002 2003 2004 2005 2006
Improper Disclosures
20 Manipulation of Assests
Manipulation of Expenses
Manipulation of Liabilities
15
Manipulation of Reserves
Revenue Recognition
10
0
1996 1997 1998 1999 2000 2001
20 Manipulation of Expenses
Manipulation of Liabilities
Manipulation of Reserves
15 Revenue Recognition
10
0
2000 2001 2002 2003 2004 2005 2006
• Revenue recognition fraud dominates the earlier years studied, whether by scheme
date or AAER release date, with a large surge in cases arising from activity in 1997
and 1998.
• The surge in revenue recognition frauds abates earlier in the manufacturing
industry than TMT or consumer business, with such schemes dropping substantially
in 1999.
• From 1999 onward, fraud schemes in manufacturing were diverse with no single
scheme dominating.
- Notes -
- Notes -
For copies of this booklet or of the full study when
released, please contact the Deloitte Forensic Center at
www.deloitte.com/us/forensiccenter or dfc@deloitte.com