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Lessons Learned from the Frauds of 2011

Several cases that were brought up or resolved in the past year should serve as warnings for companies as they continually improve their compliance programs.
Ken Springer, CFO.com | US
December 7, 2011

Let's leave wrap-ups of the most joyous highlights of 2011 to other publications such as lifestyle and entertainment magazines. I'm an expert in the field of business investigations, so my end-of-year recap will focus on frauds and wrongdoings, and how similar problems can be prevented in 2012.

The biggest scandal of 2011 was the conviction of Raj Rajaratnam, the insider-trading kingpin and Galleon Group founder who was found guilty of numerous counts of securities fraud and sentenced to serve 11 years in prison. The key takeaway from this case could be that, for the first time ever in a white-collar case, the government used wiretaps to ensnare Rajaratnam and his co-conspirators who have pleaded guilty to charges related to insider trading. The message was received loud and clear: the government will be taking fraud quite seriously. Considering the Securities and Exchange Commission filed 57 insider-trading cases in its 2011 fiscal year, this will likely be an issue regulators will revisit.

For the accounting world, big attention was paid to Chinese companies using reverse mergers of shell companies to list on U.S. shores. Halfway through the year, the SEC announced it was investigating more than a dozen auditors who conducted financial evaluations of these Chinese firms. Most notably, Longtop Financial Technologies saw its accounting firm, Deloitte Touche Tohmatsu, walk out the door when Deloitte realized it had been snowed or blocked by Longtop's management team for information. The company's CFO, Derek Palaschuk, stepped down at the same time.

Beyond and including business done in China, the U.S. Department of Justice continued its crackdown on violators of the Foreign Corrupt Practices Act (FCPA). Within the past few months, we have seen FCPA inquiries (and some violations and related fines) brought against numerous multinational companies, such as Diageo plc, Tyson Foods, Alcoa, Johnson & Johnson, and, most recently, Avon and Pfizer. These ramped-up efforts by the government to enforce the FCPA may be getting more powerful; in May, Lindsey Manufacturing was the first company to be tried and found guilty of FCPA violations. In the past, FCPA violators have usually been handed settlement agreements and sizable monetary fines. That practice may continue in the near term, considering that Lindsey's conviction, as well as the convictions of two executives, was overturned last week.

To protect the integrity of their position, CFOs must make sure their firms are operating ethically. For your 2012 resolutions, consider the following practices to avoid vulnerability to similar situations that got headline attention in 2011.

1. Get familiar. Multinational companies and companies thinking about overseas expansion should have copious reviews of the books of all their branches. Familiarize yourself with as many employees, vendors, and third-party agents as possible, and make sure any business relationship is not dependent upon bribes or gifts. If a recently acquired business has relied on the old-school method of pay-to-play with authorities, educate the employees and these associates on the new model of success, and enforce the rules of the FCPA and U.K. Bribery Act to avoid fines and reputational embarrassment.

2. Cozy up to compliance. Work closely with compliance officers. If they notice any suspicious behavior or activity (à la insider trades, Ponzi schemes, and so on), assist in identifying the problem and catching it before it unravels.

3. Verify backgrounds. When hiring new employees, especially C-suite executives and board members, conduct thorough background checks. While this is not a new lesson, it bears repeating. This process will alert you to an individual's involvement in any previous lawsuits (by, or against, former employers, shareholders, investors, or others), criminal matters, disciplinary actions, controversial media attention, or other issues that would pose a conflict of interest to the successes of your firm.

4. Give employees ways to give tips. If you don't have one already, consider installing an ethics hotline for employees, officers, vendors, and others to anonymously report any instances of wrongdoing, fraud, or inappropriate behavior. This will give you a set of eyes on the inside and allow you to react to the situation before it spirals.

5. If you hear a rumor, hunt it down. Other high-profile scandals of the past year — including the News Corp. hacking scandal and the Penn State debacle — demonstrate that rumors or suggestions of impropriety need to be addressed and resolved, not ignored.

Ken Springer is president and founder of Corporate Resolutions Inc., a business-investigations firm that conducts background checks and business intelligence and offers a suite of other specialized investigative services. Springer is a certified fraud examiner, a former special agent of the FBI, and co-author of Digging for Disclosure: Tactics for Protecting Your Firm's Assets from Swindlers, Scammers and Imposters (FT Press, 2011).




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