Some General Issues of Concern and Recommendations"The main pillar of our capitalistic free market economic system, which is a cornerstone of democracy, is the integrity of financial information. Without reliable financial information, capitalism cannot and will not survive. However, the integrity of financial information can only be achieved through building blocks such as sound internal controls and independently verifiable financial information. The well educated, skilled, and experienced accountant is the first line of defense for the capitalist system." --- May 10, 2006: Sam E. Antar comments submitted to the Securities and Exchange Commission and the Public Company Accounting Oversight Board for its Conference on Sarbanes Oxley and Internal Controls
from a Former White Collar Criminal with a CPA Background
from a Former White Collar Criminal with a CPA Background
We require a comprehensive approach by law enforcement, the accounting profession, the education establishment, government, and private industry to effectively deal with the issue of white collar crime. To effectively combat white collar crime we require:
I believe that reforms embodied under Sarbanes-Oxley and other reforms relating to Wall Street do not go far enough. Even with any reforms, Congress cannot legislate competence on the part of management, external auditors, outside directors, audit committees, and others.
There is a movement today to weaken Sarbanes-Oxley. One area relates to the reporting of internal controls. As a "former criminal," I can say that the first line of defense against financial fraud is strong internal controls. I would recommend fighting any weakening of such measures to reduce monitoring of internal controls by external independent auditors who are experienced, skilled, and competent.
Recently the S.E.C. exempted companies with market capitalizations under $125 million from certain provisions of Sarbanes-Oxley. Crazy Eddie had a market capitalization of $40 million when it went public.
Critics complain about the increased costs associated with implementing Sarbanes Oxley. The plain truth is that before SOX audit fees were preset at extra "low ball" or low profit margin rates in efforts of drawing other business from audits clients by accounting firms. In addition the cost of frauds is now approximately 10% of the average revenue of major accounting firms.
A proper review of internal controls has always part of audit theory and practice. SOX has only increased adherence to the ultimate goals of an adequate audit. You cannot conduct a credible audit on a company that does not have a good system of internal controls in place.
For example, in 1986, Antar family members took $2 million of previously skimmed funds (before Crazy Eddie went public) from Crazy Eddie and re-deposited the funds back into the company bank accounts. Crazy Eddie's comparable store sales and profits were overstated in 1986 from this particular fraudulent action. The auditors recognizing Crazy Eddie’s lack of internal controls, reviewed all bank reconciliations to verify cash balances.
My point is that internal controls and good auditing are not mutually exclusive as some of the critics ,who would have Sarbanes-Oxley relaxed for small companies, would have you believe. The cash was there, but how the cash got there was never examined. The auditors failed to detect any fraud.
Eddie Antar and Sam M. Antar sold over $30 million in Crazy Eddie stock after the comparable store sales report was issued and the company sold $72 million in convertible debentures after the earnings report was issued. For additional information, please read the Crazy Eddie Fraud page in this web site.
Other critics complain that permitting accounting firms to provide consulting services to the companies they audit increases their knowledge of the client and reduces errors. From my experience at Crazy Eddie, I can say that point is absolutely untrue. Our auditors had major consulting agreements for work that exceeded the audit billing by over eight times. The audit firm at one point in time had staff at Crazy Eddie year round doing consulting work.
Many others have argued that Sarbanes-Oxley is causing many companies to seek capital in other markets not regulated by its requirements. I believe that we should compete with those capital markets on the greater transparency and quality of investor protections our system offers.
Others have said that there will be more frauds to come despite the recent reforms under Sarbanes Oxley and other changes. I agree. However, to prevent such frauds, as enumerated on this web site, we need to further improve the effectiveness of Sarbanes Oxley and new accounting and auditing regulations and not weaken them. Now is not the time to retreat from progress.
Long Prison Sentences is not a Substitute for Strong Internal Controls in Preventing Fraud
Many critics of Sarbanes-Oxley have said that strong prison sentences for white collar criminals would be more effective in deterring white collar crime. I believe that such a policy would result in leaving us in a position of uncovering corporate crime only after it happens and the end result would be more of the same - the damage has already been done and billions of dollars lost.
We cannot prevent white collar crime by solely sentencing criminals to long prison sentences. You may ask any prison inmate and recently convicted corporate criminal if they ever planned on going to jail. While I support strong prison sentences for white collar crime such a policy should be used as society's means of imposing responsibility on such criminals and not be considered a primary means of fraud prevention.
I doubt that almost every criminal upon learning about the recent convictions and long prison sentences imposed on recent corporate felons will "wake up the next morning and begin life again reborn." No significant amounts of crimes contemplated and no crimes in progress are stopped by criminals being informed of very long prison sentences given to other criminals. You may ask any criminologist about the same issues.
The best tool to combat white collar crime and increase the integrity of financial information is for companies to have strong internal controls which are reviewed by external independent auditors who are properly educated, skilled, trained and experienced. Strong internal controls create barriers to crime and result in the increased integrity of financial information.
We require effective monitoring of internal controls required by Sarbanes-Oxley. However, in order for SOX to be effective we must solve the education problem in the accounting profession.
I believe that most critics of Sarbanes-Oxley are well intentioned persons of high integrity. As such, I respectfully believe such criticism is misguided as they do not see its strengths from the perspective I have to offer as a former criminal who has corrupted the trust placed upon me as an officer and director of a public corporation.
For additional information, please read my submission of comments to the SEC and PCAOB for their May 10, 2006 Roundtable on Sarbanes-Oxley on the Sarbanes-Oxley page in this web site.
Accounting Education and the Accounting Profession
While we cannot legislate competence, it can be learned. Accounting students are not receiving the proper amount of fraud training and education they require to prepare themselves for today's audit environment. Most accounting students never take a separate college level course on fraud or internal controls. I can unequivocally say that the accounting profession is not adequately trained to deal with the likes of fraudsters of my former caliber.
The current inadequate amount of fraud training provided to our future CPAs must not be allowed to continue and must be immediately expanded as a matter of public policy. It is vital for their education, and it is vital for the integrity of capitalism. Without adequate fraud training, future generations of criminals similar to my past caliber will continue to have an "upper hand" in the escalating carnage caused by their economic crimes.
In addition, accounting students must take separate college level courses in criminology, securities laws, internal controls, insurance/risk management, and other vital "real experience" areas for the field work they will encounter on audits. In-depth, detailed courses in audit techniques which include investigative techniques such as proper questioning of management are seriously lacking at most colleges.
In fact, there are still many important subject areas covered in CPA review (cram) courses and on the CPA exams that are never taught to accounting students in college. For example courses such as securities law are almost never taught to accounting students in college. Such courses must be part of the basic 150 credit curriculum taught to accounting students and not taught as electives.
Even today with the increased emphasis required by the accounting profession to focus on areas of internal controls under Sarbanes-Oxley and SAS No. 99 significantly most accounting students today never take a single specific course on internal controls, white collar fraud, criminology, or securities law.
Many complaints related to reviews of internal controls under SOX by companies are due to the lack of deep understanding in internal controls by auditors. Many auditors are mostly filling out questionnaires and checking boxes in forms in their reviews of internal controls. Internal controls evaluations cannot be handled through a "bean counter" approach.
The very fact that most accounting students never take a separate college level course in specifically in accounting fraud, criminology, securities law, and internal controls in today's environment is equivalent to sending troops to battle without arms and body amour.
Sarbanes-Oxley and other reforms cannot be fully effective until the accounting profession has the requisite education, training, experience, and skills to implement them.
In short, the whole accounting/audit curriculum requires a new overhaul to the real world. Even if it requires a law school type structure or a 2 or 3 year postgraduate education to enter the profession, so be it.
The American Institute of Certified Public Accountants (AICPA) only recommends and does not require CPA to take 10% of their annual Professional Continuing Professional Education Credit hours in fraud. Therefore, where most states require CPAs to take 40 hours per year of Continuing Education, only 4 hours per year is "recommended" to be taken in fraud even if the CPAs spend most of their work in this area.
The education required for this profession must evolve to keep up with the changing requirements of the financial world or it will continue to lose credibility and battles with criminals.
If the profession does not adjust to the changing demands placed upon it by the changing environment it faces by properly educating its entry level accountants, it risks being deemed another licensed trade instead of a profession.
The profession and licensing authorities are not adequately flushing out accountants who perform malpractice. Many accountants who, as partners and managers, presided over audits that went bad, have never been disciplined and have even gone on to higher positions in the profession. This cannot be a profession where incompetence rises to the top.
The Securities and Exchange Commission should require minimum education, skills, and training standards for accountants/CPAs that participate in public company audits. Such a requirement would push the profession and the educational community to wake up and adapt to the changing reality of the needs of professionals involved in audits concerning their education, training, experience, and overall competence.
For additional information, please read the Accounting Education page in this web site.
Today's overall audit model must be rethought in terms of the rapid growth of technologies that can circumvent internal controls without detection. The "year-end audit model" is in many situations obsolete and must be replaced by continuous year-round audits.
The CEO and CFO should not be the only persons in a company certifying financial information. Accounting and other corporate personnel throughout the entire accounting, financial, and internal control structure should sign off individually to the auditors about any information they control or represent to them. There must be full direct accountability throughout the corporate accounting structure for the information presented to auditors.
Firms auditing a client should provide no other services to that client without exception during the audit relationship and for a certain period even after the audit relationship terminates.
When an audit relationship terminates the reasons must be disclosed publicly and to the new auditors.
The SEC should periodically, independently review audit work papers for public corporations similar to the way the IRS reviews tax returns.
Stop Board of Director "Window Dressing"
We require people with the intelligence, background, and experience specific to the Board’s they serve on and the functions they are responsible for. We do not need well meaning, intelligent people, who in many cases make ineffective Board members serving in positions they are not suited for.
The time for “window dressing” must end.
The external auditors are supposed to be monitored by the Audit Committee of the Board of Directors. In practice such Audit Committees are no better prepared (if not worse) to handle their responsibilities than the external auditors they oversee.
Many Audit Committee members receive compensation in stock options or own company stock of the Board they serve on which provides a disincentive to effective independent oversight and can affect their objectivity and professional skepticism.
In addition, many members of Audit Committees have no formal accounting, auditing, internal control, and fraud education or backgrounds. Their requisite education, skills, training, and experience required to fulfill their responsibilities are lacking.
For additional information, please read my blog post entitled, "Audit Committees and External Auditors: A Perfect Storm for Disaster."
The Public Company Accounting Oversight Board (PCAOB)
The Public Company Accounting Oversight Board (PCAOB) is wrong in not making public quality-control problems and structural deficiencies found during its inspections of audits of accounting firms. The reasoning that making such information public only if they are not fixed within twelve months creates any incentive for such firms to remedy such problems is simply flawed.
The inspection process has found far too many problems in the quality of audits conducted by accounting firms. Many of these problems could be alleviated by better education and training that would increase competency in the profession. However, education and training needs to be focused in areas effecting risks affecting the public and the profession today such as fraud, interviewing skills, internal controls, etc.
For additional information, please read my blog post entitled, "Open Letter to the Public Company Accounting Oversight Board."
Stock Options (Who Should Not Get Them)
Corporate directors, financial, and accounting personnel should not be compensated with stock options or any other compensation that would give them a direct beneficial interest from "earnings management." While there is plenty of debate about the proper accounting of stock options, there is little discussion as to the proper awarding of them. The awarding of stock options in such an unwise manner can induce otherwise honest people in key areas, like accounting and internal audit, to commit white collar fraud.
Reliance on Management to Review and Report on Internal Controls
There have been recommendations to reform Sarbanes-Oxley to increase auditor reliance on management internal control representations and/or have management report on such controls. However, the people administering the internal controls structure within companies do not have enough independence for such reliance by auditors since their compensation and job position is determined by management.
Instead there should be greater accountability by internal accountants and internal auditors for external audits. All work that they perform should be certified to the auditors as truthful and accurate to the best of their knowledge and understanding.
We must require professional accredited, licensed, trained, skilled, and adequately educated internal auditors. While their work is not a substitute for the external audit function, as licensed professionals their work can be invaluable in preventing fraud by increasing internal controls by the nature of their knowledge on their company. We need to strengthen this profession by requiring the licensing of internal auditors similar to the way our States license Certified Public Accountants. By requiring licensing of internal auditors they will have increased independence, responsibility, and accountability for the work they perform.
The internal auditors should report directly to the Audit Committee of the Board of directors. The CEO and CFO should have no authority over them.
For additional information, please read my blog post entitled, "How Should Internal Auditors Report to? How This Very Important Function can be More Effective."
Reform the Private Securities Litigation Act (1995)
This legislation must be reformed. It has shifted the power of selection of the lead counsel in class action litigation to the large institutional investors. Many of these institutional investors are large public employee pension funds. The Trustees to the funds are either elected government officials or appointed by elected government officials.
Some of the class action law firms have contributed huge sums of money directly and indirectly benefiting the politicians who control the public employee pension funds. Such political contributions create a conflict of interest when these funds are involved in the selection of lead counsel for class action law suits. This "pay to play" practice must stop.
In addition the Act has caused a concentration of power in the class action bar and has eliminated competition among rival qualified law firms seeking to protect investor interests at the least cost.
For additional information, please read my blog post entitled, "The Private Securities Litigation Reform Act of 1995: The Unintended Consequence of 'Pay to Play.'"
Wall Street/Investment Banking
We should be concerned about the integrity, independence, and quality of internally generated research reports issued by Wall Street brokerage firms. We should also be concerned about the potential for opinion shopping for the outside research reports used in conjunction with IPOs. Analysts who write such reports should disclose what actual experience they have working in the specific area of the industry they are reporting on. Analysts must disclose their track records based on certain standards in easily understandable terms and uniform reporting criteria.
Investment banking firms, brokerages, and banks should not issue research reports on companies. Such reports should be issued by completely independent firms subject to rigorous professional standards that are strictly enforced. When I dealt with Wall Street, the so-called "Chinese Walls" were fictional. We cannot realistically expect to have investment bankers issue objective research reports on companies which they have a relationship with. In too many instances such reports have become marketing tools.
Fairness opinions should come from completely independent entities.
Law Enforcement Resources
Top-notch, experienced FBI agents are leaving the Bureau for higher paying, private industry jobs as soon as they qualify for retirement causing a brain drain within the FBI. As white collar crime is becoming increasingly complex, our government would be well advised to pay these agents fair market value.
The FBI, the Securities and Exchange Commission, and other federal agencies responsible for white collar crime do not have adequate legal, technological, and personnel resources to meet their responsibilities. Compensation levels do not compete with the private sector causing inadequate human resources.
Other Concerns and a Prediction
In 2005, when I started this website, I made the following predication:
With today's computer automation and the ability to move money across borders in seconds, and the fact that banks and financial institutions handle gross dollar value transactions on a single day many times their net worth, are today's controls and audit structure keeping up with the times? In addition, with these companies merging, there is often a period of flux where the various computer systems of each entity have not been made fully compatible with each other.
I believe that within the next 5 years, there will be a $30 billion massive financial fraud that will shake the foundations of our financial system.
Unfortunately, almost 20 years after "Crazy Eddie," I still see the same mistakes made over and over again!
Sam E. Antar.