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Aug 15, 2023 111 likes •405 views

Who are you looking at? P R O F E S S O R K A R E N V A N P E U R S E M P H D ( W A I K A T O ) , C A ( N Z ) , C P A ( U . S . ) Department of Accounting, University of Waikato Financial Statement Fraud: Governing Bodies and the

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P R O F E S S O R K A R E N V A N P E U R S E M P H D ( W A I K A T O ) , C A ( N Z ) , C P A ( U . S . )

Who are you looking at?

Department of Accounting, University of Waikato

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CAN A COR P OR ATE GOVE R N I N G B OD Y TAKE ACTI ON S TH AT M I GH T GI VE TH E M A B E TTE R CH AN CE OF P R E VE N TI N G M ATE R I AL F I N AN CI AL F R AU D ?

Financial Statement Fraud: Governing Bodies and the Auditors

Department of Accounting, University of Waikato

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What are their responsibilities?

 Governing bodies  Auditors

Department of Accounting, University of Waikato

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According to New Zealand Statute

Department of Accounting, University of Waikato

... oversight, providing direction, conducting practices with due care, acting in ‘good faith and in the best interests of the company” (NZ Companies Act, 1993, S131)

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According to New Zealand Listing Regulations

Department of Accounting, University of Waikato

 ‘keep the market ... informed on matters

that may affect the price of their securities’

 restricts insider conduct  But may rely on ‘professional or expert

advice given’ (CA, S138)

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In comparison to U.S. Listings Regulation

Department of Accounting, University of Waikato

An emphasis on within-board skills and sub- committee involvement

 Foreign Corrupt Practices Act 1977  Sarbanes-Oxley (2002) : Audit Committee

requirements

 Exchange provisions and requirements

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The accounting professions and standards setting bodies may disagree

Department of Accounting, University of Waikato

.... the accounting profession and standard setters express interest in ensuring the governing body and management have a strong role in fraud prevention

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International Standard of Auditing

Department of Accounting, University of Waikato

The prim ary responsibility for the prevention and detection of fraud rests w ith both those charged w ith governance... and m anagem ent (ISA (NZ) 240, para 4)

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... and

Department of Accounting, University of Waikato

It is im portant that m anagem ent... governance, place a strong em phasis on fraud prevention... a com m itm ent to creating a culture of honesty and ethical behaviour .... ... includes considering the potential for override

f controls.. [and] earnings m anagem ent (p4)

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.... And therefore

Department of Accounting, University of Waikato

... identifying fraud w ithin the

rganisation is view ed by the

accounting profession as an im portant role of the governing body

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The auditor’s role ...

...is to provide reasonable assurance that the financial statements are ‘True and fair’ and that they are free from material misstatement (ISA (NZ) 240)

Department of Accounting, University of Waikato

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The auditor shall identify and assess the risks of m aterial m isstatem ent due to fraud...(ISA (NZ) 240k p25)

Department of Accounting, University of Waikato

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That is, and according to the accounting profession, the role of the auditor is to

Department of Accounting, University of Waikato

... evaluate fraud potential .... follow up suspicions of fraud .... communicate issues appropriately

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... A view reluctantly (?) formed over time

Department of Accounting, University of Waikato

1997: no requirem ent to look other than to ‘take into consideration risk...’, low er level of assurance on fraud 2003: Follow up suspicions em erging from ‘norm al’ audit evidence gathering procedures 2007: Plan, consider risks, discuss, design tests in response to know n risks....

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This is where the courts step in..

Department of Accounting, University of Waikato

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How can a board structure themselves as to best prevent corporate financial fraud?

Department of Accounting, University of Waikato

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N I CO L A B U R K E , K A R E N V A N P E U R S E M , I A N E G G L E T O N

Department of Accounting, University of Waikato

Relationships between Corporate Governance and Fraud in U.S. Listed Companies

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Governance ‘characteristics’ said to contribute toward corporate fraud protection...

Department of Accounting, University of Waikato

 Independence  Expertise  Communication practices  Their own relationships with the company

By

 Board sub-committees  Board member composition  Board communication practices  Shareholder representative characteristics

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What was examined

Department of Accounting, University of Waikato

 519 U.S. Fraud-committing companies

(2004-2006)

 Data from SEC’s Accounting Enforcement

Releases, official sites, corporate reports

 Matched pairs reduces to refined sample

f 152 fraud and no-fraud companies (76

each)

 Regression to identify governance

characteristics associated with fraud

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Board Sub-Committee Characteristics and Communication Practices

Department of Accounting, University of Waikato

Audit committee member

 numbers  Independence  financial expertise  meeting frequency  average tenure  (other) directorships held

Nominating Committee

 Existence  Numbers

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Board member composition characteristics

Department of Accounting, University of Waikato

 Number of directors  Number of independent directors  Whether the chief executive officer is also a

director

 Ownership share by inside (and outside)

directors

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Shareholder representative characteristics

Department of Accounting, University of Waikato

 Outside blockholder ownership numbers

and proportion * Auditor

 Tenure  International firm (or not)

* External to Board control

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Tests applied:

Department of Accounting, University of Waikato

 Companies matched by industry, size, leverage, age,

growth...

 Univariate matched t-tests  Validating tests  Logistic regression

What governance characteristics ‘accom pany’ the presence of fraud in these com panies?

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Findings

Department of Accounting, University of Waikato

5 characteristics significantly associated with fraudulent corporate financial statements include:

1. Number of directorships held by (AC) directors

2. Smaller proportion of independent directors

3. Companies without a Nominating Committee

4. CEO who is also Chairman That is.... Independence issues

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Surprise finding #5

Department of Accounting, University of Waikato

The only other significant correlation w as betw een the percentage of com pany ow nership held by outside blockholders and the presence of corporate financial fraud...

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Findings as to the auditor?

Department of Accounting, University of Waikato

Neither the size of the firm nor their tenure proved to be significant to fraud practice.

Limitation: We only examine select measures of auditor independence, other auditor independence studies may identify further issues

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Implications

Department of Accounting, University of Waikato

Would be risky for the governing board to rely on the auditor alone to pick up instances of corporate fraud. Ambiguous guidance makes it difficult to anticipate responsibility, and the governing board may be in a stronger position to structure the company to help prevent corporate financial fraud

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That is, w hile the auditors have a grow ing responsibility to ‘look’ for m aterial fraud, our findings suggest that potential for fraud prevention m ay lie in the structure (and independence) of the board.

Department of Accounting, University of Waikato

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Thank you!

Department of Accounting, University of Waikato