Tuesday, July 22, 2014

Do Nu Skin Inventory Red Flags Spell Trouble Ahead?

Last Friday morning, a comment posted on Twitter by Marc Cohodes about Nu Skin Enterprises (NYSE: NUS), a Utah based multi-level marketing company, caught my curiosity. Cohodes is a legendary short-seller with an excellent track record and looks for "fads, frauds, and failures" involving public companies. He wrote, "The Clown who runs NUS tried to squeeze shorts. Screw him! He will get what's coming to him in spades one day. Too much Inventory is an issue." Afterwards, I decided to take a close look at Nu Skin's financial reports. So far, my first issue is that management's explanation for its massive increase in inventory levels does not square against its own historical numbers, guidance it gave to investors, and analysts' consensus estimates. In addition, Nu Skin may be have to take significant margin reductions to unload its excess inventory and possibly have to recognize a material impairment charge against inventory in a future period.

Background

Generally, if a company is efficient at managing its inventory levels, its inventory and cost of goods sold should grow in tandem over time. If a company becomes more efficient at managing its inventory levels, its cost of goods sold will grow faster than inventory reflecting shorter periods of time to turnover its inventory into revenues. However, over the last seven quarters, Nu Skin's reported inventory levels grew significantly faster than its growth in cost of goods sold resulting in longer periods of time to turn its inventory into sales.

A more troubling issue is that Nu Skin's reported revenues exceeded its own maximum revenue projections while its inventory turnover decreased for each of the last seven quarters. In two of those seven quarters, Nu Skin beat its maximum revenue guidance by over $90 million. Generally, it provided revenue guidance for the current quarter approximately 4 to 5 weeks into same quarter. Therefore, Nu Skin already possessed several weeks of sales data before it provided revenue guidance for the entire 13 week quarterly period. Since Nu Skin's reported revenues exceeded its most optimistic forecasts within a relatively short period of time, its inventory turnover should have increased because it should have ended the period with fewer inventories on hand than it had anticipated. However, an analysis of Nu Skin's numbers indicates that it is taking progressively longer periods of time to turn its inventory into sales.

Calculations

Days-Sales-in-Inventory (DSI) measures the number of days it takes for a company to turn its inventory into sales. DSI is computed as follows: (Ending inventory/Cost of goods sold during the period) X number of days in period. If the DSI number grows over time it indicates that a company's inventory turnover is decreasing because it is taking longer periods of time for a company to turn its inventory into sales. In general, a growing DSI could indicate one or more of the following potential red flags:
  1. A company is mismanaging its inventory,
  2. A company may be required to reduce gross margins in future periods to sell slow moving products to normalize inventory levels,
  3. A company may be required to take a one-time material impairment charge against earnings in a future period to write-down to the cost of slow moving or obsolete inventory to its lower market value, or
  4. A company is possibly inflating inventory numbers to overstate income by either fabricating inventory numbers or by its failure to write-down inventory to market value.
Click on the image below to enlarge it.



Note: In Q4 2013, Nu Skin reduced its revenues and selling expense going back at least three years to correct an accounting error in classifying certain rebates. According to the company, the reclassification had no effect on gross profit, operating income, net income or comprehensive income, the consolidated balance sheet or cash flow (2013 10-K report page 50). However, the error caused relatively small changes in previously reported revenues. For 2012 and 2013, I used the revised quarterly revenue numbers tucked inside page 68 of its 2013 10-K report. However, Nu Skin did not disclose the effect of the revenue correction on 2011's quarterly numbers. Therefore, I used 2011's quarterly revenue numbers as they were originally reported in filings with the S.E.C. to make comparisons against management's 2011 quarterly revenue guidance. The error had no effect on DSI calculations.

Huge surge in inventories during latest quarter

In the latest quarter ended March 31, 2014 (Q1 2014), Nu Skin's reported revenues exceeded its maximum revenue projection by $1.1 million. Its cost of goods sold increased by 18.6% over the previous year's first quarter (Q1 2013). However, its inventories mushroomed 175.5% to $410.7 million compared to $149.1 million in the same period of the previous year. It took Nu Skin 346.4 days to turn its inventory into sales in Q1 2014 compared to only 149.1 days in Q1 2013, an increase of 132.3% extra days to sell its products. In Q1 2014, DSI was over three times the level it was in Q1 2011.

Rising inventory levels don't square with management's explanation

In its Q1 2014 10-Q report, Nu Skin claimed that, "we built a large amount of inventory during the first quarter for planned product launches in 2014...." However, its disproportionate buildup in inventories does not square against its own historical numbers, guidance it gave to investors, and analysts' consensus projections. DSI has been progressively growing from 2011 levels. (Click on the image below to enlarge it.)


In Q1 2013, Nu Skin turned its inventory into sales 0.6 times (cost of goods sold $90 million/inventory $149.1 million). In Q1 2014, its inventory mushroomed to $410.7 million. To maintain the same rate of inventory turnover in Q1 2014 as it did in Q1 2013, Nu Skin would have needed to sell inventory costing it $247.9 million during Q1 2014 (Q1 2013 inventory turnover 0.6 X Q1 2014 inventory $410.7 million). In Q1 2014, Nu Skin realized revenues on its inventory at a multiple of 6.29 times its cost ($671.1 million revenues/$106.7 million cost of goods sold). Therefore, the approximate amount of revenues required for Nu Skin to maintain its historical level of inventory turnover without eroding gross profit margins was $1.559 billion for that quarter.

However, Nu Skin reported only $671.1 million revenues for Q1 2014. In May 2014, Nu Skin projected only $700 million of revenues for Q2 2014. The current analyst consensus estimate for Q2 2012 is $712.2 million in revenues, Q3 2014 is $858.5 million in revenues, and Q4 2014 is $948.2 million in revenues. The analyst consensus estimate for revenues in full year 2014 is $3.19 billion, slightly higher than revenues of $3.17 billion reported for 2013.

There are plenty of other issues of concern involving Nu Skin's multi-level marketing business model, domestic and foreign regulatory issues, its apparent dislike of whistleblowers and financial disclosures, but it will have to wait for another day. If Nu Skin's management does not act like mature grownups, I might make investigating and reporting about the company my new hobby. Right now, I have my doubts on management's story about its disproportionately huge rise in inventory levels.

Written by:

Sam E. Antar

Disclosure

I am a convicted felon and a former CPA. As the criminal CFO of Crazy Eddie, I helped my cousin Eddie Antar and other members of his family mastermind one of the largest securities frauds uncovered during the 1980's. I committed my crimes in cold-blood for fun and profit, and simply because I could. If it weren't for the heroic efforts of the FBI, SEC, Postal Inspector's Office, US Attorney's Office, and class action plaintiff lawyers who investigated, prosecuted, and sued me, I would still be the criminal CFO of Crazy Eddie today. I do not want or seek forgiveness for my vicious crimes from my victims. My past sins are unforgivable.

There is a saying, "It takes one to know one." I've done professional work for the FBI, IRS, SEC, Justice Department, and other federal and state law enforcement agencies in training them to identify fraud and catch white-collar criminals. Often, I refer cases to them as an independent whistleblower. In addition, I teach white-collar crime classes for various government entities, professional organizations, businesses, and colleges and universities. In addition, I perform forensic accounting services for law firms and other clients.

I do not own any Nu Skin securities long or short and I have no financial relationship with Marc Cohodes, but in 2011 he did name a rooster after me. PricewaterhouseCoopers, Nu Skin's auditors, has sponsored many events where I appeared as a speaker on accounting irregularities, securities fraud, and other white-collar crime.

Wednesday, July 16, 2014

Indicted Former Utah Attorney General Mark Shurtleff was bribed by Overstock.com too

My experience in dealing with former Utah Attorney General Mark Shurtleff goes way back. On October 30, 2007, Overstock.com (NASDAQ: OSTK) paid him $5,000 purportedly as a "campaign contribution." Two weeks later, Overstock.com issued a press release together with a defamatory "open letter" written by Shurtleff making baseless allegations against me. It was no coincidence. Instead it was a blatant effort by its CEO Patrick Byrne to get me to back off from investigating securities law violations and other illegal conduct by him and his company.

It was only a matter of time before the law caught up with Mark Shurtleff's pattern of soliciting and receiving illegal bribes in return for favors. Yesterday, he was arrested by FBI agents and local law enforcement along with another former Utah Attorney General John Swallow. The charges yesterday concern other donors, not Byrne. He may be protected by the statute of limitations, or maybe not. His behavior needs to be examined by the prosecutors in the Shurtleff-Swallow case. What we do know is that Shurtleff, judging from the indictment, was a lot dirtier than even my experience with him indicates.

According to the Salt Lake Tribune:

Shurtleff, who served 12 years as attorney general before making Swallow his handpicked Republican successor, was charged with 10 felony counts, including receiving or soliciting bribes, accepting gifts, tampering with witnesses and evidence, and participating in a pattern of unlawful conduct.

The news was no surprise to me and other long-time critics of Overstock.com. Since 2006, my blog has exposed lies to investors by Patrick Byrne dating back to 1999 and a series of illegal accounting maneuvers used by Overstock.com to materially overstate its earnings and report phony profits when it was losing money. My accounting analysis was proven correct by the company's later revisions of accounting practices and restatements of financial reports. In many cases, those corrections were forced upon it by the Securities and Exchange Commission. Back in October 2007, Patrick Byrne was desperate to discredit me, hoping I would quit investigating his illegal actions. Byrne went as far as to bribing then serving Utah Attorney General Mark Shurtleff to write a defamatory open letter about me that was republished by Overstock.com as part of a press release.


Patrick Byrne "tee'd off" about Utah Attorney General's Office invitation to me

In August 2007, the Deputy Attorney General Richard Hamp invited me to appear at the Utah Attorney General’s 14th Annual White Collar Crime Conference on October 31, 2007. I agreed to do the presentation for no compensation and paid all travel costs out of pocket. Weeks after the presentation, Chief Deputy Attorney General Kirk Torgensen, in a tape recorded telephone conversation, admitted to me that Overstock.com CEO Patrick Byrne was “tee’d off” about my scheduled appearance at the conference and wanted the Utah Attorney General’s office to cancel it. At the time, Hamp did not tell me that Byrne was upset, but he asked me not to mention Overstock.com during my presentation unless someone questioned me about it. I agreed. That was my only agreement with the Utah Attorney General's office.

On October 30, 2007, Overstock.com made a $5,000 “campaign contribution” to Utah Attorney General Mark Shurtleff. However, Overstock.com did not publicly report the contribution until months later. A day later, I spoke at the conference. No one asked me about Overstock.com and I did not mention the company.

Praised for teaching at conference

I thought everything had gone well. I received nothing but praise from the Utah Attorney General’s office. The next day, Deputy Attorney General John Kimble sent me an email saying:

Thank you for giving such a dynamic and thought-provoking talk. I've received nothing but positive feedback. I hope you enjoyed your brief stay in Salt Lake. Also feel free to contact me if there's anything I can do for you in the future.

Andrew Adams from KSL News Radio interviewed Chief Deputy Attorney General Kirk Torgensen and me. He reported:

There was a "rock star" in a room full of "good guys" downtown today. It was a bad guy at the "White Collar Crimes Conference. The women auditors were almost in a swoon.
Sam Antar just explained how his family had skimmed $20 million off the top, and then made another $75 million from pumping and dumping Crazy Eddie, Inc. stock in the 1980s.
Chief Deputy Attorney General Kirk Torgenson was a sponge. "When you hear it from somebody who did it, it gives you insights into how they think," Torgersen (sic) said.
"I'm no rock star, I'm a crook," Antar said. "White collar crime is just as brutal as violent crime."
That was Antar's message. He says the way to crack down is with better auditing and policing. He also says his CPA license was just revoked; that should have happened 15 years ago.

Overstock.com issues press release with open letter from Mark Shurtleff

To my surprise, on November 14, 2007 Overstock.com issued a press release together with an "open letter" from Utah Attorney General Mark Shurtleff. His letter claimed that I broke a purported agreement with his office. In the press release, Patrick Byrne ranted on about me somehow being involved in an illegal media conspiracy to take down his company:

"The letter from the Attorney General of Utah, which Sam has, for a week, ignored and refused to post to his blog as twice requested, speaks to Sam's perfidy," Byrne added. "The real investigative business journalists left in this country might explore whose interests are being served by the promotion of Sam Antar by CBS MarketWatch, Dow Jones, and Fortune."

Mark Shurtleff's open letter claimed:

As Utah Attorney General, I am writing this letter to rebut a blog Sam Antar posted on his website on November 1, 2007. I tried to post this letter as a comment on his blog but Mr. Antar apparently refused to post it….
I was warned that Mr. Antar might use this speaking engagement to suggest that my office or I personally, endorse or support his accusations against Overstock.com or some other public company. Based on that warning, officials in my office secured a promise from Mr. Antar that he would not use this invitation for that purpose. So much for the promises of a convicted felon! [Note: The open letter was erroneously dated a year later in 2008]

No one from the Utah Attorney General’s office tried to contact me about any complaints, not Shurtleff or anyone else. Utah Attorney General Mark Shurtleff did not even consult with his own Deputy Attorney Generals Richard Hamp and John Kimble before making his reckless lies. They were my contacts at the Utah Attorney General’s office. Later, they confirmed to me that my only agreement was to refrain from mentioning Overstock.com during my presentation unless asked and that I abided by the agreement. In any case, I never suggested that anyone at the Utah Attorney General's Office endorsed my criticisms of Overstock.com, which turned out to be correct anyway.

Tape recorded conversations expose Mark Shurtleff's reckless lies

After Overstock.com published Mark Shurtleff's letter, I called Deputy Attorney General Richard Hamp and Chief Deputy Attorney General Kirk Torgensen to demand an explanation and retraction of Shurtleff’s reckless lies. Since New York and Utah are "one-party consent" states, I secretly recorded the calls for my protection.

I told Richard Hamp:

I certainly never agreed with you to not post on my blog. The agreement that we had was, was that we would not discuss any matters relating to Overstock.com at the meeting [my presentation at the Utah Attorney General’s 14th Annual White Collar Crime Conference], unless of course it was bought up and I complied with that agreement.

Richard Hamp’s reply:

I fully agree. You did everything I asked you to do, Sammy.

Later, Richard Hamp said:

It puts me in a bad spot as well because I disagree with him [Utah Attorney General Mark Shurtleff]…. What’s happening here has nothing to do with John [John Kimble, Deputy Attorney General] and I….
What is happening does not reflect my or John’s feelings, wishes, desires, or anything else. What you did is exactly what you promised to do for exactly the price you promised to do it at with no expense on our side and total expense on your side. You promised you would not open the Overstock door while you were here. You didn’t. I have absolutely no fault to you and I have nothing but praise from all the things I’ve read about your presentation….
No one consulted with me or John [Kimble]…. Here, I extend an invitation for you to come out here and do a presentation and you do exactly what it was I asked you to do. You do an excellent job of it and you know, and it makes me feel good, it makes the whole audience feel good, and then afterwards this whole thing happens and it kind of personally embarrasses me, too, at that stage because no one ever consulted with me or and John's, here saying….John here, agrees. To finish the thought, here we invite this poor guy to come out here. He comes out on his own dime and then we slap him in the face. Neither John nor I knew what was going on at the administrative level….

In a follow up phone conversation, Richard Hamp told me:

I am not going to argue any of the points Sammy. Sammy you did exactly what you said you would do for me. Kirk [Chief Deputy Attorney General Kirk Torgensen] even brought up the fact that Sammy agreed not to blog this. I said no, Kirk. We never had a discussion about blogs one way or the other. Sammy agreed he would not mention Overstock during...his presentations. He didn’t. You know. Just so Kirk was on the same page with me.
I am not going to misrepresent what our agreement was. Our agreement was that you wouldn’t mention Overstock while you were here. That was the end of the agreement. In all honesty, I didn’t even think about the blogs to even bring em up or mention em…. I've read it [your blog] and I don't have the same problem parts of my office do have with it....
I really feel bad about it, Sammy, because you did everything I asked you to do and I can’t fault you for any of this. Well there.

At Richard Hamp's suggestion, I called Chief Deputy Attorney General Kirk Torgensen to demand a complete retraction from Utah Attorney General Mark Shurtleff. At first, Torgensen said:

He [Utah Attorney General Mark Shurtleff] can apologize to you, but what kind of action do you want?

I demanded that Shurtleff's retraction to be “widely disseminated” in the same manner as Shurtleff's false allegations about me. However, in a follow up phone call, Kirk Torgensen backtracked and told me that Mark Shurtleff “may be stubborn on this thing” and offered an apology from the “Office” of the Utah Attorney General, rather than directly from Shurtleff himself:

What I would like to do Sam is. I gotta tell. I would like to you. I would like to. First, I will tell you personally that and I told you this when you came to Utah, I appreciated you coming. I thought that your presentation was very helpful….
I told my guys after your presentation that it was exactly what I was looking for, that your candor was exactly what I was looking for. Uh, everybody else appreciated immensely that you came out. You did it on your own time. You did it on your own dime because we didn’t have a budget for anything and we really appreciate that.
Um, I gotta ask you this Sam. I mean, the Attorney General may be stubborn on this thing. What if I sent you something? …. Ultimately, this damage is my office…. That hurts the office, you know that Sam…. My job is to find a way to undo the harm…

A few days, later, Kirk Torgensen wanted me to be satisfied with only the private verbal apologies previously conveyed to me by Richard Hamp, John Kimble, and him. He told me, "Sam, you’ve gotten an apology from three people in my office." Mark Shurtleff never retracted his false remarks about me.

Overstock.com continues to promote Shurtleff's reckless lies


To this very day, Overstock.com proudly promotes Shurtleff's reckless lies about me on its website and from time-to-time Patrick Byrne stills refers to those lies in an effort to smear me. White-collar criminals usually don't stop doing crime unless they are caught and held accountable. It was only a matter of time before the law caught up with Mark Shurtleff and it's only a matter of time when the law will catch up with Patrick Byrne. For example, in January 2014 California Judge imposed a $6.8 million judgment against Overstock.com (NASDAQ: OSTK) for false advertising and unlawful business practices.

Written by:

Sam E. Antar

Disclosure

I am a convicted felon and a former CPA. As the criminal CFO of Crazy Eddie, I helped my cousin Eddie Antar and other members of his family mastermind one of the largest securities frauds uncovered during the 1980's. I committed my crimes in cold-blood for fun and profit, and simply because I could. If it weren't for the heroic efforts of the FBI, SEC, Postal Inspector's Office, US Attorney's Office, and class action plaintiff's lawyers who investigated, prosecuted, and sued me, I would still be the criminal CFO of Crazy Eddie today. I do not want or seek forgiveness for my vicious crimes from my victims. My past sins are unforgivable.

There is a saying, "It takes one to know one." I've provided professional work for the FBI, IRS, SEC, Justice Department, and other federal and state law enforcement agencies in training them to identify fraud and catch white-collar criminals. Often, I refer cases to them as an independent whistleblower. In addition, I teach white-collar crime classes for various government entities, professional organizations, businesses, and colleges and universities.

I do not own any Overstock.com securities long or short.

Tuesday, July 08, 2014

A Felon’s View of White-Collar Crime - Why Society is Very Vulnerable to Fraud

White-collar crime is more brutal than violent crime. The actions of one or a few corrupt public officials and corrupt businessmen can affect the livelihoods of thousands, even millions of people. Fraudsters use a combination of persuasion and deceit to execute their crimes. Unfortunately, most people are unaware of how easy it is for fraudsters prey on their behavioral and cognitive vulnerabilities. Furthermore, the amount of prosecutions of white-collar criminals recommended by the FBI has steadily declined over the last 20 years. The government devotes far more resources to battling street crime than white-collar crime. The current framework involving, compliance, audits, and law enforcement does little to protect investors from fraud.

Every person is capable of doing white-collar crime. At the 22nd Annual Conference of the Association of Certified Fraud Examiners Conference in San Diego California in 2011, Joan Pastor, PhD, Clinical Psychologist and Fraud Expert said, “We’re all capable of committing fraud. Every single person in this room is capable of committing crimes.” For all of us, ethics is a matter of convenience depending on the situation and pressures involved. White-collar crime is an inevitable byproduct of the human condition. Seriously, can anyone truthfully claim that they live without sin and temptation?

Image from FBI
At best, people can prevent themselves from being victims of fraud. However, there is relatively little that our society can do to stop fraudsters from victimizing other naive and vulnerable people. If you are smart enough to avoid being victimized by a fraudster, they will simply find someone else with an exploitable weakness. Everybody has an exploitable weakness. The fraudster's job is to find the people who have an exploitable weakness that he/she can take advantage of.

Exploitable Weaknesses

White-Collar criminals use a combination of persuasion and deceit to achieve their objectives. Fraudsters prey on the psychological and cognitive vulnerabilities of their victims using the following techniques:

  • White-collar criminals consider your humanity, needs, desires, ethics, morality, and good nature as weaknesses to be exploited in the execution of their crimes.
  • White-collar criminals measure their effectiveness by the comfort level of their victims. They use a combination of charm and deceit to achieve their objectives. It’s far easier to get a potential victim to believe your lies, if they like you.
  • White-collar criminals fabricate false integrity to gain the trust of their victims. Stature, generosity, and good deeds gain the respect of their potential victims and make it less likely that victims will question their behavior.

White-collar criminals will always have the initiative to commit their crimes. Your ethics, morality, and good nature limit your behavior, but fraudsters have no such constraints on their behavior. The ethical foundation of our society is based on trust and legal basis of our society is based on the presumption of innocence. The inclination to trust and the presumption of innocence gives the fraudster the initial benefit of any doubt while they are free to plan and execute their crimes. Therefore, trusting and decent law abiding human beings are easier prey for fraudsters.

It's common knowledge that effective internal controls, oversight, and checks-and-balances reduce the opportunity for fraud. However, people tend to ignore the fact that their trust, ethics, and good nature limit their behavior and create a fertile opportunity for white-collar criminals to seize the initiative and execute their crimes. Fraudsters are unfettered by society’s moral constraints on behavior.

Crime and Punishment

Many people mistakenly believe that strong punishment such as long prison sentences is a major deterrent to white-collar crime. Recently, many white collar criminals have received very stiff prison sentences, which I firmly support. At best, it holds those guilty of white-collar crime accountable and responsible for their actions. However, strong punishment does relatively little to prevent white-collar crime. Often, we watch prosecutors pound the podium in front of the cameras and claim that their latest successful case sends a strong message to fraudsters to stop doing crime. However, white-collar criminals don't listen to the rhetoric of prosecutors. No white-collar criminal discovers ethical behavior and stops doing crime because another criminal ends up in prison. While white-collar criminals take precautions against failure, they do not plan on ever ending up in prison.

Don't Trust. Just Verify

Trust is a hazard that will destroy your future livelihood. While you initially give a fraudster the benefit of the doubt, they will attempt to solidify their trustworthiness before you follow up to verify their claims. The fraudster hopes that you trust them enough to never verify their claims. However, if you later seek to verify their claims, your skepticism may be substantially diminished by your increased comfort level with them. In other words, you will accept the fraudster’s deceptive answers as factual, even if you have some doubts.

A common mistake made by victims of fraud is called "unexamined acceptance." Claims received from any source should not be taken for granted as being truthful and accurate without any critical analysis, investigation, and verification. Therefore, learn to exercise professional paranoia. Do not trust. Just verify

Apologies

Apologies are irrelevant. While contrition and forgiveness are admirable traits, apologies do not change the past or undo the harm caused by fraudsters. Apologies tend to make the victims feel a small measure of comfort and make fraudsters, as a minimum, appear remorseful. However, apologies should not be relied on to predict future behavior. People should be ultimately judged by their actions, not by their "well meaning" words or claimed "good" intentions.

Invisible White-Collar Criminals

According to the Association of Certified Fraud Examiners (ACFE) 2014 Report to the Nations on Occupational Fraud and Abuse, “Occupational frauds can be classified into three primary categories: asset misappropriations, corruption and financial statement fraud.” Less than 10% of fraud perpetrators had been previously charged with a crime or had criminal records. As the economic impact of an economic crime goes higher, it is less likely that the perpetrators involved have any previous criminal records. Did Bernie Madoff, Ken Lay (Enron), Bernie Ebbers (Worldcom), or Dennis Kozlowski (Tyco) have criminal records? The answer is no. Therefore, it is difficult for law enforcement and professionals to profile the white-collar criminals among us.

Most Fraud is Discovered from Tips

The ACFE 2014 report found that, “Tips are consistently and by far the most common detection method. Over 40% of all cases were detected by a tip — more than twice the rate of any other detection method.” Specifically, the study states that 42.3% of occupational frauds are initially detected from tips and 6.8% of such frauds are found by accident. Therefore, 49.1% of occupational frauds are found by tip or accident. Furthermore, the ACFE stated, “Management review and internal audit rank second and third, respectively, in frequency of detection, but they lag far behind tips.” Only 16.0% of frauds were detected by management review, 14.1% by internal audits, and 3% of frauds by external audits. Unfortunately, our society must primarily rely on the actions of whistleblowers to inform us about most frauds.

Who are the Whistleblowers?

While many whistleblowers are glamorized by the press, most of them are not motivated by altruism, but are motivated by revenge or personal gain. Every source has an agenda. To government investigators, it’s known as the XXX principle (and I am not talking about pornography).

  1. Ex-lovers: Divorced spouses, former girlfriends and boyfriends.
  2. Ex-business associates: Former customers and suppliers.
  3. Ex-employees: Fired employees, laid off employees, and employees who quit working for the entity.

Whistleblowers can provide useful information. Most whistleblowers have an ax to grind and are looking to promote their particular personal agendas. They may have known about the crime during the execution of it, but did not report it until later. A whistleblower’s credibility should be judged on the basis of actionable verifiable information they provide, not what they say.

Do Audits Really Protect Investors?

Many investors blindly rely on the integrity of audits to protect them against fraud. Unfortunately, audits give investors a false sense of security. Traditional financial statement audits of public and private companies are not designed to find fraud. What accounting firms call an “audit” of financial reports is really a compliance review designed to find unintentional material errors in financial reports by examining a limited sample of transactions. In other words, traditional financial statement audits are designed to be spell-checkers and catch the accounting equivalent of innocent typos.

Despite the built-in limitations of audits, the major accounting firms do a poor job conforming to professional standards and rules for carrying them out. In 2012, the Public Company Accounting Oversight Board (PCAOB) inspected various audits conducted by the biggest four accounting firms and reported serious deficiencies in 25% to 49% of them:

  • Ernst & Young: 51 audits inspected /deficiencies (49%)
  • Pricewaterhouse Coopers: 52 audits inspected/21 deficiencies (40%)
  • KPMG: 48 audits inspected/17 deficiencies (35%)
  • Deloitte & Touche: 51 audits inspected/13 deficiencies (25%)

The latest inspection reports issued by the PCAOB for 2013 show that Pricewaterhouse Coopers had serious deficiencies in 19 of 57 audits inspected (33%) and Deloitte & Touche had serious deficiencies in 15 of 51 audits inspected (29%).

Dwindling Law Enforcement Efforts to Battle White-Collar Crime

From 1993 to 2013, the amount of prosecutions of white collar criminals recommended by the FBI has steadily declined, according to data obtained by Transactional Records Access Clearinghouse (TRAC) under the Freedom of Information Act from the Department of Justice. See the charts below provided by TRAC:






As a nation, we devote far more resources fighting blue-collar crime or street crime, than we do battling white-collar crime. For example, the NYC Police Department employs approximately 34,000 cops in uniform battling street crime. However, the FBI employs approximately 13,600 special agents, the IRS Criminal Investigative Division employs approximately 2,600 special agents, the SEC employs approximately 3,958 people, and the US Postal Inspectors Office employs approximately 1,500 postal inspectors. The NYC Police Department has more man power directly battling street crime than those four federal law enforcement agencies combined have fighting nationwide white-collar crime.

Written by:

Sam E. Antar

© Copyright by Sam E. Antar. All rights reserved.

Disclosure

I am a convicted felon and a former CPA. As the criminal CFO of Crazy Eddie, I helped my cousin Eddie Antar and other members of his family mastermind one of the largest securities frauds uncovered during the 1980's. I committed my crimes in cold-blood for fun and profit, and simply because I could. If it weren't for the heroic efforts of the FBI, SEC, Postal Inspector's Office, US Attorney's Office, and class action plaintiff's lawyers who investigated, prosecuted, and sued me, I would still be the criminal CFO of Crazy Eddie today. I do not want or seek forgiveness for my vicious crimes from my victims. My past sins are unforgivable.

There is a saying, "It takes one to know one."Today, I advise federal and state law enforcement agencies about white-collar crime and trains them to identify and catch white-collar criminals. Often, I refer cases to them as an independent whistleblower. I teach about white-collar crime for government entities, businesses, professional organizations, and colleges and universities. In addition, I perform forensic accounting services for law firms and other clients.