How to Detect and Prevent Company Fraud

Executive Summary 

The Leslie Fay Companies, Inc. is an organization that was established to sell apparels and sportswear. After a series of excellent financial performance and exponential growth, the economic recession led to a decrease in sales of the products. With high financial target and expectations, the Chief Finance Officer engineered a scheme to doctor and falsify accounting bookings resulting in fraud. The discovery of fraud affected the stakeholder significantly. First, the corporate image of the organization was maligned leading to further decline in the number of customers. The stakeholders withdrew their shares plunging the company into a financial crisis. Eventually, the company was declared bankrupt. The company was revived after the acquisition. The resolutions to avoid further recurrence of similar fraud include an emphasis on ethical focus and setting of reasonable financial expectation and target. 

Option #1: Company Fraud: An Evaluative Report 

Brief History 

Fred Pomerantz started Leslie Fay Company in 1947. The company specializes in the sales of apparels and sportswear in different departmental stores spread the country. The products range from moderate price brands to better-priced brands. For approximately thirty-five years, the family of the founder ran the company. In 1952, the company went public attracting more investors who would provide crucial funds required for the expansion of operation and exploration of new market frontiers. With the expansion of activities across the country, Leslie Fay experienced exponential growth. The company’s distinctive style of marketing in the early 1980’s was very significant. During this period, many business organizations resorted to using computers to track sales of the product. Conversely, Leslie Fay focused more market testing on determining the potential performance of different brands they were producing and availing to the ever-changing market environment (Beasley, 2015). 

Leslie Fay faced a major change in its structure and management in 1982 following a $58 million leveraged buyout. After the leveraged buyout, the Leslie Fay changed its name to The Leslie Fay Company. Two years after the first buyout, the company again was acquired through a lump sum buyout of $158 million. The company changed its name again to the Leslie Fay Companies. The fashion craze of the 1980’s catapulted the company to greater heights. Despite competition from other fashion companies, The Leslie Fay Companies recorded significant growth judging from the number of stores that were established, market capitalization, assets and net profits. The company was listed on the stock exchange with its stock prices increasing tremendously. The company set organizational goals, especially regarding the anticipated profits. The economic recessions hurt the company’s objectives as the sales of various merchandise plummeted (Beasley, 2015). The reduced sales and higher profit expectations obliged the finance department to engage in accounting improprieties that form the basis of this evaluative report. 

Fraud and Impact on Stakeholders 

The Leslie Fay Companies just like any other business entity may face turbulence in its operations. As an organization that deals with consumable products, the success or performance of the business is assessed on the sales. An increasing volume of sales translates into higher profits. The growing profit margin implies that the stakeholders will enjoy the benefits of investing in the company. The fraud that occurred in the company is attributed to a decrease in sales. What the company executives and especially the Chief Finance Officer failed to realize is that multiple factors determine the performance of the business. Whereas some factors are can be controlled through mitigation, measures and strategic, planning, other factors may be beyond the control of the organization. The fraud indictment of the company was predicated on two issues. The first issue was a falsification of accounting books. The second issue was an overstatement of profits. The problems came to light when the stakeholders realized the company was involved in accounting malpractices (Beasley, 2015). 

The management of the company owed the investor’s money. As such, when the company’s sales started to dwindle, the finance department ventured into the well-schemed and elaborate plan of backdating the invoices. The actions mean that the company would record profits for orders that were not paid. To cover their tracks, the Chief Finance Officer in collaboration with other staff in the Finance Department doctored the accounting books. The investigations by the Security Exchange Commission (SEC) revealed that after the discovery of the fraud that was taking place at The Leslie Fay Companies, the perpetrators attempted to cover their tracks by destroying crucial evidence (Beasley, 2015). The fraud that was uncovered at the company affected the stakeholders immensely. 

The most profound effect of fraud in the company was the tarnished corporate image. The company was operating in an intensely competitive environment. The company relied on its corporate image to gain customers and benefit from the related competitive advantage. The discovery of the fraud and accounting malpractices in the organization adversely affected the business. The negative publicity that was spread in the media destroyed the company moral stance (Cohen et al., 2012). In the current business setting, customers are considering other factors of an organization. The consumers are looking for organizations that are ethically oriented. The clients believe that organizations with an ethical focus are likely to produce quality products while considering the secondary impacts resulting from their production. For instance, the society is grappling with environmental challenges. As such, consumers will associate with companies that have proved to be environmentally conscious, for example, those companies that have policies to preserve or conserve the environment. 

The negative public image of the company aggravated the problems The Leslie Fay Companies was facing. First, the customers who were the primary and the backbone of the organization lost faith in the organization. The resultant effect was a further depression in the sales of the products. Indeed, the customers are justified to desist or resist obtaining products from the company for its engagement in the unlawful activity. The company was operating in a perfect competition market meaning that its business rivals capitalize on the failures to capture more market share (Cohen et al., 2012). The second impact of fraud was lawsuits that affected the company’s financial reserves. The stakeholders sued the company for various crimes including concealment of information, falsification of documents, abuse of office, and overstatement of profits. Lawsuits are expensive for the defendant especially in cases where there is sufficient evidence to substantiate the claims. The Leslie Fay Companies spent a vast amount of money and resources in the court. It should be noted that the primary reason for engaging in accounting impropriety was the decline in revenues. Ironically, the process the executives anticipated would seal the loopholes in the profit margin was counterproductive (Cohen et al., 2012). The funds that were used in defending the company in the court further depleted the almost empty finance reserves. 

The stock prices reduced drastically. The investors lost faith in the company. By withdrawing their stakes in the company and selling their shares at throwaway prices, the company was on the brink of collapse. The Leslie Fay Companies was declared after series of fateful events. It is evident that the bold move the finance department took proved to be an effort in futility. Arguably, judging from the past performance of the business, it expected that adopting appropriate strategies would put the organization back on the right track. However, the fraud that took place in the organization proves that the company was eventually going to engage in more serious criminal and unethical conducts. Interestingly, the scam took place without the knowledge of Chief Executive Officer Pomerantz. An intriguing question that arises from this incidence is the role of senior managers in the business. Seemingly, the CEO of the company was detached from the financial aspect of the business. Assuming Mr. Pomerantz was assessing the financial performance of the business then the gravity of the accounting malpractices would have been reduced. Perhaps, another question that would challenge the first question is the whether the CEO of the company has the technical expertise to assess accounting books and financial information. Again, it is imperative to note that the CEO can hire a certified independent auditor who can provide a reliable and credible report based on the actual analysis of the company’s financial information. 

Analysis of Auditors’ Roles in the Fraud 

The fraud that occurred at The Leslie Fay Companies has many facets. Whereas the perpetrators of the malpractices were the individuals within the finance docket, the auditors also contributed to the spread of fraud in the organization. The failure of the auditors to diagnose fraudulent activities in the organization underscores possible fault lines in the accounting standards of the organization (Jackson et al., 2010). The accounting standards that are used by auditors in virtually every nation are globally approved. The efforts that internationally recognized accounting bodies have taken to solve accounting crisis seems to be fruitless due to the incompetence and utter disregard of the standard by the accounting professionals including auditors (Jackson et al., 2010). In the case of The Leslie Fay Companies, the auditors played a significant role in the aggravation of fraud and financial impropriety in the organization. Auditors tasked with verifying and reporting on the financial information of the company raises questions on the underpinnings of the general auditing standards. 

According to the dictates of the general auditing standards, the auditors must possess sufficient technical training, proficiency, and experience to perform the auditing tasks. As a matter of logic, an accounting student who is doing an internship program in the organization lacks sufficient knowledge to produce a credible and reliable audit report for a vast organization like The Leslie Fay Companies. However, considering the discrepancies in the audit report that were availed to the public, it is plausible to conclude that the auditors who undertook the assignment lacked experience and proficiency. Critical analysis of the audit reports reveals lack of independence in the preparation of the report. Auditors should exemplify the highest level of independence and principle. Considering auditors’ work is to analyze, verify, and report on the financial information of the company, their work can be compromised through coercion, threats, and bribery. An auditor, who relays false information, demonstrates lack of independence and moral foundations. Moral foundations enable the auditor to be steadfast and unequivocal in matters relating to controversial audit queries. 

Auditing the accounting books of the organization was a labor-intensive job that required many expert auditors to complete. In such a case, the success of the task depends on proper planning and supervision of the assistant. It seems the auditing staff failed to have a concise plan regarding how to complete the assignment without hitches. Again, monitoring of the auditing assistants is vital. A preliminary report shows that the auditors at in the organization lacked supervision. Lack of guidance especially in critical tasks like auditing is disastrous to the organization. Supervision ensures that the assistants are competent and productive (Jackson et al., 2010). Again, the auditing assistance gains a sense of accountability and responsibility in their work. Conversely, through supervision, the assistants can express challenges including occupational stressors that are hindering their work. The supervising or chief auditor can find solutions to increase the productivity and the performance of the assistants. Failure of the auditors to identify discrepancies in the financial information of the company points out to a systematic problem in the auditing department (Jackson et al., 2010). It would be expected that at least one of the auditor would discover the malpractices that were ongoing in the organization earlier, which was not the case. The uniformity of incompetence and lack of independence of the auditors shows that some influences and pressures were exerted. The last failure of the auditors in the fraud case was misunderstanding the internal controls of the organization. The auditors can only create a credible audit report by first understanding how the internal control system of the organization works. The auditors failed to assess the functions of internal control at The Leslie Fay Companies, Inc. From the accounting standards, it is evident that violation of the principle led to sustained fraud at the company. 

Internal Controls in the Organization 

The accounting fraud in the company is partially attributed to weak and ineffective internal controls that were established. Robust internal control ensures that accounting systems are accurate, reliable, and credible. An organization with a strong emphasis on internal control will set a concise framework that aims at detecting fraud and identifying error before they compound into challenges that are more significant (Morris, 2011). To this end, it is logical to state that all the procedures of internal control were ignored or disregarded by the respective staffs. Internal control demands for the separation of duty. Such implies that all the accounting activities are apportioned to different personnel. Separation of responsibility enhances accuracy as an individual focuses on one aspect of accounting. The staff can easily identify errors in the records and inform the supervisors. Chances that one staff will discover the errors in the account are high when roles are split. In this scenario, the Chief Finance officer failed to separate the duties among the employees. The CFO had an elaborate scheme to commit accounting malpractices by first ensuring that the underlying block of internal control is uprooted. 

Another internal control aspect that was circumvented was physical audits. The internal auditors failed to examine the receipt to verify their credibility physically. Again, the company also had cash, which could be counted and reconciled with the sales. Probably, backdating of the invoices is premised on the loophole that existed due to lack of physical audit. Suppose hand-counting cash was a normal routine in the company, then the auditors would easily discover discrepancies in the receipts. Discovery of the errors would instigate an investigation, which would unveil the fraud that was orchestrated by the CFO in the company. 

The finance department flouted periodic reconciliation of the accounts. Internal control promotes periodic reconciliation of accounts to ensure that balances held by other business entities including creditors, banks, and suppliers match (Morris, 2011). For example, the company should have compared the receipts and record of deposits with that of the bank. However, failure for such reconciliation promoted falsification of receipts. The resultant effect is that the company was reporting higher profits while the bank accounts stated otherwise. The approval authority ratifies the person to initiate a transaction in the organization. There was no explicit approval authority in The Leslie Fay Companies, Inc., which facilitated intensification of fraudulent activities among the employees. Whereas the overall blame has been placed on the Chief Finance Officer, it should be noted that employees were instrumental in the process. 

Prevention Mechanism: Appropriate Accounting Policy 

Fraud and accounting malpractices have far-reaching consequences for the organization. Fraud is inevitable in any organization due to the diversity and differential moral orientation of the staff. For instance, frauds that have been reported in many organizations have always implicated the top management. In the case of The Leslie Fay Companies, Inc., the CFO was indicted for engineering the fraud. The CEO was unaware of the unscrupulous activities that were happening in the organization. The fraud activities resulted in the company becoming bankrupt, and it was reinvigorated after another firm acquired it. Therefore, it is difficult to determine the accounting policies that were enacted to prevent recurrence of a similar event. However, fraud is common and universal for all organization. The proposed accounting policy will ensure that companies avoid facing a similar fate as The Leslie Fay Companies, Inc. 

The appropriate accounting policy should have anti-fraud guidelines (Wells, 2017). Considering the development in the accounting field, frauds can only be prevented by adopting another dimension. Organizations should espouse the culture of honesty and ethics. The tone should start from the top all the way to the bottom. Managers and business leaders should promote ethical behaviors and conduct. A senior leader of the organization sets a good example for the junior staffs when he or she exemplifies moral and ethical principles. The CFO of The Leslie Fay Companies, a leader who should exhibit the highest degree of ethical focus operated below the ethical threshold. The staffs under his jurisdiction had to follow what their leader had directed probably for fear of intimidation or victimization. 

The occurrence of similar fraud can be prevented by setting a reasonable budget and other financial targets. The high financial expectation instigated the falsification of the accounting books and overstatement profits that the company had given the stakeholders. As such, when the company failed to realize its financial target, it opted to falsify financial statements. Therefore, organizations should be consciously aware of the operational risks that may affect the financial position (Wells, 2017). In-depth, analysis of the economic factors will ensure that the company sets a reasonable financial target and expectation. 

Conclusion 

The report has critically examined the circumstances leading to fraud at The Leslie Fay Companies, Inc. It is evident that doctoring of accounting books and falsification of profits had severe consequences for the organization. By flouting the accounting standards, the auditors played an essential role in the fraud. Again, it is noted that internal control procedures were violated, leading to the sustained commission of fraud in the organization. As much as fraud affects companies’ corporate image and financial position, adoption of appropriate strategies can mitigate the core issues. Companies should espouse ethical focus to minimize the occurrence of fraud. 

References  

Beasley, M. S. (2015). Auditing cases: An interactive learning approach . Prentice Hall. 

Cohen, J., Ding, Y., Lesage, C., & Stolowy, H. (2012). Corporate fraud and managers’ behavior: Evidence from the press . In Entrepreneurship, governance and ethics (pp. 271-315). Springer, Dordrecht. 

Jackson, K., Holland, D. V., Albrecht, C., & Woolstenhulme, D. R. (2010). Fraud isn’t just for big business: Understanding the drivers, consequences, and prevention of fraud in small business. Journal of International Management Studies, 5(1), 160-164. 

Morris, J. J. (2011). The impact of enterprise resource planning (ERP) systems on the effectiveness of internal controls over financial reporting. Journal of Information Systems, 25(1), 129-157. 

Wells, J. T. (2017). Corporate fraud handbook: Prevention and detection . John Wiley & Sons.