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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 CORPORATE GOVERNINGBODY TAKE ACTIONS THAT

MIGHT GIVE THEM A BETTER

CHANCE OF PREVENTING

MATERIAL FINANCIAL FRAUD?

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 bestinterests of the company (NZCompanies Act, 1993, S131)

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According to New Zealand Listing Regulations

Department of Accounting, University of Waikato

keep the market ... informed on mattersthat 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 standardssetting bodies may disagree

Department of Accounting, University of Waikato

.... the accounting profession andstandard setters express interest inensuring the governing body andmanagement have a strong role in fraudprevention

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International Standard of Auditing

Department of Accounting, University of Waikato

The primary responsibility for the

prevention and detection of fraud restswith both those charged with

governance... and management

(ISA (NZ) 240, para 4)

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... and

Department of Accounting, University of Waikato

It is important that management... governance,

place a strong emphasis on fraud prevention...

a commitment to creating a culture of honestyand ethical behaviour ....

... includes considering the potential for overrideof controls.. [and] earnings management (p4)

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.... And therefore

Department of Accounting, University of Waikato

... identifying fraud within theorganisation is viewed by theaccounting profession as animportant role of the governing body

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The auditors role ...

...is to provide reasonable assurance that thefinancial statements are True and fair and

that they are free from materialmisstatement (ISA (NZ) 240)

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The auditor shall identifyand assess the risks of

material misstatement dueto fraud...(ISA (NZ) 240k

p25)

Department of Accounting, University of Waikato

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That is, and according to the accountingprofession, the role of the auditor is to

Department of Accounting, University of Waikato

... evaluate fraudpotential

.... 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 requirement to look other than to takeinto consideration risk..., lower level ofassurance on fraud

2003: Follow up suspicions emerging fromnormal audit evidence gathering procedures

2007: Plan, consider risks, discuss, design tests

in response to known 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 C O 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 CorporateGovernance and Fraud in U.S.

Listed Companies

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What was examined

Department of Accounting, University of Waikato

519 U.S. Fraud-committing companies(2004-2006)

Data from SECs Accounting Enforcement

Releases, official sites, corporate reports Matched pairs reduces to refined sample

of 152 fraud and no-fraud companies (76each)

Regression to identify governancecharacteristics associated with fraud

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Board Sub-Committee Characteristics andCommunication 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 adirector

Ownership share by inside (and outside)

directors

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Shareholder representative characteristics

Department of Accounting, University of Waikato

Outside blockholder ownership numbersand 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 accompany thepresence of fraud in these companies?

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Findings

Department of Accounting, University of Waikato

5 characteristics significantly associated withfraudulent corporate financial statements include:

1. Number of directorships held by (AC) directors2. 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

was between the percentage ofcompany ownership held by outsideblockholders and the presence ofcorporate 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 besignificant to fraud practice.

Limitation: We only examine select measures ofauditor independence, other auditor independencestudies may identify further issues

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Implications

Department of Accounting, University of Waikato

Would be risky for the governingboard to rely on the auditor alone topick up instances of corporate fraud.

Ambiguous guidance makes itdifficult to anticipate responsibility,and the governing board may be in astronger position to structure the

company to help prevent corporatefinancial fraud

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That is, while the auditors have agrowing responsibility to look for

material fraud, our findings suggest thatpotential for fraud prevention may lie inthe structure (and independence) of theboard.

Department of Accounting, University of Waikato

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Thank you!

Department of Accounting, University of Waikato