How cover-ups can beat an auditor's radar scan
Corporate America may not be ready for complete financial accountability, argues Gerald Michaluk.
As the discredited Labour spin doctor said at the time of the September 11 attacks "it's a good time to bury bad news". Well as upsetting as it was to hear this said, it was perfectly true.
The aftermath has allowed a number of companies to bury any skeletons. Turnover falling was expected to by the market, which had already reacted and was awaiting it. You were not going to get fired if you wrote off stock or R&D investment or reported a fall in sales, or did not make a quarter's numbers. An opportune time to wipe the slate clean. Where there were any "misclassifications" of expenses they could have buried within reason in write-offs.
It is for this reason I suspect there will not be too many more Enrons, WordComs and the like, but those that do follow in their wake are going to he huge, having been unable to clear all the skeletons out even with the catastrophic impact of the terrorist action to hide behind.
You must remember that not all companies fit the profile for these type of activities to occur, nor are they in the right types of market, subjected to the right type of market pressure nor have the right management structure to make this kind of fraud likely or undetectable. There are therefore only a limited number of companies that have the capability to be involved in these frauds and of those even fewer have had the intent. You need both the capability and the intent for this type of fraud to be perpetrated and therefore the markets can relax a bit and get back to normal with the caveat that only a few companies are still to fall from grace.
In my book, Riding the Storm, I give several examples of "profit flexibility" discovered by our Global Marketing Advantage System (GMAS).
In the course of installing GMAS, a system offering total visibility strategic and tactical planning alignment, designed to provide a marketing advantage, we have found that it has the unfortunate side effect of being able to identify irregularities between the "real world" and the financial records.
In one global company, in the telecoms sector, this got us fired, the vice president who hired us transferred from the US to Europe and assigned to "special projects", and his former department, with some 14 staff closed down.
What we uncovered over the years was: companies with sales figures that just after the reporting quarter start with a negative number: goods being delivered that had never been ordered; goods being sold by one subsidiary being returned to another company in the group; goods being traded around groups of companies with different accountancy disclosure rules in the different countries making it possible for the sale to appear genuine, CAP schemes where promises to buy product at future date are logged as sales, bias research designed to verify false market share claims: and a whole lot more all easily detectable when a company is running a GMAS system but totally invisible to even the most thorough auditors.
Why does the traditional audition not pick up these tricks? Let me give you an example. We identified in a US multinational what appeared to be a major quality problem: large numbers of goods were being returned as DOA (dead on arrival, that is they did not work when they customer plugged them in.) We had no indication of this from the customer satisfaction studies that we conducted on a continuous basis, yet there were complaints about getting goods that had not been ordered and the inconvenience this caused.
The GMAS system highlighted issues and recommended we investigate. On investigation we found warehouses full of returned goods awaiting fault testing - more than $30m worth in one warehouse alone. Its diagnostic team consisted on only four or five staff and it would take them several man-years to get around to testing the equipment that was being returned.
We decided to send the next batch of returns to a contractor to have them tested, as it looked on the face of it we had a major quality problem that somehow was not impacting on customers. You can imagine our surprise when we read the reports on the tests, "no fault found in any of the units tested".
We immediately dispatched field interviewers to more than 20 countries where these units had been returned from only to discover the goods had been returned not because of a fault but because they had not been ordered. Why had the DOA system been used? They told us that the sales staff told them to use the DOA forms as this was the fastest way to clear up the problem. We immediately estimated the cost of this and the scale and, rather proud of ourselves, marched off to visit the CEO with the result I described above, not quite what we expected.
The CEO of this company was, within months, forced out of the office but the replacement simply covered up the operation and I am sure, like so many other companies with skeletons in their cupboards, used the events of September 11 to readjust their sales figures and write off things, thus burying the past. How had the audits not detected anything? Well for one thing the activity involved many different countries. The auditors don't look at sales patterns. They don't ask questions like why all the sales are made on the last week of the last month of the quarter. The don't physically walk around the warehouses, talk to the customers, understand the nature of the business, and don't get much time or support to do their work. Lets face it, even the most upstanding companies begrudge paying auditors' fees, they are expensive and simply tell you what you already know, if you have a good accountancy function and are honest. If you are deceitful, clearly some auditors can't detect it.
It is time for "reality checks" such as those provided by companies utilising GMAS to support financial auditing. But GMAS may be too radical - it would tell you what is actually going on. Are the financial markets really ready to know the truth about corporate America?
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