Ten things about

financial statement
fraud
A review of SEC enforcement releases,
2000-2006
Deloitte Forensic Center
June 2007
Deloitte Forensic Center

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Ten things about financial statement fraud:

Despite increasingly stringent legislation such as the Foreign Corrupt Practices

Act and the Sarbanes-Oxley Act aimed at combating fraud — and despite
increased enforcement efforts by the SEC — financial statement fraud remains a
public concern.

But just what types of fraud is the SEC describing in its enforcement actions?
In what industries are frauds most prevalent? Have fraud types and industry
patterns changed over time?

To address these questions, and to learn how fraud schemes have evolved
since the Committee of Sponsoring Organizations of the Treadway Commission
produced its last comprehensive report on fraud in 1999, the Deloitte Forensic
Center has, in 2007, completed an analysis of hundreds of SEC enforcement
releases issued from 2000 through 2006.

This booklet provides snapshots of the data collected from the SEC’s
enforcement releases relating to frauds allegedly committed by companies,
officers, and employees. It reports the number of frauds by industry and type and
comments on the trends emerging in this millennium.

The Forensic Center will, in the future, update the study annually to provide
longer views of trends, and to broaden coverage by including restatements and
securities litigation in the analysis.

The findings may have significance for the global effort to develop more robust
business processes for managing the risk of fraud. The efficacy of such processes
will depend on knowing the fraud schemes typically committed and industry-by-
industry differences in those schemes.
Overview of Methodology

The SEC reports on its administrative enforcement actions through its Accounting
and Auditing Enforcement Releases (AAERs). The Deloitte Forensic Center’s staff
reviewed slightly more than 1300 AAERs that the SEC released from January
2000 through December 2006. For our analysis, we considered, where possible
but not in all cases, final AAERs that addressed financial statement fraud,
excluding releases that dealt with insider trading; actions against vendors, or
auditors. This filtering process resulted in the 344 AAERs that are the subject of
this study.

We sorted each company into one of nine industries, using categories we

developed, as well as noting sub-industry as appropriate:

• Aviation & Transport Services • Manufacturing

• Consumer Business • Public Sector
• Energy & Resources • Real Estate
• Financial Services • Technology, Media, &
Telecommunications
• Life Sciences & Health Care

We classified the frauds identified into 12 categories based on how the fraud
was committed, and within them 57 sub-categories. AAERs typically describe
more than one fraud scheme active in a company in a given time period.
The 12 main categories are:
• Aiding & Abetting • Manipulation of A/R
• Asset Misappropriation • Manipulation of Assets
• Bribery & Kickbacks • Manipulation of Expenses
• Goodwill • Manipulation of Liabilities
• Improper Disclosures • Manipulation of Reserves
• Investments • Revenue Recognition

For each AAER, we also captured the date of the final release and, importantly,
the earliest date of evidence of each scheme.
 - -1
How many financial statement fraud
AAERs has the SEC issued?

Chart 1: Financial statement fraud AAERs issued by the SEC, by year

of issue

77

58
55
50
44

35

25

2000 2001 2002 2003 2004 2005 2006

• From 2000 through 2006, the SEC issued 344 financial statement fraud
AAERs relating to its registrants.
• The flow hit its peak in 2003 at 77 releases.
• In 2002, the U.S. Government dedicated additional funding to the SEC and
charged it with increasing its scrutiny of financial statement fraud within
public companies.
• The SEC doubled the number of financial statement fraud AAERs from 2001
to 2002, and issued another 42% more in 2003. The annual rate has since
fallen to about 50 AAERs per year.
 2
- -
What is the average time lag, in years, between
the initial fraud and the SEC
enforcement release?

Chart 2: Average time lag, in years, between commission of fraud

and SEC’s issue of an AAER

5.6

5.0 5.0
4.7
4.2 4.3
4.1

2000 2001 2002 2003 2004 2005 2006

• We examined the length of time between the start of a fraud scheme,

initiation date, and the date of the most recent AAER issued by the SEC,
usually the final release.
• Average time elapsed between the date identified as the initiation date and
the date the SEC issued its most recent AAER is 4.7 years.
• The lengthiest period between the initiation date of the fraud and the SEC
AAER was 18 years.
• After dropping to a little over 4 years in 2002–2004, the average lag increased
by one-third, to 5.6 years in 2006.
 - -3
How many fraud schemes are described in
AAERs between 2000 through 2006?

Chart 3: Number of fraud schemes identified in AAERs issued, by year

252

215 210 208

183

98

74

2000 2001 2002 2003 2004 2005 2006

• We identified 1,240 fraud schemes in the 344 financial statement fraud

AAERs in this study. A single enforcement release often identifies multiple
fraud schemes operating at a given time in a company.
• At the peak level of activity in 2004, AAERs in effect described a fraud scheme
for every working day of the year.
 - - 4
How many fraud schemes were identified
per company?

Chart 4: Number of companies with X number of fraud schemes

83

64

47 47

25
22

13
10 9
3

1 2 3 4 5 6 7 8 9 10+

• This chart plots the number of companies that had one or more fraud
schemes identified in the SEC releases.
• Most companies (82%) had from one to five fraud schemes — but over 20
had 10 or more.
• Four of the 22 companies that had 10 or more fraud schemes under
investigation had over 20 fraud schemes.
 - -5
What fraud schemes are most common?

Chart 5: Fraud frequency, by type

Investments 1%
Goodwill 1%

Aiding and Abetting 2%

Manipulation of A/R 3%
Bribery & Kickbacks 3%
Asset Misappropriation 4%

Manipulation of
Reserves 7% Revenue
Recognition 41%

Manipulation of
Liabilities 7%

Manipulation of
Assets 8%

Manipulation of
Expenses 11% Improper Disclosures 12%

• Revenue recognition fraud schemes are by far the most prevalent, at 41% of
the total. This finding is consistent with earlier studies and reinforces the need
for focus on this area.
• Other fraud schemes involving manipulation of various financial statement
items account for more than a third of all fraud schemes identified.
 6
- -

What are the most common types of

revenue recognition fraud?

Chart 6: Most common types of revenue recognition fraud

Recording of fictitious revenue

Recognizing inappropriate amount of
revenue from swaps, round-tripping or
41 barter arrangements
12%
Recognition of revenue from sales
transactions billed, but not shipped ("bill
46 123
and hold")
13% 35%
Recognition of revenue where there are
contingencies associated with the
transaction that have not yet been
42 resolved
12%
Improper accounting for or failure to
establish appropriate reserves for rights
58 to refunds or exchange, liberal
43 cancellation or refusal rights or liberal or
12% 16%
unconditional rights of return granted
through undisclosed oral or written side
agreements

Recognition of revenue when products or

services are not delivered, delivery is
incomplete, or delivered without
customer acceptance

• The ‘top’ 6 fraud schemes, depicted above account for 70% of all revenue
recognition schemes identified.
• Recording fictional revenue is the most common type of revenue-recognition
fraud.
• Next was recognizing inappropriate revenue from swaps, “round-tripping,” or
barter arrangements.
• The remaining four subtypes were fairly evenly distributed.
 7
- -
How are the fraud schemes distributed
over industries?

Chart 7: Number of fraud schemes identified, by industry

480

371

129
95
77
58
9 5 16

TMT
Manufacturing
Energy & Resources

Financial Services

Life Science & Healthcare

Consumer Business
Aviation & Transport Services

Real Estate
Public Sector

• The 1,240 fraud schemes identified in the 344 AAERs in this study break
down by industry very unevenly.
• With 480 fraud schemes, the Technology, Media, & Telecommunications
industry was responsible for 39% of identified schemes.
• Consumer Business, with 371 fraud schemes, was second, at 30% of
identified schemes.
• Manufacturing companies had the third largest group of fraud schemes,
129 in total, amounting to 10% of the total.
 - - 8
In the “top” 3 industries, how are the schemes
spread across sub-industries?

Chart 8: Distribution of frauds by sub-industry for the three

industries with the most frauds identified
290
Consumer Business 230
Manufacturing

TMT

122
88 83
68
37
14 18 20
9 1
Aerospace Defense

Automotive

Health Plans

Tourism, Hospitality &

Consumer Products

Consumer Services

Retail, Wholesale &

Publishing, Media &

Telecommunications

Technology
Industrial Products

Process Industries
Manufacturing &

Entertainment
Distribution
Diversified

Leisure

• Within the Manufacturing sector, 68% of identified fraud schemes occurred

within Process Industries and another 14% occurred within Diversified
Manufacturing and Industrial Products.
• Within the Consumer Business sector, 62% of identified frauds occurred
within Retail, Wholesale & Distribution and another 22% occurred within
Consumer Services.
• Within the Technology, Media, & Telecommunications sector, 60% of
identified fraud schemes occurred within Technology and another 25%
occurred within Telecommunications.
 - - 9
What are the trends for the “top” 6 fraud types?
Chart 9a: Incidence of top 6 fraud schemes, by scheme date
120 Improper Disclosures

Manipulation of Assests

Manipulation of Expenses
100
Manipulation of Liabilities

Manipulation of Reserves
80 Revenue Recognition

60

40

20

0
1996 1997 1998 1999 2000 2001

Chart 9b: Incidence of top 6 fraud schemes, by release date

120 Improper Disclosures

Manipulation of Assests

Manipulation of Expenses
100
Manipulation of Liabilities

Manipulation of Reserves
80 Revenue Recognition

60

40

20

0
2000 2001 2002 2003 2004 2005 2006

• These charts show the trends in the six most prevalent fraud schemes
measured first by the scheme initiation date and then by the date of the final
enforcement release.
• Revenue recognition frauds account for most of the change in fraud types
over time when measured by either method.
• For example, revenue recognition fraud increased almost 350% when
measured by the scheme date, jumping from 25 identified incidents in 1996
to 111 in 2000.
 - 10a-
What are the fraud trends within the
Technology, Media, & Telecommunication
industry?
Chart 10a1: Incidence of top 6 fraud types in TMT industry,
by scheme date
70 Improper Disclosures

Manipulation of Assests
60
Manipulation of Expenses

Manipulation of Liabilities
50
Manipulation of Reserves

40 Revenue Recognition

30

20

10

0
1996 1997 1998 1999 2000 2001

Chart 10a2: Incidence of top 6 fraud types in TMT industry,

by release date
70 Improper Disclosures

Manipulation of Assests
60 Manipulation of Expenses

Manipulation of Liabilities

50 Manipulation of Reserves

Revenue Recognition

40

30

20

10

0
2000 2001 2002 2003 2004 2005 2006

• Revenue recognition appears to be the primary type of fraud addressed within

this industry.
• When observed by the scheme initiation date, revenue recognition fraud
increased 319% from 1996 to 2000, to a peak of 67 events. But in the next
year, 2001, incidents declined to 50, near 1999’s level of 51.
 - 10b -
What are the fraud trends within the Consumer
Business industry?
Chart 10b1: Incidence of top 6 fraud types in Consumer Business
industry, by scheme date
35

Improper Disclosures
30 Manipulation of Assests
Manipulation of Expenses
Manipulation of Liabilities
25
Manipulation of Reserves
Revenue Recognition
20

15

10

0
1996 1997 1998 1999 2000 2001

Chart 10b2: Incidence of top 6 fraud types in Consumer Business

industry, by release date
35 Improper Disclosures

Manipulation of Assests
30 Manipulation of Expenses

Manipulation of Liabilities

25 Manipulation of Reserves

Revenue Recognition

20

15

10

0
2000 2001 2002 2003 2004 2005 2006

• Although revenue recognition fraud remained the most common fraud

type when observed by scheme initiation date, expense manipulation fraud
exceeded revenue recognition fraud in 2004 when observed by release date.
• Manipulation of expenses appears to be a more common type of fraud in
this industry than in the other industries we have broken out for separate
observation.
 - 10c -
What are the fraud trends within the
Manufacturing industry?
Chart 10c1: Incidence of top 6 fraud types in Manufacturing industry,
by scheme date
25

Improper Disclosures
20 Manipulation of Assests

Manipulation of Expenses
Manipulation of Liabilities
15
Manipulation of Reserves

Revenue Recognition

10

0
1996 1997 1998 1999 2000 2001

Chart 10c2: Incidence of top 6 fraud types in Manufacturing industry,

by release date
25
Improper Disclosures
Manipulation of Assests

20 Manipulation of Expenses
Manipulation of Liabilities
Manipulation of Reserves

15 Revenue Recognition

10

0
2000 2001 2002 2003 2004 2005 2006

• Revenue recognition fraud dominates the earlier years studied, whether by scheme
date or AAER release date, with a large surge in cases arising from activity in 1997
and 1998.
• The surge in revenue recognition frauds abates earlier in the manufacturing
industry than TMT or consumer business, with such schemes dropping substantially
in 1999.
• From 1999 onward, fraud schemes in manufacturing were diverse with no single
scheme dominating.
- Notes -
- Notes -
For copies of this booklet or of the full study when
released, please contact the Deloitte Forensic Center at
www.deloitte.com/us/forensiccenter or dfc@deloitte.com

The video program discussing these findings can be viewed at

www.deloitte.com/us/forensiccenter or can be ordered from
the Deloitte Publications web site.

Document – Item # 7401

Video – Item # 7402

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