Fraud at Trio Capital - Thesis Example

Name: Tutor: Course and Code: Date: Introduction Trio Capital was plagued by superannuation fraud, which resulted in loss amounting to $122 million. An inquiry into the fraud by a Parliamentary Joint Committee on Corporations and Financial Services revealed that a number of organised crime entities had targeted the Australian superannuation savings. Part I of article examines fraud at Trio capital. It also applies the fraud triangle to explain the cause of the fraud (Incentives, opportunities, rationalisation). Further, it discusses how the company’s system of internal control and the system of risk management might have prevented and detected the fraud. Part II of the article prepares a horizontal and vertical analysis of the balance sheet for the Sharp & Shady Company. Based on the results from the horizontal and vertical analysis, it describes the relationships that appear unusual and gives opinion on the fraud schemes which might have caused these unusual relationships. PART I Fraud of Trio Capital Trio Capital was plagued by superannuation fraud, which resulted in loss amounting to $122 million. An inquiry into the fraud by a Parliamentary Joint Committee on Corporations and Financial Services revealed that a number of organised crime entities had targeted the Australian superannuation savings. The fraud basically involved early release scams, where fraudsters promised victims access to their funds before required legal release age. The victims’ superannuation funds were afterwards packaged into a self-managed fund, allowing the fraudsters to access the entire amount, or submit to the victims the funds after subtracting substantial amounts (Australian Crime Commission n.p). Australia had one of the largest superannuation funds saving pools globally, many Australians were disengaged from their savings. In addition, superannuation funds were a product of compulsory superannuation system of many youths who had low balances. Further, investors were incapable of accessing their funds until they had retired. Because of these, many individuals paid little attention to how their funds performed. At Trip Capital, false account statements called ‘Member Benefits Statement’ were created for many years, and since the account holders had no reason to withdraw their money, the fraud went on for many years without being discovered (ASIC 2-4). According to a report by the Department of Treasury (5), the fraud started when the managed investment scheme (MIS) was initiated. The trustees, investors and directors were incessantly deceived throughout the period MIS operated, with regard to the actual existence of the supposed rates of return on investment and the assets. Despite the conduct of a number of financial planners who appeared to have been motivated by the higher commissions by recommending clients into the Trio Capital Products, the Fraud was prevalent in off shore hedge accounts. Australian managed investment schemes and superannuation funds commonly invested overseas. However, the major risk was that investing overseas opened up potentials for fraud since the jurisdictions abroad had less strict regulatory regimes. This led to exposures to theft of rollover funds, use of identity theft to steal funds and ‘phisher’ attacks. Fraud triangle A common preferred model that explains the causes of fraud in an organization is the fraud triangle. According to the model, three factors have to be present in order for a fraud to occur. These include incentives (pressure), opportunities and rationalization (Turner, Mock and Srivastava 3). Pressure Also known as incentive or perceived non-sharable financial need, pressure is what motivates the crime from the outset (Wolfe and Hermanson n.p.). In the case of Trio Capital, the fraudsters must have been faced by some financial problems that they were unable to solve through any legitimate means (see Figure 1). Consequently, the fraudster considered stealing the superannuation funds through phases, identity thefts or falsifying documents to solve their financial problems. According to the theory, the financial problems could either be personal, such as financial debts, or professional such as job insecurity (Turner, Mock and Srivastava 3). Figure 1: Financial Triangle (Turner, Mock and Srivastava 1) Opportunity Opportunity is the second leg of the fraud triangle. Opportunity refers to the method that can be used to commit the crime. In the case of Trio Capital, the fraudsters conjured a means to steal the superannuation funds after MIS was instituted. The fraudsters have to use their position and influence as trustees to solve their financial problems with minimal perceived risk of getting caught. In this case, the fraudsters had to solve their financial problems in secret. The Trio Capital Fraud became one of the major cases of fraud in Australia’s superannuation system since the responsibility of the management of the superannuation funds lay with the trustees of the fund. The trustees were either self-managed superannuation fund (SMSF) trustees, or were either regulated by the Australian Prudential Regulation Authority. This means that the trustees were able to steal the funds because of their positions (Anon 2-3). Rationalisation Rationalisation is the third leg of the fraud triangle. The fraud triangle model hypothesises that the majority of the fraudsters are usually first-time offenders with no criminal records. Generally, they are therefore not viewed as criminals (Turner, Mock and Srivastava 3). The fraudsters also view themselves as honest and ordinary people who are caught up in unfortunate state of circumstances. In the case of Trio Capital, since the fraudsters did not view themselves as criminals, they are forced to justify the crime to themselves in a way that makes it justifiable and acceptable. This process is known as rationalisation (Anon 2-3). The model points out that the perpetrator must first rationalise the crime to himself before committing the fraud. How the company’s system of internal control and the system of risk management might have prevented and detected the fraud. The company’s system of internal control and risk management could have prevented and detected the fraud at an early stage. Trio capital should also have had an effective deterrence program in place that targeted the three components of the Fraud Triangle. These included reducing pressures on its employees and the trustees that could push them into commissioning the fraud. A possible way would be through higher wages and easy access to loan facilities. Second, Trio Capital should have reduced opportunities to commit the fraud. In the case of Trio Capital, the fraud was complex in nature. Trio Capital should have had a system in place that allows the Australian authorities to monitor their savings. This is since Australia’s superannuation fund was one of the largest globally. Hence, disengaging Australians from their savings, many young people had low balances and could only access the funds once they retired. Trio Capital should also have set out strict and effective compliance plans and audits to oversee the transfer to investment in foreign accounts that had less stringent regulatory regimes. The standards of compliance should also have set out auditing of accounts of the managed investment scheme (MIS), which provided a leeway for frauds. Third, Trio Capital should also have dispelled rationalisations among the trustees and its employees for engaging in the fraud. This could have been ensured in the early stages after the auditing process uncovered some misappropriations. Punishing the early fraudsters would have made the employees and the trustees to see their actions as punishable and unjustified. PART II Horizontal Analysis Overview Horizontal analysis refers to the evaluation of the historical financial data of a business over a series of years, or reporting period (Accounting Toolsa). It also refers to the comparison of ratios derived from a balance sheet. Specific items are compared over the specified accounting periods. For instance, the accounts payable can be evaluated over a fiscal year. The objective of the analysis is to determine the change in amounts and percentages over a series of financial years. The method allows for assessment of the relative revenues and behaviors of expenses over time. The changes are indicated in percentage and in dollars, using the formula (Bushman 3-6). The horizontal analysis for Sharp & Shady company over three periods, X, Y and Z, are performed on the company’s balance sheet, with references to items including expenses, revenues, profits, sale of goods and cash, and cash equivalent. Table 1: Absolute figures for horizontal analysis Table 2: Negative and Positive Changes Table 3: Horizontal Analysis Vertical Analysis Vertical analysis can be used to evaluate separate figures to a single specific figure in a financial statement (AccountingTools). In sum, this method compares a number of items to one specific item within the same accounting period. The comparison is then reported as percentage. In conducting vertical analysis of a balance sheet, each item in the balance sheet is compared to total asset. Each item is then presented as a percentage of the total assets. The vertical analysis for or Sharp & Shady company over three periods, X, Y and Z, is presented below. Fraud Red Flags Financial statement red flags provide a general overview of the warning signs investors should take note of. Several accounting anomalies are noted. This includes decreasing cash trend without corresponding accounts receivable (Anon 3-4). The two should move more or less in tandem. This is because the company generates sales since it sells products. Since the products had to be manufactured or purchased, they involved expenditures for labour or raw materials. In this case, for each sale, an associated cost must exist. Hence, if sales increase, the cost of goods sold should increase proportionally. However, there are cases where the company might have adopted more efficient method or selling its products or manufacturing, hence reducing the cost. However, there are still costs associated with the sales (ACFE n.p.). There is sharp increase and then sudden fall in accounts receivable trade in addition to growing inventories. This may show outdated goods that the company records fictitiously for future sales. When a business makes sales, then the company will move the products to the customer before the customer pays. This results in account receivable for the company. This implies that the relationship between the accounts receivable and sales is directly proportional. In this case, if sales increase, then it means that the accounts receivable should as well increase at almost the same rate (Grove and Cook 133-135). Concerning sales and inventory, the company’s inventory involved the products that are ready to be sold. Typically, a company will often anticipate the demand by having sufficient supply of inventory (Grove and Cook 133-135). This means that, the inventory will often reflect the sales. When the sales increase, then the inventory should increase to meet the demands of sale. However, in period Z, inventory grows at a much faster pace than the sales. This might be an indicator of an overstated inventory. In conclusion, the horizontal and vertical analysis has helped discover and examine unexpected relationships in Sharp and Shady Company’s financial statement. These two analytical techniques are based on the premise that a comparatively stable relationship must exists in the financial transactions. Further, the known contrary conditions that may cause the inconsistent relationships include unusual transactions. Both the analytical procedures can help to analyse the unexpected differences in business transactions, lack of expected differences, some potential errors, non-recurring transactions and most importantly, potential fraud acts. Works Cited AccountingTool. Horizontal Analysis. 2012a. 30 Sept 2013 AccountingTools. Vertical Analysis. 2012b. 30 Sept 2013 ACFE. How To Detect And Prevent Financial Statement Fraud. 2009. 30 Sept 2013 Anon. Detecting Fraud in Financial Reporting. Ch4. 2004. 30 Sept 2013 Anon. Understanding Why Employees Commit Fraud, 2007. 30 Sept 2013 ASIC. PJC Inquiry into the collapse of Trio Capital Limited Submission by the Australian Securities and Investments Commission, 2011. 30 Sept 2013 Australian Crime Commission. Frauds. 2013. 30 Sept 2013 Bushman, Mellisa. Financial Statement Analysis Methods: Horizontal vs. Vertical Analysis, 2007. 30 Sept 2013 Department of Treasury. Review of the Trio Capital Fraud And Assessment Of The Regulatory Framework, 2013. 30 Sept 2013 Grove, Hugh and Tom Cook. "Lessons for Auditors: Quantitative and Qualitative Red Flags." Journal of Forensic Accounting, 5. 1 (2004): 131-146 Turner, Jerry, Theodore Mock and Rajendra Srivastava. An Analysis of the Fraud Triangle, 2003. 30 Sept 2013 Wolfe, David and Dana Hermanson. The Fraud Diamond: Considering the Four Elements of Fraud. The New York State Society of CPAs, 2004. 30 Sept 2013 Read More