30 Aug Analysis of the applicable accounting and/or audit rules
Please respond question 6 and 7 of the picture attached
The answers to the questions should include a definition of terms, analysis of the applicable
accounting and/or audit rules that may apply and an analysis of the question using the rules and
the facts. This may require the team to do some research. This case provides research in the
Reference section at the end of the case. That will give you a good start.
Also, you should integrate into the answers the concepts that you are learning from the in-class
readings where applicable. Do the reading on conspiracy and mail and wire fraud; department of justice policy and the
federal sentencing guidelines have application to Q. #7?
These are just an examples. It is not enough to simply brainstorm the case and submit some
ideas. However, I do expect your thoughts, ideas and analysis to accompany your research and
readings in the answers.
Instructions: Please read American Food Suppliers Case. All of the other information attached you will use it to support your answers. Do not use any other source. The most important attachment is 2019 US Froud Examiners Manual (like a bible). The objective of this assignment is to demonstrate that you read the material given.
Answer only questions number:
1-
2-
Guide “ Attention”
Answers must have: 1- definition of terms
2- analysis of applicable accounting and audit rules, regulations, articles that may apply.
3- analysis of the question using the rules and facts.
4-Concepts learn in class ( in power points attached)
5-Thoughts, ideas and analysis to accompany your research and readings in the answers
6- The course reading must be sited (Author name, page #) in every idea. ( this is the must important aspect of the project and it should have at least 4 citation per answer using different pdfs) You have to demonstrate that you read the all the material attached. Ex: (2019 US Froud Examiners Manual, page 2.697)
7- See ideas from different prospective (not only concepts from the book). See ideas from regulations, GAO reports, government, practitioners and court.
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U.S. Regulatory Environment Who are the regulators? How do they regulate? Self-Regulation as a Guiding Regulatory Philosophy
Federal /State/ Local
Professor Miriam F. Weismann
U.S. Constitution
Establishes a “federalist” system of government (with authority divided between the federal and state governments)
Allocates power among the three federal branches of government (legislative, executive, and judicial)
Establishes a system of “checks and balances”
The Supremacy Clause (Article V of the United States Constitution)
Provides that federal law is the “supreme law” of the United States
Any state or local law that directly conflicts with federal law is void
Preemption Doctrine—when Congress “preempts the field” of regulation, any state regulation of that field is void, even in the absence of a conflict with the federal law.
Hierarchy of Laws
U.S. Constitution
Federal Law
Treaty
Executive Order/Executive Agreement
State Law
The Commerce Clause —Authority for Federal Regulation of Business
The primary source of authority for federal regulation of business
States that the U.S. Congress has the power to “regulate Commerce with foreign Nations, and among the several States…”
Simultaneously empowers the federal government and restricts the power of state governments
State Regulation of Business
The “dormant” commerce clause:
The states may regulate commerce unless such regulation places an undue burden on interstate commerce
Nine Characteristics of A Regulatory System
GAO Report
History and Development of U.S. Regulatory System
“Reactive Legislative Model”
GAO Report
Regulatory Oversight: More or less regulation?
How to achieve credible regulatory oversight that provides meaningful control of the nations’ financial infrastructure and at the same time preserves self-regulation, innovation and growth in the marketplace?
What is credible regulatory oversight?
A function of whether the agency is doing the job that it is authorized by law to do!
Credible supervision is not credible oversight. Supervision may not uncover fraud and abuse because:
Lack of congressional authorization
External policy decisions
Market innovation outpaces regulatory control
Concealment impedes oversight
Current Regulatory Oversight Model
Hybrid of government and private sector governance
Concept of Functionality
Regulatory “Expectation” Gap
Cannot create economic policy through regulation
The Model of Business Self-Regulation
The SEC
Statement of the SEC in 2000: pre-Enron
“Self-regulation has been a cornerstone in the securities industry since the very beginning. Indeed, the fundamental principle of self-discipline predates the securities laws. At its most basic level, self-regulation is the manner in which all firms self-police their own activities to ensure that they are meeting all fiduciary and other duties to their clients.”
Self-Regulation Model
Paradigm of Self-Regulation: 1933 Securities Act and 1934 Securities and Exchange Act
Centerpiece of the corporate behavioral model of regulatory enforcement of publicly traded companies.
Regulations establish baseline ethical and legal normative standards, left to corporate discretion to implement in conformity with institutional systems of checks and balances.
Benefits of self-regulation
Standard of restraint most compatible with free market economy.
Rational choice theory: two key assumptions
First, corporations will achieve regulatory compliance through an internal system of checks and balances which can be relied upon by the regulators.
Second, the least intrusion by regulators into internal corporate affairs provides the most efficient and effective means of corporate governance and internal control practices.
Disadvantages of self-regulation
Behavioral Influences: competition and pressures from the marketplace
SRO conflict of interest: need to self-protect
“shotgun behind the door” because of breakdowns in self-policing
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Introduction and Overview of the Justice System Corporate Existence and Liability Fraud and Internal Controls
Week #1 Part #1
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Federal Court Jurisdiction: Limited Jurisdiction
The term jurisdiction means the power to adjudicate. As the framers wrote the Constitution, some feared that the federal courts might threaten the independence of the states and the people. To combat this fear the framers set up a federal court system that can only hear cases in special circumstances. This is called courts of limited jurisdiction. Since the federal courts can only hear certain kinds of cases, most of the day-to-day cases that courts deal with happen in state courts.
Basically, federal courts hear only 2 types of cases; those that raise a federal question and those involving lawsuits between citizens of different states known as diversity of jurisdiction.
Also, all criminal tax cases are federal question jurisdiction arising under Title 18 or Title 26 of the U.S. Code. So, all criminal federal tax cases are filed in the federal district court.
Additional some civil tax cases are heard in the federal courts as well.
State Court Jurisdiction: General Jurisdiction
General Jurisdiction
The Tenth Amendment provides that “powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people.”
The ultimate effect these provisions have upon state courts is to reserve to them the right to hear and decide any legal matter not expressly reserved for the exclusive jurisdiction of federal courts (such as lawsuits between states).
Thus, state courts are courts of general jurisdiction. They hear all the cases not specifically selected for federal courts. Just as the federal courts interpret federal laws, state courts interpret state laws. Each state gets to make and interpret its own laws. This helps the states retain power, and makes sure that the national government does not become too strong.
The Tax Court: An Inferior Court
The United States Tax Court is a federal trial court of record established by Congress under Article I of the U.S. Constitution, section 8 of which provides (in part) that the Congress has the power to "constitute Tribunals inferior to the supreme Court".
When the taxpayer is called for an audit, the taxpayer has two choices: agree with the IRS or disagree.
If the taxpayer agrees, the case is over. If the taxpayer disagrees, the IRS sends the taxpayer a "notice of deficiency" (also called a 90-day Letter), stating the adjustments that the Service wants to make to the tax return. The taxpayer then has 90 days to file a petition with the Tax Court. If not filed within 90 days, the taxpayer has agreed with the IRS.
By going to the Tax Court, the taxpayer is suing the IRS in court.
The Tax Court consists of 19 judges who travel the circuit to all 50 states. Tax Court cases do not get tried before a jury. In a regular Tax Court case, if the taxpayer loses, the taxpayer can file an appeal in the federal US Court of Appeals in the district; 90 days to file this appeal.
The U.S. Court of Federal Claims
The United States Court of Federal Claims is a court of record with national jurisdiction. The court consists of sixteen judges nominated by the President and confirmed by the Senate for a term of fifteen years.
The Court of Federal Claims is authorized to hear primarily money claims founded upon the Constitution, federal statutes, executive regulations, or contracts, express or implied in fact, with the United States.
Many cases before the court involve tax refund suits, an area in which the court exercises concurrent jurisdiction with the United States district courts. The cases generally involve complex factual and statutory construction issues in tax law.
CORPORATE EXISTENCE AND LIABILITY The Organization and the Players
An exercise in legal fiction and self-regulation
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Theory of Respondeat Superior
Acts done by the agents of a corporation, in the course of its business and of their employment are imputed to the corporation. Thus, the corporation is responsible in the same manner and to the same extent as an individual is responsible under similar circumstances.
A “Legal Fiction”
Prior to the industrial revolution: it was not an entity subject to suit; in other words, not a legal “person”
In 1858, the S.Ct. recognized that corporations were legal persons who could sue and be sued in civil cases
In 1909, Congress enacted the corporate income tax subjecting corporations to taxation independent of ownership (system of double taxation)
In 1909, in New York Central and Hudson River RR the S. Ct. held that corporations were subject to criminal prosecution under the theory: respondeat superior
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At the common law, there was no such thing as the separate existence of a legal being known as a corporation. What do I mean by this? It was not a legal entity that could sue or be sued. It did not exist separate and apart from the business transaction.The sovereign had the power to issue a corporate charter for special privilege under the king but that was the sum and substance of its existence.
The Klein and Coffee text has a very interesting explanation of the historical development of corporations in the US post American Revolution and post turn of the century industrial revolution.
Why is a corporation referred to as a legal fiction?
Because it is treated as a legal person separate from its owner. It is a fictional person meaning that it is subject to taxation and it may sue and be sued just like a natural person. Today we might call this fictional person a virtual person. Same idea.
Go over history in slide
Liability Theory of Corporate Civil and Criminal Responsibility
Strict Liability based upon Respondeat Superior Supreme Court’s decision in New York Central & Hudson River R.R. v. United States (1909).
Applied the civil tort concept of respondeat superior to criminal corporate liability: “[i]f the act was…done [by a corporate employee] it will be imputed to the corporation…There is no distinction any longer in essence between the civil and criminal liability of corporations, based upon the element of intent or wrongful purpose.”
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212 U.S. 481, 494-95 (1909)
What were the facts in NY Central & Hudson River RR?
Corporations, while artificial in nature, are “legal persons” capable of suing and being sued, and capable of committing crimes.
No Guilty Mind
Strict Liability means that the law dispenses with the mens rea, the guilty mind
Significance: common law requirement that every crime consist of a mens rea, the guilty mind, and the actus reus, the unlawful act
The corporation is strictly liable for the acts of its agents performed during the course of agent’s employment
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This leads us back to the theory of strict liability.
So, what does our legal fiction look like in terms of its basic legal structure and capital structure. This is valuable to study not only interms of this course but also in terms of understanding the functions of business entities generally. By the way feel free to contribute to the discussion along the way.
Basic Structure of A Corporation
Formal structure for control and operations is defined by 3 groups:
shareholders or stockholders
directors or board of directors
officers
Characteristics of Shareholders
Ownership of the corporation
Buy shares and collectively own the equity of the company
Ownership interest entitles them to earnings and appreciation in the value of the corporation’s assets
Key reason: no individual liability for the debts of the corporation
Control the company by electing a board of directors to supervise and control day to day affairs through hiring officers
More about shareholders
Officers are accountable to the directors and both are accountable to shareholders
But shareholders only act through the directors and do so by voting their shares of stock
Neither agents nor principles of the corporation, so…they have no power to bind the corporation
Directors
The business “shall be managed by or under the direction of the board of directors”
Principle responsibility is to hire management (officers) and supervise
No inherent authority to bind the corporation and act through resolutions voted on and approved by the full board
Fiduciary Duty is owed to the corporation and its shareholders: Duty of Care and Duty of Loyalty
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It is the breach of their fiduciary duty that exposes the board to legal exposure.
Fiduciary Duty: Central Organizing Principle of Corporate Self Governance
A business is carried organized and carried on primarily for the profit of the shareholders. The powers of the directors and officers are to be employed for that end.
Principle of “Shareholder Wealth Maximization”
Key concept: “Artificial entities are about stewardship.”
Trust is the foundation to modern capitalism and the baseline principle of stewardship model of corporate governance
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p. 893, 895/Kuney. Stewardship as a key concept. As part of the duty of care and the duty of loyalty to the shs, is the board’s responsibility along with management to ensure that the company’s financial statements which are presented to shs and the investing public fairly represent the financial condition of the company. That means more than technical compliance with GAAP. This point is reflected in fn 9 of the Kuney article and is a statement taken from the Powers report which you have. The Powers report is the results of the Enron bd of directors own internal investigation. There is a name for this principle and that is transparency. You will see it repeated in the Greenspan speech and in other parts of your readings. The idea that real transparency is not just a disclosure of facts that technically comply with accounting or ethics rules, but which fairly represent what is actually going on inside the company.
-loss of trust in the stewardship is what necessitated SOX. Investor psychology; the need to recreate lost sense of security in the marketplace. I am in complete agreement that SOX was unescessay and I published a whole article about it.
Two Prongs
Duty of care includes 2 parts: decision-making duty and oversight duty
Duty of loyalty is to act in good faith with respect to all matters of the corporation and the shareholders and to avoid any self dealing or usurpation of corporate opportunities.
The Relationship Between Fiduciary Duty and Economics
System of Capitalism based on free markets and natural market forces
No regulatory interference in the market place… distorts capitalism
Common law notion of fiduciary duty serves as the central organizing principle of corporate self regulation
Economics Determines Self-Regulatory Model of Corporate Governance
This was embedded in several legislative models including the securities laws.
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Officers
Officers and other employees of the company are agents and can bind the corporation by their acts.
Authority to act comes from the directors and there must be board approval for business decisions that are not otherwise part of the day-to-day affairs or in the ordinary course of business.
Role as managers
Doctrine of Apparent Authority
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Apparent authority: If the corporation creates the impression to the outside world that the agent had the actual delegated authority to act, then even if the agent doesn’t, the corporation is bound by his acts
Business Judgment Rule
Limits the ability of the courts to second guess the business decisions of the board and the officers.
A policy of non-judicial review: American courts will not review the business judgment of corporate directors, even the bad ones, unless there is a claim that the directors’ violated their fiduciary duty of care. Does not apply to duty of loyalty.
Courts will not substitute their own judgment of sound business practices unless the presumption of regularity is rebutted.
Formation of a Corporation
Articles of Incorporation
Designate shares issued, identity of directors, principal place of business and registered agent
Subchapter S election (avoids double taxation problem)
Why do companies pick Delaware as the place to incorporate?
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Subch S election allows the tax attributes to flow through to the individual taxpayer.
Characteristics
Unlimited life (unless dissolved by the shareholders or by court order)
Shares are freely transferable (unless agreed otherwise)
Change of shareholder identity does not impact existence (ie: partnerships: changes in identity dissolve the partnership)
Types of Corporations
Closely Held: usually fewer than 10 shareholders; shared identity as shareholders, directors and managers.
-reasons: limited liability, unlimited life and subs election
Publicly traded: must register with the SEC; traded on exchanges
-reasons: principle purpose of an issuance is to raise capital (primary and secondary markets)
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Co-issuer of stock uses an investment advisor for an issuance in a primary market. Issuer retains an investment banker that specializes in underwriting the issuance. The underwriter sells directly purchasers solicited by the underwriter who gets a fee or commission on every sale. Here is where the problems begin. (Go to Weismann article: On the road shows) Kuney article really explains the conflict of interest well. Pp.384-85. No ethical wall between investment banking operations (raising money for the issuer) and the securities analysis practice ( rates securities based on risk for 3rd party investors). Read cite. Take a look at fn 40, further conflicts of interest wit investment bankers. P.885
All other transactions between shareholders occurs in the secondary markets
Make sure we understand that the new accounting and ethics rules and SOX itself only apply to publicly traded companies.
Securities Markets
Biggest secondary markets: NY Stock Exchange (NYSE) and the American Stock Exchange (AMEX)
Over-the-counter market (OTC): electronic trading in lieu of a physical market (Nasdaq)
What constitutes a crime?
Mens rea: What does someone have to be thinking to commit the crime?
Actus reus: What does someone have to be doing to commit the crime?
Both need to happen simultaneously
Statutory based definitions
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How does corporate culture facilitate fraud?
Corporate culture is intrinsically tied to the regulatory environment in which it exists
Tied to the economic theory of managerial capitalism
Regulatory philosophy embedded in the law
Self-Regulation
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Behavioral models of white collar crime: Rational Choice Theory
Rational Choice Theory: Crime by Choice
The cost/benefit analysis
Lure and opportunity
Common denominator: FRAUD
How have auditors been challenged to discover fraud?
SOX 108(d) and SAS 99
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Statement on Auditing Standards (SAS) 99: Consideration of Fraud in a Financial Statement Audit An auditing statement issued by the Auditing Standards Board of the American Institute of Certified Public Accountants (AICPA) in October 2002.
An Exercise in rational Choice Theory The Fraud Triangle
SAS 99: Fraud Conditions (“Fraud Triangle”)
Incentive
(Pressure)
Opportunity Rationalization
(Attitude)
Responding to the Risk of Fraud in the Audit Process Overall Requirement: Professional Skepticism
An audit should be planned and performed to obtain reasonable assurance about whether the financial statements are free of material misstatements, whether caused by error or fraud.
An audit requires due professional care, which in turn requires that the auditor exercise professional skepticism.
Causes of Misstatements
Causes
Errors Fraud
Fraudulent Misappropriation
Financial of Assets
Reporting
Two Types of Fraud Considered in an Audit
Fraudulent financial reporting (“cooking the books”)–examples
Falsification of accounting records
Omissions of transactions
Misappropriation of assets–examples:
Theft of assets
Fraudulent expenditures
Professional Skepticism
An attitude that includes a questioning mind and a critical assessment of audit evidence
The engagement should be conducted recognizing possibility of material misstatement due to fraud
An auditor should not be satisfied with less than persuasive evidence
SAS 99 Checklist: Steps involved in Considering the Risk of Fraud
Staff discussion
Obtain information needed to identify risks
Identify risks
Assess identified risks
Respond to results of assessment
Evaluate audit evidence
Communicate about fraud
Document consideration of fraud
Step 7—Communicate about Fraud
Communicate
All fraud to an appropriate level of management
All management fraud to audit committee
All material fraud to management and audit committee
Determine if reportable conditions related to internal control have been identified; communicate them to the audit committee
Public companies that are required by the Securities and Exchange Commission to use a “suitable” framework are widely expected to update their internal controls over financial reporting to the new COSO framework after COSO officials put its old framework to pasture in December 2014. Private companies are not subject to the same requirement to report on the effectiveness of their internal controls. The SEC has said the longer a public company waits to adopt the new framework, the more likely it will face questions from regulators.
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