Do you know about the warning signs of financial fraud?
The Association of Certified Fraud Examiners (ACFE) states that just one case of occupational fraud can cost a business to lose an average of $1.5 million. As an accountant, it’s critical that you be familiar with the laws protecting individuals and businesses from financial fraud as well as the characteristics of fraudsters.
Gusto, along with our partners at CPA Academy, presented an edifying webinar that will enlighten you about financial fraud and detail fascinating case studies. The webinar, “Fraud: Steinhoff’s Overstated Profits & Dane Cook’s Embezzling Half Brother,” featured Greg Kyte, founder of Comedy CPE, and Caleb Newquist, editor-at-large at Gusto, and you can watch the full presentation here.
In this article, you’ll learn the details of a fascinating fraud case that occurred at Steinhoff International. It will inform you about the ACFE, as well as about the warning signs leading up to Steinhoff’s multi-billion dollar financial scandal.
ACFE and financial statement fraud
The fraud case of Steinhoff International came to light as this multinational corporation with over forty brands overstated its profits by $7.4 billion. Before we detail the intricacies and red flags of Steinhoff International’s financial statements, you first need to know about the organization that gathers statistics and characteristics of the people and companies that commit fraud.
The Association of Certified Fraud Examiners (ACFE) was founded in 1988 and is the largest anti-fraud organization in the world. The ACFE gathers information regarding fraud cases and perpetrators to inform the public about characteristics and factors they should note when dealing with organizations. Greg observed that the ACFE has collected profiling data that indicates correlations between certain behaviors and fraud:
“The Association of Certified Fraud Examiners has shown some correlations between certain characteristics in a higher likelihood for fraudulent behavior. … We’re going to take a look at these cases, specifically for internal controls that may have been missing, and to identify some [characteristics] that they could have used to have possibly either prevented the fraud or detected it earlier than they did.”– Greg Kyte
Being aware of the different signs of fraud is vital for avoiding a potential disaster. Although the Steinhoff International scandal didn’t come to light until 2017, JP Morgan Chase employees were suspicious of Steinhoff’s financial statements in 2007 because of the different fraud warning signs.
Financial statement fraud occurs when an individual or business misrepresents profits. The ACFE definition of financial statement fraud is the “deception or misrepresentation that an individual or entity makes knowing that the misrepresentation could result in some unauthorized benefit to the individual or to the entity or some other party.” Following this definition, Steinhoff International committed financial statement fraud.
The median loss from financial statement fraud is $1 million per event, so Steinhoff International’s deception of $7.4 billion is an extreme example of a company committing financial statement fraud. Greg noted that the ACFE indicates that the longer the duration of fraud committed, the greater the losses:
“According to ACFE, the average duration of a financial statement fraud is 24 months. They show that only 7% of frauds will last longer than five years, [and the Steinhoff International fraud lasted for] eight years. The other thing that they’re really clear about … [is that] the longer fraud goes on, the higher the damages that are resulting from that fraud.”– Greg Kyte
Steinhoff International deceived investors for a much greater length of time than the average company or individual who commits fraud. This resulted in significant losses and, ultimately, a $12 billion valuation write down for the company.
Account fraud case study: Steinhoff International
Steinhoff International was able to get away with deceiving investors for an extended period because of the complexities of the multinational company. The fraud resulted from corrupt leadership:
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“This was perpetrated by a small group of top executives. … It’s pretty clear that the CEO, his name is Markus Jooste, was the main [person] who was behind this whole thing, but they also identified that it wasn’t just him. There were some top executives that at least had knowledge of what was going on, if not being instrumental in pulling off the scheme.”– Greg Kyte
The ACFE indicates that 20% of fraud cases are carried out by company owners or executives. On top of that statistic, 35% of fraud cases are perpetrated by managers. Statistics indicate that the largest frauds are perpetrated by only a small number of people.
The Steinhoff International financial fraud resulted from intercompany loans that misrepresented the profits they made. Steinhoff owns numerous retail brands, so they moved money through intercompany loans to inflate its numbers:
“They used intercompany loans … to increase revenues into decreased expenses. They were booking entries to increase these loans between companies. … The complexity of Steinhoff was part of the reason why these intercompany loans happen[ed]. … They’ve got a whole bunch of different names that they can throw out there to say, ‘That’s not us—that’s a different company.’ … That’s part of what the assumption is in terms of how they got away with using that to inflate their profits by $7.4 billion. … [Loans] can just live on your books forever, too. That’s how you keep inflating profits.”– Greg Kyte
With the suspected fraud period running from at least 2009 to 2017, it’s no wonder it’s losses were so great. This is an important lesson about heeding early warning signs of a potential company or individual committing fraud. Earlier intervention could have mitigated losses.
Steinhoff International’s signs of fraud
Although it wasn’t until 2017 that Steinhoff International’s fraud was discovered, events and warning signs led up to the revelation. Members of JP Morgan Chase found Steinhoff’s numbers suspicious in 2007:
“[JP Morgan Chase employees] questioned their accounts, claiming that they lacked information regarding sources of revenue with too much focus on tax rates rather than the business itself. … What analysts do is [evaluate], ‘Hey, is this business doing good? Or is it just a bunch of smoke and mirrors?’ … When it comes to tax breaks, it feels like a lot of smoke and mirrors.”– Caleb Newquist
We don’t know if Steinhoff inflated its numbers as early as 2007, but other warning signs occurred before 2017. Greg observed that employees indicated a problematic corporate culture within Steinhoff International:
“The corporate culture at Steinhoff was that they were very aggressive, results-at-all-costs kind of company, and I think a reflection of that is when people are trying to be super aggressive and even be a bit braggadocious about their tax acumen and an exploitation of tax loopholes to minimize their taxes.”– Greg Kyte
In addition to the questionable corporate culture, German authorities seized data from Steinhoff International in 2015. Steinhoff is a South African-based company, but it was founded in Germany, and still held a significant presence in Europe.
“[The Germans] were looking for exactly what turned out [to be true]. They had enough evidence to convince them that there might be some inflated sales that they raided [the Steinhoff] offices.”– Greg Kyte
The 2015 raid gave an overwhelming indicator of questionable business practices from Steinhoff. Two years later, Steinhoff CEO Markus Jooste outright stated that he had made mistakes with the company and promptly resigned, resulting in a massive dip in stock price:
“[The stock price] immediately dropped 87%, and there was still another 10% that was coming right after that.”– Greg Kyte
The multinational audit and accounting company PricewaterhouseCoopers (PwC) conducted a 14-month investigation into Steinhoff International’s finances which detailed the inflated profits they lied about for at least eight years.
Greg and Caleb noted that there weren’t overwhelming signs of corruption through the years leading up to the Steinhoff scandal until the German government’s raid. It can be challenging for accountants to detect corrupt business practices when they occur, so it’s important to stay vigilant when dealing with businesses and individuals to avoid falling victim to fraud.
Learn more about fraud
Steinhoff International offers an extreme case of financial statement fraud, but it’s important to note that fraud is incredibly common. If you’re ready to learn more about fraud and potential warning signs detailed by the ACFE, read Part Two and Part Three of this webinar article series. You can also watch the entire webinar here.
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