ACC 571 Final, Part 2 Open Book, Open Notes 1.

Describe the composition of the Security and Exchange Commission. The U.S. Securities and Exchange Commission (frequently abbreviated SEC) is a federal agency[2] which holds primary responsibility for enforcing the federal securities laws and regulating the securities industry, the nation's stock and options exchanges, and other electronic securities markets in the United States. In addition to the 1934 Act that created it, the SEC enforces the Securities Act of 1933, the Trust Indenture Act of 1939, the Investment Company Act of 1940, the Investment Advisers Act of 1940, the Sarbanes-Oxley Act of 2002 and other statutes. The SEC was created by section 4 of the Securities Exchange Act of 1934 (now codified as 15 U.S.C. 78d and commonly referred to as the 1934 Act). The SECs composition is as follows: The SEC has five Commissioners who are appointed by the President of the United States with the advice and consent of the Senate. No more than three can be from a single political party. Each commissioner serves a fiveyear term, which is staggered so that one commissioner's term ends on June 5 of each year. Currently the SEC commissioners are chairman Mary L. Schapiro, Kathleen L. Casey, Elisse B. Walter, Luis A. Aguilar and Troy A. Paredes. 2. What are some of the enhanced financial disclosures under Section IV of SOX? ccording to Wiki leaks, the following are the enhanced financial disclosures under Section IV of SOX:

SEC. 401. DISCLOSURES IN PERIODIC REPORTS.

(a) DISCLOSURES REQUIRED Section 13 of the Securities Exchange Act of 1934 (15 U.S.C. 78m) is amended by adding at the end the following: ``(i) ACCURACY OF FINANCIAL REPORTS Each financial report that contains financial statements, and that is required to be prepared in accordance with (or reconciled to) generally accepted accounting principles under this title and filed with the Commission shall reflect all material correcting adjustments that have been identified by a registered public accounting firm in accordance with generally accepted accounting principles and the rules and regulations of the Commission. ``(j) OFF-BALANCE SHEET TRANSACTIONS Not later than 180 days after the date of enactment of the Sarbanes-Oxley Act of 2002, the Commission shall issue final rules providing that each annual and quarterly financial report required to be filed with the Commission shall disclose all material off-balance sheet transactions, arrangements, obligations (including contingent obligations), and other relationships of the issuer with unconsolidated entities or other persons, that

may have a material current or future effect on financial condition, changes in financial condition, results of operations, liquidity, capital expenditures, capital resources, or significant components of revenues or expenses..

SEC. 403. DISCLOSURES OF TRANSACTIONS INVOLVING MANAGEMENT AND PRINCIPAL STOCKHOLDERS.

(a) AMENDMENT Section 16 of the Securities Exchange Act of 1934 (15 U.S.C. 78p) is amended by striking the heading of such section and subsection (a) and inserting the following: ``SEC. 16. DIRECTORS, OFFICERS, AND PRINCIPAL STOCKHOLDERS. ``(a) DISCLOSURES REQUIRED ``(1) DIRECTORS, OFFICERS, AND PRINCIPAL STOCKHOLDERS REQUIRED TO FILE Every person who is directly or indirectly the beneficial owner of more than 10 percent of any class of any equity security (other than an exempted security) which is registered pursuant to section 12, or who is a director or an officer of the issuer of such security, shall file the statements required by this subsection with the Commission (and, if such security is registered on a national securities exchange, also with the exchange). ``(2) TIME OF FILING The statements required by this subsection shall be filed ``(A) at the time of the registration of such security on a national securities exchange or by the effective date of a registration statement filed pursuant to section 12(g); ``(B) within 10 days after he or she becomes such beneficial owner, director, or officer; ``(C) if there has been a change in such ownership, or if such person shall have purchased or sold a security-based swap agreement (as defined in section 206(b) of the Gramm-Leach-Bliley Act (15 U.S.C. 78c note)) involving such equity security, before the end of the second business day following the day on which the subject transaction has been executed, or at such other time as the Commission shall establish, by rule, in any case in which the Commission determines that such 2-day period is not feasible. ``(3) CONTENTS OF STATEMENTS A statement filed ``(A) under subparagraph (A) or (B) of paragraph (2) shall contain a statement of the amount of all equity securities of such issuer of which the filing person is the beneficial owner; and ``(B) under subparagraph (C) of such paragraph shall indicate ownership by the filing person at the date of filing, any such changes in such ownership, and such purchases and sales of the security-based swap agreements as have occurred since the most recent such filing under such subparagraph. ``(4) ELECTRONIC FILING AND AVAILABILITY Beginning not later than 1 year after the date of enactment of the Sarbanes-Oxley Act of 2002 ``(A) a statement filed under subparagraph (C) of paragraph (2) shall be filed electronically;

``(B) the Commission shall provide each such statement on a publicly accessible Internet site not later than the end of the business day following that filing; and ``(C) the issuer (if the issuer maintains a corporate website) shall provide that statement on that corporate website, not later than the end of the business day following that filing.. (b) EFFECTIVE DATE The amendment made by this section shall be effective 30 days after the date of the enactment of this Act.

SEC. 404. MANAGEMENT ASSESSMENT OF INTERNAL CONTROLS.

(a) RULES REQUIRED The Commission shall prescribe rules requiring each annual report required by section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)) to contain an internal control report, which shall (1) state the responsibility of management for establishing and maintaining an adequate internal control structure and procedures for financial reporting; and (2) contain an assessment, as of the end of the most recent fiscal year of the issuer, of the effectiveness of the internal control structure and procedures of the issuer for financial reporting. (b) INTERNAL CONTROL EVALUATION AND REPORTING With respect to the internal control assessment required by subsection (a), each registered public accounting firm that prepares or issues the audit report for the issuer shall attest to, and report on, the assessment made by the management of the issuer. An attestation made under this subsection shall be made in accordance with standards for attestation engagements issued or adopted by the Board. Any such attestation shall not be the subject of a separate engagement.

SEC. 406. CODE OF ETHICS FOR SENIOR FINANCIAL OFFICERS.

(a) CODE OF ETHICS DISCLOSURE The Commission shall issue rules to require each issuer, together with periodic reports required pursuant to section 13(a) or 15(d) of the Securities Exchange Act of 1934, to disclose whether or not, and if not, the reason therefor, such issuer has adopted a code of ethics for senior financial officers, applicable to its principal financial officer and conroller or principal accounting officer, or persons performing similar functions. (b) CHANGES IN CODES OF ETHICS The Commission shall revise its regulations concerning matters requiring prompt disclosure on Form 8-K (or any successor thereto) to require the immediate disclosure, by means of the filing of such form, dissemination by the Internet or by other electronic means, by any issuer of any change in or waiver of the code of ethics for senior financial officers. (c) DEFINITION In this section, the term ``code of ethics means such standards as are reasonably necessary to promote

(1) honest and ethical conduct, including the ethical handling of actual or apparent conflicts of interest between personal and professional relationships; (2) full, fair, accurate, timely, and understandable disclosure in the periodic reports required to be filed by the issuer; and (3) compliance with applicable governmental rules and regulations. (d) DEADLINE FOR RULEMAKING The Commission shall (1) propose rules to implement this section, not later than 90 days after the date of enactment of this Act; and (2) issue final rules to implement this section, not later than 180 days after that date of enactment.

SEC. 407. DISCLOSURE OF AUDIT COMMITTEE FINANCIAL EXPERT.

(a) RULES DEFINING ``FINANCIAL EXPERT The Commission shall issue rules, as necessary or appropriate in the public interest and consistent with the protection of investors, to require each issuer, together with periodic reports required pursuant to sections 13(a) and 15(d) of the Securities Exchange Act of 1934, to disclose whether or not, and if not, the reasons therefor, the audit committee of that issuer is comprised of at least 1 member who is a financial expert, as such term is defined by the Commission. (b) CONSIDERATIONS In defining the term ``financial expert for purposes of subsection (a), the Commission shall consider whether a person has, through education and experience as a public accountant or auditor or a principal financial officer, comptroller, or principal accounting officer of an issuer, or from a position involving the performance of similar functions (1) an understanding of generally accepted accounting principles and financial statements; (2) experience in (A) the preparation or auditing of financial statements of generally comparable issuers; and (B) the application of such principles in connection with the accounting for estimates, accruals, and reserves; (3) experience with internal accounting controls; and (4) an understanding of audit committee functions. (c) DEADLINE FOR RULEMAKING The Commission shall (1) propose rules to implement this section, not later than 90 days after the date of enactment of this Act; and (2) issue final rules to implement this section, not later than 180 days after that date of enactment.

SEC. 408. ENHANCED REVIEW OF PERIODIC DISCLOSURES BY ISSUERS.

(a) REGULAR AND SYSTEMATIC REVIEW

The Commission shall review disclosures made by issuers reporting under section 13(a) of the Securities Exchange Act of 1934 (including reports filed on Form 10K), and which have a class of securities listed on a national securities exchange or traded on an automated quotation facility of a national securities association, on a regular and systematic basis for the protection of investors. Such review shall include a review of an issuer's financial statement. (b) REVIEW CRITERIA For purposes of scheduling the reviews required by subsection (a), the Commission shall consider, among other factors (1) issuers that have issued material restatements of financial results; (2) issuers that experience significant volatility in their stock price as compared to other issuers; (3) issuers with the largest market capitalization; (4) emerging companies with disparities in price to earning ratios; (5) issuers whose operations significantly affect any material sector of the economy; and (6) any other factors that the Commission may consider relevant. (c) MINIMUM REVIEW PERIOD In no event shall an issuer required to file reports under section 13(a) or 15(d) of the Securities Exchange Act of 1934 be reviewed under this section less frequently than once every 3 years.

SEC. 409. REAL TIME ISSUER DISCLOSURES.

Section 13 of the Securities Exchange Act of 1934 (15 U.S.C. 78m), as amended by this Act, is amended by adding at the end the following: ``(l) REAL TIME ISSUER DISCLOSURES Each issuer reporting under section 13(a) or 15(d) shall disclose to the public on a rapid and current basis such additional information concerning material changes in the financial condition or operations of the issuer, in plain English, which may include trend and qualitative information and graphic presentations, as the Commission determines, by rule, is necessary or useful for the protection of investors and in the public interest.. 3. How does a forensic scientist establish forensic identification? Forensic scientists analyze the physical evidence they receive from police, and then prepare reports describing the results of their analysis. Those documents, along with forensic scientists expert testimony, can be important prosecutorial tools for convicting the accused. Analyzing evidence. Whenever a crime is committed, police try to preserve the scene until an investigator collects every piece of evidencelike hair and fiber samples, pieces of clothing, or other personal belongingsthat might provide clues to solving the case. The evidence is then turned over to forensic scientists for analysis. Their analyses involve a variety of sciences, mathematical principles, and problem-solving methods, including use of complex instruments; chemical, physical, and microscopic examining techniques;

and reference literature. Forensic scientists can thus use physical evidence to determine the make, model, year, and, ultimately, identity of the car involved in a crimeand through further analysis can also tell which way the car was facing, how it pulled away from the crime scene, and in which direction. Some forensic scientists are generalists; others specialize in a particular area of laboratory analyses. Persons employed in large laboratories tend to specialize. Most crime lab professionals work in one or more of the following areas. Controlled substances and toxicology. Crime lab professionals specializing in this area examine blood and other body fluids and tissues for the presence of alcohol, drugs, and poisons. Biology. Crime lab professionals compare body fluids and hair for typing factors, including DNA analysis. DNA analysis determines how frequently parts of a persons genetic code are found in the population; forensic scientists isolate DNA strands from an individuals body fluids to compare that persons unique DNA to the DNA of a sample of others. Chemistry. Forensic scientists analyze trace physical evidence such as blood spatters, paint, soil, and glass. For example, blood spatters help reconstruct a crime scene: The patterns of spatters and the shapes of blood droplets tell how the crime was committed. Document examination. Document examination includes many areas of expertise, including forgery, document dating, and analysis of handwriting, typewriting, and computer printing, and photocopying. Firearms and Toolmark identification. Firearms examination involves matching identifying characteristics between a firearm and projectile and between a projectile and target. Typically, this includes matching bullets to the gun that fired them. Toolmark identification involves matching some identifying characteristics of a tool, such as a pry bar, to the object on which it was used, such as a door frame. It also includes explosives and imprint evidence. Psychophysical detection of deception exam. The psychophysical detection of deception exam (formerly known as the polygraph) is based on the scientific theory that when telling a lie, a persons body responds in a certain way despite any attempts to avoid detection. Forensic scientists use special equipment to measure changes to internal body functions including breathing, blood pressure, and pulse ratein response to their questions and then analyze the results. 4. Describe some types of physical evidence. A successful crime investigation depends upon the collection and analysis of various kinds of evidence. Forensic scientists classify evidence in different ways and have specific ways of dealing with it. One major distinction is between physical and biological evidence. Physical evidence refers to any item that comes from a nonliving origin, while

biological evidence always originates from a living being. The most important kinds of physical evidence are fingerprints, tire marks, footprints, fibers, paint, and building materials. Biological evidence includes bloodstains and DNA. Impression marks are another important kind of physical evidence. When an item like a shoe or a tire comes into contact with a soft surface, it leaves behind a pattern showing some or all of its surface characteristics, known as an impression. The collection and analysis of impression evidence found at the scene of a crime can often be very important to an investigation. Fingerprints are perhaps the most significant type of physical evidence in most crimes. The technology of collecting and analyzing fingerprints has been well known for over a century and has been refined over the years. A fingerprint is important as individualizing evidence. It can tie a specific person to a crime, because no two individuals have ever been found to have the same fingerprint. If a fingerprint from the scene of a crime can be linked to one in a database or from a suspect, then an identification can be made. Other kinds of physical evidence such as tire tracks and shoeprints are class evidence, rather than individualizing, evidence. This means that on its own such evidence may not be enough to convict. A shoe print taken from a relatively new shoe merely suggests the make, style, and maybe the size of a shoe. 5. What are some of the financial statement fraud differences between large and small businesses? Financial statement fraud involves the intentional publishing of false information in any portion of a financial statement. It usually occurs when a company overstates assets or revenue, or when it understates liabilities and expenses. Oftentimes stockholders, employees and investors are kept completely in the dark about the value of corporate assets and the existence of liabilities when such a fraud is taking place. However, there differences in financial statement fraud between small and large businesses. Financial statement frauds in large businesses are more complex and sophisticated to an extent that they are obscured by relying on various interpretations of accounting standards used in preparing the financial statements. Financial statement frauds in small businesses are not sophisticated but very glaring forms of frauds and not to increase their net assets or incomes. 6. List and describe at least five document indicators for fraud. Fraud is not an openly visible crime. It can be detected only through red flags that indicate that ethics and honesty have been compromised within the company. A red flag is a set of circumstances that are unusual in nature or vary from the normal activity. It is a signal that something is out of the ordinary and may need to be investigated further.

Remember that red flags do not indicate guilt or innocence but merely provide possible warning signs of fraud. Such red flags can be from the accounting system, lack of segregation of duties and other crucial internal control features, lack of integrity in top management behavior, unusual or extravagant behavior on part of employees, and numerous complaints or hotline tips. All these are indicators that fraud may exist not necessarily proof of fraud. Employee Red Flags Employee lifestyle changes: expensive cars, jewelry, homes, clothes Significant personal debt and credit problems Behavioral changes: these may be an indication of drugs, alcohol, gambling, or just fear of losing the job High employee turnover, especially in those areas which are more vulnerable to fraud Refusal to take vacation or sick leave Lack of segregation of duties in the vulnerable area Management Red Flags Reluctance to provide information to auditors Managers engage in frequent disputes with auditors Management decisions are dominated by an individual or small group Managers display significant disrespect for regulatory bodies There is a weak internal control environment Accounting personnel are lax or inexperienced in their duties Decentralization without adequate monitoring Excessive number of checking accounts Frequent changes in banking accounts Frequent changes in external auditors Company assets sold under market value Significant downsizing in a healthy market Continuous rollover of loans

Changes in Behavior Red Flags The following behavior changes can be Red Flags for Embezzlement: Borrowing money from co-workers Creditors or collectors appearing at the workplace Gambling beyond the ability to stand the loss Excessive drinking or other personal habits Easily annoyed at reasonable questioning Providing unreasonable responses to questions Refusing vacations or promotions for fear of detection Bragging about significant new purchases Carrying unusually large sums of money Rewriting records under the guise of neatness in presentation

7. Name and describe at least four schemes for overstating revenues. Probably the most common financial statement fraud is the manipulation of sales (revenue) figures. It's in the companys best interest to report higher sales, as opposed to lower sales, so virtually every company runs the risk of overstating sales. Channel stuffing is the business practice where a company, or a sales force within a company, inflates its sales figures by forcing more products through a distribution channel than the channel is capable of selling to the world at large. Also known as "trade loading", this can be the result of a company attempting to inflate its sales figures. Alternatively, it can be a consequence of a poorly managed sales force attempting to meet short term objectives and quotas in a way that is detrimental to the company in the long term. Consignment sale is the act of consigning sales, which is placing a person or thing in the hand of another, but retaining ownership until the goods are sold or person is transferred. This may be done for shipping, transfer of prisoners, or for sale in a store (i.e. a consignment shop). This is abused in the sense that shipments of goods are done at the end of the year and are considered as sales. Premature revenue recognition errors or deliberate distortions involving revenue recognition fall into two categories: situations in which revenue legitimately earned is reported in the incorrect fiscal (financial reporting) period, often referred to as cutoff errors, and situations in which revenue is recognized although never actually earned. Given the emphasis on periodic reporting (e.g., quarterly earnings announcements in the case of publicly held entities), even simple cutoff errors can have enormous impact, notwithstanding the fact that these should tend to offset over several periods. 8. Describe big bath accounting and what would make a company engage in it. Big Bath in accounting is an earnings management technique whereby a one-time charge is taken against income in order to reduce assets, which results in lower expenses in the future. The write-off removes or reduces the asset from the financial books and results in lower net income for that year. The objective is to take one big bath in a single year so future years will show increased net income. This technique is often employed in a year when sales are down from other external factors and the company would report a loss in any event. For example, inventory valued on the books at $100 per item is written down to $50 per item resulting in a net loss of $50 per item in the current year. Note there is no cash impact to this write-down. When that same inventory is sold in later years for $75 per item, the company reports an income of $25 per item in the future period. This process takes an inventory loss and turns it into a profit. Corporations will often wait until a bad year to employ this big bath technique to clean up the balance sheet. Although the process is discouraged by auditors, it is still used. In recent times, General Motors and other US Corporations have taken huge write downs on balance sheet assets resulting in massive losses. The same result can be achieved by recording in one year the future cash costs of expected plant

closing or employee layoffs. The objective is to take these loses all at once, so future periods can show positive net income. 9. In terms of catching employee fraud, what is the most important concept and how can it assists in catching employees actions? Business owners and senior management must themselves be role models of honesty and integrity, or they may risk setting up a work environment that justifies illegal and criminal activity. Avoid at all costs allowing the finances of a business to be handled and controlled by a single individual. Separation of duties is critical, and no employee should be responsible for both recording and processing a transaction; i.e., dont allow the same person who sends out bills to collect the mail and prepare bank deposits. Run irregularly scheduled surprise audits or have a third party audit your books once a year. Also insist that your bookkeeper or any employee who has access to monies take a yearly vacation so you can examine their records. Make sure all checks, purchase orders, and invoices are numbered consecutively, and regularly check for missing documents. 10. Describe at least three methods that vendors could use to fraud a company. Businesses often implicitly trust their vendors; however, various vendor fraud schemes exist in which the entity is overcharged for goods or services provided. Routine vendor audits can prevent or detect vendor fraud. These audits send the message that the entity is monitoring transactions with the vendor to ensure that it is complying with ethical standards and contractual agreements. Some types of vendor frauds are discussed as follows. They include: Fictitious "shell entities" set up by employees or others that may or may not actually provide goods or services. In the shell entity fraud, a company employee creates a false entity, a shell, and becomes the middleman or broker who supplies goods and services to the company including a "mark-up" on the original invoice price. Typically these employees are the ones who either approve the purchase and/or the payment of goods and services, or they supervise employees who perform these functions. Usually the transactions are not large individually, but in the aggregate, are substantial. The substitution-of-material scheme that supply faulty or inferior goods for payment. Material substitution fraud schemes typically use materials of lesser quality, which are billed at the cost of higher quality materials. In an employee corruption scheme, an employee could extort a vendor to receive favorable treatment or to avoid unfavorable treatment. Vendors will often over-bill the company to pass on the cost of the extortion.

Short shipments or goods not delivered are presented for payment by vendors. In an overcharge fraud scheme, the vendor may use prices other than those agreed to, or bill separately for items that should be part of a contract price. Services allegedly performed that were not needed, such as equipment repairs, or services never performed at all. High prices when the goods can be bought directly or less expensively from the same or another vendor; and, corruption schemes including improper payments and kickbacks, conflicts of interest, gifts and gratuities to company employees, and commissions to brokers and others. 11. Compare and contrast affirmative indications and affirmative acts. Affirmative indications serve as a sign or symptom, or signify that actions may have been done for the purpose of deceit, concealment or to make things seem other than what they are. Indications in and of themselves do not establish that a particular process was done; affirmative acts also need to be present. Examples include substantial unexplained increases in net worth, substantial excess of personal expenditures over available resources, and bank deposits from unexplained sources substantially exceeding reported income. Affirmative acts are those actions that establish that a particular process was deliberately done for the purpose of deceit, subterfuge, camouflage, concealment, some attempt to color or obscure events, or make things seem other than what they are. Examples include omissions of specific items where similar items are included, concealment of bank accounts, failure to deposit receipts to business accounts, and covering up sources of receipts. 12. What kinds of innocent errors can taxpayers make and not be liable for the civil fraud penalty? There are some innocent errors that tax payers can make and would not be liable for the civil fraud penalty. These errors include conducting large transactions in cash, failure to file tax returns, failure to pay estimated taxes, filing questionable deductions that could not be fully substantiated and not filing gambling winnings when the tax payer believes that he had lost estimated amounts as the winnings.