Where Does the Target Stand On Fraud Prevention? Fraud-fighting buyers pursuing acquisitions must determine whether the target is proactive in deterring accounting misconduct

Sarbanes-Oxley may be the most important set of rules impacting financial disclosure and corporate governance since the Securities Act of 1933. But while it boosts accountability and transparency it was not designed to create an anti-fraud environment in compliant firms, says Carl Pergola, National Director of the FIRSTGlobal Investigations division of BDO Seidman. Doing the Bare Minimum? In most cases, he adds, firms complying with the letter but not necessarily the spirit of Sarbanes-Oxley with regard to fraud prevention – simply meeting its requirements rather than being proactive in trying to thwart misconduct. Therefore, a key question for fraud-fighting acquirers is: How serious is the target about working vigorously to deter and hinder fraudulent practices? Sarbanes-Oxley falls short in establishing some basic requirements for prevention of financial wrongdoing. For instance, Pergola states, it stipulates that companies disclose whether at least one member of their audit committee qualifies as a financial expert, yet does not require that the person have experience in investigating fraud. “In many of the recent frauds, even the most sophisticated financial people have been deceived, so simply requiring that at least one member be a financial expert, in my mind, does little to nothing to prevent fraud,” he says, adding that there are no requirements for training in fraud detection or prevention at the audit committee level, for senior management, or for employees. There also is no requirement for pre-employment screening of executives. “The situation with Al Dunlop could have been prevented with a thorough background check,” he asserts. The former Sunbeam chief executive dramatically increased profits at the company but, as it turned out, did so by cooking the books. Additionally, Section 301 of Sarbanes-Oxley – the “whistleblower provision” – calls for companies to implement a hotline for receiving anonymous reports of questionable accounting or auditing practices but does not require that the company publicize the existence of the hotline or provide employees training on how to use the system. Therefore, companies take it upon themselves to decide how aggressively to launch fraud-fighting initiatives. Companies at the forefront of fraud prevention will, among other things, restrict employment of ineligible persons; hire a compliance officer and/or appoint a compliance committee; publish a set of values that reflect the expectation of ethical work practices; train employees in how to implement the company’s ethics code; and provide ongoing training in fraud detection and prevention. Robert Mattson Jr., a partner in Morrison & Foerster’s Orange County office engaged in a general corporate finance and securities practice, notes that some companies have been leaders on the corporate governance front and for years have had in place whistleblower systems and corporate ombudsmen to whom employees could voice concerns. Companies like those that hit the acquisition trail will want to ensure that prospective targets are like-minded when it comes to stemming fraud. “If a significant portion of the combined company doesn’t share the notion of the value of fraud prevention, it would be very hard for an anti-fraud program to be effective,” notes Harvey Kelly, a principal at AlixPartners, a financial advisory and performance improvement firm. Thanks to the Sarbanes-Oxley hotline requirement, acquirers have gained a new tool for routing out potential fraud problems at target companies, says Alice Peterson, president of Listen Up Group, a leading provider of whistleblower services for Sarbanes-Oxley compliance. Buyers increasingly are asking target management about any complaints that have come into their anonymous tip line and what follow-up actions have been taken. “We have been asked to put together reports that can be provided to an acquirer.” Although Sarbanes-Oxley compliance can be expensive, “the cost of a fraud problem far outweighs the compliance expenses,” states Cathy Fleming, a partner and head of the Corporate Integrity and White Collar Crime Practice Group at Edwards & Angell. Yet, some experts think that most people continue to regard compliance as something to be complied with, rather than as an innovative, profit-maximizing possibility – which it can be. “A smart organization will see that’s there a great opportunity to not only comply with Sarbanes-Oxley but to be viewed on the Street as a pure’ organization. If I were a buyer, I’d have much greater confidence in that kind of company. You can clearly set yourself apart and create shareholder value,” says Pergola. Copyright 2004 Thomson Media Inc. All Rights Reserved. http://www.thomsonmedia.com http://www.majournal.com