Koss Fraud: Losses Higher, Grant Thornton Fired, Baker Tilly Virchow Krause Hired

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kossI’ve had plenty to say about the massive fraud Koss Corp has suffered at the hands of their Vice President of Finance, Sue Sachdeva.

In this news story from Milwaukee’s ABC affiliate, WISN 12, I talk about how a company with annual revenue in the $40 million range can fall victim to a fraud loss of $31 million (current estimate, up from original estimate of $4.5 million and first revision of $20 million):

I’ve also been quoted by the Milwaukee Journal Sentinel, and the Milwaukee Business Journal. At Daily Finance, I have written about why executives everywhere should fear a situation like this and why the auditors from Grant Thornton aren’t necessarily to blame. More of my comments are seen in this article on CFO.com: Fraud Case Feeds Sarbox-Exemption Critics.

Koss has hired Baker Tilly Virchow Krause as its new auditors, and this firm will not only do future audits, but will also audit any prior period financial statements that need to be restated.

As much as people would like audits to uncover fraud, that’s not what they’re designed to do. Financial statement audits rarely detect fraud because that’s not what the auditors are hired to do. If companies want someone to detect fraud, then they need to hire forensic accountants specifically to perform tests aimed at detecting and preventing fraud. They simply can’t rely on the auditors.

Some people say that auditors should change their work in order to detect more fraud. But that’s not what they’re engaged to do. They are engaged to audit. They are not engaged to detect fraud. The responsibility lies with the companies and their management, and they need to do something in addition to financial statement audits if they want to find fraud.

For a look at how Sachdeva spent the money she embezzled from Koss, check out this feature at Clusterstock.

4 thoughts on “Koss Fraud: Losses Higher, Grant Thornton Fired, Baker Tilly Virchow Krause Hired

  1. Richard A

    Tracy – Really disagree with your spin that GT isn’t necessarily to blame because attest audits aren’t intended to detect fraud. While that is generally true, the auditing standards requiring the planning process to assess internal controls risk and fraud risk have been around for a long time. True that the standards have been strengthened more in recent years, but part of the fraud period was covered by the newer risk and controls assessment standards, which apply only to the audit of financial statements and are separate from the SOX audit standards. While a relatively small fraud could have been missed, how does an audit miss a fraud that averaged around 15% of revenue or something in the range of 17%-20% of pre-tax total expenses. In order to meet the risk assessment standards, the firm is expected to understand the client’s business well enough to perform a proper risk assessment and to be able to arrive at the audit conclusion of whether or not the statements fairly present the company’s results on a GAAP basis, which is GAAP as applied to the type of business the company is in. That is one reason the SEC requires that a pre-issuance reviewer be knowledgeable of the client’s industry and type of business. So, at the very least, the appearance is that GT took the representations and work of the “trusted” exec who committed the fraud at face value, instead of maintaining an appropriate audit skepticism. Whether or not that rises to the level of negligence necessary to make GT liable is a question for the courts. But pre-spinning the defense is hardly an appropriate position for a forensic auditor to take. Don’t convict them in the court of public opinion without evidence, but don’t exonerate them either. Especially by using the auditors party line that audits aren’t intended to detect fraud. So far, it doesn’t appear that there is an indication of collusion, which would make it difficult for a typical audit to detect the fraud. Just one person cooking the books by 15% or more per year to divert funds to her own benefit. At an average of $6 million per year – $500 thousand per month – $25 thousand per work day, are you trying to say that the transactions were too small to be within audit scope for detailed testing.

  2. Tracy Coenen

    Richard – What I’ve said is not spin. It’s the truth. The truth is that audits rarely find fraud, and that’s because they’re not designed to do so. Do auditors rarely find fraud because they’re incompetent? Or is it because of the design of audits? Audits have never been intended to be fraud detection tools. Yes, if an auditor finds something that is suspicious, they’re required to follow up on that.

    But we all know that it’s very easy for an executive to override internal controls, even if those controls appear strong. This isn’t the first time that a relatively large fraud has gone undetected for years. Why does that happen? Because fraudsters understand the audit process very well and know how to hide their misdeeds.

    I agree that Sachdeva stole a very material amount of money. I have said that several times in the media. But I can come up with a very plausible scenario which would easily hide this fraud. One part of that scheme was likely booking the theft by breaking it into many small dollar amounts, all which would have fallen below the scope of the auditors’ tests. Now I don’t know if my theory is correct. But at the same time, you are suggesting the auditors could have and should have known this fraud was ongoing. And you have no basis for that. Unless we see the workpapers, we won’t know. Auditors who are dismissed and/or sued aren’t necessarily incompetent, negligent, or otherwise culpable for not finding fraud.

    The fact that audits aren’t designed to detect fraud isn’t a “party line.” It’s the truth. An audit has a specific purpose. And if management and shareholders really cared enough about finding fraud, they’d engage other professionals (forensic accountants or fraud investigators) to do the type of work that is much more likely to uncover fraud.

    In closing, I’m not a “forensic auditor.” Your use of that phrase calls into question your knowledge of audits and the work of a forensic accountant. I’m not spinning anything, just explaining the unfortunate facts surrounding this situation.

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