Guest Post by Ronald Kral, MBA, CPA, CMA
Managing Partner of Candela Solutions LLC

All organizations use some form and degree of monitoring in reaching strategic, operational, reporting and compliance objectives. Yet, many organizations do not fully leverage the power of monitoring in reaching objectives or in supporting their regulatory control assessments. This article explores monitoring in an effort to reap the benefits of cost-efficient and effective control systems.

The relevancy today is especially vivid considering the increase in modified or qualified external audit opinions pertaining to “going concerns”. While a company’s ability to continue functioning as a business entity relates primarily to operational objectives, it is achieved in large part through sound controls. Monitoring is a necessary component of the internal control process.

VIDEO: World of forensic accounting unveils how companies are cheated out of millions

The story of the alleged $31 million fraud at Koss Corp by the company’s former VP of Finance, Sue Sachdeva, hasn’t gotten much air time over the last month or so.  Aside from the usual class action lawsuits when there is a fraud discovered at a public company, the only bits of news that are remotely notable at Koss are the continued declaration of dividends and the filing of a 10-Q without any financial statements included.

Koss is a public company, but the stock is thinly traded. The Koss family apparently owns about 70% of outstanding shares of stock. The declaration of a dividend, therefore, is nothing more than the Koss family publicly announcing that they are going to pay themselves.

UPDATE: On February 17, 2010, Medifast Inc. filed suit in US District Court, Southern District of California, alleging defamation, violation of California Corporations Code, and unfair business practices. On March 29, 2011, Judge Janis Sammartino dismissed all of Medifast’s claims against me in her ruling on my anti-SLAPP motion.

Last week, Medifast Inc. (NYSE:MED) announced that it changed auditing firms. The company previously used Bagell, Josephs, Levine and Company, and they were criticized for the choice of auditors by Fraud Discovery Institute and Sam Antar. FDI’s criticism was summed up in a press release:

Expert’s letter sites possible stock-touting of Medifast (NYSE:MED) stock by company’s single-officed, New Jersey based, outside auditors through their alleged independent investment entity. Expert also notes that PCAOB cited Medifast auditors for significant deficiencies in three of six audit engagements reviewed by them, or 50% of audits in their sample.

Antar simply said that if Medifast was serious about the quality of its auditors, then it would find new ones.

How does a company with about $40 million in annual revenue fall victim to a $31 million (or more) fraud by the VP of Finance? Simply, Koss Corp. gave Sue Sachdeva the keys to the castle. She apparently ran the company’s finance function with little oversight from anyone else.

Koss has done something I think is a bit unusual. In a filing with the SEC, the company detailed the alleged theft by year:

The latest news related to the $31 million fraud committed by Koss Corp.’s ex-VP of Finance Sue Sachdeva is activity at Strattec. Laughably, Michael Koss was the chairman of Strattec’s audit committee since 2003. In January, he was removed as head of that committee, but still remains on the board and on the audit committee. It’s interesting that Strattec didn’t announce the developments related to Michael Koss anywhere, and we’re only finding about it now because Journal Sentinel reporter Cary Spivak started asking questions.

So Koss was removed as audit committee chairman but remains on the board and on the audit committee. I think it’s time for the Strattec board members to ask themselves a serious question: If Michael Koss didn’t care enough about his own company to pay attention to the financial statements, what makes you think he’ll pay attention at Strattec?

I’ve been more than happy to publicly state that Michael Koss and the rest of the executives were asleep at the wheel while Sachdeva was stealing at least $31 million from them in a fraud scheme that lasted over five years.  And amazingly, the executives don’t seem to have plans to change much in wake of the fraud, as they stated in their most recent 10-Q (bold added by me):

Although numerous actions were taken beginning in late December 2009 following the discovery of the unauthorized transactions, including changes relating to the Company’s banking procedures and certain other internal policies and procedures, as well as the other actions described in the Explanatory Note, the Company implemented no formal changes in the Company’s internal control over financial reporting during the Company’s most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Koss Corporation (NASDAQ:KOSS) filed a 10-Q with the Securities and Exchange Commission yesterday that pointed out the obvious… Now that their VP of Finance isn’t stealing at least $31 million from them, they think they’ll be more profitable.

The company says they’ll be restating the financial statements for the fiscal years ended June 2008 and June 2009, at the very least, and also restate the quarterly reports filed so far for fiscal 2010. The company says their numbers will improve now that Sue Sachdeva isn’t stealing from them (bold added by me):

An article in today’s Compliance Week, Koss Fraud Spotlights Small Filers’ Internal Control Issues (subscription required), quotes me on internal controls and the auditors as it relates to the huge fraud committed by VP of Finance Sue Sachdeva at Koss Corp (NASDAQ:KOSS).

I’m no fan of Sarbanes-Oxley because I believe it was ridiculously expensive, and hasn’t really produced any meaningful results. Fraud is just as rampant as before SOX became law, and the only thing companies have to show for it is a huge bill from auditors and consultants.

The case of the alleged theft of at least $31 million by Sue Sachdeva from Koss Corp. (NASDAQ:KOSS) carries on. Last week, Sachdeva was charged with 6 counts of wire fraud. Experts are saying this indictment came much faster than usual, as the Feds usually spend much more time thoroughly investigating cases. They’re speculating that a guilty plea is going to come quickly, and the indictment was the first step toward that.

The indictment is interesting. Not only did she use company funds to pay her American Express bill as we had heard, she’s also been accused of getting cashier’s checks from a bank account belonging to Koss, writing Koss checks to Petty Cash and keeping the funds, and using Koss traveler’s checks for personal purposes.

Professor David Albrecht wrote a great piece today about the push to move from U.S. GAAP (Generally Accepted Accounting Principles) to IFRS (International Financial Reporting Standards). His conclusion? The push to switch is motivated purely by greed.

Accounting standards exist so that financial statements have some uniformity. Users of financial statements outside of the companies producing the numbers are able to compare financial statements and understand what the users mean because standards have … standardized… financial statements.

I’ve been talking here, at DailyFinance.com, and to the media about the massive fraud at Koss Corp. and how I think it may have been committed and covered up. The time has come to get more specific about how I think it happened, and why I think the auditors did not find it.

Disclaimer: I have no inside knowledge of the situation at Koss. I have never worked for or with them, and I have never worked for or with Grant Thornton, the auditors. I haven’t seen anything other than what’s been released publicly by the press. I am merely speculating.

The contention has been made that the auditors should have found this fraud, as they are required to consider fraud in planning and performing their audits. Further, the fraud is at an estimated $31 million (my guess is it will end around $50 million), which is clearly material to Koss.  “Material” generally means it’s big enough to matter to the overall financial picture of the company. With annual sales hovering around $40 million a year at Koss Corp., $31 million (or more) stolen over a 5+ year period is certainly material.

So how did the auditors miss it? That’s easy. Three simple steps by Koss VP of Finance Sue Sachdeva could prevent the auditors from encountering evidence pointing them to the fraud.