Fighting Fraud with Both Fists

Article excerpt

Few people imagined the events of the past two years: case after spectacular case of alleged and actual occurrences of fraud that have shaken not only the financial industry and investor confidence, but also the very core of the global economy. The fallout from the subprime mortgage failure, far-reaching Ponzi schemes, prominent hedge fund closures, and highly publicized SEC and Department of Justice (DOJ) investigations have made it imperative for companies to increase their efforts to combat fraud. Why? Because the potential damage of not addressing fraud risk is so high, including not only the obvious financial risk, but also reputational risk. The mere accusation of wrongdoing in the current fraud-sensitive environment can result in the loss of trust on the part of investors and regulators that a company may never recover from.

Why act now? Because fraud detection and punishment has become a top-of-mind issue for the government, the media, and the public at large. On the federal front, passage of the Fraud Enforcement and Recovery Act of 2009 (FERA) as weU as antifraud provisions in both the American Recovery and Reinvestment Act of 2009 (commonly known as the economic stimulus plan) and the Patient Protection and Affordable Care Act (the recently enacted healthcare reform legislation), reflects the government's determination to combat fraud. The FERA amends and strengthens the False Claims Act, which protects the government from being deliberately overcharged for goods and services. Once primarily invoked against defense contractors, in recent years, the False Claims Act's most active target has become healthcare fraud.

Even more recently, the 2010 DoddFrank Wall Street Reform and Consumer Protection Act introduces whistleblower provisions that provide monetary rewards of 10% to 30% for information leading to SEC enforcement actions that recover more than $1 million. Given that in July 2010, the SEC settled three securities cases with recoveries of $550 million, SlOO million, and $75 million, respectively, the potential reward for whistleblowers is considerable. For companies, these new financial incentives to report securities law violations create equally strong incentives to prevent such violations in the first place through rigorous internal fraud detection and prevention programs.

These legislative activities are supported by stepped-up enforcement. The SEC reported 671 enforcement actions in fiscal year 2008 (the second highest on record) and 664 in fiscal year 2009 (the third highest) ("SEC Announces Fiscal 2008 Enforcement Results," www.sec.gov/ news/press/2008/2008-254.htm; "FBI Financial Crimes Report to the Public," www.fbi.gov/publications/fmancial/fcs_rep ort2009/financial_crime_2009.htm). The FBI reported nearly 600 open corporate fraud investigations through fiscal year 2009, as well as more than 1,500 pending cases of securities and commodities fraud, nearly 2,800 pending cases of mortgage fraud, and 350 pending cases of money laundering. We believe it's reasonable to expect this brisk enforcement emphasis and activity will continue, if not increase. The DOJ's fiscal year 2010 budget requested "a $62.6 million increase, including 54 agents and 165 attorneys, to aggressively pursue mortgage fraud, corporate fraud, and other economic crimes" (www.justice.gov/jmd/2010summary/pdf/ bud-summary .pdi).

Finally, the magnitude of recent fraud events has drawn heightened media attention, and, in turn, public attention, to such a degree that even the accusation of fraud can pose a serious threat to a company's reputation. An actual investigation of a company by regulatory authorities further raises the threat of reputational damage, even if no wrongdoing is found.

In fact, what constitutes wrongdoing has been an issue in recent investigations. A number of practices in the financial industry, some quite common, have come under intense scrutiny and debate as government investigators, attorneys, investors, and the public at large attempt to clarify what is legal behavior and what is fraud. …