For in-depth interviewing techniques, please refer to the “Interview Theory and Application” chapter in the Investigation section of the Fraud Examiners Manual.
Financial statement fraud does not occur in an isolated environment. People in organisations who have both motive and opportunity are the prime candidates to commit fraudulent misstatement. In the overwhelming majority of situations, two key managers participate actively in the fraud: the chief executive officer and the chief financial officer. Others become involved largely out of necessity. Those who are not directly involved most often are not aware that anything is wrong.
Investigations of financial statement frauds are unique in that they almost always involve interviewing the executive management of the organisation. To detect or deter financial statement fraud, it is absolutely necessary that top management be interviewed by a competent and experienced fraud examiner who possesses the ability to solicit honest answers to tough—but vital—questions about whether anyone has tampered with the books.
Situations in which accountants are tempted to misstate financial statements most often involve pressure connected with financial performance. The following is a fictitious conversation between upper managers of a corporation. The example shows how the pressure to commit financial statement fraud can greatly influence accounting personnel.
CFO: (To CEO) “Boss, it looks like we will not have a good year financially. We told the shareholders (or bank) that our earnings would be $4 a share, and it looks like we’ll be very lucky to even make $3.”
CEO: “Well, what are we going to do about it? If we miss the earnings projections (or don’t get the loan) our gooses will be cooked; we’ll both lose our jobs. We must get those earnings up to where they should be.”
CFO: “What do you mean?”
CEO: “What I mean is that it is your job to bring in the numbers. You’re going to have to find a way to get them up. I’m sure we can probably make up the difference next year, but for now, you get our earnings/assets/equity up however you have to. All financial statements are essentially estimates anyhow. So you figure out how to ‘estimate’ the numbers more in our favour. I don’t know how to do it, and I don’t want you to tell me. But get it done.”
The CFO faces a dilemma: cook the books or lose his job. The CFO’s actions are very hard to predict. If he steps over the edge, chances are he will need to enlist the aid of accounting and clerical personnel to carry out the details, even if these employees do not know what they are actually doing. For example, the CFO might tell the chief accountant to book certain receivables and income, which would produce the needed effect—pumping up the equity. Such a scheme might only be apparent to the real insiders.
To detect financial statement frauds through interviews, management and key support staff must be interviewed. Fraud examiners and auditors (collectively referred to as “examiners”) must consider many important issues when conducting interviews. One important issue examiners should keep in mind is that there is generally no liability in asking questions in which they have a legitimate interest, no matter how insulting the questions might be to the respondents. Examiners, therefore, have the legal right to be fearless in asking questions, as long as the questions are asked privately and under reasonable circumstances. This legal right doesn’t extend to accusations—only to questions. “Are you still cooking the books?” is an accusation, whereas “Are you cooking the books?” is a question. It is important to know the difference and to frame questions accordingly.
Examiners should also be sure to interview only one person at a time. Groups of people should not be interviewed together because members tend to influence each other. The interviews should always be conducted under private conditions, which permit the respondent to answer candidly.
It is important that examiners aim to be nonthreatening in their interview approaches. The less threatening the interviewer appears, the less reluctant the respondent will be to answer questions. An interviewer should not be judgemental or show surprise or disgust; such actions can inhibit the flow of information.
Examiners should warm up respondents thoroughly before asking sensitive questions. It is best to obtain all of the procedural information and information pertaining to internal controls prior to discussing fraud. Fraud should usually be the last thing covered in an interview.
To reduce the possibility of offending respondents, examiners can explain the nature of their interest before asking sensitive questions. For example, an examiner can say, “As you know, as an auditor, I am required to actively look for fraud. This means I must ask you some direct questions about the subject. Do you understand?” Then, after obtaining a positive response, the examiner can proceed to ask questions about fraud. It is best to ask the least difficult questions first.
Another approach examiners can take to make tough interview questions more palatable is to phrase them hypothetically, especially during the beginning of the interview. For example, rather than asking a chief financial officer, “Have you committed fraud?” an examiner can say to the executive, “Suppose someone in the position of chief financial officer decided to pump up the financials. How would he do it?” The latter question is far more likely to elicit specific information than the former. Later in the interview, the executive should be asked specifically if he has committed the fraud. The examiner can say something along the lines of “My professional responsibilities require me to ask you one particularly sensitive direct question. Have you committed fraud or other illegal acts against the company?” The vast majority of respondents will answer “No” to such a question without hesitation, whether they have or not; however, simply asking the question places the examiner in a much more favourable position if attacked professionally for not detecting a fraud.
Fraud examiners and auditors should ask questions designed to elicit the most specific information possible in a professional manner.
THE CHIEF EXECUTIVE OFFICER
Generally, the CEO should be interviewed first in any proactive or reactive fraud situation. There are several good reasons for this approach. First of all, the auditor or fraud examiner must have a thorough understanding with management as to what his responsibilities in this area are. Second, it is unwise to conduct sensitive inquiries within any organisation without first advising the CEO. If he learns from some other source that you are making discreet fraud-related inquiries without telling him, he is more likely to misunderstand your objectives and take the inquiry as a personal affront. Third, if there is any significant cooking of the books, the CEO is almost always involved. The fraud-related questions you should ask in connection with a regular audit should include the following, at a minimum. Note how the questions are for “set up” purposes.
- Mr. CEO, as you know, we are required to assess the risk that material fraud exists in every company, not just yours. This is sort of a sensitive area for everyone, but our professional responsibilities dictate that we address this area. Do you understand? (Wait for an affirmative response before proceeding.)
- Do you have any reason to believe that material fraud is being committed at any level within the organisation?
- Mr. CEO, one trend in fraud is that small frauds are committed by employees with little authority, which means that the largest ones are usually committed with upper management’s knowledge. Do you understand that? (Wait for an affirmative response before proceeding.)
- Because of that, we are required to at least look at the possibility that all CEOs, including you, might commit significant fraud against customers, investors, or shareholders. Do you understand our situation? (Wait for an affirmative response.)
- So during this audit (examination) we need to ask direct questions about this subject to you and your staff. As a matter of fact, we will at least discuss the possibility of fraud with every employee we talk with in connection with this audit (examination). Do you have any problem with that? (Wait for a negative response. If the CEO protests, satisfy his objections. If he cannot be satisfied, assess the risk of whether the CEO is attempting to obstruct the audit or examination.)
- First, let’s look at your CFO. Can you think of a reason he might have to get back at you or the company by committing fraud?
- Has the CFO ever asked you to approve any financial transaction you thought might be improper or illegal?
- Do you know whether the CFO has any outside business interests that might conflict with his duties here?
- Does the CFO employ any friends or relatives in the company? (Look for possible conflicts or sweetheart deals.)
- What information do you have about the CFO’s lifestyle? (Look for expensive homes, cars, toys, and habits.)
- What is your general impression of how the CFO gets along with his staff? (Look for abuses of authority, etc., that would motivate employees directly below the CFO to participate in fraud.)
- How do you think fraud in your company compares with others in the same industry?
- Of course, Mr. CEO, I must ask you many of the same questions about yourself. Is there any reason that anyone below you might claim you are committing fraud against the company?
- I must also ask you some personal financial questions. Do you have any problem with this? (Wait for a negative response.)
- Please give me a current estimate of your personal assets, liabilities, income, and expenses. (List.) What percentage of your net worth is tied directly to this company? (Look for highly leveraged individuals whose company holdings are a significant portion of their net worth.)
- Are you currently experiencing any personal financial problems? (Look for lawsuits, liens, judgments, or other indicators.)
- Do you have friends or relatives working for this company? (Look for conflicts of interest.)
- Do you have friends or relatives working for major suppliers or vendors to this company? (Look for conflicts of interest.)
- Do you own any portion of a company that does business with this organisation? (Look for conflicts of interest.)
- Hypothetically, if you wanted to pump up your company’s profits, what would be the easiest way to do it?
- As I said, we will be required to ask many questions of your staff. Is there any reason why someone who works for you would say you are at risk to commit significant fraud against the company or its shareholders?
- Mr. CEO, this is the last question, and it should be obvious why I have to ask it. Have you committed fraud or other illegal acts against the company? (Do not apologise for asking the question; it’s your job.)
THE CEO’S TOP STAFF
CEOs of corporations, large and small, are busy individuals. Because they tend to be “big picture” people by nature, they rely heavily on their staffs—principally their personal assistants—to take care of details. But personal assistants do not usually become closely tied to the boss without a demonstrated history of loyalty and discretion. In short, if you make the boss’s assistant mad, your fraud-related questions are going to be interpreted in the worst possible light, thereby making your job much more difficult.
So the key to interviewing the CEO’s top staff is to approach the interviewing process correctly from the outset. This means laying a great deal of groundwork before asking sensitive questions. Start with procedural matters or some other non-sensitive topic, and ask the fraud-related questions towards the end of your conversation.
- Mr. Assistant, part of my job as an auditor (fraud examiner) is to assess the risk that the company’s books are not materially correct as a result of fraud by employees or management. I have already talked about these issues with your boss. He understands their importance and is aware that, as part of the audit, I will be talking to everyone about the subject to some extent. Do you have any problem with this? (Wait for a negative response.)
- Do you think fraud is a problem for business in general? (Icebreaker.)
- How do you think this company stacks up to others in terms of its employees’ and managers’ honesty?
- Have you ever heard rumours in the company that someone is committing fraud, especially someone high up in the organisation?
- Is the company in any kind of financial trouble that would motivate management to misstate the company’s profits?
- Do you think your colleagues are essentially honest?
- Has anyone you work with ever asked you to do something you felt was not legal or ethical?
- How would you handle such a situation? (Solicit information on the company’s fraud reporting programme.)
- If someone in a position of authority in the company wanted to commit fraud, what would be the easiest way to do it?
- As your auditor, may I ask you to report any instances in the future of anyone asking you to do anything to the books and records that you feel is not right? (Solicit future cooperation.)
THE CHIEF FINANCIAL OFFICER
In the vast majority of cases the CFO is an integral part of any financial statement fraud, as was illustrated previously. As a result, the interview with the CFO should concentrate not only on possible motivations to commit fraud, but also on the opportunity to do so. Since most CFOs are accountants, they should more readily understand your fraud-related mission. This can be good or bad; good if the CFO is honest, and bad if he isn’t. Among all financial personnel, the CFO is in the best position to know how to cook the books and keep it from being uncovered. As if that weren’t enough, many CFOs are hired directly from the firms that audit the company. Is there any other person more likely to be at the centre of the fraud?
The following are recommended fraud-related questions for a company’s CFO.
- Mr. CFO, you now know that audit standards require us to actively assess the risk that material fraud could be affecting the financial statements. We have talked with the CEO, and he is fully aware that we will be asking most everyone we speak with about the possibility of fraud or irregularities. You understand this, don’t you? (Wait for an affirmative response.)
- Of the accounts on the company’s books, which do you suspect might be the most vulnerable to manipulation, and why?
- What kind of history does the company have with fraud in general, including defalcations and employee thefts? (Look for signs of a weak corporate culture.)
- We know that fraud usually exists to some extent—even if it is small—in most companies. How do you think your company compares to others?
- What is your overall impression of the company’s ethics and corporate culture?
- During our assessment of fraud risk in your company, are there any specific areas you’d like to discuss with us?
- Is there any reason that anyone in the company might say that management had a motive to misstate the financials?
- Has anyone you work with ever asked you to do anything with the books that you thought was questionable, unethical, or illegal?
- Are you involved in the personal finances of the CEO? If so, is there anything about them that might make you think he is under personal financial pressure?
- Do either the CEO’s lifestyle or habits give you any reason to think he might be living beyond his means?
- Has anyone in a position of authority ever asked that you withhold information from the auditors, alter documents, or make fictitious entries in the books and records?
- Is there anything about your own background or finances that would cause someone to suspect that you had a motive for committing fraud?
- Because of your importance as CFO, I must ask you one final question: Have you, yourself, committed fraud or illegal acts against this company? (Remember—don’t apologise.)
THE ACCOUNTING STAFF
If a financial statement fraud has been ordered by the CFO, he will either do the actual dirty work himself or get his staff to do it. In some cases, the staff will understand the big picture, but in most situations, the employee is told only what he needs to know. It is uncommon for a CFO to share with a lower staff person the fact that he is cooking the books.
As a result, the fraud examiner generally must complete his audit work before beginning the interviews of the accounting staff. This will allow specific transactions to be discussed with the people who actually entered them into the company’s records. For example, all thorough audits will examine the major journal entries. Frequently, these journal entries will be ordered by the CFO but actually entered by a staff member. There would generally be no record of the CFO requesting the entry, so this fact must be established through interviews.
Interviews of the accounting staff will allow for sufficient examination of procedures and controls over assets. After these questions are answered, you can generally pursue the line of inquiry suggested previously for the CEO’s assistant.
It should be noted that there are similarities and differences in the questions asked of the CEO, the CFO, and their staffs. In the case of the CEO and the CFO, both were specifically asked if they had committed fraud against the company, albeit in a nice way. The staffers were not asked that specific question.
The reasoning is this: significant financial statement fraud, as previously stated, generally originates with one or both of these two executives. Staffers have less motivation to engage in financial statement fraud and are, therefore, at less risk to do so. They are also less likely to have the financial authority to enter transactions into the books without higher approval.
So absent any specific information to the contrary, asking the employees point blank if they have committed fraud is less likely to produce information and more likely to offend them. But with the CFO and the CEO, asking the direct question will add measurably to the prevention of fraud. There are few defences to not asking the question, other than the spectre of embarrassing the executives you are auditing. That will, of course, sound rather weak in a court of law where you are fighting for your professional life.