It depends whom you ask. To an audit committee, it is financial representation, pure and simple. But to a securities lawyer, when such misrepresentation flows from an "altruistic" motive (for instance, to save a fledgling company, rather than financial gain), it could be hard to prove criminal liability.
Therein lies a conundrum, which can be explained by examining the so-called "fraud triangle."
Many organizations spend a great deal of time focusing on ways to prevent fraud before it occurs. Of the three sides of the fraud triangle—pressure,opportunity, and rationalization—the bulk of the effort over the last 15 years has gone to addressing the opportunity to commit fraud, primarily through internal controls. Such controls have been greatly fortified in recent years thanks to the 2002 Sarbanes-Oxley Act and the application of information technology.
Still, because fraud is the result of the intersection of human choices with system failures, it’s important to be wary of the false sense of security that internal controls, even well- designed ones, can bring. Collusion, and the ability of management to override controls, means that no system can fully prevent fraud. (For example, senior executives—those most likely to commit large-scale accounting fraud—are often well placed to collude with others and override such controls.)
While pressure and opportunity can to a great extent be controlled by the organization, the element of rationalization is the wild card. That’s because it lives, not on a computer, or in a procedural manual, but inside the mind of a human being.
Partner, Global Forensics Leader, PwC US
Tel: +1 (415) 302 3428