127 CASE STUDY 17: Cash Embezzlement Over 12 Years SD Hugh Grove, DBA, MBA University of Denver ating de LEARNING OBJECTIVES After completing and discussing this case, you should be able to Recognize the lack of internal controls Describe methods used to steal $34 million in cash Spor various false journal entries Recommend internal control to stop embezzlement of cash 61-62 John Moss is recognized for creating the stereo headphone industry in 1958 with his first stereo headphone. Moss Corp. (MOSS) was incorporated in 1971 in Green Bay, Wisconsin and manufactures stereo headphones, speaker phones, computer headsets, telecom headsets, noise reducing headsets, and wireless headsets. Moss Corp. went public in 1965 at $5 per share. Over the last eleven years, its stock price has ranged from $8 in July 2002, to its peak at $15 in July 2006 to its low at $4 in July 2010. Ir currently trades at approximately $5.50 per share. Accordingly , its market capitalization has ranged from $3.4 million to $12.8 million to its current level of $5.1 million. Thus, it was below the $75 million market value cutoff for a full implementation level of the Sarbanes-Oxley its financial reporting. The Chief Executive Officer (CEO), Michael Moss, the founder's son, and his family directly or indirectly own in excess of 70 percent of the company's 851,000 shares. A $34 million embezzlement of cash from the Moss Corp. occurred and went undetected over a 12 year period from 1997 through December 2009 even though unqualified audit reports were issued every year by a Big Five audit firm. 128 Case Studies in Fore NO. 3340, 10/24/12 ACCOUNTING AND AUDITING ENFORCEMENT RELEASE TAAER) SEC. Moss Corporation and Michael Moss, Civil Case No. 2:41-cv-01991 proposed settlement with, MOSS and Michael Moss (MM), its CEO On October 24, 2012, the SEC filed a Complaint this AAER) against statements, books and records, and lack of adequate internal controls from former CFO, based on MOSS's preparation of materially inaccurate financi Principal Accounting Officer, Secretary, and Vice-President of Finance, and cal years 2005 through 2009. During this period, Sue Smith, MOSSsformer fraud to cover up Smith's cmbezzlement of $34 million from MOSS. The SEC, Jones. MOSSs former Senior Accountant, engaged in a wide-ranging account Excerpts Complaint alleges that: stole approximately $8.5 million, while MOSS reported total sales of $38.2 statements. For example, during the fiscal year ending June 30, 2009. Smith million, net income of $2.0 million, cash of $1.7 million, total assets of $285 million, total equity of $23.6 million including retained earnings of $21 million, basic/diluted earnings per share of $0.54, and dividends per shume of $0.52. MOSS's financial records were misleading in part because MOSS and MM did not adequately maintain internal controls to reasonable assure the accurao and reliability of financial reporting. The $34 million embezzlement started in 1997 and ran until December 2009. While MOSS's internal controls policy required MM to approve invoices of $5,000 or more for payment, its controls did not prevent Smith and Jones from stealing $34 million from MOSS to pay for Smith's personal purchases (lavish shopping sprees at Neiman Marcus among others) without seeking at obtaining MM's approval. MM knew that MOSS's computerized accounting system was almost 30 years old and he twice deferred proposals for a new system. Access to the accounting systems could not be locked at the end of the day or month and there was no audit trail. Smith and Jones were thus able to make undetected post-closing changes (false journal entries) to the books and bypass an internal control requiring Michael Moss to authorize those changes. MOSS did not regularly change the password to access the computer, me accounting terminals were not locked when unattended. MOSS did not monitor network and application security violations or to report have information technology (IT) security policies and controls to log and to management. incidents Cash Embezzlement Over 12 Years 129 Elogue thares were mt many critical duties were combined and given to a few employees. Rased upon the fraudulent accounting books and records prepared by Smith Due to the limited number of people working in MOSS's accounting departe and Jones, MOSS prepared, and MM certified, materially inaccurate audited financial statements and materially inaccurate current, quarterly and annual sports for the fiscal years 2005 through 2009. the Nedag stock exchange halted trading in Moss shares at the company's te When the embezzlement accusations were made public on December 21, 2010, et Moss shares had then traded at $5.51, down from an adjusted 52-weck the company's stability and that MOSS was forced to cut profit sharing and pay Ajch of $7.89 in April 2010 MM testified that Smith's thefts had threatened Aix employees. After resuming trading, by March 2013 over two years later, the trading at $5.33 per . Sue Smith was arrested in December 2010 after the results of an internal investigation were turned over to authorities. She is in het mid-40s and was paid 5173.734 by MOSS in total compensation in fiscal 2009 and $206,462 in fiscal 2008. Her embezzlement ran in spurts. There was a flurry of check-writing over three days in August 2007 totaling $478,735. On August 1. S154,021 was paid to Valentina Inc., an exclusive clothing store. On August 2, S181,000 was paid to Neiman Marcus and $10,120 to Saks Fifth Avenue. On August 3, $296,494 was paid to American Express on her personal credit card. Over a five-year period, Smith spent more than $5 million at the Valentina boutique whose owner said the figure seemed high. Concerning more spending spurts, on February 3, 2007 checks were written to American Express for $204,287 and from July 11 to 17, 2003, $20,182 was spent at Marshall Fields, $26,420 at Saks Fifth Avenue, and $104,738 went to American Express. Smith used the money from MOSS to buy personal items, including women's dothing, furs, purses, shoes, jewelry, a 2007 Mercedes Benz and other automo- biles, china, statues, household furnishings, and a vacation ownership interest in personal travel expense for herself and others, renovations and improvements to her home, and personal services for her and her family. She never even took the fit it all in her house. Investigators seized more than 22,000 items she may have tags off of many of the items and rented two storage spaces because she couldn't that Smith likely suffered from bipolar disorder and compulsive shopping but bought with company money. Prosecutors did nor dispute her lawyer's defense they said that it was an explanation, but not an excuse, for her behavior. In the U.S. District Court on November 17, 2011, Smith pleaded guilty to six counts 22,000 purchases be sufficient?!), and was sentenced to 11 years in prison. was ordered to pay $34 million in restitution (would selling all of her of fraud, 130 Case Studies in Forensic Accounting and Fraud Auditing REQUIRED 1. Describe methods that Smith and Jones could have used to steal $34 mil- lion in cash over 12 years under MOSS's existing internal control system. 2. Describe various false journal entries that Smith and Jones could have used to cover up the $34 million theft of cash over 12 years. 3. Recommend internal controls that MOSS should implement to prevent future cash thefts