The Parmalat Fraud Could Have Been Prevented

Brentwood, Tenn. - The Parmalat accounting fraud is the largest cash and investment fraud ever recorded but this is not the first time this fraud scheme has been used to falsify financial reports.  In the 1980's, the highly glamorized story of ZZZZ Best Carpet Cleaning highlighted how a single executive, Mark Morze the CFO, used white out and a copy machine to create over 10,000 false documents including false bank statements to provide auditors the paper evidence needed to bilk banks and investors out of $100 million.  In 2002 it was discovered that over 14 people at HealthSouth conspired to create 1,000's of false documents leading accountants to certify financial statements that included $300 million in false cash.        

Providing false documents, though, is only the first part of this fraud scheme.  The second part is accomplished by providing false bank contact information to the accountant in order to circumvent the confirmation process which is used by accountants to validate the company's documents.  When ZZZZ Best Carpet Cleaning was audited for its initial public offering, Mark Morze simply changed the mailing address and account balance on the statements he provided to his auditors.  The accountants then sent confirmations to Mark's friend and received back an official looking confirmation that "verified" the funds in the account.  Similarly, Parmalat employees used a scanning machine to change their bank statements.

Capital Confirmation is a company that has been working with banks and accounting firms over the last year to eliminate this fraud from the audit process.  According to Chris Schellhorn, chairman and CEO of Capital Confirmation, the company is working with Big 4 firms and top 100 banks to implement an electronic audit confirmation process that only allows independently authenticated banks and accounting firms to participate in the audit confirmation process.

"The successful pilot in the southeast (with one of the Big 4 firms) highlighted the usefulness of the service, and recent events illustrate the importance of a service like Capital Confirmation's to the audit process," Schellhorn stated.

But why is the confirmation process so easy to manipulate.  Brian Fox, a CPA who worked for both Ernst & Young and PriceWaterhouseCoopers and who is an Associate Member of the Association of Certified Fraud Examiners, says that the answer lies in the fact that historically, auditors have overlooked the need to control the confirmation process from start to finish and rely too much on the client for information.  "In public practice, we always assumed that by placing the confirmations in the mail we controlled the process" Brian states, "It wasn't until we looked at the confirmation process that we realized the contact information either came from the client's documents or directly from a client representative that we sought to improve the process."

As long as so many firms, from the Big 4 to sole practitioners, continue to rely on the client or client documents for the confirmation contact information, this fraud opportunity will remain.  The liability to the accounting firms that certify these fraudulent financial statements is tremendous and can be disastrous as was the case for Arthur Andersen in the Enron accounting scandal.  More often than not, when an accounting fraud occurs and a company's resources are depleted, the restitution provided by insurance and the executives is not enough to make the investors whole and the burden falls on the accountants who are viewed as the watchdogs that should have caught the fraud.

Financial institutions involved also face a significant exposure by relying on these later discovered fraudulent financial statements to make loans or to extend credit to one of these companies.  Huge losses can be incurred as well as high legal costs if the public believes a financial institution could have done more to protect their interests.

In light of these risks and the knowledge of this fraud scheme involving cash, why haven't more firms and financial institutions updated their confirmation practices?   Chris Schellhorn, the CEO of Capital Confirmation, believes that the answer lies in the deep rooted traditions of the confirmation process that have only recently come under fire, "Many companies think that by just having a signature on a piece of paper they are protected from liability."  In reality, not validating the authenticity of a signature still  banks are at risk when they don't a patent-pending process that allows bank account balances to be confirmed on-line during the auditing process, was launched today according to officials of Capital Confirmation, creators of the service. CashConfirm allows for increased efficiency, improved productivity of banking and accounting firm employees, and adds credibility to the information generated.

Initial participants in the pilot test include four banks and eight accounting firms, the majority of which are located in Middle Tennessee. 

According to Chris Schellhorn, chairman and CEO of Capital Confirmation, the company completed a successful beta test of the product earlier this year with MB Financial, a $5 billion bank located in Chicago, and Grannis Whisenant and Associates, a Nashville accounting firm.  The purpose of the test was to analyze the technology platform built for CashConfirm.

"The success of the beta test helped us confirm that our technology is sound.  We have now refined the platform for added scalability and have begun execution of a full pilot launch, which continues through August," Schellhorn stated.

"During the pilot test, we will further monitor the technology in a real-world setting, and gather quantifiable data to demonstrate the efficiency of using CashConfirm in the auditing process.  We also will generate our first repeatable revenue from customers using the product," he added.

The purpose of the pilot program is to validate CashConfirm's abilities to:

  • Change the time required to confirm account balances from an average of 28 days to one day;
  • Reduce numerous forms to one standard form;
  • Increase productivity of banking and auditing employees;
  • Reduce auditor's cost as much as 30%.

In addition, Capital Confirmation founder and vice president of business development Brian Fox believes that one of the most important benefits of CashConfirm is added integrity to the auditing process because the service validates the legitimacy of both the sender and receiver of the balance inquiry.  It also establishes a traceable, electronic record of service usage and results. 

"The accounting and auditing industries are under a microscope right now, but we can add credibility to this step of the auditing process, and that benefits the entire process channel," Fox concluded.

About Capital Confirmation, Inc.

Based in Nashville, Tennessee, Capital Confirmation transforms the paper-based process of confirming bank account balances for banks and accounting firms during a public audit into an electronic process.  Their service, CashConfirm, allows for increased efficiency in the confirmation process, improved productivity of banking and accounting firm employees, and adds credibility to the information generated.  Capital Confirmation markets to the auditing industry, which includes banks and accounting firms.