Today’s Topics

1. Today’s Topics • E-Commerce Fraud & Risk • Legal Resolution and Courts Overview • Criminal Litigation Process • Cash Flow Shenanigans • Metrics Shenanigans FORENSIC ACCOUNTING - MSA 220I

2. E-CommerceThe Good, The Bad & The Ugly • The Good • Faster, cheaper and less prone to error • Customer centric • The Bad • Hardware issues…spotted owl disease • False sense of organization • Initial cost and implementation issues • Emerging economy issues…haves and have-nots • The Ugly • The bad guys and hackers…our focus today FORENSIC ACCOUNTING - MSA 220I

3. Consider This… • The race to 60 million users • Radio—30 years • TV—15 years • The Internet—3 years to 90 million users FORENSIC ACCOUNTING - MSA 220I

4. E-Commerce Fraud Risks • P – O – R…see text FORENSIC ACCOUNTING - MSA 220I

5. E-Commerce Fraud Prevention • Difficult to impact pressure and rationalization at this time • Lack of personal contact with fraudsters • Avoid “iffy” situations and “sketchy” firms • Focus on reducing opportunities FORENSIC ACCOUNTING - MSA 220I

6. Prevention in the Opportunity Sector • The control environment • Integrity and ethics • Board and Audit Committee involvement • Tone at the Top • Human resource policies and practices (training) • Risk assessment efforts • Implementation of control activities FORENSIC ACCOUNTING - MSA 220I

7. Risk Assessment • Data theft is the big issue…not cash • Sniffing for passwords • Unauthorized password access • False identification of users • Spoofing for headers and “IP” (protocol models) • Impersonation of customers • False or misleading websites • Hijacking to copy-cat websites FORENSIC ACCOUNTING - MSA 220I

8. Prevention Through Control Activities • Separation of duties • Authorization techniques • Firewalls • Passwords • Digital signatures • Biometrics • Documentation and encryption • Physical control • Independent assessment (operational auditing) • On-going not spot-checking FORENSIC ACCOUNTING - MSA 220I

9. E-Commerce Fraud Detection • Proactive posture • On-going analysis and effort • Defending the Digital Frontier, Mark Doll, Sajay Rai and Jose Granado. Ernst & Young, LLP. FORENSIC ACCOUNTING - MSA 220I

10. Caveats • I am not an attorney • Always obtain legal advice FORENSIC ACCOUNTING - MSA 220I

11. Legal System • State court system • Federal court system • Note the time and cost of using the legal system for resolution • Recall our earlier discussion about the lack of legal resolution FORENSIC ACCOUNTING - MSA 220I

12. State Courts: State and Local Laws • Lower trial courts (i.e. Municipal Court) • Superior court • Generally a function of amount of suit • Appellate Court • State Supreme Court FORENSIC ACCOUNTING - MSA 220I

13. Federal Courts:Federal Laws • Bankruptcy and Tax Magistrates • Tax Court and U.S. District Court • Circuit Court of Appeals (12 circuits) • 9th Circuit (our circuit) is extremely liberal • U.S. Supreme Court FORENSIC ACCOUNTING - MSA 220I

14. Litigation Process • Criminal, civil or no litigation • Settlement often takes place before trial • Why do you think that is? FORENSIC ACCOUNTING - MSA 220I

15. Criminal Trial • Public impact • Jail, fines and restitution • 12 jurors • Unanimous verdict • Beyond a reasonable doubt FORENSIC ACCOUNTING - MSA 220I

16. Civil Trial • Violation of private rights • Compensation for damages • 6 -12 jurors • Often judge-only based hearings • Unanimity not required • Preponderance of the evidence FORENSIC ACCOUNTING - MSA 220I

17. Being an Expert Witness • See page 632 for Does and Don’ts FORENSIC ACCOUNTING - MSA 220I

18. Criminal Litigation Process • Defendant’s rights strictly protected • 4th, 5th and 6th amendments • Federal rules of evidence and criminal procedures • Process • Filing of charges • Arresting and charging the defendant • Illegal searches preclude the use of the evidence—patience! • Preliminary hearing of Indictment by a Grand Jury • Less public disclosure via a Grand Jury • Arraignment—not guilty, guilty or “nolo contendere” • Discovery and Pre-trial Motions • Trial • Appeal FORENSIC ACCOUNTING - MSA 220I

19. Civil Litigation Process • Investigation and Pleadings • Discovery • Requests, questions and depositions • Subpoenas • Motions • Settlement Negotiations • Trial and Appeal FORENSIC ACCOUNTING - MSA 220I

20. Cash Flow Shenanigans • CFS #1: Shifting Financing inflows to Operating inflows • CFS #2: Shifting Operating outflows to Investing outflows • CFS #3: “Inflating” Operating inflows through normal but infrequent ops • CFS #4: “Inflating” Operating inflows through normal operations FORENSIC ACCOUNTING - MSA 220I

21. CFS #1 • Bank borrowings as CFO • Sale of receivables as CFO • Sham sale of receivables as CFO FORENSIC ACCOUNTING - MSA 220I

22. CFS #2 • Boomerang transactions • Capitalization of operating expenses • Treating inventory purchases as investing activities FORENSIC ACCOUNTING - MSA 220I

23. CFS #3 • Inheriting cash flows via acquisition • Acquisition of customers or products • Structuring a divestiture to benefit operating cash flows FORENSIC ACCOUNTING - MSA 220I

24. CFS #4 • Paying vendors more slowly • Collecting from customers more quickly • Purchasing less inventory • Limited disclosure of one-time benefits FORENSIC ACCOUNTING - MSA 220I

25. Metrics Shenanigans • MS #1: Misleading metrics that overstate performance • MS #2: Distorting metrics that avoid bad news FORENSIC ACCOUNTING - MSA 220I

26. MS #1 • Proforma revenue metrics • Proforma earnings metrics • Proforma cash flow metrics FORENSIC ACCOUNTING - MSA 220I

27. MS #2 • Distorting A/R metrics • Distorting inventory metrics • Distorting financial asset metrics • Distorting debt metrics FORENSIC ACCOUNTING - MSA 220I