However, the major regulatory-reform bill passed by the House in mid-December would permanently exempt small businesses from 404(b). Small-business proponents have pushed for the exemption, saying audits of internal controls over financial reporting are disproportionately costly and perhaps even unnecessary since, individually, small companies represent only minuscule blips of total market capitalization in the United States.
Still, it’s debatable whether small businesses will get the exemption after the Senate works on its version of the bill later this month. Investor advocates are hoping they won’t. “Investors believe that auditor’s expertise can provide management with additional perspective on the quality of its system of internal control, which can have a positive impact on the quality of a company’s financial reporting,” wrote four investor groups, including the CFA Centre for Financial Market Integrity, in a recent letter to House members. The Koss case could bolster such arguments against the exemption.
According to the complaint against Sachdeva, neither Koss’s auditors nor its executives uncovered the alleged fraud. Rather, American Express alerted the company’s CEO, Michael Koss, to several large wire transfers made from a Koss Corp. bank account to Sachdeva’s personal credit card. The purchases in question included $382,400 at two jewelry stores and $1.4 million at one clothing boutique. Michael Koss did not respond to CFO‘s request for comment.
According to the complaint, Sachdeva told FBI agents she had authorized an assistant to make the wire transfers, which she later concealed by falsifying the balance in Koss’s bank account. The complaint does not explain how she allegedly made these changes or why they were not detected sooner. Her attorney, Martin Kohler of Kohler & Hart LLP, told CFO he was unable to comment on the case.
From an outsider’s point of view, it appears that Koss had control issues, namely in the area of segregation of duties. “If someone can have access to cash and the books, they can, on an ongoing basis, perpetuate fraud without getting caught,” says Bob Benoit, president and director of SOX research at consultancy Lord & Benoit.
Without more detail on the alleged fraud, it’s hard to know whether an internal-control audit would have uncovered the problems. However, the knowledge that an auditor is coming in for the extra review could have prevented Sachdeva from perpetuating the fraud, contends James D. Ratley, president of the Association of Certified Fraud Examiners, which has been actively protesting the proposed 404(b) exemption. Still, “management bears the ultimate responsibility for not noticing her lavish lifestyle and the auditors for not noticing anomalies in the company’s financial reporting,” he tells CFO.
Coenen is critical of the other executives and Koss’s board for not picking up on the alleged fraud sooner. The company could have been alerted to the problems by having a fraud hotline and giving employees (such as Sachdeva’s assistant) a way to raise suspicions, she says.
Based on his company’s outreach to potential clients, Benoit believes many small companies are not complying with 404(a), even though their management says they have effective internal controls in their annual reports. “It appears many outside auditors are looking the other way” and not verifying that internal-controls assessments are getting done, he says.
While Michael Koss certified the company’s financials and internal controls in the latest annual report under his dual titles of CEO and CFO, Sachdeva signed the 10-K as the company’s principal accounting officer. She had been working at Koss since at least 1997, when she praised the merits of telecommuting to CFO. At the time, she was managing a nine-person finance department from her home in Texas, 1,200 miles from Koss’s Milwaukee headquarters. She later moved closer to the company but was known to take work home with her. The government’s complaint says she made the questionable wire transfers from her office at Koss, where the CEO apparently found several piles of clothing with the price tags — totaling over $2,000 — still attached.