So what’s an auditor to do if the local bank is in on a massive fraud?

So the auditor goes to the new client’s bank and gets copies of the bank statements from them. An entire year’s worth of statements. Does all the audit work. Everything looks fine. Issues their report. Everything is fine, right?

Except that in addition to the client cooking the books, the local bank made up those bank statements. Fraud came tumbling down because the auditor, yes notice the auditor tumbled to the fraud, went to the bank’s home office to get copies of the bank statements, which were drastically different from what the local branch provided.

This, according to Bronte Capital, is what happened with Deloitte in their audit of Longtop, a company in China that apparently made up more than a few of their numbers.

Discussion from Mr. John Hempton, in his post at Bronte Capital: China frauds: In (partial) defense of the auditor’s.

Bronte Capital quotes a press release on the fiasco.

Amongst other reasons, Deloitte resigned because cash balances were false, management deliberately interfered with the audit, and Longtop took custody of the audit files and refused to let Deloitte have access to them.

So, back to the first question. What to do when staff at the fraudster’s bank go to the printer and pulls off fabricated statements? For a couple years in a row?

Don’t know what you should do. Don’t know how I would catch that.

One possible hint at an answer is an earlier column by Mr. Hempton in which he points out some metrics that were troublesome for him. Remember he wrote this post shortly before Deloitte resigned.

  • Why would a company go to the market when their cash is equal to 26 quarters of all expenditures. Cash on hand is equal to five years of expenses! Microsoft, an incredibly cash-rich company, has cash equal to just over one year of expenses. Not total current assets, but cash.
  • Incremental capital expenditures per staff member are in the range of one nice computer per year. Implication is it’s extremely hard to run a company that is growing rapidly without buying desks, chairs, carpet, file servers, software, conference tables, etc.
  • Weird things noticed while looking at the LinkedIn profiles of staff. Some senior staff have minimal experience and some departing staff either can’t be seen or take jobs that are substantially below their previous positions.

Those are some creative things for an investment company to look at.

I have not pursued this as far as I want to.  Obviously much more to the story.

In terms of timing it looks like Mr. Hempton and Deloitte both came to the conclusion that something was seriously wrong about the same time.  Obviously Deloitte noticed something that concerned them and they took action based on those concerns.

hat tip: Going Concern (You really should either bookmark Going Concern’s site or set them up on your RSS feed.)

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