Reference no: EM132052906

Background Information and Introduction:

post office box. He stole from his customers’ accounts for years in order to finance a new $24 million headquarters for Peregrine, personal shopping binges, a private jet and other luxuries. The fraud went undetected for approximately 20 years and Wasendorf stole approximately $200 million during this time. What regulators and investors are asking is, “Why didn’t the auditors catch this fraud?” The failure of the auditors to catch this blatant fraud has regulators demanding to know why it was not detected. In addition, regulators are asking why the bank did not notice that Wasendorf was using client funds for personal use.

Russell Wasendorf, Sr. came from a modest upbringing. He founded Peregrine Financial Group (also known as PFG or PFGBest) in 1992. Peregrine Financial Group was an independent futures brokerage, also known as a futures commission merchant (FCM). An FCM “solicits or accepts orders to buy or sell futures contracts, options on futures, retail off-exchange forex contracts or swaps and accepts money or other assets from customers to support such orders” (NFA, 2016).

Controls were lacking regarding both risk and how to keep separate customer trading accounts from other firm activities (Fox Business, 2011). To the public, Wasendorf grew PFG into what appeared to be a very successful trading business. Wasendorf lived a lavish lifestyle with two luxury homes, extravagant vacations, his own high-end Italian restaurant and a private jet. However, in violation of regulations, customer funds were not kept segregated, so PFG had access to customer money and Wasendorf was able to misappropriate it. The auditors and regulators failed to detect this for years.

In 2012, twenty years after he formed PFG, Wasendorf, called the regulators and agreed to use of the electronic confirmation service. The next day, he was found in his car in an attempted suicide. In the car was a note to his wife and a confession letter that said he had been committing fraud for twenty years. Wasendorf Sr.’s son, Russell Jr., who was the President and COO of PFG, arrived at work that day and found a suicide note addressed to him as well as an exact copy of the confession letter that was in the car. Wasendorf Sr. wrote in the letter, “I have committed fraud.”

How the Fraud Was Perpetrated

A normal procedure in generally accepted auditing standards (GAAS) is for the independent auditor to obtain and examine bank statements. Wasendorf simply used software such as Photoshop to create phony bank statements showing heavily inflated balances. According to Wasendorf’s confession, he was the “sole individual with access to the US Bank accounts held by PFG. No one else in the company ever saw an actual US Bank statement.” When the bank statements arrived in the mail, they were delivered to Wasendorf, who opened them and then made phony bank statements, passing the phony statements on to the accounting department. Wasendorf also made sure that he was the only person with online access to PFG’s bank account. Another standard auditing procedure is to send confirmation requests directly to the bank and obtain confirmation of balances and other information directly from the bank. Wasendorf simply set up a phony bank address at a post office box and tricked the auditors into believing it was a legitimate address for the bank. Wasendorf would then intercept all confirmation requests from the auditors, fill in the information with fictitious amounts, and send them back to the auditors.

Auditing standards call for maintaining professional skepticism throughout the planning and performance of an audit, describing professional skepticism as, “an attitude that includes a questioning mind, being alert to conditions that might indicate possible misstatements due to fraud or error, and a critical assessment of audit evidence” (Arens et al., 2014). In Auditing Standard No. 15, the Public Company Accounting Oversight Board details standards for audit evidence. AU 316 describes the procedures for consideration of fraud in an audit. (PCAOB, 2016). Previous frauds at Parmalat and Olympus illustrate the problems with relying on paper confirmations. Only after Parmalat defaulted on a $185 million bond payment did the auditors uncover the fraud. “Some 38% of Parmalat's assets were supposedly held in a $4.9 billion Bank of America (BAC) account of a Parmalat subsidiary in the Cayman Islands. But on Dec. 19, Bank of America reported that no such account existed” (Bloomberg, 2004). Managers simply forged documents over a15 year period and eventually put the company in bankruptcy. Similarly, an investigation in to the Olympus scandal uncovered evidence that a company executive sent a fake confirmation letter to the auditor to perpetuate the fraud (Vanderford, 2013).

Required:

Explain the role of professional skepticism in an audit and in your opinion?

Why wasn’t this fraud detected sooner?.

What internal controls were deficient or lacking at Peregrine?

Name and explain 4 red flags existed in this case?

Explain the fraud triangle. Detail how all elements of the fraud triangle were present in this case.