2.99 See Answer

Question: John C. Koss started his first company,


John C. Koss started his first company, J.C. Koss Hospital Television Rental Company, in 1953, based in Milwaukee, Wisconsin, but John had greater ambitions. Eventually he partnered with Martin Lange, an engineer, and by 1958 the two had founded Koss Electronics, Inc. Their first product, the SP/3 Stereophone (the world’s first high-fidelity headset) wasn’t even intended to be a major product. Rather, the two business partners built it simply as an accessory to demonstrate the superior high-fidelity stereo sound of the portable stereo phonograph they had developed (if you don’t know what a phonograph is, search the Internet or ask a parent or grandparent). The high-fidelity headset debuted at a convention in Milwaukee where Koss and Lange demonstrated their new phonograph. What was novel about the instrument was a privacy switch that allowed people to plug in and listen through the headset without disturbing others around them. The phonograph with the privacy switch was intended to be Koss’s and Lange’s big innovation. But the headset stole the show.
The high-fidelity sound provided by the Koss headset was vastly superior to other headsets in use at the time; plus, the Koss headset, called a “private listening unit,” was the first to be commercially available to the public. The market was ripe for these “private listening units” because just two years earlier, Elvis Presley had released his first hit single, “Heartbreak Hotel” and Rock ’n’ Roll was just taking off. These headsets allowed teens to listen to their radically different music without annoying their parents! Over the years, Koss attempted to expand their business by developing other products. None of these products proved successful, and the company eventually stuck to the business of designing, producing, and selling high-fidelity headsets.
MICHAEL J. KOSS, SUJATA SACHDEVA, AND THE $34 MILLION EMBEZZLEMENT1
Michael J. Koss, son of founder John Koss, began working at the company in 1977, just after graduating from college with degrees in anthropology and art. In the same year, Sujata “Sue” Sachdeva and her family escaped from Burma (Sue’s father was a high-ranking Burmese military official. Burma is now Myanmar), and began rebuilding their lives in New York. Sue graduated from Stony Brook University in 1985 with a degree in finance. In 1989 Sue was hired as a temporary helper by Michael Koss who had been named President and Chief Operating Officer of Koss Corporation.
Sue spent the next 20 years working at Koss Corporation—until she was arrested on charges of embezzlement in 2009. Sue perpetrated the fraud over several years with the help of her assistant Julie Mulvaney, a senior accountant at Koss and Tracy Malone, another Koss accounting employee. The fraud began in 1997 and went undiscovered until 2009, when the fraud unit of American Express called Michael Koss with evidence suggesting fraudulent activity by Sue. The uncovering of the massive embezzlement and accounting fraud led to Sue’s arrest in December of that same year. Koss corporation quickly found itself embroiled in a number of law suits, including one filed by the shareholders against Koss Corporation for failure to protect their interests, and another by Koss against its former auditor, Grant Thornton, as well as against American Express for their failure to discover the fraud earlier.
When the embezzlement and fraud were finally uncovered, authorities seized more than 22,000 items from Sue Sachdeva’s personal residence, storage facility, resale shops, and shops that held paid-for-clothing and other items for her. Among the items and services that were at least partly paid for with embezzled funds were Sue’s expansive home, a luxury Mercedes Benz automobile, a time share property in Hawaii, expensive artwork, furs, designer clothing, high-end watches, jewelry, servants, and a limo service. Some of the clothing and jewelry had never been worn because they were put immediately in storage. One retail establishment that she frequented estimated that she never picked up nor would she allow them to deliver upwards of 90% of the items that she purchased, but rather forced the establishment to store the items for her. Multiple stores that she visited echoed the same description of her behavior, saying that Sue would sometimes buy items that she had previously purchased. When reminded of the items she had already purchased, she became irate, saying that no one could tell her what she could and couldn’t buy. When ordering shoes, she would sometimes order every color of a particular style in her size. Ironically, while she was engaged in the massive embezzlement and accounting-fraud scheme, she was active in attending church, serving on or participating with boards or committees for non-profit and service organizations, and with charities.
Sue pled “not guilty” to all charges, arguing that she had been a “law-abiding citizen until now,” that the embezzlement and fraud was “simple,” and that she suffered from “oniomania,” a compulsive shopping disorder. A court-ordered psychological examination showed that Sue did show symptoms of bipolar disorder. However, her claim to oniomania was dismissed.
How did the ninth largest embezzlement fraud in U.S. history go undetected by Koss Corporation, the financial statement auditor Grant Thornton, and by American Express? The voices of those involved, based on court records, will largely tell the story. The following dialogue are direct excerpts or adapted excerpts from the depositions of Michael Koss and Sue Sachdeva.
ACCOUNTING MANAGEMENT AT KOSS
Michael J. Koss Deposition—adapted excerpts
[Q] During the entire period of time when Sue Sachdeva was embezzling money from Koss Corporation, you were her immediate supervisor; correct?
[A] I believe that’s correct.
[Q] And during the entire time that Sue Sachdeva was embezzling money from Koss Corporation, you were the President, Chief Operating Officer, Chief Executive Officer and Chief Financial officer of Koss Corporation— correct?
[A] Yes.
[Q] You received a Bachelor of Arts degree from Beloit College in 1976—correct?
[A] Yes.
[Q] And your major was both anthropology and art; correct?
[A] Yes. Anthropology is the study of man.
[Q] While at Beloit College, did you take any classes in accounting?
[A] No.
[Q] While at Beloit College, did you take any classes in economics?
[A] Yes. One class, I think it was Econ 101. It was an introductory course.
[Q] While at Beloit College, did you take any classes in financing…mathematics…business…or management?
[A] No.
[Q] Do you currently hold [or have you ever held] any professional licenses or certificates?
[A] No.
[Q] You’re not a CPA; are you?
[A] No.
[Q] And you do not have an MBA degree; do you?
[A] No.
[Q] Have you ever attended any seminars or presentations on the subject of employee theft?
[A] No.
[Q] What were Ms. Sachdeva’s roles, duties and responsibilities at Koss Corp.?
[A] Ms. Sachdeva was the Vice-President of finance, chief accounting officer, and the secretary. She oversaw the accounting department, maintained the books and records, filed required necessary documents with respective government agencies…supervised the treasury function, supervised accounts receivable and the accounts payable functions. She was responsible for all aspects of the record keeping for the company and for the board she attested to certain documents, filed certain documents, and maintained the records for the board.
[Q] Sue Sachdeva was not a CPA. Was it concerning to you at all that Sue Sachdeva was not a CPA?
[A] No.
THE EMBEZZLEMENT
Sujata “ Sue” Sachdeva’s Deposition—adapted excerpts
[Q] Can you tell me the various methods you utilized to embezzle money from Koss?
[A] Cashier’s checks, traveler’s checks, wire transfers and some petty cash.
[Q] And one of the reasons why you utilized cashier’s checks as part of the embezzlement, as opposed to another method of payment, was to keep the embezzlement from Michael Koss, correct?
[A] Yes.
[Q] And you were also aware that Michael Koss would not be reviewing the actual bank statements?
[A] Yes.
[Q] For a period of time you were sending cashier’s checks to pay your personal American Express card, correct?
[A] Yes.
[Q] And then you began using wire transfers?
[A] Yes.
[Q] Why?
[A] Because Julie (Mulvaney) came to me and said all these cashier’s checks you’re sending, you could just wire the money and it would be a lot easier than sending someone to the bank to pick up stuff. I said, sure.
[Q] So Ms. Mulvaney was the one that came up with that idea. In your view, could you have embezzled the sum of money that you did without the knowing assistance of Ms. Mulvaney?
[A] No.
[Q] Was all of the money that came into the company from retail establishments and customers deposited in the company accounts?
[A] They were all deposited in the company’s bank accounts, yes.
[Q] And were the payments recorded in the books and records of the company?
[A] Mostly, but I know they’re not recorded in June – at year end.
[Q] Okay. Why is it that you know for each year the monies were not posted during the month of June?
[A] Because I would have a panic attack at the end of May when I realized how much was missing, and Julie would tell me she’d take care of it, and she didn’t reduce the accounts receivable balances for monies received in June so that the bank cash in the bank and recorded on the book married up.
[Q] All right. So let me make sure that I understand this. As the fiscal year-end, June 30, grew near, you would begin to have a panic attack about how much cash you had taken from the company’s cash accounts and you were concerned that the company’s year-end financial statements would reflect that fact …so as a result, Julie would not post the money that came in during the month of June to AR…then money would merely be deposited in the cash accounts and the AR balance would subsequently be misstated as of June 30th of each year?
[A] Yes.
[Q] The actual cash balance of Koss would be understated once your embezzlement was taken into account— correct?
[A] Right.
[Q] So, when the money would come in during the month of June, it would be deposited into the bank, correct?
[A] Yes. The monies would come into the bank which would match up to the cash ledger and AR would be overstated.
[Q] So, in other words, what would happen is the monies would be received and deposited into the accounts without any entries to accounts receivable in the company’s books and records until the amount of cash in the bank matched the cash balance on the books?
[A] Right. We did this for fiscal years ending June 30, ’09, ’08, ’07, and ’06.
[Q] Was Julie always able to find enough cash during the month of June to make up the balance?
[A] Yes.
FAILURE TO DISCOVER THE EMBEZZLEMENT AND ACCOUNTING FRAUD BY MANAGEMENT
Michael J. Koss Deposition—adapted excerpts
[Q] Was it your job to review the internal controls and procedures at various times and make recommendations for any changes to them?
[A] It was my responsibility to be aware of the internal controls and the soundness of the internal controls, the design of the internal controls and monitoring of the internal controls.
[Q] Was it your job to review them at regular intervals to make sure that they were effective?
[A] It was my job to make certain they were reasonable at all times.
[Q] Whose job was it, if anyone’s, to make sure that they were effective at all times?
[A] That would be my job.
[Q] Do you believe you adequately performed that job?
[A] Yes. But I also believe the design of the internal controls was inadequate because they failed to detect any circumvention and any collusion.
[Q] Okay. As Sue Sachdeva’s immediate supervisor and as the president, COO, CEO, and CFO of Koss Corporation during the time of the embezzlement, do you accept any responsibility for failing to detect Sue Sachdeva’s embezzlement from Koss corporation prior to December 18, 2009?
[A] Yes. I believe I trusted her too much.
[Q] Was insuring the accuracy of the annual financial statements anybody else’s responsibility other than yourself and Sue Sachdeva?
[A] No.
[Q] Did you review bank statements on a monthly basis during Sue Sachdeva’s embezzlement from Koss Corporation?
[A] No.
[Q] Could you have done that?
[A] I could have.
[Q] Did you ever test the truthfulness of the daily reports?
[A] No.
[Q] Who was the only person involved in preparing the data for the daily cash reports prior to 2010?
[A] Ms. Mulvaney.
[Q] Did you personally check and test whether the financial statements of Koss were prepared consistent with GAAP?
[A] No.
[Q] So, your certification of the fairness of the financial statements was based on what Sue Sachdeva was telling you and your belief that the statements were being audited; correct?
[A] Yes.
[Q] So, when the company’s general checking account was opened, the authorized persons were four different people and any one of them could withdraw some or all of the funds from the account; right?
[A] Yes.
[Q] Did you ever consider having two signatures being required to withdraw funds?
[A] I don’t recall ever thinking about that.
[Q] Was there any written policy or procedure relating to the use of cashier’s checks prior to 2010?
[A] No. I was to review all invoices in excess of $5,000 and I have to sign company checks over $5,000. Nothing was to be processed without my signature in excess of $5,000…we had no business purpose for cashier’s checks and they were not being used in the normal course of business. I didn’t authorize any of the payments coming out of the bank for any cashier’s checks.
NOTE In the deposition, it was clarified that while Koss’s policy was that any check over $5,000 had to be approved by Michael Koss, the signatory rights at the bank allowed Sue or Julie to issue cashier’s checks and wire transfers without Michael Koss’s approval. It was also revealed that during the time of the embezzlement, the entire Koss Corporation internal audit function essentially was the responsibility of Tracey Malone, a lower level accountant who reported to Julie Mulvaney. Ms. Malone was allegedly aware of the embezzlement and accounting fraud, but never said anything.
FAILURE TO DISCOVER BY GRANT THORNTON AND AMERICAN EXPRESS
Sujata “ Sue” Sachdeva’s Deposition—adapted excerpts
[Q] Did you expect Grant Thornton to catch you and if so why?
[A] Yes. Because it’s – I stole large amounts of money and covered it up with accounting fraud. Why wouldn’t they catch me?
[Q] When did you first expect Grant Thornton to catch you?
[A] Day one.
[Q] What do you recall the auditors from Grant Thornton asking you, if anything, about the internal controls of the company?
[A] They never asked me. We handed to them a memo about the internal controls when they came for the audit in May, and then I believe they tested the systems to make sure that those internal controls were in place.
[Q] Did anyone from Grant Thornton ever express any concerns about the internal controls of the company?
[A] No.
[Q] Did anyone from Grant Thornton ever question any disbursements from any of the bank accounts?
[A] No.
[Q] To the best of your knowledge, did anyone from Grant Thornton ever make any inquiries relating to payments to American Express to cover your personal credit cards?
[A] No.
[Q] Were you surprised by the lack of inquiry by Grant Thornton?
[A] Yes.
[Q] Here is a copy of the letter delivered by Grant Thornton to Koss management in connection with the fiscal 2008 audit. Ms. Sachdeva, please take a look at the letter and tell me if there are any material weaknesses identified by Grant Thornton.
[A] I don’t think so.
[Q] Did Grant Thornton ever bring to anyone’s attention at Koss, to the best of your knowledge, any material weakness in the internal controls of the company?
[A] No.
[Q] To the best of your knowledge, is it a new concept that, generally speaking, management should not be embezzling from the publicly traded company that they work at?
[A] No.
[Q] The letter from the auditors indicates that upon review of the company’s internal controls, overall controls appear to be designed effectively. And then they go on to talk about improvements that could be made, correct, generally?
[A] Correct.
[Q] Are you aware of any improvement that was ever suggested by Grant Thornton relating to detection of fraud?
[A] No.
[Q] You mentioned earlier that in June customers’ payments were not posted to accounts receivable. Didn’t that cause the accounts receivable aging to be longer than in reality it was?
[A] Yes.
[Q] I think it would add something like 30 days on top of whatever it was in reality, right?
[A] Yeah.
[Q] So, in other words, if the average accounts receivable (AR) aging during the year was 42 days, at year end because of the effort to delay posting to AR, that would cause the AR aging to increase relative to the average or to the previous month’s AR aging?
[A] Correct.
[Q] Did anyone from Grant Thornton ever ask you or anyone else to the best of your knowledge about any issues relating to the AR aging?
[A] No.
[Q] Is it true that because of the method by which you would embezzle money throughout the fiscal year and then avoid posting the actual cash payments received in the last month of the year, that that process minimized the potential number of adjusting entries that you had to make to the GL immediately before year end?
[A] Yes.
[Q] And so, if someone were to examine the GL of Koss for the fiscal year, they would see customer payments posted every month to the GL accounts cash and AR with the exception of June which might have no payments or much smaller amounts posted to cash and AR?
[A] Yes.
[Q] Was the disparity to the best of your recollection between June and other months significant?
[A] Yes.
[Q] Did anyone from Grant Thornton ever question why June’s receivables balances were higher than other months or why fewer customer payments were received than every other month?
[A] Never.
[Q] In the last four years of your employment at Koss, so let’s say January 1st of 2006 through December 21 of 2009, did you make any legitimate payments to your personal American Express card?
[A] No.
[Q] So, every payment that was made to that account during that period of time was made using embezzled Koss funds, is that right?
[A] Yes.
AFTERMATH
Given the massive accounting fraud and embezzlement, Koss Corporation was forced to restate its financial statements from 2005 through 2009. Restated net sales amounted to $41,717,114 for the fiscal year ended June 30, 2009, $3,532,964 higher than originally reported, and restated net sales amounted to $49,084,321 in 2008,
$2,141,028 higher than first reported. Taking out the effects of the embezzlement, operating income was $8,158,340 for the fiscal year ended June 30, 2009 or 19.6% of net sales, compared to operating income of $10,763,225 or 21.9% of net sales in 2008.
While the embezzlement began as early as 1997, the bulk of the embezzlement happened over the course of the five years leading up to its discovery in 2009. Ultimately, Sue Sachdeva was found to have embezzled more than $34 million, which made the Koss embezzlement the ninth largest defalcation fraud in United States history up to that point in time.
Sue initially used company funds with the intent to pay the company back: “I was supposed to pay back the company, and it never happened, and it just – the practice went on.” She hid much of the merchandise she had purchased with the stolen funds from her husband in their basement and in a rented storage facility. When the fraud was discovered, it was discovered that she had stored several boxes of clothing, shoes, and jewelry in the empty office between her and Michael Koss—office space that probably should have been used to house a well-qualified CFO. Sachdeva spent about $8.5 million of stolen funds in 2009 alone. On November 17, 2010, she was sentenced to 11 years in prison and ordered to pay $34.3 million in restitution. She was released from prison early in April 2017 for cooperating with prosecutors.
Koss Corporation reportedly settled with Grant Thornton and American Express for $8.5 and $3 million, respectively, and recovered a few million dollars from an auction of the merchandise that Sue had stored away. Michael J. Koss was forced to return bonuses that he had earned during the time that the embezzlement had been ongoing. Julie Mulvaney and Tracy Malone were both fired from Koss, but neither was prosecuted for criminal offenses.
REQUIRED
[1] Describe management’s responsibilities in implementing effective internal control over financial reporting in a public company. What responsibilities did Koss Corporation’s management have to prevent or detect the embezzlement and accounting fraud?
[2] In what ways did Koss management fail in its responsibilities relating to internal control over financial reporting? Note: Please be brief but be specific—consider organizing your response in accordance with the components (and principles) of COSO’s 2013 Internal Control: Integrated Framework (which can be found at www.coso.org).
[3] As Koss Corporation’s financial statement auditor, what responsibilities did Grant Thornton have to detect the embezzlement and accounting fraud? List and briefly describe at least three red flags that could have alerted the auditor to the fraud. What audit procedures might the auditor have used to address those red flags in order to discover the accounting fraud and the embezzlement?
[4] Based on the information presented in the case, do you believe Grant Thornton failed in its responsibilities to provide reasonable assurance that Koss Corporation’s financial statements were presented fairly in all materials respects? Justify your answer using specific arguments and examples. Include in your answer an assessment as to whether you believe an $8.5 million embezzlement in a single year at Koss would typically be considered material by most auditors, and why.
[5] Assume the role of an expert witness who has been asked by a court of law to assess whether and to what extent Koss management and Grant Thornton were responsible for failing to prevent or detect the embezzlement and accounting fraud. Write a two-page professional opinion summarizing what you believe went wrong, and whether and how Koss management and Grant Thornton failed in their responsibilities. Cite specific examples to support your conclusion. Conclude your report with an assessment of whether Koss management and Grant Thornton should be held at least partly responsible for failing to prevent or detect the fraud.
[6] List and briefly justify three or four specific steps that you believe would be most important for Koss Corporation to move forward after discovery of the fraud.
PROFESSIONAL JUDGMENT QUESTION
It is recommended that you read the Professional Judgment Introduction found at the beginning of this book prior to responding to the following question.
[7] Define the “overconfidence” bias and indicate how it may have played a role in the failure of Koss management and Grant Thornton to prevent or detect the fraud.

2.99

See Answer