Forensic accounting

CASE STUDY 29: Consideration of Fraud in a Financial Statement Audit
Charles J. Russo, Ph.D., CPA, CVA, CMA Amber Stone, M.S., CPA Charles L.

Martin Jr., DBA, CPA Towson University

LEARNING OBJECTIVES After completing and discussing this case, you should be

able to

Apply the Fraud Triangle. Understand the auditor’s role in the case. Evaluate related
party transactions. Understand the Sarbanes Oxley Act, Section 404.
INTRODUCTION OF KEY DECISIONS AND DECISION MAKERS

INTRODUCTION

This case is based on actual fraud and the litigation that followed the discovery of the
fraud. The Securities and Exchange Commission (SEC) filed suit against Insignia, Inc.
in U.S. District Court in 2011. This court case involves falsified journal entries,
misappropriation of assets, securities fraud, violation of the Sarbanes-Oxley Act
(SOX), and responsibilities of the independent auditor. The key decisions and key

decision makers are outlined below.
KEY DECISIONS

Falsified Journal Entries Alan Nixon, CEO and shareholder Bobbie Grant, Controller

and shareholder

206 Case Studies in Forensic Accounting and Fraud Auditing
Misappropriation of Assets Alan Nixon, CEO and shareholder

Securities Fraud Alan Nixon, CEO and shareholder Charles Hoover, Former CEO and
shareholder Bobbie Grant, Controller and shareholder David Polk, Company Attorney

and shareholder
KEY DECISION MAKERS

Alan Nixon — CEO The CEO, Alan Nixon, was falsifying journal entries and
diverting money from the company into personal accounts. The journal entries debited

payroll tax li-abilities on the balance sheet and credited shareholder loans. Insignia,
Inc. then made payments on the shareholder loans by paying Nixon. Securities fraud
was the result when the falsified financial statements were filed with the SEC. Nixon
also misappropriated additional cash by directing purchasers of newly issued stock to
transfer funds to accounts controlled by Nixon. The FBI website had the background
information on the CEO as reported by the U.S. Attorney’s Office in 2014 including

the following:

1. Nixon had transferred funds to his personal bank account and other ac-counts under

his control.

2. Nixon manipulated the financial statements by understating the amount of payroll

tax liabilities.

3. Nixon overstated the amount of loans made to him by the company. 4. Nixon
directed purchasers of newly issued shares to transfer funds to ac-counts under the

CEO’s control.

5. Nixon stole $6 million and spent it on himself. The city newspaper reported that in
federal court, Nixon’s family and sup-porters presented Nixon as a man who works
hard at maintaining a small farm that he leased, as well as being a good father to his
18-month old son. The SEC countered that Nixon lied, cheated, and stole from the
company for over two years and that this was a side of Nixon that family members

have never seen.
Charles Hoover — Former CEO

The former CEO Charles Hoover was also associated with the Insignia fraud
activities. Hoover appeared to have been motivated by his need for an over-the-top
upper class lifestyle. An online business newspaper had the following description of
the Hoover’s rather extraordinary life style that included a vacation home in the
Caribbean, a large brokerage account, and other personal assets.

Consideration of Fraud in a Financial Statement Audit 207

The Hoovers later agreed to turn over $5.5 million in assets to the SEC. The SEC
asked a federal judge to appoint a receiver to sell the former CEO’s assets, including

the vacation home in the Caribbean, a brokerage account, a custom motorcycle, Rolex

watches, and upscale jewelry.
Bobbie Grant — Controller

Based on Grant’s 2012 SEC Administrative Hearing the controller, age 35, was a
certified public accountant. The SEC alleged that the controller, at the direc-tion of
Alan Nixon and on her own accord, was engaged in the fraud scheme. The result was
false and misleading financial statements for 2006 and 2007. The SEC Administrative
Hearing cited falsified journal entries, understating expenses, understating liabilities,
and providing false information to Insignia’s independent auditors. As a result of this
SEC Administrative Hearing, Grant was suspended from appearing or practicing

before the SEC as an accountant.

David Polk — Company Attorney Based on the company attorney’s 2012 SEC
Administrative Hearing, David Polk, age 50, was an experienced attorney licensed to
practice in multiple states. He served the company as an attorney to assist with SEC
filings and other corporate matters. The SEC alleged first that Polk drafted two post-
effective amendments and a supporting legal opinion that he knew or should have
known contained false statements regarding the registration of millions of shares of
Insignia stock; and second that Polk sold Insignia securities without a filed
registration state-ment. The SEC suspended him from appearing or practicing before
the SEC as an attorney. He can apply for reinstatement with the SEC after two years.
Insignia Auditors — Rigby Stevens., LLP As the independent outside auditor, Rigby

Stevens, LLP certified:

1.

“That it had audited Insignia’s financial statements in accordance with generally

accepted auditing standards;

2. That it had planned and performed its audits “to obtain reasonable assurance about
whether the financial statements are free of material misstatements”;
3. That, in its opinion, the company’s financial statements “present fairly, in all
material respects, the financial position” of Insignia in conformity with generally
accepted accounting principles; and that its audits provided “a reasonable basis for

(its) opinions” (Sarbanes-Oxley Act of 2002, Sec. 302).

Rigby Stevens, LLP was named as a defendant in the class action claim filed

against certain of Insignia’s former officers and directors, its then external audi-tor,
Rigby Stevens, LLP, and its stock transfer agent, Stock Registration, Inc., for

violations of the SEC Act of 1934.

208 Case Studies in Forensic Accounting and Fraud Auditing COMPANY
BACKGROUND AND FORENSIC INFORMATION

COMPANY HISTORY Alan Nixon, CEO, and Charles Hoover, former CEO, formed
Health Care Staffing, Inc. in 2001. In 2004, a shell company called Insignia, Inc.
(Insignia) was formed that never earned revenue or did business. In February 2005,
Health Care Staffing, Inc. and Insignia performed a reverse merger. As a result, the
new entity kept the name Insignia, Inc., and Health Care Staffing, Inc. became its
subsidiary. Insignia then started operating exclusively in the health care staffing
industry. Insignia was a publicly traded company and therefore was subject to SEC
regulations. When Nixon joined Insignia in 2005, Insignia’s annual revenue was $3.5
million. By 2006, Nixon had managed to increase the company’s revenue to over $40
million. One of the ways Nixon increased revenue was through acquiring small
companies. The acquisitions were financed through a combination of In-signia stock,
promissory notes, and cash. According to Form 8-K, Nixon held a Bachelor of
Science (1998) in Business Administration degree from a large state university, and a
Master’s degree (2002) and a Doctoral degree (2003) from an Internet-based
university. However, it was later confirmed that Nixon did attend the large state
university but did not graduate with a Bachelor of Science degree. Nixon claimed to
hold masters and doctoral degrees, but this online university is a known diploma mill,
offering degrees over the Internet with no substantial work to be completed.
According to the class action complaint filed in Federal District Court, Nixon owned
6,000,000 shares, or 22.5% of all common stock as of April 2006. Nixon became
CEO in 2006. Charles Hoover, former CEO, held the position from 2005 to 2006
while also serving as a Board member. Hoover never attended any of the Board
meetings. As the CEO of a public company, there are certain burdens and
responsibilities placed on CEOs, such as reviewing and verifying certain documents
and signing them before they are filed. Hoover signed many documents without even
reading them, let alone reviewing for accuracy. Ad-ditionally, Hoover’s lack of
understanding as to how the accounting system at Insignia worked made it extremely
difficult to verify anything related to Insignia’s finances. Bobbie Grant served as

controller for Insignia from 2005 through 2007.

In 2006, she became a licensed CPA in the jurisdiction where Insignia’s cen-tral
office was located. Grant made false journal entries under the direction of Alan
Nixon. As a CPA, she knew that the entries she made were incorrect and
misleading. Her motivations were unclear, but the 2012 SEC Administrative Hearing
stated that Grant not only made false journal entries at the request of the president and
CEO, but that she also made false journal entries on her own initiative. The result was

Insignia filing materially false and misleading financial
Consideration of Fraud in a Financial Statement Audit 209

statements in the company’s annual and quarterly reports from 2005 through the first
quarter of 2007. The company attorney, David Polk, was not an employee of Insignia,

but

provided services to Insignia from April 2006 to June 2007. Polk had been practicing
law for nearly ten years prior to his services for Insignia. Polk also had credentials in
securities regulation and his practice centered on financial securities. He filed forms
for Insignia with the SEC that were later determined to be false. Polk was fined and
enjoined from further violating Sections of the Securities Act of 1933 and ordered to
pay disgorgement and prejudgment interest and a civil penalty while also suspending
him from appearing or practicing before the Commission as an attorney for two years.
David Polk’s involvement with Insignia began when the company needed to file post-
effective amendments to some of its SEC filings. They intended to use the
amendments as a way to register a new issue of stock, but regulations stated that the
amendments could not be used for that purpose. They also reported the number of
outstanding shares at $1 million less than it actually was. Additionally, the company
attorney attached a legal opinion to the filings, which stated that he performed due
diligence in preparing the forms. The class action complaint alleges that he was
reckless in filing the forms because he knew, or should have known based on his title
and experience, that what he was doing was wrong. Ultimately, David Polk consented

to an order permanently enjoining him

from violating Sections 5(a), 5(c), 17(a)(2) and 17 (a)(3) of the Securities Act of 1933
as well as requiring him to pay disgorgement and prejudgment interest of $160,000
and a $20,000 civil penalty. He also agreed to settle a related ad-ministrative
proceeding by consenting to the entry of an order suspending him from appearing or

practicing before the Commission as an attorney for two years.

CEO Resignation and Class Action Lawsuit Insignia appeared to be profitable and
successful until August 2007 when Nixon suddenly announced his resignation. One

day after Nixon announced his resignation, Insignia’s stock price dropped by nearly
48%. A few days later, Insignia announced that it would be launching an investigation
into a variety of accounts and transactions that seemed unusual. The stock price kept
decreasing and subsequently led Insignia to file Chapter 7 bankruptcy. The SEC then
filed civil charges against Nixon, Hoover, Grant, and Polk in 2011. The Insignia
Board of Directors generally consisted of three members after the merger: Alan
Nixon, CEO/chairman, and two other individuals, Michael Shaw and Frank Young.
Board members Shaw and Young were appointed by Nixon in 2006. The board held
no annual meetings in 2005 or 2006, and public shareholders did not elect any
directors. According to the 2010 federal bankruptcy case for Insignia, as CEO and
board chairman, Nixon had general authority to execute Shaw’s signature on board-
related documents. Therefore, Nixon had the power to execute documents on behalf of

the majority of the board (two board members out of three). Nixon
210 Case Studies in Forensic Accounting and Fraud Auditing

was directly involved in the fraud and served as board chairman during his entire time
with Insignia. Bobbie Grant and David Polk, who were not board members, were also
named as defendants. In the 2006 Proxy Statement, Shaw was discussed as having
financial expertise in asset structuring, corporate structure finance, and multi-location
profit centers. A class action suit was filed in the United States District Court that

alleged:

1. manipulations that enriched Nixon at the expense of the company ; 2.
manipulations that artificially inflated Insignia’s operating income and reported

margins; and

3. manipulations that enabled Insignia to increase its borrowing, thus post-poning the
time when the company would run out of cash. This resulted in investors in Insignia

common stock losing their investments.

The board members named as defendants in the class action suit included
Nixon; Frank Young, member of the board of directors and chair of the Audit
Committee; and Michael Shaw member of the board of directors and the Audit
Committee. Others named in the suit included Jamie West, chief operating officer and
acting CEO after the departure of Nixon; Rigby Stevens, LLP, the independent
auditing firm; and Stock Registration, Inc., who failed to keep a proper accounting of
the number of shares of stock issued by Insignia. The class action complaint also

noted that during 2005 and 2006, Insignia acquired six healthcare staffing companies

as subsidiaries financed as follows:

Subsidiary 1: December 2005, for $4 million cash, 300,000 shares of common stock,
and assumption of $400,000 debt. Subsidiary 2: April 2006, for $13 million cash and
100,000 shares of com-mon stock. Subsidiary 3: May 2006, for $250,000 and
additional contingent payments. Subsidiary 4: June 2006, for $2 million cash, 700,000
shares of common stock , and additional contingent payments. Subsidiary 5: October
2006, for $6 million cash and 750,000 shares of com-mon stock, with additional
contingent payments to be made in stock. Subsidiary 6: November 2006, for $7
million cash, 200,000 shares of com-mon stock, and assumption of $250,000 debt.
According to the class action suit, Insignia’s reported revenue grew to over $40
million in 2006 from $3.5 million in 2005, and its disclosed market capitalization
quintupled from $21 million on March 25, 2006, to $120 million on March 31, 2007.
By the end of 2006, Insignia had over 300 corporate employees and 1,000 full time
equivalent healthcare staffing professionals. Nixon exercised immense power over the

company as president of Insignia

from February 2005 until his resignation in August 2007. He also served as CFO for
the majority of his time as president, as well as CEO and board chairman from June
2006 until his resignation. Nixon was in complete control of Insignia
Consideration of Fraud in a Financial Statement Audit 211

during his employment. This control allowed him to direct funds out of Insignia for
his personal benefit, improperly issue Insignia stock, and make false journal entries,
which led to incorrect financial statements and SEC filings. Because of his control
over the company, Nixon’s actions constituted the largest part of the fraud and are
discussed in greater detail below. Because Insignia was under $75 million in sales, it
did not need an internal control report from its external auditors per SOX regulations.
However, the external auditors still had to review internal control in order to
determine the appropriate audit procedures needed to support the client’s financial
statements when rendering their audit opinion on this publicly-held company. This
issue will be explored in a discussion ques-tion involving the auditor’s role.

KEY ISSUES

FALSIFIED JOURNAL ENTRIES During his time as CEO period, Nixon personally
made entries for payroll accounts into the Insignia’s computer system. Nixon also had
administrative access to the computers of all employees at company headquarters,

giving Nixon the opportunity to alter or delete employees’ documents, without their
knowledge. The suit claims that the other defendants were aware that Nixon served as
the only internal control at the company, and no one made any effort to determine
whether his reports to the other defendants were verified independently. Insignia
payroll software correctly recorded the amount withheld from each
paycheck as a liability of Insignia and the entries included a credit to a payroll tax
liability account. However, the payroll tax liability was later reduced by an offsetting
entry to the “Alan Nixon loan” account. The effect of this misclassifying journal entry
was to eliminate the payroll taxes payable balance by reclassify-ing them as amounts
owed to Nixon. These reclassified amounts originating as payroll liabilities, appeared
in Insignia’s published financial statements for the quarter ended June 30, 2006, as a
related party loan of $1.5 million without further explanation. By September 30, 2006,
the related party loan to Nixon was $3.5 million and was $3 million at December 31,
2006, with this reduction in loan amount in the fourth quarter due to payments to
Nixon. The loans were undocumented and had no interest. Nixon made, and directed
the controller to make, a number of fraudulent journal entries to Insignia’s books.
Rather than debiting the proper expense account, Nixon would debit a liability
account called Loan Related Party. This account represented the loan from Nixon to
Insignia. Due to the false entries, Insignia’s financial statements led the reader to

believe that Insignia was paying

212 Case Studies in Forensic Accounting and Fraud Auditing

down a liability when it was actually incurring expenses by debiting a liability instead
of debiting an expense. These entries made both the balance sheet and income
statement appear healthier than they actually were. The pair also ran expenses through
the Additional Paid-In Capital (APIC) account decreasing APIC. Although Nixon
decided to book a lot of expenses to the wrong accounts, there were also expenses that
were not placed on the books at all. These missing entries related mainly to the
expenses of issuing stock to employees. All of the expense-related false journal
entries led the annual reports to understate expenses by up to 1,500 percent during the
years Nixon was in control. When Insignia encountered a liability, such as payroll

taxes, Nixon would

record the liability into the Loan Related Party account rather than the correct liability
account. When Insignia’s external auditors, Rigby Stevens, LLP, ques-tioned the large
balance in a liability account titled Payroll Clearing, Nixon made a back-dated entry
to move $1 million from the Payroll Clearing account to the Loan Related Party
account. After making that entry, Nixon and the controller still signed a Management

Representation Letter stating, among other things, they did not know of any fraud in

the financial statements.
MISAPPROPRIATION OF ASSETS

Nixon also used false journal entries to allow him to pull money out of Insignia for
himself. The entries to the Loan Related Party account that were discussed above
made it appear that Insignia owed Nixon $3.1 million more than it actu-ally did. He
also pocketed $3.3 million by personally selling stock to investors and keeping the
money for himself. Nixon also appeared to be selling his own stock in Insignia to a
hedge fund, but he was actually issuing new stock to the hedge fund. This allowed
payments from the hedge fund to be deposited to his personal bank account. In total,
Nixon was able to steal $6.5 million dollars from Insignia over a period of

approximately two and half years.
SECURITIES FRAUD

Form S-8 is required to be filed with the SEC to register newly issued shares of a
company but no audit of an S-8 is required. When filing Form S-8, a stock issuer
incorporates by reference, the audited financial statements of its Form 10K. The issuer
may include the accountant’s consent to use the accountant’s report either directly or
indirectly in the registration statement as an exhibit or via incorporation by reference
to a consent filed with the Form 10K. When Insignia issued new shares, Nixon

provided false information on the

forms regarding the number of shares and to whom the shares were being issued.
Nixon and Hoover both signed off on these forms asserting that the information being
provided was accurate, although they knew the information was incorrect. They also
signed off on the quarterly and annual forms, which grossly misrep-resented the

number of shares outstanding.

Consideration of Fraud in a Financial Statement Audit 213 The independent
auditing firm of Rigby Stevens, LLP had accepted Nixon’s

verbal explanation. Rigby Stevens did not review the reclassifying journal entries in
detail. If they had, they would have seen adjustments to the payroll tax liability
account on the same day there were adjustments to the loan account. Insignia paid
over $2.5 million to Nixon during the first quarter of 2007. The ending balance of the
loan account dropped to $1 million by March 31, 2007. There were over $4.5 million
of unpaid payroll tax liability assessments from the IRS found in Nixon’s office when

he resigned. In the February 2008 federal bankruptcy filing, Insignia cited tax

liabilities, penalties, and interest of $7 million.
IMPROPER ACCOUNTING FOR ISSUED SHARES

Insignia, Inc. December 31, 2006 annual report stated that Insignia had 45,000,000
shares outstanding. Stock Registration, Inc. was responsible for the stockholder
registration list. The Stock Registration list stated that there were several million
additional shares outstanding. Stock Registration, Inc. sent Nixon the correct
registration list in an Excel file. Nixon edited the Excel file, and re-duced the number
of shares outstanding. Nixon then provided the edited list to the independent auditors.
Rigby Stevens, LLP did not independently verify the number of shares outstanding by
obtaining the official list from Stock Registra-tion, Inc., as required by AU Section
326.21(a). Rigby Stevens, LLP should have obtained the official registration list and
compared it with the data provided for the Insignia financial statements. Not doing so
was a serious departure from generally accepted auditing standards. The plaintiffs in

the class action suit believed that the unreported shares

were sold by Nixon on the open market. Under AU Section 316.85, inadequate
segregation of duties should have alerted the auditor to the opportunity for the

misappropriation of assets.

SOX SECTION 302 FALSE FINANCIAL STATEMENTS AND FALSE

CERTIFICATIONS

There were multiple instances of securities fraud including:

1. Booking $1,000,000 in additional revenue by debiting accounts receivable and

crediting revenue from a nonexistent reality television show.

2. 3.

In the first quarter 2007, inappropriately reporting income from operations from the

exercise of stock warrants.

Increasing the debt borrowing limit with Cap Source by providing false certification
of income. Insignia then borrowed close to the maximum new debt borrowing limit.
4. Filing false Form 8-K, Form 10-QSB, and Form IO-KSB with the SEC, and

misleading the investing public.

214 Case Studies in Forensic Accounting and Fraud Auditing

5. Nixon signing false financial statement certifications under SOX, including Form

8-K, Form 10-QSB, and Form IO-KSB.

Based on AU Section 316.85 A.2, “Opportunities,” subsection b, Rigby
Stevens, LLP should have been alerted to the risk associated with the lack of
separation of duties and the consolidation of authority in one individual. The class
action law suit alleges that Rigby Stevens knew of misrepresentations in Nixon’s
educational history and that the certifications included misrepresenta-tions. The class
action suit states that the auditing firm was reckless in failing to make themselves
aware of clear deficiencies in Insignia’s internal controls, especially related to Nixon.
Information released to the public on August 16, 2007, caused an immediate
drop in the price of Insignia stock from $3.50 per share to $2.35 per share on volume
of over 20,000,000 shares. Investors who contacted Insignia between August 16 and
19, received false reassurances that the company was financially stable despite the
resignation of Nixon. However, Nixon, at the time of his res-ignation, had a personal
brokerage account worth over $40 million with more than half of it in Insignia stock.

SOX SECTION 404 INTERNAL CONTROLS

SOX Section 404 states that each annual report required by the SEC must contain an
internal control report. Each public accounting firm that prepares or issues the audit
report shall attest to, and report on, the required internal control assessment made by
management. The standards for performing the attest function shall be made in
accordance with standards of attestation adopted by the Public Company Accounting

oversight board (PCAOB). The text of Section 404 is as follows:

SEC. 404. MANAGEMENT ASSESSMENT OF INTERNAL CONTROLS (a) Rules

REQUIRED

.—The Commission shall prescribe rules requiring each annual report required by
section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or
78o(d)) to contain an internal control report, which shall—(1) state the responsibility
of management for establishing and maintain-ing an adequate internal control

structure and procedures for financial reporting; and

(2) contain an assessment, as of the end of the most recent fiscal year of the issuer, of
the effectiveness of the internal control structure and procedures of the issuer for

financial reporting.

Consideration of Fraud in a Financial Statement Audit 215

(b) INTERNAL CONTROL EVALUATION AND REPORTING.—With respect to
the internal control assessment required by subsection (a), each registered public
accounting firm that prepares or issues the audit report for the issuer shall at-test to,
and report on, the assessment made by the management of the issuer. An attestation
made under this subsection shall be made in accordance with standards for attestation
engagements issued or adopted by the Board. Any such attestation shall not be the

subject of a separate engagement
AUDITOR RESPONSIBILITIES

The auditor of Insignia was Rigby Stevens, LLP. In the April 21, 2008, class ac-tion
complaint filed in U.S. District Court Rigby Stevens, LLP was named as a defendant
along with Insignia former officers for misrepresenting the financial condition of
Insignia through the SEC filings. There were three general categories of fraud
identified in the class action complaint as interconnected frauds that ultimately
resulted in Insignia common stock investors losing their investments:
1. Manipulation that enriched former CEO Andy Nixon at the expense of the

company.

2. Manipulation that artificially inflated Insignia’s operating income and reported

margins; and

3. Manipulation that enabled Insignia to increase its borrowing, thus postpon-ing the

time when the company would run out of cash.

The Rigby Stevens CPA firm provides tax, audit, and consulting services
on a regional basis in Florida. The audit fees charged by Rigby Stevens, LLP to
Insignia were not disclosed at the time of publication of this case study. In a Form 8-
K/A filed with the SEC on August 30, 2005, the company an-nounced that its former
auditors, Rigby Stevens, LLP discussed audit difficulties with the Audit Committee of
Insignia. Rigby Stevens, LLP informed the Audit Committee of difficulties it had
encountered in performing the audit of Insignia’s financial statements for the year
ended December 31, 2006, regarding the untimely receipt of documents, including
asset acquisition documents, board of directors’ resolutions, and confirmations from
management. The filed Form 8-K/A stated that despite encountering these difficulties,
Rigby Stevens’ reports on Insignia’s financial statements did not contain an adverse

opinion or a disclaimer of opinion.
FINAL THOUGHTS

The four defendants all agreed to settlements for their civil charges that involved
repaying the amount of money that they received from their involvement in the

216 Case Studies in Forensic Accounting and Fraud Auditing

fraud. Nixon’s settlement included a ban from being an officer or director of a public
company and to pay back the $6.5 million of funds he stole from the company plus
interest. Hoover’s settlement included paying $5.5 million plus interest and a
$100,000 civil penalty, as well as a ban from being an officer or director of a public
company. Grant’s settlement included a permanent injunction and paying $400,000
plus interest. Polk agreed to pay $160,000 plus interest and a $20,000 civil penalty, as
well as settling an action banning him from appear-ing before the SEC as counsel for
two years. Based on their individual financial positions at the time of settlement,
Nixon’s and Grant’s payments were waived. Thus, the financial penalty was reduced
based on inability to pay. However, Nixon still had to pay $40,000 to one former

Insignia shareholder.

This shareholder was the only person who took action seeking repayment of his
losses. Once the civil charges were settled, some of the defendants still had pend-ing
criminal charges. In April 2014, Grant was sentenced to five years’ probation for her
role in the fraud. On December 4, 2014, Nixon was sentenced to 130 months in
prison, beginning January 1, 2014. Upon his release, he will have to serve three years’
probation. Although this fraud was estimated to have cost investors well over $200
million, the court reduced this amount to $40 million based on unability to repay. One
of the reasons for Nixon’s reduced sentence is that he cooperated with prosecutors and
aided the bankruptcy trustees in rein-venting Insignia under a new name. When asked
why he committed the fraud, Nixon’s response was simply that he wanted to appear

successful.

Assignment:

Please answer Q1 and Q4 only in detail !!

5 pages total !

DISCUSSION QUESTIONS

1. Describe Nixon’s actions in terms of the fraud triangle.

2. Discuss the requirements of AU Section 316, “Consideration of Fraud in a
Financial Statement Audit.” Discuss the role of the auditor in the case of Insignia, Inc.

under AU Section 316.

3. A lot of the fraudulent transactions were run through the Loan Related Party
account. What audit procedures under AU Section 334 should have been performed in
evaluating related party transactions? In your opinion, should the external auditors
have discovered the fraud through the Loan Related Party account?
4. One reason that the Insignia fraud could occur was due to nearly non-existent
internal controls. SOX was passed in 2003, and companies were required to be in
compliance for fiscal year 2005, which is when the Insignia fraud ended. What
constitutes an effective system of internal control as it relates to the requirements of
Section 404? Who is responsible for establish-ing internal controls?