With the most recent regulations, the SEC is in a position where it must relegate more public companies and their directors. Repeated allegations of violating security laws have prompted this change in action, and with this case study, we see how it impacts stakeholders, members and other parties under the legislation of Dodd-Frank.
The stakeholders outlined in the complaint are former CEO David Brooks and CFO Dawn Schlegel. Details from the compliant describe the three ‘independent’ directors as Jerome Krantz, Cary Chasin, and Gary Nadelman; these individuals were obligated to alert the SEC to fraudulent behavior of DHB (now Point Blank Solutions, Inc.). Rather than overseeing these behaviors, the three directors either passively or actively allowed for the falsification of statements or omissions of statements about business practices. Close relationships between the independent directors and DHB complicated efforts of the audit committee to accurately do their job as well. Three different audit organizations (Grant Thornton, Weiser and Gibson Dunn), failed to check for fraudulent actions such as financial reporting, inventory overvaluation and transactions by Brooks.
Two main factors lead to the independent directors and audit committee being liable to DHB’s fraudulent behavior. The gross overstatements of inventory lead to conflated numbers of value for materials and the annual reports. A component of DHB’s vests became obsolete, in addition to new U.S. Army specifications changing (Mintz & Morris “Chapter 6” 2014). DHB sold its product under false pretenses and using old materials that could be harmful to the consumers.
The lack of internal maintenance caused a severe loss in company funds due to the CEO’s malpractice of accounts and corporate money. Since these internal controls were not monitored, the CEO was able to use corporate money for personal expenses such as cars, jewelry, prostitutes, and electronics. As a public company, the audit committees and directors failed to oversee the use of these funds to prevent such gross mishandling and are responsible for the losses.
Comparing the DHB case to the previous Tyco Fraud case, there are some parallels to consider. The Fraud Triangle outlined in Exhibit 5.2 shows that in both cases the severe lack of oversight and regulation creates an environment for parties and entities to commit fraud. In both situations, there was a failure of the audit committees to thoroughly check the corporations for red flags in operations and statements.
This case study is one of many instances where regulation is often necessary not only to protect the consumer and ethics of a company but to prevent fraud as a whole. Had the independent directors and audit committee done a detailed investigation and recused themselves from a close relationship with the CEO, these actions could be preventable.
Mintz, Steven M, and Roselyn E Morris. “Chapter 6.” Ethical Obligations in Decision Making and Accounting: Text and Cases, Third ed., McGraw Hill Publication, New York, NY, 2014, pp. 397–400.