Briefs

By Willie D. Jones, April 2009, IEEE Spectrum

In December, when Bernard Madoff’s hedge fund turned out to be a gigantic Ponzi scheme that was US $50 billion in the red, everybody wondered how this had gone undetected for more than a decade. Amazingly, in separate audits, government auditors saw no evidence of wrongdoing.

Embarrassed into action, the U.S. Securities and Exchange Commission (SEC) has announced plans to implement an off-the-shelf electronic monitoring system that tracks transactions conducted by 8000 hedge funds. The system will allow SEC accountants to examine hedge funds using scenario analysis and dozens of different graphical representations of the data it collects. But the SEC is intended to be the backstop in the financial accounting system, with most crooked firms getting caught by internal or outside auditors. So technological sleuthing capability belongs in the average auditor’s toolbox and not just the government’s.

Firms such as PricewaterhouseCoopers, a Big Four auditor, have been working on data-mining systems -- software that looks for fraud by finding hidden patterns in financial data. PwC’s automated Ledger Analyzer (formerly known as Sherlock) detects anomalies such as a higher-than-normal number of credits to expense accounts or late-posted transactions. These are among the more than 100 indicators of a significant risk of error or fraud taken into account by the system, says David M. Steier, director of research at the company’s Center for Advanced Research in San Jose, Calif. Researchers at the auditing firm are refining the software so that as more data points are added, it becomes better at spotting these anomalies, while reducing the number of false positives.

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