II. CAUSE AND EFFECTS
The fraud at DHB Industries developed directly from collusion of upper-management, poor oversight by the board of directors, and equity based compensation. Knapp and Knapp (2012) note the constant involvement of Brooks, Hatfield, and Schlegel in falsifying accounting records and attempting to conceal the fraud. With the ability to override controls within the company which identify such irregularities, the involvement of practically all executives allowed for the concealment of the fraud to occur. As Eaglesham (2013) points out, frauds which involve upper management typically go on for longer periods of time. Although the fraud was inevitably exposed, the direct involvement of upper-management prolonged an earlier exposure of the fraud. Thus, when considering a potential investment, the following three accounting fraud risk components must be considered: whether management performs their duties ethically, the existence of effective corporate governance mechanisms, and executive performance-pay composition. Poor oversight by the board of directors allowed for weak ethical standards to be followed at DHB Industries. According to the SEC (2011), Brooks obtained unrestricted control over all aspect of DHB’s business. Dorminey and Fleming (2012) illustrate how a company’s weak corporate governance structure and subpar internal controls facilitates management’s ability to conceal fraudulent records. The same can be seen at DHB Industries. The SEC (2011) declares that Brooks’ controlled the board of directors since he was chairman of the board; his friends and even neighbors were nominated and elected, providing no authentic oversight of management on behalf of DHB Industries’ shareholders. Equity based compensation for Brooks, Hatfield, and Schlegel attributed to the perceived incentives each had for committing the fraud. According to a class action lawsuit filed by the United States Attorney General’s Office of the Eastern District, New...
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