How to detect illegal activity;

              HOW TO DETECT ILLEGAL ACTIVITY
by ROBERT S. KAY
Much has been said about the auditor's responsibility— often pronounced "guarantee"—for the adequacy of financial statement disclosures. This is particularly true con-cerning those transactions that are regarded as lining the wallets of insiders, to the possible detriment of share-holders and creditors. But is there also a role for the finan-cial executive with respect to these related party transac-tions now in the news?
The seriousness of charges recently levied at not only independent accountants but also corporate directors and officers, including financial officers, should prompt us to evaluate what the financial executive can do—indeed, should do.
The responsibility for adequate disclosure of related party transactions is not a new issue. Financial executives of publicly held companies know that information required by the SEC must be contained in SEC filings, whether or not the information is also included in the financial state-ments. It is at least debatable, therefore, whether a com-pany's financial statements are "complete" or "adequate" when they do not disclose related party transactions, even if that disclosure is elsewhere within the filing.
How much information should be contained in the finan-cial statements, including the footnotes? If none, what ob-ligation is there to disclose these transactions with related parties in documents filed with regulatory authorities? Is there no guide to follow?
Financial executives, you're in luck! But you may not have recognized it, because the source of your good fortune is contained in a recent Statement on Auditing Standards (SAS) issued by the AICPA's Auditing Standards Executive Committee (AudSEC), It has been said that SASs are written for auditors only. Right? Wrong! Indeed, I would recommend highly that financial executives be familiar with SASs, since they guide the independent CPA who performs the audit of his company. In this instance, it is SAS 6, "Related Party Transactions,"that suggests the audit-ing standards and disclosure specifications that the finan-cial executive should be alert to.
On the basis of what may not be an auditor's responsi-bility could well be a responsibility of the financial execu-tive, J will discuss here SAS 6 (effective for financial state-ments for periods ending on or after December 26,1975),
and a Touche Ross Technical Letter, issued in 1974, on "Management Involvement in Material Transactions."
The SAS describes steps designed to (1) identify related party transactions and (2) audit the substance of such trans-actions, including financial statement disclosures. Natural-ly, for the auditor to be satisfied in these areas, so must be the financial executive who is responsible for preparing the financial statements.
Overview of SAS 6
The SAS does not apply to intercompany transactions that are eliminated when consolidated financial statements are presented. This is obvious. On the other hand, when separate financial statements of components are pre-sented, intercomponent transactions generally are not eliminated, and the provisions of SAS 6 are certainly then applicable.
Who is a related party? The SAS definition includes the reporting entity, its affiliates, principal owners, manage-ment and members of their immediate families, and APB Opinion 18 investors and investees. It also covers any other party with whom the reporting entity may deal, when that party's influence extends to the ability to prevent the reporting entity from fully pursuing its own interests. In-cluded, too, are situations in which entities dealing with each other are both susceptible to influence by a third party, such as when a series of companies are subject to the owner's discretion concerning which company shall handle a particular transaction.
Note that even though some transactions are not given accounting recognition, they are nonetheless related party transactions. For example, a parent company may provide services to a subsidiary without charge.
Excluded from related party transactions are situations in which a company is economically dependent on one or more parties with which it does a significant amount of business—such as a supplier, franchiser, distributor, general agent, borrower, or lender. While these parties are not related parties—there is not a significant management or ownership influence—disclosure of economic depen-dency may be necessary in the financial statements.
The cardinal rule in SAS 6 is that "established accounting
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