Fifth Edition Chapter 1 The Nature of Fraud © 2019 Cengage. All rights reserved. The Definition of Fraud (1 of 2) • Seven Specific Parts of Fraud 1. a representation 2. about a material point 3. which is false 4. and intentionally or recklessly so 5. which is believed 6. and acted upon by the victim 7. to the victim’s damage The Definition of Fraud (2 of 2) • • • • • • • • • • • Fraud is… intentional to trick or deceive someone out of his/her assets theft a crime Fraud is not… taken by physical force a mistake or error victimless insignificant because no one is hurt acceptable or justifiable © 2019 Cengage. All rights reserved. The Various Classifications of Fraud (1 of 2) • There are many ways to classify the various types of fraud, the most common way is to simply divide frauds into those that are committed against organizations and those that are committed on behalf of organizations • Employee fraud • Occupational fraud • A third classification divides frauds according to victims © 2019 Cengage. All rights reserved. The Various Classifications of Fraud (2 of 2) TYPE OF FRAUD Employee embezzlement PERPETRATO R VICTIM EXPLANATION Employees of an organization The employer Vendor fraud Vendors of an organization The organization to which the vendors sell goods or services Employees use their positions to take or divert assets belonging to their employer. This is the most common type of fraud. Customer fraud Customers of an organization The organization which sells to the customers Vendors either overbill or provide lower quality or fewer goods than agreed. Management fraud (Financial statement fraud) Management of a company Shareholders and/or debtholders and regulators (taxing authorities, etc.) Customers don't pay, pay too little, or get too much from the organization through deception. Investment scams and other consumer frauds Fraud perpetrators— all kinds Unwary investors Management manipulates the financial statements to make the company look better than it is. This is the most expensive type of fraud. Other (Miscellaneous) types of fraud All kinds— depends on the situation All kinds—depends on the situation These types of frauds are committed on the Internet and in person and obtain the confidence of individuals to get them to invest money in worthless schemes. Other (Miscellaneous) types of fraud All kinds— depends on the situation All kinds—depends on the situation Any time anyone takes advantage of the confidence of another person to deceive him or her. Criminal and Civil Fraud Laws • When people commit fraud, they can be prosecuted criminally and/or civilly. • Criminal law is that branch of law that deals with offenses of a public nature • Civil law deals with the rights of individuals Fraud-fighting Careers TYPES OF EMPLOYERS TYPE OF CAREER Government and law enforcement FBI, postal inspectors, Criminal Investigation Division of the IRS, U.S. marshals, inspector generals of various governmental agencies, state investigators, and local law enforcement officials. CPA firms Conduct investigations, support firms in litigation, do bankruptcyrelated accounting work, and provide internal audit and internal control consulting work. Corporations Prevent, detect, and investigate fraud within a company. Includes internal auditors, corporate security officers, and in-house legal counsels. Consulting Serve as an independent consultant in litigation fraud work, serve as expert witness, consult in fraud prevention and detection, and provide other fee-based work. Law firms Lawyers provide litigation and defense work for companies and individuals being sued for fraud and provide special investigation services when fraud is suspected. Fifth Edition Chapter 2 Why People Commit Fraud © 2019 Cengage. All rights reserved. Type of People That Commit Fraud • What type of people commit fraud? – Anyone! – Not demographically or psychologically differentiated – Have the profile of other honest people The Fraud Triangle Pressure (1 of 4) • Divided into four main groups: – Financial pressures – Vices – Work-related pressures – Other pressures • Financial pressure is the most common type of pressure to commit fraud. © 2019 Cengage. All rights reserved. Pressure (2 of 4) • Common Financial Pressures: 1. Greed 2. Living beyond one’s means 3. High bills or personal debt 4. Poor credit 5. Personal financial losses 6. Unexpected financial needs © 2019 Cengage. All rights reserved. Pressure (3 of 4) • Vice Pressures • Examples include: – Gambling – Drugs – Alcohol – Expensive extramarital relationships © 2019 Cengage. All rights reserved. Pressure (4 of 4) • Work-Related Pressures • “Get even with the employer” • Motivated by these factors: – Getting little recognition – Feeling job dissatisfaction – Fear of losing one’s job – Being overlooked for a promotion – Feeling underpaid © 2019 Cengage. All rights reserved. Opportunity • Six major factors that increase opportunity: 1. Lack of controls 2. Inability to judge performance quality 3. Failure to discipline fraudsters 4. Lack of access to information 5. Ignorance, apathy and incapacity 6. Lack of audit trail Recruitment of Fraudsters Chapter 3 Fighting Fraud: An Overview © 2019 Cengage. All rights reserved. To the Student (1 of 2) • . The most cost-effective fraud-fighting activities involve preventing fraud from occurring. • The second most cost-effective fraud-fighting activities involve implementing proactive approaches to detect fraud early, before it has a chance to grow. • Once fraud has been detected (or there is predication that fraud might be occurring), organizations undertake various types of fraud investigation methods. • After fraud has been investigated and the perpetrators are known, various types of legal action are possible. © 2019 Cengage. All rights reserved. How Organizations Fight Fraud Organizations fight fraud by implementing: 1. Fraud prevention 2. Early fraud detection 3. Fraud investigation 4. Follow-up legal action and/or resolution • Preventing fraud is generally the most cost-effective way to reduce losses from fraud. © 2019 Cengage. All rights reserved. Fraud Prevention (1 of 2) • • Create a Culture of Honesty & High Ethics Five critical elements: 1. Have top management model appropriate behavior 2. Hire the right kind of employees 3. Communicate expectations and require periodic written acceptance to the expectations 4. Create a positive work environment 5. Enforce policies for handling fraud © 2019 Cengage. All rights reserved. Fraud Prevention (2 of 2) • • Eliminate Fraud Opportunities Organizations should: 1. Identify sources and measure fraud risks 2. Implement preventative and detective controls 3. Create widespread monitoring by employees 4. Have internal and external auditors Early Fraud Detection • Three Primary Ways to Detect Fraud 1. By chance 2. By providing “whistle-blowing” systems 3. By data mining • In the past, most frauds were detected by accident. © 2019 Cengage. All rights reserved. Fraud Investigation (1 of 2) • The first approach to fraud investigation is the evidence square. • How is the evidence square useful in thinking about fraud investigation? Fraud Investigation (2 of 2) A second approach to fraud investigation is to focus on the two different fraud triangles. Follow-Up Legal Action (1 of 2) • Civil Action The purpose of civil action is to recover money or other assets from the fraud perpetrators and others associated with the fraud. • Criminal Action Criminal action can only be brought by law enforcement or statutory agencies. © 2019 Cengage. All rights reserved. Follow-Up Legal Action (2 of 2) • It is much more difficult to get a criminal conviction than a judgment in a civil case