CCIA 2011 Fall Conference
Occupational Fraud
Schemes & Increasing
Fraud Awareness
Jenny Dominguez
Sr. Manager, VLS Fraud Solutions
October 6, 2011
Presenter Contact Information
Jenny Dominguez, CPA/CFF, CFE
Vicenti, Lloyd & Stutzman, LLP
jdominguez@vlsllp.com
www.vlsllp.com
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Topics To Cover
I.
The Fraud Triangle – factors that influence the
commission of fraud
II. The Fraud Tree – occupational fraud & abuse
classification system
III. Fraud Schemes – Case Studies
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I.
Three Factors of the Fraud
Triangle
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What 3 Factors Influence the
Commission of Fraud?
Pressures
Serious financial
problem that
“Pressures”
requires immediate
(Motive) attention
and cannot be resolved by
ordinary financial resources
Opportunities
Become aware that financial
problem can be solved by
stealing from organization or
“Opportunities”
falsifying organizations
records
FRAUD
TRIANGLE
Rationalization
Mindset and thinking that
what you are doing is justified
“Rationalization”
(Developed by Donald R. Cressey)
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II.
The Fraud Tree:
Occupational Fraud & Abuse
Classification System
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Occupational Fraud
The use of one’s
occupation for personal
enrichment through the
deliberate misuse or
misapplication of the
employing
organization’s
resources or assets.
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What is the Fraud Tree?
Three Major Types of Occupational Fraud
(page 7 of ACFE 2010 Report to the Nations)
Corruption
Off-book frauds that
occur in the form of
kickbacks, gifts, or
gratuities to
employees from
contractors /
vendors
Asset
Misappropriation
Theft or misuse of
organization’s cash
or assets
Fraudulent
Statements
Deliberate
misrepresentation of
the financial
condition of an
organization through
intentional
misstatement or
omission
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III.
Fraud Schemes
Case Studies
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Corruption – Interesting Facts
32.8% of the cases studied in the ACFE 2010 Report to the
Nations involved some form of Corruption.
The median loss suffered was $250,000.
Of the 90 cases studied involving organizations in the “Education”
industry, Corruption was the 2nd most common type of
occupational fraud committed, after billing schemes.
(page 35 of ACFE 2010 Report to the Nations)
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Corruption – Types of Frauds
•Conflicts of Interest
-Purchase Schemes
-Sales Schemes
-Other
•Bribery
-Invoice Kickbacks
-Bid Rigging
-Other
•Illegal Gratuities
•Economic Extortion
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Corruption – Case Study
Background / Summary
•Government agency
•Performed $100 - $400 million in construction activity annually
•Construction work was contracted out – internal project managers
•“Emergency” work was approximately $2 million per year
•95% of “emergency” work went to the same vendor
•Several large construction projects had change orders that exceeded
50% of the original contract, one exceeded 100%
•Manager of construction management department moved up the ranks
from field personnel
•Manager and CEO vacationed with one particular vendor
Any of these stand out as red flags?
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Corruption – Case Study
Internal Audit Revealed
•“Emergency” work being performed did not qualify as emergency under
PCC:
Fixing potholes outside of Board member’s house
Painting & other general work due to project time constraints
•Documentation was not kept to support that all contractors on approved
list for emergency work were solicited for quotes
•Change orders paid on some projects were not related to the original
construction contract
•Project tracking system not reconciled to accounting system
•Construction contracts did not include “right to audit” clause
What would next steps be?
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Asset Misappropriation – Interesting Facts
86.3% of the cases studied in the ACFE 2010 Report to the
Nations involved some form of Asset Misappropriation.
The median loss suffered was $135,000.
Of the 90 cases studied involving organizations in the “Education”
industry, “Billing” schemes were the most common type of
occupational fraud committed.
(page 35 of ACFE 2010 Report to the Nations)
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Asset Misappropriation – Types of Frauds
•Cash
-Larceny
-Skimming
-Fraudulent Disbursements
•Inventory & All Other Assets
-Misuse
-Larceny
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Asset Misappropriation – Case Study
Background / Summary
•Small dental practice
•Office manager handled:
Entering patient services into patient billing system – creating A/R
Collecting patient payments
Entering patient payments into patient billing system
Billing patients
Creating deposits and taking to bank
•Over 2 years “skimmed” approximately $35,000
Unrecorded sales
Write-offs and write-downs
Modified historical payment amounts
•Patient billing system did not have the capability to lock older months
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Asset Misappropriation – Case Study
Red Flags
•Lack of segregation of duties
•No reconciliations between accounting software and other systems
•Change in level of activity for certain collection type, particularly cash
•Refusal to take vacation or share duties
•Increase in Accounts Receivable
•Increase in Write-offs
•Working during “off” hours
•Write-offs / other adjustments don’t require approval
•Assets are not safeguarded
•Deposits done infrequently or irregularly
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Asset Misappropriation – Case Study
How Can This Be Prevented / Detected Earlier?
•Prevention:
Better segregation of duties
Secondary / separate approval or log-in required for write-offs
Lock patient tracking system to prevent modification
Perform background checks of new employees
Issue pre-numbered receipts for all payments (perform independent
check daily)
•Detection:
Analytical procedures – compare sales / collections over time
Review of historical write-offs
Perform regular reconciliations between the patient tracking system
(which reports total collections) to QuickBooks
Have aggressive collection department / personnel
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Fraudulent Statements – Interesting Facts
4.8% of the cases studied in the ACFE 2010 Report to the Nations
involved some form of Financial Statement Fraud.
The median loss suffered was $4.1 million.
Of the 90 cases studied involving organizations in the “Education”
industry, “Financial Statement Fraud” was the least common type
of occupational fraud committed.
(page 35 of ACFE 2010 Report to the Nations)
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Fraudulent Statements – Types of Frauds
•Financial
-Timing Differences
-Fictitious Revenue
-Concealed Liabilities & Expenses
-Improper Disclosures
-Improper Asset Valuations
•Non-Financial
-Employment Credentials
-Internal Documents
-External Documents
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Fraudulent Statements – Case Study
(Improper Disclosures)
Background / Summary
•City government - defined benefit pension plan
•Beginning in 1982 adopted use of “surplus earnings” to alleviate financial
obligations of City:
“13th Check” – extra check to retirees
$10 million, one-time reduction in City’s contribution to pension
Paid 100% of post-retirement healthcare benefits
•1996: Passed “MP-1” which set City contribution rates at negotiated rates
lower than the actuarially calculated rate
•2002: Pass “MP-2” which reduced trigger in MP-1 and slowly ramped up
contribution rates
•Manipulated actuarial valuations:
Changed valuation methods based on what favored City
Excluded certain liabilities as “contingent” – legally required to pay
Reset amortization period of unfunded liability
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Fraudulent Statements – Case Study
(Improper Disclosures)
Background / Summary
•Investigated financial statement disclosures over 7 years
•Primary issue: Disclosures related to pension plan funding
City claimed it was funding the pension system at
actuarially determined rates, when it was not
City failed to disclose that surplus earnings were used
to pay for retiree healthcare benefits
•Secondary issue: Conflict of interest
Pension board members voted on changes to the
pension system that eroded assets and increased their
individual benefits
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Fraudulent Statements – Case Study
(Improper Disclosures)
Motivation?
•City issued $3.1 billion in public bonds from 1996 - 2003
•City sought credit ratings from the various Rating Agencies
Better rating provided for better interest rate
•Email communication discovered during investigation:
“…when we book the NPO [Net Pension Obligation]
the rating agencies won’t like it. It will be a negative for
the City. As we market a large amount of bonds it might
cost us a lot of money…” - 1998
“…my biggest suggestion to her is to eliminate any
reference to fitch and rating agencies…this letter will be
seen by press and the city does not need to telegraph its
pension problems to the rating agencies…” - 2002
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Fraudulent Statements – Case Study
(Improper Disclosures)
Cost to City
•$$$$$
$24 million in fees for investigation
Increased auditor fees
Additional costs to comply with SEC & DA investigations
Higher interest rate on bonds
•Decreased credit rating
•Delayed / rejected bond approvals by tax payers
•Delayed audits (FY2003 completed in 2007)
•Employees fired and under investigation
•Significant reduction in public services
•Reduction in benefits for incoming employees
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Fraudulent Statements – Case Study
(Improper Disclosures)
Red Flags
•Ineffective Board of Directors or Audit Committee
•Significant, unusual, or highly complex transactions
•Recurring attempts by management to justify marginal or
inappropriate accounting
•Formal or informal restrictions on the auditor that limit
access to people or information
•Non-financial management’s excessive involvement in
determination of significant estimates
•Insufficient training of accounting staff
•Lack of “ownership” of financial statements
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Fraudulent Statements – Case Study
(Improper Disclosures)
How Can This Be Prevented / Detected Earlier?
•Implement full internal audit department
•Implement use of independent fraud hotline
•Ownership for financial statements is clearly assigned –
establish accountability
•Adequate and continuous technical training for employees
(accounting department)
•Training for all employees on what constitutes dishonest
behavior
•Implement Audit Committee
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THANK YOU!
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