Protecting Your Business
From Fraud
Jacque James, MBA, MAFM
President of
Asset Recovery Associates, LLC
September 27, 2012
Overview of Presentation
• Discussion topics:
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Overview of Occupational Fraud
Fraud Statistics
Red Flags of Fraud
Hiring Ethical Employees
Payroll Fraud Schemes
4 Step Fraud Prevention Process
Prevention Best Practices
Q&A
What is Occupational Fraud?
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.
Classifications of Fraud
Asset
Misappropriation
Schemes
• 86.7% of all fraud schemes
• Smallest dollar loss $120,000
• Average time of detection is 12 – 24 months
Financial
Statement Fraud
• 7.6% of fraud cases in 2011
• Average dollar loss was $1,000,000
• Average time of detection is 27 months
Corruption
• 33.4% of fraud cases in 2011
• Median dollar loss was $250,000
• Average time of detection is 18 months
51 Fraud Schemes
Fraud Statistics In Small Business
• Accounts for 31% of all fraud
• Small businesses are targets for fraud due to fewer antifraud controls compared to that of larger organizations
• The most common types of fraud are:
▫ Payroll Fraud Schemes
▫ Billing Fraud Schemes
▫ Skimming Schemes
The Cost of Fraud
• The average organization loses 5% of its revenues to
fraud annually
• The median loss caused by occupational fraud cases is
$140,000
• Most frauds last an average of 18 months before being
detected
*Source: 2012 Report of the Nation - Association of Certified Fraud Examiners
Median Duration of Fraud Based on
Scheme Type
Why Fraud Occurs
Three Criteria Needed For Fraud To Occur:
Opportunity
Motive
Ability to
Rationalize Behavior
Why Fraud Occurs
• Opportunity
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Poor company culture
Knowledge of weak internal controls
Accounting anomalies not monitored
Lack of supervision
Employees believe they will not get caught
• Motive
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Financial struggles
Pressure to perform
Divorce
Family or peer pressure
Addiction problems (Alcohol, drugs, gambling)
Why Fraud Occurs
• Ability to Rationalize Behavior
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Employee believes he/she is not being adequately compensated
Employee believes the organization OWES him/her
Feeling of insufficient recognition for job performance
Personal need for money
Have the intent to repay the money
Who Commits the Fraud?
Position of Fraudster
Position
Percent
Median Loss
Time To
Detection
Empl oyee
43.0%
$60,000
12
Ma na ger
34.3%
$182,000
24
Owner / Executi ve
18.5%
$573,000
24
Other
4.2%
$100,000
10
• 65% of men commit acts of fraud compared to 35% of women.
• Average median loss caused by males is $200,000 vs $91,000
caused by females.
Top 10 Behavioral Red Flags
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Employees living beyond their means
Financial difficulties
Control issues, unwillingness to share duties
Unusually close vendor/customer relationship
Wheeler dealer attitude
Divorce, family pressures
Irritability, suspiciousness or defensiveness
Addiction problems
Refusal to take vacations
Past employment related issues
Hiring Ethical Employees
Did You Know?
• 53% of all job applications contain inaccurate
information
• 34% of all application forms contain outright lies about
experience, education, and ability to perform essential
functions on the job
• 11% of job applicants misrepresented
why they left a former employer
Purpose of Interview Process
• Get to know the “real” candidate
▫ Who they normally are vs. who they want us to
believe they are
• Assess skill set and past employment
history
• Determine fit for your organization
The Application
• Does everyone require an application?
• Candidates often omit or exaggerate important
information
▫ Is the application filled out completely?
▫ Are there gaps in employment?
▫ Is there language regarding falsifying
application?
▫ Did the candidate sign the application?
the
Interview Room Set Up
• Select a quiet and comfortable room
• Clear table or desk
• Sit next to the interviewee
 Do NOT sit behind a desk – creates a psychological
barrier
What is Baseline Behavior?
• The individuals normal behavior in a relaxed
state
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Posture
Eye contact
Gestures with hands and arms
Legs and feet
Speech
Tone of voice
Behavioral vs. Assumptive
Questioning
• Behavioral Based
▫ Open ended question that probes into behavior
▫ Tell me about a time when you didn’t meet individual
performance.
• Assumptive Based
▫ Open ended questions that “assumes” a behavior or
action
▫ When was the first time you were disciplined on the job,
either verbally or written?
▫ Ask follow up questions
Threatening vs. Non Threatening
Questions
• Ask non threatening questions to determine
baseline
▫ Tell me about your hobbies
▫ What type of skills do you possess?
• Threatening
▫ When was the last time you were ever terminated from
an employer?
Detecting Deception Through
Verbal & Non Verbal Indicators
Body Language Basics
Positive Body Language
Negative Body Language
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Moving or leaning closer to you
Relaxed, uncrossed limbs
Long periods of eye contact
Looking down and away out of
shyness
• Genuine Smiles
Moving or leaning away from you
Crossed arms or legs
Looking away to the side
Feet pointed away from you, or
towards an exit
• Rubbing/scratching their nose,
eyes, or the back of their neck
Non Verbal Indicators
• Typical signs that that may indicate
deception:
▫ Closed position
• Arms / Legs crossed
• Body is turned away from you
▫ Facial expressions
▫ Hand or fingers cover mouth
Non Verbal Indicators
• Typical signs that that may indicate deception:
▫ Signs of stress
• Breathing rate increases
• Perspiration increases
• Complexion changes
▫ Lack of eye contact
Verbal Indicators
• Paralinguistics – Gestures immediately after a
verbal response
 Coughing
 Laughter
 Clearing of throat
• Words spoken in wrong tense
 Deceptive people refer to past events as if the event was
occurring in the present
Verbal Indicators
• Lack of self – reference
 The subject removes him / herself from the story
"The safe was left unlocked"
• Euphemisms / Minimizers
 “took” vs “stole”
 “borrowed”
• Lack of detail
Other Deceptive Indicators
• Distractors
 Grooming
 Repeating the question
 Answering questions with questions
Pre-Employment Interview Guide
Pre-Employment Interview Guide
• Purpose of the Interview Guide
▫ Designed to obtain information about the candidates
background that may not otherwise be discovered
▫ Identifies possible integrity issues
▫ Determines past employment issues
Role Play
Payroll Fraud
What is Payroll Fraud?
• Occupational fraud in which a person who works for
an organization causes that organization to issue a
payment by making false claims for compensation
▫ Ghost Employee Schemes
▫ Falsified Hours and Salary Schemes
▫ Commission Schemes
• Payroll fraud represents 9.3% of all fraud cases
• Average loss is $49,000
Ghost Employee Scheme
• A Ghost employee is someone on the payroll who
does not actually work for the victim company
Ghost Employee Scheme
• Add the ghost to the payroll
▫ Using names similar to real employees
▫ Failing to take terminated employees off the payroll
• Collecting timekeeping information
▫ Fake timecards
▫ Approval of timecards
• Delivery of the paycheck
▫ Mailed to the employees address
▫ Direct deposited
Preventing and Detecting Ghost
Employee Scheme
• Separate the hiring function from the payroll function
▫ Personnel records maintained separate from payroll & timekeeping
• Owners / Manager should approve all payroll changes
• Check payroll records against personnel records
• Periodically run computer reports for employees
▫ Are there duplicate social security numbers for two employees?
▫ Are there duplicate bank account numbers for multiple employees?
• Compare payroll to schedules
Falsified Hours and Salary
• Overpayment of wages is the most common form of
misappropriating payroll funds
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Increase hours worked
Change rate of pay
Time clock & time card manipulation
Being paid for time not worked
Underreport leave time
“Accomplice” clocks in absent employee
Preventing and Detecting
Falsified Hours and Salary Schemes
• A manager should verify all wage rate changes
• Time cards should be secured and monitored
• Supervisor should initial any changes to timecard
• Run programs to actively seek out fraudulent payroll
activity
• Compare payroll to production schedules
Preventing and Detecting
Falsified Hours and Salary Schemes
• Preparation, authorization, distribution, and
reconciliation should be segregated
• Review payroll report to scheduled hours
• No sick leave/vacation without management approval
• Look for individuals with excessive overtime
• Look for payroll expenses that exceed budget projections
or prior years
Commission Schemes
Commission fraud is very common in companies
whose culture is sales orientated
• Falsify the amount of sales made
▫ Create fraudulent sales orders, customer purchase orders, credit
authorizations, packing slips, invoices, et
▫ Ring up a false sales on the cash register
▫ Overstate legitimate sales
▫ Alter price on existing sales
• Claim sales made by other employees
Detecting Commission Schemes
• Run periodic reports to show an unusual relationship
between sales figures and commission figures
• Look for high levels of uncollected sales
• Track commission earned per salesperson; investigate
unreasonably high levels
• Randomly contact customers to verify sales
• Commissions should be handled independently of sales
department
Payroll Controls
• Separate the following duties:
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Payroll preparation
Payroll disbursement
Payroll distribution
Payroll bank reconciliation
Human resources
• Payroll accounting should be independent of general
ledger function
• Appropriate approval for time worked, overtime,
rate of pay, commission rates, etc.
Create a Fraud Free Culture with the
4 Step Fraud Prevention Process
Step 1
Hire Ethical
Employees
Step 2
Organizational
Culture
Step 4
Reporting &
Reward System
Step 3
Internal
Controls
4 Step Fraud Prevention Process
1.
Hire ethical candidates
 Perform assessments and/or conduct integrity interviews
 Conduct Background Screenings on key personnel
 Pre-employment statement analysis (LSAT)
2.
Create a positive company culture
 People won’t steal when they have a sense of ownership and loyalty to the
organization
3. Implement and assess internal controls
 Implement and enforce anti fraud policies and procedures
 Instill a system of checks and balances
 Conduct Fraud Risk Assessments
4. Instill mechanism for reporting fraud
 Implement a hotline and reward system
 Hotline will reduce the time to detection from 24 months to 12 months
Fraud Prevention Best Practices
• Create a “Perception of Control”
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Educate employees on fraud
Have a Conflict of Interest & Code of Conduct Policy
“Inspect what you expect” by conducting surprise audits
Reconcile bank statements on a monthly basis
Separation of duties
• Insure for loss
▫ “Crime Policy” or Fidelity Bond
▫ “Cybercrime Insurance”
Fraud Prevention Best Practices
• Have policies and procedures in place that outline what
is and what is not acceptable
• Proper check signing authorizations / secure signature
stamp
• Match employee addresses on payroll records against
addresses on vendor lists
• Spot check expense reimbursements
• Open the mail periodically
• Conduct Fraud Risk Assessments annually
Why Are Controls Important?
Duration of Fraud Based on Presence of Anti Fraud Control
Control
Job Rotation / Manadatory Vacation
Percent of Cases
Implemented
Control In Place
Control NOT in
Place
Percent
Reduction
16.7%
9 months
24 months
62.5%
9.4%
9 months
22 months
59.1%
Surprise Audits
32.2%
10 months
24 months
58.3%
Code of Conduct
79.0%
14 months
30 months
53.3%
Anti Fraud Policy
48.6%
12 months
24 months
50.0%
External Audit
67.5%
12 months
24 months
50.0%
Formal Fraud Risk Assessment
35.5%
12 months
24 months
50.0%
Fraud Training for Employees
46.8%
12 months
24 months
50.0%
Fraud Training for Managers / Execs
47.4%
12 months
24 months
50.0%
Hotline
54.0%
12 months
24 months
50.0%
Management Certifi cation of F/S
60.5%
12 months
24 months
50.0%
Independent Audit Committee
59.8%
13 months
24 months
45.8%
Internal Audit
69.4%
13 months
24 months
45.8%
Management Review
68.5%
14 months
24 months
41.7%
Employee Support Programs
57.5%
16 months
21 months
23.8%
External Audit of Financal Statements
80.1%
17 months
24 months
29.2%
Rewards for Whistleblowers
Protect Your Investment
 Do your employees rate the company culture a 9 or 10?
 Do you conduct pre-employment screenings?
 Do you have policies and procedures in place to prevent
misconduct? This includes HR
 Do you have a crime policy & cyber crime policy in place?
 Do you have the proper amount of coverage?
 Have you conducted a Fraud Risk Assessment lately?
 If fraud occurs in your business, call a professional!
Test Your Fraud IQ Answers
1. How much do small businesses lose to fraud each year?
d. 140,000
2. What percentage of revenue is lost to employee theft and
occupational fraud each year?
a. 5%
3. Most employee theft is committed by 1st time offenders.
True
4. What percentage of your employees are likely to steal?
d. 61–90%
Test Your Fraud IQ Answers
5. If there is little cash coming in to the organization, the risk of theft
is low.
False
6. Trusted employees have the opportunity to steal.
True
7. Most embezzlement schemes in small businesses are discovered
by:
b. Tip
“Trust But Verify”
Please leave your business card if you would
like an electronic copy of the interview guide or
this presentation.
Contact Information:
Jacque James - President
Asset Recovery Associates, LLC
2464 Taylor Rd, #115
Wildwood, MO 63011
Ph: 636-346-9273
Email: jjames@assetrecoverystl.com
Website: www.assetrecoverystl.com
Services Offered:
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Fraud Assessment & Risk Evaluations
Internal Theft & HR Investigations
Fraud Training
Internal Control Implementation
Asset Investigations
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Skip Tracing
Judgment Enforcement
Due Diligence Investigations
Background Screenings