An Introduction to Fraud - University of New Mexico

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An Introduction to Fraud
Dr. Richard G. Brody, CPA, CFE, CFF, FCPA
Anderson School of Management
Douglas Minge Brown Professor
University of New Mexico
Estimated Costs/Impacts of Fraud
Report to the Nation
• $994 billion per year (2010 Global Estimate is
more than $2.9 trillion)
• $6,860 per employee
• $18.30 per day per employee
• 5 - 7% of revenue lost
• 5 - 7 cents on every revenue dollar stolen
The Seriousness of Fraud
• How is the magnitude perceived to be changing?
• Size and dollars
• Effect on stock price
• Collusion
• Credibility issue
Fraud is a Costly Business Problem
• Fraud reduces a firm’s • Fraud Robs Income
net income on a
dollar-for-dollar basis.
• If the profit margin is
10%, revenues must
increase by 10 times
losses to recover the
effect on net income.
Revenues
Expenses
Net Income
Fraud
Remaining
$100
90
$ 10
1
$ 9
100%
90%
10%
To restore income to $10, need
$10 more dollars of revenue to
generate $1 more dollar of
income.
What Does the Fraudster Look Like?
• Like you and me
• No specific psychological profile
• Male: U.S. 57%; Global 67%
• Occupational fraudsters are generally
first-time offenders.
– Only 7% of fraud perpetrators had prior
convictions, and only 10% had been
previously terminated by an employer for
fraud-related conduct.
Seven Elements 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
Why Are We so Often Conned?
• Trusting – we trust too much
o Often a “I can’t believe it” response
• Greed – rules many decisions
o The perpetrator is not the only one
Ways to Classify Frauds
• Fraud against an organization
• Fraud on behalf of or for an organization
The Fraud Triangle
Personal Integrity and the
Likelihood to Commit Fraud
• The higher the personal integrity, the less
likely to commit fraud.
• Will take much more of the three fraud
elements to move them to commit fraud.
• Fraud studies show that levels of honesty
are decreasing.
The First Element:
Perceived Pressure
1. Financial
2. Vices
3. Work-related
4. Other
The Second Element:
Perceived Opportunity
The three components of perceived opportunity:
1. To commit fraud
2. To conceal fraud
3. To avoid punishment
Factors that Increase Opportunities to
Commit Fraud
1. Ability to get around internal controls that
prevent or detect fraud
2. Inability to judge quality of performance
3. Lack of an audit trail
4. Failure to discipline prior fraud perpetrators
Conditions that Create
Opportunities for Fraud
•
Management not caring about
honesty or ethics
•
Unreasonable Budget
Expectations
•
Inadequate Pay
•
Short-Term Focus
•
Low Loyalty
•
Reactive vs. Proactive
•
Crisis Management
•
Hostile Work Environment
•
Poor Promotion Opportunities
•
Poor Training
•
Rapid turnover of key
employees
•
•
Absence of periodic rotations
or transfers of employees
Failure to inform employees
about rules and discipline of
fraud perpetrators
•
Lack of internal security
•
Familiarity with operations
•
Close association with suppliers
and other key people
•
Absence of mandatory
vacations
The Third Element:
Rationalization
• People rationalize their unacceptable
behavior
• Helps the fraudster hide from the
dishonesty of the acts
• Involved in nearly every fraud
Common Rationalizations
• They owe it to me.
• I’m only borrowing the money.
• Nobody will get hurt.
• I deserve more.
• It’s for a good cause.
• We’ll fix the books as soon as we get past this
little financial problem.
• It’s for my sick child.
Activities Fundamental
to Fraud Prevention
First:
Create and Maintain a Culture of Honesty,
Openness and Assistance
Activities Fundamental
to Fraud Prevention
Second:
Assess the Risk of Fraud and Develop Concrete
Responses to Minimize Risk and Eliminate
Opportunity
Current Model for Dealing with Fraud
1. Fraud incident
2. Investigation
3. Action
4. Resolution
Actions Fraud Savvy Organizations
Take to Minimize Fraud
1. Tone at the top
2. Education and training
3. Integrity risk and controls
4. Reporting and monitoring
5. Proactive detection
Tone at the Top
Management and Directors
• Backgrounds
• Motivations
• Influence on Decision Making
Tone at the Top (continued)
Management’s Expectations
1. Appropriate Values & Ethics
2. Fraud Awareness & Training
3. Consistent Punishment of Violators
Education and Training
• Prevention is the key!
• Proactive fraud education
– Employees
– Vendors
– Other outsiders
Integrity Risk & Controls
• Implement effective internal controls
– An ongoing task
– Override of controls
– Ignore controls
• Learn from frauds that are detected
– Implement controls to prevent future occurrences
– Who was involved in the fraud?
– Were controls compromised or were they absent?
Reporting and Monitoring
• Most frauds are detected from tips
• Employees must be alert to red flags that
signal fraud
• Employees must be willing and able to report
potential fraud
• Company should report fraud so that
employees know that fraud does exist and it
is THEIR problem, one they can prevent
Proactive Fraud Auditing/Detection
1. Identify risk exposures
2. Identify fraud symptoms for each exposure
3. Audit programs proactively look for
symptoms and exposures
4. Investigate identified symptoms
Summary
Keys to Fraud Prevention/Detection
• “Walking the talk” – leading by example
• Educating employees and others – they understand the
problem and know what to do if they suspect fraud
• Hotlines/Anonymous reporting mechanisms – potential
fraud can be reported
• Control procedures prevent and detect fraud
• Fraud audits create fraud awareness – individuals know
their work is always subject to review
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