Stomping Out the Fraud Fire
advertisement
Stomping Out the Fraud Fire Stomping Out the Fraud Fire Fraud Knowledge Survey GSCPA 1) Which type has the highest occurrence? A) Asset misappropriation B) Corruption North Perimeter Chapter C) Financial statement fraud May 20, 2008 Part 1 Presented By: James H. Rumph, CPA, CFE, CIA © Habif, Arogeti & Wynne, LLP, 2007 1 2) Which type has the highest average loss? A) Asset misappropriation © Habif, Arogeti & Wynne, LLP, 2007 2 © Habif, Arogeti & Wynne, LLP, 2007 3) Which tenure range has the highest occurrence? A) <1 C) 5-10 C) Financial statement fraud May 20, 2008 4) Which level of education has the greatest average loss? A) High school diploma B) Bachelor’s degree B) Corruption © Habif, Arogeti & Wynne, LLP, 2007 3 4 B) 1-5 © Habif, Arogeti & Wynne, LLP, 2007 D) 10+ 5 James H. Rumph, CPA, CFE, CIA C) Postgraduate degree © Habif, Arogeti & Wynne, LLP, 2007 6 Stomping Out the Fraud Fire 5) Which position has the highest occurrence? 6) Which position has the greatest average loss? Presentation Overview 1. Fraud Overview A) Employee A) Employee B) Manager B) Manager C) Owner/executive C) Owner/executive 2. Fraud Triangle 3. Fraud Detection 4. Fraud Prevention 5. “Crazy” Eddie Antar Dissection © Habif, Arogeti & Wynne, LLP, 2007 7 © Habif, Arogeti & Wynne, LLP, 2007 8 2006 ACFE Report to the Nation 1. Fraud Overview © Habif, Arogeti & Wynne, LLP, 2007 May 20, 2008 10 Participants in the study estimated that U.S. organizations lose an estimated 5% of annual revenues due to occupational fraud. © Habif, Arogeti & Wynne, LLP, 2007 11 James H. Rumph, CPA, CFE, CIA © Habif, Arogeti & Wynne, LLP, 2007 9 Hypothetical Example: Wal-Mart Fiscal Year 2007 Reported Net Sales $345.0 Billion Reported Net Income $11.3 Billion Hypothetical 5% Occupational Fraud Loss $17.3 Billion © Habif, Arogeti & Wynne, LLP, 2007 12 Stomping Out the Fraud Fire Fraud Occupational Fraud Fraud has many definitions ACFE 2006 Report to Nation definition: In the broadest sense, fraud is: ¾ 13 1) Asset misappropriation ¾ The use of one’s occupation for personal enrichment through the deliberate misuse or misapplication of the employing organization’s resources or assets. an intentional deception made for personal gain. © Habif, Arogeti & Wynne, LLP, 2007 Occupational Fraud: Broad Types © Habif, Arogeti & Wynne, LLP, 2007 14 2) Corruption 3) Financial statement fraud © Habif, Arogeti & Wynne, LLP, 2007 15 1) Asset misappropriation 2) Corruption 3) Financial statement fraud Stealing inventory Accepting or paying a bribe or kickback Booking fictitious revenues Skimming and embezzling Undisclosed conflicts of interest Overstated assets Ghost employees Undisclosed liabilities © Habif, Arogeti & Wynne, LLP, 2007 May 20, 2008 16 © Habif, Arogeti & Wynne, LLP, 2007 17 James H. Rumph, CPA, CFE, CIA © Habif, Arogeti & Wynne, LLP, 2007 18 Stomping Out the Fraud Fire Who Does Fraud Hurt? Fraud Hurts Everyone! © Habif, Arogeti & Wynne, LLP, 2007 19 The Fraud Fire Fire Triangle Fraud Triangle 2. Fraud Triangle © Habif, Arogeti & Wynne, LLP, 2007 20 © Habif, Arogeti & Wynne, LLP, 2007 21 Fraud Triangle: Pressure Fraud Triangle: Rationalization Fraud Triangle: Opportunity Pressure to commit fraud. A frame of mind that allows Circumstances, actual or perceived, that allow Examples: Examples: Examples: ¾ Sudden financial hardship ¾ Profit-based compensation justification for fraud. fraud to occur. ¾ “I will pay it back.” ¾ “Everyone does it.” ¾ Lack of segregation of duties ¾ Failure to prosecute offenders Walt Pavlo Former Senior Manager WorldCom *Clip from the ACFE’s “Fraud and the Tone-at-the-Top” video © Habif, Arogeti & Wynne, LLP, 2007 May 20, 2008 22 © Habif, Arogeti & Wynne, LLP, 2007 23 James H. Rumph, CPA, CFE, CIA © Habif, Arogeti & Wynne, LLP, 2007 24 Stomping Out the Fraud Fire Imagine: Imagine: You lost your job 6 months ago (decided to You have access to fraudulently “borrow” the Your home was just washed away in a flood You have no other access to the necessary Your spouse just passed away You will be able to get a job to pay the money save money by dropping your family’s health insurance coverage) (no flood insurance) funds you need to pay for your living expenses and surgery Fraud Knowledge Survey funds back in 4 months Part 2 You just found out that your 3-year old child needs critical surgery that will cost $100K © Habif, Arogeti & Wynne, LLP, 2007 25 What would you do? © Habif, Arogeti & Wynne, LLP, 2007 26 The Company Investors are concerned about decreased ¾ Owned by several passive investors ¾ Closes sales of new homes ¾ Three employees © Habif, Arogeti & Wynne, LLP, 2007 May 20, 2008 28 © Habif, Arogeti & Wynne, LLP, 2007 27 The Predication Big Time Closers, Inc. Who’s the Fraudster? © Habif, Arogeti & Wynne, LLP, 2007 29 James H. Rumph, CPA, CFE, CIA revenues in a thriving real estate market. Customers have started complaining that Big Time Closers, Inc. has become Big “Cost” Closers, Inc. © Habif, Arogeti & Wynne, LLP, 2007 30 Stomping Out the Fraud Fire The Employees Alicia Armstrong (Bookkeeper) Brandi Brown (Real estate closer) Calvin Carr (Real estate closer) Alicia Armstrong (Bookkeeper) Brandi Brown (Real estate closer) © Habif, Arogeti & Wynne, LLP, 2007 31 Calvin Carr (Real estate closer) Age: 46 Tenure: 3 Years Salary: $78K/Yr Vehicle: 2005 Corvette Home: Purchased in 1997 Single & enjoys the nightlife © Habif, Arogeti & Wynne, LLP, 2007 May 20, 2008 34 Age: 48 Tenure: 1 Year Salary: $48K/Yr Vehicle: 2006 Lexus RS330 Home: Purchased in 2007 Only employee with access to accounting software Only employee authorized to write checks and make deposits Married, quiet, & keeps to herself Two children in college © Habif, Arogeti & Wynne, LLP, 2007 32 Age: 49 Tenure: 3 Years Salary: $78K/Yr Vehicle: 2005 Acura TL Home: Purchased in 1995 Married with two children in middle school Bowls four nights a week © Habif, Arogeti & Wynne, LLP, 2007 33 Who’s the Fraudster? A.) Alicia Armstrong (Bookkeeper) 3. Fraud Detection B.) Brandi Brown (Real Estate Closer) C.) Calvin Carr (Real Estate Closer) © Habif, Arogeti & Wynne, LLP, 2007 35 James H. Rumph, CPA, CFE, CIA © Habif, Arogeti & Wynne, LLP, 2007 36 Stomping Out the Fraud Fire Finance-Related Red Flags Other Red Flags Cash shortages Excessive turnover of executives Unbalanced ledgers Tips or complaints Unreasonable expenses or reimbursements Strange financial statement relationships (e.g., increased revenues with decreased receivables) Initial Detection of Occupational Frauds* 34.20% Tip Extravagant lifestyles Unusual behaviors ¾ Guilt leads to fear ¾ Fear leads to stress ¾ Stress leads to behavior changes Detection Method Unreasonable document sequences Detection Method Study 25.40% By Accident 20.20% Internal Audit 19.20% Internal Controls 12.00% External Audit 3.80% Notified by Police 0% 5% 10% 15% 20% 25% Percent of Cases * Data from the 2006 ACFE Report to the Nation on Occupational Fraud & Abuse 37 © Habif, Arogeti & Wynne, LLP, 2007 © Habif, Arogeti & Wynne, LLP, 2007 38 © Habif, Arogeti & Wynne, LLP, 2007 39 What’s Wrong? Fraud Knowledge Survey What’s Wrong? Part 3 © Habif, Arogeti & Wynne, LLP, 2007 May 20, 2008 40 © Habif, Arogeti & Wynne, LLP, 2007 41 James H. Rumph, CPA, CFE, CIA © Habif, Arogeti & Wynne, LLP, 2007 42 30% 35% 40% Stomping Out the Fraud Fire Fraud Triangle Detection Technique Other Fraud Detection Techniques Pressure Data-mining (e.g., ACL or IDEA) ¾ Who has had a recent change in their lifestyle (e.g., from a divorce)? Statistical analysis of company databases (e.g., Benford’s law) Rationalization ¾ Are all employees given competitive compensation? Risk-based analysis (e.g., determining common frauds within the industry, and identifying typical symptoms of those frauds) Opportunity ¾ Where are significant control weaknesses (e.g., lack of segregation of duties)? © Habif, Arogeti & Wynne, LLP, 2007 43 Analyzing financial statements (e.g., ratio analyses) © Habif, Arogeti & Wynne, LLP, 2007 44 © Habif, Arogeti & Wynne, LLP, 2007 Fraud Prevention Creating a Culture of Honesty, Openness, and Assistance 1. Creating a culture of honesty, openness, and Creating a positive work environment Hiring honest people and providing assistance 2. Minimizing opportunities for fraud 4. Fraud Prevention fraud awareness training Implementing employee assistance programs 45 Minimizing Opportunities for Fraud Effective internal control is the other key to minimizing opportunities to commit fraud. Dr. Stephen Salbu Organizational Behavior Specialist *Clip from the ACFE’s “Fraud and the Tone-at-the-Top” video. © Habif, Arogeti & Wynne, LLP, 2007 May 20, 2008 46 © Habif, Arogeti & Wynne, LLP, 2007 47 James H. Rumph, CPA, CFE, CIA © Habif, Arogeti & Wynne, LLP, 2007 48 Stomping Out the Fraud Fire Internal Controls Internal Controls Internal Controls Cash Inventory Investment Securities Posting notices offering customers gifts if they Halting production or controlling movement Maintaining a record of due dates for income Accounts Receivable Fixed Assets Using a lockbox system. Using a capital budget and following up on don’t receive a receipt or it’s incorrect. © Habif, Arogeti & Wynne, LLP, 2007 49 during physical counts. Accounts Payable excess costs. © Habif, Arogeti & Wynne, LLP, 2007 Locking up unused checks and signature stamps. 50 © Habif, Arogeti & Wynne, LLP, 2007 Internal Controls Payroll Equity Requiring that someone independent of the Using prenumbered stock certificates, issuing NO them sequentially, and reviewing their sequence periodically. Why? Borrowing Always a risk of management override of Periodically obtain copies of the organization’s controls credit report. © Habif, Arogeti & Wynne, LLP, 2007 May 20, 2008 52 51 Can a Company Eliminate All Opportunities? Internal Controls payroll function mail or deliver paychecks. (such as bond income) and follow up if it is not received promptly. © Habif, Arogeti & Wynne, LLP, 2007 53 James H. Rumph, CPA, CFE, CIA © Habif, Arogeti & Wynne, LLP, 2007 54 Stomping Out the Fraud Fire Should a Company Try to Eliminate All Opportunities Possible of Being Eliminated? Is that a Precise Process? NO NO Why? Why? Must always weigh costs with benefits. © Habif, Arogeti & Wynne, LLP, 2007 55 Crazy Eddies 5. “Crazy” Eddie Antar Dissection Companies may be able to estimate costs, but cannot precisely estimate benefits since they are unknown until it’s too late. © Habif, Arogeti & Wynne, LLP, 2007 56 Overview © Habif, Arogeti & Wynne, LLP, 2007 57 Eddie’s Frauds Eddie evolved a small discount electronic store into a powerhouse in the discount electronic industry. In the process, Eddie engineered one of the longest-lasting fraud schemes in the modern business world. Tax Fraud to Securities Fraud Insurance Fraud Eddie had many perceived pressures, Eddie’s Frauds Lasted Approximately 18 Years perceived opportunities, and rationalizations. *Clip from RetroJunk.com. © Habif, Arogeti & Wynne, LLP, 2007 May 20, 2008 58 © Habif, Arogeti & Wynne, LLP, 2007 59 James H. Rumph, CPA, CFE, CIA © Habif, Arogeti & Wynne, LLP, 2007 60 Stomping Out the Fraud Fire Eddie’s Tax Fraud Eddie’s Securities Fraud Eddie’s Insurance Fraud Hiding revenues Inflation of revenues Inflation of thefts ¾ Under floorboards ¾ Israeli bank accounts Avoiding payroll taxes ¾ Paying employees with skimmed cash ¾ Panama Pump ¾ Based on the logic that, if the thieves were caught, who would believe them? Inflation of inventories ¾ Backdating shipping documents ¾ Counting empty boxes ¾ Building tall “dummy” columns of boxes Inflation of water losses ¾ Watered down merchandise from previous losses was reused in new water claims. Insider trading © Habif, Arogeti & Wynne, LLP, 2007 61 © Habif, Arogeti & Wynne, LLP, 2007 62 © Habif, Arogeti & Wynne, LLP, 2007 63 Crazy Eddie: Pressures Crazy Eddie: Rationalizations Crazy Eddie: Opportunities Financial Distress “I will only do this until I get back on my feet.” No “outsiders,” including board of directors Preoccupied with being “successful” “No one will get hurt.” “Educated” family member Challenge to “beat the system” “There is nothing wrong with switching a Ineffective audit procedures Greed customer to an item that better fits his or her needs.” (relating to bait & switch schemes) Lack of detection and punishment “It’s us against them.” © Habif, Arogeti & Wynne, LLP, 2007 May 20, 2008 64 © Habif, Arogeti & Wynne, LLP, 2007 65 James H. Rumph, CPA, CFE, CIA © Habif, Arogeti & Wynne, LLP, 2007 66 Stomping Out the Fraud Fire Eddie’s Detection Have We Learned Our Lesson? Crazy Eddies was hostilely taken over in 1987. During the takeover, Eddie tried to counter- Increased fraud awareness Sarbanes-Oxley Act of 2002 ¾ Increased accountability & penalties * Officers * Board of directors & audit committees * Auditors offer but couldn’t hold it off. After the takeover, inventory was found to be grossly overstated (approximately $80 million). This finding launched numerous investigations and lawsuits. © Habif, Arogeti & Wynne, LLP, 2007 67 THE BOTTOM LINE Occupational fraud is a serious threat to all businesses. The fraud triangle (pressures, rationalizations, and opportunities) is a very powerful tool for both fraud detection and prevention. Fraud detection occurs after damage occurs to an organization. Fraud prevention efforts are essential for all Eddie’s frauds could still occur today but would be… Less likely to occur Less likely to last as long Statement on Auditing Standards No. 99 (SAS 99) ¾ Fraud brainstorming sessions ¾ Emphasis on inquiry and analytics ¾ Considering antifraud programs and controls © Habif, Arogeti & Wynne, LLP, 2007 68 © Habif, Arogeti & Wynne, LLP, 2007 Resources 69 Questions? 2006 ACFE “Report to the Nation on Occupational Fraud & Abuse” www.acfe.com/documents/2006-rttn.pdf “Fraud and the Tone-at-the-Top” video - www.acfe.com/video/tone-at-the-top.wmv “The World’s Dumbest Fraudsters” written by Joseph T. Wells and published in May 2003 www.aicpa.org/PUBS/jofa/may2003/wells.htm James H. Rumph, CPA, CFE, CIA Habif, Arogeti & Wynne, LLP james.rumph@hawcpa.com (404) 898-7531 businesses. © Habif, Arogeti & Wynne, LLP, 2007 May 20, 2008 70 © Habif, Arogeti & Wynne, LLP, 2007 71 James H. Rumph, CPA, CFE, CIA © Habif, Arogeti & Wynne, LLP, 2007 72
