37 Years of Excellent Client Service
FRAUD AWARENESS
Presented by
William Blend, CPA, CFE
William Blend, CPA, CFE
Fraud Awareness
•
ACFE I f
ACFE Information
ti
E
Examples of Fraud in Government and FS Fraud
l
fF di G
d FS F d
Red Flags
Detection / Prevention Information
Audit Committee
2
ACFE INFORMATION
3
ACFE 2010 Report to the Nations
ACFE 2010 Report to the Nations
• Issued during the summer of 2010, covering Jan. 2008 –
ssued du g t e su
e o 0 0, co e g Ja
008
Dec. 2009
• Studied
Studied 1,843 cases worldwide (1,021 in U.S.) of 1,843 cases worldwide (1,021 in U.S.) of
occupational fraud (use of one’s occupation for personal gain)
• Focused on 3 major categories of fraud (asset misappro‐
priation, corruption, and financial statement)
• Estimated that typical organization loses 5% of its annual revenue, or approximately $2.9 trillion worldwide
pp
y
4
ACFE 2010 Report to the Nations
ACFE 2010 Report to the Nations
• More than 80% of fraud was committed by individuals in the following departments:
o
o
o
o
o
o
Accounting
Operations
Sales
Management
Customer Service
Customer Service
Purchasing
• Warning signs perpetrators often displayed
o living beyond means (43%) o experiencing financial difficulties (36%)
• Small
Small organizations were most victimized organizations were most victimized – typically typically
lacking in anti‐fraud controls
5
Fraud By Type
Fraud By Type
Financial Statement Fraud
10.3%
4.8%
26.9%
Corruption
2008
32.8%
2010
88.7%
Asset Misappropriation
Asset Misappropriation
0 0%
0.0%
86.3%
20 0%
20.0%
40 0%
40.0%
60 0%
60.0%
80 0% 100.0%
80.0%
100 0%
6
Median Loss by Type
Median Loss by Type
$2,000,000 Financial Statement Fraud
$1,730,000 $375,000 Corruption
2008
$175,000 $
,
2010
$150,000 Asset Misappropriation
Asset Misappropriation
$100,000 $
$‐
$1 000 000
$1,000,000 $2 000 000
$2,000,000 $3 000 000
$3,000,000 7
Initial Detection
Initial Detection
Top Three Detection Methods:
Top Three Detection Methods:
1. Tips – 40.2%
2 Management Review –
2.
Management Review 15.4%
15 4%
3. Internal Audit – 13.9%
Top Three Sources of Tips:
1. Employees –
p y
49.2%
2. Customers – 17.8%
3. Anonymous – 13.4%
8
Victim Organizations
g
Number of Number
of
Employees
% of Cases
Median Loss
<100
30.8%
$155,000
100 999
100 –
22 8%
22.8%
$200 000
$200,000
1,000 – 9,999
1,000 25.9%
$139,000
>10,000
20.6%
$164.000
9
Internal Control Weaknesses
10
Beyond the Fraud Triangle
y
g
• Article from the September/October 2011 Fraud Magazine
• Re
Re‐evaluates
evaluates the fraud the fraud “Triangle”
Triangle
• Provides information on an alternative motivation theory: “MICE”
i i
h
“
”
• Provides information on and presents the p
“Fraud Diamond”
11
Fraud Triangle…
Fraud Triangle…
The capability to
commit the fraud
Opportunity
12
Fraud Diamond
Fraud Diamond
• Discussed in The CPA Journal, December ,
2004
• “Incentives” used in place of “Pressure”
“I
ti ”
di l
f “P
”
• “Capability” added
p
y
13
The Fraud Diamond
14
Collusion and Management Override
Fraud triangle generally considers individuals Fraud
triangle generally considers individuals
acting alone:
– LLacks proper consideration of assessing the k
id
i
f
i
h
likelihood of collusion
– Collusion is the central element of complex frauds
Coll sion is the central element of comple fra ds
– Collusion often occurs in financial statement fraud
– Better organized
B
i d
– Better concealment schemes
– Better prepared to deal with auditors
15
Capability
Fraud triangle addresses “Opportunity”. However, “Capability” is also key, especially in large dollar or extended fraud cases.
– Perpetrator generally must have the authority or functionality within the organization
– Capacity to understand and exploit weaknesses – Confidence/Ego to commit the fraud ‐
/
“I won’t get caught”
– Capability to deal with the stress
C
bilit t d l ith th t
16
Capability (cont
Capability (cont’d
d.))
Assessment of capabilities requires the assessment of ke personnel and
assessment of key personnel and employees who can perpetrate and conceal fraud
17
Fraud Motivation
Money
Ideology
gy
MICE
Coercion
Ego/
E titl
t
Entitlement
18
Fraudsters – More than one
Flavor
Fl
Accidental Fraudster
Predator Fraudster
Focus of Fraud Triangle
Deliberate, Arrogant
First Time Offender
First Time Offender
Seeks Opportunities
Seeks Opportunities
Well Educated, Male, Middle Class, Good Person
No Pressure or Rationalization
Pressure Occurs
May Begin as Accidental
Rationalization
Criminal Mindset
Criminal Mindset
19
More on the Predator
• Predators
– Seek out where they can start to scheme almost immediately – Accidental fraudsters may turn into predators
A id t l f d t
t
i t
d t
– Far more deliberate and focused
– Better organized
Better organized
– Better concealment schemes
– Better prepared to deal with auditors
Better prepared to deal with auditors
• To ensure proper evaluation of possible f d h P d
fraud, the Predator must be acknowledged.
b
k
l d d
20
The Fraud Diamond
The capability to
commit the fraud
21
ACFE Fraud Prevention Check‐Up
p
• A simple test of an entity’s fraud health
p
y
• Helps identify major gaps and fix them
• Some highlights of the test
S
hi hli ht f th t t
– Fraud risk oversight
– Fraud risk ownership
Fraud risk ownership
– Fraud risk assessment
– Fraud risk tolerance and risk management policy
Fraud risk tolerance and risk management policy
– Process‐level anti‐fraud controls
– Environment‐level anti‐fraud controls
– Proactive fraud detection
22
EXAMPLES OF GOVERNMENT FRAUD
23
Local Government Fraud
Local Government Fraud
•A
A town
town’ss former supervisor and his wife former supervisor and his wife
received $378,000 to which they were not entitled t titl d
– Former supervisor’s signature stamp was used to sign 316 of 347 unauthorized checks – In April 2010, the former supervisor’s wife p
,
p
was indicted on 350 counts related to theft of these town funds
24
Local Government Fraud
Local Government Fraud
•A
A former town clerk admitted to former town clerk admitted to
embezzling more than $50,000 in town f d d i th
funds during the past eight years t i ht
– Stole cash from the town’s safe at night and created fake deposit tickets to hide the losses – Took cash payments and paid tax stubs and used the interest and penalties paid by p
p
y
others to cover the amounts taken 25
Local Government Fraud
Local Government Fraud
•A
A treasurer diverted $85,861 in moneys treasurer diverted $85 861 in moneys
received on behalf of the district into b k
bank accounts held by him
t h ld b hi
– Disbursed $26,868 in moneys from district accounts for unauthorized purposes – Paid himself stipends totaling $6,700 p
g ,
26
Local Government Fraud
Local Government Fraud
• Authority’s
Authority s executive director executive director
misappropriated $45,000 and incurred questionable expenditures of more than
questionable expenditures of more than $160,000 – Situation occurred because the executive Situation occurred because the executive
director could override the authority’s internal control system
control system – The authority’s Board had abdicated its oversight role and essentially did not monitor
oversight role and essentially did not monitor the authority’s financial operations 27
Local Government Fraud
Local Government Fraud
• Highway
Highway superintendent purchased superintendent purchased
$100,000 of overpriced and unnecessary hi h
highway supplies li
– Admitted to accepting $2,000 in gift‐card kickbacks from the vendor – In September 2009, the highway p
,
g
y
superintendent was charged with felony official misconduct 28
Local Government Fraud
Local Government Fraud
• District
District Manager misappropriated Manager misappropriated
$108,650 – Issuing himself unauthorized checks
– Improperly increasing his own salary – Using district funds to pay for his personal tax liabilityy
29
Local Government Fraud
Local Government Fraud
Etcetera etcetera etcetera
Etcetera, etcetera, etcetera…
30
Types of Fraud
Types of Fraud
• Costly Types of Fraud:
Costly Types of Fraud:
– Financial Statement Fraud
– Procurement or Contract Fraud
– Check Forgery (over periods of time)
– Credit Card Fraud (over periods of time)
– Medical/Insurance Claim Fraud (over Medical/Insurance Claim Fraud (over
periods of time)
31
Types of Fraud
Types of Fraud
• Common types of fraud
Common types of fraud
– Falsifying timesheets
– Stealing/misappropriation of any kind
– Forgery
– Lapping collections on customers’ accounts – Pocketing payments on customers
Pocketing payments on customers’ accounts, issuing receipts on self‐designed receipt books
receipt books
32
Types of Fraud
Types of Fraud
• Other common types of fraud Other common types of fraud (cont
(cont’d
d.):
):
– Personal purchases on the procurement card
– Inappropriate charges to a travel or account I
i t h
t t
l
t
payable voucher
– Conflicts of interest
C fli t f i t
t
– Nepotism
– Seizing checks payable to vendors
Sei ing checks pa able to endors
– Recording fictitious transactions to cover up theft
33
Infamous Financial Statement Fraud Case
34
Crazy Eddie
Crazy Eddie
35
Crazy Eddie
Crazy Eddie
• Fictitious
Fictitious Revenues: Prepared phony invoices, Revenues: Prepared phony invoices
major suppliers cooperating.
• Fraudulent Asset Valuation: Inventory Fraudulent Asset Valuation: Inventory
cooperation of suppliers, shifting inventory.
• Timing Differences: Sales and payables cutoff.
Ti i Diff
S l
d
bl
ff
• Concealed Liabilities: Year‐end accruals, held invoices.
p p
y
• Improper Disclosure: Lack of consistency of income reporting through disclosure changes.
36
Financial Statement Fraud
Rationalization:
•
•
•
•
•
•
Encourage entity investment (sale of stock/ ownership)
hi )
Increase dividend / ownership distributions
Cover up liabilities / show better cash flow
Obtain financing (Govt.)
Debt compliance (Govt.)
Management bonuses (Govt.)
g
(
)
37
Financial Statement Fraud
Pressures / Incentives:
• Sudden decrease in revenue or market share
• Unrealistic budgets (Govt.)
• Market performance expectations (Govt.)
p
p
(
)
• Personal gain (Bonuses) (Govt.)
38
Financial Statement Fraud
Opportunity and Capability:
• Improper oversight of management by governance, Audit Committee (Govt.)
• Weak internal controls (Govt.)
(
)
• Unusual or complex transactions (Govt.)
• Estimates that require significant subjective Estimates that require significant subjective
judgment by management (Govt.)
39
RED FLAGS
RED FLAGS
40
What is a Red Flag?
What is a Red Flag?
Circumstances that are unusual in nature or vary from the normal activity.
y
A signal that something is out of the ordinary.
h
di
Red flags do not indicate guilt or R
d fl
d
t i di t
ilt
innocence but provide possible warning signs of fraud.
41
Red Flags ‐ General
Red Flags ‐
• Do not ignore a red flag
Do not ignore a red flag
– Studies of fraud cases show that red flags were present
– Take action to investigate and determine if fraud was committed
• Remember ‐ Sometimes an error is just an error
– Recognize the difference
– Responsibility for investigation should be by a Responsibility for investigation should be by a
measured and responsible person
42
Red Flags – General Red Flags –
General (cont’d.)
(cont’d )
• General Factors Contributing to Fraud
General Factors Contributing to Fraud
– Fraud risk oversight
– Poor internal controls
– Management override of internal controls
– Collusion between employees
– Collusion between employees and third Collusion between employees and third
parties
43
Red Flags ‐ Personnel
Red Flags ‐
• Personnel Red Flags categorized by
Personnel Red Flags categorized by
– Employee red flags
– Management red flags
44
Red Flags –
g Employee and p y
Management
• Lif
Lifestyle Problems: Dependent on drugs, l P bl
D
d
d
alcohol, gambling or other addictions
• Patterns to look for:
– Absenteeism
– Regular ill health or “shaky” appearance
– Easily making and breaking promises and Easily making and breaking promises and
commitments
– Series of creative Series of creative “explanations”
explanations
– High level of self absorption
45
Red Flags –
g Employee and p y
Management
• Financial pressure patterns to look for:
Fi
i l
l kf
– Medical bills
– Family responsibilities
– A spouse losing a job
A spouse losing a job
– Divorce
– Debt requirements
b
– Maintaining current lifestyle
46
Red Flags ‐ Personnel
Red Flags ‐
• Employee red flags
Employee red flags
– Employee lifestyle changes
– Behavioral changes
– Refusal to take vacation or sick leave
– Lack of segregation of duties in the vulnerable area
vulnerable area
47
Red Flags –
g Personnel ((cont’d.))
• Management red flags
– Reluctance to provide information to Reluctance to provide information to
auditors
– Frequent disputes with auditors
Frequent disputes with auditors
– Decisions dominated by an individual or small group
small group
– Disregard for regulatory bodies
– Weak internal control environment
Weak internal control environment
– Accounting personnel lax or inexperienced in their duties
in their duties
48
Red Flags – Personnel Red Flags –
Personnel (cont’d.)
(cont’d )
• Management red flags (cont’d.)
– Excessive number of checking accounts
– Frequent changes in external auditors
q
g
– Decentralization without adequate monitoringg
– Compensation program that is out of p p
proportion
– Excessive number of year end transactions
49
RED FLAGS ‐ PROCESS
RED FLAGS 50
Red Flags ‐ Process
Red Flags ‐
• Financial Statements
Financial Statements
– Accounting anomalies – growing revenues without increase in cash
– Increased financial condition while similar entities experience decreasing financial condition
– Increase in receivables – creation of false revenue
– Increase in assets – shift of operating expenditures
di
– Aggressive accounting positions
51
Red Flags ‐ Process
Red Flags ‐
• Red Flags in Cash/Accounts Receivable
Red Flags in Cash/Accounts Receivable
– Excessive number of voids, discounts and returns
– Unauthorized bank accounts
– Taxpayer complaints that they are receiving Taxpayer complaints that they are receiving
non‐payment notices
– Discrepancies between bank deposits and Discrepancies between bank deposits and
posting
52
Red Flags ‐ Process
Red Flags ‐
• Red Flags in Cash/Accounts Receivable g
/
(cont’d.)
– Abnormal number of expense items, supplies, or reimbursement to the employee
– Presence of employee checks in the petty cash for the employee in charge of petty cash
– Excessive or unjustified cash transactions
– Large number of write‐offs of accounts
L
b
f i
ff f
– Bank accounts that are not reconciled on a ti l b i
timely basis
53
Red Flags ‐ Process
Red Flags ‐
• Red Flags in Payroll
Red Flags in Payroll
– Inconsistent overtime hours for a cost center
– Overtime charged during a slack period
Overtime charged during a slack period
– Overtime charged for employees who normally would not have overtime wages
normally would not have overtime wages
– Budget variations for payroll by cost center
– Employees with duplicate Social Security Employees with duplicate Social Security
numbers, names, and addresses
– Employees with few or no payroll deductions
Employees with few or no payroll deductions
54
Red Flags ‐ Process
Red Flags ‐
• Red Flags in Purchasing/Inventory
Red Flags in Purchasing/Inventory
– Increasing number of complaints about products or service
– Increase in purchasing inventory but no increase in sales
– Abnormal inventory shrinkage
Ab
li
t
hi k
– Lack of physical security over assets/inventory
– Charges without shipping documents
g
pp g
– Vendors without physical addresses
– Vendor addresses matching employee addresses
– Purchasing agents that pick up vendor payments P h i
h
i k
d
rather than have it mailed
55
Red Flags ‐ Process
Red Flags ‐
• Red Flags in Procurement / Bids
– Deliberate discarding or “losing” of proposals
– Improperly disqualifying proposal
– Acceptance of non‐responsive bids
– Inappropriate contact between entity and bidder
– Unauthorized release of information related to bids
– Conflict of interest in selection committee
56
Red Flags ‐ Process
Red Flags ‐
• Red Flags in Procurement / Bids (cont’d.)
– Steering, or bids awarded to the same contractor on a regular basis
– Low bidder awarded; however, subsequent bid modifications result in costs in excess of other bids
– Regular deviations from procurement policy without true justification and documentation (sole source, phone bids, etc.)
57
Detection
58
Detection
• Computer programs have been developed that identify a red flag
p
q
y
• Computer techniques used to identify red flags include:
– Listing that compares actual vs. budgeted g
p
g
expenditures for employee reimbursements to determine unusual patterns
– Duplicate or nonexistent Social Security numbers for employees or vendors
– Taxpayer complaints
59
– Unusual patterns of overtime payments
Detection
• It
It is essential that local governments is essential that local governments
have policies and procedures in place for reporting irregularities and/or suspected ti i
l iti
d/
t d
fraud
• These policies and procedures need to be clearly communicated to all employees
clearly communicated to all employees
• Reviewed periodically to ensure that th
they still make sense
till
k
60
Detection ‐ Beneish M
Detection M‐Score
Score
Financial Statement Fraud Detection Tool:
Financial Statement Fraud Detection Tool:
• Developed by Professor Messod Daniel B
Beneish
ih
• Utilizes Eight Financial Indictors / Ratios
• Correctly Identified 76% of Financial Statement Manipulators (1982‐1992)
61
Detection ‐ Beneish M
Detection M‐Score
Score
Ratios:
• Days Sales in Receivables (DSRI) – days sales in inventory, CY vs. PY (manipulators score a mean of 1.465)
• Gross Margin Index (GMI) – measures ratio of gross margin. CY vs. PY (manipulators score a i CY
PY (
i l
mean of 1.193)
• Asset Quality Index (AQI) –
Asset Quality Index (AQI) measures ratio of non‐
measures ratio of non
current assets, other than PP&E, to total assets, CY vs PY (manipulators score a mean of 1 254)
CY vs. PY (manipulators score a mean of 1.254)
62
Detection ‐ Beneish M‐Score
Ratios (cont’d.):
(
)
• Sales Growth Index (SGI) – measures ratio of sales, CY vs. PY (manipulators score a mean of 1.607)
• Depreciation Index (DEPI) – measures ratio of the rate of depreciation, CY vs. PY (manipulators score a mean of 1 077)
mean of 1.077)
• Sales, G&A Expense Index (SGAI) – measures ratio of sales to G&A, CY vs. PY (manipulators score a mean
sales to G&A, CY vs. PY (manipulators score a mean of 1.041)
• Leverage Index (LVGI) – ratio of total debt, CY vs. PY (manipulators score a mean of 1.111)
63
Detection ‐ Beneish M
Detection M‐Score
Score
Ratios (cont’d.):
• Total Accruals to Total Assets (TATA) – assesses the extent to which managers make discretionary
extent to which managers make discretionary accounting choices to alter earnings. Total A
Accruals are calculated as the change in working l
l l t d th h
i
ki
capital accounts other than cash, less depreciation (manipulators score a mean of 0.031)
64
Detection ‐ Beneish M‐Score
Analysis:
• The eight variables are then weighted in a formula to come up with the “M”
formula to come up with the M score. score.
• An M score greater than (less negative than) 2.22, is a strong indicator of an entity is a strong indicator of an entity
‐2.22,
manipulating the financial statements.
As an example, Enron’ss M
M‐Score
Score was was ‐1.89
1.89
• As an example, Enron
65
Internal Controls to Prevent F d
Fraud
• Use
Use a system of checks and balances to ensure a system of checks and balances to ensure
no one person has control over all parts of a financial transaction
financial transaction
• Reconcile bank accounts every month • Restrict use of procurement cards and verify all charges made to credit cards or accounts to ensure they were business‐related
g
• Provide Board of Directors oversight of operations and management
66
Internal Controls to Prevent F d (cont’d.)
Fraud • Prepare
Prepare all fiscal policies and procedures in all fiscal policies and procedures in
writing and obtain Board approval
• Ensure that assets such as vehicles, cell Ensure that assets such as vehicles cell
phones, equipment, and other resources are used only for official business
used only for official business
• Protect petty cash funds and other cash funds
• Protect checks against fraudulent use
Protect cash and check collections
• Protect cash and check collections
• Avoid or discourage related party transactions67
Fraud Prevention and Detection
• The key to a successful proactive fraud detection program
– Ensure that it is reasonably focused on the y
organization's most vulnerable fraud threats
– Tailored to generate investigative fraud lead
• Fraud
Fraud normally leaves clues visible only normally leaves clues visible only
to the employees who are connected to th t
the transaction cycle (target employees)
ti
l (t
t
l
)
68
Fraud Prevention and Detection
• Educating your targeted employees will increase reported incidents
g
,p
• Establishing an effective, proactive fraud detection program is a two‐step approach
pp
– Identify the most vulnerable fraud threats to your organization's process
– Tailor the detection program to generate fraud leads/indicators from targeted employees
l
69
Fraud Prevention and Detection
• Identification of the most likely fraud threats is the single most important step in the entire detection program
• Don't allow the identification of vulnerabilities to become a burdensome
vulnerabilities to become a burdensome process
• Don't limit your fraud detection techniques D 't li it
f d d t ti t h i
to only traditional fraud awareness education
70
Fraud Prevention and Detection
• The targeted employees must understand and "buy into" the vulnerability descriptions
• Descriptions must be:
p
– Recognizable: Uses commonly known terms such as "criminal violations”
– Believable: Easy to visualize fraud happening in the organization
– Actionable: Have realistic detection steps for the targeted employees
– Emotional: Causes a motivation for action
71
Fraud Prevention and Detection
• Tailor the program primarily to employees who are in the best position to observe the fraud i h b
ii
b
h f d
indicators
• Now you need to consider:
– Who are my targeted employees?
– What occupations do my targeted employees work Wh
i
d
d
l
k
in?
– How do I effectively communicate fraud How do I effectively communicate fraud
vulnerabilities to them?
– What specific fraud indicators do I want them to p
look for?
72
– How should they report possible leads?
Audit Committee
Audit Committee
73
Audit Committee
Responsibilities Related to Fraud:
Responsibilities Related to Fraud:
• Monitoring financial reporting process
• Monitoring internal control system
M i i i
l
l
• Overseeing the external audit and internal audit functions
• Reporting findings to Governance
p
g
g
• Monitoring and overseeing the whistle‐
blower policy and hotline
blower policy and hotline
74
37 Years of Excellent Client Service
QUESTIONS?
75