The Importance of a Fraud  Misconduct Strategy

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BST Advisors, LLC. 1. AGENDA:. Introduction Tone at the TopCode of ConductEffective Fraud and Misconduct StrategyBest PracticesGrant Administration. BST Advisors, LLC. 2. Unknown:. Confidence and trust are like a mortal's need for air. When the required good is present, it's never noticed.

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The Importance of a Fraud Misconduct Strategy

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1. The Importance of a Fraud & Misconduct Strategy NYSICA March 25, 2004 Presented by: Christopher J. Rosetti, Partner BST Advisors, LLC Forensic Accounting and Investigative Services

2. BST Advisors, LLC 1 AGENDA: Introduction Tone at the Top Code of Conduct Effective Fraud and Misconduct Strategy Best Practices Grant Administration

3. BST Advisors, LLC 2 Unknown: “Confidence and trust are like a mortal’s need for air. When the required good is present, it’s never noticed. When it’s missing, it’s all that’s noticed”

4. BST Advisors, LLC 3 Public Misconduct

5. Audit Risks for the Public Sector

6. BST Advisors, LLC 5 The Principal Types of Fraud Bribery Conflicts of Interest Theft of Money or Property Breach of Fiduciary Duty

7. BST Advisors, LLC 6 Bribery Giving or receiving a thing of value to influence a business decision without the consent or knowledge of the principal.

8. BST Advisors, LLC 7 Conflicts of Interest An agent taking an interest in a transaction that is actually or potentially adverse to the principal without full and timely disclosure to the principal

9. BST Advisors, LLC 8 Theft of Money or Property Embezzlement The defendant took or converted, without the knowledge or consent of the organization, money or property of another that was properly entrusted to the defendant. Larceny Taking and carrying away money or property of another, without the consent of the owner, with the intent to permanently deprive the owner of its use or possession.

10. BST Advisors, LLC 9 Breach of Fiduciary Duty The principal fiduciary duties are loyalty and care. Duty of Loyalty requires that the employee act solely in the best interest of the employer, free of any self dealing, conflicts of interest, or other abuse for personal advantage. Duty of Care requires that persons in a fiduciary relationship must conduct business affairs prudently with the skill and attention normally exercised by a person in similar positions.

11. Many technological advances reduce the audit trail and facilitate perpetration of sophisticated computer crimes which siphon funds to fictitious or unauthorized accounts.

12. BST Advisors, LLC 11 Internal Control Facts Internal control starts with a strong control environment: Management has the proper attitude and operating style Management is the owner of internal control Internal controls are built into the business process Adapted from the 12/03 issue of Financial & Audit Solutions

13. BST Advisors, LLC 12 Is there an ethics/compliance program in place? Has it been designed to satisfy leading governmental models (e.g., federal sentencing guidelines)? Has it been implemented throughout the organization, are there indicators that it is operating as intended (e.g., frequency of training, volume of hotline calls, consistency of discipline)? Has it been effective in achieving compliance with the organization’s ethical and legal obligations? Tone at the Top

14. BST Advisors, LLC 13 An Effective Fraud and Misconduct Strategy

15. BST Advisors, LLC 14 An Effective Fraud and Misconduct Strategy (continued)

16. BST Advisors, LLC 15 Effective Ethics/Code of Conduct Helps prevent misconduct Detects violations and provides and early warning system Timely and responsible actions help avert prosecution

17. BST Advisors, LLC 16 Code of Conduct Checklist Use of equipment (telephone, vehicle, photocopiers, scanner, supplies, credit cards) Use of the internet during work hours and/or for non-work related reasons. Acceptance of gifts from vendors, suppliers and contractors

18. BST Advisors, LLC 17 Code of Conduct Checklist (continued) Conflicts of interest (sign form annually): Having direct or indirect, financial or otherwise, in any transaction or activity that conflicts with the proper discharge of the employee’s duties. Outside employment or dual employment Confidential information Intellectual property

19. BST Advisors, LLC 18 Code of Conduct Checklist (continued) Use of official position to secure unwarranted privileges or exemptions On-site weapons Restricting competition Computer security Time and attendance

20. BST Advisors, LLC 19 Code of Conduct Checklist (continued) Exercising common sense Expense reimbursements Disparaging contractors Illegal betting or gambling Destruction of organizational records

21. BST Advisors, LLC 20 Reasons for Failure The message is not supported by senior management The ethics policy/code of conduct does not provide practical guidance or example Regular training is not provided Compliance officer is overburden with other matters

22. BST Advisors, LLC 21 Reasons for Failure (continued) People are not aware of the hotline nor is it used Corrective actions are not initiated Compliance is not monitored and an annual report is not issued

23. BST Advisors, LLC 22 Periodically Reinforce Values Annual training Annual conflicts of interest affidavit Posted flyers Reminders with W-2s

24. BST Advisors, LLC 23 Periodically Reinforce Values (continued) Weekly or monthly email reminders about policies Code of conduct and ethics policy posted on intranet Posters advertising anonymous reporting mechanism

25. BST Advisors, LLC 24 An Effective Fraud and Misconduct Strategy (continued)

26. BST Advisors, LLC 25 Effective Personnel Policies Recruitment screening Verify identity Check qualifications, names of schools Probe employment gaps Obtain references Vacation policies and work patterns Enforce vacations Appraisal and counseling Employee attitude surveys

27. BST Advisors, LLC 26 Effective Personnel Policies (continued) Background checks Social security number verification OFAC check Media checks

28. BST Advisors, LLC 27 An Effective Fraud and Misconduct Strategy Fraud\misconduct awareness Typical fraud risks Common indicators Behavioral issues Control benchmarking Reporting fraud suspicions

29. BST Advisors, LLC 28 Quality of Your Fraud and Misconduct Strategy Score each of these on a 1 to 10 scale. What is the quality of your anti-fraud and misconduct strategy? Is responsibility for managing fraud and misconduct risk well defined? How clear are reporting channels for reporting suspicions of fraud or misconduct? Are there clear protections for those reporting fraud or misconduct? How effective is your fraud and misconduct awareness program?

30. BST Advisors, LLC 29 Quality of Your Fraud and Misconduct Strategy Score each of these on a 1 to 10 scale. How effective is your recruitment screening process? How developed is the understanding of fraud and misconduct risks facing your organization? How have you matched these risks to controls to see how they are managed? How effectively does your organization learn from fraud and misconduct incidents? How aware of fraud and misconduct are head office and regional personnel? What is the total score?

31. BST Advisors, LLC 30 Quality of Your Fraud and Misconduct Strategy (continued) How did your organization rate? 90 to 100 points = Strong 80 to 89 points = Effective 70 to 79 points = Needs Improvement 60 to 69 points = High Risk Below 60 points = Very High Risk

32. BST Advisors, LLC 31 Indications of Low Fraud and Misconduct Awareness

33. BST Advisors, LLC 32 An Effective Fraud and Misconduct Strategy (continued) Effective Fraud and Misconduct Reporting and Response Program Fraud and misconduct reporting channels Whistler blower protection and non-retaliation policy Fraud and misconduct response plans

34. BST Advisors, LLC 33 Effective Fraud and Misconduct Reporting and Response Questions Why investigate? When to investigate? What to investigate? Who should investigate? How to conduct investigation?

35. BST Advisors, LLC 34 Effective Fraud and Misconduct Reporting and Response (continued) Importance of fraud risk management Every organization should have a documented anti-fraud strategy and corporate integrity program. At a minimum it should include: Agency’s stance on fraud and other breaches of company’s policies and ethical code To whom and how should suspicions of fraud or misconduct be reported What will be done and by whom in the case that fraud or other breaches are suspected Employee rights - including limitations on expectations of privacy and company’s rights to gain access and search all work areas

36. BST Advisors, LLC 35 Effective Fraud and Misconduct Reporting and Response (continued) Why investigate? It’s your duty It’s the right thing

37. BST Advisors, LLC 36 Effective Fraud and Misconduct Reporting and Response (continued) Why it’s your duty Organizations have no choice 1991 Sentencing Guidelines Prevalence of government voluntary disclosure programs Administrative and court rulings

38. BST Advisors, LLC 37 Effective Fraud and Misconduct Reporting and Response (continued) Why it’s the right thing Best practice Conducting internal investigations is the norm rather than the exception 94% of companies responding to 1998 Fraud Survey said that conducting an investigation was the leading response to the discovery of fraud Assists organizations in determining the extent of potential civil or criminal liability Assists in determining facts, available defenses, and appropriate response Assist in negotiating a favorable resolution or avoiding an intrusive government investigation

39. BST Advisors, LLC 38 Effective Fraud and Misconduct Reporting and Response (continued) Why it’s the right thing Bottom Line protection Deterrence Given the cost of fraud, a fraud response is essential Recovery Asset tracing and recovery Insurance coverage Public relations Permits affirmative, proactive communications strategy Avoids charge of cover up

40. BST Advisors, LLC 39 Effective Fraud and Misconduct Reporting and Response (continued) When to investigate Knowledge of information suggesting reasonable possibility that a third party and/or an employee might have engaged in wrongful conduct exposing the organization to risk of criminal liability, substantial monetary loss or damage, injury to its reputation, or other type of significant harm

41. BST Advisors, LLC 40 Effective Fraud and Misconduct Reporting and Response (continued) When to investigate Timing Decision should be made as soon as possible Advantages of early start Greater ability to develop appropriate response and defense Increases likelihood that corporations can gather information and interview employees before government Enables corporations to qualify for credit for full cooperation under Sentencing Guidelines Importance of Fraud and Misconduct Response Plan as part of a compliance program Corporation needs to be prepared in advance to insure prompt and appropriate response

42. BST Advisors, LLC 41 Effective Fraud and Misconduct Reporting and Response (continued) What to investigate Fraud – Internal or external Falsification of financial data Misappropriation of assets Theft or embezzlement

43. BST Advisors, LLC 42 Effective Fraud and Misconduct Reporting and Response (continued) What to investigate Violations of organization policy Examples Conflicts of interest Policies regarding giving or receiving gifts Waste/Mismanagement Mishandling of confidential or proprietary information

44. BST Advisors, LLC 43 Effective Fraud and Misconduct Reporting and Response (continued) Who should investigate Chief of internal compliance (Integrity Officer) An individual should be designated by each organization to whom all information regarding potential misconduct should be reported Responsibility To receive reports of fraud or misconduct To conduct initial evaluation (refer to either HR or GC) General Counsel Responsibility To determine seriousness of allegation To determine scope and direction of investigation To consult and advise other relevant executives To determine the need for retention of outside counsel

45. BST Advisors, LLC 44 Effective Fraud and Misconduct Reporting and Response (continued) Who should investigate All internal investigations should always be directed by counsel Principal reason: Permits invocation of privilege to protect the confidentiality of internal investigative results

46. BST Advisors, LLC 45 !!!Assume all Cases Will End in Litigation!!!

47. BST Advisors, LLC 46 Findings Could Result in: Civil Litigation Criminal Litigation No Action

48. BST Advisors, LLC 47 False Imprisonment Occurs When There Is An intent to confine An act resulting in confinement Consciousness of confinement or resulting harm.

49. BST Advisors, LLC 48 Effective Fraud and Misconduct Reporting and Response (continued) How to investigate Develop Investigative Hypothesis Theory of fraud or misconduct - Extent and elements Who may be involved Where is the evidence likely to be found Documents Witnesses Individual computers Transportable media Network servers Constantly refine and re-examine

50. BST Advisors, LLC 49 Effective Fraud and Misconduct Reporting and Response (continued) How to investigate Develop Work Plan Consistent with theory of fraud or misconduct Identify documents to be examined Procedures to be followed Examples Document examination and verification Types of analysis Manual review Gap, variance Reconciliation Sorting and comparisons Trend

51. BST Advisors, LLC 50 Effective Fraud and Misconduct Reporting and Response (continued) How to investigate Identify potential sources of electronic or voice information and data Examples PCs Laptops Transportable media Network servers Voice-mails Emails Recorded conversations – e.g. securities trading Video tapes Procedures and tools to be used to retrieve electronic and voice data

52. BST Advisors, LLC 51 Effective Fraud and Misconduct Reporting and Response (continued) How to investigate Identify individuals to be interviewed Inside organization Outside organization – e.g. vendors Develop interview menus Order of interviews Questions to be asked Identify other investigative procedures Public database searches Data analysis

53. BST Advisors, LLC 52 Effective Fraud and Misconduct Reporting and Response (continued) Respecting employee rights Employee’s Duty to Cooperate: Duty to cooperate exists in every internal investigation, unless compliance is impossible unlawful unreasonable

54. BST Advisors, LLC 53 Effective Fraud and Misconduct Reporting and Response (continued) Respecting employee rights Employee Rights include: Contractual Right Example If employee is a member of a union, union contract or collective bargaining agreement may contain restrictions on investigation procedures Whistleblower laws Protect employees who report misconduct to government from retaliatory action

55. BST Advisors, LLC 54 An Effective Fraud and Misconduct Strategy (continued) Effective Compliance Program Standards and procedures that are reasonably capable of preventing fraud and misconduct High-level oversight Due care in delegating discretionary authority Effective communication of standards and procedures (Training) Monitoring and auditing of compliance program Enforcement of program through discipline Appropriate response upon notification of wrongdoing

56. BST Advisors, LLC 55 Federal Sentencing Guidelines for an Effective Compliance Program High level oversight Standards of conduct Communications and training Compliance auditing and monitoring Pre-employment screening Enforcement of standards and disciplinary actions Corrective actions taken

57. BST Advisors, LLC 56 An Effective Fraud and Misconduct Strategy (continued)

58. BST Advisors, LLC 57 Objectives of a Fraud Response Plan Provide a conduit for whistleblowers Identify internal affairs personnel Outline the manner in which all reviews should proceed Prevent further loss Identify high risk areas

59. BST Advisors, LLC 58 Objectives of a Fraud Response Plan Respond quickly Secure evidence Identify parties involved Identify loss remedies Identify specialists

60. BST Advisors, LLC 59 Best Practices (continued) Collecting payments with credit cards: Reduces exposure to cash and transfers risk to credit card issuer. Typical payments: Water rents, sewer rents, taxes.

61. BST Advisors, LLC 60 Best Practices (continued) Third party receives complaints about billing, collections and payments. Clerk who issued bills, collected cash and received complaints misappropriated $357,000 via a lapping scheme involving 4,000 water utility customers.

62. BST Advisors, LLC 61 Best Practices (continued) Bonding employees: Estimate the amount and add a cushion (Nobody steals small amounts)

63. BST Advisors, LLC 62 Best Practices (continued) Telephone Audits: Type in telephone number and hit google search. 900 calls by mailman during lunch Go out an let people know what your doing. They don’t know who you’re looking at.

64. BST Advisors, LLC 63 Best Practices (continued) Checking inventory annually to identify excess inventory

65. BST Advisors, LLC 64 Right to Audit Obtaining the right: Right to Audit Agreement - on the back of purchase order or procurement form Right to Audit Clause in a Contract - include language in the body of the contract

66. BST Advisors, LLC 65 Best Practices (continued) Compliance audits of purchasing policies (kickbacks and embezzlements) Written policies and procedures

67. BST Advisors, LLC 66 The Value of Nothing No telephone number is master vendor file Telephone number is the same digit, i.e. all 9’s No address No contact person of fed ID #

68. BST Advisors, LLC 67 Grant Administration Right to audit Purchasing vs. leasing Tel Calls Travel Food Vendors Subcontracts Employees

69. Questions? Chris Rosetti [email protected] BST Advisors, LLC 26 Computer Drive West Albany, New York 12205 Tel: 518-459-6700 / 800-724-6700 ? Fax 518-459-8492

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