Fraud Schemes and scams: Lessons from the trenches

1. Fraud Schemes and scams: Lessons from the trenches Shauna Woody-Coussens, CFE Managing Director

2. Today’s agenda • Top fraud trends • Common occupational frauds • Cost effective internal controls and data mining procedures you can implement today

3. Occupational fraud defined • The use of one’s occupation for personal enrichment through the deliberate misuse or misapplication of the employing organization’s resources or assets --Association of Certified Fraud Examiners “2018 Report to the Nations”

4. 5 TOP FRAUD TRENDS

5. HIGH COST OF FRAUD • 5% of revenue lost to fraud and abuse each year • Cost of external assistance with investigation for insurance or criminal purposes • Lawyers • Forensic accountant • Higher insurance costs in following year(s)

6. HIGH COST OF FRAUD • Non-monetary loss can bemore damagingthan the actual monetary loss • Loss of reputation • Public assumptions • Loss of employee morale • Loss of productivity due to internal investigation

7. Industries most victimized IndustryFrequency Median Loss Banking 19.8% $110,000 Manufacturing 11.8% $240,000 Government 10.8% $125,000 Health Care 8.7% $100,000 Retail 6.0% $50,000 Source: 2018 ACFE Report to the Nations

8. Industries With largest lossES IndustryMedian Loss Communications & Publishing $525,000 Energy $300,000 Prof. Services $258,000 Manufacturing $240,000 Construction $227,000 Source: 2018 ACFE Report to the Nations

9. Most common schemes #2 #4 #1 #4 #5 #3 #4 Source: 2018 ACFE Report to the Nations

10. Most effective controls Source: 2018 ACFE Report to the Nations

11. RECOVERING FUNDS IS THE EXCEPTION • In53%of the reported frauds, there was NO recovery • For the 15% of reported frauds in which there was full recovery, the source of recovery was usually an insurance policy

12. Insights on fidelity bonds • Likely only chance at meaningful recovery as money is usually gone • Lavish lifestyle • Compulsive shopping • Gambling • Other addiction • Civil litigation to recover losses often fruitless • Criminal verdict - restitution often goes unpaid • Watch your internal controls if you expect your insurance to pay…

13. REPLY FROM INSURANCE COMPANY AFTER FIDELITY BOND CLAIM FILED

14. Further response

15. Almost no prior criminal history 89% have no criminal history Reminder:Background checks are good, but don’t depend on them to evaluate someone’s likelihood to commit fraud after hiring them Source: 2018 ACFE Report to the Nations

16. WHICH ONE LOOKS SUSPICIOUS? $3 million $1.0 million $4.6 million $31 million $1.1 million $20 million

17. Profile of Fraud Perpetrator • More likely to be male than female (69%/31%) • 36 to 45 years old • College educated • Works in accounting/financefunction or related role • Holds asenior management position • Employed by the company for 1-5 years • No prior fraud charges or convictions Source: 2018 ACFE Report to the Nations

18. TIPS ARE THE TOP METHOD OF DETECTION • For organizations with hotlines, 46% of frauds were detected by tips • Compared to only 30% of frauds for organizations without a hotline • 4th most prevalent method is BY ACCIDENT

19. The medians • Median loss across industries: $130,000 • Median loss for large businesses: $104,000 • Median loss for small businesses: $200,000 • Median fraud duration: 16 months • “18 month rule”

20. Most common fraud schemes #1 Corruption #2 Billing Schemes #3 Non Cash Schemes #4 Cash Schemes #5 Expense Reimbursement/P-Card Schemes

21. corruption

22. Corruption • Anemployee misuses his or her influence in a business transaction in a way that violates his or her duty to the employerin order to gain a direct or indirect benefit • In most businesses, the most common form of corruption is the payment of kickbacks related to purchases

23. Red flags & anti-fraud controls for corruption • Off-book fraud, so very hard to detect • Payments often do not go through the organization’s accounting records • Payments often paid in cash • Look for “behavioral” red flags • Rapidly increasing purchases from one vendor • Excessive purchases of goods and services • Too close of a relationship with a vendor

24. BEHAVIORAL RED FLAGS

25. ANTI-FRAUD CONTROLS FOR CORRUPTION • Publicize your fraud/ethics hotline • Implement a strong ethics and conflicts of interest policy • Require reporting of potential conflicts of interest • Limit gifts from vendors and contractors • Develop/follow a well defined procurement process • Rotate buyers • Conduct contract audits

26. DATA ANALYTICS FOR CORRUPTION • Overpaid purchase orders • Invoices greater than goods receipt • Compare quantities ordered and received • Compare order quantity to optimal reorder quantity • Compare purchase volumes/prices from like vendors • Split transactions

27. Billing fraud

28. BILLING SCHEMES • Fraudstercreates false support for a fraudulent purchase, causing the company to pay for goods or services that are nonexistent, overpriced or unnecessary • Invoicing via shell company • Invoicing via an existing vendor • False invoicing for non-accomplice vendors • Pay-and-return schemes • Personal purchases with company’s funds

29. red flags for billing fraud schemes • Invoices for unspecified consulting or other service • Unfamiliarvendors • Vendors with PO boxes • Vendor name consisting of initials • Rapid increases in purchases • Employee/vendor address match • Consecutively numbered invoices from a vendor • Repeated requests to expedite payments to particular vendors • Invoice forround dollar amounts

30. ANTI-FRAUD CONTROLS FOR BILLING SCHEMES • Prior to authorizing payment,verify validity of vendor, receiptof goods/services, and accuracyof pricing • Prior to processing payment, check invoice for proper authorization • Strictlycontrol access to the Vendor Master file • Implement a mandatory approved vendor lists • Control over selection of new vendors • Who can select them? How are they selected? • Due diligence performed on new vendors • Is vendor real? Is pricing reasonable? Periodically reassess vendor relationships • Minimize or eliminate conflicts of interest • Is vendor related to an employee?

31. DATA ANALYTICS FOR BILLING SCHEMES • Vendor attribute analysis • Trending of vendor payments • Identification of high risk payments

32. VENDOR ATTRIBUTE ANALYSIS -EMPLOYEE/VENDOR MATCHING

33. TRENDING OF VENDOR PAYMENTS Vendor: JLM Plumbing Authorized: Janice L. McPhearson Getting Greedy Acceleration as confidence builds Test phase

34. VENDOR PAYMENTS- TIME SERIES ANALYSIS TIME SERIES ANALYSIS Possible fictitious vendor Possible abuse of dormant legitimate vendor Possible abuse of active legitimate vendor

35. IDENTIFICATION OF HIGH RISK PAYMENTS – MAIL DROPS Mail Drop – an address used only to receive letters and packages to be picked up later

36. IDENTIFICATION OF HIGH RISK PAYMENTS – PROXIMITY ANALYSIS Vendor (A) Shauna’s Design Company, 123 5th Street Anytown, MO (Total Payments = $84,337) Employee (B) Shauna Woody, 4300 Oak Street Anytown, MO

37. Non-cash schemes

38. Non-cash fraud schemes • Any scheme in which an employee steals or misuses non-cash assets of the victim organization • Employee steal inventoryfrom a warehouse or storeroom • Employee extracts customer’s personal and account information from a database and then sells that data – identity theft • Employee steals employer’s competitive data and supplies it to a competitor • Common when employees change employers • Inappropriate usage (borrowing) of organization assets • Often computers or software • Conflict of interest resulting in personal benefit

39. Red flags for non-cash schemes • Shrinkagein inventory/supplies • Employees who frequently visit the office after hours • Missing/borrowedtools, equipment, office supplies, etc. • Missing, altered, or unmatched supporting documents

40. ANTI-FRAUD CONTROLS FOR NON-CASH SCHEMES • Restrict access to sensitive information, inventory and supplies • Automated monitoring of: • The date, time and source of online access, especially if the system can be accessed from a WAN or the Internet • Report generation and downloading, including operational and custom reports or queries, especially those containing account information • E-mails sent and received and attachment sizes

41. ANTI-FRAUD CONTROLS FOR NON-CASH SCHEMES • Segregation of duties involving requisition of inventory, receipt of inventory, disbursement of inventory, and conversion of inventory to scrap • Physical inventory count/observation should be done by someone knowledgeable of the inventory, but independent of the purchasing or warehousing function • Assets that do not meet the threshold of capitalization should be tracked and accounted for. Smaller dollar assets are more likely to be stolen (think tablets), especially if they are not inventoried

42. DATA ANALYTICS FOR NON-CASH SCHEMES • If tracked electronically, will often leave evidence of access by: • Unauthorized users • User who have no relevant business purpose for the information/assets • Users accessing the information /assets on non-standard days or at non-standard times • Usersdownloading or copying information for which they have no relevant business purpose

43. Skimming the revenue cycle

44. Skimming the revenue cycle • Employeepockets the payment from a customer and does not record the charge • Stealing payments on accounts receivable and covering them up withadjustments or write-offs • Lapping • Customer A pays on account and employee pockets the payment. Customer B pays on account and employee records the payment by Customer B on Customer A’s account. This goes on until the employee caught or covers up the fraud, usually through an adjustment or write-off • Alteringbank deposits

45. Red flags for skimming schemes • Employees who do not take vacation • Employees who do not like others to perform their duties • Missingregister tapes or other records • Consistent differences in register or cash receipts to cash on hand • Complaints from customers that they are receiving billing for invoices that have already been paid

46. ANTI-FRAUD CONTROLS FOR THE RECEIPTS CYCLE • Use of cameras in cash handling areas • Segregation of cash receipt and accounting duties • Issuereceipts, trackthem in the accounting system and reconciletimely • Rotation of duties (preferably without notice) • Review of old deposits in transit or late deposits • Reconcile depositsper accounting and AR records with depositsper bank • Review of AR aging andpast due balances • Surprisecash counts • Follow-up on customer complaintsabout billing

47. Expense reimbursement/credit card/p-card fraud

48. Expense reimb./credit cards/p-cards • Any scheme in which an employee makes a claim for reimbursement for fictitious or inflated business expenses • Employee files fraudulent expense report, claiming personal travel, nonexistent meals, etc. • Employee purchases personal items and submits and invoice to employer for payment

49. RED FLAGS FOR EXPENSE REIMB./P-CARD SCHEMES • Photocopies of the receipts are provided instead of originals • Overall expenses for the organization areconsiderably over budgetcompared to other years • Expense reimbursement amounts are regularlyjust below the threshold for review • Excessive or unusual reimbursements to one employee compared to other employees in the organization • A lack of supporting documents

50. RED FLAGS FOR EXPENSE REIMB./P-CARD SCHEMES • Employee/managerbecomes defensive when asked to provide supporting documents • Purchases appear to be for non-businessproducts or services • Parts of the dates or amounts on receipts appear to be altered or missing • Submitted receipts are consecutively numbered • Expenses in round dollar amounts • Expensive business lunch/dinner expenses without names/organizations of attendees and business purposenoted