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7 Keys to Fraud Prevention and Detection

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  1. 7 Keys to Fraud Prevention and Detection Ron Steinkamp, CPA, CIA, CFE, CRMA, CGMA 314.983.1382 rsteinkamp@bswllc.com 6 CityPlace Drive, Suite 900 │ St. Louis, Missouri 63141 │ 314.983.1200 1.888.279.2792 │ www.bswllc.com

  2. Session Benefits

  3. What is Occupational Fraud?

  4. Definition The use of one’s occupation for personal enrichment through the deliberate misuse or application of the employing organization’s resources or assets. Three general categories: • Asset misappropriation • Corruption • Financial statement fraud

  5. Asset Misappropriation Employee steals or misuses an organization’s assets/resources. • Examples: • Skimming cash receipts. • Falsifying voids and refunds. • Tampering with company checks. • Overstating expenses. • Creating a ghost employee. • Creating a fictitious vendor and false invoice.

  6. Corruption Employee’s use of his/her influence in business transactions in a way that violates his/her duty to the employer for the purpose of obtaining benefit for him/herself or someone else. • Examples: • Conflicts of interest. • Illegal gratuities. • Bribery.

  7. Financial Statement Fraud Intentional misstatement or omission of material information in the organization’s financial reports with the intent to mislead. • Examples: • Inflating revenues on the financials to show greater profit. • Concealing liabilities. • Forcing actual expenditures to match budget by moving expenses between accounts. • Improperly accounting for revenues and expenditures.

  8. 2012 ACFE Global Fraud Study Report to the Nations on Occupational Fraud and Abuse

  9. Summary of Findings • Typical organization loses 5% of annual revenue to fraud – applied to 2011 Gross World Product translates to potential fraud loss of more than $3.5 trillion annually. • Median loss in the study was $140,000. • Fraud lasted a median of 18 months. • Asset misappropriation schemes (fraudulent disbursements, theft of cash receipts, other asset misappropriations) were the most common form of fraud, representing 87% of the cases and least costly at a median loss of $120,000. • Financial statement fraud schemes were the least common form of fraud, representing 8% of the cases and most costly at a median loss at $1 million.

  10. Summary of Findings • Corruption schemes fell in the middle, comprising just over 33% of cases and causing a median loss of $250,000. • Occupational frauds are most likely to be detected by tips (43%) followed by management review (15%) and Internal Audit (14%). • Small organizations are disproportionately victimized by occupational fraud. • Government/public administration was one of the most commonly victimized industries. • Anti-fraud controls appear to help reduce the cost and duration of occupational fraud schemes. • High-level perpetrators cause the greatest damage to their organizations.

  11. Summary of Findings • 80% of frauds were committed by individuals in one of six departments: • Accounting • Operations • Sales • Executive/upper management • Customer service • Purchasing • More than 85% of fraudsters had never been previously charged or convicted for a fraud-related offense. • Fraud perpetrators often display warning signs – most common behavioral red flag reported in the survey were perpetrators living beyond their means (36%) and experiencing financial difficulty (27%). • Nearly half of victim organizations do not recover any losses that they suffer due to fraud.

  12. How are Frauds Detected?

  13. Source of Tips

  14. Conclusions and Recommendations Occupational fraud is a global problem – trends in fraud schemes, perpetrator characteristics and anti-fraud controls are similar regardless of where the fraud occurred. Fraud reporting is a critical component of an effective fraud prevention and detection system. Organizations over-rely on audits. Employee education is the foundation of preventing and detecting occupational fraud. Most frauds are detected by tips and anti-fraud training for employees and managers results in lower fraud losses. Surprise audits are an effective, yet underutilized, tool in the fight against fraud. Useful in detecting fraud, but most important benefit is in preventing fraud by creating a perception of detection. Small business are particularly vulnerable to fraud due to far fewer controls in place. Need to focus on hotlines and setting an ethical tone. Internal controls alone are insufficient to fully prevent occupational fraud.

  15. Conclusions and Recommendations Fraudsters exhibit behavioral warning signs of their misdeeds. For example: • Living beyond their means. • Financial difficulties. • Exhibiting control issues – unwillingness to share duties. • Unusually close relationship with vendor/customer. • Wheeler dealer attitude. • Family problems. • Irritability, suspiciousness or defensiveness. • Addiction problems. • Refusal to take vacation. • Etc. Auditors and employees should be trained to recognize the common behavioral signs that a fraud is occurring. Effective fraud prevention measures are critical

  16. Red Flags

  17. The Fraud Triangle

  18. Pressure “Red Flags” High personal debts. Living beyond their means. Excessive investment speculation. Excessive gambling. Substance abuse. Extra-marital affairs. Job frustration. Resentment of superiors.

  19. Opportunity “Red Flags” Inadequate internal controls. Too “cozy” with suppliers. Annual vacation or sick days not taken. Weak management or excessive turnover. Ineffective or no internal audit. No rotation of job duties among employees. Procedures not well understood/always in crisis mode. Large amounts of cash on hand or processed.

  20. Rationalization “Red Flags” Not compensated fairly. No recent raises/cost of living adjustments. Everyone else does it. Intended to pay it back. Needed the money. Felt cheated and wanted revenge. Bribe/kickback to tempting.

  21. 7 Keys

  22. 1. Anti-Fraud Culture • Set the tone at the top = Lead by Example • Responsibility of elected officials and City management • Behave ethically and openly communicate expectations to employees • Treat all employees equally • Zero tolerance • Create a positive workplace environment • Focus on employee morale • Empower employees • Communicate • Hire and promote appropriate employees • Conduct background investigations before hiring or promoting • Check candidate’s education, employment history, references • Continuous and objective evaluation of compliance with entity values • Violations addressed immediately

  23. 1. Anti-Fraud Culture • Code of Conduct • Formalized and founded on integrity • Defines acceptable employee behavior • Communicated to all employees • All employees are held accountable for compliance • Discipline • Sends a strong message throughout the entity • Should be appropriate and consistent • Consequences of committing fraud clearly communicated throughout the entity

  24. 1. Anti-Fraud Culture • Oversight Process • City Council/Elected Officials • Evaluate management’s “tone at the top”, identification of fraud risks and implementation of anti-fraud controls • Ensure that management implements anti-fraud measures • Consider the potential for management override of controls • Management • Directs, implements and monitors anti-fraud controls • Sets the ethical tone • Trains employees • Internal Auditor (if available) • Identifies fraud indicators • Assesses fraud risks • Evaluates anti-fraud controls • Recommends actions to mitigate risks • Investigates potential frauds

  25. 2. Fraud Policy • Demonstrate commitment to combating fraud • Apply to all Elected officials, City management, employees, consultants, vendors, contractors, etc. • Should include: • Statement of organization’s position on fraud • Scope of the policy – who does it apply to • Management’s responsibility for prevention and detection of fraud • Definition of fraud • Actions constituting fraud • Fraud reporting process/procedures • Fraud investigation process/procedures • Unit responsible for administration of the policy and investigating fraud allegations • Statement on anonymity/confidentiality • Consequences

  26. 2. Fraud Policy • Reviewed and updated regularly. • Signed off and agreed to by the City Council/Mayor. • See the ACFE for an example Fraud Policy http://www.acfe.com/uploadedFiles/ACFE_Website/Content/documents/Sample_Fraud_Policy.pdf

  27. 3. Fraud Awareness/Training • All new employees should be trained at time of hiring on the Code of Conduct and Fraud Policy. • Training should include: • Their duty to communicate certain matters • A list of the types of matters to be communicated along with examples • How to communicate those matters • Affirmation from senior management regarding employee expectations and communication responsibilities • Refresher training periodically

  28. 4. Hotline • Enable employees, vendors, customers and others to communicate concerns about known or suspected wrongdoing. • Telephone, email, internet. • Anonymous. • Adequately publicized. • Internal or External. • Complaint monitoring and investigation/resolution.

  29. 5. Assess Fraud Risks • Conduct an annual fraud risk assessment. • Assists management in systematically identifying where and how fraud may occur and who may be in a position to commit fraud • Focus on fraud schemes and scenarios to determine the presence of internal controls and whether or not the controls can be circumvented. • General steps: • Identify areas and processes to assess • Identify potential fraud schemes in each area/process • Assess likelihood and significant of each scheme • Map existing anti-fraud controls to potential fraud schemes • Test operating effectiveness of antifraud controls • Identify any control gaps and/or deficiencies = Residual risks • Document and report on the fraud risk assessment

  30. 5. Assess Fraud Risks • Mitigate Fraud Risks • Make changes to activities and/or processes = transfer or eliminate the risks • Improve anti-fraud controls • Monitor Fraud Risks • Develop data analytics for management to use to monitor fraud risks • Utilize Internal Audit to conduct audits of risk areas.

  31. 6. Fraud Review/Investigation • All concerns/suspicions of wrongdoing should be reviewed and determination made whether a fraud investigation is warranted. • Develop a policy for fraud reviews and investigations that specifies: • Who is responsible for the review/investigation • Roles of Legal Counsel, Human Resources, Internal Audit, others • Process for conducting the review/investigation • Documentation requirements • Reporting requirements • When to involve law enforcement

  32. 6. Fraud Review/Investigation • Gather sufficient information and perform procedures necessary to determine: • Whether fraud has occurred • Loss or exposure associated with the fraud • Who was involved and how it happened • Must prepare, document and preserve evidence sufficient for potential legal proceedings. • Include experts = Certified Fraud Examiner (CFE)

  33. 7. Improved Controls • Use lessons learned from any fraud reviews or investigations to improve anti-fraud controls. • All fraud review and investigations should include a report to management with recommendations for control improvement.

  34. Fraud Self Assessment

  35. Fraud Self Assessment If you are interested in taking our free Fraud Risk Assessment, please provide your card our send an email to Ron Steinkamp at rsteinkamp@bswllc.com

  36. Training Academy January Survey • We rely on your feedback to provide training on topics you want to hear; please take a few short minutes to fill out this brief evaluation of this presentation: https://www.surveymonkey.com/s/2YTWCBH