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Forensic and Investigative Accounting. Chapter 5 Employee Fraud: The Misappropriation of Assets. © 2011 CCH. All Rights Reserved. 4025 W. Peterson Ave. Chicago, IL 60646-6085 1 800 248 3248 Egotistical Risk taker Hard worker Greedy Disgruntled or a complainer

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forensic and investigative accounting

Forensic and Investigative Accounting

Chapter 5

Employee Fraud:

The Misappropriation of Assets

© 2011 CCH. All Rights Reserved.

4025 W. Peterson Ave.

Chicago, IL 60646-6085

1 800 248 3248

employee fraudsters

Risk taker

Hard worker


Disgruntled or a complainer

Overwhelming desire for personal gain

Pressured to perform


Rule breaker

Under stress

Financially needy

Big spender

Close relationship with vendors/suppliers

Employee Fraudsters

Lisa Eversole, in “Profile of a Fraudster,” lists the following characteristics of occupational fraudsters:

Forensic and Investigative Accounting

effects of fraud
Four-year class action lawsuit against Tyco.

Fraud was $1 to $2 billion.

PWC payment $225 million

Tyco payment $2.975 billion

Total $3.2 billion

Effects of Fraud

Forensic and Investigative Accounting

fannie mae forensic probe
BOD hired investigators who cleared the current management of Fannie Mae of knowingly participating in any wrongdoing.

The report took 17 months; 616 pages plus 2,000 plus pages of supporting documents.

Cost of $60 million to $70 million.

The fraud was estimated to be $11 billion.

Former N.H. Senator Warren Rudman used The Huron Consulting Group.

Fannie Mae Forensic Probe

Forensic and Investigative Accounting

a forensic accounting expert witness
Harvey R. Kelly led the investigation and testified against CEO Richard M. Scrushy (HealthSouth).

He acknowledged turning up “nothing that had Mr. Scrushy’s name on it,” that connected the former CEO to the fraud at HealthSouth, which inflated earnings by $2.7 billion.

“Our job wasn’t to figure out who all the bad guys were. Our job was to help the company get the right numbers and figure out how much the fraud was.”

He and his investigators sifted through millions ofdocuments during their 23,000-hours fraudinvestigation. PWC was paid about $9 million to conduct the forensic audit in 2003.

HealthSouth deleted old e-mails every 60 days.

Now with the NYC office of Alix Partners LLC, he was being paid about $700 an hour by the government for his testimony.

Source: Evelina Shmukler, “Scrushy Team Cross-Examines Forensic-Accounting Witness,” WSJ, February 1, 2005, C-4.

A Forensic Accounting Expert Witness

Forensic and Investigative Accounting

governmental fraud
Governmental Fraud

Where Is $9 Trillion? The U.S. Federal Reserve can not account for $9 trillion in off-balance sheet transactions. Also, no one at the Federal Reserve has any idea what are the losses on its $2 trillion portfolio.

On May 12, 2009, Inspector General Elizabeth Coleman could not explain the $1 trillion plus expansion of the Federal Reserve’s balance sheet since September 2008. While testifying before Congress, Coleman said the IG does not have jurisdiction to audit the Federal Reserve.

If a U.S. business lost $9 trillion or created $9 trillion on their balance sheet, they would suffer severe penalties.

Source: Julie Crawshaw, “Federal Reserve Cannot Account for $9 Trillion,” May 12, 2009.

Forensic and Investigative Accounting

employee fraudsters7
Employee Fraudsters

Bev Harris, in “How to Unbezzle a Fortune,” says that fraudsters and embezzlers are the nicest people in the world:

Wide-eyed mothers of preschoolers. Your best friend. CPAs with impeccable résumés. People who profess deep religious commitments. Your partner. Loyal business managers who arrive early, stay late, and never take a vacation. And sometimes, even FAMILY MEMBERS. So if you’re looking for sinister looking, waxed mustache, and shifty eyes, you’re in for a surprise—scoundrels come in every description.

Forensic and Investigative Accounting

careful with property tax refund checks
Careful With Property Tax Refund Checks

Supervisor of the Real Property Tax Adjustment Unit in Washington, D.C., Harriette Walters, used at least 92 payments to dummy corporations in a scam to obtain $31.7 million.

Fraud was never noticed by city officials, internal, or external auditors. Auditors never examined why the city’s property tax refunds were steadily rising.

Sham companies’ bank accounts were controlled by Walters’ brother.

Many applications for refund were identical to prior ones.

In a FBI raid of her house, 100 pieces of jewelry, a mink coat, 90 designer purses, 68 pairs of shoes, designer luggage, Rolex watch, silver bar cart, and more were found. She had a $1.4 million in bills at Neiman Marcus on a $81,000 yearly government salary.

Forensic and Investigative Accounting

discrepancies that may indicate fraud
Discrepancies That May Indicate Fraud
  • Transactions that are not recorded in a complete or timely manner or are improperly recorded as to amount, accounting period, classification, or entity policy.
  • Unsupported or unauthorized balances or transactions.
  • Last-minute adjustments that significantly affect financial results.
  • Evidence of employees’ access to systems and records inconsistent with that necessary to perform their authorized duties.

Forensic and Investigative Accounting

types of misappropriations
Types of Misappropriations
  • Embezzlement
  • Cash and check schemes
    • Larceny of cash
    • Skimming
    • Swapping checks for cash
    • Check tampering
    • Kiting
    • Credit card refund and cancellation schemes

(continued on next slide)

Forensic and Investigative Accounting

types of misappropriations11
Types of Misappropriations
  • Accounts receivable fraud
    • Lapping
    • Fictitious receivables
    • Borrowing against accounts receivable
  • Inventory fraud
    • Stealing inventory
    • Short shipments with full prices

(continued on next slide)

Forensic and Investigative Accounting

types of misappropriations12
Types of Misappropriations
  • Accounts payable fraud
    • Double billing
    • Shell companies
  • Fictitious disbursements
    • Doctored sales figures
    • Sham payments
    • Price manipulations: land flipping, pump and dump, and cybersmearing
    • Money laundering
    • Bid rigging

Forensic and Investigative Accounting

fighting fraud
Fighting Fraud

An organization may want to:

  • Put in place a business ethics policy.
  • Reflect the company’s position on fraud in Rules of Conduct.
  • Identify and assess primary potential risks faced by the business.
  • Determine adequate plans and procedures to deal with fraud once it has been discovered.
  • Have a forensic accountant review and help to audit the company’s security measures.
  • Select and promote staff based on sound employment practices.

Forensic and Investigative Accounting

preventing employee fraud
Preventing Employee Fraud
  • Have a fraud hotline.
  • Institute a mandatory vacation policy.
  • Rotate assignments of employees who handle cash, payables, and receivables.
  • Have a written and signed ethics policy.
  • Have internal auditors do different procedures each time they audit a unit.
  • Observe and listen to employees; look for lifestyle changes.

(continued on next slide)

Forensic and Investigative Accounting

preventing employee fraud15
Preventing Employee Fraud
  • Really understand the business unit and what functions employees actually perform.
  • Do not allow employees or executives to get away with anything.
  • In a small business, the owner should receive the monthly bank statements unopened.
  • Bank statements should always be reconciled.

(continued on next slide)

Forensic and Investigative Accounting

preventing employee fraud16
Preventing Employee Fraud
  • Supervisors should try to think like criminals.
  • Do not assume employees behave honestly.
  • Check employee references and résumés.
  • Think outside the box.
  • Bond employees.
  • Use a positive pay system.
  • Use a locked box system.

(continued on next slide)

Forensic and Investigative Accounting

preventing employee fraud17
Preventing Employee Fraud
  • Count the cash twice in one day.
  • Count the cash at irregular intervals.
  • Unannounced inventory counts.
  • Have a fraud risk assessment.
  • Beware of related parties.
  • Avoid check-signing machines and signature stamps.
  • Be careful allowing employees to make side agreements.

Forensic and Investigative Accounting

proactive and reactive fraud investigations
Proactive and Reactive Fraud Investigations

There are two major types of fraud investigation:

  • Reactive investigations occur after there is a reason to suspect fraud or after there is a significant loss.
  • Proactive investigations occur as a part of normal operations even when there is no reason to suspect fraud.

(continued on next slide)

Forensic and Investigative Accounting

proactive and reactive fraud investigations19
Proactive and Reactive Fraud Investigations
  • The threat of a future investigation reduces the occurrence of fraudulent behavior from 75% to only 43%.
  • When the IRS began to require taxpayers to list a social security number for dependents, the number of reported dependents dropped by 7,000,000 the next year.

Forensic and Investigative Accounting

steps to consider once fraud is detected
Steps to Consider Once Fraud Is Detected
  • Call legal counsel.
  • Get the insurance carrier involved as early as possible.
  • Take immediate steps to safeguard existing assets from further damage.
  • Quietly and confidentially gather evidence.
  • Manage information on a need to know basis in the early stages of discovery.

(continued on next slide)

Forensic and Investigative Accounting

steps to consider once fraud is detected21
Steps to Consider Once Fraud Is Detected
  • Consider communications very carefully whether they are to employees or those outside the company.
  • Consider setting aside time immediately to scope out an action plan.
  • Consider those who might assist in the crisis and take steps to eliminate any conflict of interest issues.
  • Consider prosecution which acts as a deterrent for future fraud.

Forensic and Investigative Accounting

wells report measures
Wells Report Measures

The 2004 Wells Report provides an excellent ranking of the helpful measures for preventing fraud:

  • Strong internal controls (3.66)
  • Willingness of companies to prosecute (3.44)
  • Regular fraud audit (3.40)
  • Fraud training for auditors (3.33)
  • Anonymous fraud reporting mechanisms (3.27)
  • Background checks of new employees(3.25)
  • Established fraud policies (3.12)
  • Ethical training for employees (2.96)
  • Workplace surveillance (2.89)

Forensic and Investigative Accounting

fraud in not for profit organizations
Fraud in Not-for-Profit Organizations

The website of Clark, Schaefer, Hackett & Company states the following reasons not-for-profit organizations become targets of fraud:

Many smaller not-for-profits just don’t have the personnel size required for a real segregation of duties. They often don’t require much approval for disbursements. And, when fraud is discovered, they frequently don’t prosecute it very aggressively because of the perceived negative publicity.

Forensic and Investigative Accounting

state and local government susceptibility
State and Local Government Susceptibility

Government bankruptcy is an important issue for fraud prevention and detection because like business corporations and organizations, governments facing severe financial difficulties can be fertile ground for fraud. Government bankruptcy also may trigger an investigation in order to determine if fraud has contributed to such financial distress.

Forensic and Investigative Accounting

uncovering elusive fraud
Uncovering Elusive Fraud
  • Analyze account records and trace funds.
  • Research background and search for assets.
  • Develop confidential sources.
  • Interview/interrogate persons and find witnesses.
  • Conduct surveillance efforts.
  • Guide undercover operations.
  • Recognize and preserve physical evidence.

Forensic and Investigative Accounting

game theory and strategic reasoning
Game Theory and Strategic Reasoning
  • Fraud risk assessment
    • Auditors who use long lists of fraud cues and fraud checklists are inaccurate in their fraud risk assessments.
    • Auditors generally overweight cues indicative of management’s character even though these cues are the most likely cues to be unreliable.
    • Audit standards should be designed to persuade auditors to consider how management might manipulate their perceptions of fraud cues.

(continued on next slide)

Forensic and Investigative Accounting

game theory and strategic reasoning27
Game Theory and Strategic Reasoning
  • Audit planning
    • Auditors should develop audit strategies that are unpredictable, especially with regard to the nature of their evidence.
    • Audit plans are more predictable and less effective at detecting fraud when auditors use procedures based on prior audits or standard audit programs.

(continued on next slide)

Forensic and Investigative Accounting

game theory and strategic reasoning28
Game Theory and Strategic Reasoning
  • Audit planning (cont’d)
    • Audit standards should require auditors to engage in strategic reasoning by considering the types of fraud that management might perpetrate and how these frauds might be concealed from the audit.
    • The goal of audit standards should be to encourage auditors to gather new, unusual, or random audit evidence not easily anticipated by management.

(continued on next slide)

Forensic and Investigative Accounting

game theory and strategic reasoning29
Game Theory and Strategic Reasoning
  • Implementation of the audit
    • Learning from experience is critical to effectively performing in a strategic setting.
    • Auditors are often insensitive to new evidence regarding fraud risk and can more effectively learn from their interactions with the client.
    • Audit standards can improve learning by requiring activities such as documenting and communicating the nature of their interactions with management.

Forensic and Investigative Accounting

continuous monitoring
Continuous Monitoring

Some benefits to continuous monitoring are:

  • Independent testing of controls.
  • Timely notification to management of controls breakdowns.
  • Fraud reduction and improved risk management.
  • Improvements to efficiency and effectiveness.
  • Extensibility to multiple end-to-end business processes.

Forensic and Investigative Accounting

some forensic techniques and tools
Check, deposit, and credit card spreads

Timeline analysis

Tracing schedule

Link analysis



Proof of cash

Entity charts

Full- and-false inclusion tests

Net worth method

Some Forensic Techniques and Tools

Forensic and Investigative Accounting

check kiting scheme
Check Kiting Scheme

Peter L. Cash, a director of Peoples Bank of Coffee County, Alabama, kited checks between various bank accounts for each of his businesses to create an involuntary overdraft of more than $8 million between October 2005 and July 2008. Cash would continuously draw an insufficient check on one account and deposit that check into another account. This process gave the four victim banks the false impression that there was money in his business accounts. The fraud became apparent when he ended the kiting scheme and all checks and deposits cleared the various banks.

Source: “Elba Businessman Pleads Guilty to Bank Fraud Charges,” U.S. Attorney’s Office, 25 October 2010; available at press/2010 10 25 cash.pdf

Forensic and Investigative Accounting

embezzlement scheme
Embezzlement Scheme

Fraudsters may use simple methods to commit their embezzlement. Teri Lyn, an accounts payable clerk at McClelland Equipment, wrote 18 checks to herself for a total of $18,000. She would type her name and address on an address label which she put over the “account” or “to - - pay to the order of” person that she had dummied the check out to get it signed.

The fraud was discovered when a check processor peeled back the label on one of the dummied checks and found that the check was supposed to go to a company rather than Teri Lyn’s individual account. The processor called Lyn’s company, she confessed, and served 13 months of a two-year sentence.

Source: The Montel Williams Show, “My Life As a Thief,” June 11, 2004, 2004 Paramount Pictures Corp.

Forensic and Investigative Accounting

form 1099 technique
Form 1099 Technique
  • Fraudster taxed in year of embezzlement.
  • Victim allowed deduction in year of discovery.
  • Form 1099 Approach probably not worthwhile.

Forensic and Investigative Accounting