Red flags of fraud. Joseph Chianese Ian Haimoff John McSwain Melissa Wiseman

Transcription

1 Red flags of fraud Joseph Chianese Ian Haimoff John McSwain Melissa Wiseman

2 Agenda Introduction and Background Common red flags and symptoms Role of the internal auditor - leading practices Conclusion Questions & answers Some resources to consider 1

3 Introduction & background

4 Fraud: Defined Any illegal acts characterized by deceit, concealment, or violation of trust. These acts are not dependent upon the application of threat of violence or of physical force. Frauds are perpetuated by individuals and organizations to obtain money, property, or services; to avoid payment or loss of services; or to secure personal or business advantage. Source: The Institute of Internal Auditors International Standards for the Professional Practice of Internal Auditing -- Deception brought about by misrepresentation of material facts, or silence when good faith requires expression, resulting in material damage to one who relies on it and has the right to rely on it. I.R.S. Fraud Handbook ( 3

5 Fraud Basics: Types of fraud Misappropriation of Assets Fraud Fraudulent Financial Reporting Disclosure Corrupt Business Practices 4

6 Why does fraud occur? The Fraud Triangle helps encapsulate the events or conditions that influence the commission of a fraud. Incentives and pressures: Management or employees have an incentive or are under pressure, real or perceived, which may provide a reason to commit the fraud. Opportunity: Circumstances exist that provide an opportunity for fraud to be perpetrated. Attitudes and rationalizations: Those involved in the fraud are able to rationalize committing a fraudulent act. Where could the fraud occur? What would the fraud look like? What type of fraud is the area susceptible to? What are the effects on the books and records? When could the fraud occur? 5

7 Moral People Lie If you don t acknowledge that fraud happens, you are not going to find it.

8 General Spheres that investigators work in Audit Interviewing Other Research Informational interviews Third parties Former employees Informants Witnesses Admission seeking Public records Media Analyze computer images Surveillance Phone records Document analysis Analytical reviews Trending Assessment of controls 7

9 Valuable soft skills Think like a fraudster Pay attention to the details Use information gathering techniques Communicate and build rapport All segments of an audit are connected Use an unpredictable and flexible audit approach Facilitate a control self assessment Perform and understand data analytics 8

10 Common red flags and symptoms

11 Categories of fraud symptoms Behavioral symptoms Lifestyle symptoms Accounting anomalies Internal control symptoms Analytical anomalies Tips and complaints Source: Internal Auditor Magazine, October 1996, Employee Fraud by W. Steve Albrecht 10

12 Potential Behavioral red flags & symptoms: Common characteristics On the surface: Long-time employee In a position of trust who appears to be extremely dedicated Hard-working employee who never takes vacations Has unexplained cash or other wealth Can you tell who is Stealing? In Debt? Beneath the surface: Lifestyle (house, cars, boats) beyond known income sources Drug, gambling, alcohol or other vice addiction Behavior indicating displeasure or dissatisfaction with the organization Secretiveness towards accounting documents or policies Corrupt? Incompetent? Desperate? 11

13 Behavioral red flags of perpetrators Living beyond means 35.6% Financial difficulties 27.1% Unusually close association with vendor/customer Control issues, unwillingness to share duties Wheeler-dealer attitude Divorce/family problems Irritability, suspiciousness or defensiveness 19.2% 18.2% 14.8% 14.8% 12.6% Addiction Problems Past employment-related problems Complained about inadequate pay Refusal to take vacations Excessive pressure from within organization Past legal problems Complained about lack of authority Excessive family/peer pressure for success Instability in life circumstances 8.4% 8.1% 7.9% 6.5% 6.5% 5.3% 4.8% 4.7% 4.1% 0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0% 35.0% 40.0% 12 Source: ACFE s Report to the Nation on Occupational Fraud and Abuse 2012

14 Potential Symptoms and red flags: Accounts receivable/cash receipts Customer complaints Unexplained change in uncollectable accounts and aging Customer statements are not sent or are not sent timely Timing differences between collections and posting to accounts Staff not taking vacations Credits to a customer account followed by an identical debit Changes to customer accounts or new customers with unusual names/addresses Shipping to customers without proper credit approval Unusual ship to address is different from company address 13

15 Potential Symptoms and red flags : Accounts receivable/cash receipts, continued Inventory discrepancies Unusual collection agency activity (low recovery/high utilization) Changes in sales (increase or decrease) not consistent with changes in cash receipts Unusual number of reverse transactions/voids Unusual number of pricing overrides Unusual number of credit overrides Credit level increases not consistent with sales volume 14

16 Potential Symptoms and red flags: Accounts payable/cash disbursements Actual costs over budget Original documents are not available for inspection Missing documentation Changes to vendor master file are not approved Payment not properly authorized or typical controls are overridden Vendor names appear to be unusual Vendors with multiple addresses or addresses that change frequently Common name, address, bank account number between vendor and employee master files Vendor address is a P. O. box Frequent changes to vendor master file Unexplained fluctuations in payments to vendors 15

17 Potential Symptoms and red flags: Accounts payable/cash disbursements, continued Changes in employee habits and lifestyle Invoices are hand delivered Check sequences, anomalies, or gaps Endorsement anomalies Strange or unusual payees Lack of physical security protocol over check stock and signature stamps or plates Bank reconciliations with long-term outstanding checks Differences between the payee per the check register and the cancelled check Cancelled checks cannot be located Vendors not being paid timely or being paid sooner than other vendors 16

18 Potential Symptoms and red flags: Purchasing Frequency of purchases and amount of vendor spend sharply increase (particularly with new vendors) Vendor used consistently in the past suddenly is no longer used Vague descriptions provided on invoices (e.g., materials purchased or services rendered) Unusual number of purchases below approval threshold level purchases broken into smaller pieces One payment applies discount, another pays full invoice (invoices amounts with 2% difference, etc.) Volume of purchases not supported by a rational need P-Cards - Unusually high spend activity at the end of the year P-Cards - Weekend purchases and holiday purchases P-Cards - Purchases from vendors not in the normal course of business (jewelry stores, casinos, furniture stores, gentlemen s clubs, etc.) 17

19 Potential Symptoms and red flags: Purchasing, continued Excessive sole source justifications Unusual restrictions or time limits to exclude or reduce competition Prequalification procedures that restrict robust competition Vague bid specifications Specifications developed by a vendor who then submits a bid One party represents a number of potential bidders Unknown or unusual vendors Acceptance of late or incomplete bids Permitting changes after receipt of bids Bids submitted in editable electronic formats Selecting vendors with records of poor performance history. Qualified vendors stop submitting bids. 18

20 Potential Symptoms and red flags: Revenues Sales trends out of line with industry Sales exactly meet budget or analysts expectations Bonuses tied to sales Excessive returns after period end Side agreements identified in confirmations Recurring negative cash flows from operations Sales on tax return differs from sales reported in financial statements. Missing documentation Commissions not paid to sales rep. when otherwise would be expected Unusual increase in the number of days sales in receivables Customer invoice shows extended payment terms or unusual return allowances Credit limits exceeded 19

21 Potential Symptoms and red flags: Corporate corruption Operating in countries or industries notorious for fraud or corruption Expenses over budget Excessive consulting fees Unauthorized payments for goods and services Complaints from suppliers regarding bidding or relationships Fluctuations in vendor volumes 20

22 Leading practices

23 Proactive fraud risk management strategies: Investigations Some purposes: Determine if laws, regulations or company policy have been violated Quantify any losses and identify parties involved Determine financial and regulatory reporting impacts Provide support to recover funds from perpetrator or insurance Provide factual basis for employee/business partner discipline/ termination/prosecution Learn fraud schemes in use and aid risk assessment updates Identify vulnerabilities in business processes and controls and develop recommendations for improvements Demonstrate to regulators/shareholders due care by management Deter future frauds by showing action is taken Restore company s credibility and authority Remove uncertainty and help rebuild market capitalization 22

24 Proactive fraud risk management strategies: Fraud risk assessment & investigations Intentionally recording sales prematurely 2. Bribery/corruption 3. Creating fictitious sales Fraudulent claims by retail customers 5. Intentional overcharges by vendors 6. Intentional overstatement of assets used to secure finance Significance Unauthorized trades in financial markets 8. Unsupportable product performance statements 9. False employee expense report claims 10. Employee embezzlements 23 Likelihood Sample fraud & corruption risk heat map only. Ratings will vary by company.

25 Proactive fraud risk management strategies: Advance preparation/ process in place Allegation system Allegation triage Case investigation Protocols, e.g., privacy/data protection/interviewing methods Resources, e.g., location/language/financial/computer forensics Case management Reporting Resolution The worst time to plan for a crisis? When you are in one. 24

26 Conclusion Death, taxes, fraud Companies would be wise to prepare Understand, prioritize and manage your company's fraud risks Have a detailed program to prevent, deter, detect, and respond to fraud Proactive tools and data analytics may help you identify frauds earlier People will lie to you If you suspect a problem, demand an explanation Do not be intimidated into ignoring what you know to be questionable activity If something does not make sense to you, it will make less sense to law enforcement 25

27 Questions

28 Resources

29 IIA Resources Managing the Business Risk of Fraud A Practical Guide (July 2008) Includes performance metrics How do your organization s practices compare to those recommended? Free download at Practice Guide Internal Auditing and Fraud (Dec 2009) Includes a fraud investigations framework and a fraud risk assessment template Global Technology Audit Guide (GTAG) Fraud Prevention and Detection in an Automated World (Dec 2009) Knowledge Alert Emerging Trends in Fraud Risks (Jan 2010) 28

30 ACFE Resources 2012 ACFE Report to the Nations on Occupation Fraud and Abuse Includes fraud prevention checklist Free download at ACFE fraud prevention check-up Free download at ww.acfe.com/documents/fraud_prev_checkup_ia.pdf 29

31 IPPF Practice Guide Fraud Prevention and Detection in an Automated World Selected Topics Include Analytical techniques for fraud detection Typical types of fraud tests Analyzing full data populations Fraud prevention and detection program strategies Analyzing data using internal and external data sources 30

32 IPPF Practice Guide Internal Auditing and Fraud Selected topics Include Fraud awareness Typical roles and responsibilities for fraud Fraud risk assessment Fraud prevention and detection Fraud investigation Internal Audit s role 31

33 Deloitte Forensic Center resources Book: Corporate Resiliency: Managing the Growing Risk of Fraud and Corruption (Wiley, 2009) Monthly For Thoughts topical e-newsletter Videos on a variety of fraud and corruption subjects More information at forensiccenter 32

34 Visit the Deloitte Forensic Center 33

35 Contact information John McSwain Director Deloitte Financial Advisory Services LLP

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