Steven Boyer Vice-President, Gallagher Bassett Services Inc.

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1 Employee Dishonesty and Fraud Motive, Rationale & Opportunity Steven Boyer Vice-President, Gallagher Bassett Services Inc. Randall Wilson, CPA/CFF, CFE, Cr.FA Partner, National Practice Director Fraud & Fidelity RGL Forensics scs Mike Wroblewski Managing Director, GB Religious i Niche Gallagher Bassett Services Inc.

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3 Employee Dishonesty and Fraud Motive, Rationale & Opportunity Steven Boyer Vice-President, Gallagher Bassett Services Inc. Randall Wilson, CPA/CFF, CFE, Cr.FA Partner, National Practice Director Fraud & Fidelity RGL Forensics Mike Wroblewski Managing Director, GB Religious Niche Gallagher Bassett Services Inc. Recent Media Headlines Church Secretary denies Theft Charges Former Employee indicted in Theft Case Church Employee Arrested and Accused of Stealing Ex-Employee Stole from Church Church Employee Admits to Stealing Pastor nabbed in Theft from Church Based on a comprehensive study of 959 cases of occupational fraud investigations conducted by Certified Fraud Examiners around the country: The Religious, Charitable or Social Services category ranked ninth in frequency of occurrence out of a total of twenty one industry categories. The median loss in the Religious, Charitable or Social Services category was $106,

4 Bottom Line It really can happen to you!! Purpose of Today s Presentation Our goal today is twofold first, to increase your awareness of the incidence of occupational fraud as well as educate you on some of the techniques employed in the investigation of these matters. Second, should you have an Employee Dishonesty claim, to discuss what to expect and what your insurance carrier expects. Occupational Fraud (includes Misappropriation) Occupational Fraud defined: According to the Association of Certified Fraud Examiners, occupational fraud is defined as the use of one s occupation for personal enrichment through the deliberate misuse or misapplication of the employing organizations resources or assets. definition very broad. 6 2

5 Magnitude of Occupational Fraud Cost of Fraud Based on its most recent Report to the Nation, the Association of Certified Fraud Examiners estimates that losses resulting from Occupational Fraud equals seven percent of total revenue per year (or when applied to U.S. Gross Domestic Product) totals nearly one trillion dollars nationally each year. [The ACFE believes these estimations of the magnitude of fraud are likely understated.] What is the likelihood that someone in your organization is committing occupational fraud? 7 Can Insurance Coverage Help? Absolutely Insurance companies provide products that protect organizations from Employee Dishonesty. They are commonly referred to as Fidelity Bond policies in that they insure the honesty of an entity s employees. But always remember that prevention and detection are critical in that fidelity policies, like all insurance policies, are contracts that have insuring provisions, exclusions, conditions, etc. In other words, not everything is insurable at a reasonable price. It is the nature of risk management. What does your occupational fraud prevention and detection plan look like? Are you proactively addressing the possibility of fraud in your organization? 8 General Fidelity Coverage Provisions Commercial Crime Employee Dishonesty Dishonest Act, Committed by an Employee, with the manifest intent to cause the insured entity to sustain a loss, and with the intent of the employee to derive a financial benefit [this financial benefit cannot be wages, salaries, commissions earned in the normal course] or to intentionally cause another to benefit financially Intent is critical to Employee Dishonesty 9 3

6 Fidelity Bond Coverage Provisions Other Provisions Types of Property Insured Money, Securities and Property Policy Limit The maximum payable for all periods, no stacking Measurement Basis Typically the cost to replace as of date of discovery 10 Fidelity Bond Coverage Provisions Other Provisions Discovery The date of loss in fidelity bond coverage is the date of discovery; the typical coverage allows for the loss to be addressed if discovered during the policy period and generally up to one year following the expiration of the policy this additional period is referred to as the discovery tail Question Why is discovery extended beyond the policy period? 11 Discovery Fidelity Bond Coverage Provisions Discovery Tails The discovery tails are important because they determine the extent to which prior period fidelity losses are covered by the current carrier Loss During Prior Policy Periods The current fidelity bond policy typically addresses loss sustained during prior periods including periods insured by other bond carriers whose discovery period has ended In addition to the expiration of the prior carrier s discovery, this is to the extent that there is coverage limit available under the current policy and that the loss would have been covered by the prior carrier 12 4

7 Discovery Example 13 Discovery January 2010 Bond Carriers Current carrier has insured the Archdiocese since January 2008 with a limit of $500,000 excess coverage over the $100,000 Self Insured Retention (SIR) Previous carrier had excess coverage of $50,000 over a $50,000 SIR Loss by Year 2010 $ 10, , , ,000 Total $260,000 Is the Archdiocese fully covered for this loss? [2007 is only covered for $100,000] Occupational fraud schemes tend to be extremely costly. The median loss was $175,000 with more than one fourth of all frauds at least $1 million. Occupational fraud schemes frequently continue for years before they are detected. The typical fraud lasted two years from the time it started to the time it was caught (or discovered) by the victim organization. 14 Unrecoverable Cost of Misappropriation Losses in Excess of Policy Limits Cost of Investigation and Preparation of the Claim Legal Fees for Claim Handling, Document Recovery, and Restitution Expert Fees for Recovery / Restitution Indirect Losses - Lost Opportunity or Lost Profits Cost of Recruiting and Training Employees Loss of Trust Loss of Confidence of Employees, Suppliers and Customers 15 5

8 The prototypical fraudster is often not who you would expect, as they often display the following traits: Friendly Knowledgeable of Systems and Documents Competent in their Work Prompt and Hardworking Eager to please his or her Supervisor Enthusiastic in promoting the organization s objectives Sometimes boasts they are protecting the company s assets Of course this in no way means that every employee with these qualities is stealing, it is just that if they are stealing then these are techniques used to keep you from suspecting them. 16 Typical Fraudster or Dishonest Employee In its simplest form, the typical fraudster is someone so inclined to commit fraud that has a motive and the accessibility to assets and systems to carry it out Within this definition are the concepts that embody the fraud triangle relevant to employee dishonesty; motive, opportunity and rationale Probably one of the most important concepts that we want to pass along to you today is that fraudulent or dishonesty activity can come from a source that you least expect 17 Occupational frauds often committed by the accounting department or by management. 29% of frauds were committed by persons in the accounting department, while 18% committed by executives with the losses from executives very costly in amount. Occupational fraudsters are generally first-time offenders. Only 7% of perpetrators had prior convictions. 18 6

9 5/7/2010 Motive for Misappropriation / Desperation or Calculation Common motives for misappropriation: Gambling Addiction Drug / Alcohol Addiction Greed / Maintain Lifestyle Financial Difficulty / Employee or Family Health Problems / Coverage Limited 19 The most commonly cited behavioral red flags were perpetrators living beyond their apparent means (39% of all cases) or experiencing financial difficulties at the time of the frauds (34% of total cases). In financial i statement t t fraud cases, which h tend to be the most costly, excessive organizational pressure to perform was a particularly strong warning sign. While you may not be able to inquire as to how the employee is living beyond apparent means, you can check on opportunity and controls. 20 Rationale for Misappropriation Common rationale for misappropriation: Loan / Intent to Pay Back Lack Character Under-Paid / Under-Appreciated Employer Wealthy / Won t Miss it Employer should provide better Health Benefits 21 7

10 Forensic Investigation Intent Within the context of the forensic accounting investigation of misappropriation, the concept of intent is critical The investigative components of this concept include the following: Scheme Concealment and Opportunity 22 Lack of adequate internal controls was most commonly cited as the factor that allowed fraud to occur. 35% of survey responders cited inadequate internal controls as a primary factor in the frauds they investigated. Lack of management review and override of existing controls were also each cited by 17% of the respondents. 23 Example 1 Scheme Checks issued to the subject employee and to outside entities for the benefit of the subject employee (payment on credit cards) Concealment The transactions were recorded as payments to regular vendors Opportunity Subject is bookkeeper responsible for preparation of checks to vendors and management of the general ledger. 24 8

11 Example 2 Scheme Cash stolen by subject employee from the cash drawer Concealment Under-recorded cash receipt transactions and credits issued on receivable account Opportunity Subject is office employee responsible for receipt of cash and checks from customers on account and recording of payments on accounts receivable system 25 Example 3 Scheme Over payment of purchase invoice, request for refund, which is transposed for cash or deposited in personal account of subject employee Concealment Inflated amount of invoice recorded as regular payment amount to vendor in the ledger Opportunity Subject is bookkeeper responsible for preparing checks in payment to vendors and for sorting the daily mail 26 Example 4 Scheme Payment of vendor invoices for which goods or services were not delivered or provided with kickback by the vendor to the subject employee Concealment Falsified approved purchase order in the vendor file and, if goods, the fabrication of a dock receipt or the generation of an electronic dock receipt Opportunity Subject is production manager responsible for ordering goods and services for operations 27 9

12 Example 5 Scheme Employee sets up a company and a bank account and requests to be an approved vendor of his or her employer in order to submit fictitious invoices for services not delivered Concealment Employee establishes budget for services in excess of need and falsifies purchase orders to his or her new company / vendor and approves them Opportunity Subject is operations manager responsible for ordering goods and services for operations; no new vendor diligence or policy (notice not in accounting department) 28 Occupational frauds are much more likely to be detected by a tip than by audits, controls or any other means. 46% of the cases in the survey were detected by tips from employees, customers, vendors and other sources. This statistic continues despite the increase in anti-fraud controls from Sarbanes-Oxley and mandated consideration of fraud in financial statement audits pursuant to SAS Methods for Detection / Deterrence Ways that misappropriation is detected: 1. Anonymous Tip by an Employee, Supplier, 2. Vendor, Customer or Other Accidentally Internal Audit 7. External Audit 8. Internal Control / Discovered in Course Periodic Control Review 30 10

13 The least utilized anti-fraud measures are considered some of the most effective in preventing and detecting occupational fraud: Hotline / Reward for Whistleblowers Job Rotation / Mandatory Vacation Surprise Audits Written and Communicated Anti-Fraud Policy Fraud Training for Employees Fraud Training for Employees How many of these measures are being implemented in your organization? 31 Risk of Fraud by Vendors Problems: The fidelity bond insurance companies are concerned about the incidence and magnitude of misappropriation by employees in collusion with vendors, fictitious vendors and / or extortion ti by vendors Based on interviews of the claims and underwriting departments of the major carriers, vendor related losses account for one third to one half of all losses 32 Solutions to Fraud by Vendors 1. Diligence in the fight against vendor fraud prevention is an attitude 2. Communicate the costs of fraud and benefits of prevention to Employees as well as management s attitude of prosecution 3. Establish an Anonymous Fraud Tip Hotline 4. Vigilance fraud prevention requires a sustained effort with the understanding that the risk is ongoing regular audits 5. Partner with your fidelity bond carrier, including compliance with recommended programs of misappropriation risk reduction 6. Consider assessing the risk of misappropriation by vendors or vendors in collusion with employees / analytical software 33 11

14 What to Expect should you have an Employee Dishonesty Claim Detailed Investigation is Required Think about the following requirements of the insurance company when conducting your investigation: Verification of Employment Perpetrators Anyone that Colluded or Assisted the Perpetrators Access of the Perpetrators to Assets and to the Books and Records [Opportunity] Concealment Methodology Used [Intent] Document Discovery Verify the Misappropriation 34 What does your Insurance Carrier expect when you have such a Claim Cooperation Sworn Statement in Proof of Loss with Support Your assistance with the following: Interviewing You and Other Employees Access to Review additional Books and Records Consideration in Prosecuting the Perpetrators Identifying Assets of the Perpetrators And, notification of potential restitution and recovery as quickly as possible to facilitate their strategy in recovering from dishonest and negligent parties In other words, partner with your insurance carrier and SIR adjuster, they have a great deal of experience in this area and can help you and you can help them through your cooperation and support 35 Remember It really can happen to you!! But now you are more aware! 12

15 Resources Association of Certified Fraud Examiners website of Committee of the Sponsoring Organizations of the Treadway Commission website of COSO publications through the American Institute of Certified Public Accountants ( Internal Control - Integrated Framework, 2 Vols. RGL Forensics website of Presenters today: Steven Boyer Randall Wilson Mike Wroblewski 37 Any Questions / Comments Thank for your kind attention today, please help us in the good fight against the incidence of fraud and misappropriation as well as our efforts to increase awareness. 38 Bottom Line It really can happen to you!! 13

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