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1 Ethics Hotlines: A Key Part of Your Risk Avoidance Strategy for Commercial Industries Jim Snyder, J.D., CFE Managing Partner Forensics & Valuation Services jsnyder@bkd.com experience expertise // Elevate your understanding of key forensics concepts with guidance from BKD Forensics Institute. To Receive CPE Credit Individual Attendee o Participate in entire webinar o Answer polls when they are provided Group Attendees o Complete group attendance form with Title & date of live webinar Your company name Your printed name, signature & address o All group attendance sheets must be submitted to training@bkd.com within 24 hours of live webinar o Answer polls when they are provided If all eligibility requirements are met, each participant will be ed a CPE certificate within 15 business days of live webinar 2 1

2 What We Will Cover Today Look at the events over the last 10 years that underscore some risk issues facing every organization Fraud in the industries of construction & real estate & manufacturing & distribution Examine why implementation of an ethics or fraud hotline is recognized as the single most cost-effective strategy Study common hotline implementation issues that can stand in the way of having the desired impact Challenge our thinking about hotlines & what they can do 3 Revenue Losses 5% $ 3.5 Trillion 4 2

3 How I Came to Experience Hotlines I m a reformed lawyer Manager/owner of a business Fraud examiner 5 Those who cannot remember the past are condemned to repeat it 6 3

4 Could an Effective Hotline Have Minimized These Scandals? 7 Enron Houston we have a problem 8 4

5 Enron 9 Source: 10 Source: 5

6 Enron Lynn Brewer, former Enron executive 11 Enron s Hotline Internally managed 300% increase in reports between 2000 & 2001 Went from two per month in early 2000 to two per day in early 2001 o 33% of reports were criminal activity o 75% were reports of fraud 12 6

7 WorldCom 13 Source: WorldCom Cynthia Cooper 14 7

8 Waste Management 15 Source: Hotlines Used as Cornerstone of Antifraud Program Waste Management Maurice Myers 16 8

9 Boggs Paving, Inc. Accused of receiving more than $87 million in state & federal contracts 29-count indictment 17 Bernard L. Madoff Investment Securities LLC Bernie Madoff Harry Markopolos 18 9

10 Penn State Jerry Sandusky Mike McQueary 19 Dina Wein-Reis Scammed Fortune 500 corporations out of $20 million Swindled companies in Connecticut, Indiana, Missouri, New Jersey & Kentucky 20 10

11 Lessons Learned from These Debacles Fraud & violations of policy are often well known within organization (Enron, WorldCom, Boggs Paving, Madoff) For organizations that wish to promote risk-sensitive environment & tone at the top, a hotline is an effective way to accomplish this objective (Waste Management) Hotline system should be designed to have appropriate reporting with redundancy & escalation provision (Enron, Penn State) 21 Lessons Learned from These Debacles Design a system that captures the report in the words of the reporter (Penn State) Design a system that has independence & anonymity if implemented, you want it to be used!! Design a system that is easy to use & keep it front of mind 22 11

12 Executive Summary Summary of Findings Survey participants estimated typical organization loses 5% of its revenues to fraud each year. Applied to 2011 Gross World Product, this figure translates to a potential projected annual fraud loss of more than $3.5 trillion Frauds reported to us lasted a median of 18 months before being detected Occupational fraud is more likely to be detected by a tip than by any other method. Majority of tips reporting fraud come from employees of victim organization

13 Industries Characteristics of Fraud Construction & Real Estate Manufacturing & Distribution 25 Construction & Real Estate Fraud Overview Prevalence: 61% of companies in sector affected by fraud Areas of Loss o Theft of physical assets or stock (22%) o Vendor, supplier or procurement fraud (16%) o Internal financial fraud or theft (15%) Increase in Exposure: 59% of companies in sector have experienced increased exposure to fraud o Due largely to increased IT complexity 26 Source: 13

14 Manufacturing & Distribution Fraud Overview Prevalence: 87% of companies in sector affected by fraud Areas of Loss o Theft of physical assets or stock (50%) o Corruption & bribery (29%) o Vendor, supplier or procurement fraud (23%) o Internal financial fraud or theft (23%) Increase in Exposure: 90% of companies in sector have experienced increased exposure to fraud o Due largely to increased IT complexity 27 Source: Median Loss 28 14

15 Types of Cases 29 Executive Summary Presence of antifraud controls is notably correlated with significant decreases in cost & duration of occupational fraud schemes. Victim organizations that had implemented any of 16 common antifraud controls experienced considerably lower losses & time-to-detection than organizations lacking these controls Perpetrators with higher levels of authority tend to cause much larger losses. Median loss among frauds committed by owner/executives was $573,000, median loss caused by managers was $180,000 & median loss caused by employees was $60,

16 Executive Summary Nearly half of victim organizations do not recover any losses that they suffer due to fraud. As of the time of our survey, 49% of victims had not recovered any of the perpetrator s takings; this finding is consistent with our previous research, which indicates 40-50% of victim organizations do not recover any of their fraud-related losses 31 Executive Summary Conclusions & Recommendations The nature & threat of occupational fraud is truly universal. Though our research noted some regional differences in methods used to commit fraud as well as organizational approaches to preventing & detecting it many trends & characteristics are similar regardless of where fraud occurred 32 16

17 Executive Summary Providing individuals a means to report suspicious activity is a critical part of an antifraud program Fraud reporting mechanisms, such as hotlines, should be set up to receive tips from both internal & external sources & should allow anonymity & confidentiality Management should actively encourage employees to report suspicious activity, as well as enact & emphasize an antiretaliation policy 33 Executive Summary Targeted fraud awareness training for employees & managers is a critical component of a well-rounded program for preventing & detecting fraud Not only are employee tips the most common way occupational fraud is detected our research shows organizations that have antifraud training programs for employees, managers & executives experience lower losses & shorter frauds than organizations without such programs in place At a minimum, staff members should be educated regarding what actions constitute fraud, how fraud harms everyone in the organization & how to report questionable activity 34 17

18 Detection of Fraud Schemes Frauds are much more likely to be detected by tips than by any other method 35 Detection of Fraud Schemes Initial Detection of Occupational Frauds 36 18

19 Detection of Fraud Schemes Source of Tips Identifying the most common sources of tips is essential to crafting a system that encourages individuals to step forward with information While just over half of all tips originated from employees, our research reveals several other parties tip off organizations to a substantial number of frauds Organizations should consider this data when deciding how to best communicate reporting policies & other resources to potential whistleblowers 37 Detection of Fraud Schemes There are several reasons why a person might want anonymity when reporting a tip, & data shows that a significant number of tips (12%) came from an anonymous source Tools such as anonymous hotlines or web-based portals, which allow individuals to report misconduct without fear of retaliation or of being identified, can help facilitate this process 38 19

20 Detection of Fraud Schemes Source of Tips 39 Detection of Fraud Schemes Impact of Hotlines 40 20

21 Detection of Fraud Schemes Impact of Hotlines Presence or absence of a reporting hotline has an interesting impact on how frauds are discovered. Not surprisingly, organizations with some form of hotline in place saw a much higher likelihood that fraud would be detected by a tip (51%) than organizations without such hotline (35%) 41 Detection of Fraud Schemes Another wide disparity between these two classes of organizations is seen in frauds detected by accident More than 11% of frauds in organizations without hotlines were caught by accident, whereas less than 3% of cases were detected by accident in organizations that had implemented a hotline Similarly, external audit was the detection method for 6% of cases in organizations without hotlines, but only 1% in organizations with hotlines

22 Detection of Fraud Schemes Detection Method by Size of Victim Organization 43 Detection of Fraud Schemes Initial Detection of Frauds in Small Businesses Compared to large organizations, small businesses (those with fewer than 100 employees) differ widely in organizational structure & availability of resources. Our data suggest that small organizations tend to have far fewer antifraud controls in place than larger organizations Furthermore, small organizations in our study were victimized by fraud more frequently than larger organizations, & they suffered a disproportionately large median loss of $147,

23 Detection of Fraud Schemes Difference in levels of control could explain some of discrepancies between detection methods observed in small & large organizations, as illustrated in the previous chart depicting detection method by size Note that smaller companies are substantially less likely to detect fraud based on tips or internal audits, while they are more likely to uncover fraud by accident, external audit or police notification 45 Use the Right Tool 46 23

24 The Cost of Occupational Fraud The typical organization loses an estimated 5% of its annual revenues to occupational fraud 47 Impact of an Ethics Hotline Association of Certified Fraud Examiners states 5% of revenues lost to fraud each year Frauds last a median of 18 months before being detected Occupational fraud is more likely to be detected by tip than by any other method Antifraud controls help detect fraud o 12 months faster o Median loss 44% less 48 24

25 Why an Ethics Hotline? Can act as an integral part of any organization s fraud or ethics program o Upgrade or replace required compliance hotline Provides a great way to demonstrate tone at the top Acts as a strategy to deter fraud & unethical conduct Acts as a way discover fraud & unethical behavior ROI 49 What Should Be Reported? Actions or concerns that o o o o May lead to incorrect financial reporting Are unlawful Are not in line with an organization s board policy May amount to serious improper conduct 50 25

26 Implementation: Keys to a Successful Hotline 51 What Does a Successful Hotline Look Like? 1. It is well implemented 2. It is designed for your organization 3. It is well supported by upper management 4. It is part of a more comprehensive program for establishing tone at the top 5. It is well known to employees 6. It is based on reliable technology 7. It provides different avenues to report through a. Phone b. Web 8. It has redundancy in reporting 9. It is kept front of mind by management 10. It has follow-up mechanisms in place 52 26

27 Sources The Association of Certified Fraud Examiners, Report to the Nations content/uploads/2013/10/fraudreport_ pdf speoverview.htm 53 Some Key Resources for You Jim Snyder o ( ) o jsnyder@bkd.com Our IntegraReport team: Shauna Woody-Coussens, Angela Morelock, Todd Burchett, Julia (Mast) Swafford, Bryan Callahan, Forrest McCurren

28 Continuing Professional Education (CPE) Credits BKD, LLP is registered with the National Association of State Boards of Accountancy (NASBA) as a sponsor of continuing professional education on the National Registry of CPE Sponsors. State boards of accountancy have final authority on the acceptance of individual courses for CPE credit. Complaints regarding registered sponsors may be submitted to the National Registry of CPE Sponsors through its website: The information in BKD webinars is presented by BKD professionals, but applying specific information to your situation requires careful consideration of facts & circumstances. Consult your BKD advisor before acting on any matters covered in these webinars. 55 CPE Credit 1 CPE credit in Specialized Knowledge & Applications field of study may be awarded upon verification of participant attendance For questions, concerns or comments regarding CPE credit, please the BKD Learning & Development Department at training@bkd.com 56 28

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