Cressey s fraud triangle: All 3 conditions must be present for fraud to occur

Transcription

1 DEfINITION Of fraud AND fraud INvESTIgATION Dilek ÇİLİNgİR Ernst & Young What is fraud? According to International Standard on Auditing (240): An intentional act By one or more individuals among management, those charged with governance, employees, or third parties Involving the use of deception To obtain an unjust or illegal advantage Cressey s fraud triangle: All 3 conditions must be present for fraud to occur

2 fraud Scale: when is fraud risk increases? High Risk Low Risk Situational pressure High Low Opportunity High Low Personal integrity Low High Red flags Red flags are the risk factors or risk indicators that conditions for fraud exist 1)Risk factors: Opportunity -Ineffective monitoring of management -Assets susceptible to diversion -Financials are based on estimates that involve judgment or uncertainties difficult to corroborate -Unusual or highly complex transactions especially close to period end -Ineffective accounting, information and control systems -Absence of ethical business culture -Not paying enough attention -Deficiencies in internal control (Approval mechanism, IT controls, segregation of duties etc.) 2)Risk factors: Incentive -Personal financial obligations -Perceived or real adverse effects of reporting poor financial results -Personal financial situation is threatened by the entity s financial performance

3 -Excessive pressure to meet financial targets -Recurring negative cash flows while reporting profit -Personal benefit -Company pressure (aiming higher targets) 3)Risk factors: Rationalization Changes in behavior or lifestyle Communication of inappropriate values or ethical standards Non-financial management s excessive participation in the selection of accounting principles or the determination of significant estimates Excessive interest in maintaining or increasing the entity s stock price or earnings trend Failing to correcting known reportable conditions on a timely basis Not getting enough appreciation Need for an asset that exceeds company s need for the same asset Cues of Rationalization - Everyone else was doing it - They can afford it - I needed the money - It was just a loan I would have repaid it - I felt used and wanted revenge - I meant no harm and did no harm - I did it to keep the business afloat - Bribery is the norm in this type of business - What I did was entirely appropriate for someone in my position - My employer didn t compensate me well enough, so I took what was due to me

4 Importance of rationalization Rationalization cuts right to the heart of the psychology of the fraudster: the ability of fraudsters to convince themselves that what they are doing is acceptable enables otherwise good people to do stupid things A Guide To Forensic Accounting Investigation (Thomas W Golden) If you are above average intelligence you are at risk of perpetrating fraud because the strength of your cognitive equipment Why Smart People Do Dumb Things (Mortimer Feinberg and John J Tarrant) Some fraud Truths -Unlike their expectation most companies experience fraud -Most fraud goes undetected -Most frauds reveal some indicators that they are in progress -Most frauds start small and grow bigger -Most frauds involve a number of fraud schemes -Most people are capable of fraud fraudsters are not obvious -Most serious fraud is committed by management -Management fraud has the highest impact fraud Impact

5 Characteristics of a fraudster? How does this profile of the typical white collar criminal help you identify fraud? Older (30+ years) 55% male, 45% female Appearance of stable family Above average education Less likely to have criminal record Good psychological health Position of trust Detailed knowledge of accounting systems and weaknesses Prior accounting experience (Research by Michael L Belson and Elizabeth Moore) Can you spot a fraudster? There are two types of fraudster: Predators (less common) A professional deceiver - searches out opportunities to commit fraud Will seek to look normal as part of modus operandi Unconcerned about the harm caused Calm (most common) Find themselves in and take advantage of conditions conducive to fraud Acts normal except for abnormal circumstances Do not intend to cause harm Both look normal and so are difficult to identify

6 Working assumption All nice people are fraudsters* *Potentially Most Common Techniques in fraud Detection fraud Categories Corruption Conflict of Interest - Turnaround sale - Defective invoicing - Erasing receivables - Business Diversion - Resource Diversion

7 Bribe - Kick back - Bid-rigging Economic Extortion Illegal Gratuities Asset Misappropriation 1.Cash 2.Inventory and Other Assets Cash Misappropriation 1.Cash Theft 1.Theft of incoming cash 2.Theft form bank accounts 2.Fraudulent Disbursements 1.Register Disbursement Schemes (shell companies, innocent vendors and personal purchases) 2.Payroll Fraud (ghost employees, commission schemes, falsified salary) 3.Expense Reimbursement Schemes (mischaracterized expense reimbursements, overstated or fictitious expense reimbursements, multiple reimbursements) 4.Check Tampering 5.Expense Reimbursement Schemes from Petty Cash 3.Cash Skimming 1.Sales Skimming (unrecorded sales and understated sales) 2.Receivables Skimming (forcing account balances or destroying accounting records and lapping)

8 Asset Misappropriation: Inventory and Other Assets Misuse of inventory and other assets Theft of inventory and other assets o Asset transfers o Fraudulent bankruptcy o Falsifying incoming shipments o Undisguised larceny Distorted financial Statements Overstatement of Assets / Income Timing differences Overstated or fictitious income Understated expenses Improper asset valuations Improper disclosures Understatement of Assets / Income Other fraud Schemes (examples only) Long shore fraud Seemingly legitimate company established, collects customer monies then disappears Advanced fee fraud Fees collected on promise of services with no intention of delivery Insurance fraud Manipulating insurance claims Parallel business Running a private business using employer s time/resources Ponzi (pyramid/round robin) scheme Scheme that relies on new customers monies to repay earlier commitments but is in total not viable

9 Other Type of frauds Fraudulent Bankruptcy Tax Fraud Security Fraud Money Laundering Customer Frauds Computer and Internet Fraud Government Fraud Intellectual Property Fraud Insurance Fraud financial Institution fraud Embezzlement is the illegally transformation of others money for someone s own benefit Misuse is illegally using/directing others money for someone s own benefit Embezzlement Schemes False accounting entries Unauthorized withdrawal of money Unauthorized disbursement of funds to outsiders Paying personal expenses from bank funds Theft of physical property Moving money from customers dormant or inactive accounts Unauthorized, unrecorded cash payments Theft and other unauthorized use of collateral general Loan frauds Loans to nonexistent borrowers Sham loans with kickbacks and diversion

10 Double-pledging collateral Reciprocal loan arrangements Daisy chain Linked financing (large deposits are offered to a bank on the condition that loans are made to particular persons affiliated with deposit broker, generally the loans are longer term than the deposits) Construction Loans Most common 3 schemes are: Estimates of costs to complete (overstatement of costs), Developer overhead (used to bring forward the payment time) Non practice of contract in order to decrease costs Other than above we can call real estate, appraisal, ATM and letter of credit schemes. Money Laundering: What is it and how is it done? Money laundering: moving funds of illicit origin ( dirty money ); the ultimate objective is to disguise the illicit origin (create apparently clean money ) It is a much broader concept than fraud as it concerns monies from all illicit activities and not just fraud Whilst financial institutions are most at risk (as funds transfer is a core business) all businesses are at risk of involvement Basic Anti-Money Laundering ( AML ) Measures Limits and law enforcement reporting requirements on cash transactions More rigorous for susceptible cash businesses e.g, Casinos High value retailers Requirement to validate new customers bona fides ( Know Your Customer (KYC) )

11 Requirement for transaction monitoring (data analytics) of activities against expected behavioral norms based on KYC and historical transaction patterns Anti-fraud Program An effective anti-fraud program should include each of the following elements: The purpose of the code of ethics is to promote: Honest and ethical conduct Full, fair, accurate, timely, and understandable disclosure in reports and documents Prompt internal reporting of violations of the code formal fraud prevention policies should: Guide employees through complex issues Be specific to the individual organization and its operations Provide a channel for employees or third-parties to report fraud Communication andztraining should focus on: Educating employees on the organization s code of ethics Understanding protocols for reporting suspicious activity The purpose of the fraud risk assessment is to identify: Common types of fraud schemes that could occur within any organization Specific fraud schemes that are industry/sector-specific Fraud schemes that may be more prevalent in specific geographic locations

12 fraud Controls monitoring should: Develop action plans to improve fraud controls for priority fraud risks Assess, improve and monitor controls against general fraud risks Report the results of the action plans to executive management and/or the audit committee Effective fraud Response Plan: Investigation protocols Improve current fraud response plan Prepare systematic and disciplinary procedures Investigation Developing an Investigation Plan, Performance, Interview, Reporting, Following Up After Investigation Developing an investigation plan Understanding the operational flow Initial inquiries with operational units, High level documentation of processes, Identifying resources Auditing, Human Resources, Timeframe Developing the audit plan, Resource, inspection scope and methodology

13 Performance, Commitment to the engagement plan, Sharing unexpected findings, By setting periodic and instantaneous meetings with sponsor, findings that may cause difficulty for the client are to be shared Reassessment of Investigation Scope, In the light of new findings assessing the interim period scope level and allocation of resources and deadlines for the issues that will be added to the inspection scope Reassessing projected timeframe Commitment to Auditing Principles and Feedback, All auditors should get frequent feedbacks from the engagement leader regarding the principles set at the beginning of the engagement, Secrecy Result oriented work Material findings Efficiency of documentation are some of the principles that auditors should not deviate from Generally Accepted Auditing Standards. Finding: Physical facts that have not gained legal property yet Evidence: Evidence is the total of physical findings and documents needed to substantiate a thesis Evidence is any finding and proof that is legally unprohibited to substitute and that causes to solve a legal issue, to prove a crime act and determine the crime suspects Every evidence is a finding but every finding is not an evidence For instance, presence of gunpowder gas in a crime place is a finding but it is not an evidence until it is measured with a gas emission equipment and the measurement is properly registered and documented Non-evidence findings, Recordings without permission cannot be used as evidence (Turkish Criminal Code)

14 For example: Phone recordings, Recordings with secret cameras Personal notes and writings, Electronic mails gathered from the person s work computer unless it is permitted in the job contract, Copies of documents, Oral statements Important Issues, It is essential to protect the evidence due to loss and fraudulent alteration risks Copies should be made as soon as the original evidence is acquired Signatures on the documents that are considered as evidence should be subject to eye examinati on with comparison to the book of authorized signatures. In case of any objection, related documents and signature specimen should be sent to Forensic Science Lab for further analysis Interview, To understand the documentation process, timing and causality, it is needed to have an inter view with an employee that is knowledgeable about the related transaction Interviews are the planned meetings preferable made face to face Most crucial aspect of a good interview is to gather the relevant information from the interviewed person within the shortest timeframe Important properties of a good interview -Effective planning -Effective interview -Listening techniques -Effective communication management Interviews can be classified as the ones made with the witnesses and the ones made with the suspects. The aim is to gather information in the former while the real aim is to get the confession in the latter.

15 Differences between the two types of interviews mentioned above. Suspects tendency is generally to hide information and not to confess. Hence, they are likely to give false statements to the inquirer and due to this reason to get successful results a more effective inquiry technique is needed. Inquirers need to direct the suspect to make valid statements regarding the crime. Types of Questions Comprehensive open ended questions Would you tell us what were mentioned during the meetings? Focused open ended questions What did Mr. Ahmet mention during the meeting? Open ended investigation questions Who decided to pay to Mr. Mehmet during the meeting? Close ended investigation questions Hence it is Mr. Ahmet who offered to pay to Mr. Mehmet isn t it? Approval questions As far as I understand you heard Mr. Ahmet saying Give Mr. Mehmet some money, did I get that correct? Completeness affirmation Is there anything else about this subject that you would like to add before we continue with another subject? Reporting, Issues Regarding Effective Reporting: Material Findings, Finding the Effective Expression Method, Chronological Expression, Thematic Expression, Findings and Suggestions,

16 Efficient usage of visuals, Confirmation of the presence of all findings in working papers to be forwarded to the end reports Material findings, All issues in the reports should be supported by material documents Evidence should be noted if they could not be confirmed with regards to the oral statements Report should be free of any personal experience and subjectivity Each and every number in the report should match with supporting documents and other numbers in the report. If there is any deviance this issue should be stated in the report finding the Effective Expression Method, Chronological Expression Should be used for one-dimensional investigations (i.e. unfair promotion of someone, presence of a fraudulent transaction and disputation of the results, etc.) Should be used when the chronological order of transactions is important for the investigation (i.e. emergence of a tax related punishment) Thematic Expression To express complicated and multi issued cases, subject should be separated into simple parts (i.e. Cash theft and embezzlement of client properties by an employee, inadequate control of firm processes, etc.) Deficiencies about different issues should be consolidated in the report under the part Management Summary. In this summary only the subjects that are expressed in detail in the report should take place. findings and Suggestions This type of expression should be used when end findings and suggestions point the results.(i.e. Due to lack of control, acceptance of a high amount invoice by the accounting department) Can be used with both chorological and thematic expression (Chronological Progress + Findings and Suggestions) Findings and suggestions should be corresponding and cognizable to the reported parties.

17 Efficient Usage of visuals, Report Visuals (Tables, graphs, charts, flow charts etc.) Should support the end result, Should express the opinion at a glance to the reported party, Should be consistent, Should not deviate from the core aim of the report. Assuring the transfer of all findings in working papers to the end report All working papers would be related to engagement plan. All working papers should be examined to make sure that all findings are transferred to the report in a correct and precise manner Issues that are open to comment in the working papers whould be noted in the report (i.e. To the letter we sent for account reconciliation, 2 banks haven t replied as of report date) following up the investigation, Following up the elimination of flaws Elimination of findings that are mentioned in Findings/Suggestions report should be documented by the client in writing. An affirmative visit should be scheduled after a reasonable time For the flaws due to lack of information related personnel should be encouraged to participate in related education When material damage is found, Should proceed to legal counselor in the light of material findings and evidence A copy of the report should be directed to the court with a summarized cover letter prepared by the legal counselor When needed the summary of the report should be expressed as a witness during the court by the auditor