7 keys to fraud prevention

7 Keys to Fraud Prevention and Detection

Ron Steinkamp, CPA, CIA, CFE, CRMA, CGMA314.983.1382rsteinkamp@bswllc.com

6 CityPlace Drive, Suite 900 │ St. Louis, Missouri 63141 │ 314.983.1200 1.888.279.2792 │ www.bswllc.com

Session Benefits

What is Occupational Fraud

2014 ACFE Global Fraud Study

Red Flags

7 Keys

Fraud Self Assessment

Code of Conduct

What is Occupational Fraud?

The use of one’s occupation for personal enrichment through the deliberate misuse or application of the employing organization’s resources or assets.

Three general categories:

Asset misappropriation

Corruption

Financial statement fraud

Definition

Employee steals or misuses an organization’s assets/resources.

- Examples:• Skimming cash receipts.• Falsifying voids and refunds.• Tampering with company checks.• Overstating expenses.• Creating a ghost employee.• Creating a fictitious vendor and false invoice.

Asset Misappropriation

Employee’s use of his/her influence in business transactions in a way that violates his/her duty to the employer for the purpose of obtaining benefit for him/herself or someone else.

- Examples:• Conflicts of interest.• Illegal gratuities.• Bribery.

Corruption

Intentional misstatement or omission of material information in the organization’s financial reports with the intent to mislead.

- Examples:• Inflating revenues on the financials to show greater profit.• Concealing liabilities.• Forcing actual expenditures to match budget by moving

expenses between accounts.• Improperly accounting for revenues and expenditures.

Financial Statement Fraud

2014 ACFE Global Fraud StudyReport to the Nations on Occupational

Fraud and Abuse

Summary of Findings

1. Typical organization loses 5% of annual revenue to fraud – applied to 2013 Gross

World Product translates to potential fraud loss of more than $3.7 trillion annually.

2. Median loss in the study was $145,000 with more than 22% of the cases involving

losses over $1 million.

3. Fraud lasted a median of 18 months.

4. Asset misappropriation schemes (fraudulent disbursements, theft of cash receipts,

other asset misappropriations) were the most common form of fraud, representing

85% of the cases and least costly at a median loss of $130,000.

5. Financial statement fraud schemes were the least common form of fraud,

representing 9% of the cases and most costly at a median loss at $1 million.

Summary of Findings

6. Corruption schemes fell in the middle, comprising just over 37% of cases and

causing a median loss of $200,000.

7. Occupational frauds are most likely to be detected by tips (40%) followed by

management review (15%) and Internal Audit (14%).

8. Small organizations are disproportionately victimized by occupational fraud.

9. Government/public administration was one of the most commonly

victimized industries.

10. Anti-fraud controls appear to help reduce the cost and duration of occupational

fraud schemes.

11. High-level perpetrators cause the greatest damage to their organizations.

Summary of Findings

12. 77% of frauds were committed by individuals in one of six departments:• Accounting• Operations• Sales• Executive/upper management• Customer service• Purchasing• Finance

13. More than 85% of fraudsters had never been previously charged or convicted for

a fraud-related offense.

14. Fraud perpetrators often display warning signs – most common behavioral red

flag reported in the survey were perpetrators living beyond their means (36%)

and experiencing financial difficulty (27%).

15. Nearly half of victim organizations do not recover any losses that they suffer due

to fraud.

How are Frauds Detected?

Source of Tips

Conclusions and Recommendations

• Occupational fraud is a universal problem – trends in fraud schemes, perpetrator characteristics and anti-fraud controls are similar regardless of where the fraud occurred.

• The longer frauds last, the more financial damage they cause. Proactive detection methods – hotlines, management review procedures, internal audits, employee monitoring mechanisms – are vital in catching frauds early and limiting losses.

• Small businesses/organizations are disproportionately victimized by fraud and under protected by anti-fraud controls.

• External financial audits are among the least effective controls in combating fraud – primary detection method of fraud in 3% of cases versus 7% of cases detected by accident.

• Many of the most effective anti-fraud controls are being overlooked – data monitoring and analysis, surprise audits, fraud risk assessment.

• Majority of fraudsters are first-time offenders – don’t over rely on background checks.

Red Flags

The Fraud Triangle

Pressure “Red Flags”

• High personal debts.

• Living beyond their means.

• Excessive investment speculation.

• Excessive gambling.

• Substance abuse.

• Extra-marital affairs.

• Job frustration.

• Resentment of superiors.

Opportunity “Red Flags”

• Inadequate internal controls.

• Too “cozy” with suppliers.

• Annual vacation or sick days not taken.

• Weak management or excessive turnover.

• Ineffective or no internal audit.

• No rotation of job duties among employees.

• Procedures not well understood/always in crisis mode.

• Large amounts of cash on hand or processed.

Rationalization “Red Flags”

• Not compensated fairly.

• No recent raises/cost of living adjustments.

• Everyone else does it.

• Intended to pay it back.

• Needed the money.

• Felt cheated and wanted revenge.

• Bribe/kickback to tempting.

7 Keys

Anti-Fraud Culture

Fraud Policy

Fraud Awareness/Training

HotlineAssess Fraud Risks

Review/Investigation

Improved Controls

• Set the tone at the top = Lead by Example– Responsibility of elected officials and City management– Behave ethically and openly communicate expectations to

employees– Treat all employees equally– Zero tolerance

• Create a positive workplace environment– Focus on employee morale– Empower employees– Communicate

• Hire and promote appropriate employees– Conduct background investigations before hiring or promoting– Check candidate’s education, employment history, references– Continuous and objective evaluation of compliance with entity

values– Violations addressed immediately

Client Logo

1. Anti-Fraud Culture

• Code of Conduct– Formalized and founded on integrity– Defines acceptable employee behavior– Communicated to all employees– All employees are held accountable for compliance

• Discipline– Sends a strong message throughout the entity– Should be appropriate and consistent– Consequences of committing fraud clearly communicated

throughout the entity

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• Oversight Process– City Council/Elected Officials

• Evaluate management’s “tone at the top”, identification of fraud risks and implementation of anti-fraud controls

• Ensure that management implements anti-fraud measures• Consider the potential for management override of controls

– Management• Directs, implements and monitors anti-fraud controls• Sets the ethical tone• Trains employees

– Internal Auditor (if available)• Identifies fraud indicators• Assesses fraud risks• Evaluates anti-fraud controls• Recommends actions to mitigate risks• Investigates potential frauds

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• Demonstrate commitment to combating fraud

• Apply to all Elected officials, City management, employees, consultants, vendors, contractors, etc.

• Should include:– Statement of organization’s position on fraud– Scope of the policy – who does it apply to– Management’s responsibility for prevention and detection of

fraud– Definition of fraud– Actions constituting fraud– Fraud reporting process/procedures– Fraud investigation process/procedures– Unit responsible for administration of the policy and

investigating fraud allegations– Statement on anonymity/confidentiality– Consequences

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2. Fraud Policy

• Reviewed and updated regularly.

• Signed off and agreed to by the City Council/Mayor.

• See the ACFE for an example Fraud Policy http://www.acfe.com/uploadedFiles/ACFE_Website/Content/documents/Sample_Fraud_Policy.pdf

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2. Fraud Policy

• All new employees should be trained at time of hiring on the Code of Conduct and Fraud Policy.

• Training should include:– Their duty to communicate certain matters– A list of the types of matters to be communicated along with

examples– How to communicate those matters– Affirmation from senior management regarding employee

expectations and communication responsibilities

• Refresher training periodically

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3. Fraud Awareness/Training

• Enable employees, vendors, customers and others to communicate concerns about known or suspected wrongdoing.

• Telephone, email, internet.

• Anonymous.

• Adequately publicized.

• Internal or External.

• Complaint monitoring and investigation/resolution.

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4. Hotline

• Conduct an annual fraud risk assessment.– Assists management in systematically identifying where and how

fraud may occur and who may be in a position to commit fraud

– Focus on fraud schemes and scenarios to determine the presence of internal controls and whether or not the controls can be circumvented.

– General steps:• Identify areas and processes to assess• Identify potential fraud schemes in each area/process• Assess likelihood and significant of each scheme• Map existing anti-fraud controls to potential fraud schemes• Test operating effectiveness of antifraud controls• Identify any control gaps and/or deficiencies = Residual risks• Document and report on the fraud risk assessment

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5. Assess Fraud Risks

• Mitigate Fraud Risks– Make changes to activities and/or processes = transfer or eliminate

the risks– Improve anti-fraud controls

• Monitor Fraud Risks– Develop data analytics for management to use to monitor fraud risks– Utilize Internal Audit to conduct audits of risk areas.

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5. Assess Fraud Risks

• All concerns/suspicions of wrongdoing should be reviewed and determination made whether a fraud investigation is warranted.

• Develop a policy for fraud reviews and investigations that specifies:– Who is responsible for the review/investigation– Roles of Legal Counsel, Human Resources, Internal Audit, others– Process for conducting the review/investigation– Documentation requirements– Reporting requirements– When to involve law enforcement

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6. Fraud Review/Investigation

• Gather sufficient information and perform procedures necessary to determine:– Whether fraud has occurred– Loss or exposure associated with the fraud– Who was involved and how it happened

• Must prepare, document and preserve evidence sufficient for potential legal proceedings.

• Include experts = Certified Fraud Examiner (CFE)

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6. Fraud Review/Investigation

• Use lessons learned from any fraud reviews or investigations to improve anti-fraud controls.

• All fraud review and investigations should include a report to management with recommendations for control improvement.

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7. Improved Controls

1. Separation of duties 2. Documentation 3. Authorization and

approval 4. Security of assets 5. Reconciliation and review

Top 10 Governmental Internal Controls

6. Policies and procedures 7. Fraud Policy and reporting8. Access to systems9. Physical control10. Verification (i.e. pre-

employment)

To ensure proper stewardship of public funds:

Fraud Self Assessment

Code of Conduct

Ron Steinkamp, CPA, CIA, CFE, CRMA, CGMA

Principal, Risk Advisory Services

Brown Smith Wallace LLC

314.983.1238 (Direct)

rsteinkamp@bswllc.com

Contact Information

7 keys to fraud prevention

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