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FRAUD RISK

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Andrea St.Rose, LLB(Hons), FCIS,CFE,MBA,CGA,CA. Bay Gardens Hotel JUNE 22, 2007 ... FRAUD RISK & THE AUDIT COMMITTEE. 1. The ... Why Fraud is commited: ... – PowerPoint PPT presentation

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Title: FRAUD RISK


1
FRAUD RISK THE AUDIT COMMITTEE
  • Presented by
  • Andrea St.Rose, LLB(Hons), FCIS,CFE,MBA,CGA,CA

Bay Gardens Hotel JUNE 22, 2007
2
FRAUD RISK THE AUDIT COMMITTEE
Agenda
1. The Internal Audit Function
2. Risk Management and Internal Audit
3. Fraud An Overview
4. Categories of Occupational Fraud and Abuse
3
FRAUD RISK THE AUDIT COMMITTEE
Agenda
5. Fraud Red Flags
6. Fraud Prevention Programs
7. ACFE s Annual Fraud Check Up
8. Conclusion
4
FRAUD RISK THE AUDIT COMMITTEE
Agenda
9. Case Studies in Detection and Prevention
10. ACFEs Annual Fraud Check Up
11. Wrap up Questions and Answers
5
FRAUD RISK THE AUDIT COMMITTEE
  • THE INTERNAL AUDIT FUNCTION

6
Fraud Risk The Audit Committee
  • What is Internal Audit?
  • Internal Audit is an independent, objective,
    assurance and consulting activity designed to add
    value and improve the operations of an
    organization. ( The IIA)

7
FRAUD RISK THE AUDIT COMMITTEE
  • How is value added?
  • Conducts risk-based reviews of an organizations
    business activities providing assessments and
    comments on risk management techniques/ internal
    controls and governance processes.
  • Works consultatively with management to ensure
    risk management issues are addressed.
  • Provides constructive recommendations.

8
Risk Management and Internal Audit
  • The Institute of Internal Auditors
  • ECCB Guidelines
  • Sarbanes-Oxley Act - USA

9
Risk Management and Internal Audit
  • The IIA
  • IIA Performance Standard 2100
  • The internal audit activity should evaluate
    and contribute to the improvement of risk
    management, control and governance processes
    using a systematic and discipines approach (
    Source The IIA).

10
Risk Management and Internal Audit
  • The IIA
  • IIA Performance Standard 2110
  • The Internal Audit activity should assist the
    organisation by identifying and evaluating
    significant exposures to risk.
  • (Source The IIA)

11
Risk Management and Internal Audit
  • ECCB - Guidelines For Internal Auditing of
    Institutions Licensed Under The Banking Act
    (Sec.7.0)
  • An Internal Audit function in the financial
    institution assists management in evaluating and
    improving the risk management, control and
    governance systems.
  • (Source ECCB)

12
Risk Management and Internal Audit
  • RISK Management
  • Decisions to accept exposure or to reduce
    vulnerabilities by either mitigating the risks or
    applying cost effective controls.(Source
    www.utmb.edu/is/security/glossary.htm )

13
Risk Management and Internal Audit
  • What are some of the vulnerabilities that an
    organisation faces?
  • Business Continuity
  • Liquidity Risk
  • Market Risk
  • Fraud Risk

14
Risk Management and Internal Audit
  • Legislation/ Standards Fraud Risk
  • IIA
  • ISA
  • SOX

15
Risk Management and Internal Audit
  • The IIA Standards and Fraud Risk
  • Sec 1210.A.2
  • The internal auditor should have sufficient
    knowledge to identify the indicators of fraud but
    is not expected to have the expertise of a person
    whose primary responsibility is detecting and
    investigating fraud. (Source The IIA)

16
Risk Management and Internal Audit
  • Standard External Auditors Report
  • Managements Responsibilities ( paragraph)
  • this responsibilities include
    designing,implementing,and maintaining internal
    control relevant to the preparation and fair
    presentation of financial statements that are
    free from material misstatement, whether due to
    FRAUD or ERROR.

17
Risk Management and Internal Audit
  • Sarbanes Oxley Act ( USA)
  • Section 404
  • As a deterrence to fraudulent financial
    reporting, the Act requires CFO and CEO of public
    companies to personally certify their quarterly
    and annual Sec filings.

18
FRAUD AN OVERVIEW
  • What is it?
  • Why is it committed?

19
FRAUD AN OVERIEW
  • FRAUD What is it?
  • There are 4 basic elements
  • A false representation of a material nature.
  • Knowledge that the representation is false
  • Reliance the person receiving the represenation
    reasonably relied on it.
  • Damages financial, resulting from above .
  • (source A Guide to Forensic Investigation
    Golden,Skalak and Clayton)

20
FRAUD AN OVERVIEW
  • Why Fraud is commited
  • Trusted persons become trust violators when they
    conceive of themselves as having a financial
    problem which is nonsharable, are aware that this
    problem can be secretely resolved by violation of
    the position of financial trust and are able to
    apply their own conduct in that
    situation,(Cressey)

21
FRAUD AN OVERVIEW
  • Nonshareable Problems
  • Inability to meet debt obligations
  • Bad judgement resulting in losses
  • Status Ambitions contd associations
  • Relations with Employer working conditions etc.
  • Drug abuse

22
THE FRAUD TRIANGLE
  • Hypothesis The Fraud Triangle
  • Opportunity
  • Pressure Rationalization

23
THE FRAUD TRIANGLE
  • Pressure
  • Opportunity
  • Rationalisation

24
CATEGORIES OF OCCUPATIONAL FRAUD AND ABUSE
  • Asset misappropriation
  • Fraudulent statements
  • Corruption

25
ASSET MISAPPROPRIATION
  • According to ACFE in its 2006 report to the
    Nation
  • Asset Misappropriation- Any scheme that
    involves the theft or misuse of an organizations
    assets. e.g. payroll fraud

26
ASSET MISAPPROPRIATION
  • Most common form of fraud
  • Target cash, cheques, money orders (87 of
    reported cases in 2006)
  • Non cash 23 of reported cases in 2006

27
ASSET MISAPPROPRIATION
  • CASH
  • Larcency cash stolen after recorded
  • Skimming cash stolen before recorded
  • Fraudulent disbursements non bona fide payments
  • Other Assets
  • Misuse
  • Larcency outright stealing e.g theft of
    inventory

28
CATEGORIES OF OCCUPATIONAL FRAUD AND ABUSE
  • Fraudulent statements

29
FRAUDULENT FINANCIAL STATEMENTS
  • What happened at Enron?
  • Creation of SPEs to hide losses
  • Questionable accounting treatments

30
FRAUDULENT STATEMENTS
  • What is it?
  • How detected?
  • How prevented?

31
FRAUDULENT STATEMENTS
  • Manipulation of financial statements
  • Overstatement of revenues
  • Understatement of expenses/ liabilities
  • Timing differences
  • Asset valuations
  • Non disclosure of material transactions

32
FRAUDULENT STATEMENTS
  • DETECTION
  • Disgruntled Employee
  • Employee Hot Line
  • Internal Audit
  • External Audit

33
FRAUDULENT STATEMENTS
  • HOW CAN WE PREVENT?

34
FRAUDULENT STATEMENTS
  • PREVENTION
  • Apply the Fraud Triangle
  • Reduce Pressures - How?
  • Reduce Opportunities How?
  • Reduce rationalisation - How?

35
FRAUDULENT STATEMENTS
  • REDUCE PRESSURES
  • Tone at the top organisation
  • Set realistic targets
  • Pay system - fair
  • Performance Systems
  • Reduce pressure from stock brokers

36
FRAUDULENT STATEMENTS
  • REDUCE OPPORTUNITIES
  • Background checks for prospective employees
  • KYE
  • Proper system Internal Controls
  • Segregation of incompatible duties
  • Physical security for assets
  • Procedures manual clear
  • Accounting policies and procedures clear
  • Monitoring Controls internal audit
  • Protect whistleblowers
  • Job rotation vacation policy

37
FRAUDULENT STATEMENTS
  • REDUCE RATIONALIZATION
  • Code of Conduct clearly communicated
  • Communication of Values Zero tolerance
  • Clear communication regarding non compliance with
    accounting polices/procedures
  • Promote Integrity throughout the organisation
  • Training

38
FRAUDULENT STATEMENTS
  • DETECTION
  • Financial Statement Analysis
  • Ratio Analysis
  • Trend Analysis
  • Horizontal Analysis yr to yr
  • Vertical Analysis analyzing relationships
  • Surprise Audits

39
FRAUDULENT STATEMENTS
  • RED FLAGS
  • Weak internal control environment
  • Unsupported adjusting journal entries near end
    of financial period
  • Missing support for disbursements/purchases
  • Forgery of supporting documentation
  • No background checks performed for employees
  • Bonuses tied to profitability

40
CATEGORIES OF OCCUPATIONAL FRAUD AND ABUSE
  • CORRUPTION

41
CORRUPTION
  • Corruption Any scheme in which a person uses
    his or her influence in a business transaction to
    obtain an unauthorised benefit contrary to that
    persons duty to his employer (source ACFE 2006
    Report to the Nation)

42
CORRUPTION
  • Conflicts of interest most common
  • Bribery
  • Illegal gratuties
  • Extortion

43
CORRUPTION
  • Conflicts of interest
  • Employee or executive has not disclosed an
    interest in a transaction that negatively impacts
    on the entity.
  • e.g. Employee A, the purchasing manager of
    Company B enters into a contract with Company C,
    however Company C is owned by Employee A. The
    costs incurred are 10 per cent above market rates.

44
CORRUPTION
  • BRIBERY
  • Usually takes the form of a gift/kickback which
    is geared at influencing a party the employer
    has not consented. Includes Offers.
  • e.g. Employee A disloses to Company B that the
    terms of a contract out for tender will change.
    Company B submits a low bid, gets the contract.
    Variation orders submitted eventually increase
    the cost of the contract. Company B pays 5,000
    to employee As Offshore Bank account for
    awarding the contract.

45
CORRUPTION
  • ILLEGAL GRATUTIES
  • The giving of a gift as a result of securing a
    favourable business decision the principal has
    no knowledge.
  • Company A offers an all expenses paid vacation to
    Loan Officer B of IntL Bank C. Company A is a
    delinquent debtor of the Bank.

46
CORRUPTION
  • EXTORTION
  • The coercion of another to enter into a
    transaction or deliver property based on
    wrongfuluse of actual or threatened force, fear
    or economic duress (source ACFE)
  • Company A, a large company is the major purchaser
    of furniture manufactured by B, a sole
    proprietor. Purchasing manager Peter indicates
    that quality is poor and the company will
    discontinue purchases unless B hires a Quality
    consultant who happens to be Peters Mistress.

47
CORRUPTION
  • DETECTION - BRIBERY
  • General purchasing
  • Prebid solicitation
  • Bid Solicitation
  • Bid or Contract Acceptance
  • Behaviour profile of recipient
  • ( source Corporate Fraud Handbook J.T. Wells
    -299)

48
CORRUPTION
  • PREVENTION - BRIBERY
  • Bribery prevention policy
  • Gift Acceptance Policy
  • Entertainment Policy
  • (Source Corporate Fraud Handbook J.T.Wells 302)

49
CORRUPTION
  • DETECTON - CONFLICT OF INTEREST
  • Tips and complaints
  • Comparison of Vendor addresses with employee
    addresses
  • Vendor ownership review
  • Interview Purchasing Staff

50
CORRUPTION
  • PREVENTION Conflicts of interests
  • Annual disclosures
  • Independence Statements
  • Vendor Right to Audit Clauses
  • Code of Ethics clearly communicated

51
FRAUD RED FLAGS
  • Fraud against the organisation
  • Fraudulent financial statements

52
FRAUD RED FLAGS FRAUD AGAINST ORGANISATION
  • Major Signs
  • Inconsistencies in financial reports
  • Lifestyles that are not in keeping with income
    levels
  • Unwarranted organisational structure e.g.
    outsourcing arrangements
  • Unusually large dollar value of transactions
  • Significant amount of large cash transactions
  • Discontinued control structure expanded span of
    control reduced chain of command

53
FRAUD AGAINST THE ORGANISATION RED FLAGS
  • KPMG
  • Personal financial pressure
  • Vices such as drug abuse
  • Grievances against the company
  • Internal budgetary pressures
  • Short vacations
  • Extravagent life styles

54
FRAUD RED FLAGS- FRAUDULENT STATEMENTS
  • RED FLAGS
  • Weak internal control environment
  • Unsupported adjusting journal entries near end
    of financial period
  • Missing support for disbursements/purchases
  • Forgery of supporting documentation
  • No background checks performed for employees
  • Bonuses tied to profitability

55
Detecting Occupational Fraud
  • 20 increase in detection by Internal Control
  • 27 increase in detection by Internal Audit

Data obtained from Association of Certified Fraud
Examiners 2004 Report to the Nation
56
Detecting Fraud in Small Business
1
2
  • Detection of Fraud by Small Business
  • 28 fewer frauds detected by Internal Audit
  • 24 fewer frauds detected by Internal Controls

Data obtained from Association of Certified Fraud
Examiners 2004 Report to the Nation
57
FRAUD PREVENTION PROGRAMS
  • Code of Business Ethics
  • Fraud Policy
  • Compliance Programs

58
CODE OF BUSINESS ETHICS CONDUCT
  • Covers
  • Compliance with Laws and Regulations
  • Conflict of Interest
  • Gifts and Entertainment
  • Treatment of Confidential Information
  • Employee Conduct
  • Reporting Violations
  • Discipline
  • Compliance Letter

59
FRAUD POLICY
  • COVERS
  • Scope any irregularity
  • Responsibility Mgmt
  • Actions Constituting Fraud
  • Investigation Responsibilities
  • Confidentiality of Info Received

60
FRAUD POLICY
  • Contd
  • Authorization for Investigating Suspected Fraud
  • Reporting Procedures
  • Termination Procedures
  • Administration of Policy

61
COMPLIANCE PROGRAMS
  • Covers
  • Scope and Implementation
  • Standards of Conduct
  • Role of Compliance Coordinator
  • Communications of Standards and Procedures to
    Employees
  • Monitoring, Auditing and Reporting
  • Role of the Board

62
ACFE FRAUD PREVENTION CHECK UP
  • ACFE FRAUD PREVENTION CHECK UP

63
FRAUD PREVENTION CHECK UP
  • What is the Check up about?
  • Uses a questionnaire to identify gaps in an
    entitys fraud prevention processes indicated
    by low scores.
  • There is no passing grade other than 100 per cent

64
ACFE FRAUD PREVENTION CHECK UP
  • WHAT DOES IT COVER?
  • Fraud Risk Oversight
  • Fraud Risk Ownership
  • Fraud Risk assessment
  • Fraud Risk Tolerance and risk management policy
  • Process Anti-fraud controls
  • Environment level anti fraud controls
  • Proactive Fraud detection processes

65
ACFE FRAUD PREVENTION CHECK UP
  • WHO SHOULD COMPLETE THE QUESTIONNAIRE?
  • Collaboration between A Fraud Specialist e.g.
    CFE, and those within the organisation with
    extensive knowledge about its operations

66
Closing Remarks
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