Fraud Prevention Awareness for Managers

1
Fraud Prevention Awareness for Managers

• Sponsored by
• The Department of Administration
• Risk Management and Tort Defense Division
• The Office of Budget and Program Planning

2
Outline

• Why People Commit Fraud.
• Profile of the White Collar Criminal.
• Types of Frauds Found in Government.
• Interesting Fraud Facts.
• What to Watch for and Why!!

3
Introduction
The term fraud may be defined as
Any means by which one or more people
intentionally make a false representation of a
material fact which is acted on by another party
to that partys detriment.
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Elements of Fraud

• A material false statement.
• Knowledge that the statement was false when it
  was uttered.
• Reliance on the false statement by the victim.
• Damages resulting from the victims reliance on
  the false statement.
• Hard to prove intent!!

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Occupational Fraud and Abuse
Asset Misappropriations
Corruption
Fraudulent Statements
Conflicts of Interest
Cash
Financial
Bribery
Inventory All Other Assets
Nonfinancial
Illegal Gratuities
Economic Extortion
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Unknown

• Fraud prevention and detection is like a
  mortals need for air. When its present, its
  never noticed. When its missing, its all
  thats noticed.

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My Favorite Quote

• Fraud Looks a Lot Like Stupid.

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Prevention VS Detection

• An ounce of prevention is better than a ton off
  treatment.
• In order to prevent fraud there is a need to
  understand what fraud is and how to prevent minor
  frauds from becoming major frauds.

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Know Thy Fraudster

• What fraud perpetrators do.
• They dont play by the rules
• (1) Ignore internal controls.
• (2) Compromise internal controls.

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The Circle/Square Concept

• Circle Anti-Fraud procedures.
• Square What employees really do.

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Caution Controls Do Not

• Guarantee fraud will not occur.
• Guarantee errors will not occur.
• Guarantee management will abide by controls.
• Guarantee fraud will be detected.
• Guarantee errors will be detected.
• Guarantee collusion will not occur.
• Guarantee staff will follow controls.

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Effects of Decreased Funding

• Less money available for certain programs.
• Less money available to perform routine audits.
• More opportunity to commit fraud.
• Fraudsters become more confident.

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I. Why People Commit Fraud

• 3 Reasons???

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Opportunity
Fraud Triangle
Pressure
Rationalization
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Opportunity

• Lack of or weak internal controls.
• Lack of understanding.
• Collusion
• Change

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Pressure

• Financial
• Employment
• Vices
• Unexpected events

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Rationalization

• Belief that internal controls wont detect them.
• Non-physical
• They deserve it.
• Its small, nobody will notice.
• Ill pay it back later.
• Everybody does it.

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Stand Up if You Are

• Over 40 years old.
• Been working for your employer between 6 and 10
  year.
• Are in a management position.
• Are a male.
• Have a bachelors degree.
• Married
• Never been charged or convicted.

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Good News

• The Profile is Changing

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Profiles of Fraud Perpetrators

• Less likely to be caught or turned in to law
  enforcement.
• Less likely to serve long sentences.
• Fraud perpetrators are older than normal prison
  population.
• Better educated.

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Profiles of Fraud Perpetrators

• What is different about fraud perpetrators vs.
  college students?
• More dishonest
• More independent
• More sexually mature
• More socially deviant
• Perpetrators are like us. They appear normal.

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Unusual Behaviors

• Unusual behaviors could include
• Compulsive behaviors such as alcohol abuse,
  legal/illegal gambling and drugs.
• Unusual irritability, insomnia, inability to
  relax, fear of getting caught.
• Defensiveness, argumentativeness, embarrassment
  around co-workers.

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• T H E E F F E C T O F P O S I T I O N
• One of the strongest indicators of the size of
  the loss in an occupational fraud scheme is the
  employees position.
• As the above data shows, schemes committed by
  managers/executives, on average, cause median
  losses of 250,000 WHY?

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T H E E F F E C T O F G E N D E R The
following chart reflects the relative frequency
and median losses for males and females. Losses
from schemes committed by males were more than
three times as high as the losses caused by
females.
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T H E E F F E C T O F A G E There is a direct
correlation between age and median loss. Median
losses for the oldest employees (those older than
60) were 500,000, which was 27 times higher than
losses caused by employees under 26 years of age.
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T H E E F F E C T O F E D U C A T I O
N Losses caused by perpetrators who had college
degrees were about 3.5 times as high as losses
caused by perpetrators with only high school
diplomas.
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C R I M I N A L H I S T O R Y O F P E R P E T
R A T O R S The following chart shows that only
about seven percent of occupational fraud
perpetrators were known to have been convicted
for a previous crime.
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III. Types of Fraud in Govt.

• Bribery Corruption
• Fictitious Disbursements
• 90 of all Frauds involve corruption or
  misappropriations!
• Corruption, i.e., fraud committed in the form of
  kickbacks, gifts, or gratuities, cost employers
  20 billion dollars per year.

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Bribery Corruption

• Commercial Bribery
• Illegal Gratuity
• Economic Extortion
• Conflicts of Interest

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Commercial Bribery

• Giving or receiving (or offering or soliciting).
• Any thing of value.
• To influence
• A business decision.
• Without the employers knowledge and consent.

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Illegal Gratuity

• Giving or receiving (or offering or soliciting).
• Any thing of value.
• For or because of
• An official act.
• An illegal gratuity is a lesser included offense
  of bribery.

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Elements of Corruption

• Economic extortion
• Conflicts of interest

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Economic Extortion

• A demand of payment by the recipient.
• To refrain from discriminating against
• A business decision.

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Conflict of Interest

• An agent taking an interest in a transaction.
• Which is actually or potentially adverse to the
  interest of the principal.
• Without disclosure to the principal.

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Conflicts of Interest

• Has an undisclosed financial interest in a
  transaction which has actual or potentially
  adverse ramifications for their employer.
• Sets up a bogus contractor or vendor or buys
  through a broker or middleman that the employee
  controls.
• Is involved in other business ventures with a
  supplier or contractor.
• Has an interest in a business that competes with
  his or her employer.
• Accepts inappropriate gifts, travel,
  entertainment, or fees (kickbacks) from a
  vendor.
• Negotiates for or accepts employment with a
  supplier.

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Red Flags of Conflict of Interest

• Unexplained or unusual favoritism of particular
  contractor or vendor, e.g.
• Payment of unjustified high prices.
• Purchase of unnecessary or inappropriate goods or
  services.
• Continued acceptance of high priced, low quality
  work.

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Red Flags of Conflict of Interest

• Contracting or purchasing employee lives beyond
  means.
• Contracting employee fails to file Conflict of
  Interest or Financial Disclosure Forms.
• Keen interest by the contracting employee in a
  particular vendor.
• Employee declines promotions from a procurement
  position.

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Red Flags of Conflict of Interest

• Close socialization and inappropriate gifts.
• Contracting employee appears to conduct side
  business.

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Red Flags of Conflict of Interest

• Vendor EIN matches employee SSN.
• Vendor address is incomplete.
• Vendor address is a mail drop.

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Methods of Making Illegal Payments

• Gifts, travel, and entertainment.
• Cash payments.
• Checks and other financial instruments.
• Hidden interests.
• Other methods.

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Gifts, Travel, and Entertainment

• Wine and liquor (consumables).
• Clothes and jewelry for the recipient or spouse.
• Sexual favors.
• Lavish entertainment.
• Paid vacations.

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Gifts, Travel, and Entertainment

• Free transportation on corporate jets.
• Free use of resort facilities.
• Gifts of the bribers inventory or services, such
  as construction of home improvements by a
  contractor.

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Cash Payments

• The next step is usually cash payments.
• Cash is not practical if large sums are required.
  
• The use of currency in major transactions may
  itself be incriminating.

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Checks and Other Financial Instruments

• As the scheme grows, illicit payments are often
  made by normal business check, cashiers check or
  wire transfer.

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Hidden Interests

• In the latter stages of sophisticated schemes,
  the payer may give a hidden interest in a joint
  venture or other profit-making enterprise.

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Other Methods

• Loans
• Payment of Credit Card Bills.
• Transfers at Other Than Fair Market Value.
• Promises of Favorable Treatment .

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Fictitious Disbursements

• Check tampering schemes
• Purchase schemes
• Expense reimbursement fraud
• Payroll fraud

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Purchase Schemes

• Personal purchases with company funds.
• False invoicing
• Altering existing purchase orders/requisitions
• Related-party businesses

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Billing Schemes
Shell Company
Non-Accomplice Vendor
Personal Purchases
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Billing Schemes

• The perpetrator uses false documentation to cause
  a payment to be issued for a fraudulent purpose.
• Actual disbursement is issued as would a
  legitimate disbursement.

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Shell Company Schemes

• Fictitious entities created for the sole purpose
  of committing fraud.
• Fabricated name and post office box is used.
• Bank account is usually set up in the companys
  name.
• Forming a shell company
• Certificate of incorporation or assumed-name
  certificate set up.
• Shell company may be formed in someone elses
  name.

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Shell Company

• Submitting false invoices
• Invoice is manufactured by using a professional
  printer, personal computer, or a typewriter.
• Self-approval of fraudulent invoices
• Most fraudsters are in a position to approve
  payment.
• Approvals may be forged.
• Rubber stamp supervisors
• Supervisors dont check the documentation and
  approve whatever is submitted.

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Shell Company

• Collusion
• Two or more employees conspire to steal.
• More difficult to detect.
• Circumvents controls that implemented to prevent
  fraud.
• Purchases of services rather than goods
• Services are intangible and fraud is more
  difficult to detect.
• Pass-through schemes
• Goods or services are purchased by the employee
  and resold to the victim company at an inflated
  price.

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Preventing and Detecting Shell Company Schemes

• Maintain and regularly update an approved vendor
  list.
• Independently verify all vendors before payment.
• Identifying shell company invoices.
• Lack of detail on the fraudulent invoice.
• Invoice that lacks detailed descriptions of the
  items billed.
• Mailing address may be an indicator of fraud.
• Consecutively numbered invoices over a period of
  time.
• Reviewing payables and sorting payments by vendor
  and invoice number.

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Preventing and Detecting Shell Company Schemes

• Testing for shell company schemes
• Investigate budget overruns and departments that
  regularly exceed their budget.
• Conduct horizontal analysis of expenses .
• Investigate unexplained increases in soft
  accounts.
• Investigate unexplained increases in quantity of
  items purchased.

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Preventing and Detecting Shell Company Schemes

• Verifying whether a shell company exists
• Use the phone book to verify the vendor.
• Contact others in the industry.
• Conduct a site visit of the vendor.
• Identifying the employee behind a shell company
• Conduct a public records search of the companys
  registration.

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Detection of Billing Schemes

• Investigate unusual payees (i.e., employees,
  handwritten vs. computer generated non-vendors
  non-corporate sponsored credit-card companies).
• Computer analysis of the following
• Employee addresses matching vendors addresses.

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The Value of Nothing
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Master Vendor File Does Not Contain a Telephone
Number
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Master Vendor File Does Not Contain an Address
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Telephone Number Field is the Same Digit
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Round Dollar Amount
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Vendors With Similar Names
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Two or More Vendors With the Same Address
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Vendors With P.O. Boxes
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Vendors With The Same Federal I.D. Number
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Vendors With The Same Contact Person
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Vendors With The Same Telephone Number
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Employee Analysis

• Payments to fictitious vendors
• Vendor address employee address.
• Tax ID employee social security number.

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Same Invoice Number, Same Dollar Amount,
Different Vendor
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Same Invoice Number, Amount, and Vendor, But
Different Date
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BENFORDS LAW
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Benfords Law
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Simon Newcomb
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Benfords Law

• Number Log Formula
• 10 1.0000 LOG(10)
• 11 1.0414 LOG(11)
• 12 1.0792 LOG(12)
• 13 1.1139 LOG(13)
• 14 1.1461 LOG(14)
• 15 1.1761 LOG(15)
• 16 1.2041 LOG(16)
• 17 1.2304 LOG(17)
• 18 1.2553 LOG(18)
• 19 1.2788 LOG(19)
• 20 1.3010 LOG(20)

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Logarithm Example

• Multiply 320 by 417 (Answer 133,440)
• Log(320) 2.50515
• Log(417) 2.620136
• Log (320) Log (417) 5.125286
• 105.5125286 133,440

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Note on the Frequency of Use of the Different
Digits in Natural Numbers

• Theory A multi-digit number is more likely to
  begin with 1 than any other number. In other
  words, these are probably the most faded numbers
  on our calculators.

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Frank Benford

• Multi digit numbers beginning with 1, 2 or 3
  appear more frequently than multi digit numbers
  beginning with 4, 5, 6, etc.
• The frequency of which these digits appear in
  nature was published in The Law of Anomalous
  Numbers.

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How Does this help us?

• Because human choices are not random, invented
  numbers are unlikely to follow Benfords Law,
  I.e., when people invent numbers, their digit
  patterns (which have been artificially added to a
  list of true numbers) will cause the data set to
  appear unnatural.

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Fraud Cases

• What will you generally see
• Fraudster starts out small then increases the
  dollar amount. The amounts will be just below a
  limit that requires further review. The numbers
  will not follow a digital pattern. The amounts
  will not be rounded, and certain digit patterns
  will be repeated.

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Example

• Examined over 1,000 cash disbursements (entire
  population) during the year (amounts over 500
  required 2 signatures and amounts over 5,000
  required competitive bids).
• Sample is on next slide

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Example

• Amount Description
  Check. No.
• 225.95 SEIU - LU 82 ED ASSES FUND 6/98. 4001
• 1,212.97 SCHINDLER ELEV CORP JUN 98. 4002
• 4,999.50 YORK INT CORP - 7/98-9/98. 4003
• 339.13 US FOODSERVICE 10/29/98. 4004
• 473.98 VIRGINIA DEPT OF TAXATION JUNE '98
  4005
• 250.81 W W GRAINGER INC - SUPPLIES 4006
• 504.00 LJC LIGHTING SUPPLY - LIGHT BULBS. 4007
• 171.70 CLERK, DC SUPERIOR COURT 12/25/98. 4008
• 225.15 SEIU - SEIU LU 82 ED ASSES FD
  9/98. 4009
• 477.26 VIRGINIA DEPT OF TAXATION -1998. 4010

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Expected First Digit Frequency
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Actual First Digit Frequency
84
Actual First and Second Digit Frequency
85
Expense Account Fraud

• Fictitious expenses
• Altered expenses
• Mischaracterized expenses
• Duplicate reimbursements

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Fictitious Expenses

• Expenses which never occurred
• Picking up blank receipts from restaurants.
• Claiming mileage that never occurred.
• Renting a car and claiming mileage.

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Altered Expenses

• Altering the date the expense occurred.
• Altering the amount.
• Reimbursement for expensive meals and indicating
  that more than one person dined.

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Mischaracterized Expenses

• Disguising alcohol for meals.
• Paying for meals that are personal.
• Claiming non-allowed expenses as something else.
• Claiming mileage for personal errands.

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Preventing and Detecting Fictitious Expense
Reimbursements

• High dollar items that were paid in cash.
• Expenses that consistently rounded off, ending
  with 0 or 5.
• Expenses that are consistently for the same
  amount.
• Reimbursement requests that consistently fall at
  or just below the reimbursement limit.
• Receipts that are submitted over an extended time
  that are consecutively numbered.
• Receipts that do not look professional or lack
  information about the vendor.

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Payroll Fraud

• Ghost employees
• Overpayment of wages
• Withholding tax schemes
• Bogus claims

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Detecting Payroll Fraud

• Independent payroll distribution.
• Analysis of payee addresses or accounts.
• Search for duplicate Social Security numbers.

• Investigating employees who have a pattern of
  on-the-job injuries.

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Motives to Spend

• Budgeted funds must be spent or returned.
• Budget cuts if funds not used.

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IV. Interesting Fraud Facts

• Common Fraud Schemes
• Facts About Fraud

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Common Fraud Schemes

• Larceny
• Theft of cash from deposits.
• Theft of cash from register (parks, etc).
• Misuse of assets
• Telephone
• Vehicles
• Flight travel
• Credit cards
• Hotels

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Telephone Usage

• Personal long distance calls
• Repeated local calls
• Calls of unusual duration
• Calls at unusual times
• Excessive cell calls

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Telephone Expenses
97
State Vehicle

• Personal use during work week.
• Use on weekends.
• Undocumented meetings.

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Personal Vehicle
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Airline Travel

• First class accommodations.
• Arrangements made at the last second.
• Unnecessary flights.
• Chartered airlines.
• Flights for family members.
• Personal flights.

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Airline Travel
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Airline Travel
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Credit Card Schemes

• Personal use expenses.
• Interest paid by the State.
• Reimbursements not made on a timely basis.

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Credit Card Schemes
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Credit Card Schemes
105
Credit Card Schemes
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Credit Card Schemes
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Hotel Usage

• Exorbitant prices
• Family present
• Non-business events

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Hotel Use
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Other Common Fraud Schemes

• No-bid contracts
• Related party transactions
• Improper use of facilities

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No-Bid Contracts

• Board not aware
• Questionable services
• Family and/or friends

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No-Bid Contracts
112
No-Bid Contracts
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Related Party Transactions
114
Related Party Transactions
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Frequency of Fraud Schemes

• Asset misappropriation schemes are most common
  represent about 80 of all fraud.
• Corruption and billing schemes are most common
  types of misappropriation schemes.

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V. What to Watch For

• Segregation of Duties
• Job Rotation
• Lifestyle Symptoms
• Physical Safeguards
• Independent Checks
• Review Authorization
• Override
• Inadequate Systems

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Segregation of Duties

• Segregation of duties Separation of the
  authorization, recording, custodial and
  reconciliation functions.
• Divide responsibilities between different
  employees so one individual doesnt control all
  aspects of a transaction.
• Reduce the opportunity for an employee to commit
  and conceal errors (intentional or unintentional)
  or perpetrate fraud.
• MLKI

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Considerations for Limited Staff

• If possible each activity should be performed by
  a different employee.
• Cash custody should be independent of receipts,
  disbursements and the recording function.
• G/L personnel should be independent of custody,
  receipts, disbursements, and as many other
  activities in the transaction process as
  possible.
• Personnel making bank deposits should be
  independent of cash custody, receipts,
  disbursements, and bank reconciliations.

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Considerations for Limited Staff

• As separation of duties becomes less possible
  more emphasis must be placed on
• Review of Supporting Documentation.
• Limiting access to facilities/assets.
• Transaction Authorization.
• Departmental Reconciliation.
• Independent verification by internal/external
  auditors.

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Job Rotation

• Encouraging rotation to learn and understand
  other functions within the unit.
• Goldberg.

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Lifestyle Symptoms

• Changes in an individuals spending habits or way
  of living.
• People dont save for a rainy day.
• DHCR

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Physical Safeguards

• Preventive
• Deters Fraud - Chain link fence at a junkyard
• Required Approvals
• Segregation of Duties
• Securing Assets
• Detective or Corrective
• Detects errors Junkyard Dog!
• Reconciliations
• Reviews
• Event Notification

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Security of Assets

• Secure and restrict access to equipment, cash,
  inventory, confidential information, etc. to
  reduce the risk of loss or unauthorized use.
• Perform periodic physical inventories to verify
  existence, quantities, location, condition, and
  utilization.
• Base the level of security on the vulnerability
  of items being secured, the likelihood of loss,
  and the potential impact should a loss occur.

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Independent Checks

• Trust but verify!!!!!!
• Secondary Reviews
• DSAS (Contracts)

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Review Authorization

• Mandatory not cursory.
• Management documents and communicates which
  activities require approval, and by whom, based
  on the level of risk to the organization.
• Ensure that transactions are approved and
  executed only by employees acting within the
  scope of their authority granted by management.
• PSC

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Override

• Deliberate circumvention of controls.
• ORDA (Credit cards, contracts).

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Inadequate Systems

• Having systems that are outdated and not
  compatible with current software.
• HRBR (Payroll, Accounting).

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Hard vs. Soft Controls

• Hard controls Policies, procedures, systems.
• Soft controls The competence, attention and
  integrity of the people.

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Fraud Misconduct Plan Elements

• Strong ethical culture
• Effective personnel policies
• Awareness
• Reporting mechanisms
• Compliance programs

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I. Strong Ethical Culture

• 1. Credible leaders
• 2. Values statement
• 3. Communication of values
• 4. Code of conduct/ethics policy
• Define acceptable and unacceptable behavior.
• Address potential ethical dilemmas.

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Code of Conduct Checklist

• Use of mail facilities
• Personal use of equipment
• Gift acceptance. Gift definition
• Internet
• Conflicts of interest
• Outside employment

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Periodically Reinforce Values

• Annual training
• Annual conflicts of interest affidavit
• Posted flyers
• Intranet
• Periodic emails

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II. Effective Personnel Policies

• Recruitment
• Valuation system
• Employee surveys

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(No Transcript)
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Effective Personnel Policies

• Recruitment
• Verify identity
• Check qualifications, names of schools (HALL)
• Probe employment gaps
• Obtain references

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Recruitment Statistics

• A poll revealed
• 30 of employees lied while applying for jobs.
• 18 think its necessary to exaggerate.
• 34 of managers do not check the background of
  their applicants.
• 36 or organizations state that untruths on CVs
  cost them significant amounts of money.

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Sample from Facebook

• The candidates web page stated his interests
• Smoking blunts (cigars stuffed with pot).
• Shooting people and
• Obsessive sex.

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III. Awareness

• Fraud Risk Assessments
• Identify and test red flags
• Benchmarking performed
• Conduct surprise audits

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How do we Increase Fraud Awareness

• Lectures to management.
• Presentations
• Company intranet
• Circulation of fraud articles
• Publications of internal investigations.
• Involve staff to develop and re-evaluate a fraud
  response plan.

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IV. Reporting Mechanisms

• Anonymous reporting systems
• Whistleblower protection
• Response Plans

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Reporting Programs

• Should emphasize
• Information can be provided anonymously.
• No recrimination.
• The report need not be made to ones immediate
  supervisor.

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V. Compliance Programs

• Effective Compliance Program
• Standards and procedures that are reasonably
  capable of preventing fraud and misconduct.
• High-level oversight.
• Due care in delegating discretionary authority.
• Effective communication of standards and
  procedures (Training).
• Monitoring and auditing of compliance program.
• Enforcement of program through discipline.
• Appropriate response upon notification of
  wrongdoing.

143
Facts About Fraud

• Occupational fraud schemes frequently continue
  for years before they are discovered.
• Occupational fraud schemes are much more likely
  to be detected by tip than by audits or internal
  controls.
• Lack of internal controls was the most common
  factor that allowed frauds to occur.

144
More Facts About Fraud

• Most frauds committed by senior management.
• Most common behavioral red flags were
• Person living beyond their means.
• Person experiencing financial crisis.

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More Facts About Fraud

• Median loss for all fraud schemes for governments
  was 100,000.
• 28 of all fraud schemes are between 100,000 and
  499,000.
• Median loss of corruption schemes is 375,000.
• Median duration of corruption schemes is 2 years.

146
More Facts About Fraud

• Besides tips most frauds are discovered by
  accident.
• Tips account for 50 of frauds within
  governments.
• 57 of all tips come from employees, 12 come
  from vendors.
• Background checks help ensure the reliability of
  the employers workforce.

147
Questions and Discussion

• Chris Rosetti
• crosetti_at_bstadvisors.com
• BST Valuation Litigation Advisors, LLC
• 26 Computer Drive West
• Albany, New York 12205
• Tel [phone]
• www.bstadvisors.com