Forensics and Financial Fraud: Real World Issues and Answers

• Chapter 1 - Fraud Basics
  • Learning Objectives
  • Introduction
  • What Do We Mean By Fraud
  • Three Level Response to Fraud
    • Level 1 – Deterrence and Prevention Initiative
    • Level 2 – Early Detection Initiative
    • Level 3 – Fraud Handling Initiative
  • Issues Unique to Industry and Public Accounting
  • Keep a List of Action Ideas
  • Caution!
    • First, It Is Just Not Possible to Prevent All Wrongdoing and Fraud
    • Second, Every Fraud Incident Is Unique
    • Third, the Ideas in This Program Are Not Legal Advice
    • Fourth, When Fraud Occurs Emotions Must Be Managed – Including Our Own
  • Who Commits Fraud, and Why
  • “Relative Honesty”
  • What Keeps Honest People Honest
  • Fraud Risk Management Strategy
    • Develop a Sound Understanding of Fraud Risks
    • Adopt or Support Strong Prevention and Deterrence Strategies
    • Adopt or Support Strong Detection Strategies
    • Be Ready to Deal with Fraud When It Is Discovered
  • Summary
• Chapter 2 - Deterrence and Prevention
  • Learning Objectives
  • Introduction
  • Limitations
  • Create and Maintain a Culture of Honesty and Ethics
    • Factor 1 – A Proper Tone at the Top
    • Factor 2 – A Positive Work Environment
    • Factor 3 – Discipline and Penalties
    • Factor 4 – A Policy on Suspected Misconduct and Dishonesty (Fraud Policy)
  • Strong Internal Controls
  • The Essential Fraud Risk Inventory
    • Step 1 – Identify Specific Fraud Risks
    • Step 2 – Develop Prevention Controls Aimed at Each Step in the Scheme
• Educate All Employees in Fraud Risk Management
  • Integrity
  • Interest
  • Courage
  • Competency
• Other Factors in Fraud Prevention
• The Risk of Management Override of Internal Controls
• Summary
• Appendix 2A – Introducing a Fraud Policy
• Chapter 3 - Early Detection Strategy
  • Learning Objectives
  • Introduction
  • What Could Go Wrong
  • Fraud “Commonalities”
    • Question 1 – “But What About Lifestyle Indicators?”
    • Question 2 – “What Percentage of Fraud Is Discovered?”
    • Question 3 – “Exactly How Much Fraud Is Out There?”
    • Question 4 – “Why Do Managers and Auditors Miss Fraud?”
  • How Fraud Is Found
  • Employees and Internal Controls
  • Internal Audit Professionals
  • External Auditors
  • Third Parties
  • The Perpetrator
  • Luck
  • The Three-Step Fraud Detection Strategy
    • Step 1 – Think Like a Thief: Fraud-Based Brainstorming
    • Step 2 – Use Discovery Techniques Aggressively
    • Step 3 – Determine the Cause of All Fraud Indicators Surfaced
  • Summary
• Chapter 4 - Misappropriation and Results Reporting: Schemes, Indicators and Detection Steps
  • Learning Objectives
  • Introduction
  • Misappropriation
    • Misappropriation Examples
    • Reducing the Risk of Misappropriation
  • Group Seminar Exercise
  • Results Reporting
    • The Importance of Intent
    • Results Reporting Examples
  • Group Seminar Exercise
  • Special Challenges from Third Party Relationships
  • A Typical Case
  • Summary
• Chapter 5 - Issues in Fraud Incident Response
  • Learning Objectives
  • Introduction
  • Overall Fraud Handling Issues
    • Fraud Is Usually Hidden from the Accountant or Auditor, and Those Involved Will Lie, Mislead, and Delay
    • Protection of Innocent Parties Is the Single Highest Priority
    • Things Go Wrong
  • Crisis Management: Issues When Fraud Is Found
  • The Response Team
    • Legal Oversight
    • Investigators, Fraud Examiners, and Forensic Accountants
    • Human Resources
  • Loss Recovery
  • Coordination with Law Enforcement, Prosecutors, and Other Government Authorities
  • Addressing Control Weaknesses
  • Publicity Concerns
  • Employee Morale Issues
  • Summary
  • Case Study 5-1 – National Publishing
    • Discussion Questions
• Chapter 6 - Issues for the CPA in Public Practice
  • Learning Objectives
  • Introduction
  • Managing Client Expectations
  • SAS 99 Guidance, Requirements, and Implementation Challenges
  • How SAS 99 Has Improved Audits
    • Responding to Identified Fraud Risks
    • Surprise and Unpredictability
  • Two Sticky Topics
    • Management Override of Internal Controls
    • Find Fraud, Lose Client; Miss Fraud, Lose Client
  • Summary
  • Case 6-1 – Brainstorming and Professional Skepticism
    • Required
    • Garden State Holdings, Incorporated – Part 1
    • Garden State Holdings, Incorporated – Part 2
    • Discussion Question
    • Garden State Holdings, Incorporated – Part 3
    • Discussion Questions
• Chapter 7 - Issues for the CPA in Industry
  • Learning Objectives
  • Introduction
  • Fraud Prevention
    • Quadrant 1 – Desired State
    • Quadrant 2
    • Quadrant 3
    • Quadrant 4
  • Suggested Actions
  • Managing the Cost of Fraud
  • The Role of Internal Auditing in Fraud Deterrence and Detection
  • Summary
  • Case 7-1 – Brainstorming and Professional Skepticism
    • Garden State Holdings, Incorporated – Part 4
    • Discussion Questions
    • Garden State Holdings, Incorporated – Part 5
    • Discussion Question
    • Garden State Holdings, Incorporated – Part 6
• Chapter 8 - Summary and Action Plan
  • Learning Objectives
  • Introduction
  • 15 Suggested “Best Practices”
  • Summary
• Chapter 9 - Latest Developments
• Appendix A – SAS 99
• Appendix B – Answer Please: Fraud-Based Interviewing
• Appendix C – Management Override of Internal Controls
• Appendix D – Managing the Business Risk of Fraud: A Practical Guide

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Chapter 1 - Fraud Basics

Learning Objectives

After studying this chapter you should be able to

• Agree on a working definition of fraud that will be used in this program.

• Understand the Three Level Response to fraud.

• Understand who commits fraud, and why.

• Identify the impact of pressure, rationalization and opportunity on basically honest people.

• Understand how Statement of Auditing Standards 99 Consideration of Fraud in a Financial Statement Audit can form the basis of effective fraud risk management for both auditors and organization managers.

Introduction

In recent years, the fraud expectations placed on professional accountants and auditors have reached an all time high. In government, the board room, and throughout the general public the belief exists that CPAs are experts in fraud issues, and that regardless of whether we are in public practice or industry, we possess and can deliver solid solutions to the many risks of fraud, wrongdoing, and misconduct. For the most part, this belief is seriously flawed.

This program is designed to assist professional accountants in the management of fraud risks for their clients and employers. The content includes concepts and suggestions that can be applied by both external and internal auditors as well as professional accountants in for profit business, government, education, and not-for-profit organizations.

What Do We Mean By Fraud

To start, let us agree on a working definition of fraud. Dictionaries definitions include terms like trickery or deceit aimed at obtaining an unfair advantage. Black’s Law Dictionary provides further insight: it includes “all multifarious means…which are resorted to by one individual to get an advantage over another by false suggestions or suppression of the truth.”

In Rule 10b-5, the Securities and Exchange Commission states the following:

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or the mails, or of any facility of any national securities exchange,

(a) to employ any known device, scheme, or artifice to defraud,

(b) to make any untrue statement of material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or

(c) to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.

In July 2008, the AICPA, the Institute of Internal Auditors, and the Association of Certified Fraud Examiners released a joint document titled “Managing the Business Risk Fraud: A Practical Guide.” According to this very helpful document, “Fraud is any intentional act or omission designed to deceive others, resulting in the victim suffering a loss and/or the perpetrator achieving a gain.” (This Guide is included as Appendix D.)

Common in all of these and other definitions is the concept of false statements or acts, with intent to deceive a victim, resulting in damages to the victim. For simplicity in this program, this broad definition will work well. We will use the term fraud to include all similar acts regardless of whether they actually meet the standard of violations of the law. We will include the risks of wrongdoing, misconduct, and corruption. In short, we are talking about lying and stealing. And in this program, we will call it all fraud.

Three Level Response to Fraud

Throughout the program, we will emphasize the three distinct levels at which all organizations must be ready to address fraud and related risks. These “levels” build upon each other in much the same way as the levels in a house build upon a solid foundation.

Level 1 – Deterrence and Prevention Initiative

Using assumptions can be dangerous. But one fraud-based assumption will continue to stand the test of time and experience. Simply – it is best not to have fraud to begin with. Efforts to deter or prevent fraud from occurring will form the base level or foundation of this program. Chapter 2 will provide ideas on deterrence and prevention, and will provide suggestions on creating and maintaining an Antifraud Business Environment.

Managers at every level must remain vigilant. Not all wrongful acts can be prevented. Unknown outsiders can attack our controls, but danger also comes from inside the control structure – from employees and others in a position of trust who will use that position to commit fraud.

Review of every transaction and entry before posting is the simple yet effective way to prevent fraud. But the reality is that there is not enough time in the day to test the legitimacy or accuracy of transactions and entries before they are posted. And by the time an auditor becomes involved, it is too late. To manage these realities, we need more than just best efforts to deter wrongdoing. We also have to be on the lookout for actual fraud acts.

Level 2 – Early Detection Initiative

How fraud is found is important to understand so that we can take advantage of what works best. Chapter 3 will provide a Three Step Approach to Fraud Detection. These steps work equally well for managers and internal and external auditors. Knowledge of fraud acts as well as the related symptoms and indicators is required. Chapter 4 will provide examples of what can go wrong in the areas of misappropriation and results manipulation.

Level 3 – Fraud Handling Initiative

Prevention has failed, but detection has worked. The alarm has sounded, and you are now in incident response mode. Emotions are running high, and confusion abounds. On top of that, the press is at your door and the culprit’s attorneys are on the phone. Innocent employees want to know what is going on. Now is definitely not the time to create a fraud response plan.

Chapter 5 provides ideas on creating a comprehensive response plan – before it is needed! Building on prevention and early detection efforts, organizations should attempt to forecast the resources that will be needed should a fraud act occur and require handling. Investigation is just part of the plan. Organizations should also consider how to respond to inquiries from the press, employees and others. Recovering losses and fixing control weaknesses related to the incident will be reviewed.

Issues Unique to Industry and Public Accounting

No training program can provide ideas that will work equally well in all environments. Chapters 6 and 7 take this into account, each highlighting some of the fraud challenges unique to participants in public accounting (Chapter 6) and in industry (Chapter 7).

Keep a List of Action Ideas

Participants in this program are encouraged to develop a list of ideas and action items for use in their own organizations or at specific clients. Tailor the program ideas for your own needs, and then pledge to put your ideas into action.

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