Taking a Closer Look - Assessing Risk of Fraud in the Payday Advance Industry

Taking a Closer LookAssessing the Risk of Fraud in thePayday Advance IndustryD. Michael Costello, CPA•ABV•CFF, CFEPrincipal, Decosimo Advisory Services2009 CFSA Annual Meeting and ConferenceMarch 6, 2009 Orlando, Florida

"We chose Decosimo because their CPAsand advisors have the most experienceserving our industry."Ben Paramore, CFO

Report Summary• Study based on 959 cases of occupational fraud between January 2006 and February 2008• U.S. organizations lose 7% of their annual revenues to fraud or approximately $994 billion in fraud losses.• Schemes were extremely costly. The median loss was $175,000. Over 25% involved losses of at least $1 million.• The typical fraud in the ACFE study lasted two years.

Report Summary• Focused on 11 distinct categories of occupational fraud. o The most common fraud scheme: Corruption - 27% of all cases, o Fraudulent billing schemes - 24% of all cases. o Financial statement fraud - most costly category with a median loss of $2 million

Report Summary• Occupational frauds are much more likely to be detected by a tip o 46% of the cases in this Report were detected by tips from employees, customers, vendors, and other sources o Tips were also the most common means of detection in 2002, 2004, and 2006

Report Summary• Anti-fraud controls have a measurable impact on an organization’s exposure to fraud o Organizations that conducted surprise audits suffered a median loss of $70,000 o Organizations that did not conduct surprise audits had a median loss of $207,000

Report Summary• The industries most commonly victimized by fraud in our study were: o Banking and Financial Services - 15% of cases o Government - 12% o Healthcare - 8%• Among industries with at least 50 cases, the largest median losses occurred in: o Manufacturing - $441,000 o Banking - $250,000 o Insurance -$216,000

Report Summary• Small businesses are especially vulnerable to occupational fraud o The median loss suffered by organizations with fewer than 100 employees was $200,000 o Check tampering and fraudulent billing were the most common small business fraud schemes

Report Summary• 78% of victim organizations modified their anti- fraud controls after discovering that they had been defrauded• Occupational frauds were most often committed by the accounting department or upper management o 29% - persons in the accounting department o 18% - executives or upper management

Report Summary• Occupational fraudsters are generally first-time offenders o 7% had prior convictions o 12% previously terminated by an employer for fraud-related conduct• Fraud perpetrators often display behavioral traits that serve as indicators of possible illegal behavior o Perpetrators living beyond their apparent means - 39% of cases o Experiencing financial difficulties at the time of the frauds - 34%

What is Occupational Fraud?―The use of one’s occupation for personal enrichmentthrough the deliberate misuse or misapplication of theemploying organization’s resources or assets.‖

What is Occupational Fraud?• Includes a wide range of misconduct by employees, managers, and executives• Can be as simple as pilferage of company supplies or as complex as sophisticated financial statement frauds• Occurs in all sizes and types of organizations

Asset misappropriation (false invoicing, payroll fraud, skimming, etc.) CorruptionHow is it (receive or offer bribes, extortCommitted? funds from third parties, etc.) Financial statement fraud (intentional misstatement or omission of material information from the organization’s financial reports)

Asset misappropriation Most commonly reported Least costly - median loss $150,000How is it CorruptionCommitted? 25% of cases Median loss $375,000 Financial statement fraud Least commonly reported Median loss $2 million

Committed by Owners and Executives Tips - most common methodHow is itDetected? Internal controls less effective - most top level personnel can override External audits - detected greatest percentage - external accountability is the key

Largest Frauds Independent auditors were involved with the detection of the largestHow is it casesDetected? External audits involved with 15% of cases with a loss of $1 million or more 42% of million-dollar frauds detected with a tip or complaint

In Small Businesses Weaker internal controls - lower percentage of frauds caught byHow is it internal controlsDetected? Tips and internal audits detected fewer cases Small businesses have room for improvement in proactive fraud detection efforts

By Organization Type Privately held companies: 35% detected by accidentHow is itDetected? Government entities: 25% detected by internal audit Public companies: largest percentage detected by tips and internal controls

Tips Of 417 cases in which a tip was instrumental in detecting fraud, 31%How is it came through a hotline or formal mechanismDetected? Greatest number of tips came from within the organization 30% of tips came from external sources

Who are theperpetrators?

Quick profile 66% acted alone Schemes with two or more individuals resulted in a loss 4xWho are the higherperpetrators? Collusion enables employees to circumvent some controls Perpetrators in the 50s stole an average of $500,000 - twice as high as any age bracket

Tenure No strong correlation between tenure and onset of fraudWho are theperpetrators? 48% worked at organization 5 years or less, 52% over five years Longer-term employees commit larger frauds

Position Majority of schemes perpetratedWho are the by employees and managersperpetrators? Less than 25% of cases involved owners and executives, but median loss was 5X greater - $834,000

Gender Majority of schemes perpetratedWho are the by menperpetrators? Men associated with median loss 2X greater than women Gender gap may be caused by the glass ceiling phenomenon

Education 11% - post graduate degree 50% - some college or college degreeWho are the 34% - high school graduatesperpetrators? College graduates stole 2X more than high school graduates (median - $210,000)

Department Highest percentage - accounting department 2nd highest - Executives andWho are the upper managementperpetrators? Least common - internal auditors Only 8 cases in our study involved the legal department - but highest median loss of $1.1 million

Department (continued)Who are the Executives and upper management caused a medianperpetrators? loss of $853,000 Customer Service had least impact, median loss of $45,000

Accounting Department 231 case involved an employee of the accounting department 1/3 of cases involved checkWho are the tamperingperpetrators? Greatest opporuntity to produce false checks More likely to engage in cash larceny, payroll fraud and billing schemes; very low rate of non- cash misappropriations

Executive and Upper Management More likely to engage inWho are the corruption and fraudulent statement schemesperpetrators? Of 142 cases, 45% involved corruption 25% involved fraudulent statements

Operations 8% of all cases in studyWho are the Lowest rates of all types of fraud schemesperpetrators? Check tampering very uncommon Highest rate of cash misappropriation

50% of victims in the study ran an employment checkWhat aboutbackground 40% ran a criminal background checkchecks? Majority of fraudsters are first time offenders - less than 20% have committed criminal act or been terminated by previous employer for fraud

Unusually irritabileBehavioral Lavish spending - this warning sign was evident in more thanRed Flags 40% of cases Secretive about professional activities

• A remote location of a chain had a lack of oversight and of internal controls• Manager’s authority: o sign checks,make computer entries,make deposits,keep customer records,prepare and sign payroll checks,receive and reconcile bank statements• What’s wrong with this picture?

Concentration of Duties• When one person has certain combinations of responsibilities, he can cover his own tracks• The manager had been there several years— ownership, to its cost, trusted him• Manager pocketed cash while entering the payments as being made• Thus, bank and customer records differed—but no one reconciled them

Other Lapses ofOversight• Bookkeeper never questioned checks being cashed instead of deposited, commission advances not being repaid, bad checks from the manager not followed up on—was too busy dealing with many locations• Management dismissed the branch’s poor performance as ―to be expected for a small town‖

Endgame• New bookkeeper quickly noticed something was wrong• But by the time management had it checked out, all the records had been destroyed

Other “War Stories”• Employee ―Hotline‖ used to detect fraud• Performance of ―Fraud Risk Assessment‖ procedures• Investigation of ―trusted‖ bookkeeper• Surprised executive due to assistants fraudulent activities• Family fraud case

Fraud Prevention T.E.E.A.M. Timely Effective Efficient Accurate Mobile

Timely• Timely data is critical• Be ahead of the situation—err on the side of overprotection• Analyze data daily to find anomalies, and act on them immediately o Problems are caught quickly o The tone discourages illegal activity

Effective and Efficient• Use information that is relevant and correlated with the problem• Daily deposit totals are a critical variable• If data’s not relevant, don’t bother with it—you’ll just waste time you could use on something more important

Accurate• The data used must properly reflect what it appears to• Test the accuracy of counts regularly

Mobile• Managers should make regular visits to locations• Managers should know and closely observe those operations

Operating Procedures• Communicate to employees by way of a manual• Routine ―surprise‖ audits• Weekly management audits• Monthly full audits• Twice/year collections audits• Employee ―Hotlines‖

Fraud Detection Interviews• Conduct with all employees—not a sign of a specific suspicion of a person• Establish rapport and get basic facts first• Then move on to the fraud-related questions

Questions to ask:• Do you understand the purpose of this interview? o Again, note this is not an accusation• Do you think fraud is a problem for business in general?• Do you think this company has a problem with fraud?• If employees or managers are stealing from the company, why do you think they would do it? ???

More Questions• If you knew another employee was stealing from the company, what would you do?• Do you know anyone that might be stealing or taking unfair advantage of the company?• Suppose someone who worked at the company decided to steal or commit fraud. How could he or she do it and get away with it? ??? ???

Even More Questions• In your opinion, who is beyond suspicion when it comes to committing fraud at this company?• Did you ever think about stealing from the company even though you didn’t go through with it?• Is there any information you wish to furnish regarding possible fraud in this company? ??? ??? ???

―To Do‖ List• Implement a ―Fraud Risk Assessment‖ program covering Prevention, Detection and Response  Where are you at risk for fraud?  Consider internal and external opportunities  Develop a written Plan of Ethics and Code of Business Conduct that is communicated ―from the top‖

―To Do‖ List• Basic things to implement – o Segregate financial and accounting duties o Duplicate sensitive tasks, such as requiring two signatures on checks over a certain amount o Require employees to take annual vacations o Reconcile all bank accounts o Employee ―Hotline‖ for tips o Conduct ―surprise‖ audits o Conduct interviews

―To Do‖ List• Basic things to implement – o Use passwords and IDs on computer files o Restrict unauthorized access to offices and computer o Train supervisors and managers to spot fraud, and o Perform internal and external audits that include fraud prevention measures

Final To-Do

QUESTIONS?To download a copy of this presentation: www.decosimo.com/cfsa2009 For more information, contact:D. Michael Costello, CPA•ABV•CFF, CFE Principal, Decosimo Advisory Services 800-782-8382, decosimo.com

Taking a Closer Look - Assessing Risk of Fraud in the Payday Advance Industry

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