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NONPROFIT FRAUD: WHAT
YOU NEED TO KNOW
PART II: THE DETECTION
May 7, 2014
Lawrence J. Hoffman, CPA/CFF, CVA, CFE
Senior Pa...
OBJECTIVES
NONPROFIT FRAUD: THREE-PART SERIES
PART I: THE FRAUD
• Why it is important that you are educated in fraud
• The...
AGENDA
• Why do people commit fraud?
• How is fraud detected?
• Who are the perpetrators?
• Fraud detection techniques
• W...
WHY DO PEOPLE COMMIT FRAUD?
THREE BASIC REASONS WHY PEOPLE COMMIT
CRIMES
• Economics  $$$$$
• Passion  love, lust, a cau...
WHY DO PEOPLE COMMIT FRAUD?
THE FRAUD TRIANGLE
Part II: The Detection * Page 5
Rationalization
(frame of mind or
ethical c...
WHY DO PEOPLE COMMIT FRAUD?
THE FRAUD TRIANGLE
THE FRAUD TRIANGLE ORIGINATED FROM
DR. DONALD CRESSEY'S HYPOTHESIS:
“Truste...
THE FRAUD TRIANGLE
PRESSURE
Part II: The Detection * PagePart II: The Detection * Page 7
WHY DO PEOPLE COMMIT FRAUD?
PRESSURE / INCENTIVE
Part II: The Detection * Page 8
Source Financial Non-Financial
Personal
•...
THE FRAUD TRIANGLE
OPPORTUNITY
Part II: The Detection * PagePart II: The Detection * Page 9
WHY DO PEOPLE COMMIT FRAUD?
Opportunity (perceived)
A High Fraud Environment!
• Tone at the Top - lack of oversight and su...
THE FRAUD TRIANGLE
RATIONALIZATION
Part II: The Detection * PagePart II: The Detection * Page 11
WHY DO PEOPLE COMMIT FRAUD?
RATIONALIZATION (A WAY TO RATIONALIZE THE
BEHAVIOR AS ACCEPTABLE)
• “I am just borrowing the m...
THE FRAUD TRIANGLE
WHEN ALL THE ELEMENTS COME TOGETHER
Part II: The Detection * PagePart II: The Detection * Page 13
HOW IS FRAUD DETECTED?
• The detection of fraud involves the ability to recognize in a
timely manner whether fraud has occ...
HOW IS FRAUD DETECTED?
Part II: The Detection * Page 15
2012 REPORT TO THE NATIONS ON OCCUPATIONAL FRAUD AND ABUSE
HOW IS FRAUD DETECTED?
Part II: The Detection * Page 16
2012 REPORT TO THE NATIONS ON OCCUPATIONAL FRAUD AND ABUSE
Part II: The Detection * Page 17
HOW IS FRAUD DETECTED?
2012 REPORT TO THE NATIONS ON OCCUPATIONAL FRAUD AND ABUSE
HOW IS FRAUD DETECTED?
KEY TAKEAWAY: ESTABLISH POLICIES,
PROCEDURES AND MECHANISMS FOR TIPS!
• Employees
• Vendors
• Custo...
WHO ARE THE PERPETRATORS?
Part II: The Detection * Page 19
THE ONE COMMON ELEMENT IN EVERY
FRAUD!
WHO ARE THE PERPETRATORS?
THE FACES OF FRAUD
Part II: The Detection * Page 20
WHO ARE THE PERPETRATORS?
Part II: The Detection * Page 21
THREE POTENTIAL FRAUD
PERPETRATORS
1. Those who are totally hon...
WHO ARE THE PERPETRATORS?
Part II: The Detection * Page 22
IS EVERYONE A POTENTIAL CRIMINAL?
WHO ARE THE PERPETRATORS?
TYPICAL PROFILE
• Usually living above their means or has an addictive need
• Does not have a pr...
WHO ARE THESE PEOPLE?
THE DILEMMA
• Everyone has to a degree a propensity to commit a crime!
• 90-99% of the population ma...
WHO ARE THE PERPETRATORS?
WHITE COLLAR CRIME CONTINUUM
Part II: The Detection * Page 25
80% 9%9% 1%1%
Neurotic Psychopathi...
WHO ARE THE PERPETRATORS?
Part II: The Detection * Page 26
*Simon (2010)
Neurotic Psychopathic
Well-developed, overactive
...
WHO ARE THE PERPETRATORS?
DOMAINS AND TRAITS OF THE PSYCHOPATH*
Part II: The Detection * Page 27
*Psychopathy Checklist: S...
WHO ARE THE PERPETRATORS?
WHO DID THE FBI PROFILE WITH
THESE SYMPTOMS AND SIGNS?
• Anger and arrogance
• Capable of acting...
WHO ARE THE PERPETRATORS?
Part II: The Detection * Page 29
WHO ARE THE PERPETRATORS?
Part II: The Detection * Page 30
WHO ARE THESE PEOPLE?
Part II: The Detection * Page 31
Selected Quotes from Bernie Madoff
• “I‟m not the kind of person I‟...
FRAUD DETECTION TECHNIQUES
RED FLAGS
BEHAVIOR FLAGS
• Financial difficulties
• Living beyond means relative to known incom...
FRAUD DETECTION TECHNIQUES
Part II: The Detection * Page 33
2012 REPORT TO THE NATIONS ON OCCUPATIONAL FRAUD AND ABUSE
LIV...
FRAUD DETECTION TECHNIQUES
Part II: The Detection * Page 34
2012 REPORT TO THE NATIONS ON OCCUPATIONAL FRAUD AND ABUSE
LIV...
FRAUD DETECTION TECHNIQUES
FINANCIAL AND BUSINESS FLAGS
• Business is inexplicably unprofitable
• Company is having cash f...
FRAUD DETECTION TECHNIQUES
FINANCIAL AND BUSINESS FLAGS (continued)
• Accounting personnel exhibit inexperience or laxity ...
FRAUD DETECTION TECHNIQUES
INTERNAL CONTROL FLAGS
• A single employee controls the company finances and
accounting-lack of...
FRAUD DETECTION TECHNIQUES
INTERNAL CONTROL FLAGS (continued)
• Missing documents
• Altered documents
• Photocopy of docum...
FRAUD DETECTION TECHNIQUES
PREVENTIVE VS. DETECTIVE
CONTROLS
Part II: The Detection * Page 39
FRAUD DETECTION TECHNIQUES
PREVENTIVE CONTROLS
Preventive controls attempt to deter or prevent undesirable
events from occ...
FRAUD DETECTION TECHNIQUES
PREVENTIVE AND DETECTIVE CONTROLS IN ACTION
Part II: The Detection * Page 41
FRAUD DETECTION TECHNIQUES
PREVENTIVE CONTROLS
• Segregations of duties with well defined job descriptions and
policies an...
FRAUD DETECTION TECHNIQUES
PREVENTIVE CONTROLS (CONTINUED)
• Back up financial files daily
• Pre-employment background inv...
FRAUD DETECTION TECHNIQUES
DETECTIVE CONTROLS
• Whistleblower Policies and Hotlines (TIPS!!!)
• Management and supervisory...
WHAT SHOULD YOU DO WHEN YOU
UNCOVER FRAUD?
FOR THE INDIVIDUAL WHOM SUSPECTS FRAUD
• Follow your organization‟s Fraud Polic...
WHAT SHOULD YOU DO WHEN YOU
UNCOVER FRAUD?
FOR THE ORGANIZATION
• Employers have a duty to investigate promptly and thorou...
WHAT SHOULD YOU DO WHEN YOU
UNCOVER FRAUD?
CONDUCTING A FRAUD INVESTIGATION
• Objectives of the investigation should be co...
WHAT SHOULD YOU DO WHEN YOU
UNCOVER FRAUD?
AFTER THE INVESTIGATION
• Evaluate and decide on legal actions and recovery opt...
WHAT YOU NEED TO KNOW ABOUT FRAUD
THE FIVE MOST IMPORTANT TAKEAWAYS – AGAIN!
1. Trust is not an internal control!
– Establ...
MY BOOK!
EXPECTED RELEASE
THIS SUMMER!
STAY TUNED!
50Part II: The Detection * Page
HOW CAN RAFFA ASSIST YOU IN
PREVENTING AND DETECTING FRAUD?
A resource for the nonprofit community to help
organizations e...
HOW CAN RAFFA ASSIST YOU IN
PREVENTING AND DETECTING FRAUD?
OUR WEEKLY NEWSLETTER
OU
Part II: The Detection * Page 52
HOW CAN RAFFA ASSIST YOU IN
PREVENTING AND DETECTING FRAUD?
Are you threatened by fraud, litigation or
insolvency?
Are you...
HOW CAN RAFFA ASSIST YOU IN
PREVENTING AND DETECTING FRAUD?
How We Empower You
• We identify and mitigate fraud risk by pe...
HOW CAN RAFFA ASSIST YOU IN
PREVENTING AND DETECTING FRAUD?
Part II: The Detection * Page 55
Fraud Investigations &
Preven...
HOW CAN RAFFA ASSIST YOU IN
PREVENTING AND DETECTING FRAUD?
Part II: The Detection * Page 56
Business Valuation & Due
Dili...
SOME AREAS WE WILL BE GOING OVER IN
OUR OTHER PRESENTATION
PART III: THE PREVENTION –
JUNE 11, 2014, 12:00-2:00 P.M.
• Fra...
RESOURCES AND SUGGESTED READING
• 2012 Report to the Nations on Occupational Fraud and Abuse,
Association of Certified Fra...
QUESTIONS AND ANSWERS
Part II: The Detection * Page 59
BIOGRAPHY
Part II: The Detection * Page 60
• 35 years of consulting, audit, accounting and tax experience in the public an...
BIOGRAPHY
Part II: The Detection * Page 61
• Assisted companies and nonprofits with restructuring and turnaround situation...
BIOGRAPHY
Part II: The Detection * Page 62
LAWRENCE J. HOFFMAN,
CPA/CFF, CVA, CFE
SENIOR PARTNER
EDUCATION & CERTIFICATION...
BIOGRAPHY
• 9 years of fraud investigation and financial audit experience
• Started career with U.S. Government Accountabi...
THE FRAUD TRIANGLE
PRESSURE
Part II: The Detection * PagePart II: The Detection * Page 64
THE FRAUD TRIANGLE
RATIONALIZATION
Part II: The Detection * PagePart II: The Detection * Page 65
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2014-05-07 Nonprofit Fraud - What You Need to Know Part II - The Detection

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2014-05-07 Nonprofit Fraud - What You Need to Know Part II - The Detection

  1. 1. NONPROFIT FRAUD: WHAT YOU NEED TO KNOW PART II: THE DETECTION May 7, 2014 Lawrence J. Hoffman, CPA/CFF, CVA, CFE Senior Partner and Director of Forensic Accounting Services Leslie C. Kirsch, CFE Manager, Forensic Accounting Services
  2. 2. OBJECTIVES NONPROFIT FRAUD: THREE-PART SERIES PART I: THE FRAUD • Why it is important that you are educated in fraud • The magnitude of fraud in nonprofits • The types of frauds in nonprofits • Why does fraud occur in nonprofits • Some important fraud prevention takeaways PART II: THE DETECTION • Why do people commit fraud? • How is fraud detected? • Who are the fraud perpetrators? • Fraud detection techniques • What should you do when you uncover fraud? PART III: THE PREVENTION • Fraud risk assessments • Setting the tone at the top and your board of directors • What are the best preventative measures and controls? • The five critical takeaways! Part II: The Detection * Page 2
  3. 3. AGENDA • Why do people commit fraud? • How is fraud detected? • Who are the perpetrators? • Fraud detection techniques • What should you do when you uncover a fraud? Part II: The Detection * Page 3
  4. 4. WHY DO PEOPLE COMMIT FRAUD? THREE BASIC REASONS WHY PEOPLE COMMIT CRIMES • Economics  $$$$$ • Passion  love, lust, a cause (religious beliefs) • Mental instability  nuts Part II: The Detection * Page 4
  5. 5. WHY DO PEOPLE COMMIT FRAUD? THE FRAUD TRIANGLE Part II: The Detection * Page 5 Rationalization (frame of mind or ethical character) Opportunity (lack of controls) Pressure / Incentive (The “Unshareable” Need or “Greed”)
  6. 6. WHY DO PEOPLE COMMIT FRAUD? THE FRAUD TRIANGLE THE FRAUD TRIANGLE ORIGINATED FROM DR. DONALD CRESSEY'S HYPOTHESIS: “Trusted persons become trust violators when they conceive of themselves as having a financial problem which is non- shareable, are aware this problem can be secretly resolved by violation of the position of financial trust, and are able to apply to their own conduct in that situation verbalizations which enable them to adjust their conceptions of themselves as trusted persons with their conceptions of themselves as users of the entrusted funds or property.1 ” 1DONALD R. CRESSEY, OTHER PEOPLE'S MONEY (MONTCLAIR: PATTERSON SMITH, 1973) P. 30. Part II: The Detection * Page 6
  7. 7. THE FRAUD TRIANGLE PRESSURE Part II: The Detection * PagePart II: The Detection * Page 7
  8. 8. WHY DO PEOPLE COMMIT FRAUD? PRESSURE / INCENTIVE Part II: The Detection * Page 8 Source Financial Non-Financial Personal • Distressed finances (DEBT!) • Divorce or extramarital affair • College education • Investment losses • Vices (gambling, alcohol, sex, drugs, rock n‟ roll) • High lifestyle • Greed • Lack of discipline • Health issues Job • Compensation is “too low” • Need to justify high compensation • Stock options / incentives • Bonuses based on performance • Production goals • “Unfair” treatment • Fear of job loss • Resentment • Challenge to beat system External • Threat of business failure • Market expectations • Board of Directors • Boss • Analysts • Reputation • Image • Social expectations • Peer pressure • Relatives and friends
  9. 9. THE FRAUD TRIANGLE OPPORTUNITY Part II: The Detection * PagePart II: The Detection * Page 9
  10. 10. WHY DO PEOPLE COMMIT FRAUD? Opportunity (perceived) A High Fraud Environment! • Tone at the Top - lack of oversight and supervision, poor leadership, no anti-fraud policy, code of conduct, hotlines, awareness • Communication - poor communications within organization, lack of expectations • Internal controls - lack of controls, segregation of duties, no monitoring, surprise audits, too predictable • Access - lack of safeguards, sufficient access to assets and information that enables the crime • Trust - too much trust placed in person or position. (Remember: trust is not an internal control!) • Discipline - lack of prosecution for previous frauds Part II: The Detection * Page 10
  11. 11. THE FRAUD TRIANGLE RATIONALIZATION Part II: The Detection * PagePart II: The Detection * Page 11
  12. 12. WHY DO PEOPLE COMMIT FRAUD? RATIONALIZATION (A WAY TO RATIONALIZE THE BEHAVIOR AS ACCEPTABLE) • “I am just borrowing the money and will repay it” • “I‟ll stop once I pay off my debts” • “The company won‟t even realize this amount is gone; it‟s not that much” • They feel they deserve it: “I am getting underpaid and am underappreciated” • “Management is „living high,‟ while I am oppressed” • “Everyone‟s doing it, I am no different” • “It is for a good purpose” • They need the money Part II: The Detection * Page 12
  13. 13. THE FRAUD TRIANGLE WHEN ALL THE ELEMENTS COME TOGETHER Part II: The Detection * PagePart II: The Detection * Page 13
  14. 14. HOW IS FRAUD DETECTED? • The detection of fraud involves the ability to recognize in a timely manner whether fraud has occurred or is occurring • However, a properly designed and executed audit may still NOT detect material fraud, especially one involving: – Forgery – Deliberate failure to record transactions –Intentional misrepresentations – Collusion • Ability to detect fraud depends on: – Skillfulness of perpetrator – Frequency and extent of manipulation – Degree of collusion – Relative size of individual amounts manipulated – Seniority of individuals involved Part II: The Detection * Page 14
  15. 15. HOW IS FRAUD DETECTED? Part II: The Detection * Page 15 2012 REPORT TO THE NATIONS ON OCCUPATIONAL FRAUD AND ABUSE
  16. 16. HOW IS FRAUD DETECTED? Part II: The Detection * Page 16 2012 REPORT TO THE NATIONS ON OCCUPATIONAL FRAUD AND ABUSE
  17. 17. Part II: The Detection * Page 17 HOW IS FRAUD DETECTED? 2012 REPORT TO THE NATIONS ON OCCUPATIONAL FRAUD AND ABUSE
  18. 18. HOW IS FRAUD DETECTED? KEY TAKEAWAY: ESTABLISH POLICIES, PROCEDURES AND MECHANISMS FOR TIPS! • Employees • Vendors • Customers • Other stakeholders Part II: The Detection * Page 18
  19. 19. WHO ARE THE PERPETRATORS? Part II: The Detection * Page 19 THE ONE COMMON ELEMENT IN EVERY FRAUD!
  20. 20. WHO ARE THE PERPETRATORS? THE FACES OF FRAUD Part II: The Detection * Page 20
  21. 21. WHO ARE THE PERPETRATORS? Part II: The Detection * Page 21 THREE POTENTIAL FRAUD PERPETRATORS 1. Those who are totally honest 2. Those who are situationally honest 3. Those who are totally dishonest
  22. 22. WHO ARE THE PERPETRATORS? Part II: The Detection * Page 22 IS EVERYONE A POTENTIAL CRIMINAL?
  23. 23. WHO ARE THE PERPETRATORS? TYPICAL PROFILE • Usually living above their means or has an addictive need • Does not have a prior criminal conviction or charged with a fraud • Has a position of trust and responsibility • Most likely a male between the age of 31 to 45 • Is well educated, with a college degree • Understands and skillfully uses technology • Usually comes across as a nice person, charming • Usually well respected • They usually spend everything they steal! • 80% will buy a new car! Part II: The Detection * Page 23
  24. 24. WHO ARE THESE PEOPLE? THE DILEMMA • Everyone has to a degree a propensity to commit a crime! • 90-99% of the population may commit a crime! • 1-5% are hard-core white collar criminals – psychopaths! • We are interested in the severity of the propensity of the 90-99% and definitely don‟t want the 1-5% working for us! Part II: The Detection * Page 24
  25. 25. WHO ARE THE PERPETRATORS? WHITE COLLAR CRIME CONTINUUM Part II: The Detection * Page 25 80% 9%9% 1%1% Neurotic Psychopathic Situational HonestyTotal Honesty Total Dishonesty Frauds: Smaller Larger Impact: Not individually materially Very destructive, can significant but can be completely destroy the costly over time organization If a person is making themselves miserable, they are probably neurotic. If a person is making everyone else miserable, they are character-disordered.
  26. 26. WHO ARE THE PERPETRATORS? Part II: The Detection * Page 26 *Simon (2010) Neurotic Psychopathic Well-developed, overactive superego; “suffer from too much conscience”* Significantly underdeveloped conscience, or no conscience at all Excessive capacity for guilt and shame Diminished capacity for share of guilt or remorse Suffer unreasonable and excessive anxiety Limited or no feeling of anxiety; impulsive; risk-taker Submissive Possessive; insensitive to the needs/wants of others; manipulative Hypersensitive to adverse consequences and social rejection Self-focused/self-centered; egomaniacal; narcissistic Ego-dystonic Ego-syntonic
  27. 27. WHO ARE THE PERPETRATORS? DOMAINS AND TRAITS OF THE PSYCHOPATH* Part II: The Detection * Page 27 *Psychopathy Checklist: Short Version (PCL:SV); Hare, Hart, & Cox • 1 - Superficial • 2 - Grandiose • 3 - Deceitful Interpersonal • 4 - Lacks remorse • 5 - Lacks empathy • 6 - Doesn‟t accept responsibility Affective • 7 - Impulsive • 8 - Lacks goals • 9 - Irresponsible Lifestyle • 10 - Poor behavior controls • 11 - Adolescent antisocial behavior • 12 - Adult antisocial behavior Antisocial Scoring: 2 points per trait; score of 18+ is generally diagnosed psychopathy
  28. 28. WHO ARE THE PERPETRATORS? WHO DID THE FBI PROFILE WITH THESE SYMPTOMS AND SIGNS? • Anger and arrogance • Capable of acting witty and charming • Good at flattery and manipulating other people‟s emotions • Disregards the safety of self and others • Does not show any guilt • Lies, steals, and fights often • Breaks the law repeatedly • Substance abuse and/or legal problems Part II: The Detection * Page 28
  29. 29. WHO ARE THE PERPETRATORS? Part II: The Detection * Page 29
  30. 30. WHO ARE THE PERPETRATORS? Part II: The Detection * Page 30
  31. 31. WHO ARE THESE PEOPLE? Part II: The Detection * Page 31 Selected Quotes from Bernie Madoff • “I‟m not the kind of person I‟m being portrayed as.” • “I made a lot of money for my clients.” • “My notoriety impresses [fellow inmates]. It shouldn‟t, but it does.” • “Does anybody want to hear that I had a successful business and did all these wonderful things for the industry? And got all these awards? And so did my family? I did all of this during the legitimate years. No. You don‟t read any of that. • “I realized from a very early stage that the [financial & investment] market is a whole rigged job. There‟s no chance that investors have in this market.” • “I was very proud of my sons, and they were very proud of me, what I accomplished. They liked being a Madoff. There was a lot of recognition in that, you know. • “Everyone was greedy. I just went along. It's not an excuse. Look, there was complicity, in my view. It‟s unbelievable. Goldman…no one has any criminal convictions – the whole new regulatory reform is a joke. The whole government is a Ponzi scheme.”
  32. 32. FRAUD DETECTION TECHNIQUES RED FLAGS BEHAVIOR FLAGS • Financial difficulties • Living beyond means relative to known income level • Family problems • Serious addiction to drugs, alcohol, or gambling • An unwillingness to share duties or allow others to help • Defensive behavior-overly nervous when questioned • A refusal to take vacations or very short vacations • Over-devotion to the job-working a lot of overtime and weekends-never calls in sick or misses work! • A close personal relationship with vendors or customers • Change in behavior • Rule breakers Part II: The Detection * Page 32
  33. 33. FRAUD DETECTION TECHNIQUES Part II: The Detection * Page 33 2012 REPORT TO THE NATIONS ON OCCUPATIONAL FRAUD AND ABUSE LIVING BEYOND MEANS #1!
  34. 34. FRAUD DETECTION TECHNIQUES Part II: The Detection * Page 34 2012 REPORT TO THE NATIONS ON OCCUPATIONAL FRAUD AND ABUSE LIVING BEYOND MEANS FUELED BY ASSET MISAPPROPRIATION!
  35. 35. FRAUD DETECTION TECHNIQUES FINANCIAL AND BUSINESS FLAGS • Business is inexplicably unprofitable • Company is having cash flow problems • Under capitalized • Financial statements are always late • Financial statement trends/ratios are inconsistent and do not make sense • Financial records and books are in disarray and always out of balance • Management‟s operating and financial decisions are dominated by a single person or a few persons acting in concert • Background checks are not conducted on key employees • High turnover of management and/or key accounting personnel • Management displays a propensity to take undue risks Part II: The Detection * Page 35
  36. 36. FRAUD DETECTION TECHNIQUES FINANCIAL AND BUSINESS FLAGS (continued) • Accounting personnel exhibit inexperience or laxity in performing their duties • Numerous banks and accounts • Frequent change in independent auditors/accounting firm • Management places undue pressures on the auditors, through fees and unreasonable deadlines • Frequent legal matters • Frequent change in legal counsel and multiple law firms • Operates on a “crisis” basis • Fire people quickly if they don‟t do what they want • Significant transactions with related parties • Problems with governmental and regulatory agencies Part II: The Detection * Page 36
  37. 37. FRAUD DETECTION TECHNIQUES INTERNAL CONTROL FLAGS • A single employee controls the company finances and accounting-lack of segregation of duties! • Bank accounts are not timely reconciled and not reviewed by someone independent of preparer • Invoices are paid without verifying receipt or purchase authorizations • Reimbursements are not supported by receipts or other supporting documentation • Excessive sales voids and credit memos • Missing deposit slips and/or cancelled checks • Unexplained inventory shortages or adjustments • Subsidiary account balances not reconciled • Unexplained and numerous end-of-period adjusting entries Part II: The Detection * Page 37
  38. 38. FRAUD DETECTION TECHNIQUES INTERNAL CONTROL FLAGS (continued) • Missing documents • Altered documents • Photocopy of documents when originals should be available Part II: The Detection * Page 38
  39. 39. FRAUD DETECTION TECHNIQUES PREVENTIVE VS. DETECTIVE CONTROLS Part II: The Detection * Page 39
  40. 40. FRAUD DETECTION TECHNIQUES PREVENTIVE CONTROLS Preventive controls attempt to deter or prevent undesirable events from occurring. They are proactive controls that help prevent a loss. DETECTIVE CONTROLS Detective controls, on the other hand, attempt to detect undesirable acts. The provide evidence that a loss has occurred but do not prevent a loss from occurring. Detective techniques should be used to uncover fraud events when preventive measures fail or unmitigated risks are realized. Part II: The Detection * Page 40
  41. 41. FRAUD DETECTION TECHNIQUES PREVENTIVE AND DETECTIVE CONTROLS IN ACTION Part II: The Detection * Page 41
  42. 42. FRAUD DETECTION TECHNIQUES PREVENTIVE CONTROLS • Segregations of duties with well defined job descriptions and policies and procedures • Job rotation • Mandatory vacations • Obtaining pre-approval on transactions before processing • Require dual signatures on checks above a certain amount • Using document control numbers to account for all transactions-checks, purchase orders, invoices etc… • Matching and comparing documents • Testing clerical accuracy • Physical controls over cash, checks, signatures, inventory and other assets • Computer passwords and access controls to prevent unauthorized electronic access Part II: The Detection * Page 42
  43. 43. FRAUD DETECTION TECHNIQUES PREVENTIVE CONTROLS (CONTINUED) • Back up financial files daily • Pre-employment background investigations • Employee training programs-fraud prevention • Prosecute the guilty Part II: The Detection * Page 43
  44. 44. FRAUD DETECTION TECHNIQUES DETECTIVE CONTROLS • Whistleblower Policies and Hotlines (TIPS!!!) • Management and supervisory reviews and approvals • Reconciliations • Independent review of bank reconciliations and supporting documents-cancelled checks • Independent review of vendor control file for suspicious vendors • Independent review of payroll files for suspicious employees. • Investigate customer and vendor complaints promptly • Physical inspections/counts • Financial analysis, budget vs. actual • Data analysis, data mining and continuous auditing techniques • Other technology tools • Audits-external, internal, surprise Part II: The Detection * Page 44
  45. 45. WHAT SHOULD YOU DO WHEN YOU UNCOVER FRAUD? FOR THE INDIVIDUAL WHOM SUSPECTS FRAUD • Follow your organization‟s Fraud Policy • Report through your designated anonymous reporting process or mechanism (e.g. hotline, anonymous letter to appropriate official, etc.) • Share your concern with your immediate supervisor or appropriate management, or organization‟s audit committee • Document observations promptly and your discussions • Do not confront the suspected perpetrator • Do not investigate the matter on your own • Do not discuss the matter with others Part II: The Detection * Page 45
  46. 46. WHAT SHOULD YOU DO WHEN YOU UNCOVER FRAUD? FOR THE ORGANIZATION • Employers have a duty to investigate promptly and thoroughly • Organization management should retain counsel (attorney/client privilege) • Counsel should retain a forensic expert to assist in the investigation (attorney/client privilege) • Employee (suspect) may be suspended with or without pay- but do it swiftly if enough predication is present • Employee (suspect) access to offices, computer systems, banking, communications and other access rights and privileges should be suspended or terminated • Establish communications protocol • Preserve evidence (documents, hard drives, secure office) • Understand legal implications (false allegations-termination) • Inform your insurance carriers (or other appropriate parties) Part II: The Detection * Page 46
  47. 47. WHAT SHOULD YOU DO WHEN YOU UNCOVER FRAUD? CONDUCTING A FRAUD INVESTIGATION • Objectives of the investigation should be conducted with integrity, fairness, impartiality and respect and include: – Determining the merits of the complaint (predication) – Gathering the facts-documenting the case (forensic accountant‟s report) – Complying with any legal obligations – Maintaining confidentiality – Preserving the reputations of individuals and the organization – Avoiding liability (slander, libel, wrongful termination) – Preventing future claims and incidences (root cause) Part II: The Detection * Page 47
  48. 48. WHAT SHOULD YOU DO WHEN YOU UNCOVER FRAUD? AFTER THE INVESTIGATION • Evaluate and decide on legal actions and recovery options • Take proper remedial actions-implement changes to internal controls, processes and procedures, personnel, security etc… to reduce future fraud risk exposure • Adopt a Fraud Prevention Policy and Program-include a ZERO TOLERANCE policy and reporting mechanism! • Have a Fraud Risk Assessment performed! • Organizational “damage” control-deal with swiftly, honestly and with full disclosure • Required disclosures and reporting Part II: The Detection * Page 48
  49. 49. WHAT YOU NEED TO KNOW ABOUT FRAUD THE FIVE MOST IMPORTANT TAKEAWAYS – AGAIN! 1. Trust is not an internal control! – Establish, to the extent possible, controls and procedures that eliminate the element of trust – Always segregate the custody of the asset with the recordkeeping for the asset 2. Set the tone from the top! – “If you are stealing, your employees are stealing!” – E.g., office supplies, expense reports, etc. 3. Know your employees! – Background investigations and public records checks before hiring – Meet and establish a baseline relationship 4. Institute a fraud policy – No tolerance – Will prosecute 5. Establish a hotline for tips – Number one method for detecting fraud! – Can outsource Part II: The Detection * Page 49
  50. 50. MY BOOK! EXPECTED RELEASE THIS SUMMER! STAY TUNED! 50Part II: The Detection * Page
  51. 51. HOW CAN RAFFA ASSIST YOU IN PREVENTING AND DETECTING FRAUD? A resource for the nonprofit community to help organizations effectively manage risk and better ensure the prevention and detection of fraud. VISIT US AT WWW.RAFFA.COM/FRAUD Part II: The Detection * Page 51
  52. 52. HOW CAN RAFFA ASSIST YOU IN PREVENTING AND DETECTING FRAUD? OUR WEEKLY NEWSLETTER OU Part II: The Detection * Page 52
  53. 53. HOW CAN RAFFA ASSIST YOU IN PREVENTING AND DETECTING FRAUD? Are you threatened by fraud, litigation or insolvency? Are you selling your business, transferring assets or structuring a new venture? Raffa forensic accounting experts will do more to assist you in these challenging circumstances. Part II: The Detection * Page 53 Forensic Accounting Services Group Our Team’s Services: • Fraud Investigations & Prevention • Litigation Support & Expert Testimony • Business Valuation & Due Diligence • Insolvency & Reorganization
  54. 54. HOW CAN RAFFA ASSIST YOU IN PREVENTING AND DETECTING FRAUD? How We Empower You • We identify and mitigate fraud risk by performing a fraud risk assessment • We provide fraud investigations if you are, or suspect you are, a victim of fraud • We provide litigation support, expert testimony and forensic accounting services in business disputes, financial investigations, bankruptcies, arbitrations and mediations • We analyze, investigate and interpret complex transactions to provide an understandable, well-researched and unbiased valuation of your business or organization • We have expertise in restructuring and turnaround management for underperforming organizations Part II: The Detection * Page 54 Forensic Accounting Services Group
  55. 55. HOW CAN RAFFA ASSIST YOU IN PREVENTING AND DETECTING FRAUD? Part II: The Detection * Page 55 Fraud Investigations & Prevention • Fraud examinations and internal investigations • Fraud risk assessments • Review of internal controls and management practices • Financial statement misrepresentations • Background and workplace investigations • Computer forensic analysis, imaging, data mining and recovery • Reconstruction of accounting records • Continuous audit services • Anti-fraud consulting and training Forensic Accounting Services Group Litigation Support & Expert Testimony • Lost earnings and profits • Lost value • Breach of contract • Breach of fiduciary duty • Business interruption • Contract costs and claims • Tortious interference • Patent infringement • Professional malpractice • Shareholder disputes • Theft of intellectual property • Wrongful termination • Wrongful death
  56. 56. HOW CAN RAFFA ASSIST YOU IN PREVENTING AND DETECTING FRAUD? Part II: The Detection * Page 56 Business Valuation & Due Diligence • Mergers, acquisitions and divestitures • Marital dissolution • Partner/shareholder disputes • Estate and gift tax planning • Financial reporting • Compensation related • Employee stock ownership plans • Benchmark studies • Financial modeling Forensic Accounting Services Group Insolvency & Reorganization • Viability analysis and survival assessment • Strategic restructuring • Cash flow analysis and forecasting • Liquidation analysis • Evaluating creditor and debtor positions • Restructuring debt • Interim management services, including Chief Restructuring Officer • Preparing plans of reorganization and disclosure statements • Pre-bankruptcy planning and post- filing compliance • Bankruptcy litigation consulting to trustees
  57. 57. SOME AREAS WE WILL BE GOING OVER IN OUR OTHER PRESENTATION PART III: THE PREVENTION – JUNE 11, 2014, 12:00-2:00 P.M. • Fraud risk assessments • Setting the tone at the top and your board of directors • What are the best preventative measures and controls? • The five critical takeaways! Part II: The Detection * Page 57
  58. 58. RESOURCES AND SUGGESTED READING • 2012 Report to the Nations on Occupational Fraud and Abuse, Association of Certified Fraud Examiners, http://www.acfe.com/rttn.aspx • Managing the Business Risk of Fraud: A Practical Guide; AICPA, ITA, and ACFE; https://na.theiia.org/standards- guidance/Public%20Documents/fraud%20paper.pdf • The CPA’s Handbook of Fraud and Commercial Crime Prevention, AICPA • “The American Fraud Report,” www.jpsimsconsulting.com • “Fraud Talk” Blog, fraudtalk.blogspot.com • “American Greed” series, CNBC on Wednesdays at 9 p.m. Part I: The Fraud* Page 5858Part II: The Detection * Page
  59. 59. QUESTIONS AND ANSWERS Part II: The Detection * Page 59
  60. 60. BIOGRAPHY Part II: The Detection * Page 60 • 35 years of consulting, audit, accounting and tax experience in the public and private sectors. • Started career with a Big-Four international accounting firm in Washington, DC. • Founded a regional certified public accounting and consulting firm in 1982 and grew it to on of the Washington, DC‟s largest firms in seven years. Merged his practice with Raffa P.C. in 2008. • Managed and conducted audit and accounting engagements ranging from small privately held to large publicly held businesses in various industries, including multi-national businesses, nonprofit organizations, and governmental entities and agencies. • Performed economic and financial analysis, including projections and forecasts, in support of litigation and claims for lost earnings and profits, business interruption, shareholder disputes, patent and trademark infringements, bankruptcy and restructuring, and structural settlements; assistance with interrogatories, document requests and depositions; and serving as an expert and consulting witness. • Performed and supervised business valuations for both public and closely held companies in a variety of industries, individuals and estates, family limited partnerships and limited liability companies, including valuations for business combinations (SFAS 141R), mergers, acquisitions, and divestitures, estate and gift taxes, marital dissolution proceedings, buy- sell agreements, intangible assets and intellectual property, purchase price allocations, goodwill (SFAS 142) and long-lived asset (SFAS 144) impairment, fair value accounting (SFAS 157), cheap stock (IRC 409A), stock-based compensation (SFAS 123R), phantom stock and employee stock ownership plans. • Conducted and led teams of forensic accountants on fraud audits and investigations, including fraudulent financial statements, misappropriations of assets and embezzlements; money laundering, kickbacks, bribery and conflicts of interest; insurance claims; bankruptcy; financial institutions and loan fraud. Also has conducted fraud risk assessments, anti-fraud programs, and fraud training and education. LAWRENCE J. HOFFMAN, CPA/CFF, CVA, CFE SENIOR PARTNER RAFFA, P.C. 1899 L STREET, NW WASHINGTON, DC 20036 TEL. 202-822-5408 FAX 202-822-0669 LHOFFMAN@RAFFA.COM
  61. 61. BIOGRAPHY Part II: The Detection * Page 61 • Assisted companies and nonprofits with restructuring and turnaround situations, including recapitalizations, reorganizations and liquidations. Advised entities on Chapters 11 and 7, bankruptcy filings and proceedings and non-judicial workouts. Developed and administered crisis management plans, cash flows, liquidation and turnaround analysis, debt restructuring and creditor negotiations, and turnaround plans. • Formulated strategic short- and long-term business and financial planning for various business organizations and served as interim “C” level positions, including for a major North American sports league, European and U.S. aircraft manufacturer, aviation charter airline and travel company, and a multi-chain quick service food chain. • Formulated syndication strategies and prepared business plans and private placement offerings, including financial forecasts, market research and analysis, due diligence, securities pricing and structuring for various public and private securities offerings, including SEC filing. • Founded and developed a regional NASD licensed broker dealer investment banking firm. Placed over $150 million in debt and equity and represented over $200 million in merger and acquisition transactions. • Founded and developed two private equity funds in excess of $10 million, including investments in early stage and mature emerging companies in the form of debt and equity. Portfolio investments included aviation, food and hospitality, software and technology, telecommunications, sports and entertainment, banking and financial institutions, healthcare, and wholesale and retail. • Co-founded and managed various real estate acquisition, ownership, and operating entities, including commercial office buildings, shopping centers, flex warehouses, residential housing and developed land. • Performed tax and financial consulting services for individuals and closely held businesses. • Instructor in audit, accounting, finance, and forensic accounting. LAWRENCE J. HOFFMAN, CPA/CFF, CVA, CFE SENIOR PARTNER
  62. 62. BIOGRAPHY Part II: The Detection * Page 62 LAWRENCE J. HOFFMAN, CPA/CFF, CVA, CFE SENIOR PARTNER EDUCATION & CERTIFICATIONS • Bachelor of Science, Accounting – Mount St. Mary‟s University • Certified Public Accountant (CPA) • Certified Fraud Examiner (CFE) • Certified in Financial Forensics (CFF) • Certified Valuation Analyst (CVA) • Private Investigator (PI), Virginia • Series 7 General Securities Representative (not active) • Series 24 General Securities Principal (not active) • Series 63 Uniform Securities Agent (not active) PROFESSIONAL ASSOCIATIONS & AFFILIATIONS • American Institute of Certified Public Accountants, Member • Virginia Society of Certified Public Accountants • Association of Certified Fraud Examiners • National Association of Certified Valuation Analysts • Institute of Business Appraisers PERSONAL INTERESTS • Private pilot with instrument, multi-engine, high performance complex and aircraft ratings • Golf and fishing • Reading and politics
  63. 63. BIOGRAPHY • 9 years of fraud investigation and financial audit experience • Started career with U.S. Government Accountability Office‟s Forensic Audits and Special Investigations Unit • Led as many as 3 concurrent forensic audits and investigations on a variety of topics, including: Federal contractor/grantee eligibility fraud and integrity issues; federal tax collection program integrity; abuse of government purchase cards, travel cards, and premium class travel privileges; employment of sex offenders and child abusers at schools and child care facilities; passport application fraud; manufacture and marketing of herbal dietary supplements • Planned, developed, and completed audit and investigative objectives, scope, and methodology • Designed innovative analytical strategies and investigative techniques to identify fraud indicators in complex datasets, using software packages such as IDEA and SAS • Identified, investigated, and ultimately referred hundreds of cases of potential fraud, waste, and abuse to federal authorities for administrative action • Led multiple undercover operations of varying complexity and political sensitivity • Drafted numerous congressional testimonies and publicly available audit reports (see co-authorship experience below) • Designed and implemented internal quality assurance policies and procedures • Bachelor of Science, Accounting – University of Maryland, College Park • Bachelor of Science, Finance – University of Maryland, College Park • Designated as a Certified Fraud Examiner (CFE) by the Association of Certified Fraud Examiners Leslie C Kirsch, CFE Manager RAFFA, P.C. 1899 L STREET, NW WASHINGTON, DC 20036 TEL. 202-955-7204 FAX 202-822-0669 LKIRSCH@RAFFA.COM Part II: The Detection * Page 63
  64. 64. THE FRAUD TRIANGLE PRESSURE Part II: The Detection * PagePart II: The Detection * Page 64
  65. 65. THE FRAUD TRIANGLE RATIONALIZATION Part II: The Detection * PagePart II: The Detection * Page 65

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