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CPE Event: Business Fraud
- 1. Business Fraud – “It’s Really Simple” Charles W. Schulze, CPA, CFF, CFE © 2012 Elliott Davis, PLLC © 2012 Elliott Davis, LLC
- 2. This material was used by Elliott Davis during an oral presentation; it is not a complete record of the discussion. This presentation is for informational purposes and does not contain or convey specific advice. It should not be used or relied upon in regard to any particular situation or circumstances without first consulting the appropriate advisor. No part of the presentation may be circulated, quoted, or reproduced for distribution without prior written approval from Elliott Davis. © 2012 Elliott Davis, PLLC © 2012 Elliott Davis, LLC 2
- 3. Overview of Business Fraud Our Goal Today: -Who steals? -How they steal? -How we find out? © 2012 Elliott Davis, PLLC © 2012 Elliott Davis, LLC 3
- 4. Overview of Business Fraud • The Association of Certified Fraud Examiners “ACFE”, of which I am a member, publishes an excellent survey on business fraud. The survey is done every other year and contains very detailed statistics on business fraud. Like other surveys you can be bogged down with details that aren’t needed. This presentation will highlight things that are beneficial for you in understanding the major issues facing us today regarding fraud.
- 5. Overview of Business Fraud • We are going to relate some of the ACFE findings with cases I have seen in the Southeast over the last few years. There will be differences. • We are going to look at some simple steps that can be can used to minimize fraud in the organizations we are associated (client businesses, our business, organizations where you serve as a board member – which include non-profits). • We will look at some examples of business fraud-some of which will surprise you for being so simple.
- 6. ACFE’s 2014 Report to the Nations “The cost of fraud is the equivalent of a financial iceberg; some of the direct losses are plainly visible, but there is a huge mass of hidden harm that we cannot see.” - Report to the Nations, ACFE
- 7. The Cost of Business Fraud
- 8. Most Popular Things to Steal
- 9. How Long Does Fraud Last?
- 10. Duration of Fraud Schemes
- 11. How are Most Fraud Schemes Found?
- 12. Sources of Tips
- 13. Type of Victim
- 14. ACFE’s 2014 Report to the Nations
- 15. ACFE’s 2014 Report to the Nations
- 16. Who Steals?
- 18. How Old Are These Crooks?
- 19. ACFE’s 2014 Report to the Nations
- 20. ACFE’s 2014 Report to the Nations
- 21. ACFE’s 2014 Report to the Nations
- 22. Red Flags
- 23. Referrals to Law Enforcement
- 24. So Much for National Statistics… What does that mean for us in the Southeast? •The survey showed an average loss of about $150,000. That is generally on the low side of what we see in the Southeast. •Frauds in the $150,000 range are usually associated with religious and non-profit organizations. •We have seen several frauds from $1-$2M. These have been with small-medium sized businesses here in South Carolina.
- 25. Fraud in our Area • The Granddaddy is a current case where 3 CPA’s lost their licenses for their participation in the Fraud scheme. • The total lost over the ten year period appears to be in excess of $60,000,000 in a mortgage fraud and Ponzi scheme that is currently before the US Attorney. •While we see some very large cases, it is rare that they are associated with cash misappropriations • The examples we gave under $2M are all cash deals.
- 26. How do they get away with it? • Most often it’s the level of trust we place on those who work for us. We should trust our employees but you need to maintain a healthy degree of skepticism when dealing with them. There is nothing wrong with reviewing or questioning their work from time to time. If you don’t…YOU ARE AT RISK!
- 27. Behavior Patterns to Look For • Top 3 Patterns we see in most fraud cases 1. Living beyond ones means and personal financial problems 2. Close relationships with vendors and customers 3. Management style of those in charge of finances
- 28. How to Minimize Business Fraud? 1. Maintain healthy degree of skepticism. 2. Stay involved with your business on a daily basis – avoid being an absentee owner. 3. Make it a habit to review bank statements and reconciliations and ask questions even if you know the answers. 4. Review invoices and deposits on a regular basis. 5. Set an anti-fraud tone at the top. Make sure employees understand that fraud will not be tolerated.
- 29. Examples of Fraud – Case One • Case One (active case – has not gone to court) - A church secretary was arrested after our investigation was concluded. - We first looked at bank transactions to see if secretary was stealing via checks. - See the images that follow.
- 31. Case One Evidence cont…
- 32. Case One Evidence cont…
- 33. Case One – What we Learned • The Secretary did crazy things with the bank statements BUT this evidence had very little to do with why the church had no money. • So, we decided to look at cash but found nothing missing with cash collections from Sunday church services. • The church operated a day care center. We decided to look as cash collections and deposits for it.
- 34. Review of Cash deposits – Church day care center • Eight year review of financials (SECRETARIES MAKING DEPOSITS) MONTHS AVERAGE MAKING TOTAL MONTHLY DEPOSITS CASH CASH DEPOSIT J. A. 14.00 19,062.86 1,361.63 L. SP. 75.00 41,891.80 558.56 A. S. 11.00 35,231.92 3,202.90 100.00 96,186.58 A. & S. 25.00 54,294.78 2,171.79 SP. 75.00 41,891.80 558.56 1,613.23 DIFFERENCE TIMES 75 MONTHS 120,992.54
- 35. Examples of Fraud – Case Two • Case Two - Local non-profit taken to the cleaners for $240,000 over a seven year period. - April Miller, the bookkeeper was convicted of breach of trust over $10,000 and ordered to make restitution (probably won’t happen).
- 36. Miller Was Good • She used seven techniques to keep her fraud going: 1. Taking checks from the rear of the checkbook where the checks would not be discovered for years. 2. Noting the payee in the checkbook as another entity and making out the actual check to Ms. Miller. 3. Noting a smaller amount in the checkbook in checks to Ms. Miller and making out the check for a much larger amount.
- 37. Miller was Good! Cont… 4. Making her payroll check from the proper bank account and then at the same time or a day or two later another “payroll” check from another bank account. 5. Per some former authorized signors of checks, their signatures had been forged on some checks. 6. Photo shopping the bank statement and manipulating it make it look like the organization of plenty of funds. 7. Maintaining two sets of QuickBooks.
- 38. Case Two – Supporting Documents
- 39. Examples of Fraud – Case Three • Case Three - Columbia, SC small company controller steals more than $1 million over course of 6+ years. - No names included here as investigation and legal proceedings are ongoing. - Former controller (“Suspect”) was employed by Company from 2005 through 2013. - During that time, Suspect made payments to him/herself via direct deposit from Company’s payroll bank account at least in the amount of $978,311 . - Additionally, payments made to Suspect in amount of $51,388 in 2 altered checks.
- 40. Case Three - Small Company Controller and Embezzler • How did Controller do it? - Two bank accounts: operating and payroll. - In addition to “normal” bi-monthly company-wide payroll disbursements, Controller initiated three smaller direct deposit transactions most months to Controller’s personal bank account. - In the GL, these three transactions were recorded as one transaction, most typically as an expense transaction to one of the Company’s most significant income statement line items.
- 41. Case Three - Small Company Controller and Embezzler • How was Controller able to get away with it? - Lack of segregation of duties: Controller had responsibilities over payroll, A/P disbursements, and bank reconciliations. - General manager of Company “reviewed” bank statements but clearly did not understand them or look very closely; evidence does not indicate that General Manager was ever even provided with the payroll account monthly statement. - Three-payment pattern per month consistently followed over several years, but never during month of September (company year end was Sept. 30).
- 42. Case Three - Small Company Controller and Embezzler • How was Controller caught? - Controller quit company early 2013. - Before leaving Controller got greedy and careless • Recorded illicit transactions in GL against inventory account rather than expense account (on accident?) • Additionally, altered two checks recorded in GL to Company’s largest supplier and made payable to shell company of Controller - Financial statement audit for FY 2013: inventory sub-ledger was out of balance which led to subsequent investigation.
- 43. Case Three - Small Company Controller and Embezzler •What was the fall-out? - Known amounts embezzled: • 2007 – $ 90,000 • 2008 – $ 141,000 • 2009 – $ 190,000 • 2010 – $ 143,000 • 2011 – $ 141,000 • 2012 – $ 204,000 • 2013 – $ 121,000 (resigned 4 months into fiscal year) Total – $ 1,030,000
- 44. Case Three - Small Company Controller and Embezzler Behavior signs: - Complained about compensation - Very protective of her work - Lifestyle did not match her compensation FROM POLICE REPORT: “She paid her fellow employees to attend her wedding out of state including airfare and lodging and paid her wife’s wedding cost”
- 45. Have you seen anything that was difficult? • The techniques used by these fraudsters are based on plain old common sense! • The most difficult technique was photo shopping the bank statements and keeping two sets of books! • This was not done by a college graduate…just someone with a high school diploma.
- 46. What should you take away from this? • Financial fraud is simple and is based on three things: 1. OPPORTUNITY 2. RATIONALIZATION 3. FINANCIAL PRESSURE
- 47. QUESTIONS ?
- 48. Charles W. Schulze, CPA, CFF, CFE Email: cschulze@elliottdavis.com Phone: 864-229-4951 Website: www.elliottdavis.com Elliott Davis, LLC/PLLC is one of the largest accounting, tax and consulting services firms in the Southeast and ranks among the top 50 CPA firms in the U.S. With offices in SC, NC, GA and VA, the firm provides clients across a wide range of industries with smart, customized solutions and its people with rewarding opportunities. Founded in 1925, Elliott Davis is a member of The Leading Edge Alliance, an international professional association of independently owned accounting firms based in the U.S. and is strategically aligned with LEA Europe and LEA Asia Pacific, a worldwide network of more than 450 offices in 100 countries around the globe. For more information about Elliott Davis and its services, visit http://www.elliottdavis.com. © 2012 Elliott Davis, PLLC © 2012 Elliott Davis, LLC 48
Editor's Notes
- One metric that can be effectively measured and used to analyze the cost of fraud is the amount of financial damage caused by individual instances of known fraud. Of the 1,483 cases in our study, 1,445 included information about the total dollar amount lost to fraud; for those, the median loss caused by the scheme was $145,000. Additionally, over our last three studies, the dollar losses of the cases analyzed have followed a relatively distinct pattern, with just over half causing losses under $200,000 and more than one-fifth involving losses of at least $1 million.
- Of the three primary categories of occupational fraud, asset misappropriation is by far the most common, occurring in more than 85% of cases analyzed for this Report; however, it is also typically the least costly of the three types, causing a median loss of $130,000. In contrast, financial statement fraud occurs much less frequently, accounting for 9% of the cases in our latest survey, but it causes the greatest financial impact of the three categories by far, with a median loss of $1 million. Corruption tends to fall in the middle in terms of both frequency and median loss.
- The correlation between how long fraud schemes last and the amount of financial damage they cause might seem self-evident. However, Figure 9 provides a clear illustration of the importance of early detection. It is encouraging to note that one-quarter of the frauds in our study were detected in the first six months of their occurrence; for those cases, the median loss was limited to $50,000. In contrast, the longer frauds were able to go undetected, the more costly they became.
- How long does it take to detect a fraud scheme? It depends. On average, the types of schemes we see more of are going to be detected within three years. We rarely see a scheme last less than 3-4 years.
- As Figure 11 demonstrates, tips are consistently the most common detection method for cases of occupational fraud by a significant margin, which has been an observed trend since we first began tracking this data in 2002. Management review and internal audit follow tips, which was also true for the 2010 and 2012 Reports.
- It is well known that employees are a valuable source of information for discovering potential fraud, and Figure 13 shows that employees were the source of almost half of all tips that led to the detection of fraud. Occupational fraud has a negative impact on an organization, including those who work for it, which might explain why employees so often step forward. At the same time, there is often a risk of backlash for whistleblowers, which might explain why a substantial amount of tips came from anonymous parties (14.6%). The fact that more than half of all tips involved parties other than confirmed employees emphasizes the importance of cultivating tips from various sources. For example, many employers circulate a whistleblower policy or fraud hotline information to employees only, but our data indicates that it is also advantageous to educate vendors, customers and owners/shareholders on how to report suspicions of fraud.
- As in previous studies, privately owned and publicly traded organizations accounted for approximately two-thirds of the victims in the cases reported to us. These for-profit organizations also suffered the greatest median losses, which is consistent with our previous Reports. In contrast, government entities and not-for-profits made up 15.1% and 10.8%, respectively, of the cases analyzed and reported much lower median losses than their for-profit counterparts.
- Figure 22 categorizes the cases reported to us by industry of the victim organization. Similar to the findings in our previous Reports, banking and financial services, government and public administration, and manufacturing were the most represented sectors among the fraud cases analyzed. On the other end of the spectrum, the industries with the lowest frequency of fraud cases were mining; communications and publishing; and arts, entertainment and recreation. While this data shows the distribution of cases in our study, it does not necessarily mean that certain industries are more at risk of fraud than others. Our study focuses on cases investigated by CFEs, so Figure 22 primarily reflects the industries in which CFEs work. The fact that CFEs tend to be hired more in some industries than others could indicate those industries are at greater risk of fraud, but it could also be a sign that they are more proactive in dealing with anti-fraud issues.
- Survey respondents where asked what they thought were the primary internal control weaknesses that contributed to the frauds they had investigated. As noted in Figure 39, in nearly one-third of the cases, the victim organization lacked the appropriate internal controls to prevent the fraud, which reinforces the importance of targeted anti-fraud controls. A lack of controls played an even bigger role in those cases affecting small businesses; this was attributed as the primary weakness at more than 41% of cases at organizations with fewer than 100 employees. Additionally, according to the CFEs who participated in our study, one-fifth of the reported cases could have been prevented if managers had done a sufficient job of reviewing transactions, accounts or processes.
- Figure 40 shows the distribution of fraud perpetrators based on their level of authority. Forty-two percent of occupational frauds were committed by employee-level perpetrators, 36% were committed by managers and approximately 19% were committed by owners/executives. The distribution of these categories has remained remarkably consistent from year to year.
- More than half of the frauds in our study were committed by a single perpetrator, but when two or more individuals conspired to commit an occupational fraud, losses rose dramatically (see Figure 53). When employees collude in a fraud scheme, they can subvert the system of independent checks that might otherwise catch a fraudulent transaction, thus enabling them to steal larger amounts. Furthermore, in a scheme involving multiple perpetrators, there are more individuals expecting a payout, which might also help explain why multiple-perpetrator frauds tend to involve greater losses. Interestingly, we found no correlation between the number of perpetrators and the duration of schemes; frauds with multiple perpetrators did not tend to last any longer than single-perpetrator frauds, even though they caused much larger losses.
- The age distribution of the fraudsters in our study is shown in Figure 55. This distribution is very similar to those of our previous studies, with approximately 52% of perpetrators between the ages of 31 and 45. While the age distribution of fraudsters fits a bell curve model, the median loss of frauds tends to rise with the age of the perpetrator, as seen in Figure 56. In our 2014 data, the rise was fairly gradual and consistent as ages increased. In 2010 and 2012, we saw certain outlier categories where median losses jumped significantly (in the >60 age range for 2010 and in the 51-55 age range for 2012). Overall, however, the data seem to show that older fraudsters tend to generate larger losses. This is probably an indirect reflection of the fact that high-level personnel within an organization tend to be older than lower-level employees. For example, 36% of the fraudsters in our study who were over 50 years of age were owners/executives, while only 15% of those who were 50 or younger were owners/executives.
- Figure 57 shows that approximately two-thirds of the fraudsters identified in our study were male, which is consistent with past findings. Guess what? I do not see that. Well over sixty percent of my cases over the last ten years have been females!
- The distribution of fraudsters in our study based on their tenure with the victim organization is shown in Figure 63, and we can see that it has remained consistent with our 2010 and 2012 data. The largest group of fraud perpetrators (41%) had been employed by their targets between one and five years before committing their crimes. Less than 7% committed fraud within the first year of employment with the victim. However, fraudsters in the first-year group were more than three times as likely to have a prior fraud-related conviction (15% of all first-year fraudsters had prior convictions, as opposed to only 4% of those with at least one year of tenure), and they were twice as likely to have been previously charged but not convicted of a fraud (14% for first-year fraudsters versus 7% for those with at least one year of tenure).
- Figure 66 shows the departments that the fraud perpetrators worked in. There were seven departments that each accounted for 5% or more of all cases: accounting, operations, sales, executive/upper management, customer service, purchasing and finance. Collectively, these seven departments were responsible for approximately 77% of all frauds in our study. The department with the greatest incidence of fraud was accounting, but the level of frauds perpetrated by accounting personnel in our 2014 study (17%) was much lower than what we found in our two previous Reports. However, this was the first study we’ve conducted in which frauds in the finance department accounted for at least 5% of all cases.
- These are the national stats. In a moment I will tell you my top three. Our survey respondents were asked to identify which, if any, common behavioral indicators were exhibited by the perpetrators before their frauds were detected. Overall, at least one red flag was identified in 92% of cases, and, in 64% of cases, the fraudster displayed two or more behavioral red flags. Figure 71 shows the distribution of those red flags. Approximately 44% of fraud perpetrators were living beyond their means while the fraud was ongoing, and 33% were experiencing known financial difficulties. Other common red flags were an unusually close association with a vendor or customer (22%), displaying control issues or an unwillingness to share duties (21%), a general “wheeler-dealer” attitude involving shrewd or unscrupulous behavior (18%), and recent divorce or family problems (17%). These six red flags were also the most common behavioral indicators in each of our last three studies. In general, the distribution of behavioral red flags from year to year has followed a remarkably consistent curve despite the fact that each of our studies contains entirely distinct cases of fraud and perpetrators.
- The majority of cases reported (61%) were referred to law enforcement for criminal prosecution, down about 4% from 2012. The median loss for cases referred for criminal prosecution was $200,000, while cases that were not referred had a median loss of $75,000. These findings are almost identical to the 2012 data ($200,000 and $76,000, respectively).
- Notice that she started out small in 2007! She was on track for over $300,000 when she resigned.