The document discusses fraud awareness for managers. It defines fraud and provides examples of regulatory definitions. It outlines factors that can contribute to fraud such as lack of controls and management oversight. The document emphasizes the importance of prevention through controls and establishes tone at the top. It lists behavioral and other red flags that could indicate fraud.

1. FRAUD AWARENESS For MANAGERS Ricardo Rios CFE

2. DEFINITIONS OF FRAUD “ Deceit, trickery; cheating, intentional deception to cause a person to give up property or some lawful right.” (Webster’s Dictionary) “ Any intentional act, or series of acts, that is designed to deceive or mislead others and that has an impact or potential impact on an organization’s financial Statements.” (AICPA EDP Fraud Review Task Force) “ Fraud is criminal deception intended to financially benefit the deceiver.” ( The Accountant’s Handbook of Fraud and Commercial Crime) “… all multifarious means which human ingenuity can devise, and which are resorted to by one individual to get an advantage over another by false suggestions or suppression of the truth. It includes all surprise, trick, cunning or dissembling, and any unfair way by which another is cheated.” (Black’s Law Dictionary, as cited by the ACFE)

3. WHAT IS THE INDUSTRY SAYING…… New Regulations New Enforcement Customer Focus Investor Focus Stiffer Fines Firms are under tighter scrutiny Regulators are acting with renew vigor, authority and political backing

4. REGULATORY ENVIRONMENT Current Regulatory environment is simply not business friendly. Staggering financial losses both by major institutions and by consumers have highlighted the need for greater transparency from institutions and more oversight on the part of the regulators. Consumer and investor protection is the primary focus of all regulators. High profile fraud cases, such as Madoff, have resulted in the need to step-up regulation of all financial services industries. Administration and Congressional initiatives have increased the pressure on regulators act now, re-examine their internal operations and re-focus their priorities as they push for greater accountability. Every firm has at least one horror story about a bad associate that regulators seize on to justify greater oversight of the firm.

5. FINRA WATCHDOG Significant initiatives undertaken by FINRA in the wake of the Madoff and Stanford scandals. FINRA launched a new initiative to target fraud within its purview of the financial industry. New leadership. Establishment of the Office of the Whistleblower. Designated the Office of Fraud Detection and Market Intelligence Changes in the FINRA enforcement program. Sweep examinations. Given near carte blanche to pursue fraud after FINRA missed the multibillion dollar Ponzi schemes of Madoff and Allen Stanford, whose broker-dealers were registered FINRA members and under its supervision.

6. FINRA REGULATORY NOTICE ON DISBURSEMENTS FINRA has “suggested” that all firms re-review controls and supervision for disbursements from client accounts Third party disbursements Confirming client identity and validating client signatures on instructions Are disbursements being made to Rep? Rep family? OBA? Address Change Requests Is address being changed to P.O. Box? Reps address? Rep’s OBA address? Scrutinize cases on OSJ Tool and common address reports: Unless client truly lives with Rep, Rep address should never be address of record. A call to the client to confirm should be done in suspicious circumstances IF YOU SEE SOMETHING, SAY SOMETHING

7. WHY FRAUD IS A BIGGER CONCERNS IN THE CURRENT ECONOMIC ENVIRONMENT The cost of fraud to organizations remains high Economic downturn Slow economic times bring increased incidence of fraud. Employee engagement Technological advances New technologies have increased the number of employees accessing corporate systems Growing complexity of the organization New products Culture transformation

8. FACTORS THAT CAN CONTRIBUTE TO FRAUD In a 2010 survey conducted by the Association of Certified Fraud Examiners, participants were asked what they believed were the most important contributing factors that allowed fraud to occur. The top three responses were: Lack of controls Absence of Management Reviews Override of existing controls

9. CONTROLS While the definition of "internal control" historically applied almost exclusively to the accounting profession, it has evolved over time. The U.S. Securities and Exchange Commission (SEC) has acknowledged that having proper internal controls is essential in the prevention and detection of fraud.

10. CONTROLS Controls and established procedures are in place to reduce risk and minimize the opportunity for errors and fraud. When controls are ignored or circumvented, the opportunity for fraud increases. It is management’s responsibility to ensure that all controls are in place and appropriate procedures are followed.

11. INTERNAL CONTROLS AND EVALUATION Internal control system consists of policies and procedures designed to provide management with reasonable assurance that goals and objectives are met. One of the major purposes of internal controls is to safeguard the assets and records or the company, its businesses, and clients against fraud, errors and misuse. The effectiveness of internal controls depends on the competency and dependability of the people implementing and following them. Most cost-effective way to combat fraud is through prevention. Anti-fraud controls had a significant impact on the reduction of losses when a fraud was occurring.

12. ANTI-FRAUD CONTROLS Internal controls related to fraud… Preventive controls Detective controls Corrective controls

13. ANTI-FRAUD CONTROLS (continue) Preventive controls Designed to discourage or pre-empt errors or irregularities from occurring. Deter problems before they arise. Focused on protecting the company’s assets and information by stopping fraud from occurring. Effective preventive controls Hiring highly qualified accounting personnel Appropriately segregating employee duties, and effectively controlling physical access to assets, facilities and information

14. ANTI-FRAUD CONTROLS (continue) Detective controls Designed to search for and identify errors after they have occurred. Account reviews and reconciliations, observations of payroll distribution, periodic physical inventory counts, passwords, transaction edits and internal/compliance auditors are all examples of detective controls

15. INDUSTRY REPORTS SHOW……….. If fraud were a virus, almost everyone would be slightly ill. Increase of fraud in the Financial Service Fraud is most often an inside job Data breach – increase of incidence of information theft A call from a client complaining that his/her account has be looted Corporate information technology systems are increasingly under attack Disgruntle employee walking into the office with a memory stick and walking out with details of the companies most valuable intellectual property Mishandled paper can reveal as much as mishandled data files Easy to steal and have tangible value

16. MANAGEMENT PHILOSOPHY Management has articulated its position on the following matters: Business Practices Conflicts of Interest Care of Assets Reporting Violations

17. THE POWER OF CORPORATE CULTURE KPMG LLP, Integrity Survey – found that among companies with a comprehensive ethics and compliance program, 90 percent of the respondents described the environment as one where the people feel motivated and empowered to do the right thing. A Strong ethical culture starts with an organization's most senior leaders (thus the phrase “Tone at the top” and cascades down through the entire organization. It reflects and reinforces the companies operating value. Senior leaders have a level of commitment to integrity, to doing the right thing at all costs.

18. FRAUD IN THE NEWS

19. THE EVOLUTION Knowing what might provoke an employee, even an otherwise lawful individual, to blur the line between legal and illegal activity is one of the key to fighting fraud effectively. Famed criminologist Donald R. Cressey first identified three elements – Opportunity, Pressure, and rationalization – as the “fraud triangle” in the 1950’s to explain why people commit fraud.

20. LEVERAGING THE FRAUD TRIANGLE TO IDENTFY POTENTIAL FRAUD Incentives/Pressures: Expensive lifestyle to maintain Dissatisfaction with the company Career Disappointment Layoff/redundancy Pressures from management and third parties Opportunity: Insufficient internal controls External collaboration Management override Internal collaboration Corrupt business customs Rationalization/Attitude: Lacking awareness of wrongdoing Low temptation threshold Self-denial of consequences to company

21. WHAT IS A RED FLAG A Red Flag is a set of circumstance that are unusual in nature or vary from the normal activity. Its is a signal that something is out of the ordinary and may need to be investigated further. Does not indicate quilt or innocence but merely provided possible warning sign of fraud.

22. RED FLAGS OF FRAUD Understanding symptoms of fraud is the key to detecting fraud. A symptom of fraud may be defined as a condition which is directly attributable to dishonest or fraudulent activity. It may result from the fraud itself or from the attempt to conceal the fraud. The following are representative examples of symptoms or “red flags” of fraud: A document goes missing. Someone acts suspiciously.

23. RED FLAGS OF FRAUD (continue) An accounting relationship doesn’t make sense. Other explanations for these red flags…… documents are really lost person came into an inheritance the suspicious actions maybe caused by family problems accounting activities maybe the result of unrecognized changes in underlying economic factors “ Analytical anomalies” relationships, procedure, and events that do not make sense

24. BEHAVIORAL RED FLAGS OF FRAUD Significant changes in personal behavior in the workplace. Reluctance to take vacation or be away from the office. Tendency to manage by crisis; a disregard for structure, controls, or procedures. A desire to control operations and assets; a disregard for the segregation of duties. Chronic job frustration; active opposition to rules and order. Continual adversarial relationships with groups or individuals within and outside the organization, particularly auditors.

25. BEHAVIORAL RED FLAGS OF FRAUD (Continued) Resentment about perceived favoritism, always feeling passed over. Pattern of exceptions. Exceptions are the rule, not the exception. Extraordinary personal hardship or stress (e.g. Financial, gambling, substance abuse, or long-term illness in family). Suggestions of heavy personal debt. Extravagant purchases or lifestyle.

26. RED FLAGS Wheeler-dealer attitude Secretive, territorial Intellectual challenge to “beat the system” Not taking vacations or more than two or three days A department that does not enforce proper procedures fir authorization of transactions Unusually high personal debts Living beyond on one’s mean Excessive gambling habits Feeling of insufficient recognition for job performance

27. POOR MANAGERS INCREASE LIKELIHOOD OF MISCONDUCT Low passion to succeed Lack of respect and trust for his/her employees Commitment to job greater than commitment to the company Culture of retaliation and discomfort raising concerns Willing to comprise values for power and control Willing to break the rule in order to advance in the company

28. SKEPTICISM – AN ENEMY OF FRAUD Its not only for Auditors but for Manager’s as well in their conduct of responsibility. A questioning mindset and an attitude that withholds judgment until evidence is adequate. Promotes risk awareness. Adopt an attitude of skepticism. Its health and appropriate .

29. DAY-TO-DAY MANAGEMENT All Supervisors and Managers have responsibilities. Awareness of Red Flags. Enforcement of policies. Code of conduct. Promote ethical behavior. Deter wrongdoing. Setting an example. Understanding the Risk. Open door policies. Open communication makes it easy to resolve the issue. Allows employee to speak freely.

30. MANAGEMENT RESPONSIBILITIES In order to help prevent fraud, Management has a responsibility to implement adequate internal controls and to set the Tone at the Top . A few examples of internal controls are: Background checks. Anti-fraud training. Setting authority levels commensurate with levels of responsibilities. Segregation of duties.

31. MANAGEMENT RESPONSIBILITIES (CONTINUED) Have a basic understanding of fraud and be aware of the red flags Understand their role in the internal control framework Read and understand polices and procedures )fraud policy, code of conduct, whistleblower policy, etc.)

32. PREVENTION AND DETECTION Prevention and detection is your responsibility. Remember managers, you are part of: Tone at the Top Be familiar with the types of frauds that might occur within your area of responsibility. Know the warning signs or red flags that might indicate a fraud is taking place. Facts or circumstances or events which, singly or in combination, support(s) an inference that fraud has been committed.

33. TRUE COST OF FRAUD……….. Goes beyond financial losses, the organizations fraud impacts include: Scrutiny by the public Reputational damage Loss of investor confidence Loss of capital Regulatory and Criminal Investigations Financial penalties