Henri Teittinen Aling with the textbook: Romney & Steinbart (2012) AIS Fraud Henri Teittinen Aling with the textbook: Romney & Steinbart (2012)

Learning Objectives Explain the threats faced by modern information systems. Define fraud and describe both the different types of fraud and the process one follows to perpetuate a fraud. Discuss who perpetrates fraud and why it occurs, including the pressures, opportunities, and rationalizations that are present in most frauds.

INTRODUCTION Information systems are becoming increasingly more complex. Organizations and society are becoming increasingly more dependent on these systems.

Threats to AIS Natural and Political disasters Software errors and equipment malfunctions Unintentional acts Intentional acts

Fraud Any means a person uses to gain an unfair advantage over another person; includes: A false statement, representation, or disclosure A material fact, which induces a victim to act An intent to deceive Victim relied on the misrepresentation Injury or loss was suffered by the victim Fraud perpetrators are often referred to as white-collar criminals. Fraud is white collar crime

THE FRAUD PROCESS Fraud against companies may be committed by an employee or an external party. Former and current employees (called knowledgeable insiders) are much more likely than non-employees to perpetrate frauds (and big ones) against companies. Largely owing to their understanding of the company’s systems and its weaknesses, which enables them to commit the fraud and cover their tracks. Organizations must utilize controls to make it difficult for both insiders and outsiders to steal from the company.

Two Categories of Fraud Misappropriation of assets Theft of company assets which can include physical assets (e.g., cash, inventory) and digital assets (e.g., intellectual property such as protected trade secrets, customer data) Fraudulent financial reporting “cooking the books” (e.g., booking fictitious revenue, overstating assets, etc.)

Conditions for Fraud Opportunity to: Commit Conceal Convert to personal gain Rationalize Justify behavior Attitude that rules don’t apply Lack personal integrity These three conditions must be present for fraud to occur: Pressure Employee Financial Lifestyle Emotional Financial Statement Management Industry conditions

PRESSURES THAT LEAD TO EMPLOYEE FRAUD FINANCIAL Living beyond means High personal debt/expenses “Inadequate” salary/income Poor credit ratings Heavy financial losses Bad investments Tax avoidance Meet unreasonable quotas/goals EMOTIONAL Greed Unrecognized performance Job dissatisfaction Fear of losing job Power or control Pride or ambition Beating the system Frustration Non-conformity Envy, resentment Arrogance, dominance Non-rules oriented LIFESTYLE Support gambling habit Drug or alcohol addiction Support sexual relationships Family/peer pressure

WHO COMMITS FRAUD AND WHY Financial statement fraud is distinct from other types of fraud in that the individuals who commit the fraud are not the direct beneficiaries. The company is the direct beneficiary. The perpetrators are typically indirect beneficiaries. Reasons for Fraudulent Financial Statements Deceive investors or creditors Increase a company’s stock price Meet cash flow needs Hide company losses or other problems

WHO COMMITS FRAUD AND WHY There are many opportunities that enable fraud. Some of the most common are: Lack of internal controls Failure to enforce controls (the most prevalent reason) Excessive trust in key employees Incompetent supervisory personnel Inattention to details Inadequate staff

WHO COMMITS FRAUD AND WHY Management may allow fraud by: Not getting involved in the design or enforcement of internal controls; Inattention or carelessness; Overriding controls

WHO COMMITS FRAUD AND WHY How many people do you know who regard themselves as being unprincipled or sleazy? It is important to understand that fraudsters do not regard themselves as unprincipled. In general, they regard themselves as highly principled individuals. That view of themselves is important to them. The only way they can commit their frauds and maintain their self image as principled individuals is to create rationalizations that recast their actions as “morally acceptable” behaviors.

WHO COMMITS FRAUD AND WHY These rationalizations take many forms, including: I was just borrowing the money. It wasn’t really hurting anyone. (Corporations are often seen as non-persons, therefore crimes against them are not hurting “anyone.”) Everybody does it. I’ve worked for them for 35 years and been underpaid all that time. I wasn’t stealing; I was only taking what was owed to me. I didn’t take it for myself. I needed it to pay my child’s medical bills.

WHO COMMITS FRAUD AND WHY Fraud occurs when: People have perceived, non-shareable pressures; The opportunity gateway is left open; and They can rationalize their actions to reduce the moral impact in their minds (i.e., they have low integrity). Fraud is much less likely to occur when There is low pressure, low opportunity, and high integrity. Unfortunately, there is usually a mixture of these forces in play, and it can be very difficult to determine the pressures that may apply to an individual and the rationalizations he/she may be able to produce.

Fraud Classifications Input Fraud Alteration or falsifying input Processor Fraud Unauthorized system use Computer Instructions Fraud Modifying software, illegal copying of software, using software in an unauthorized manner, creating software to undergo unauthorized activities Data Fraud Illegally using, copying, browsing, searching, or harming company data Output Fraud Stealing, copying, or misusing computer printouts or displayed information

Preventing and Detecting Fraud 1. Make Fraud Less Likely to Occur Organizational Systems Create a culture of integrity Adopt structure that minimizes fraud, create governance (e.g., Board of Directors) Assign authority for business objectives and hold them accountable for achieving those objectives, effective supervision and monitoring of employees Communicate policies Develop security policies to guide and design specific control procedures Implement change management controls and project development acquisition controls

Preventing and Detecting Fraud 2. Make It Difficulty to Commit Organizational Systems Develop strong internal controls Segregate accounting functions Use properly designed forms Require independent checks and reconciliations of data Restrict access System authentication Implement computer controls over input, processing, storage and output of data Use encryption Fix software bugs and update systems regularly Destroy hard drives when disposing of computers

Preventing and Detecting Fraud 3. Improve Detection Organizational Systems Assess fraud risk External and internal audits Fraud hotline Audit trail of transactions through the system Install fraud detection software Monitor system activities (user and error logs, intrusion detection)

Preventing and Detecting Fraud 4. Reduce Fraud Losses Organizational Systems Insurance Business continuity and disaster recovery plan Store backup copies of program and data files in secure, off-site location Monitor system activity