7 Keys to Fraud Prevention and Detection Ron Steinkamp, CPA, CIA, CFE, CRMA, CGMA 314.983.1382 rsteinkamp@bswllc.com 6 CityPlace Drive, Suite 900 │ St. Louis, Missouri 63141 │ 314.983.1200 1.888.279.2792 │ www.bswllc.com

Session Benefits What is Occupational Fraud 2014 ACFE Global Fraud Study Red Flags 7 Keys Fraud Self Assessment Code of Conduct © 2014 All Rights Reserved Brown Smith Wallace LLC

What is Occupational Fraud? Violation of trust. Three general categories: Asset misappropriations = employee steals or misuses an organizations resources. Corruption = employee’s use of influence in business transactions in a way that violates duty to the employer for the purpose of obtaining benefit for self or someone else. Financial Statement Fraud = intentional misstatement or omission of material information in financial reports. © 2014 All Rights Reserved Brown Smith Wallace LLC

Definition The use of one’s occupation for personal enrichment through the deliberate misuse or application of the employing organization’s resources or assets. Three general categories: Asset misappropriation Corruption Financial statement fraud Violation of trust. Three general categories: Asset misappropriations = employee steals or misuses an organizations resources. Corruption = employee’s use of influence in business transactions in a way that violates duty to the employer for the purpose of obtaining benefit for self or someone else. Financial Statement Fraud = intentional misstatement or omission of material information in financial reports. © 2014 All Rights Reserved Brown Smith Wallace LLC

Asset Misappropriation Employee steals or misuses an organization’s assets/resources. Examples: Skimming cash receipts. Falsifying voids and refunds. Tampering with company checks. Overstating expenses. Creating a ghost employee. Creating a fictitious vendor and false invoice. Violation of trust. Three general categories: Asset misappropriations = employee steals or misuses an organizations resources. Corruption = employee’s use of influence in business transactions in a way that violates duty to the employer for the purpose of obtaining benefit for self or someone else. Financial Statement Fraud = intentional misstatement or omission of material information in financial reports. © 2014 All Rights Reserved Brown Smith Wallace LLC

Corruption Employee’s use of his/her influence in business transactions in a way that violates his/her duty to the employer for the purpose of obtaining benefit for him/herself or someone else. Examples: Conflicts of interest. Illegal gratuities. Bribery. Violation of trust. Three general categories: Asset misappropriations = employee steals or misuses an organizations resources. Corruption = employee’s use of influence in business transactions in a way that violates duty to the employer for the purpose of obtaining benefit for self or someone else. Financial Statement Fraud = intentional misstatement or omission of material information in financial reports. © 2014 All Rights Reserved Brown Smith Wallace LLC

Financial Statement Fraud Intentional misstatement or omission of material information in the organization’s financial reports with the intent to mislead. Examples: Inflating revenues on the financials to show greater profit. Concealing liabilities. Forcing actual expenditures to match budget by moving expenses between accounts. Improperly accounting for revenues and expenditures. Violation of trust. Three general categories: Asset misappropriations = employee steals or misuses an organizations resources. Corruption = employee’s use of influence in business transactions in a way that violates duty to the employer for the purpose of obtaining benefit for self or someone else. Financial Statement Fraud = intentional misstatement or omission of material information in financial reports. © 2014 All Rights Reserved Brown Smith Wallace LLC

2014 ACFE Global Fraud Study Report to the Nations on Occupational Fraud and Abuse Violation of trust. Three general categories: Asset misappropriations = employee steals or misuses an organizations resources. Corruption = employee’s use of influence in business transactions in a way that violates duty to the employer for the purpose of obtaining benefit for self or someone else. Financial Statement Fraud = intentional misstatement or omission of material information in financial reports. © 2014 All Rights Reserved Brown Smith Wallace LLC

Summary of Findings Violation of trust. Three general categories: Typical organization loses 5% of annual revenue to fraud – applied to 2013 Gross World Product translates to potential fraud loss of more than $3.7 trillion annually. Median loss in the study was $145,000 with more than 22% of the cases involving losses over $1 million. Fraud lasted a median of 18 months. Asset misappropriation schemes (fraudulent disbursements, theft of cash receipts, other asset misappropriations) were the most common form of fraud, representing 85% of the cases and least costly at a median loss of $130,000. Financial statement fraud schemes were the least common form of fraud, representing 9% of the cases and most costly at a median loss at $1 million. Violation of trust. Three general categories: Asset misappropriations = employee steals or misuses an organizations resources. Corruption = employee’s use of influence in business transactions in a way that violates duty to the employer for the purpose of obtaining benefit for self or someone else. Financial Statement Fraud = intentional misstatement or omission of material information in financial reports. © 2014 All Rights Reserved Brown Smith Wallace LLC

Summary of Findings Violation of trust. Three general categories: Corruption schemes fell in the middle, comprising just over 37% of cases and causing a median loss of $200,000. Occupational frauds are most likely to be detected by tips (40%) followed by management review (15%) and Internal Audit (14%). Small organizations are disproportionately victimized by occupational fraud. Government/public administration was one of the most commonly victimized industries. Anti-fraud controls appear to help reduce the cost and duration of occupational fraud schemes. High-level perpetrators cause the greatest damage to their organizations. Violation of trust. Three general categories: Asset misappropriations = employee steals or misuses an organizations resources. Corruption = employee’s use of influence in business transactions in a way that violates duty to the employer for the purpose of obtaining benefit for self or someone else. Financial Statement Fraud = intentional misstatement or omission of material information in financial reports. © 2014 All Rights Reserved Brown Smith Wallace LLC

Summary of Findings Violation of trust. Three general categories: 77% of frauds were committed by individuals in one of six departments: Accounting Operations Sales Executive/upper management Customer service Purchasing Finance More than 85% of fraudsters had never been previously charged or convicted for a fraud-related offense. Fraud perpetrators often display warning signs – most common behavioral red flag reported in the survey were perpetrators living beyond their means (36%) and experiencing financial difficulty (27%). Nearly half of victim organizations do not recover any losses that they suffer due to fraud. Violation of trust. Three general categories: Asset misappropriations = employee steals or misuses an organizations resources. Corruption = employee’s use of influence in business transactions in a way that violates duty to the employer for the purpose of obtaining benefit for self or someone else. Financial Statement Fraud = intentional misstatement or omission of material information in financial reports. © 2014 All Rights Reserved Brown Smith Wallace LLC

How are Frauds Detected? © 2014 All Rights Reserved Brown Smith Wallace LLC

Source of Tips © 2014 All Rights Reserved Brown Smith Wallace LLC

Conclusions and Recommendations Occupational fraud is a universal problem – trends in fraud schemes, perpetrator characteristics and anti-fraud controls are similar regardless of where the fraud occurred. The longer frauds last, the more financial damage they cause. Proactive detection methods – hotlines, management review procedures, internal audits, employee monitoring mechanisms – are vital in catching frauds early and limiting losses. Small businesses/organizations are disproportionately victimized by fraud and under protected by anti-fraud controls. External financial audits are among the least effective controls in combating fraud – primary detection method of fraud in 3% of cases versus 7% of cases detected by accident. Many of the most effective anti-fraud controls are being overlooked – data monitoring and analysis, surprise audits, fraud risk assessment. Majority of fraudsters are first-time offenders – don’t over rely on background checks. © 2014 All Rights Reserved Brown Smith Wallace LLC

Red Flags Violation of trust. Three general categories: Asset misappropriations = employee steals or misuses an organizations resources. Corruption = employee’s use of influence in business transactions in a way that violates duty to the employer for the purpose of obtaining benefit for self or someone else. Financial Statement Fraud = intentional misstatement or omission of material information in financial reports. © 2014 All Rights Reserved Brown Smith Wallace LLC

The Fraud Triangle © 2014 All Rights Reserved Brown Smith Wallace LLC

Pressure “Red Flags” High personal debts. Living beyond their means. Excessive investment speculation. Excessive gambling. Substance abuse. Extra-marital affairs. Job frustration. Resentment of superiors. © 2014 All Rights Reserved Brown Smith Wallace LLC

Opportunity “Red Flags” Inadequate internal controls. Too “cozy” with suppliers. Annual vacation or sick days not taken. Weak management or excessive turnover. Ineffective or no internal audit. No rotation of job duties among employees. Procedures not well understood/always in crisis mode. Large amounts of cash on hand or processed. © 2014 All Rights Reserved Brown Smith Wallace LLC

Rationalization “Red Flags” Not compensated fairly. No recent raises/cost of living adjustments. Everyone else does it. Intended to pay it back. Needed the money. Felt cheated and wanted revenge. Bribe/kickback to tempting. © 2014 All Rights Reserved Brown Smith Wallace LLC

7 Keys Violation of trust. Three general categories: Asset misappropriations = employee steals or misuses an organizations resources. Corruption = employee’s use of influence in business transactions in a way that violates duty to the employer for the purpose of obtaining benefit for self or someone else. Financial Statement Fraud = intentional misstatement or omission of material information in financial reports. © 2014 All Rights Reserved Brown Smith Wallace LLC

Fraud Awareness/Training Anti-Fraud Culture Fraud Policy Fraud Awareness/Training Hotline Assess Fraud Risks Review/Investigation Improved Controls © 2014 All Rights Reserved Brown Smith Wallace LLC

1. Anti-Fraud Culture Set the tone at the top = Lead by Example Responsibility of elected officials and City management Behave ethically and openly communicate expectations to employees Treat all employees equally Zero tolerance Create a positive workplace environment Focus on employee morale Empower employees Communicate Hire and promote appropriate employees Conduct background investigations before hiring or promoting Check candidate’s education, employment history, references Continuous and objective evaluation of compliance with entity values Violations addressed immediately © 2014 All Rights Reserved Brown Smith Wallace LLC

1. Anti-Fraud Culture Code of Conduct Discipline Formalized and founded on integrity Defines acceptable employee behavior Communicated to all employees All employees are held accountable for compliance Discipline Sends a strong message throughout the entity Should be appropriate and consistent Consequences of committing fraud clearly communicated throughout the entity © 2014 All Rights Reserved Brown Smith Wallace LLC

1. Anti-Fraud Culture Oversight Process Management City Council/Elected Officials Evaluate management’s “tone at the top”, identification of fraud risks and implementation of anti-fraud controls Ensure that management implements anti-fraud measures Consider the potential for management override of controls Management Directs, implements and monitors anti-fraud controls Sets the ethical tone Trains employees Internal Auditor (if available) Identifies fraud indicators Assesses fraud risks Evaluates anti-fraud controls Recommends actions to mitigate risks Investigates potential frauds © 2014 All Rights Reserved Brown Smith Wallace LLC

2. Fraud Policy Demonstrate commitment to combating fraud Apply to all Elected officials, City management, employees, consultants, vendors, contractors, etc. Should include: Statement of organization’s position on fraud Scope of the policy – who does it apply to Management’s responsibility for prevention and detection of fraud Definition of fraud Actions constituting fraud Fraud reporting process/procedures Fraud investigation process/procedures Unit responsible for administration of the policy and investigating fraud allegations Statement on anonymity/confidentiality Consequences © 2014 All Rights Reserved Brown Smith Wallace LLC

2. Fraud Policy Reviewed and updated regularly. Signed off and agreed to by the City Council/Mayor. See the ACFE for an example Fraud Policy http://www.acfe.com/uploadedFiles/ACFE_Website/Content/documents/Sample_Fraud_Policy.pdf © 2014 All Rights Reserved Brown Smith Wallace LLC

3. Fraud Awareness/Training All new employees should be trained at time of hiring on the Code of Conduct and Fraud Policy. Training should include: Their duty to communicate certain matters A list of the types of matters to be communicated along with examples How to communicate those matters Affirmation from senior management regarding employee expectations and communication responsibilities Refresher training periodically © 2014 All Rights Reserved Brown Smith Wallace LLC

4. Hotline Enable employees, vendors, customers and others to communicate concerns about known or suspected wrongdoing. Telephone, email, internet. Anonymous. Adequately publicized. Internal or External. Complaint monitoring and investigation/resolution. © 2014 All Rights Reserved Brown Smith Wallace LLC

5. Assess Fraud Risks Conduct an annual fraud risk assessment. Assists management in systematically identifying where and how fraud may occur and who may be in a position to commit fraud Focus on fraud schemes and scenarios to determine the presence of internal controls and whether or not the controls can be circumvented. General steps: Identify areas and processes to assess Identify potential fraud schemes in each area/process Assess likelihood and significant of each scheme Map existing anti-fraud controls to potential fraud schemes Test operating effectiveness of antifraud controls Identify any control gaps and/or deficiencies = Residual risks Document and report on the fraud risk assessment © 2014 All Rights Reserved Brown Smith Wallace LLC

5. Assess Fraud Risks Mitigate Fraud Risks Monitor Fraud Risks Make changes to activities and/or processes = transfer or eliminate the risks Improve anti-fraud controls Monitor Fraud Risks Develop data analytics for management to use to monitor fraud risks Utilize Internal Audit to conduct audits of risk areas. © 2014 All Rights Reserved Brown Smith Wallace LLC

6. Fraud Review/Investigation All concerns/suspicions of wrongdoing should be reviewed and determination made whether a fraud investigation is warranted. Develop a policy for fraud reviews and investigations that specifies: Who is responsible for the review/investigation Roles of Legal Counsel, Human Resources, Internal Audit, others Process for conducting the review/investigation Documentation requirements Reporting requirements When to involve law enforcement © 2014 All Rights Reserved Brown Smith Wallace LLC

6. Fraud Review/Investigation Gather sufficient information and perform procedures necessary to determine: Whether fraud has occurred Loss or exposure associated with the fraud Who was involved and how it happened Must prepare, document and preserve evidence sufficient for potential legal proceedings. Include experts = Certified Fraud Examiner (CFE) © 2014 All Rights Reserved Brown Smith Wallace LLC

7. Improved Controls Use lessons learned from any fraud reviews or investigations to improve anti-fraud controls. All fraud review and investigations should include a report to management with recommendations for control improvement. © 2014 All Rights Reserved Brown Smith Wallace LLC

Top 10 Governmental Internal Controls To ensure proper stewardship of public funds: Separation of duties Documentation Authorization and approval Security of assets Reconciliation and review 6. Policies and procedures Fraud Policy and reporting Access to systems Physical control Verification (i.e. pre- employment) 34 © 2014 All Rights Reserved Brown Smith Wallace LLC

Fraud Self Assessment Violation of trust. Three general categories: Asset misappropriations = employee steals or misuses an organizations resources. Corruption = employee’s use of influence in business transactions in a way that violates duty to the employer for the purpose of obtaining benefit for self or someone else. Financial Statement Fraud = intentional misstatement or omission of material information in financial reports. © 2014 All Rights Reserved Brown Smith Wallace LLC

Code of Conduct Violation of trust. Three general categories: Asset misappropriations = employee steals or misuses an organizations resources. Corruption = employee’s use of influence in business transactions in a way that violates duty to the employer for the purpose of obtaining benefit for self or someone else. Financial Statement Fraud = intentional misstatement or omission of material information in financial reports. © 2014 All Rights Reserved Brown Smith Wallace LLC

Contact Information Ron Steinkamp, CPA, CIA, CFE, CRMA, CGMA Principal, Risk Advisory Services Brown Smith Wallace LLC 314.983.1238 (Direct) rsteinkamp@bswllc.com © 2014 All Rights Reserved Brown Smith Wallace LLC