2010 NSAC Conference Fraud in the Workplace Conrad Davis, CPA/CFF, CFE Annette Stalker, CPA/CFF/CITP, CFE

Outline  Fraud Statistics  Test Your Fraud Awareness Level  Major Fraud Categories and Schemes  A View from the Field Non-cash larceny Small business embezzlement Financial statement fraud

Participant Knowledge Check  Has anyone uncovered fraud in the course of their normal work function?  Do you have a fraud tip-line?  How many private industry participants have an internal audit team?  What analytical tools do you use to watch for fraud?

Fraud Statistics  2008 Report to the Nation on Occupational Fraud & Abuse  Published by the ACFE every two years  Based on case studies submitted by CFEs who investigated the matters

Significance?  What percent of annual revenues are lost due to fraud? Seven percent $994 billion in fraud losses (applied to GDP)  Most common means of detection? Tips (46%), most common since 2002 Accident (20%)

Significance?  Results for the Agriculture, Forestry, Fishing & Hunting industry group: Lowest number of fraud occurrences at 13 (1.4%) Second highest median loss of $450,000 (first was Telecommunications industry)

Three Major Fraud Categories

Asset Misappropriation  Accounts for 88% of frequency (was 91% in 2006)  Median loss is $150,000 (same in 2006)  Major Types Skimming Larceny Fraudulent Disbursements

Fraudulent Statements  Accounts for 10% of frequency (same in ‘06)  Median loss is $2,000,000 (same in ‘06)  Major Types Financial: over- and under- statements of assets and revenues, concealed liabilities, improper disclosures, improper asset valuations Non-Financial: employment credentials, internal documents, external documents

Corruption  Accounts for 27% of frequency (was 30% in 2006)  Median loss is $375,000 (was $538,000 in 2006)  Major Types Bribery (invoice kickbacks, bid rigging) Conflicts of Interest (purchase / sales schemes) Illegal Gratuities

Fraud Awareness Quiz Some material derived from “What’s Your Fraud IQ?” by Andi McNeal, published in Journal of Accountancy, May Copyright American Institute of Certified Public Accountants. Used with permission.

Test Yourself 1. What is the purpose of performing a Benford’s Law analysis? 2. How would you pursue suspicions regarding a purchasing agent and kickbacks? 3. Name two signs of deceptive behavior in an interview situation. 4. What is the most common behavioral red flag exhibited by fraudsters? 5. How can you monitor billing functions for possible embezzlement activity?

1. Benford’s Law Analysis  Also known as the “first-digit law”  In a population of multidigit financial numbers, the first digit will be distributed in a predictable way In 30% of the cases, the first digit will be a 1 In 4.6% of the cases, the first digit will be a 9  Many fraudsters fail to take this non-intuitive pattern into consideration  Many analytic software tools available to perform Benford’s Law Analysis

2. Kickbacks  Determine potential conflicts among employees (who have authority or a role in disbursements) and vendors  Public records search can provide information on identity of “vendors” Business filings with the Secretary of State provide ownership names Available Corporation and LLC information typically include:  Company Directors and Executives  Principle business address  Date of incorporation  Business ID numbers

3. Interview Deception  Repeating the interviewer’s questions (buying time to think of a response)  Beginning responses with “honestly” or “to tell the truth” (can be a liar’s way of attempting to add credibility)  Respond with a question such as “Why would I…” (deflect the question without providing a directly dishonest answer)  Several other non-verbal responses may be more subtle but indicate stress and discomfort (crossing arms, no eye contact, perspiration, change in posture/behavior after ‘friendly’ questions)

4. Behavioral Red Flag  Living beyond his or her means Exibited in 38.6% of cases cited in the ACFE’s 2008 Report to the Nation  Other Red Flags Include: Divorce or family problems (17.1%) Unwillingness to share duties (18.7%) Unusually close relationship with a vendor or customer (15.2%)

5. Billing Function Analysis  Billing is a common target for employee embezzlement  Tools to help detect schemes include: Queries that identify vendors with no listed contact person (indicative of accounts set up solely to submit fraudulent invoices) Vendor usage on extremely high end (may signal conflict or kickback scheme) Vendor usage on extremely low end (may signal fraudster testing waters) Compare vendor and employee contact information (similar address, phone number, tax ID numbers) Search for duplicate or consecutive invoice numbers from same vendor Stratify invoice amounts to identify those just below approval thresholds

A View from the Field  Example #1 – Non-cash Larceny Fraud  Example #2 – Cash Larceny Fraud  Example #3 - Financial Statement Fraud  Others (as time permits)

1 – Non-cash Larceny Fraud  Scenario Service industry Manager and key employees  Initial predication Decline in profitability  Work performed Analysis of materials used against costs of service

1 – Non-cash Larceny Fraud  Resolution Weird Claimed oral contract Settled for sale of business on discounted basis

2 – Cash Larceny Fraud  Scenario All cash and accounting authority resident with one long term “trusted” employee No effective management oversight  Initial predication Vendor inquiry regarding aged and unpaid invoice

2 – Cash Larceny Fraud  Work performed Discovery that bank reconciliations had not been properly performed Sub-ledgers were not reconciled with General Ledger Bank deposits were shorted by currency portion  Resolution Pending criminal prosecution (matter turned over to district attorneys office)

3 – Financial Statement Fraud  Scenario Pressure: company losing money, collateral- based loan facility Auditor not provided with lender examinations  Initial predication Bank collateral review yielded unsatisfactory results

3 – Financial Statement Fraud  Results Review of actual company assets revealed the misrepresentations Bank called LOC Company no longer had sufficient cash to be a going concern Management is terminated and charged with fraud

3 – Financial Statement Fraud  Resolution Company filed for bankruptcy protection Receiver appointed by the courts Calculation of damages is not just the “lost” assets but the cost of insolvency of the company What happened to the auditors?

Other Case Examples  Property Diversion  Ponzi Schemes  Small Company Embezzlements  External Auditor and Internal Investigations

Questions? Conrad Davis Annette Stalker ACFE Fraud Tools: AICPA JoA Fraud IQ Article: