FACE OF FRAUD Felix Lozano Chairman Nexia International Audit Committee Partner, Whitley Penn LLP November 10, 2010

INTERNATIONAL LANGUAGE What is our international language? … … QUALITY

TODAY’S AGENDA Fraud o Occupational Fraud Defined o Theory o Statistics o Types of Fraud Dealing with Fraud o Prevention o Detection

OCCUPATIONAL FRAUD DEFINED

ELEMENTS OF A FRAUD A representation About a material point Which is false Intentionally or recklessly so Relied upon by the victim To the victim’s damage

Who is Jérôme Kerviel ?Jérôme Kerviel FACE OF FRAUD TRIVIA #1

Rogue French Trader Jérôme Kerviel Ordered to Pay Back the $6.7 Billion He Lost

TURN OF THE CENTURY BULL MARKETS MAKE HEROES Scott Sullivan, WorldCom: 1998 CFO of the Year Andrew Fastow, Enron: 1999 CFO of the Year Mark Swartz, Tyco: 2000 CFO of the Year

TURN OF THE CENTURY BEAR MARKETS MAKE CROOKS Scott Sullivan, 2002: Indicted and charged with fraud. Andrew Fastow, 2002: Indicted and charged with conspiracy, fraud, money laundering, insider trading. Mark Swartz, 2002: Indicted and charged with fraud.

CURRENT CROOKS – PONZI SCHEMES "Bernie" Madoff, 2009: Pleaded guilty to 11 federal crimes Robert Allen Stanford, 2009: Pleaded "not guilty" to charges of fraud, conspiracy and obstruction Nick Cosmo, 2009: Indicted on 10 counts of wire fraud and 22 counts of mail fraud

MISAPPROPRIATION OF ASSETS Cash fraud schemes –Skimming –Larceny –Fraudulent disbursements Accounts receivable schemes –Improper posting of credits Discount Return Write-off Inventory and other asset schemes –Appropriating inventory and supplies for personal use Stealing inventory Theft of scrap proceeds

CORRUPTION Bribery Illegal gratuities Economic extortion Conflicts of interest

FINANCIAL STATEMENT FRAUD Fictitious revenues –Involves the sale or goods or services which never occurred Timing differences –Improper matching of revenues –Early revenue recognition –Recording expenses in the wrong period Concealed liabilities and expenses –Liability/expense omissions –Returns and allowances and warranties Improper disclosure –Liability omissions –Significant events –Management fraud –Accounting changes Improper asset valuation –Inventory –Fixed Assets

DONALD R. CRESSEY Known for his studies of organized crime Served as organized crime consultant to the President's Commission on Law Enforcement and Administration of Justice in 1966 and 1967 Cressey’s hypothesis later became known as the “Fraud Triangle”

WHAT DO PEOPLE STEAL? INCENTIVE/PRESSURE Fraud Triangle PERCEIVED OPPORTUNITY RATIONALIZATON

WHY DO PEOPLE STEAL? INCENTIVE/PRESSURE PERCEIVED OPPORTUNITY RATIONALIZATON CAPABILITY

FIGHTING FRAUD WHAT HAVE WE DONE IN ACCOUNTING? Treadway Commission ’87 COSO ’87 SAS 53 ’88 Certified Fraud Examiner ’88 SAS 82 ’96 Sarbanes Oxley ’02 SAS 99 -’ 02 ISA ‘04

FIGHTING FRAUD WHAT HAVE WE DONE IN LEGAL? Sarbanes Certifications Anonymous Hotlines Whistleblower Investigations DOJ Investigations SEC Investigations

INTERNAL CONTROL WEAKNESS Primary Internal Control Weakness Observed by CFEs *Obtained from 2010 Certified Fraud Examiners report “2010 Report to the Nation on Occupational Fraud and Abuse”

ORGANIZATION TYPE OF VICTIMS Organization Type of Victim — Median Loss *Obtained from 2010 Certified Fraud Examiners report “2010 Report to the Nation on Occupational Fraud and Abuse”

BASED ON SIZE OF VICTIM ORGANIZATION Size of Victim Organization — Median Loss *Obtained from 2010 Certified Fraud Examiners report “2010 Report to the Nation on Occupational Fraud and Abuse”

INDUSTRY OF VICTIM ORGANIZATIONS Sorted by Frequency *Obtained from 2010 Certified Fraud Examiners report “2010 Report to the Nation on Occupational Fraud and Abuse”

INDUSTRY OF VICTIM ORGANIZATIONS Sorted by Median Loss *Obtained from 2010 Certified Fraud Examiners report “2010 Report to the Nation on Occupational Fraud and Abuse”

INITIAL DETECTION OF OCCUPATIONAL FRAUD Initial Detection of Occupational Frauds *Obtained from 2010 Certified Fraud Examiners report “2010 Report to the Nation on Occupational Fraud and Abuse”

TENURE OF PERPETRATOR - FREQUENCY Tenure of Perpetrator — Frequency *Obtained from 2010 Certified Fraud Examiners report “2010 Report to the Nation on Occupational Fraud and Abuse”

TENURE OF PERPETRATOR – MEDIUM LOSS Tenure of Perpetrator — Median Loss *Obtained from 2010 Certified Fraud Examiners report “2010 Report to the Nation on Occupational Fraud and Abuse”

FACE OF FRAUD TRIVIA # 2 What 2002 movie was based on a young con artist who successfully impersonated an airline pilot, doctor, assistant attorney general and history professor, cashing more than $2.5 million in fraudulent checks in 26 countries? a. The Magnificent Fraud b. Catch Me if You Can c. The Bourne Identity d. Gangs of New York

AGE OF PERPETRATOR – MEDIAN LOSS Age of Perpetrator — Median Loss *Obtained from Certified Fraud Examiners report “2010 Report to the Nation on Occupational Fraud and Abuse”

AGE OF PERPETRATOR - FREQUENCY Age of Perpetrator — Frequency *Obtained from Certified Fraud Examiners report “2010 Report to the Nation on Occupational Fraud and Abuse”

EDUCATION OF PERPETRATOR Education of Perpetrator — Median Loss *Obtained from 2010 Certified Fraud Examiners report “2010 Report to the Nation on Occupational Fraud and Abuse”

FRAUD TRIVIA # 3 What did this Indiana money manager do to make national headlines in 2009?

POSITION OF PERPETRATOR – MEDIUM LOSS Position of Perpetrator — Median Loss *Obtained from 2010 Certified Fraud Examiners report “2010 Report to the Nation on Occupational Fraud and Abuse”

POSITION OF PERPETRATOR - FREQUENCY Position of Perpetrator — Frequency *Obtained from 2010 Certified Fraud Examiners report “2010 Report to the Nation on Occupational Fraud and Abuse”

GENDER OF PERPETRATOR Gender of Perpetrator — Frequency Gender of Perpetrator — Median Loss *Obtained from 2010 Certified Fraud Examiners report “2010 Report to the Nation on Occupational Fraud and Abuse”

GENDER OF PERPETRATOR Position of Perpetrator Based on Gender Position of Perpetrator — Median Loss Based on Gender *Obtained from 2010 Certified Fraud Examiners report “2010 Report to the Nation on Occupational Fraud and Abuse”

NUMBER OF PERPETRATORS *Obtained from 2008 Certified Fraud Examiners report “2008 Report to the Nation on Occupational Fraud and Abuse”

PERPETRATORS’ CRIMINAL HISTORIES Perpetrator’s Criminal Background *Obtained from 2010 Certified Fraud Examiners report “2010 Report to the Nation on Occupational Fraud and Abuse”

PERPETRATORS’ CRIMINAL HISTORIES Perpetrator’s Employment Background *Obtained from 2010 Certified Fraud Examiners report “2010 Report to the Nation on Occupational Fraud and Abuse”

FRAUD TRIVIA # 4 Approximately how much does the US lose due to fraud each year? a. More than $50 billion b. More than $200 billion c. More than $500 billion d. More than $900 billion

DISTRIBUTION OF DOLLAR LOSSES Distribution of Losses *Obtained from 2010 Certified Fraud Examiners report “2010 Report to the Nation on Occupational Fraud and Abuse”

HEALTHSOUTH, INC. TRICK Entry One A/R Revenue Entry Two Fixed Assets Cash Entry Three Cash A/R

HEALTHSOUTH, INC. TRICK Entry One A/R Revenue Entry Two Fixed Assets Cash Entry Three Cash A/R

CORRUPTION CASES BY INDUSTRY *Obtained from 2010 Certified Fraud Examiners report “2010 Report to the Nation on Occupational Fraud and Abuse”

FACE OF FRAUD TRIVIA TRIVIA # 5 What initiated the investigation into former governor Eliot Spitzer? a.He bounced a check b.Bank filed a SAR c.He confessed to his wife d.Internal audit investigation

INTERNATIONAL OUTLOOK DEPARTMENT BASED ON REGION **Obtained from 2010 Certified Fraud Examiners report “2010 Report to the Nation on Occupational Fraud and Abuse”

INTERNATIONAL OUTLOOK DEPARTMENT BASED ON REGION **Obtained from 2010 Certified Fraud Examiners report “2010 Report to the Nation on Occupational Fraud and Abuse”

INTERNATIONAL OUTLOOK ANTI-FRAUD CONTROLS BY REGION **Obtained from 2010 Certified Fraud Examiners report “2010 Report to the Nation on Occupational Fraud and Abuse”

INTERNATIONAL OUTLOOK ANTI-FRAUD CONTROLS BY REGION **Obtained from 2010 Certified Fraud Examiners report “2010 Report to the Nation on Occupational Fraud and Abuse”

ANTI-FRAUD CONTROLS BY REGION **Obtained from 2010 Certified Fraud Examiners report “2010 Report to the Nation on Occupational Fraud and Abuse”

ANTI-FRAUD CONTROLS BY REGION **Obtained from 2010 Certified Fraud Examiners report “2010 Report to the Nation on Occupational Fraud and Abuse”

INTERNATIONAL OUTLOOK Schemes Committed by Perpetrators in the Accounting Department — 367 Cases **Obtained from 2010 Certified Fraud Examiners report “2010 Report to the Nation on Occupational Fraud and Abuse”

INTERNATIONAL OUTLOOK Schemes Committed by Perpetrators in the Sales Department — 225 Cases **Obtained from 2010 Certified Fraud Examiners report “2010 Report to the Nation on Occupational Fraud and Abuse”

INTERNATIONAL OUTLOOK Schemes Committed by Perpetrators in Executive/ Upper Management Positions — 224 Cases **Obtained from 2010 Certified Fraud Examiners report “2010 Report to the Nation on Occupational Fraud and Abuse”

INTERNATIONAL OUTLOOK Schemes Committed by Perpetrators in the Customer Service Department — 120 Cases **Obtained from 2010 Certified Fraud Examiners report “2010 Report to the Nation on Occupational Fraud and Abuse”

INTERNATIONAL OUTLOOK Schemes Committed by Perpetrators in the Purchasing Department — 103 Cases **Obtained from 2010 Certified Fraud Examiners report “2010 Report to the Nation on Occupational Fraud and Abuse”

INTERNATIONAL OUTLOOK **Obtained from 2010 Certified Fraud Examiners report “2010 Report to the Nation on Occupational Fraud and Abuse”

INTERNATIONAL OUTLOOK **Obtained from 2010 Certified Fraud Examiners report “2010 Report to the Nation on Occupational Fraud and Abuse”

INTERNATIONAL OUTLOOK **Obtained from 2010 Certified Fraud Examiners report “2010 Report to the Nation on Occupational Fraud and Abuse”

INTERNATIONAL OUTLOOK **Obtained from 2010 Certified Fraud Examiners report “2010 Report to the Nation on Occupational Fraud and Abuse”

INTERNATIONAL OUTLOOK **Obtained from 2010 Certified Fraud Examiners report “2010 Report to the Nation on Occupational Fraud and Abuse”

INTERNATIONAL OUTLOOK **Obtained from 2010 Certified Fraud Examiners report “2010 Report to the Nation on Occupational Fraud and Abuse”

INTERNATIONAL CORRUPTION CASES BY REGION **Obtained from 2010 Certified Fraud Examiners report “2010 Report to the Nation on Occupational Fraud and Abuse”

INTERNATIONAL MEDIAN LOSS BASED ON GENDER AND REGION **Obtained from 2010 Certified Fraud Examiners report “2010 Report to the Nation on Occupational Fraud and Abuse”

DEPARTMENT BASED ON REGION **Obtained from 2010 Certified Fraud Examiners report “2010 Report to the Nation on Occupational Fraud and Abuse”

DEPARTMENT BASED ON REGION **Obtained from 2010 Certified Fraud Examiners report “2010 Report to the Nation on Occupational Fraud and Abuse”

BEHAVIORAL RED FLAGS *The sum of percentages in this table exceeds 100% because in several cases the perpetrator exhibited more than one behavioral red flag. **Obtained from 2010 Certified Fraud Examiners report “2010 Report to the Nation on Occupational Fraud and Abuse”

FRAUD PREVENTION What You Can Do –Tone at the Top –Code of Ethics/Conduct –Background Checks –Appropriate Compensation –Constant Training –System of Internal Controls –Consequences

WHO IS RESPONSIBLE? Board of Directors Executive Management All Employees Auditors Have a Responsibility to Plan Audit Accordingly, but WE ARE NOT REQUIRED TO FIND FRAUD

FRAUD DETECTION What You Can Do –Internal Audit –Separate Fraud Department –Software Tools –Monitoring –Whistleblower Policies –External Audit –Foster an Open Culture

WHITELY PENN FRAUD CASES Compilation Client Inflating Accounts Receivable $123,000 WP Accounting Services Identified

WHITELY PENN FRAUD CASES Neurologist’s – Identity Theft Business Manager 25 Years Refinance of Home Loan - Credit Report $176,000

WHITELY PENN FRAUD CASES Construction Fraud Collusion –Construction Superintendent (Tommy Ingram - 54) –Concrete Vendor (Ray Brooks - 57) $7.6 Million Fraudulent Charges 14 Month Investigation FBI and DA’s Office Project Team –Construction Auditor –Engineer –CPA’s Jail Term – 8 years for both Defendants

QUESTIONS?

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