1. Shenandoah University’s Business Symposium 2013 LUNCH & LEARN Session “COMBATING FRAUD IN SMALL BUSINESS” TIM FREES, Certified Fraud Examiner (CFE) 1

2. Association of “Certified Fraud Examiners (ACFE) “COMBATING FRAUD IN SMALL BUSINESS” TIM FREES, MBA, CFE CERTIFIED FRAUD EXAMINER -Consultant/Mentor/Trainer -Fraud/Loss Prevention - Sales/Management Training FREE$ADVICE LLC www.freesadvice.com Association of Certified Fraud Examiners National: www.acfe.com Local Chapter: www.acfedc.com 2

3. ABOUT YOU  30 Second Elevator Pitch  Discussion & Questions wanted  Do we learn by making mistakes?  The speed limit is………… 3

4. A ARE YOU ON TOP? OR SNOWED UNDER? IN CONTROL? 4

5. ARE YOU A FRAUD BUSTER? 5

6. FRAUD IS………….. 6

7. DEFINING FRAUD UNDER COMMON LAW  1. A material false statement  2. Knowledge that the statement was false when uttered  3. Reliance on the false statement by the victim  4. Damages as a result  The legal definition of fraud is the same whether the offense is criminal or civil; the difference is that criminal cases must meet a higher burden of proof. 7

8. CLOSE TO HOME  Business Begets Business  Fraud Begets Fraud  Recent nearby frauds: School PTO Treasurer - $12,000 Restaurant cashier - 4 years, $23,486 SAAA Director – 4 counts of embezzlement Acura Dealership, Controller – 7 yrs. $10 Million 8

9. THE FRAUD TRIANGLE Opportunity Pressure Rationalization Cressey* 9

10. THE FRAUD SCALE  Situational Pressures  High:-----------------------------------------------Low  Opportunities to Commit  High------------------------------------------------Low  Personal Integrity  Low-------------------------------------------------High Albrecht* 10

11. THE TRUTH ABOUT LYING!  How many Americans say it’s okay to lie?  2 out of 3  Average person lies how often  2- 7 times a day.  What percentage of Americans lie regularly?  91% 11

12. The 10 + 10 + 80 RULE!  Employees 15 times more likely to steal than… -Train to short change customers or lose job -Socks in the pocket -Strip search-on Founder of ACFE, J. Wells  Do we realize the realities of our actions? 12

13. FOUR CONTRIBUTING FACTORS  Employee hiring, training and perception factor  Limited or lack of controls and perception factor  The delegating and “Trust” factor” to + or -  The “Owner’s” culture/example factor 13

14. STRONG DETERENT EMPLOYEES MUST KNOW THAT..  If violation, fair hearing, swift, consistent, and serious sanctions  Similar to raising our children! BUT……….  Termination, criminal prosecution/civil action 14

15. BACK TO WHO WILL COMMIT FRAUD?  Acquaintances?  Business Associates?  Co-Workers?’  Your Boss/Supervisor?  Friends?  Family Members?  Your Children? Even Grandchildren?  YOU?  Accept the realities of human nature! 15

16. MY PERSONAL BELIEF:  Given a timely perceived need and a timely perceived opportunity, we ALL will rationalize our conduct to commit a fraudulent act.  The main difference between fraud and larceny is that: The perpetrator is usually known to the victim.  Now it’s personal! 16

17. D & Q DISCUSSION? 17

18. A FEW RED FLAGS OF FRAUD  Employee too involved, everyone’s friend  Employee that handles several duties  Employee that works excessively and refuses assistance and still has poor records Managers with dominant personalities Lack of reasonable written personnel policies Lack of independent oversight 18

19. PREVENTION * DETERRENCE * DETECTION?  Prevention: eliminate the motivation to commit  Deterrence: behavior modification by perception  Detection: all the things we do to uncover fraud  Which more effective or timely? Or less costly?  The Perception of Detection = Prevention for 80% of us. 19

20. D & Q DISCUSSION? 20

22. VICTIM ORGANIZATIONS Anti-Fraud Controls in Small Businesses  Due to their limited resources, small businesses can be especially devastated by a loss of funds to fraud. Unfortunately, however, resource restrictions in most small organizations often mean less investment in anti-fraud controls, which makes those organizations more susceptible to fraud. 22

23. 23 The typical organization loses an estimated 5% of its annual revenues to occupational fraud. COST OF OCCUPATIONAL FRAUD

24. Does your company earn 5% Net Profit as a percent of Sales? Would you accept a 3% loss? (As a major retailer does) Would you reward if lower than a 3%? WHAT IS YOUR PROFIT %? 24

25. D & Q DISCUSSION? 25

26. FRAUD CLASSIFICATION 26 Occupational Fraud and Abuse Classification System

27. FRAUD PERPETRATORS 27 Department of Perpetrator — Frequency

28. FRAUD SCHEMES 28

29. TOP ACCOUNTING PERP SCHEMES  Billing  Check Tampering  Skimming  Payroll 29

30. TOP OPERATIONS PERP SCHEMES  Corruption  Billing  Expense Reimbursement  Non-Cash 30

31. VICTIM ORGANIZATIONS  In contrast to large organizations, billing schemes were the most common fraud committed in smaller organizations.  In addition, check tampering was three times as common and payroll and skimming schemes were noted almost twice as often in smaller organizations than in their larger counterparts. 31

32. DETECTING FRAUD  The difference in levels of control in small and large organizations.  Smaller companies are substantially less likely to detect fraud based on tips or internal audits and more likely to uncover fraud by accident, external audit or police notification. 32

33. D & Q DISCUSSION? 33

34. ACCOUNTING AS A DETECTION TOOL THE ACCOUNTING EQUATION ASSETS = LIABILITIES + OWNER’S EQUITY OR LIABILITIES = ASSETS – OWNER’S EQUITY OWNER’S EQUITY = ASSETS - LIABILITIES 34

35. TYPES OF ASSETS  Cash  Accounts Receivables  Supplies  Merchandise/Inventory  Investments  Equipment/Machinery  Buildings  Land  WHICH IS MOST VULNERABLE TO FRAUD? 35

36. TYPES OF LIABILITIES  Accounts Payable  Notes Payable  Long Term Debt  WHICH IS MOST VULNERABLE TO FRAUD? 36

37. CASH FLOW STATEMENT  Operating Activities  Investing Activities  Financing Activities  BOTTOM LINE: FRAUD REDUCES EQUITY 37

38. DEBITS = CREDITS  Yes, Debits = Credits  But should Debits be controlled by the same person that controls credits?  Small Business 500 or less employees *SBA  Most business have 100 or less employees  Can you ALWAYS separate duties? 38

39. DURATION OF UNDETECTED FRAUD 39

40. LOSS BY POSITION 40 Position of Perpetrator — Median Loss

41. FRAUD DETECTION BY TIPS 41 Source of Tips

42. DETECTION OF FRAUD SCHEMES 42 Detection Method by Size of Victim Organization

43. DETECTING FRAUD  The is a difference in levels of control in small and large organizations.  Smaller companies are more likely to detect fraud based on - tips (36%) Mgt. (14%) Accident (13%) BUT - Internal Audit --------------------------10% - Document Review -------------------- 7% - Account Reconciliation ------------ 5%  YOU CAN CONTROL the 22%! 43

44. PERPETRATOR’S BACKGROUND 44 Perpetrator’s Criminal Background

45. CASE RESULTS 45 Reason(s) Case Not Referred to Law Enforcement

46. D & Q DISCUSSION? 46

47. FRAUD PREVENTION CHECK UP  Is there fraud risk oversight?  Is there fraud risk ownership?  Is there fraud risk assessment?  Is there fraud risk tolerance?  Is there a risk management policy? 47

48. FRAUD PREVENTION CHECKLIST OF 11 1. Is ongoing anti-fraud training provided to all employees of the organization? 2. Is an effective fraud reporting mechanism in place? 3. To increase employees’ perception of detection, are proactive measures taken and publicized to employees? 4. Is the management climate/tone at the top of honesty and integrity? 48

49. FRAUD PREVENTION CHECKLIST 5. Are fraud risk assessments performed to proactively indentify and mitigate the company’s vulnerabilities to internal and external fraud? 49

50. FRAUD PREVENTION CHECKLIST 6. Are strong anti-fraud controls in place and operating effectively, including the following?  Proper separation of duties  Use of authorizations  Physical safeguards  Job rotations  Mandatory vacations 50

51. FRAUD PREVENTION CHECKLIST 7. Does the internal audit department, if one exists, have adequate resources and authority to operate effectively and without undue influence from senior management? FOR SMALLER COMPANIES INDEPENDENT REVIEW OR AUDIT BY CPA OR FRAUD TRAINED TEAM 51

52. FRAUD PREVENTION CHECKLIST 8. Does the hiring policy include the following (where permitted by law)?  Past employment verification  Criminal and civil background checks  Credit checks  Drug screening  Education verification  References check 52

53. FRAUD PREVENTION CHECKLIST 9. Are employee support programs in place to assist employees struggling with addictions, mental/emotional health, family or financial problems? 10. Is an open-door policy in place that allows employees to speak freely about pressures, providing management the opportunity to alleviate such pressures before they become acute? 11. Are anonymous surveys conducted to assess employee morale? 53

54. D & Q DISCUSSION? 54

55. FRAUD PREVENTION TOOLS  1. Hire independent person to examine…  2. Written code of ethics/policy  3. Prescreen and educate all employees  4. ALL lead by example  5. Acknowledge realistic expectations  6. Treat all employees fairly and with respect  7. Restrict access to data/accounts/assets  8. Perform independent banks reconciliations  9. Open employee awareness and reporting 55

56. EMPLOYEE SURVEY RESULTS BEST DEALERSHIPS TO WORK FOR*  Time off and work flexibility (not bell to bell)  Collaboration, not conflict (a team effort reward)  More equal performance opportunities  Acts of kindness (small $ rewards or praise)  As a manager/leader it is easier to demotivate *Automotive News, Oct. 22, 2012, Best Dealerships to work for, p. B50 56

57. SUMMARY  At a minimum,  staff/employees members should be educated regarding what actions constitute fraud, how fraud harms everyone in the organization and how to report questionable activity.  Can you afford not to implement?  Can you think like a fraudster?  A well thought-out Fraud/Loss Prevention Program preserves and builds on a trust relationship between employer and employee. IT’S PERSONAL! 57

58. RESOURCES www.acfe.com 2012 Report to the Nation ACFE Small Business Fraud Prevention Manual www.acfedc.org www.sba.gov www.lfbdc.org www.scorevavalley.org 58

59. YOUR FEEDBACK IS WELCOME Tim Frees, MBA, CFE FREESADVICE LLC freesadvice@comcast.net 540-622-4266 www.freesadvice.com www.linkedin.com/in/timfrees 59

60. D & Q DISCUSSION? 60