0. Advisory Services
Managing fraud and fraud risks as part of an overall organizational cost reduction strategy
Guido van Drunen, Principal
June 16, 2011

1. What we are going to be speaking about
Risk management is becoming more and more part of everyday corporate governance and compliance. One risk that all organizations are faced with is fraud, waste, and abuse, yet little is done to specifically address this risk and at times significant business cost. This session will address the cost of fraud waste and abuse to organizations and key strategies for minimizing costs through prevention programs, proactive detection programs and how to respond to incidents of fraud, waste, and abuse to limit further losses, mitigate fines, and attempt to recover losses.

2. The problem: Fraud, waste, and abuse are business costs.
The 2010 Association of Certified Fraud Examiners (ACFE) report to the nation makes the following key observation:
“While it is unlikely that we can accurately measure the true costs of occupational fraud at any given point in time, it is still useful to try to gain some understanding of the scope of the problem with which we are confronted. Accordingly, we asked each survey participant to provide his or her best estimate of the percentage of annual revenues lost by the typical U.S. organization to fraud each year. Survey participants estimated that the typical organization loses 5 percent of its annual revenue to fraud.”
Source: 2010 ACFE report

3. The real cost
Even if the 5 percent figure is double or triple what might be occurring at your organization, the amount is still meaningful.
The amount noted above does not include the costs of investigations, management down time, and/or distractions.
While we will not discuss the issue here, there is also the cost (often times unmeasurable) on the ethical environment of the organization.
Suffice it to say the measure and quantity of the projected losses are significant.

4. The current environment
U.S.: Gross Domestic Product $14.6 trillion¹
Estimated Fraud Loss Rate² 5%
U.S. Cost of Fraud $700 billion
1 Estimate for FY 2010, per U.S. Dept of Commerce Bureau of Economic Analysis
ACFE Report to the Nation on Occupational Fraud and Abuse

5. Occurrences and cost of fraud
While financial reporting fraud costs the most per incident, it occurs least often. Medical/insurance fraud, also costly, occurs relatively infrequently. Employee fraud is among the least costly, but a full 60 percent of organizations experienced it.
Note: For percentage of total fraud cost pie chart, the “others” category is comprised of vendor-related fraud (.8%), misconduct (.27%), and computer crime (.05%)
2010 ACFE Report to the Nation on Occupational Fraud and Abuse

6. Important but hard to define costs and benefits
Leaving aside the less readily quantifiable benefits which result from strong antifraud programs and controls such as:
Tone at the top
Deterrent effects
Employee morale
Sustainability
Operational efficiencies, etc.
The potential losses projected by the ACFE provide a significant opportunity set to warrant focusing cost reduction initiatives on them.

7. Key strategies for minimizing costs through prevention programs
Conduct a high-level fraud risk assessment of the organization. This can be part of the standard enterprise risk management process.
Identify those areas considered to be of potential higher risk due to a number of issues such as volume of transactions, nature of the industry, dollar values processed, past issues, strength of control structure, ability to collude, etc.
Select the top three risks and use automated tools to conduct tests for fraud, waste, and abuse.
Assess the output produced and conduct appropriate follow-up.

8. Types of fraud and misconduct risks
Misappropri-ation of assets
Revenue/
assets
improperly
gained
Expenses/
liabilities
for improper
purposes
Expenses/ liabilities
avoided
Fraudulent
financial
reporting
Other
misconduct
[Source: FRM Whitepaper, p. 6]
Fraud and Misconduct fall into the following 6 categories of risk that can undermine public trust and damage a company’s reputation for integrity:
Fraudulent Financial Reporting
Misappropriation of Assets
Revenue/Assets Improperly Gained
Expenses/Liabilities for Improper Purposes
Expenses/Liabilities Improperly Avoided
Other Misconduct

9. Integrity survey 2009 Key findings
Prevalence of fraud and misconduct remains high
Have you personally observed or do you have first-hand knowledge of wrongdoing within your organization?
Prevalence of Fraud & Misconduct
In the survey, we asked employees whether they had “personally seen” or had “first-hand knowledge of ” misconduct within their organizations over the prior 12-month period. Roughly three quarters of employees—74 percent—reported that they had observed misconduct in the prior 12-month period, marking no statistically significant change from 2000, when 76 percent of employees surveyed indicated that they had observed misconduct over the prior 12-month period.
Impacts all industries:
Highest: Public Sector at 81%
Lowest: Real Estate and Industry sectors at 64%.
2003 KPMG Fraud Survey: 75% of the organizations surveyed had experienced fraud during the prior 12 months
ACFE’s 2004 Report to the Nation on Occupational Fraud & Abuse: the typical US organizations lose an estimated 6% of its annual revenues to fraud.
Source: KPMG Integrity Survey 2009

10. Integrity survey 2009 Key findings (continued)
Would the observation cause a “significant loss of public trust?”
Seriousness of Fraud & Misconduct
To gauge the seriousness of observed fraud and misconduct, we asked employees if what they observed could cause a “significant loss of public trust” if discovered.
2005: 50 percent of employees answered yes
2000: 49 percent of employees answered yes
Source: KPMG Integrity Survey 2009

11. Proactive detection programs
The ACFE has identified that the procurement cycle, T&E, and payroll account for over 60 percent of all organizational fraud cases.
While the largest risk remains the manipulation of the financial statements, there are opportunities for potential cost reduction in the areas identified above which are a much larger volume of the fraudulent activity and can have an integrity impact on the overall organization.
Proactive companies will have policies and procedures that contain clear segregation of duties, layout clear implications for fraud and include whistleblower policies, an anonymous hotline, and outline key oversight roles such as internal audit and/or compliance.

12. Enablers of fraud and misconduct
CEO was officer most frequently named in an AAER – 72% (Accounting and Auditing Enforcement Releases)
Senior Management involvement in most cases. Either or both CEO or CFO involved 83%
Alleged Motivation:
avoid reporting losses & bolster financial results increase stock price to increase the benefits of insider trading
cover-up assets misappropriated for personal gain Obtain national stock exchange listing status or avoid delisting
Source: Fraudulent Financial Reporting 1987–1997: An Analysis of U.S. Public Companies (COSO Study)

13. Detecting fraud and misconduct

14. Response to fraud
Response: Policies, procedures, infrastructure, relationships, and other measures designed to help a company react appropriately when fraud is discovered to help minimize damage as well as find and eliminate root causes of the fraud
Limit losses: Should you encounter incidents of fraud, a quick response is essential to limit losses. The longer a potential fraud is not addressed, the larger the loss to the organization and the larger the potential fines.
Mitigate fines: Often, a proactive approach when responding to potential fraud can result in lower fines from the government due to taking initiative and possibly presenting findings to the regulators prior to government investigation.
Recover losses: Conducting fraud-related testing on certain areas within an organization which are considered to be higher risk could result in an enhanced control structure, identification of losses, the potential opportunity to prevent further losses, and recovery of identified losses.

15. Conclusions
Even if the fraud, waste, and abuse at your organization is at a significantly lower level than that estimated by the ACFE there is still a significant cost reduction opportunity that may be obtained.
Traditionally, the low-hanging fruit resides in the procurement cycle, T&E and payroll; simple testing can have both monetary and nonmonetary benefits.
The benefits outweigh the costs, and even if nothing is located, it will demonstrate a desire to be compliant with the Corporate Sentencing Guidelines regarding antifraud programs and controls.

16. Thank you Presenter’s contact details Guido van Drunen KPMG LLP

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