Approaches to Fraud Prevention

Bill Brown: Partner – Forensic & Litigation Services Tel: 972-448-6966

E-mail: Bill.Brown@Weaver.com

Overview

• Introduction: Padlock vs. Bolt cutter• Goal of Fraud Prevention• Internal Controls, the “Conventional

Wisdom”• Fraud’s Impact on Prevention• The “People” Approach

Padlock Theory

Padlock Theory

• Basic internal control• Controls physical access• Safeguards property/assets• Will keep 95% of “honest” people honest

Bolt Cutter Theory

The Bolt Cutter Theory

• Will not deter the “other” 5% • The dishonest people will find a way to

“beat” the internal controls• They have time and energy on their side• They know where to find the bolt

cutters!

Fraud Prevention Goal

The Goal of Fraud Prevention

Fraud Prevention Goal

Anti-fraud programs should be aimed at reducing the likelihood that if fraud occurs, it will not go undetected for an unreasonable amount of time.

Internal Controls

The Conventional Wisdom Re: Controls

Internal Controls: Assumes

• Careful consideration & design• Proper implementation• Effective compliance/monitoring• Appropriate corrective remediation• Reliance on routine auditing procedure

So What’s the Problem?

Bolt Cutters

Problems w/ Internal Controls

• Intimate knowledge of controls exposes weaknesses

• Collusion will circumvent most controls• Flawed design• Ineffective implementation• Auditing procedures are very predictable

& easily fooled

Case Studies

• Energy Exploration Co.– Circumvent disbursement authorization controls

• Security Co.– Ghost employees/payroll distribution controls

• Altered bank statements– Copies of altered bank statements provided

auditors/tax preparers

Fraud’s Impact on Prevention

What is Fraud?

A generic term, embracing all multifarious means which human ingenuity can devise and which are resorted to by individual(s) to get advantage over another byfalse suggestions or suppression of truth, and includes surprise, trick, cunning, and any unfair way by which another is cheated

Nature of Fraud

• Intentional Act • Ingenious schemes based upon intimate

knowledge of controls• Concealment: – Anticipation– Manufactured evidence

• Test crash dummy! “Observe & Adapt”

“Anticipation”

Volume of

Knowledge

Forensic AuditNarrow Scope

Depth

Routine AuditBroad Scope

A/P

A/PMinimal Depth

*An increased depth results in increased costs

Fraud Engineering

Fraudulent schemes are “engineered” (meticulously designed) to perpetrate and conceal the theft, including an exit strategy complete with “fall guys” and “alibis”

Fraud’s Impact on Approach to Prevention

Detection is Difficult

• Fraud is an “intentional” act, often involving detailed planning and concealment

• Crooks “anticipate” the routine audit procedures, audit evidence is often fabricated

• Exploits weaknesses in routine audit procedures or internal controls

• Breach of trust

Initial Detection

• Tip 43.3%• Management Review 14.6%• Internal Audit 14.4%• By Accident 7.0%• External Audit 3.3%• IT Controls 1.1%

Source: 2012 ACFE Report to the Nation

Tipsters vs. Controls

Why are tipsters, management, and internal auditors the most effective sources for the detection of fraud?

Inside Info• Intimately familiar with “detailed”

information• First-hand knowledge: know the entity, live it

daily• See and hear what other employees say and

do• Understand the control systems and how to

circumvent

Motivation: Financial Duress

• Bankruptcy• Foreclosure• Legal troubles• Divorce• Medical issues

Prevention: The Approach

Goal of an Anti-fraud program

Cost vs. Benefit – You can’t completely prevent fraud.

Anti-fraud program should be aimed at reducing the likelihood that if fraud occurs, it will not go undetected for an unreasonable amount of time.

The “People” Solution

REMEDIATION95%

INVESTIGATE

EDUCATE EMPLOYEES

REPORTING MECHANISM

TONE at the Top

REDUCE DETECTIO

N TIME

Tone at the Top

• Establishes standards for ethical behavior• Affixes responsibility for maintaining

ethical culture• Sets positive example for others to follow

Informed Employees

• Informed employees will be more likely to act ethically

• Raises awareness of potentially fraudulent conduct by other employees or vendors

• Encourages reporting of fraudulent conduct (early detection)

Reporting Mechanism

• Commitment to non-retaliation• Anonymous reporting extremely

important• Appropriate response (part of the

solution or part of the problem)• Reduces detection time• Cornerstone to enterprise-wide anti-

fraud system

Investigation

• Objective/probing• Identify stakeholders/isolate interested

individuals• Utilize appropriate investigative

personnel (appropriate skills)• Timely conclusion/recommendations

Remediation

• Report to appropriate level within entity• Report facts upon which appropriate

action can be taken• Detailed recommendations for corrective

actions• Inform affected (especially the tipsters)

of investigative results and corrective actions taken

Reduce Detection Time

Common Red Flags

• Living Beyond Means 35.6%• Financial Difficulties 27.1%• Close Association with Vendor 19.2%• Control Issues 18.2%• Divorce/Family Issues 14.8%• Addiction Problems 8.4%

Source: 2012 ACFE Report to the Nation

Observe Lifestyle Changes

• Spending habits: people generally spend what they steal. The more they steal, the more they spend. Fraud almost always starts small and grows.

• Behavioral changes: look for signs of drug abuse, gambling or other patterns (dress, work habits, or attitude toward others)

Smell Test

Sometimes “things” just don’t seem right. The Smell Test is based on a hunch, feeling or instinct.

Hotline

• The most effective crime detection device is the Hotline.

• Expands your view to all the “eyes” in your organization.

• Cost effective• Provides a vehicle for honest employees

to contribute to the well being of the organization

95% Solution

• Your people are the best control system!–Encourage–Empower–Enlist