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FRAUD – AND EVERYTHING YOU WERE AFRAID TO ASK

Dr. Ted M. Hammett, DBA CPAAssoc. Professor – Accounting

University of Arkansas – Monticellohttp://www.uamont.edu/Facultyweb/

Hammett/

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Definition of Fraud

General Definitiona deception made for personal gain

Seven Specific Parts of Fraud1. A representation… 2. about a material point… 3. which is false…

4. and intentionally or recklessly so… 5. which is believed… 6. and acted upon by the victim… 7. to the victim’s damage.

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What Fraud is and is Not

Fraud is…• intentional.• to trick or deceive

someone out of his/her assets.

• theft.• a crime.

Fraud is not…• taken by physical force.• a mistake or error.• victimless.• insignificant because no

one is hurt.• acceptable or justifiable.

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Why people Commit Fraud

Fraud Triangle

Pressure

Rationalization

Opportunity

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Pressure

Divided into four main groups:1. Financial pressures2. Vices3. Work-related pressures4. Other pressures

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Pressure

Financial PressuresCommon Financial Pressures:

1. Greed2. Living beyond one’s means3. High bills or personal debt4. Poor credit5. Personal financial losses6. Unexpected financial needs

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Pressure

Vice PressuresWorse kind of pressures to commit

fraudExamples include:

Gambling Drugs Alcohol Expensive extramarital

relationships

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Pressure

Vice PressuresReal-life examples:

Dad that embezzled his six-year-old son’s allowance

Women who stole money to fund her children's drug addiction

Man that used company money to fund his drug addiction

The parents who took their new-born baby from the hospital with heroine under its tongue

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Pressure

Work-related Pressures “Get even with the

employer”Motivated by these factors:

Getting little recognitionFeeling job dissatisfactionFear of losing one’s jobBeing overlooked for a

promotionFeeling underpaid

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Pressure

Other PressuresSpouse Pressures

Spouse’s lifestyle demandsLife Pressures

Family CrisisSocial Pressures

“Being successful”

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Pressure

Financial andVice

Pressures95%

Other Pressures

5%

Financial and Vice Pressures

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Opportunity

Six major factors that increase opportunity:Lack of controlsInability to judge performance

qualityFail to discipline fraudstersLack of access to informationIgnorance, apathy and incapacityLack of audit trail

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Rationalization

Common Rationalizations for fraud• “No One will miss it”• “I will pay it back”• “I deserve it”• “They owe it to me”• The list goes on….. And on.

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Consumer Fraud

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Consumer Fraud - Defined

Any fraud that targets individuals as victims.

Two Primary Types of Consumer Fraud

1. Identity Theft2. Consumer Scams

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Consumer Fraud Statistics

Seriousness of the ProblemThe US Federal Trade Commission released

a statistical survey in 2004 with the following findings:

Nearly 25 million adults—11.2% of the adult population—were victims of fraud during the year studied.

34% of American Indians and Alaska Natives were victims

17% of African American were victims 14% of Hispanics were victims 6% of non-Hispanic, whites were victims

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Consumer Fraud Statistics

Numbers of Victims in the Top 10 Frauds

1. Advance-fee loan scams—4.55 million

victims2. Buyers’ clubs—4.05 million victims3. Credit card insurance—3.35 million

victims4. Credit repair—2 million victims5. Prize promotions—1.8 million victims

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Consumer Fraud Statistics

Numbers of Victims in the Top 10 Frauds

6. Internet services—1.75 million victims7. Pyramid schemes—1.55 million victims8. Information services—0.8 million victims9. Government job offers—0.65 million

victims10. Business opportunities—0.45 million

victims

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Consumer Sentinel

US FTC’s Response to Consumer Fraud

Consumer Sentinel – a complaint database developed by the US Federal Trade Commission that tracks information about consumer fraud and identity theft and makes it available to law enforcement partners across the US and throughout the world.

http://www.consumer.gov

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Identity Theft

The most common type of consumer fraud.

40% of the frauds reported to the FTC over the last few years have involved some type of identity theft.

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Identity Theft Defined

Circumstances when someone uses another person’s name, address, Social Security number, bank or credit card account number, or other identifying information to commit fraud or other crimes

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Identity Theft by Age

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The Identity Theft Cycle

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Identity Theft Cycle – Stage 1

DiscoveryGain Information Phase:

Searching trash Stealing mail Phishing Scanning credit card information

Information Verification Phase: Telephone scams (Pretexting) Trash searches

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Identity Theft Cycle – Stage 2

ActionAccumulating Documentation Phase:

Perpetrator gets the tools to commit the fraud (applying for credit cards, a driver’s license, or fake check in the victim’s name)

Cover-up or Concealment Actions Phase: Perpetrator takes steps to cover or hide the

financial footprints left throughout the identity theft process.

Example: Changing the billing address on a credit card so that the statements go to the fraudster’s address.

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Identity Theft Cycle – Stage 3

Trial1st Dimensional Actions Phase:

First attempts to test the stolen information. If the test works, the fraudster attempts more

2nd Dimensional Actions Phase: Actions taken after the tests are successful The fraudster usually attempts face-to-face

transactions

3rd Dimensional Actions Phase: Fraudster opens bank accounts, establishes

phone accounts, secures auto loans, etc.

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Identity Theft

Personal Information Financial GainThe perpetrator may…

Buy large-ticket items Take out car, home, or other loans Establish phone or wireless services Use counterfeit checks or debit cards Open new bank accounts File for bankruptcy Report victim’s name to police Open new credit card accounts Change victim’s mailing address

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Identity Theft – How it’s Done

Summary - Stealing a Victim’s Identity

Dumpster diving Skimming Social engineering Stealing wallets/purses Sneak into a victim’s home and steal

information Shoulder surfing Phishing Steal mail

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How to Protect Yourself

Minimizing the Risk Guard your mail from theft Opt out of preapproved credit cards Check you personal credit information

at least annually Guard Social Security card and number Safeguard all personal information Guard trash from theft Protect wallet and other valuables Protect the home, computer, passwords

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Prosecution of Identity Theft

When identity theft is committed, the perpetrator can be prosecuted criminally and/or civilly.

For prosecution, it is necessary to show the perpetrator acted with intent to defraud—usually easy to prove if evidence of the fake identity used to purchase an item, open an account, or obtain a credit card is collected.

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Identity Theft

Once Identity Theft OccursVictims should…

Contact the Federal Trade Commission Contact local FBI and/or US Secret Service

agencies Contact the credit reporting agencies Contact the local Postal Inspection Service Contact the Social Security Administration Contact personal financial institutions Change personal identification information

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Investment/Consumer Scams

Foreign Advance-Fee Scams

Nigerian Money OffersClearinghouse ScamPurchase of Real Estate ScamSale of Crude Oil at below market priceDisbursement of money from wills

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Investment/Consumer Scams

Work-at-Home SchemesMultilevel MarketingPyramid Scheme

Chain Letter, Mail Stuffing, Product Testing, and Craft Assembly

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Investment/Consumer Scams

Bogus Mystery Shopping Scams

Perpetrators promise victims a job to stroll through stores, enjoy the displays, shop for merchandise, and file reports about their experiences.

Fraudsters promise victims compensation ranging from $10–$40 an hour, plus the opportunity to keep all products evaluated.

Although some mystery shoppers’ advertisements are legitimate, the majority are not.

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Investment/Consumer Scams

Telemarketing Frauds

Fraudsters set up giant rooms (referred to as boiler rooms) in rented offices where they train salespeople to find and defraud victims

Unwary investors lose about $1 million every hour to investment fraud promoted over the telephone

Telemarketing scams on the elderly

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Investment/Consumer Scams

Safeguards Against Telemarketing Frauds

Never give a Social Security, credit card, or other information over the phone unless you initiate the call.

Put your information on the “do no call” registry

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Investment/Consumer Scams

Investment Scams

Unreasonable promised rates of return Investments that do not make sound

business sense Pressure to get in early on the investment Use of a special tax loophole or a tax

avoidance scheme A business with a history of bankruptcy or

scandals

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Bankruptcy, Divorce and Tax Fraud

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Bankruptcy and Divorce Fraud

Bankruptcy or Divorce Resulting from Fraud

When too few assets are left to pay the creditors and debtors as a result of fraud occurs and, bankruptcy is generally filed.

When a marriage partner discovers his/her spouse has committed fraud, he/she often files for divorce.

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Bankruptcy and Divorce Fraud

Bankruptcy and Divorce used to Perpetrate Fraud

During bankruptcy and divorce, an automatic stay is often granted.

Some debtors use this time to fraudulently transfer assets to other organizations

Some marriage partners fraudulently transfer assets to other (usually related) individuals.

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Bankruptcy and Divorce Fraud

Bankruptcy and Divorce used to Conceal Fraud

Generally results in the books and record or the debtor or marital partner being destroyed, inaccurate, or hard to locate.

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The Nature of Bankruptcy

DefinitionWhen people or organizations are unable to

pay their debts and have more liabilities than assets, they can file for bankruptcy by filing a bankruptcy petition with the courts.

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The Nature of Bankruptcy

Reasons behind Filing for Bankruptcy Gives a debtor relief from creditor

collection and foreclosure actions Protects creditors from unfair collection

efforts by other creditors Allows the debtor to work out an orderly

plan to settle debts or liquidate assets and distribute the proceeds to creditors in a way that is intended to treat creditors fairly.

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Criminal Bankruptcy Statutes

Concealment of Assets, False Oaths and Claims, and Bribery (18 USC

152)It is a crime to…

Conceal property of a debtor’s estate from creditors

Make a false oath or account in a bankruptcy case

Give, offer, receive, or attempt to obtain money or property, remuneration, compensation, reward, advantage or promise thereof for acting or forbearing to act in a bankruptcy case.

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Criminal Bankruptcy Statutes

Embezzlement Against the Debtor’s Estate (18 USC 153)

It is a crime for such persons to “knowingly and fraudulently appropriate to [their] own use, embezzle, spend, or transfer” any property, or to hide or destroy any document, belonging to the debtor’s estate.

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Criminal Bankruptcy Statutes

Adverse Interest and Conduct of Officers

(18 USC 154)It is a crime to knowingly…

Purchase, directly or indirectly, any property of the debtor’s estate of which the person is an officer in a bankruptcy case

Refuse to permit a reasonable opportunity for the inspection by parties in interest of the documents and accounts relating to the affairs of the estate in the person’s charge when directed by the court to do so.

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Criminal Bankruptcy Statutes

Bankruptcy FraudIt is a crime to do any of the following to

execute or conceal a fraud scheme: File a bankruptcy petition. File a document in a bankruptcy proceeding. Make a false or fraudulent representation,

claim, or promise with respect to a bankruptcy proceeding, either before or after the bankruptcy petition is filed

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Civil Bankruptcy Statutes

Offenses Leading to Revocation of Debt Discharge (Section 1144 of the

Bankruptcy Code)Example:

If a debtor lied about (usually by understating) the amount of his or her assets in order to get debts forgiven, the forgiveness or discharge of the debts could be revoked.

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Civil Bankruptcy Statutes

Fraudulent Transfers (Section 548 of the Bankruptcy Code)

A transfer made, or obligation incurred, within one year before the bankruptcy petition’s filing date that was: Made with the actual intent to hinder, delay,

or defraud creditors Made for less than reasonably equivalent

value

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Participants in the Bankruptcy Process

The parties involved in the bankruptcy process: Bankruptcy court U.S. Trustee Court-appointed or panel trustee Examiners Debtors Creditors Adjusters (operations or field agents)

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Bankruptcy & Divorce Schemes

Bust-out

Intentionally obtaining loans or purchasing inventory on a credit basis and concealing, or absconding with, the proceeds from the loan or sale of the inventory or with the inventory itself before creditors are paid.

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Bankruptcy & Divorce Schemes

Indicators of a bust-out A company’s only listed address and

phone number are a post office box and an answering service

A new company is owned and managed by persons from another state

A sudden change is made in a company’s management

Credit references either cannot be verified or seem too eager to provide favorable references

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Bankruptcy & Divorce Schemes

Indicators of a bust-out The size of orders placed on credit and

the credit balances with suppliers suddenly and dramatically increase.

The inventory is suddenly deleted, without explanation.

“Customers” have a history of buying goods at unreasonable discounts.

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Concealing and Transferring Assets

Ways assets or income may be concealed

Cash may be diverted to another entityInventory may be shipped to an off-site

locationAssets or income may be shifted to another

entity controlled by the debtorSales may not be reported properlyPayment may be made to fictitious persons

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Concealing and Transferring Assets

Indicators of Concealment Transfers of property or large payments to

related parties or individuals, such as insiders, shareholders, or relatives.

Frequent and unusual transfers between bank accounts, particularly between business and personal accounts.

Numerous transactions made in cash that normally are made on account (sales, purchases, etc.)

Unusually large and unexplainable payments to vendors.

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Concealing and Transferring Assets

Indicators of Concealment Unusual or rapid reductions in assets. Increases in operating losses that are not

explained by economic factors. Inconsistencies between financial statements

or tax returns and the official forms filed for the bankruptcy or records filed in divorce cases.

Travel to offshore tax havens or locations that allow secret bank accounts.

Missing, inaccurate, or damaged records.

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Tax Fraud

Common Tax Fraud Schemes

Deliberately underreporting or omitting income

Overstating tax deductions Keeping two sets of books Making false entries in books and records

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Tax Fraud

Common Tax Fraud Schemes

Claiming personal expenses as business expenses

Claiming false deductions Hiding or transferring assets or income Illegal money laundering schemes

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E-Commerce Fraud

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E-Commerce Fraud

New and innovative technologies for which security developments often lag transaction developments.

Complex information systems that make installing controls difficult.

The transfer of large amounts of information, a factor that poses theft and identity risks such as illegal monitoring and unauthorized access.

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E-Commerce Fraud

Removal of personal contact, which allows for easier impersonation or falsified identity.

Lack of “brick-and-mortar” and other physical facilities that facilitate falsifying Web sites and business transactions

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E-Commerce Fraud

Inability to distinguish large and/or established companies from new and/or smaller companies, making it easy to deceive customers by falsifying identity and/or business descriptions.

Electronic transfer of funds, allowing large frauds to be committed more easily.

Compromised privacy, which results in easier theft by using stolen or falsified information.

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E-Commerce Fraud

The perceived distance that decreases the personal contact between customer and supplier.

Transactions between anonymous or unknown buyers and sellers—you can’t see who you are hurting.

New economy thinking contends that traditional methods of accounting no longer apply.

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E-Commerce Fraud

In e-commerce, Be careful about what you reveal in communicating on the internet.

ENCRYPTION Look for the “https:” prefix when sending

very sensitive information such as your credit card number or social security information.

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Summary

Identity Theft is the most common form of fraud Buy a shredder Get on a do not mail list for pre-approved

credit cards Have mail delivered to a post office box or get

a lock box for your home. Don’t put out-going mail in your mail box take

it to the post office

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Summary

Always Be Alert

If it is too good to be true – IT PROBABLY IS!!

If you are a victim of fraud you have avenues to get help – But be aware that it will take time to get recovery and you may not be able to completely recover.