Preventing and Detecting Fraud: Also know as, “Why does this

always seem to happen to us?”

Prepared and presented by Frank Crawford, CPAwww.crawfordcpas.com

frank@crawfordcpas.com

The Fraud Triangle

Exacerbated ineconomic downturn

Perceived pressure

facing individual

Perceived opportunity to commit

fraud

Person’s rationalization or integrity

Victim Organizations©2008 by the Association of Certified Fraud Examiners, Inc.

©2008 by the Association of Certified Fraud Examiners, Inc

Victim OrganizationsOccupational Fraud Schemes in Government

and Public Administration (106 cases)12

12The sum of percentages in this chart exceeds 100 percent because several cases involved multiple schemes from more than one category.

Profile of Fraud Perpetrator Male or female No prior criminal history (<8%) Well liked by co-workers Likes to give gifts/compulsive shopper Gambling problems not unusual Long-term employee Rationalizes: Starts small or “borrows” Lifestyle clues

Cash Schemes Stealing cash funds

processed or on hand Not recording &

stealing the cash receipts

Under ringing & stealing the difference in cash receipts

Altering bank deposits

Accounts Receivable Schemes

Lapping Forging checks received Altering credit card

receipts Granting bogus credits Bogus bad debt write-

offs or account adjustments

Accounts Payable & Purchasing

Personal bills Fictitious suppliers Kickbacks Ordering personal

items Petty cash funds Employee

expense accounts Credit cards

Payroll Schemes Ghost employees Manipulated time

records Unclaimed payroll

checks Writing extra payroll or

bonus checks Leave time

manipulation Withholding fraud W-2 fraud

Top Ten Reasons Frauds Beat Internal Controls in

Government and What You Can Do About It…

Process mentality Just doing the steps in the process Not thinking about what one is doing

Example: Two signatures required on checks. Both check signers fail to notice the check has no payee and still sign the check.

Remedy: Reinforce the need to pay attention and the consequences for failure.

1. Goin’ Through the Motions

Blind trust Failure to acknowledge warning signals

Example: Failure to follow up on a customer complaint of an incorrect bill for service and relying on the experienced and valued billing clerk’s response that it was just an error.

Remedy: Realize that anyone can commit fraud. Assume discrepancies are fraud and prove to yourself it is only an error.

2. See No Evil, Hear No Evil

Positional immunity Rationalizing that controls don’t apply to me

because I am in upper management. Often referred to as management override.

Example: Executive director doesn’t report leave used, but still gets paid for unused leave annually.

Remedy: Identify someone within or outside the entity that you can report these circumstances to and not jeopardize your job.

3. It’s Good to be The King

Situational incompetence New employee not in a position to question why

Example: New accounts payable clerk questions why purchases from a certain vendor do not require bids, and is told that such purchases are exempt.

Remedy: If you are the supervisor, don’t assume new employee just doesn’t understand. Take their questions seriously and ask your self why. If you are the employee, ask more than one person.

4. New Kid on the Block

Workload overload Not enough time to perform control

procedures

Example: Knowing that the supervisor is too busy to reconcile accounts receivable, a billing clerk steals cash and posts unauthorized adjustments.

Remedy: Reevaluate assignment of duties, and when needed, demand more resources by focusing on the consequences of fraud.

5. Where’s All the Time Gone?

Conflict avoidance Responsible employees not comfortable in

confronting other employees

Example: A supervisor recognizes that the cash drawer is always short at the end of the day, but is uncomfortable in confronting the employee.

Remedy: Reinforce supervisory responsibilities. Provide employee management training. Don’t tolerate poor performance.

6. Can’t We All Be Happy?

Informational restraint Responsible employees lack the information

they need to identify an improper transaction

Example: An accounts payable clerk is not provided a contract that includes a not-to-exceed price limit and vendor takes advantage by over-billing.

Remedy: Reinforce with employees the openness and availability of records and information.

7. Where’s the Beef?

Behavioral ignorance Responsible employees ignore behavioral

signs or indicators of possible fraud

Example: Management and other employees fail to investigate or question an employee that is living well above their means or salary level.

Remedy: Create an environment within the government that fosters ethical and responsible behavior. Create an anonymous hotline.

8. It’s None of My Business

Informational ignorance Officials ignore fraud warning signs in

reports because they don’t understand the reports

Example: Highway patrol fine revenue was embezzled and monthly budget report shows a potential problem, but the report is too complicated for management and governing board to understand.

Remedy: When it comes to reports, use the KISS principle and train the users.

9. It’s Over My Head

Ethically challenged Employees responsible for controls are just

not ethical and morally responsible individuals

Example: Purchasing supervisor is dishonest and convinces an accounts payable employee to process fake invoices for payment and split the money between them.

Remedy: Don’t hire crooks.

10. A Bad Apple in the Bunch

Protection Mechanisms Fraud risk assessment Internal controls Proper environment External review Reporting mechanism Hire right Fidelity bonding Establish “Perception of

Detection” Forensic data mining

Protection Mechanisms Segregation of duties Effective bidding processes Vendor approval controls Policies

◦ Code conduct, fraud policies◦ Conflict of interest, gifts,

gratuities◦ Etc.

Fraud awareness training Internal audit

©2008 by the Association of Certified Fraud Examiners, Inc.

Detection of Fraud SchemesInitial Detection of Occupational Frauds4

4The sum of percentages in this chart exceeds 100 percent because in some cases respondents identified more than one detection method.

Resources Managing the Business Risk of Fraud: A

Practical Guide (AICPA & IIA) – REQUIRED READING

Management Anti-Fraud Programs & Controls (exhibit to SAS 99)

ACFE Fraud Prevention Check-Up ACFE Best Practices in Ethics Hotlines ACFE Sample Code of Conduct ACFE Sample Ethics Policy

Management Antifraud Programs and Controls

Creating a Culture of

Honesty & High Ethics

Evaluating Antifraud

Processes & Controls

Developing an Appropriate

Oversight Process

Setting the tone at the top Creating a positive workplace environment Hiring and promoting appropriate

employees Providing sufficient training Confirming accountability for code of

conduct Implementing effective discipline

Creating Culture of Honesty and High Ethics

Identifying and measuring fraud risks Mitigating fraud risks Designing and implementing appropriate

internal controls Monitoring compliance with internal

controls Don’t miss the obvious…

Evaluating Antifraud Processes and Controls

Oversight by the audit committee or equivalent

Oversight by management Use of an effective internal audit function Open and candid dialogue with

independent auditors Take advantage of the COSO internal

control element “Risk Assessment” by taking some time to “aim”…

Developing and Appropriate Oversight Process

Let’s talk a little more about Honesty and High Ethics for a bit…

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Applying Ethics is About

Ethics refer to the standards that tell us how we ought to act in situations we find ourselves in as parents, children, family members, friends, citizens, elected officials, professionals, employees, teachers, etc.

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What Ethics is Not! Ethics is not just following the law. The fact that it is

possible or legal to do something doesn’t mean it “ought to be done”.

Ethics is not just following our feelings. Our feelings can betray our ethics. Often we may feel it is uncomfortable to do the right thing.

Ethics is not just following our religion. Ethics applies to all people, whether religious or not. Some ethical dilemmas are not addressed by one’s religion.

Ethics is not just following culturally accepted norms. Some cultures may be blind to certain basic issues, such as human rights.

Ethics is not just following science. While science may provide us better information to make decisions, just because something is scientifically or technologically possible, does not mean it is ethical.

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Ethics in 21st Century As a Society are We Living a Life Worth

Living?

Corporate officers, greed, and accounting scandals

Athletes and performance-enhancing drugs Martha Stewart and broker/dealer scandals College students and increased cheating Hackers, internet viruses, and identity theft Politicians and government corruption Catholic priests and sex scandals Danny Almonte and little league baseball

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Ethics in 21st Century

Recent study found that nearly 1/3 of U.S. workers called in sick in the past year when if fact they were fine.

Most common reasons given:◦ Had plans with family and friends◦ Needed to relax or catch up on sleep◦ Just didn’t feel like going to work

Source: Harris Interactive Survey for CareerBuilder.com (Aug-Sept. 2007)

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Ethics in 21st Century

Advertising “Prepaid” Bail Bonds

Is this Really Necessary?

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Ethics in Work and Life

Hard to separate moral behavior in personal life from moral behavior in public life

Where there are ethical lapses in private life, there are often ethical lapses in public life (and vice versa)

Ethical lapses in private life can result in lack of trust in public life

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Unethical Behavior Triangle

Motive/Pressure

Opportunity Rationalization

Potential for Unethical Behavior

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Rationalizing Bad Behavior

Do we rationalize bad behavior? In what ways? The “Broken Window Rationalization

Theory” - if we allow inappropriate behavior to go unchallenged, we create the invitation for rationalizing that such behavior is considered acceptable

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An Individual’s Ethics Evolution

Stage 1 – Educational Level

Stage 2 – Societal Level

Stage 3 – Independent Level

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Educational Level

Right and wrong defined in terms of what authority figures say is right and wrong or what rewards and punishment result◦ Parents◦ Teachers◦ Ministers

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Societal Level

Right and wrong defined in terms of what society believes and law requires◦ Family◦ Friends◦ Peers◦ Community◦ Nation

Circle of Morality Theory

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The Circle of Morality©

The Circle of Morality™

CONCEPT:

For a shift to higher Ethics, there must be meaningful enough Consequences to the Actions of individuals to cause a shift in the Beliefs of a majority of society that is significant enough to change individual Values.

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Effective Consequences

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Independent Level

Right and wrong defined from an independent point of view based on our individual ideals of justice or human rights and welfare

These ideals are acquired through our knowledge, experiences, and personal feeling

These ideals may differ from the norm of society

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Ethical Orientation QuestionYou are driving on a highway (with a normal speed

limit of 70 mph) with no other vehicles around. The highway has recently been repaved. Construction is now complete and all construction barriers have been removed. However, the temporary speed limit signs of 55 mph are still posted. You are driving 70 mph.

Are you doing anything wrong?

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An Individual’s Ethics OrientationWhatever our level of moral development, we

have all developed our own individual ethical orientation or tendencies we follow when faced with making decisions that involve ethical dilemmas.

Let’s determine our own ethical orientation.

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What is my Ethical Orientation?1. Which is worse?

a. Hurting someone’s feelings by telling the truth

orb. Telling a lie and protecting their feelings

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What is my Ethical Orientation?2. Which is the worse mistake?

a. To make exceptions too freelyor

b. To apply rules too rigidly

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What is my Ethical Orientation?3. Which is it worse to be?

a. unmercifulor

b. unfair

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What is my Ethical Orientation?4. Which is worse?

a. Stealing something valuable from someone for no good reason

orb. Breaking a promise to a friend for no good

reason

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What is my Ethical Orientation?5. Which is it better to be?

a. Just and fairor

b. Sympathetic and feeling

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What is my Ethical Orientation?6. Which is worse?

a. Not helping someone in troubleor

b. Being unfair to someone by playing favorites

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What is my Ethical Orientation?7. In making a decision, on which do you rely

more?

a. Hard factsor

b. Personal feelings and intuition

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What is my Ethical Orientation?8. Your boss or superior orders you to do

something that is hurtful to someone. If you carry out the order, have you actually done anything wrong?

a. Yesor

b. No

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What is my Ethical Orientation?9. Which is more important in determining

whether an action is right or wrong?

a. Whether anyone actually gets hurtor

b. Whether a rule, law, commandment, or moral principle is broken

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What is my Ethical Orientation? Ethics of Justice (J orientation)

◦ Based on equal application of moral principles and laws or policies with little flexibility or exceptions

◦ Actions are either inherently right (truthfulness, respect, honoring promises) or inherently wrong (lying, theft, manipulation, broken promises)

◦ Generally more common of men than women Ethics of Care (C orientation)

◦ Based on sense of responsibility to reduce harm and suffering with considerable flexibility for individual cases

◦ Actions that produce more good than harm are “right”; those that don’t are “not as right”

◦ Generally more common of women than men(Based on Ethical Orientation Questionnaire developed by the Center for Ethics and Business at Loyola Marymount University)

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Contemporary Ethics Theories

Another perspective:

1. Ethics of Justice Orientation RIGHT versus WRONG

2. Ethics of Care OrientationRIGHT versus Not As RIGHT

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What is an Ethical Dilemma?

A situation where there are compelling reasons for taking an action and competing compelling reasons for not taking the action

Ethical dilemmas exist because of these conflicting or competing compelling reasons

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An Ethical Dilemma

You want to borrow another individual’s truck, without approval (compelling reason not to do it), and use it to deliver food, clothing, and sleeping bags to desperately hungry and homeless families immediately after a natural disaster strikes (compelling reason to do it).

What action should the individual take?◦ In what direction would an Ethics of Justice thinker lean?◦ In what direction would an Ethics of Care thinker lean?

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Resolving Ethical Dilemmas1. First get all the facts and consider alternative

actions.2. Analyze the actions themselves (ethics of justice

considerations) ◦ Do they comply with the law ◦ Are they honest, fair and equitable◦ Are they respectful of others rights

3. Analyze the potential results or consequences of the actions (ethics of care considerations)

◦ Do they advance the common good◦ What is the extent of good versus harm to others◦ What is the extent of good versus harm to me

4. Combine both analyses and make a decision (none of the considerations should be ignored, each acts as a check on the limitations of the other)

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Ethical Dilemma Decision Test“Ask yourself whether or not you would

feel good about your decision while appearing on prime-time television being interviewed by a highly-skilled, well-informed, and hard-hitting journalist, knowing that your family, friends and peers are watching.”

Quote from Warren Buffet

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My 10 Basic Principles of Ethics

1. Avoid conflicts of interest in fact and appearance2. Don’t misuse nonpublic information for personal gain3. Don’t accept or solicit gifts or items of value4. Put forth honest effort in duties5. Make no unauthorized or unfullfilable promises or

commitments6. Be impartial and avoid giving preferential treatment7. Don’t misuse or misappropriate company funds or

property8. Exercise civility and respect others opinions and beliefs9. Comply with laws and meet all obligations as a citizen 10. Expose corruption and report fraud, waste and abuse

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Avoid The Sergeant Shultz Approach to Responding to Immoral Behavior

“I know nothing,

I see nothing, and

I say nothing!"

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Living a Life Worth Living

QUESTIONS???