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Welcome to

ACG6686

Fraud Examination

Florida International University

C. Delano Gray, CFE, CISA, CIA, CBA, CFSA

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Introduction to Fraud Examination

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Why Study Fraud Examination?

AICPA called fraud examination (Forensic Accounting) one of the seven hot new “sizzling” career areas in accounting.

The size and the number of frauds is increasing.

Great Job Opportunities: there will be a shortage of between 25,000 and 50,000 security professionals in the next few years in the United States.

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What If I Don’t Want to Be a Fraud Expert?

Even if you decide not to become a fraud expert, the topics covered in this course will help you be a better professional in whatever career path you choose. The technology, interviewing, document examination, public records, and other tools you will learn will make you a better consultant, auditor, tax professional, or manager, as well as a better and more astute investor.

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An Important Source

http://www.cfenet.comThe website for the

Association of Certified Fraud Examiners (ACFE)

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Seriousness of the Fraud Problem

It is difficult to give you a definite answer.

ACFE conducted a fraud study in the mid-1990s. Based on voluntary reports of over 2,600 frauds, the ACFE estimated that fraud costs U.S. organizations more than $400 billion annually. It is estimated that the average organization’s fraud losses are more than $9 per day per employee, and that about 6% of a company’s total annual revenue is lost to fraud.

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Seriousness of the Fraud Problem

The FBI has labeled fraud the fastest growing crime.

Not only the number of fraud cases seems increasing, the size of discovered fraud is increasing too.

Fraud is very costly to organizations.

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Given that the frauds are very costly, the best way to maximize profits for companies is to eliminate fraud.

The best way to minimize fraud is to prevent it from occurring.

Therefore, we will cover fraud prevention, as well as fraud detection and investigation.

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What Is Fraud?

Black’s Law Dictionary defines fraud as:

“… all multifarious means which human ingenuity can devise, and which are resorted to by one individual to get an advantage over another by false suggestions or suppression of the truth. It includes all surprise, trick, cunning or dissembling, and any unfair way by which another is cheated.”

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What Is Fraud?

A victim Details of the deceptive act thought to be

fraudulent The victim’s loss A perpetrator Evidence that the perpetrator acted with

intent Evidence that the perpetrator profited

by the act(s)

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Can we sue the contractor for fraud? Assume that an entity contracted to have the

roof of a warehouse redone, specifying that an expensive rubberized sheeting be used. The job is advertised and contractor A submits the lowest bid. After the job is completed, the entity discovers that the roof leaks. Further investigation discloses that a much cheaper roofing material was installed, inferior to the quality of product that was specified in the contract. The cost difference between the two grades of roof sheeting was $10,000 and it will cost $5,000 to repair the leak.

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Types of Fraud

Misrepresentation of material facts Concealment of material facts Bribery Conflicts of interest Theft of money or property Theft of trade secrets or intellectual

property Breach of fiduciary duty Statutory offenses

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Misrepresentation of Material Facts

Deliberate making of false statements to induce the intended victim to part with money or property

The elements normally includeA material false statementKnowledge of its falsityReliance on the false statement by the victimDamages suffered.

Opinions, speculative statements about future events, even if made with intent to mislead, may not be the basis for a fraud case.

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An Accountant May Be Prosecuted for Fraud who:

Certifies that a financial statement fairly presents the financial condition of the audited company when the accountant knows it does not.

Falsely states that the audit was conducted in accordance with GAAS.

Deliberately distorts the audit results

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Concealment of Material Facts

The essential elements of fraud based on failure to disclose material facts areThat the defendant had knowledgeOf a material factThat the defendant had a duty to discloseAnd failed to do soWith the intent to mislead or deceive the

other party

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Bribery

Bribery includes official bribery, which refers to the corruption of a public official and commercial bribery, which refers to the corruption of a private individual to gain a commercial or business advantage.

Elements:Giving or receivingA thing of valueTo influenceAn official act

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Extortion

Obtaining of property from another with the other party’s “consent” having been induced by wrongful use of actual or threatened force or fear.

A demand for a bribe or kickback might constitute an extortion.

In most states and federal system, extortion is not a defense to bribery.

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Conflict of Interest

An agent taking an interest in a transaction That is actually or potentially adverse to

the principal Without full and timely disclosure to an

approval by the principalAn agent includes any person who,

under the law, owes a duty of loyalty to another, including employees of a corporation, brokers, accountants.

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Embezzlement

The wrongful appropriation of money or property by a person to whom it has been lawfully entrusted. Embezzlement implicitly involves a breach of trust.The defendant took or convertedWithout the knowledge or consent of the

ownerMoney or property of anotherThat was properly entrusted to the

defendant

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Larceny

Taking or carrying away Money or property of another With the intent to permanently deprive the

owner of its use of possession Without the consent of the owner

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Theft of Trade Secrets

That a party possessed information of value to the business

That was treated confidentially That the defendant took or used by breach

of an agreement, confidential relationship, or other improper means.

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Breach of Fiduciary Duty

People in a position of trust or fiduciary relationship, such as officers, directors, owe certain duties imposed by law to their principals or employers.The principal fiduciary duties are loyalty and care.

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Duty of Loyalty

Requires that employee/agent act solely in the best interest of the employer/principal, free of any self-dealing, conflicts of interest, or other abuse of the principal for personal advantage.

Embezzlements, thefts, acceptance of kickbacks, and conflicts of interest also violate the duty of loyalty and may be prosecuted as such in addition to or instead of the underlying offense.

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Duty of Care

People in a fiduciary relationship must conduct business affairs prudently with the skill and attention normally exercised by people in similar positions.

People in a fiduciary relationship are not guarantors against all business reverses or errors in judgment.

The Business Judgment Rule protects corporate officers and directors from liability for judgment that were made in good faith and appeared to be prudent

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Federal Legislation Related to Fraud

Most white-collar crimes are prosecuted under the state systems. Prosecution under the criminal fraud statutes in the U.S. Code requires a federal jurisdictional basis, such as an effect on interstate commerce or mail uses.

Example: mail fraud, wire fraud, Racketeer Influenced and Corrupt Organizations (RICO)

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Types of Fraud

Another easier way to classify fraud: fraud committed against an organization and fraud committed on behalf of an organization.

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Fraud Against an Organization

“The use of one’s occupation for personal enrichment through the deliberate misuse or misapplication of the employing organizations’ resources or assets.” –ACFE

Also call it occupational fraud Can range from lunch break abuses to high-

tech schemes

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Fraud on Behalf of an Organization

The most common fraud in this category is fraudulent financial reporting.

Trying to make reported earning look better or to increase a company’s stock price.

Often occurs in companies that are experiencing net losses or have profits much less than expectation.

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Another Classification Scheme

Employee embezzlement Management fraud Investment scams Vendor fraud Customer fraud Miscellaneous fraud

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Employee Embezzlement

Another name for occupational fraud Direct employee fraud: occurs when company’s

assets go directly into the perpetrator’s pockets without the involvement of third parties.

Indirect employee fraud: occurs when employees take bribes or kickbacks from vendors, customers, or others outside the company to allow for lower sales prices, higher purchase prices. Payment to employees is usually made by organizations that deal with the perpetrator’s employer, not by the employer itself.

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Management Fraud

Top management’s deceptive manipulation of financial statements.

Example: Crazy Eddie, Inc. overstated inventories on financial statements; ZZZZ Best overstated revenues and receivables.

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Investment Scams

Fraudulent and usually worthless investments are sold to unsuspecting investors.

It includes telemarketing fraud, selling of worthless partnership interests, and other investment opportunities.

Charles Ponzi is regarded as the father of investment scams.

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Vendor Fraud

Fraud perpetrated by vendors acting alone Fraud perpetrated through collusion

between buyers and vendors Overcharge for purchased goods, the

shipment of inferior goods, or the nonshipment of goods even though payment was made.

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Customer Fraud

Customers either do not pay for goods purchased, or they get something for nothing, or they deceive organizations into giving them something they should not have .

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Law Constitution is the supreme law of the land. Constitutional rights that are of particular

importance to CFE include those found in the Fourth, Fifth and Sixth Amendments.

The Fourth Amendment guarantees the right of all citizens to be free from unreasonable searches and seizures.This means that the government may not seize any records in a criminal case unless there exist reasonable grounds—”probable cause”—to believe that the records would constitute evidence of a crime, and that a suspect may not be arrested unless there is probable cause.

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Law

The Fifth Amendment guarantees subjects of a criminal investigation the right to refuse to answer questions or to provide certain personal information that might be incriminating.

The Sixth Amendment affords subjects in a criminal investigation the right to counsel, the right to confront (cross-examine) the witnesses against them and the right to a speedy trial.

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Law

The two sources of substantive law are statutes passed by Congress and state legislatures (including regulations enacted by administrative and regulatory agencies) and the common law (judge-made law).

Criminal law prosecutions are always based on statutes, but civil actions can be based on both.

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Law

Substantive law is comprised of the basic laws of rights and duties as opposed to procedural law which involves rules governing pleadings, evidence, jurisdiction, etc.

Substantive law sets the terms of any dispute; procedural law dictates how a legal dispute is handled.

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Law

Fraud can be prosecuted civilly and criminally.

Criminal and civil actions for fraud may proceed simultaneously.