Fraud and Other Fraud and Other Investigative Investigative

TechniquesTechniques

Chapter 10Chapter 10

Learning ObjectivesLearning Objectives

The definition of fraudThe definition of fraud Different types of fraudDifferent types of fraud Components of the Fraud TriangleComponents of the Fraud Triangle Utilization of ACL and i2 Analyst Utilization of ACL and i2 Analyst

Notebook in fraud investigationNotebook in fraud investigation

Learning Objectives Learning Objectives (contd.)(contd.)

Overview of fraud examination Overview of fraud examination and business investigationand business investigation

Use of computer technology and Use of computer technology and fraud examination/investigationsfraud examination/investigations

Types of value added Types of value added servicesservices

Risk assessment of fraud and illegal actsRisk assessment of fraud and illegal acts Legal counsel asks you to investigate Legal counsel asks you to investigate

embezzlement scheme involving hidden embezzlement scheme involving hidden assetsassets

Vendor kickback determinationVendor kickback determination Fact-finding for alleged frauds involving Fact-finding for alleged frauds involving

bribery, wire fraud, securities fraud…….bribery, wire fraud, securities fraud……. All of these involve forensic accounting or All of these involve forensic accounting or

litigation supportlitigation support

Fraud definedFraud defined

Intentional deception, simply lying, Intentional deception, simply lying, cheating, or stealingcheating, or stealing

A generic term, embracing all A generic term, embracing all multifarious means which human multifarious means which human ingenuity can devise, and which are ingenuity can devise, and which are resorted to by one individual to get resorted to by one individual to get advantage over another by false advantage over another by false suggestions or by suppression of suggestions or by suppression of truth. It includes surprise, trickery, truth. It includes surprise, trickery, cunning, dissembling, and any unfair cunning, dissembling, and any unfair way by which another is cheated.way by which another is cheated.

Fraud defined (contd.)Fraud defined (contd.)

Fraud includes the following elements:Fraud includes the following elements:A misrepresentation of a material A misrepresentation of a material

factfactKnown to be falseKnown to be false Justifiably relied uponJustifiably relied uponResulting in a lossResulting in a loss

Types of fraudsTypes of frauds

Fraudulent financial reporting Fraudulent financial reporting (management fraud)(management fraud) Actions whereby management Actions whereby management

attempts to inflate reported attempts to inflate reported earnings or other assets in order earnings or other assets in order to deceive outsidersto deceive outsiders

Overstating assets/revenues, price Overstating assets/revenues, price fixing, contract bidding fraud, fixing, contract bidding fraud, understating expenses/liabilitiesunderstating expenses/liabilities

Types of frauds Types of frauds (contd.)(contd.)

Misappropriation of assets Misappropriation of assets (employee fraud)(employee fraud) Actions of individuals whereby Actions of individuals whereby

they misappropriate (steal) they misappropriate (steal) money or other property from money or other property from their employerstheir employers

Embezzlement, theft of Embezzlement, theft of company property, kickbackscompany property, kickbacks

Types of fraud (contd.)Types of fraud (contd.)

Employee embezzlement – fraud in which Employee embezzlement – fraud in which employees steal company assets either employees steal company assets either directly – stealing cash or inventory –or directly – stealing cash or inventory –or indirectly – taking bribes or kickbacksindirectly – taking bribes or kickbacks

Management fraud – deception by top Management fraud – deception by top management of an entity primarily management of an entity primarily through the manipulation of the financial through the manipulation of the financial statements in order to mislead users of statements in order to mislead users of those statementsthose statements

Investment scams – the sale of Investment scams – the sale of fraudulent and often worthless fraudulent and often worthless investments (telemarketing and Ponzi investments (telemarketing and Ponzi scheme type frauds)scheme type frauds)

Types of fraud (contd.)Types of fraud (contd.)

Vendor fraud – fraud resulting from Vendor fraud – fraud resulting from overcharging for goods purchased, overcharging for goods purchased, shipment of inferior goods, or non-shipment of inferior goods, or non-shipment of inventory even when shipment of inventory even when payment has been receivedpayment has been received

Customer fraud – fraud committed by Customer fraud – fraud committed by a customer by not paying for goods a customer by not paying for goods received or deceiving the organization received or deceiving the organization in various ways to get something for in various ways to get something for nothingnothing

Miscellaneous fraud – all others – Miscellaneous fraud – all others – altering birth records or grade altering birth records or grade reports, etc.reports, etc.

Examples of fraud Examples of fraud activitiesactivities

Misappropriation of Misappropriation of assetsassets SkimmingSkimming ForgeryForgery KitingKiting Phony refundsPhony refunds LarcenyLarceny Fraudulent Fraudulent

disbursementsdisbursements LappingLapping Fictitious write-offsFictitious write-offs Duplicate paymentsDuplicate payments Nonexistent vendorNonexistent vendor KickbacksKickbacks Misdirected shipmentsMisdirected shipments TheftTheft Unauthorized personal Unauthorized personal

use of assetsuse of assets Fictitious burglaryFictitious burglary Phantom employeesPhantom employees Falsified time cardsFalsified time cards

Fraudulent financial Fraudulent financial reportingreporting Fictitious revenuesFictitious revenues Asset overstatementAsset overstatement Unrecorded liabilitiesUnrecorded liabilities Improper disclosureImproper disclosure

CorruptionCorruption Conflict of interestConflict of interest BriberyBribery Illegal gratuitiesIllegal gratuities Economic extortionEconomic extortion

The Fraud TriangleThe Fraud Triangle

Three factors in the triangle (usually all Three factors in the triangle (usually all 3 exist in a fraud)3 exist in a fraud) Motivation (perceived pressure or Motivation (perceived pressure or

incentive)incentive) Perceived opportunityPerceived opportunity RationalizationRationalization

Effective internal controls limit fraudEffective internal controls limit fraud If an organization can contain any one If an organization can contain any one

of the three elements, fraud will most of the three elements, fraud will most likely not occurlikely not occur

Overview of financial Overview of financial fraud examinationfraud examination

Two basic categories of fraud an Two basic categories of fraud an auditor investigates when auditor investigates when examining material examining material misstatement risk assessment misstatement risk assessment Fraudulent financial reportingFraudulent financial reportingMisappropriation of assetsMisappropriation of assets

Overview of financial Overview of financial fraud examination fraud examination

(contd.)(contd.) Financial reporting fraud red flagsFinancial reporting fraud red flags

Incentive/pressuresIncentive/pressures High degree of competition or market High degree of competition or market

competition in conjunction with competition in conjunction with declining profit marginsdeclining profit margins

Perceived or real adverse effects of Perceived or real adverse effects of reporting poor financial resultsreporting poor financial results

Personal guarantees by management Personal guarantees by management or board members of entity debtor board members of entity debt

Overview of financial Overview of financial fraud (contd.)fraud (contd.)

Financial reporting fraud (contd.)Financial reporting fraud (contd.)Opportunities – flagsOpportunities – flags

Highly complex transactionsHighly complex transactionsMajor international operationsMajor international operationsDeficiencies in internal Deficiencies in internal controlscontrols

Overview of financial Overview of financial fraud (contd.)fraud (contd.)

Financial reporting fraud (contd.)Financial reporting fraud (contd.) Attitudes/rationalization flagsAttitudes/rationalization flags

Ineffective communication or Ineffective communication or enforcement of ethical standardsenforcement of ethical standards

Excessive interest by Excessive interest by management in maintaining or management in maintaining or increasing the entity’s earnings increasing the entity’s earnings trendtrend

Overview of financial Overview of financial fraud (contd.)fraud (contd.)

Misappropriation of asset risk Misappropriation of asset risk factorsfactorsSusceptibility of assets to Susceptibility of assets to

misappropriationmisappropriationLarge amounts of cash on handLarge amounts of cash on handEasily convertible assets (bonds, Easily convertible assets (bonds, diamonds)diamonds)

Controls (lack of)Controls (lack of)

Overview of financial Overview of financial fraud (contd.)fraud (contd.)

Steps of the fraud examinationSteps of the fraud examination Indentify issue/plan the Indentify issue/plan the

investigationinvestigationGather the evidence/the Gather the evidence/the

investigation phaseinvestigation phaseEvaluate the evidenceEvaluate the evidenceReport he findings to Report he findings to

management?/legal counselmanagement?/legal counsel

Computer technology Computer technology in fraud investigation in fraud investigation

(contd.)(contd.) Data mining softwareData mining software

Software tool that models a database for Software tool that models a database for the purpose of determining patterns and the purpose of determining patterns and relationships among the datarelationships among the data

Wizrule – used for data cleaning Wizrule – used for data cleaning (searching for clerical errors) or (searching for clerical errors) or anomaly detection.anomaly detection.

Financial Crime Investigator – Financial Crime Investigator – systematic approach for investigating, systematic approach for investigating, detecting, and preventing contract and detecting, and preventing contract and procurement fraudprocurement fraud

Computer technology Computer technology in fraud investigationin fraud investigation

(contd.)(contd.) Data mining software (contd.)Data mining software (contd.)

IDEA (Audimation Services, inc) – allows IDEA (Audimation Services, inc) – allows user to display, analyze, manipulate, sample user to display, analyze, manipulate, sample or extract dataor extract data

Monarch – allows investigator to convert Monarch – allows investigator to convert electronic editions of reports into text fileselectronic editions of reports into text files

ACL for windows – data inquiry, analysis, and ACL for windows – data inquiry, analysis, and reporting softwarereporting software

Analyst’s notebook – assists investigators by Analyst’s notebook – assists investigators by uncovering, interpreting, and displaying uncovering, interpreting, and displaying complex information in easily understood complex information in easily understood charts.charts.

Public records – see Public records – see figure 10-7figure 10-7

Courthouse records – lawsuits, judgments, Courthouse records – lawsuits, judgments, property filings, bankruptcy filingsproperty filings, bankruptcy filings

Company records – SEC filings, Dun and Company records – SEC filings, Dun and Bradstreet has private company data, D/B/A Bradstreet has private company data, D/B/A filings with state or county, real estate filings with state or county, real estate filingsfilings

Online databases – lexis nexis, dow jones, Online databases – lexis nexis, dow jones, etcetc

The internet – knowX – fraud searches, The internet – knowX – fraud searches, switchboard – white and yellow page listing,switchboard – white and yellow page listing,