Approaches to Fraud
Prevention
Bill Brown: Partner – Forensic & Litigation Services
Tel: 972-448-6966
E-mail: [email protected]
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
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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
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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
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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 by
false 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”
Forensic Audit
Narrow Scope
Volume
of
Knowledge
Routine Audit
Broad Scope
A/P
Minimal
Depth
A/P
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
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Tip
Management Review
Internal Audit
By Accident
External Audit
IT Controls
43.3%
14.6%
14.4%
7.0%
3.3%
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
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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
TONE at the Top
REMEDIATION
95%
EDUCATE EMPLOYEES
INVESTIGATE
REPORTING
MECHANISM
REDUCE
DETECTION
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 antifraud 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
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Living Beyond Means
Financial Difficulties
Close Association with Vendor
Control Issues
Divorce/Family Issues
Addiction Problems
Source: 2012 ACFE Report to the Nation
35.6%
27.1%
19.2%
18.2%
14.8%
8.4%
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