Fraud 101 E-Book

Stephen Pedneault

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Sprache: Englisch

Veröffentlichungsjahr: 2010

Beschreibung

A straightforward guide explaining the nature of financial fraud

Fraud continues to be one of the fastest growing and most costly crimes in the United States and around the world. The more an organization can learn about fraud in general and the potential fraud risks that threaten the financial stability of the organization's cash flow, the better that organization will be equipped to design and implement measures to prevent schemes from occurring in the first place.

Fraud 101, Third Edition serves as an enlightening tool for you, whether you are a business owner or manager, an accountant, auditor or college student who needs to learn about the nature of fraud. In this invaluable guide, you will discover and better understand the inner workings of numerous financial schemes and internal controls to increase your awareness and possibly prevent fraud from destroying your organization's financial stability.

It offers guidance, understanding, and new, real-world case studies on the major types of fraud, including

• An understanding of why fraud is committed
• An overview of financial fraud schemes
• White-collar crime
• Uncovering employee embezzlements
• Establishing internal fraud controls
• The nature of collecting evidence

With case studies included throughout the book to gain insight to the real world of fraud, Fraud 101, Third Edition describes the features of fraud and then provides proven methods of prevention, as well as solutions to expose different types of fraud.

Leseprobe

Table of Contents

Title Page

Copyright Page

Dedication

Preface

Acknowledgements

Introduction

CHAPTER 1 - The World of Fraud

Definition of Fraud

The Man Types of Fraud

Note

CHAPTER 2 - Why Is Fraud Committed?

A Rationalizing Society

Financial Statement Fraud

Financial Fraud Comes in Different Shapes and Sizes

Motivators Differ by Type of Business

Employee Schemes

In the End

CHAPTER 3 - Financial Statement Fraud Schemes

Where Do Thing s Go Wrong?

Trend Analysis

Beyond Traditional Audits

Note

CHAPTER 4 - Employee Embezzlements

The Fraud Triangle

Areas for Concern

Notes

CHAPTER 5 - Other Fraud Schemes

Duplicate PaymentFraud

Multiple Payee Fraud

Shell Fraud

Defective Delivery Fraud

Defective Receipt Fraud

Defective Ship ment Fraud

Defective Pricing Fraud

CHAPTER 6 - Contract Rigging Schemes

Stage One: Obtaining the Contract

Stage Two: Contract Change Orders

Unbalanced Bidding

Detection Recommendations

Rotation Fraud

Where Do We Go from Here?

CHAPTER 7 - Responses to Fraud

Government’s Response to Fraud

Accounting Profession’s Response to Fraud

Internal Audit Profession’s Response to Fraud

New Credentials, More Training, Better Awareness

Articles, Books, and More Resources

Notes

CHAPTER 8 - The Importance of Internal Controls and Internal Audit

Why Have Internal Controls?

Déjà Vu

Good Internal Controls

Internal Audit

CHAPTER 9 - Evidence

What Is Evidence?

Documentation

Note

CHAPTER 10 - Conducting Fraud Investigations: A Practical Approach

Proactive Fraud Investigations

Discovery Investigations

Supportive Investigations

Strategy

Predication

The Investigative Plan

Conducting the Procedures

Findings

Use of the Findings

Note

CHAPTER 11 - Fraud Investigation Alternatives

Assessing the Feasibility of a Full Investigation

Monitoring Operational Areas at Risk of Fraud

Revamping Internal Controls: Closing the Barn Door

Doing Nothing?

Note

Appendix A - Vending

Appendix B - Living a Façade

Appendix C - Disappearing Inventory

Index

Copyright © 2009 by Stephen Pedneault. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada.

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Library of Congress Cataloging-in-Publication Data:

Pedneault, Stephen, 1966-Fraud 101 : techniques and strategies for understanding fraud / Stephen

p. cm.

Includes bibliographical references and index.

eISBN : 978-0-470-64784-4

1. Commercial crimes-Investigation-United States. 2. Fraud investigation- United States. I. Title. II. Title: Fraud one hundred one. III. Title: Fraud one hundred and one.

HV6769.D38 2009

363.25’963-dc22 2009015530

For Justin, Evan, and Kim

Preface

At the time of this writing of the third edition of Fraud 101, the U.S. economy is facing extraordinary challenges. Wall Street and the entire global economic and financial system are in steep decline, and the economy is in a worldwide recession. Financial institution Lehman Brothers recently filed for bankruptcy, the insurance giant AIG is in dire financial straits and required taxpayer bailouts to survive, and the mortgage giants Fannie Mae and Freddie Mac are in deep jeopardy. The U.S. federal government approved a historic funding package of up to $750 billion in stimulus payments to be made to various financial markets and industries in distress with the goal of stimulating the economy. Payments to date appear to have had little impact with no proven results on the economy.

In one of the most egregious cases in history, Bernard Madoff, a financier and investment manager, recently admitted to embezzling more than $50 billion of investors’ funds through an elaborate Ponzi scheme he perpetrated. Allegedly, the money he paid to early investors was from funds received from subsequent investors, and when too many investors demanded their funds in response to the failing economy, the scheme collapsed. Although Ponzi schemes are common and have occurred many times in history, Madoff’s scheme is the largest Ponzi scheme ever. The dimension of fraud cases is becoming unfathomable—multi-millions and even billions are becoming commonplace.

In one recent case detected in my home state of Connecticut last month, the sole equity partner of a six-office, 238-attorney law firm was accused of stealing more than $350 million in client funds. One person—$350 million. The question that remains is just how many of these schemes exist today and continue to go undetected?

“Identify theft,” a buzz word for the past two years, has been replaced by “subprime lending,” “mortgage fraud,” and record-setting foreclosures. Financial lending has come to a grinding halt, with money no longer moving between institutions, and interest rates have been cut to record lows by the Federal Reserve in the hope of jump-starting the economy. It’s not a particularly great time in history from an investor’s perspective, but an extremely interesting time for fraud professionals.

It is not unusual for policies and practices to have a direct link to increases in fraudulent activity. To examine identify theft for a moment, we would start by looking back to see how personal and financial information was safeguarded. We would not have to look far into the past to see that Social Security numbers appeared on many items, including insurance cards, voter registration cards (a matter of public record), and class lists posted on every professor’s office door in most every college and university. The use of shredders has only become commonplace in most businesses and homes since identity theft became an issue. The earlier practice was to simply throw away old and unwanted information, which allowed thieves to capture critical information merely by going through the garbage. With so much personal and financial information proliferated under past practices, it is no wonder identify theft became such an issue.

The same holds true with the new mortgage fraud industry. Prior to subprime and other questionable lending practices, would-be borrowers were required to substantiate their income and assets and support their applications for loans with credible documentation. The application package was scrutinized and verified, and the borrower would be allowed to borrow only up to a maximum value of the property. Borrowers could only borrow funds up to a limit they could afford to repay monthly, including real estate taxes and insurance costs, and also have some residual funds for living expenses. Loan products offered as late as 2006 and 2007 offered borrowers the ability to purchase homes well beyond their price range, with little to no income verification performed. Borrowers could state their income without providing any support and could borrow up to 100% of the value of the property with no money down. It is no wonder the foreclosure rate has reached historic levels, leading to the discovery of mortgage fraud in many of these deals. Individuals participating in real estate closings were often compensated with a commission for each closing, creating a financial incentive for lenders and mortgage brokers to solicit and close as many purchases and refinances as possible, at any cost. It is only after the mortgage industry’s collapse that we are finding out that many real estate professionals, including real estate agents, appraisers, lenders, mortgage brokers, and real estate attorneys fudged documents, inflated values, and perpetrated other intentional acts to ensure closings occurred.

Although it is too recent for reaction, the Madoff investment scandal will no doubt forever have an impact on the investment community and industry. New rules will likely result, and investors will review their accounts and investments in a different light, especially if an outside investment firm is involved. Future investment decisions and the ways those investment decisions are tracked will forever be examined in light of Madoff’s scheme, with the goal of ensuring what happened with the funds invested with Madoff never happens again.

According to the Association of Certified Fraud Examiners’ 2008 Report to the Nation on Occupational Fraud and Abuse, approximately 7% of an entity’s gross revenue is lost to fraud. When the 7% estimate is applied to the Gross Domestic Product, the loss due to fraud approximates $994 billion each year. In reality, the figure is likely even higher, as most frauds go unreported—or worse, have yet to be detected.

When assessing the frequency of fraudulent activity to gauge just how much fraud has been occurring, it is important to remember that only the most egregious fraud cases receive media and legislative attention. In fact, fraud is not limited to large international corporations like WorldCom and Enron. Fraud can and does occur in any size company or organization, large or small, regardless of their for-profit or nonprofit status, and in every industry. The majority of smaller frauds never appear in the media and become public knowledge, partly due to their size and frequently by investigative design.

Fraud is also not limited to financial statements, disclosures, and reports issued to investors and lenders alike. Employees are stealing from companies at alarming rates, and individuals concoct new schemes almost daily to defraud some program or system for their own personal gain.

It is clear that fraud has become a growth industry and not only for the perpetrators. Fighting fraud through education, prevention, detection, investigation training, and ultimately prosecution and punishment offers unprecedented growth opportunities in various career paths and industries. The passage of the Sarbanes-Oxley Act (SOX) alone, enacted to address fraud and the dire need for adequate internal controls and procedures within publicly traded companies, has resulted in a whole new industry in and of itself.

Fraud can be and often is broadly defined, but to really understand fraud, it needs to be contextualized to identify the characteristics and issues unique to each type of fraud. One of the goals in writing this third edition of Fraud 101 is to provide the reader with a working definition of fraud in the broad sense, followed with as many examples as possible of various types of fraud based on my personal experience as a forensic accountant and fraud professional for more than 20 years. Unlike many fraud professionals who have spent their careers investigating a specific range of fraud schemes, I have been fortunate in having the opportunity to apply my knowledge and experience in fraud prevention and investigation in a wide variety of contexts.

Building on the previous editions of Fraud 101 by Howard Davia and then Howard Silverstone, this third edition brings to focus two areas of fraud: financial statement fraud and employee fraud, including embezzlement. The new edition also provides an investigative approach and new discussion regarding investigative issues, including alternatives for resolving fraud-related matters. Lastly, as with previous editions, new case studies are included to illustrate various fraud schemes in rich detail.

In updating this book, I recognized that many great books exist detailing the history of fraud, various theories on fraud, fraud motivators, deviant traits and tendencies, prevention recommendations, investigative techniques, and other generalized information. Those books provide the depth and detail needed to become and remain proficient in this specialized field. I own most of them. However, there is also a need for books designed to introduce professionals, as well as non-accountants, to the specialized field of fraud. This book is meant to be a valuable introduction to the subject of fraud for those who have little to moderate experience dealing with it, whether preventing, detecting, or investigating it.

The approach used in this third edition is to explain fraud in a practical, easily understood manner, supplementing discussions with real-world case studies that clearly illustrate the fraud issues and schemes discussed. Three detailed cases based upon actual fraud investigations have been included as Appendices to illustrate examples of how fraud schemes are perpetrated, detected, and investigated. Each case concludes with practical advice on how the fraudulent activity could have been prevented or detected earlier, thus minimizing the loss experienced by each victim organization. Experienced fraud professionals seeking to expand and enhance their well-developed skill set may feel this book is basic, although the cases may enlighten even the most seasoned investigator.

While it would be ideal and efficient to discuss every possible aspect of fraud in every possible context all in one book, it would also be an impossible undertaking. As you will learn, the details of any one specific type of fraud could be expanded and detailed within a book dedicated only to that type of fraud, and many of those books exist today. My hope is that you will find this book a valuable introduction to how fraud works and how to prevent, detect, and prosecute fraud that could be occurring in your organization.

Stephen Pedneault

January 2009

Acknowledgments

To my family, who has both supported and tolerated my undertakings and at times crazy schedule, setting the bar high and expecting nothing less.

To my friends and trusted advisors, who have supported my career decisions, have taken personal interest in my success, and have helped bring to light the things they saw in me.

To Helen Koven, my friend and publicist, who gave me the push I needed to begin to document more than 20 years of experience in fraud and forensic accounting in a way that takes the complex and makes it easily understood by accountants and non-accountants alike.

To the folks at Wiley, who gave me this opportunity to expand into the world of writing, opening new doors into my future.

To Joseph T. Wells, founder of the Association of Certified Fraud Examiners, for his foresight into the need for a specialist cross-trained between accounting and investigations, and for providing me with someone to follow as my role model in becoming a national expert in this specialized field.

And to James Ratley and everyone in the Association of Certified Fraud Examiners down in Austin, Texas, who, unbeknownst to them, have contributed so much towards my success as a fraud examiner.

Introduction

It was a bright sunny day in November. The first frost had set in; leaves were still falling, but most had made it to the ground. I was at my desk when Jim Maxwell called. Jim was a lender at the local branch of a bank just down the street. Jim indicated that one of his customers had called him yesterday to inform him that his company would not be meeting its financial covenants when the company submitted its financial statements at the end of December. Jim indicated that the call came as a surprise to him, as the monthly financial reports the company had been submitting right up through September showed the company performing well and within the covenant ratios. A member of the bank’s asset review team had even met with the company’s president, Bob Silver, during the summer, and nothing unusual was noted. Jim indicated the bank had a term loan outstanding with Bob’s company for $2.5 million, along with a maxed-out revolving line of credit of $1 million.