FACE OF FRAUD Felix Lozano Chairman Nexia International Audit Committee Partner, Whitley Penn LLP November 10, 2010

FACE OF FRAUDFelix Lozano

Chairman Nexia International Audit Committee

Partner, Whitley Penn LLP

November 10, 2010

INTERNATIONAL LANGUAGE

• What is our international language? …

… QUALITY

TODAY’S AGENDA

• Fraudo Occupational Fraud Definedo Theoryo Statisticso Types of Fraud

• Dealing with Fraud o Prevention o Detection

OCCUPATIONAL FRAUD DEFINED

ELEMENTS OF A FRAUD

• A representation

• About a material point

• Which is false

• Intentionally or recklessly so

• Relied upon by the victim

• To the victim’s damage

• Who is Jérôme Kerviel ?

FACE OF FRAUD TRIVIA #1

http://en.wikipedia.org/wiki/J%C3%A9r%C3%B4me_Kerviel

http://en.wikipedia.org/wiki/Image:ToursSocieteGenerale.jpg

FACE OF FRAUD TRIVIA # 1

Rogue French Trader Jérôme Kerviel Ordered to Pay Back the $6.7 Billion He Lost

TURN OF THE CENTURY BULL MARKETS MAKE HEROES

Scott Sullivan, WorldCom: 1998 CFO of the Year

Andrew Fastow, Enron: 1999 CFO of the Year

Mark Swartz, Tyco: 2000 CFO of the Year

TURN OF THE CENTURY BEAR MARKETS MAKE CROOKS

Scott Sullivan, 2002: Indicted and charged with fraud.

Andrew Fastow, 2002: Indicted and charged with conspiracy, fraud, money laundering, insider trading.

Mark Swartz, 2002: Indicted and charged with fraud.

CURRENT CROOKS – PONZI SCHEMES

"Bernie" Madoff, 2009: Pleaded guilty to 11 federal crimes

Robert Allen Stanford, 2009: Pleaded "not guilty" to charges of fraud, conspiracy and obstruction

Nick Cosmo, 2009: Indicted on 10 counts of wire fraud and 22 counts of mail fraud

http://en.wikipedia.org/wiki/File:BernardMadoff.jpg

MISAPPROPRIATION OF ASSETS• Cash fraud schemes

– Skimming– Larceny– Fraudulent disbursements

• Accounts receivable schemes– Improper posting of credits

• Discount• Return• Write-off

• Inventory and other asset schemes– Appropriating inventory and supplies for personal use

• Stealing inventory• Theft of scrap proceeds

CORRUPTION

• Bribery

• Illegal gratuities

• Economic extortion

• Conflicts of interest

FINANCIAL STATEMENT FRAUD• Fictitious revenues

– Involves the sale or goods or services which never occurred• Timing differences

– Improper matching of revenues– Early revenue recognition– Recording expenses in the wrong period

• Concealed liabilities and expenses– Liability/expense omissions– Returns and allowances and warranties

• Improper disclosure– Liability omissions– Significant events – Management fraud– Accounting changes

• Improper asset valuation– Inventory– Fixed Assets

DONALD R. CRESSEY

• Known for his studies of organized crime

• Served as organized crime consultant to the President's Commission on Law Enforcement and Administration of Justice in 1966 and 1967

• Cressey’s hypothesis later became known as the “Fraud Triangle”

WHAT DO PEOPLE STEAL?

INCENTIVE/PRESSURE

Fraud Triangle

PERCEIVEDOPPORTUNITY

RATIONALIZATON

WHY DO PEOPLE STEAL?

INCENTIVE/PRESSURE

PERCEIVEDOPPORTUNITY

RATIONALIZATON

CAPABILITY

FIGHTING FRAUDWHAT HAVE WE DONE IN ACCOUNTING?

• Treadway Commission ’87• COSO ’87• SAS 53 ’88• Certified Fraud Examiner ’88• SAS 82 ’96• Sarbanes Oxley ’02• SAS 99 -’ 02• ISA 240 - ‘04

FIGHTING FRAUDWHAT HAVE WE DONE IN LEGAL?

• Sarbanes Certifications• Anonymous Hotlines• Whistleblower Investigations• DOJ Investigations• SEC Investigations

INTERNAL CONTROL WEAKNESSPrimary Internal Control Weakness Observed by CFEs

*Obtained from 2010 Certified Fraud Examiners report “2010 Report to the Nation on Occupational Fraud and Abuse”

ORGANIZATION TYPE OF VICTIMSOrganization Type of Victim — Median Loss


BASED ON SIZE OF VICTIM ORGANIZATIONSize of Victim Organization — Median Loss


INDUSTRY OF VICTIM ORGANIZATIONS

Sorted by Frequency


INDUSTRY OF VICTIM ORGANIZATIONS

Sorted by Median Loss


INITIAL DETECTION OF OCCUPATIONAL FRAUD

Initial Detection of Occupational Frauds


TENURE OF PERPETRATOR - FREQUENCY

Tenure of Perpetrator — Frequency


TENURE OF PERPETRATOR – MEDIUM LOSS

Tenure of Perpetrator — Median Loss


FACE OF FRAUD TRIVIA # 2

What 2002 movie was based on a young con artist who successfully impersonated an airline pilot, doctor, assistant attorney general and history professor, cashing more than $2.5 million in fraudulent checks in 26 countries?

a. The Magnificent Fraudb. Catch Me if You Canc. The Bourne Identityd. Gangs of New York

AGE OF PERPETRATOR – MEDIAN LOSSAge of Perpetrator — Median Loss


AGE OF PERPETRATOR - FREQUENCYAge of Perpetrator — Frequency


EDUCATION OF PERPETRATOREducation of Perpetrator — Median Loss


FRAUD TRIVIA # 3

What did this Indiana money manager do to make national headlines in 2009?

POSITION OF PERPETRATOR – MEDIUM LOSS

Position of Perpetrator — Median Loss


POSITION OF PERPETRATOR - FREQUENCY

Position of Perpetrator — Frequency


GENDER OF PERPETRATORGender of Perpetrator — Frequency

Gender of Perpetrator — Median Loss


GENDER OF PERPETRATORPosition of Perpetrator Based on Gender

Position of Perpetrator — Median Loss Based on Gender


NUMBER OF PERPETRATORS


PERPETRATORS’ CRIMINAL HISTORIESPerpetrator’s Criminal Background


PERPETRATORS’ CRIMINAL HISTORIESPerpetrator’s Employment Background


FRAUD TRIVIA # 4

Approximately how much does the US lose due to fraud each year?

a. More than $50 billionb. More than $200 billionc. More than $500 billiond. More than $900 billion

DISTRIBUTION OF DOLLAR LOSSESDistribution of Losses


HEALTHSOUTH, INC. TRICK

Entry One A/R Revenue

Entry Two Fixed Assets Cash

Entry Three Cash A/R

HEALTHSOUTH, INC. TRICK

Entry One A/R Revenue

Entry Two Fixed Assets Cash

Entry Three Cash A/R

CORRUPTION CASES BY INDUSTRY


FACE OF FRAUD TRIVIA TRIVIA # 5

What initiated the investigation into former governor Eliot Spitzer?

a. He bounced a checkb. Bank filed a SARc. He confessed to his wifed. Internal audit investigation

INTERNATIONAL OUTLOOKDEPARTMENT BASED ON REGION

**Obtained from 2010 Certified Fraud Examiners report “2010 Report to the Nation on Occupational Fraud and Abuse”

INTERNATIONAL OUTLOOKDEPARTMENT BASED ON REGION


INTERNATIONAL OUTLOOKANTI-FRAUD CONTROLS BY REGION


INTERNATIONAL OUTLOOKANTI-FRAUD CONTROLS BY REGION


ANTI-FRAUD CONTROLS BY REGION


ANTI-FRAUD CONTROLS BY REGION


INTERNATIONAL OUTLOOK

Schemes Committed by Perpetrators in the Accounting Department — 367 Cases



Schemes Committed by Perpetrators in the Sales Department — 225 Cases


INTERNATIONAL OUTLOOKSchemes Committed by Perpetrators in Executive/

Upper Management Positions — 224 Cases



Schemes Committed by Perpetrators in the

Customer Service Department — 120 Cases



Schemes Committed by Perpetrators in the Purchasing Department — 103 Cases














INTERNATIONAL CORRUPTION CASES BY REGION


INTERNATIONAL MEDIAN LOSS BASED ON GENDER AND REGION


DEPARTMENT BASED ON REGION


DEPARTMENT BASED ON REGION


BEHAVIORAL RED FLAGS

*The sum of percentages in this table exceeds 100% because in several cases the perpetrator exhibited more than one behavioral red flag.


FRAUD PREVENTION

• What You Can Do– Tone at the Top– Code of Ethics/Conduct– Background Checks– Appropriate Compensation– Constant Training– System of Internal

Controls– Consequences

WHO IS RESPONSIBLE?

• Board of Directors

• Executive Management

• All Employees

• Auditors Have a Responsibility to Plan Audit Accordingly, but WE ARE NOT REQUIRED TO FIND FRAUD

FRAUD DETECTION

• What You Can Do– Internal Audit

– Separate Fraud Department

– Software Tools

– Monitoring

– Whistleblower Policies

– External Audit

– Foster an Open Culture

WHITELY PENN FRAUD CASES

• Compilation Client

• Inflating Accounts Receivable

• $123,000

• WP Accounting Services Identified


• Neurologist’s – Identity Theft

• Business Manager 25 Years

• Refinance of Home Loan - Credit Report

• $176,000


• Construction Fraud• Collusion

– Construction Superintendent (Tommy Ingram - 54)– Concrete Vendor (Ray Brooks - 57)

• $7.6 Million Fraudulent Charges• 14 Month Investigation• FBI and DA’s Office• Project Team

– Construction Auditor– Engineer– CPA’s

• Jail Term – 8 years for both Defendants

QUESTIONS?

THANK YOU

Documents

FACE OF FRAUD Felix Lozano Chairman Nexia International Audit Committee Partner, Whitley Penn LLP November 10, 2010