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Managing fraud and fraud risks as part of
an overall organizational cost reduction strategy
Guido van Drunen, Principal
June 16, 2011
Advisory Services
© 2011 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 50716SFO
2
What we are going to be speaking about
Risk management is becoming more and more part of everyday corporate governance and compliance. One risk that all organizations are faced with is fraud, waste, and abuse, yet little is done to specifically address this risk and at times significant business cost. This session will address the cost of fraud waste and abuse to organizations and key strategies for minimizing costs through prevention programs, proactive detection programs and how to respond to incidents of fraud, waste, and abuse to limit further losses, mitigate fines, and attempt to recover losses.
© 2011 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 50716SFO
3
The problem: Fraud, waste, and abuse are business costs.
The 2010 Association of Certified Fraud Examiners (ACFE) report to the nation makes the following key observation:
“While it is unlikely that we can accurately measure the true costs of occupational fraud at any given point in time, it is still useful to try to gain some understanding of the scope of the problem with which we are confronted. Accordingly, we asked each survey participant to provide his or her best estimate of the percentage of annual revenues lost by the typical U.S. organization to fraud each year. Survey participants estimated that the typical organization loses 5 percent of its annual revenue to fraud.”
Source: 2010 ACFE report
© 2011 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 50716SFO
4
The real cost
Even if the 5 percent figure is double or triple what might be occurring at your organization, the amount is still meaningful.
The amount noted above does not include the costs of investigations, management down time, and/or distractions.
While we will not discuss the issue here, there is also the cost (often times unmeasurable) on the ethical environment of the organization.
Suffice it to say the measure and quantity of the projected losses are significant.
© 2011 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 50716SFO
5
The current environment
U.S.: Gross Domestic Product $14.6 trillion¹
Estimated Fraud Loss Rate² 5%
U.S. Cost of Fraud $700 billion
1 Estimate for FY 2010, per U.S. Dept of Commerce Bureau of Economic Analysis2 2010 ACFE Report to the Nation on Occupational Fraud and Abuse
© 2011 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 50716SFO
6
Occurrences and cost of fraud
2010 ACFE Report to the Nation on Occupational Fraud and Abuse
Con-sumer 23%
Em-ployee
37%
Finan-cial
Report-ing4%
In-suran
ce5%
Mis-conduct4%
Com-puter Crime
6%
Ven-dor-re-lated21%
Percentage of fraud occurrences
Consumer 4%
Employee 1%
Finan-cial
Report-ing
76%
In-suran
ce17%
Others1%
Percentage of total fraud of cost
© 2011 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 50716SFO
7
Important but hard to define costs and benefits
Leaving aside the less readily quantifiable benefits which result from strong antifraud programs and controls such as:
Tone at the top
Deterrent effects
Employee morale
Sustainability
Operational efficiencies, etc.
The potential losses projected by the ACFE provide a significant opportunity set to warrant focusing cost reduction initiatives on them.
© 2011 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 50716SFO
8
Key strategies for minimizing costs through prevention programs
Conduct a high-level fraud risk assessment of the organization. This can be part of the standard enterprise risk management process.
Identify those areas considered to be of potential higher risk due to a number of issues such as volume of transactions, nature of the industry, dollar values processed, past issues, strength of control structure, ability to collude, etc.
Select the top three risks and use automated tools to conduct tests for fraud, waste, and abuse.
Assess the output produced and conduct appropriate follow-up.
© 2011 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 50716SFO
9
Misappropri-ation of assets
Revenue/assets
improperly gained
Expenses/liabilities
for improper purposes
Expenses/liabilities
improperly avoided
Fraudulent financial reporting
Other misconduct
Types of fraud and misconduct risks
© 2011 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 50716SFO
10
Integrity survey 2009Key findings
Prevalence of fraud and misconduct remains high
Have you personally observed or do you have first-hand knowledge of wrongdoing within your organization?
2000
2005
2008
0 20 40 60 80 100
76
74
74
Source: KPMG Integrity Survey 2009
© 2011 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 50716SFO
11
Integrity survey 2009Key findings (continued)
Would the observation cause a “significant loss of public trust?”
Source: KPMG Integrity Survey 2009
2000
2005
2008
0 20 40 60 80 100
49
50
46
© 2011 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 50716SFO
12
Proactive detection programs
The ACFE has identified that the procurement cycle, T&E, and payroll account for over 60 percent of all organizational fraud cases.
While the largest risk remains the manipulation of the financial statements, there are opportunities for potential cost reduction in the areas identified above which are a much larger volume of the fraudulent activity and can have an integrity impact on the overall organization.
Proactive companies will have policies and procedures that contain clear segregation of duties, layout clear implications for fraud and include whistleblower policies, an anonymous hotline, and outline key oversight roles such as internal audit and/or compliance.
© 2011 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 50716SFO
13
Enablers of fraud and misconduct
Source: Fraudulent Financial Reporting 1987–1997: An Analysis of U.S. Public Companies (COSO Study)
Collusion between employees and management
Collusion between management and third parties
Collusion between employees and third parties
Inadequate oversight by directors over management
Management override of internal controls
Inadequate internal controls or compliance programs
0% 20% 40% 60% 80% 100%
27%
32%
43%
44%
47%
66%
© 2011 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 50716SFO
14
Detecting fraud and misconduct
Other means
Government regulators or law enforcement
Customers or suppliers
External auditors
Line managers
Employee whistleblowers
Internal audit, legal, or compliance personnel
0% 20% 40% 60% 80% 100%
2%
3%
4%
9%
13%
20%
47%
© 2011 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 50716SFO
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Response to fraud
Response: Policies, procedures, infrastructure, relationships, and other measures designed to help a company react appropriately when fraud is discovered to help minimize damage as well as find and eliminate root causes of the fraud
Limit losses: Should you encounter incidents of fraud, a quick response is essential to limit losses. The longer a potential fraud is not addressed, the larger the loss to the organization and the larger the potential fines.
Mitigate fines: Often, a proactive approach when responding to potential fraud can result in lower fines from the government due to taking initiative and possibly presenting findings to the regulators prior to government investigation.
Recover losses: Conducting fraud-related testing on certain areas within an organization which are considered to be higher risk could result in an enhanced control structure, identification of losses, the potential opportunity to prevent further losses, and recovery of identified losses.
© 2011 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 50716SFO
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Conclusions
Even if the fraud, waste, and abuse at your organization is at a significantly lower level than that estimated by the ACFE there is still a significant cost reduction opportunity that may be obtained.
Traditionally, the low-hanging fruit resides in the procurement cycle, T&E and payroll; simple testing can have both monetary and nonmonetary benefits.
The benefits outweigh the costs, and even if nothing is located, it will demonstrate a desire to be compliant with the Corporate Sentencing Guidelines regarding antifraud programs and controls.
Thank you
Presenter’s contact details
Guido van Drunen
KPMG LLP
206-913-4208
www.kpmg.com
© 2011 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 50716SFO
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