What You Need to Know About Occupational Fraud in Government - 2014

What You Need to About

Occupational Fraud in Government

Ron Steinkamp, CPA, CIA, CFE, CRMA, CGMA314.983.1238 | [email protected]

© 2014 Brown Smith Wallace All Rights Reserved

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Agenda

© 2014 All Rights Reserved Brown Smith Wallace LLC 2

• 2014 ACFE Global Fraud Study

• Reasons for Fraud

• Common Areas of Abuse in Government

• Fraud Case Study

• How to Prevent Fraud

• Fraud Prevention Self Assessment

2014 ACFE Global Fraud Study

2014 Report to the Nations on Occupational Fraud and Abuse


What Is Occupational Fraud?

Occupational Fraud = The use of one’s occupation for personal enrichment through the deliberate misuse or application of the employing organization’s resources or assets.

Violation of trust.

Three general categories:

Asset misappropriations = those schemes in which the perpetrator steals or misuses an organizations resources. Most frequent and least costly scheme.

Corruption = employee’s use of his or her influence in business transactions in a way that violates his or her duty to the employer for the purpose of obtaining benefit for him or herself or someone else.

Financial Statement Fraud = intentional misstatement or omission of material information in the organization’s financial reports. Least frequent and most costly scheme.


Summary of Findings

1. Typical organization loses 5% of annual revenue to fraud – applied to

2013 Gross World Product translates to potential fraud loss of more than

$3.7 trillion annually.

2. Median loss in the study was $145,000 with more than 22% of the cases

involving losses over $1 million.

3. Fraud lasted a median of 18 months.

4. Asset misappropriation schemes (fraudulent disbursements, theft of

cash receipts, other asset misappropriations) were the most common

form of fraud, representing 85% of the cases and least costly at a

median loss of $130,000.

5. Financial statement fraud schemes were the least common form of fraud,

representing 9% of the cases and most costly at a median loss at $1

million.© 2014 All Rights Reserved Brown Smith Wallace LLC 5

Summary of Findings (cont.)

6. Corruption schemes fell in the middle, comprising just over 37% of cases

and causing a median loss of $200,000.

7. Occupational frauds are most likely to be detected by tips (40%)

followed by management review (15%) and Internal Audit (14%).

8. Small organizations are disproportionately victimized by occupational

fraud.

9. Government/public administration was one of the most commonly

victimized industries.

10. Anti-fraud controls appear to help reduce the cost and duration of

occupational fraud schemes.

11. High-level perpetrators cause the greatest damage to their

organizations.© 2014 All Rights Reserved Brown Smith Wallace LLC 6

Summary of Findings (cont.)

12. 77% of frauds were committed by individuals in one of six departments: Accounting Operations Sales Executive/upper management Customer service Purchasing Finance

13. More than 85% of fraudsters had never been previously charged or

convicted for a fraud-related offense.

14. Fraud perpetrators often display warning signs – most common

behavioral red flag reported in the survey were perpetrators living

beyond their means (36%) and experiencing financial difficulty (27%).

15. Nearly half of victim organizations do not recover any losses that they

suffer due to fraud.


Conclusions and Recommendations

Occupational fraud is a universal problem – trends in fraud schemes, perpetrator characteristics and anti-fraud controls are similar regardless of where the fraud occurred.

The longer frauds last, the more financial damage they cause. Proactive detection methods – hotlines, management review procedures, internal audits, employee monitoring mechanisms – are vital in catching frauds early and limiting losses.

Small businesses/organizations are disproportionately victimized by fraud and under protected by anti-fraud controls.

External financial audits are among the least effective controls in combating fraud – primary detection method of fraud in 3% of cases versus 7% of cases detected by accident.

Many of the most effective anti-fraud controls are being overlooked – data monitoring and analysis, surprise audits, fraud risk assessment.

Majority of fraudsters are first-time offenders – don’t over rely on background checks.


Fraudsters exhibit behavioral warning signs of their misdeeds. For example:

Living beyond their means. Financial difficulties. Exhibiting control issues – unwillingness to share duties. Unusually close relationship with vendor/customer. Wheeler dealer attitude. Family problems. Irritability, suspiciousness or defensiveness. Addiction problems. Refusal to take vacation. Etc.

Conclusions and Recommendations (cont.)


Reasons for Fraud


Common Characteristics of Fraud

Pressure or incentive – need the fraudster is trying to satisfy.

Opportunity – ability to commit the fraud. Organizations can influence this characteristic the most = strong internal controls that avoid putting employees in positions to commit fraud and that detect fraudulent activities if they occur.

Rationalization – ability to justify the fraud.

AKA = Fraud Triangle


Red Flags

Pressure or Incentive (NEED) “Red Flags”

High personal debts Live beyond means Excessive investment speculation Excessive gambling Substance abuse Extra-marital affairs Job frustration Resentment of superiors

Opportunity “Red Flags” Inadequate internal controls Too “cozy” with suppliers Annual vacations or sick days not taken Weak management or excessive turnover Ineffective or no internal audit No rotation of job duties among employees Procedures not well understood/always in “crisis

mode” Large amounts of cash on hand or processed

Rationalization “Red Flags” Not compensated fairly Everyone else does it Intended to pay it back Needed the money Felt cheated and wanted

revenge Bribe or kickback was too

tempting


• Skimming• Check Tampering • Billing Schemes• Fraudulent Expense Reimbursement• Payroll Fraud• Bribery and Conflicts of Interest


Common Areas of Abuse in Government

Employee steals cash from the employer before it is recorded on the employer’s books and records. Skimming typically occurs when an employee:

• Has access to customer payments• Directs intercepted receipts to personal

accounts


Skimming

How can skimming be prevented/detected? • Segregate cash receipts and accounting

responsibility.• Issue receipts.• Track receipts in system and reconcile daily.• Surprise cash counts.• Cameras.


Skimming

Any scheme in which an employee steals employer’s funds by:

• Forging or altering a check on the employer’s bank account.

OR• Stealing a check the organization has

legitimately issued to another payee.


Check Tampering

How can check tampering be prevented/detected?• Check stock should be locked in a secure

location to ensure blank checks are not accessible to potential fraudsters.

• Checks should be mailed immediately after signing to reduce the risk of legitimate checks being stolen.

• Positive pay.• Bank reconciliations.


Check Tampering

Billing schemes occur when an employee submits a false invoice or alters an existing one, thus causing the employer to willingly (but unknowingly) issue a check for false expenses.


Billing Schemes

How can billing schemes be prevented/detected?• Prior to authorizing payment, invoices should be checked

for validity of the vendor, validity of the goods or services invoiced, accuracy, and authenticity.

• Prior to processing payment, invoices should be checked for proper authorization, accuracy and authenticity. This will prevent overpayment, as well as payments being made to fictitious vendors.

• Strictly control access to vendor master data.• Regular vendor master file analysis.


Billing Schemes

Expense reimbursement schemes occur when an employee submits false expenses in the hope of being reimbursed.


Fraudulent Expense Reimbursements

How can fraudulent expense reimbursements be prevented/detected?• Expense reimbursement policy.• Require original itemized receipts.• Receipts should be scrutinized to detect alterations or

forgeries.• Other means of proving incurred expenses, such as

airline itineraries, credit card statements, etc. should not be accepted unless approved by a supervisor.

• All expense reimbursements should be reviewed and immediately processed upon approval.

• Use a specific credit card for all business expenses. Receive this information electronically from credit card company and require electronic filing of expense reports by employees. This will minimize the possibility of fraud, and if fraud is occurring, will provide an easier means to identify it.© 2012 All Rights Reserved Brown Smith Wallace LLC 21

Fraudulent Expense Reimbursements

Payroll fraud occurs when an employee submits false documentation (i.e. timecards) in an effort to inflate his/her wages/salary. Such documentation prompts the organization to unknowingly disburse funds to the perpetrator.

Possible ways in which Payroll Fraud can occur:• Falsified hours and salary• Ghost employees


Payroll Fraud

How can payroll fraud be prevented/detected? • All timecards should be reviewed for validity and

accuracy.• Once submitted for approval, employees should never

see their timecard again. • Overtime hours must be authorized by a supervisor.• If employees use a time clock to “punch in” and “punch

out”, they must do so when they arrive for work, take breaks, go to lunch, leave for the day, etc.

• Monitor employees to assure one employee is not punching out for another.

• Strictly control access to payroll master data.


Payroll Fraud

Schemes involving the employee’s use of his/her influence in transactions in a way that violates duty to the employer for the purpose of obtaining a benefit for themselves or someone else.


Bribery and Conflicts of Interest

How can bribery and conflicts of interest be prevented/detected? • Strong ethics and conflict of interest policy.• Required reporting of potential conflicts of interest.• Limiting gifts from vendors and contractors.


Bribery and Conflicts of Interest

Fraud Case Study

© 2011-2012 All Rights Reserved Brown Smith Wallace LLC 26

City Comptroller embezzled $53 million from 1990-2012.

Facts• City of 15,000 south of Chicago.• Home of Ronald Reagan.• Annual City budget $20 million.

How did she do it?• Opened bank account and transferred in City funds from

other accounts.• Used funds to pay for her personal and private business

expenses – horse farming operations, personal credit cards, real estate and vehicles.

• Fooled the auditors by creating fictitious invoices from State of Illinois.


Dixon, Illinois

How was it detected?• Comptroller took 12 weeks of approved vacation.• Interim replacement received bank account and

determined transactions had nothing to do with City business.

Warning signs• Her lifestyle changed from modest to lavish.• Inadequate segregation of duties.


Dixon, Illinois (continued)

Lessons Learned• Segregate duties.• New bank accounts approved by the Mayor and Council.• Two responsible members of management approve all

invoices.• Payments exceeding a certain amount require two

signatures.• City Council reviews and approves all fund transfers.• Mayor and Council review and discuss financial reports

and audits.• Anti-fraud orientation provided to all new employees.• Mandatory annual fraud reorientation for all employees.• Anonymous fraud hotline.• Mandatory job rotation.• Mandatory annual vacations.• Surprise audits.


Dixon, Illinois (continued)

• Create an anti-fraud environment

• Know your fraud risks

• Develop an oversight process


How to Prevent Fraud


Create an Anti-Fraud Environment

Set the Tone at the Top

• Hold elected officials and management responsible

• Lead by example

• Behave ethically

• Openly communicate expectations to employees

• Maintain a zero tolerance policy

• Treat all employees equally, regardless of position

• Enforce a code of conduct founded on integrity



Create a Positive Workplace Environment

• Poor employee morale can affect attitudes about committing fraud

• HR is instrumental in helping to build a positive work environment

• Employees should be empowered to help create a positive workplace



Hire and Promote Appropriate Employees

• Conduct background investigations; verifying education, employment history and references

• Give regular performance reviews

• Perform an objective compliance review of your code of conduct and ethic policies at consistent intervals Address violations immediately



Fraud Awareness / Training

• All new employees should be trained upon hiring on values and code of conduct

• Offer periodic refresher training for all employees



Confirmation

• Clearly articulate that all employees are held accountable to act within the code of conduct

• Have a written Code of Conduct statement

Discipline

• Actions should be taken in response to any alleged incident of fraud

• Expectations about the consequences of committing fraud must be clearly communicated throughout the entity


Know Your Fraud Risks

• Identify and measure fraud risks

• Mitigate fraud risks

• Implement and monitor appropriate internal controls

To effectively prevent or deter fraud, an entity should have an appropriate oversight function in place that includes the following:

• Audit committee

• Management

• Internal auditors

• Independent auditors

• Certified fraud examiners


Develop An Oversight Process

FRAUD PREVENTION SELF ASSESSESSMENT


Ron Steinkamp, CPA, CIA, CFE, CRMA, CGMA

Principal, Risk Advisory Services

Brown Smith Wallace LLC

314.983.1238 (Direct)

[email protected]

© 2014 All Rights Reserved Brown Smith Wallace LLC

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What You Need to Know About Occupational Fraud in Government - 2014