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Part II of our Three-Part Nonprofit Fraud Seminar offered by Senior Partner, Larry Hoffman from the Raffa Audit Group. In this seesion, you will learn about: - How to detect fraud perpetrators - is it possible? - What are the red flags of fraud? - Fraud detection techniques and how to employ them in your organization. - What to do when you uncover a fraud, and; - Important takeaways.
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Thrive. Grow. Achieve.
Nonprofit Fraud: What You Need to Know Part II: The Detection
Lawrence J. Hoffman, CPA/CFF, CVA, CFE Senior Partner, & Director of Forensic Consulting Services
May 7, 2013
OBJECTIVES NONPROFIT FRAUD: THREE-PART SERIES
PART I: THE FRAUD • Why it is important that you are educated in fraud • The magnitude of fraud in nonprofits • The types of frauds in nonprofits • Why does fraud occur in nonprofits • Some important fraud prevention measures PART II: THE DETECTION • Why do people commit fraud? • How is fraud detected? • Who are the fraud perpetrators? • Fraud detection techniques • What should you do when you uncover fraud? PART III: THE PREVENTION • Fraud risk assessments • Setting the tone at the top and your board of directors • What are the best preventative measures and controls? • The five critical takeaways!
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AGENDA
• Why do people commit fraud?
• How is fraud detected?
• Who are the perpetrators?
• Fraud detection techniques
• What should you do when you uncover a fraud?
Part II: The Detection * Page 3
WHY DO PEOPLE COMMIT FRAUD?
THREE REASONS WHY PEOPLE COMMIT CRIMES
• Economics $$$$$ • Passion love, lust, a cause (religious beliefs) • Mental instability nuts
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WHY DO PEOPLE COMMIT FRAUD? THE FRAUD TRIANGLE
Part II: The Detection * Page 5
Rationalization (frame of mind or ethical character)
Opportunity (lack of controls)
Pressure / Incentive (The “Unshareable” Need)
WHY DO PEOPLE COMMIT FRAUD?
THE FRAUD TRIANGLE
THE FRAUD TRIANGLE ORIGINATED FROM DR. DONALD CRESSEY'S HYPOTHESIS:
“Trusted persons become trust violators when they conceive of themselves as having a financial problem which is non-shareable, are aware this problem can be secretly resolved by violation of the position of financial trust, and are able to apply to their own conduct in that situation verbalizations which enable them to adjust their conceptions of themselves as trusted persons with their conceptions of themselves as users of the entrusted funds or property.1 ”
1DONALD R. CRESSEY, OTHER PEOPLE'S MONEY (MONTCLAIR: PATTERSON SMITH, 1973) P. 30.
Part II: The Detection * Page 6
WHY DO PEOPLE COMMIT FRAUD?
PRESSURE / INCENTIVE (THE NEED, PERCEIVED OR ACTUAL)
• Financial pressure and debts • Greed – need for high lifestyle-living beyond their means • Feed a habit – gambling, drugs, other addictive behaviors • Retribution / vendetta – feels abused or exploited-holds a
grudge • Make earnings target or financial metric (bonuses) • Need for praise and gratification • Competitive pressures – keep your job • Medical issues of family or self
Part II: The Detection * Page 7
WHY DO PEOPLE COMMIT FRAUD?
OPPORTUNITY (PERCEIVED) • Weak or non-existent internal controls – lack of segregation of
duties • Has sufficient access to assets and information that enables
the crime • Has assessed that that the fraud can be committed and also
successfully concealed • Too much trust placed in person or position. (Remember: trust
is not an internal control!) • Poor communication within organization • Lack of oversight and supervision • Lack of disciplinary action for previous frauds
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WHY DO PEOPLE COMMIT FRAUD?
RATIONALIZATION (A WAY TO RATIONALIZE THE BEHAVIOR AS ACCEPTABLE)
• “I am just borrowing the money and will repay it” • “I’ll stop once I pay off my debts” • “The company won’t even realize this amount is gone; it’s not
that much” • They feel they deserve it: “I am getting underpaid and am
underappreciated” • “Management is ‘living high,’ while I am oppressed” • “Everyone’s doing it, I am no different” • “It is for a good purpose” • They need the money
Part II: The Detection * Page 9
HOW IS FRAUD DETECTED?
• The detection of fraud involves the ability to recognize in a timely manner whether fraud has occurred or is occurring
• However, a properly designed and executed audit may still NOT detect material fraud, especially one involving: – Forgery – Deliberate failure to record transactions – Intentional misrepresentations – Collusion
• Ability to detect fraud depends on: – Skillfulness of perpetrator – Frequency and extent of manipulation – Degree of collusion – Relative size of individual amounts manipulated – Seniority of individuals involved
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HOW IS FRAUD DETECTED?
Part II: The Detection * Page 11
2012 REPORT TO THE NATIONS ON OCCUPATIONAL FRAUD AND ABUSE
HOW IS FRAUD DETECTED?
Part II: The Detection * Page 12
2012 REPORT TO THE NATIONS ON OCCUPATIONAL FRAUD AND ABUSE
Part II: The Detection * Page 13
HOW IS FRAUD DETECTED?
2012 REPORT TO THE NATIONS ON OCCUPATIONAL FRAUD AND ABUSE
HOW IS FRAUD DETECTED?
KEY TAKEAWAY: ESTABLISH POLICIES, PROCEDURES AND MECHANISMS FOR TIPS! • Employees • Vendors • Customers • Other stakeholders
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WHO ARE THE PERPETRATORS?
THE FACES OF FRAUD
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WHO ARE THE PERPETRATORS?
TYPICAL PROFILE • Usually living above their means or has an addictive need • Does not have a prior criminal conviction or charged with a fraud • Has a position of trust and responsibility • Most likely a male between the age of 31 to 45 • Is well educated • Understands and skillfully uses technology • Usually comes across as a nice person, charming • Usually well respected • They usually spend everything they steal! • 80% will buy a new car!
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WHO ARE THE PERPETRATORS?
Part II: The Detection * Page 17
2012 REPORT TO THE NATIONS ON OCCUPATIONAL FRAUD AND ABUSE
FRAUD PERPETRATORS ARE NOT CAREER CRIMINALS
WHO ARE THE PERPETRATORS?
Part II: The Detection * Page 18
2012 REPORT TO THE NATIONS ON OCCUPATIONAL FRAUD AND ABUSE
FRAUD PERPETRATORS DO NOT HAVE A PRIOR HISTORY OF BEING PUNISHED OR TERMINATED BY AN EMPLOYER FOR A FRAUD-RELATED OFFENSE
WHO ARE THE PERPETRATORS?
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2012 REPORT TO THE NATIONS ON OCCUPATIONAL FRAUD AND ABUSE
FRAUD PERPETRATOR IS TYPICALLY AN EMPLOYEE OR MANAGER
WHO ARE THE PERPETRATORS?
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2012 REPORT TO THE NATIONS ON OCCUPATIONAL FRAUD AND ABUSE
LARGER LOSSES WITH THE OWNER/EXECUTIVE
WHO ARE THE PERPETRATORS?
Part II: The Detection * Page 21
2012 REPORT TO THE NATIONS ON OCCUPATIONAL FRAUD AND ABUSE
MALES TEND TO ACCOUNT FOR ABOUT TWO-THIRDS OF ALL FRAUD CASES
WHO ARE THE PERPETRATORS?
Part II: The Detection * Page 22
2012 REPORT TO THE NATIONS ON OCCUPATIONAL FRAUD AND ABUSE
TYPICALLY BETWEEN AGES 31 AND 45
WHO ARE THE PERPETRATORS?
Part II: The Detection * Page 23
2012 REPORT TO THE NATIONS ON OCCUPATIONAL FRAUD AND ABUSE
AMOUNT OF LOSS ROSE WITH AGE!
WHO ARE THE PERPETRATORS?
Part II: The Detection * Page 24
2012 REPORT TO THE NATIONS ON OCCUPATIONAL FRAUD AND ABUSE
LOSS WAS GREATER WITH TENURE OF PERPETRATOR
WHO ARE THE PERPETRATORS?
Part II: The Detection * Page 25
2012 REPORT TO THE NATIONS ON OCCUPATIONAL FRAUD AND ABUSE
MORE THAN HALF HAD A COLLEGE DEGREE OR HIGHER!
WHO ARE THE PERPETRATORS?
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2012 REPORT TO THE NATIONS ON OCCUPATIONAL FRAUD AND ABUSE
ACCOUNTING DEPARTMENT TOPS THE LIST!
WHO ARE THE PERPETRATORS?
WHO DID THE FBI PROFILE WITH THESE SYMPTOMS AND SIGNS?
• Anger and arrogance • Capable of acting witty and charming • Good at flattery and manipulating other people’s emotions • Disregards the safety of self and others • Does not show any guilt • Lies, steals, and fights often • Breaks the law repeatedly • Substance abuse and/or legal problems
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WHO ARE THE PERPETRATORS?
Part II: The Detection * Page 28
WHO ARE THE PERPETRATORS?
BERNIE’S JAIL CELL
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WHO ARE THE PERPETRATORS?
Madoff says “he is happier in prison than he was on the outside because he no longer lives in fear of being arrested and knows he will die in prison.”
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WHO ARE THE PERPETRATORS?
ANTISOCIAL PERSONALITY DISORDER (ASPD OR APD)
• A psychiatric condition in which a person manipulates, exploits, or violates the rights of others
• Usually begins in childhood or early adolescence and continues into adulthood
• “Boomerang Personality”-everything you throw at them, they throw back at you. It is always the other person’s fault. Will not accept responsibility
• Person with no conscience • Is usually criminal • Also referred to as “sociopaths” and “psychopaths”
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WHO ARE THE PERPETRATORS?
SOCIOPATHS • Are unable to experience emotional responses for other people
outside of their own personal interests • Psychological inability to show emotion or caring for others • While a sociopath can feel emotion, it is (even if it results in
care for another), because they find it viable for themselves as opposed to what would be termed as selflessness
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WHO ARE THE PERPETRATORS?
THE DILEMMA • Everyone has to a degree a propensity to commit a crime!
• 93-95% of the population may commit a crime
• 5-7% are hard-core white collar criminals
• We are interested in the severity of the propensity of the 93-95% and definitely don’t want the 5-7% working for us!
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WHO ARE THE PERPETRATORS?
THE SYNTONIC SYNDROME Five key characteristics of the hard-core white collar criminal (5-7%)
• Ego-syntonic: “not my fault-ism”, where they re-arrange events to be continually interpreted in their favor, often at the expense of another person (vs. “ego-dystonic”)
• Personality disorders: the person probably has a psychological problem called a personality disorder
• High IQ: the person has a high IQ • Differential treatment: the person treats different people
differently within organization, usually based on who can give them what they want. Bottom line: people are carefully manipulated
• Controls decisions: the person seeks to control – or create – the (decision-making) process, especially in areas where they can personally benefit
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FRAUD DETECTION TECHNIQUES
RED FLAGS BEHAVIOR FLAGS
• Financial difficulties • Living beyond means relative to known income level • Family problems • Serious addiction to drugs, alcohol, or gambling • An unwillingness to share duties or allow others to help • Defensive behavior-overly nervous when questioned • A refusal to take vacations or very short vacations • Over-devotion to the job-working a lot of overtime and
weekends-never calls in sick or misses work! • A close personal relationship with vendors or customers • Change in behavior • Rule breakers
Part II: The Detection * Page 35
FRAUD DETECTION TECHNIQUES
Part II: The Detection * Page 36
2012 REPORT TO THE NATIONS ON OCCUPATIONAL FRAUD AND ABUSE
LIVING BEYOND MEANS #1!
FRAUD DETECTION TECHNIQUES
Part II: The Detection * Page 37
2012 REPORT TO THE NATIONS ON OCCUPATIONAL FRAUD AND ABUSE
LIVING BEYOND MEANS FUELED BY ASSET MISAPPROPRIATION!
FRAUD DETECTION TECHNIQUES
FINANCIAL AND BUSINESS FLAGS • Business is inexplicably unprofitable • Company is having cash flow problems • Under capitalized • Financial statements are always late • Financial statement trends/ratios are inconsistent and do not
make sense • Financial records and books are in disarray and always out of
balance • Management’s operating and financial decisions are
dominated by a single person or a few persons acting in concert
• Background checks are not conducted on key employees • High turnover of management and/or key accounting personnel • Management displays a propensity to take undue risks
Part II: The Detection * Page 38
FRAUD DETECTION TECHNIQUES
FINANCIAL AND BUSINESS FLAGS (continued) • Accounting personnel exhibit inexperience or laxity in
performing their duties • Numerous banks and accounts • Frequent change in independent auditors/accounting firm • Management places undue pressures on the auditors, through
fees and unreasonable deadlines • Frequent legal matters • Frequent change in legal counsel and multiple law firms • Operates on a “crisis” basis • Fire people quickly if they don’t do what they want • Significant transactions with related parties • Problems with governmental and regulatory agencies
Part II: The Detection * Page 39
FRAUD DETECTION TECHNIQUES
INTERNAL CONTROL FLAGS • A single employee controls the company finances and
accounting-lack of segregation of duties! • Bank accounts are not timely reconciled and not reviewed by
someone independent of preparer • Invoices are paid without verifying receipt or purchase
authorizations • Reimbursements are not supported by receipts or other
supporting documentation • Excessive sales voids and credit memos • Missing deposit slips and/or cancelled checks • Unexplained inventory shortages or adjustments • Subsidiary account balances not reconciled • Unexplained and numerous end-of-period adjusting entries
Part II: The Detection * Page 40
FRAUD DETECTION TECHNIQUES
INTERNAL CONTROL FLAGS (continued) • A single employee controls the company finances and
accounting • Bank accounts are not timely reconciled and not reviewed by
someone independent of preparer • Missing documents • Altered documents • Photocopy of documents when originals should be available
Part II: The Detection * Page 41
FRAUD DETECTION TECHNIQUES
PREVENTIVE VS. DETECTIVE CONTROLS
Part II: The Detection * Page 42
FRAUD DETECTION TECHNIQUES
PREVENTIVE CONTROLS Preventive controls attempt to deter or prevent undesirable events from occurring. They are proactive controls that help prevent a loss.
DETECTIVE CONTROLS Detective controls, on the other hand, attempt to detect undesirable acts. The provide evidence that a loss has occurred but do not prevent a loss from occurring. Detective techniques should be used to uncover fraud events when preventive measures fail or unmitigated risks are realized.
Part II: The Detection * Page 43
FRAUD DETECTION TECHNIQUES
PREVENTIVE CONTROLS • Segregations of duties with well defined job descriptions and
policies and procedures • Job rotation • Mandatory vacations • Obtaining pre-approval on transactions before processing • Require dual signatures on checks above a certain amount • Using document control numbers to account for all
transactions-checks, purchase orders, invoices etc… • Matching and comparing documents • Testing clerical accuracy • Physical controls over cash, checks, signatures, inventory and
other assets • Computer passwords and access controls to prevent
unauthorized electronic access
Part II: The Detection * Page 44
FRAUD DETECTION TECHNIQUES
PREVENTIVE CONTROLS (CONTINUED) • Back up financial files daily • Pre-employment background investigations • Employee training programs-fraud prevention • Prosecute the guilty
Part II: The Detection * Page 45
FRAUD DETECTION TECHNIQUES
DETECTIVE CONTROLS • Whistleblower Policies and Hotlines (TIPS!!!) • Management and supervisory reviews and approvals • Reconciliations • Independent review of bank reconciliations and supporting
documents-cancelled checks • Independent review of vendor control file for suspicious
vendors • Independent review of payroll files for suspicious employees. • Investigate customer and vendor complaints promptly • Physical inspections/counts • Financial analysis, budget vs. actual • Data analysis, data mining and continuous auditing techniques • Other technology tools • Audits-external, internal, surprise
Part II: The Detection * Page 46
WHAT SHOULD YOU DO WHEN YOU UNCOVER FRAUD?
• BE AWARE OF WARNING SIGNS • REPORT IRREGULARITIES, SPECIFICALLY:
– If someone you work with asks you to do something that is illegal or unethical
– If you suspect that someone— regardless of rank or position—is committing fraud or abuse
Part II: The Detection * Page 47
WHAT SHOULD YOU DO WHEN YOU UNCOVER FRAUD?
• Follow your organizations fraud policy
• Report through hotline or other anonymous reporting mechanism
• Anonymous letter to company official
• Share your concern with your immediate supervisor or organization’s audit committee
• Do not confront the suspected perpetrator
• Do not investigate the matter on your own
Part II: The Detection * Page 48
WHAT SHOULD YOU DO WHEN YOU UNCOVER FRAUD?
• Organization management should retain counsel-attorney/client privilege
• Employers have a duty to investigate promptly and thoroughly
• Counsel should retain a forensic expert to assist in the investigation
• Employee (suspect) may be suspended with or without pay-but do it swiftly if enough predication is present
• Employee (suspect) access to offices, computer systems, banking, communications and other access rights and privileges should be suspended or terminated
• Preserve evidence
• Understand legal implications
• Inform your insurance carriers
Part II: The Detection * Page 49
WHAT SHOULD YOU DO WHEN YOU UNCOVER FRAUD?
• Objectives of the investigation should be conducted with integrity, fairness, impartiality and respect and include:
– Gathering the facts
– Determining the merits of the complaint
– Complying with legal obligations
– Maintaining confidentiality
– Preserving the reputations of individuals and the organization
– Taking proper remedial action
– Avoiding liability
– Preventing future claims and incidences
Part II: The Detection * Page 50
WHAT SHOULD YOU DO WHEN YOU UNCOVER FRAUD?
• Everyone in an organization is responsible for fighting fraud.
• Be alert to potential fraud.
• Report any suspicions to your organization
Part II: The Detection * Page 51
WHAT YOU NEED TO KNOW ABOUT FRAUD THE FIVE MOST IMPORTANT TAKEAWAYS – AGAIN!
1. Trust is not an internal control! – Establish, to the extent possible, controls and procedures that eliminate the
element of trust – Always segregate the custody of the asset with the recordkeeping for the asset
2. Set the tone from the top! – “If you are stealing, your employees are stealing!” – E.g., office supplies, expense reports, etc.
3. Know your employees! – Background investigations and public records checks before hiring – Meet and establish a baseline relationship
4. Institute a fraud policy – No tolerance – Will prosecute
5. Establish a hotline for tips – Number one method for detecting fraud! – Can outsource
Part II: The Detection * Page 52
HOW CAN RAFFA ASSIST YOU IN PREVENTING AND DETECTING FRAUD?
FORENSIC CONSULTING SERVICES • Pre-hire investigations and background checks • Fraud risk assessment • Internal control / program review • Fraud awareness training • Fraud prevention programs and policies implementation • Due diligence investigations • Fraud investigations
Part II: The Detection * Page 53
SOME AREAS WE WILL BE GOING OVER IN OUR OTHER PRESENTATION
PART III: THE PREVENTION – JUNE 5, 2013, 12:00-2:00 P.M.
• Fraud risk assessments • Setting the tone at the top and your board of directors • What are the best preventative measures and controls? • The five critical takeaways!
Part II: The Detection * Page 54
RESOURCES AND SUGGESTED READING
• 2012 Report to the Nations on Occupational Fraud and Abuse, Association of Certified Fraud Examiners, http://www.acfe.com/rttn.aspx
• “The American Fraud Report,” www.jpsimsconsulting.com
• The CPA’s Handbook of Fraud and Commercial Crime Prevention, AICPA
• Managing the Business Risk of Fraud: A Practical Guide; AICPA, ITA, and ACFE; https://na.theiia.org/standards-guidance/Public%20Documents/fraud%20paper.pdf
Part II: The Detection * Page 55
QUESTIONS AND ANSWERS
Part II: The Detection * Page 56
BIOGRAPHY
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• 35 years of consulting, audit, accounting and tax experience in the public and private sectors.
• Started career with a Big-Four international accounting firm in Washington, DC.
• Founded a regional certified public accounting and consulting firm in 1982 and grew it to on of the Washington, DC’s largest firms in seven years. Merged his practice with Raffa P.C. in 2008.
• Managed and conducted audit and accounting engagements ranging from small privately held to large publicly held businesses in various industries, including multi-national businesses, nonprofit organizations, and governmental entities and agencies.
• Performed economic and financial analysis, including projections and forecasts, in support of litigation and claims for lost earnings and profits, business interruption, shareholder disputes, patent and trademark infringements, bankruptcy and restructuring, and structural settlements; assistance with interrogatories, document requests and depositions; and serving as an expert and consulting witness.
• Performed and supervised business valuations for both public and closely held companies in a variety of industries, individuals and estates, family limited partnerships and limited liability companies, including valuations for business combinations (SFAS 141R), mergers, acquisitions, and divestitures, estate and gift taxes, marital dissolution proceedings, buy-sell agreements, intangible assets and intellectual property, purchase price allocations, goodwill (SFAS 142) and long-lived asset (SFAS 144) impairment, fair value accounting (SFAS 157), cheap stock (IRC 409A), stock-based compensation (SFAS 123R), phantom stock and employee stock ownership plans.
• Conducted and led teams of forensic accountants on fraud audits and investigations, including fraudulent financial statements, misappropriations of assets and embezzlements; money laundering, kickbacks, bribery and conflicts of interest; insurance claims; bankruptcy; financial institutions and loan fraud. Also has conducted fraud risk assessments, anti-fraud programs, and fraud training and education.
LAWRENCE J. HOFFMAN, CPA/CFF, CVA, CFE
SENIOR PARTNER RAFFA, P.C. 1899 L STREET, NW WASHINGTON, DC 20036 TEL. 202-822-5408 FAX 202-822-0669 [email protected]
BIOGRAPHY
Part II: The Detection * Page 58
• Assisted companies and nonprofits with restructuring and turnaround situations, including recapitalizations, reorganizations and liquidations. Advised entities on Chapters 11 and 7, bankruptcy filings and proceedings and non-judicial workouts. Developed and administered crisis management plans, cash flows, liquidation and turnaround analysis, debt restructuring and creditor negotiations, and turnaround plans.
• Formulated strategic short- and long-term business and financial planning for various business organizations and served as interim “C” level positions, including for a major North American sports league, European and U.S. aircraft manufacturer, aviation charter airline and travel company, and a multi-chain quick service food chain.
• Formulated syndication strategies and prepared business plans and private placement offerings, including financial forecasts, market research and analysis, due diligence, securities pricing and structuring for various public and private securities offerings, including SEC filing.
• Founded and developed a regional NASD licensed broker dealer investment banking firm. Placed over $150 million in debt and equity and represented over $200 million in merger and acquisition transactions.
• Founded and developed two private equity funds in excess of $10 million, including investments in early stage and mature emerging companies in the form of debt and equity. Portfolio investments included aviation, food and hospitality, software and technology, telecommunications, sports and entertainment, banking and financial institutions, healthcare, and wholesale and retail.
• Co-founded and managed various real estate acquisition, ownership, and operating entities, including commercial office buildings, shopping centers, flex warehouses, residential housing and developed land.
• Performed tax and financial consulting services for individuals and closely held businesses.
• Instructor in audit, accounting, finance, and forensic accounting.
LAWRENCE J. HOFFMAN, CPA/CFF, CVA, CFE
SENIOR PARTNER
BIOGRAPHY
Part II: The Detection * Page 59
LAWRENCE J. HOFFMAN, CPA/CFF, CVA, CFE
SENIOR PARTNER
EDUCATION & CERTIFICATIONS • Bachelor of Science, Accounting – Mount St. Mary’s University • Certified Public Accountant (CPA) • Certified Fraud Examiner (CFE) • Certified in Financial Forensics (CFF) • Certified Valuation Analyst (CVA) • Private Investigator (PI), Virginia • Series 7 General Securities Representative (not active) • Series 24 General Securities Principal (not active) • Series 63 Uniform Securities Agent (not active)
PROFESSIONAL ASSOCIATIONS & AFFILIATIONS • American Institute of Certified Public Accountants, Member • Virginia Society of Certified Public Accountants • Association of Certified Fraud Examiners • National Association of Certified Valuation Analysts • Institute of Business Appraisers
PERSONAL INTERESTS • Private pilot with instrument, multi-engine, high performance complex and aircraft ratings • Golf and fishing • Reading and politics