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The State of the Art of Fraud

The State of the Art of Fraud. Glenn L. Helms, Ph.D., CPA, CIA, CISA, CITP, CFF GlennHelmsCPA@aol.com. Fraud. Fraud is good in good times. Fraud is good in bad times. Fraud is good……anytime!!!. Types of Fraud. Fraudulent Financial Reporting Perpetrated by management

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The State of the Art of Fraud

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  1. The State of the Art of Fraud Glenn L. Helms, Ph.D., CPA, CIA, CISA, CITP, CFF GlennHelmsCPA@aol.com

  2. Fraud • Fraud is good in good times. • Fraud is good in bad times. • Fraud is good……anytime!!!

  3. Types of Fraud • Fraudulent Financial Reporting • Perpetrated by management • Use of journal entries, manipulating estimates, overstating assets • 90 to 95% of all dollar amount of fraud • 5 to 10% of the cases of fraud

  4. Types of Fraud • Misappropriation of Assets • By employees • Theft, embezzlement, etc. • 90 to 95% of all cases of fraud • 5 to 10% of the dollar amount of fraud • Best type of fraud – no journal entry!!! (It’s how you steal and don’t get caught!!)

  5. KPMG Study • KPMG funded a survey (KPMG Forensic Fraud Survey 2009) with executives of U.S. organizations with annual revenue of at least $250 million. Over 200 interviews were conducted • Executives expect some form of fraud or misconduct to occur in their organizations. Nearly one-third of respondents said at least one of the fraud categories - misappropriation of assets, fraudulent financial reporting, and other illegal or unethical acts) was going to increase during the next year.

  6. KPMG Study • Nearly two-thirds of executives stated that fraud and misconduct is a significant risk to their industry.

  7. KPMG Study • Respondents stated that fraud and misconduct risks will either stay the same (85%) or increase (74%) over the next 12 months. • Inadequate internal controls or compliance programs heighten the risks of fraud and misconduct. Two thirds of the respondents stated that inadequate internal controls or compliance programs at their organizations enable fraud and misconduct to occur (emphasis added).

  8. KPMG Study • Roughly a quarter of respondents (27 percent) did not have effective protocols on how investigations should be conducted and when the board of directors should be alerted to possible irregularities. Likewise, 33 percent of the respondents stated that they lacked protocols on how to remedy control breakdowns (emphasis added). • Those areas where respondents cited the most amount of at least moderate improvement needed in their anti-fraud programs include employee communication and training (67%), technology-driven continuous auditing and monitoring techniques (65%), and fraud and misconduct risk assessment (60%).

  9. KPMG Study Risk Areas Where did the KPMG respondents perceive the greatest risks? The survey found that there were anticipated increases in: • asset misappropriation (25%); • other illegal and unethical acts (20%); • and fraudulent financial reporting (8%).

  10. Factors That Enable Fraud and Misconduct – KPMG Study

  11. Level of Knowledge by Function of How Fraud Can Occur – KPMG Study

  12. The Function Most Likely to Uncover Fraud – KPMG Study

  13. KPMG StudyAnticipated Assistance – External Advisors

  14. KPMG StudyFunding to Combat Fraud 75% of the respondents expected the amount of funding at their organization to combat fraud to stay the same, 16% said increase, and 9% said decrease

  15. PWC Global Economic Crime Survey The PWC Global Economic Crime Survey, published in November of 2009, had 3,037 respondents from 54 countries

  16. Types of Economic Crimes – PWC Study The top three types of economic crime are presented.

  17. Fraud Detection Methods – PWC Study

  18. PWC – Fraud Risk Assessments

  19. COSO Study COSO sponsored a study, Fraudulent Financial Reporting: 1998-2007, (issued May, 2010) to provide a comprehensive analysis of fraudulent financial reporting occurrences investigated by the U.S. Securities and Exchange Commission (SEC) between January 1998 and December 2007.

  20. COSO Study There were 347 alleged cases of public company fraudulent financial reporting from 1998 to 2007, versus 294 cases from 1987 to 1997. Consistent with the high-profile frauds at Enron, WorldCom, etc., the dollar magnitude of fraudulent financial reporting soared in the last decade, with total cumulative misstatement or misappropriation of nearly $120 billion across 300 fraud cases with available information (mean of nearly $400 million per case). This compares to a mean of $25 million per sample fraud in COSO’s 1999 study. While the largest frauds of the early 2000s skewed the 1998-2007 total and mean cumulative misstatement or misappropriation upward, the median fraud of $12.05 million in the present study also was nearly three times larger than the median fraud of $4.1 million in the 1999 COSO study.

  21. COSO Study The SEC named the CEO and/or CFO for some level of involvement in 89 percent of the fraud cases, up from 83 percent of cases in 1987-1997. Within two years of the completion of the SEC’s investigation, about 20 percent of CFOs/CFOs had been indicted and over 60 percent of those indicted were convicted. Twenty-six percent of the fraud firms changed auditors between the last clean financial statements and the last fraudulent financial statements, whereas only 12 percent of no-fraud firms switched auditors during that same time. Sixty percent of the fraud firms that changed auditors did so during the fraud period, while the remaining 40 percent changed in the fiscal period just before the fraud began.

  22. COSO Study Initial news in the press of an alleged fraud resulted in an average 16.7 percent abnormal stock price decline in the two days surrounding the news announcement. In addition, news of an SEC or Department of Justice investigation resulted in an average 7.3 percent abnormal stock price decline. Long-term negative consequences of fraud were apparent. Companies engaged in fraud often experienced bankruptcy, delisting from a stock exchange, or material asset sales following discovery of fraud – at rates much higher than those experienced by no-fraud firms.

  23. COSO Study Most frauds were not isolated to a single fiscal period. The average fraud period extended 31.4 months, with the median fraud period extending 24 months. This was slightly longer than the average and median fraud periods of 23.7 and 21 months, respectively, reported in COSO’s 1999 study. This finding suggests that once fraud is initiated in one financial period (quarterly or annual), management often continues to perpetrate fraud in each quarterly and annual financial statement filing for about two years.

  24. Common Financial Statement Fraud Schemes - COSO Scheme to Misstate Financial Statements Percentage of Companies Using Fraud Method Improper revenue recognition: 61% Recording fictitious revenues – 48% Recording revenues prematurely – 35% No description/“overstated” – 2% Overstatement of assets (excluding accounts receivable overstatements due to revenue fraud): 51% Overstating existing assets or capitalizing expenses – 46% Recording fictitious assets or assets not owned – 11%

  25. Common Financial Statement Fraud Schemes – COSO (Concluded) Understatement of expenses/liabilities 31% Misappropriation of assets 14% Inappropriate disclosure (with no financial statement line item effects) 1% Other miscellaneous techniques (acquisitions, joint ventures, netting of amounts, etc.) 20% Disguised through use of related party transactions 18% Insider trading also cited 24% The subcategories such as premature revenues or fictitious revenues and assets do not sum to the category totals due to multiple types of fraud employed at a single company. Also, because the financial statement frauds at the sample companies often involved more than one fraud technique, the sum of the percentages reported exceeds 100 percent.

  26. Number of Fraud Cases With Asset Accounts Misstated - COSO

  27. ACFE 2010 Report to the Nations The Association of Certified Fraud Examiners (ACFE) issued its 2010 Report to the Nations in June, 2010. The report is based on a survey of 1,843 cases of occupational fraud that occurred globally between January 2008 and December 2009. All information was provided by the Certified Fraud Examiners who investigated the cases. The ACFE’s study includes cases from 105 countries outside the U.S which represent 40 percent of the cases. This section is based upon an article in the Journal of Accountancy which was reporting on the ACFE 2010 Report to the Nations.

  28. ACFE Study • Asset misappropriations are those schemes in which the perpetrator steals or misuses an organization’s resources. These frauds include schemes such as skimming cash receipts, falsifying expense reports and forging company checks. • Corruption schemes involve the 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 a benefit for him- or herself or someone else. Examples of corruption schemes include bribery (which includes invoice kickbacks and bid rigging) and conflicts of interest (which includes purchasing and sales schemes). • Financial statement fraud schemes are those involving the intentional misstatement or omission of material information in the organization’s financial reports. Common methods of fraudulent financial statement manipulation include recording fictitious revenues, concealing liabilities or expenses and artificially inflating reported assets.

  29. Frequency of Occupational Frauds - ACFE 2010 2008 Financial Statement 4.3% 10.3% Occupational 21.9% 26.9% Asset Misappropriation 89.8% 88.7%

  30. Median Loss of Occupational Frauds – ACFE(Thousands of Dollars) 2010 2008 Financial Statement $1,730 $2,000 Corruption $175 $375 Asset Misappropriation $100 $150

  31. Initial Detection of Occupational Frauds - ACFE Tip 40.9% Management Review 15.4% Internal Audit 13.9% By Accident 8.3% Account Reconciliation 6.1% Document Examination 5.2% External Audit 4.6% Surveillance/Monitoring 2.6% Notified by Police 1.8% Confession 1.0% IT Control 0.8%

  32. How to Detect/Prevent Fraud • Take some notes…..so many ways…so many ways not implemented…… • Fraudulent Financial Reporting – journal entries and estimates. • Misappropriation of Assets – preventive and detective.

  33. The Top Ten Fraud Schemes • Recording revenues prematurely • Recording fictitious revenue • Misappropriation of assets • Preparing fraudulent top-sided and other journal entries • Overstatement of assets • Manipulating estimates • Ponzi schemes • Asset flips • Bribery • Conflicts of interest

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