Approaches to Fraud Prevention

1. Approaches to Fraud Prevention Bill Brown: Partner – Forensic & Litigation Services Tel: 972-448-6966 E-mail: Bill.Brown@Weaver.com

2. Overview • Introduction: Padlock vs. Bolt cutter • Goal of Fraud Prevention • Internal Controls, the “Conventional Wisdom” • Fraud’s Impact on Prevention • The “People” Approach

3. Padlock Theory

4. Padlock Theory • Basic internal control • Controls physical access • Safeguards property/assets • Will keep 95% of “honest” people honest

5. Bolt Cutter Theory

6. The Bolt Cutter Theory • Will not deter the “other” 5% • The dishonest people will find a way to “beat” the internal controls • They have time and energy on their side • They know where to find the bolt cutters!

7. Fraud Prevention Goal The Goal of Fraud Prevention

8. Fraud Prevention Goal Anti-fraud programs should be aimed at reducing the likelihood that if fraud occurs, it will not go undetected for an unreasonable amount of time.

9. Internal Controls The Conventional Wisdom Re: Controls

10. Internal Controls: Assumes • Careful consideration & design • Proper implementation • Effective compliance/monitoring • Appropriate corrective remediation • Reliance on routine auditing procedure

11. So What’s the Problem?

12. Bolt Cutters

13. Problems w/ Internal Controls • Intimate knowledge of controls exposes weaknesses • Collusion will circumvent most controls • Flawed design • Ineffective implementation • Auditing procedures are very predictable & easily fooled

14. Case Studies • Energy Exploration Co. • Circumvent disbursement authorization controls • Security Co. • Ghost employees/payroll distribution controls • Altered bank statements • Copies of altered bank statements provided auditors/tax preparers

15. Fraud’s Impact on Prevention

16. What is Fraud? A generic term, embracing all multifarious means which human ingenuity can devise and which are resorted to by individual(s) to get advantage over another by false suggestions or suppression of truth, and includes surprise, trick, cunning, and any unfair way by which another is cheated

17. Nature of Fraud • Intentional Act • Ingenious schemes based upon intimate knowledge of controls • Concealment: • Anticipation • Manufactured evidence • Test crash dummy! “Observe & Adapt”

18. “Anticipation” Forensic Audit Narrow Scope Routine Audit Broad Scope Minimal Depth A/P Volume of Knowledge A/P Depth *An increased depth results in increased costs

19. Fraud Engineering Fraudulent schemes are “engineered” (meticulously designed) to perpetrate and conceal the theft, including an exit strategy complete with “fall guys” and “alibis”

20. Fraud’s Impact on Approach to Prevention

21. Detection is Difficult • Fraud is an “intentional” act, often involving detailed planning and concealment • Crooks “anticipate” the routine audit procedures, audit evidence is often fabricated • Exploits weaknesses in routine audit procedures or internal controls • Breach of trust

22. Initial Detection • Tip 43.3% • Management Review 14.6% • Internal Audit 14.4% • By Accident 7.0% • External Audit 3.3% • IT Controls 1.1% Source: 2012 ACFE Report to the Nation

23. Tipsters vs. Controls • Why are tipsters, management, and internal auditors the most effective sources for the detection of fraud?

24. Inside Info • Intimately familiar with “detailed” information • First-hand knowledge: know the entity, live it daily • See and hear what other employees say and do • Understand the control systems and how to circumvent

25. Motivation: Financial Duress • Bankruptcy • Foreclosure • Legal troubles • Divorce • Medical issues

26. Prevention: The Approach

27. Goal of an Anti-fraud program Cost vs. Benefit – You can’t completely prevent fraud. Anti-fraud program should be aimed at reducing the likelihood that if fraud occurs, it will not go undetected for an unreasonable amount of time.

28. The “People” Solution Remediation Tone at the Top 95% Educate Employees Investigate Reporting Mechanism Reduce Detection Time

29. Tone at the Top • Establishes standards for ethical behavior • Affixes responsibility for maintaining ethical culture • Sets positive example for others to follow

30. Informed Employees • Informed employees will be more likely to act ethically • Raises awareness of potentially fraudulent conduct by other employees or vendors • Encourages reporting of fraudulent conduct (early detection)

31. Reporting Mechanism • Commitment to non-retaliation • Anonymous reporting extremely important • Appropriate response (part of the solution or part of the problem) • Reduces detection time • Cornerstone to enterprise-wide anti-fraud system

32. Investigation • Objective/probing • Identify stakeholders/isolate interested individuals • Utilize appropriate investigative personnel (appropriate skills) • Timely conclusion/recommendations

33. Remediation • Report to appropriate level within entity • Report facts upon which appropriate action can be taken • Detailed recommendations for corrective actions • Inform affected (especially the tipsters) of investigative results and corrective actions taken

34. Reduce Detection Time

35. Common Red Flags • Living Beyond Means 35.6% • Financial Difficulties 27.1% • Close Association with Vendor 19.2% • Control Issues 18.2% • Divorce/Family Issues 14.8% • Addiction Problems 8.4% Source: 2012 ACFE Report to the Nation

36. Observe Lifestyle Changes • Spending habits: people generally spend what they steal. The more they steal, the more they spend. Fraud almost always starts small and grows. • Behavioral changes: look for signs of drug abuse, gambling or other patterns (dress, work habits, or attitude toward others)

37. Smell Test Sometimes “things” just don’t seem right. The Smell Test is based on a hunch, feeling or instinct.

38. Hotline • The most effective crime detection device is the Hotline. • Expands your view to all the “eyes” in your organization. • Cost effective • Provides a vehicle for honest employees to contribute to the well being of the organization

39. 95% Solution • Your people are the best control system! • Encourage • Empower • Enlist