ccia 2011 fall conference occupational fraud schemes & increasing fraud awareness jenny...

CCIA 2011 Fall Conference

Occupational Fraud Schemes & Increasing

Fraud Awareness

Jenny DominguezSr. Manager, VLS Fraud Solutions

October 6, 2011

Presenter Contact Information

Jenny Dominguez, CPA/CFF, CFE

Vicenti, Lloyd & Stutzman, [email protected]

www.vlsllp.com

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Topics To Cover

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I. The Fraud Triangle – factors that influence the commission of fraud

II. The Fraud Tree – occupational fraud & abuse classification system

III. Fraud Schemes – Case Studies

I.

Three Factors of the Fraud Triangle

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What 3 Factors Influence the Commission of Fraud?

FRAUDTRIANGLE

“Pressures”(Motive)

“Opportunities” “Rationalization”

(Developed by Donald R. Cressey)

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PressuresSerious financial problem that requires immediate attention and cannot be resolved by ordinary financial resources

OpportunitiesBecome aware that financial

problem can be solved by stealing from organization or

falsifying organizations records

RationalizationMindset and thinking that

what you are doing is justified

II.

The Fraud Tree:Occupational Fraud & Abuse

Classification System

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Occupational Fraud

The use of one’s occupation for personal enrichment through the

deliberate misuse or misapplication of the

employing organization’s

resources or assets.

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What is the Fraud Tree?

CorruptionAsset

MisappropriationFraudulent Statements

Three Major Types of Occupational Fraud(page 7 of ACFE 2010 Report to the Nations)

Off-book frauds that occur in the form of kickbacks, gifts, or gratuities to employees from contractors / vendors

Theft or misuse of organization’s cash or assets

Deliberate misrepresentation of the financial condition of an organization through intentional misstatement or omission

III.

Fraud SchemesCase Studies

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Corruption – Interesting Facts

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32.8% of the cases studied in the ACFE 2010 Report to the Nations involved some form of Corruption.

The median loss suffered was $250,000.

Of the 90 cases studied involving organizations in the “Education” industry, Corruption was the 2nd most common type of occupational fraud committed, after billing schemes.

(page 35 of ACFE 2010 Report to the Nations)

Corruption – Types of Frauds

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•Conflicts of Interest- Purchase Schemes- Sales Schemes- Other

•Bribery- Invoice Kickbacks- Bid Rigging- Other

•Illegal Gratuities

•Economic Extortion

Corruption – Case Study

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Background / Summary

•Government agency

•Performed $100 - $400 million in construction activity annually

•Construction work was contracted out – internal project managers

•“Emergency” work was approximately $2 million per year

•95% of “emergency” work went to the same vendor

•Several large construction projects had change orders that exceeded 50% of the original contract, one exceeded 100%

•Manager of construction management department moved up the ranks from field personnel

•Manager and CEO vacationed with one particular vendor

Any of these stand out as red flags?

Corruption – Case Study

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Internal Audit Revealed

•“Emergency” work being performed did not qualify as emergency under PCC:

Fixing potholes outside of Board member’s housePainting & other general work due to project time constraints

•Documentation was not kept to support that all contractors on approved list for emergency work were solicited for quotes

•Change orders paid on some projects were not related to the original construction contract

•Project tracking system not reconciled to accounting system

•Construction contracts did not include “right to audit” clause

What would next steps be?

Asset Misappropriation – Interesting Facts

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86.3% of the cases studied in the ACFE 2010 Report to the Nations involved some form of Asset Misappropriation.

The median loss suffered was $135,000.

Of the 90 cases studied involving organizations in the “Education” industry, “Billing” schemes were the most common type of

occupational fraud committed.(page 35 of ACFE 2010 Report to the Nations)

Asset Misappropriation – Types of Frauds

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•Cash- Larceny- Skimming- Fraudulent Disbursements

•Inventory & All Other Assets- Misuse- Larceny

Asset Misappropriation – Case Study

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Background / Summary•Small dental practice

•Office manager handled:Entering patient services into patient billing system – creating A/RCollecting patient paymentsEntering patient payments into patient billing systemBilling patientsCreating deposits and taking to bank

•Over 2 years “skimmed” approximately $35,000Unrecorded salesWrite-offs and write-downsModified historical payment amounts

•Patient billing system did not have the capability to lock older months


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Red Flags•Lack of segregation of duties

•No reconciliations between accounting software and other systems

•Change in level of activity for certain collection type, particularly cash

•Refusal to take vacation or share duties

•Increase in Accounts Receivable

•Increase in Write-offs

•Working during “off” hours

•Write-offs / other adjustments don’t require approval

•Assets are not safeguarded

•Deposits done infrequently or irregularly


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How Can This Be Prevented / Detected Earlier?•Prevention:

Better segregation of dutiesSecondary / separate approval or log-in required for write-offsLock patient tracking system to prevent modificationPerform background checks of new employees Issue pre-numbered receipts for all payments (perform independent

check daily)

•Detection:Analytical procedures – compare sales / collections over timeReview of historical write-offsPerform regular reconciliations between the patient tracking system

(which reports total collections) to QuickBooksHave aggressive collection department / personnel

Fraudulent Statements – Interesting Facts

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4.8% of the cases studied in the ACFE 2010 Report to the Nations involved some form of Financial Statement Fraud.

The median loss suffered was $4.1 million.

Of the 90 cases studied involving organizations in the “Education” industry, “Financial Statement Fraud” was the least common type

of occupational fraud committed.(page 35 of ACFE 2010 Report to the Nations)

Fraudulent Statements – Types of Frauds

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•Financial- Timing Differences- Fictitious Revenue- Concealed Liabilities & Expenses- Improper Disclosures- Improper Asset Valuations

•Non-Financial- Employment Credentials- Internal Documents- External Documents

Fraudulent Statements – Case Study(Improper Disclosures)

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Background / Summary•City government - defined benefit pension plan

•Beginning in 1982 adopted use of “surplus earnings” to alleviate financial obligations of City:

“13th Check” – extra check to retirees$10 million, one-time reduction in City’s contribution to pensionPaid 100% of post-retirement healthcare benefits

•1996: Passed “MP-1” which set City contribution rates at negotiated rates lower than the actuarially calculated rate

•2002: Pass “MP-2” which reduced trigger in MP-1 and slowly ramped up contribution rates

•Manipulated actuarial valuations:Changed valuation methods based on what favored CityExcluded certain liabilities as “contingent” – legally required to payReset amortization period of unfunded liability


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Background / Summary

•Investigated financial statement disclosures over 7 years

•Primary issue: Disclosures related to pension plan fundingCity claimed it was funding the pension system at

actuarially determined rates, when it was notCity failed to disclose that surplus earnings were used to

pay for retiree healthcare benefits

•Secondary issue: Conflict of interestPension board members voted on changes to the

pension system that eroded assets and increased their individual benefits


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Motivation?•City issued $3.1 billion in public bonds from 1996 - 2003

•City sought credit ratings from the various Rating AgenciesBetter rating provided for better interest rate

•Email communication discovered during investigation:“…when we book the NPO [Net Pension Obligation] the

rating agencies won’t like it. It will be a negative for the City. As we market a large amount of bonds it might cost us a lot of money…” - 1998

“…my biggest suggestion to her is to eliminate any reference to fitch and rating agencies…this letter will be seen by press and the city does not need to telegraph its pension problems to the rating agencies…” - 2002


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Cost to City

•$$$$$$24 million in fees for investigationIncreased auditor feesAdditional costs to comply with SEC & DA investigationsHigher interest rate on bonds

•Decreased credit rating

•Delayed / rejected bond approvals by tax payers

•Delayed audits (FY2003 completed in 2007)

•Employees fired and under investigation

•Significant reduction in public services

•Reduction in benefits for incoming employees


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Red Flags

•Ineffective Board of Directors or Audit Committee

•Significant, unusual, or highly complex transactions

•Recurring attempts by management to justify marginal or inappropriate accounting

•Formal or informal restrictions on the auditor that limit access to people or information

•Non-financial management’s excessive involvement in determination of significant estimates

•Insufficient training of accounting staff

•Lack of “ownership” of financial statements


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How Can This Be Prevented / Detected Earlier?

•Implement full internal audit department

•Implement use of independent fraud hotline

•Ownership for financial statements is clearly assigned – establish accountability

•Adequate and continuous technical training for employees (accounting department)

•Training for all employees on what constitutes dishonest behavior

•Implement Audit Committee

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THANK YOU!