Fraud and Other Investigative TechniquesChapter 10

Learning ObjectivesThe definition of fraudDifferent types of fraudComponents of the Fraud TriangleUtilization of ACL and i2 Analyst Notebook in fraud investigation

Learning Objectives (contd.)Overview of fraud examination and business investigationUse of computer technology and fraud examination/investigations

Types of value added servicesRisk assessment of fraud and illegal actsLegal counsel asks you to investigate embezzlement scheme involving hidden assetsVendor kickback determinationFact-finding for alleged frauds involving bribery, wire fraud, securities fraud.All of these involve forensic accounting or litigation support

Fraud definedIntentional deception, simply lying, cheating, or stealingA generic term, embracing all multifarious means which human ingenuity can devise, and which are resorted to by one individual to get advantage over another by false suggestions or by suppression of truth. It includes surprise, trickery, cunning, dissembling, and any unfair way by which another is cheated.

Fraud defined (contd.)Fraud includes the following elements:A misrepresentation of a material factKnown to be falseJustifiably relied uponResulting in a loss

Types of fraudsFraudulent financial reporting (management fraud)Actions whereby management attempts to inflate reported earnings or other assets in order to deceive outsidersOverstating assets/revenues, price fixing, contract bidding fraud, understating expenses/liabilities

Types of frauds (contd.)Misappropriation of assets (employee fraud)Actions of individuals whereby they misappropriate (steal) money or other property from their employersEmbezzlement, theft of company property, kickbacks

Types of fraud (contd.)Employee embezzlement fraud in which employees steal company assets either directly stealing cash or inventory or indirectly taking bribes or kickbacksManagement fraud deception by top management of an entity primarily through the manipulation of the financial statements in order to mislead users of those statementsInvestment scams the sale of fraudulent and often worthless investments (telemarketing and Ponzi scheme type frauds)

Types of fraud (contd.)Vendor fraud fraud resulting from overcharging for goods purchased, shipment of inferior goods, or non-shipment of inventory even when payment has been receivedCustomer fraud fraud committed by a customer by not paying for goods received or deceiving the organization in various ways to get something for nothingMiscellaneous fraud all others altering birth records or grade reports, etc.

Examples of fraud activitiesMisappropriation of assetsSkimmingForgeryKitingPhony refundsLarcenyFraudulent disbursementsLappingFictitious write-offsDuplicate paymentsNonexistent vendorKickbacksMisdirected shipmentsTheftUnauthorized personal use of assetsFictitious burglaryPhantom employeesFalsified time cardsFraudulent financial reportingFictitious revenuesAsset overstatementUnrecorded liabilitiesImproper disclosureCorruptionConflict of interestBriberyIllegal gratuitiesEconomic extortion

The Fraud TriangleThree factors in the triangle (usually all 3 exist in a fraud)Motivation (perceived pressure or incentive)Perceived opportunityRationalizationEffective internal controls limit fraudIf an organization can contain any one of the three elements, fraud will most likely not occur

Overview of financial fraud examinationTwo basic categories of fraud an auditor investigates when examining material misstatement risk assessment Fraudulent financial reportingMisappropriation of assets

Overview of financial fraud examination (contd.)Financial reporting fraud red flagsIncentive/pressuresHigh degree of competition or market competition in conjunction with declining profit marginsPerceived or real adverse effects of reporting poor financial resultsPersonal guarantees by management or board members of entity debt

Overview of financial fraud (contd.)Financial reporting fraud (contd.)Opportunities flagsHighly complex transactionsMajor international operationsDeficiencies in internal controls

Overview of financial fraud (contd.)Financial reporting fraud (contd.)Attitudes/rationalization flagsIneffective communication or enforcement of ethical standardsExcessive interest by management in maintaining or increasing the entitys earnings trend

Overview of financial fraud (contd.)Misappropriation of asset risk factorsSusceptibility of assets to misappropriationLarge amounts of cash on handEasily convertible assets (bonds, diamonds)Controls (lack of)

Overview of financial fraud (contd.)Steps of the fraud examinationIndentify issue/plan the investigationGather the evidence/the investigation phaseEvaluate the evidenceReport he findings to management?/legal counsel

Computer technology in fraud investigation (contd.)Data mining softwareSoftware tool that models a database for the purpose of determining patterns and relationships among the dataWizrule used for data cleaning (searching for clerical errors) or anomaly detection.Financial Crime Investigator systematic approach for investigating, detecting, and preventing contract and procurement fraud

Computer technology in fraud investigation (contd.)Data mining software (contd.)IDEA (Audimation Services, inc) allows user to display, analyze, manipulate, sample or extract dataMonarch allows investigator to convert electronic editions of reports into text filesACL for windows data inquiry, analysis, and reporting softwareAnalysts notebook assists investigators by uncovering, interpreting, and displaying complex information in easily understood charts.

Public records see figure 10-7Courthouse records lawsuits, judgments, property filings, bankruptcy filingsCompany records SEC filings, Dun and Bradstreet has private company data, D/B/A filings with state or county, real estate filingsOnline databases lexis nexis, dow jones, etcThe internet knowX fraud searches, switchboard white and yellow page listing,