Tag Archives: Corporate Counsel

First Things First

About a decade ago, I attended a training session at the Virginia State Police training center conducted by James D. Ratley, then the training director for the ACFE. The training session contained some valuable advice for CFE’s and forensic accountants on immediate do’s and don’ts if an examiner strongly suspects the presence of employee perpetrated financial fraud within a client’s organization. Mr. Ratley’s counsel is as relevant today as it was then.

Ratley advised that every significant employee matter (whether a theft is involved or not) requires thoughtful examiner deliberation before any action is taken, since hasty moves will likely prove detrimental to both the investigator and to the client company. Consequently, knowing what should not be done if fraud is suspected is often more important to an eventual successful outcome than what should be done.

First, the investigator should not initially confront the employee with his or her suspicions until the investigator has first taken several important preliminary investigative steps.  Even when those steps have been taken, it may prove necessary to use a different method of informing the employee regarding her status, imminent material harm notwithstanding. False (or even valid) accusations can lead to defamation lawsuits or at the very least to an extremely uncomfortable work environment. The hasty investigator or management could offend an innocent person by questioning her integrity; consequently, your client company may never be able to regain that person’s trust or prior level of commitment. That downside is just one example of the collateral damage that can result from a fraud. Even if the employee is ultimately found to be guilty, an investigator’s insinuation gives him or her time to alter records and conceal the theft, and perhaps even siphon off more assets. It takes only a moment for an experienced person to erase a computer’s hard drive and shred documents. Although, virtually all business records can be reconstructed, reconstruction is a costly and time-consuming process that always aggravates an already stressful situation.

Second, as a rule, never terminate or suspend the suspect employee until the preliminary investigative steps referred to above have been taken.  The desire on the part of management to take decisive action is understandable, but hasty actions may be detrimental to the subsequent investigation and to the company. Furthermore, there may be certain advantages to continuing the person’s employment status for a brief period because his or her continued status might compel the suspect to take certain actions to your client’s or to the investigation’s benefit. This doesn’t apply to government employees since, unlike private sector employees, they cannot be compelled to participate in the investigation. There can be occasions, however, where it is necessary to immediately terminate the employee. For example, employees who serve in a position whose continued employment could put others at risk physically, financially, or otherwise may need to be terminated immediately. Such circumstances are rare, but if they do occur, management (and the CFE) should document the entire process and advise corporate counsel immediately.

Third, again, as a rule, the investigator should never share her initial suspicions with other employees unless their assistance is crucial, and then only if they are requested to maintain strict confidentiality.  The CFE places an arduous burden on anyone in whom s/he has confided. Asking an employee to shoulder such responsibilities is uncharted territory for nearly anyone (including for the examiner) and can aggravate an already stressful situation. An examiner may view the confidence placed in an employee as a reflection of his and management’s trust. However, the employee may view the uninvited responsibility as taking sides with management at the expense of his relationship with other employees. Consequently, this step should be taken only if necessary and, again, after consultation with counsel and management.

Regarding the do’s, Ratley recommended that the instant that an employee fraud matter surfaces, the investigator should begin continuous documentation of all pertinent investigation-related actions taken. Such documentation includes a chronological, written narrative composed with as much specificity as time permits. Its form can take many shapes, such as handwritten notes, Microsoft Word files, spreadsheets, emails to yourself or others, and/or relevant data captured in almost any other reproducible medium. This effort will, of course, be time consuming for management but is yet another example of the collateral damage resulting from almost any employee fraud. The documentation should also reference all direct and related costs and expenses incurred by the investigator and by the client company. This documentation will support insurance claims and be vital to a subsequent restitution process.  Other collateral business damages, such as the loss of customers, suppliers, or the negative fiscal impact on other employees may also merit documentation as appropriate.

Meetings with corporate counsel are also an important do.  An employee fraud situation is complex and fraught with risk for the investigator and for the client company. The circumstances can require broad and deep expertise in employment law, criminal law, insurance law, banking law, malpractice law, and various other legal concentrations. Fortunately, most corporate attorneys will acknowledge when they need to seek additional expertise beyond their own experience since a victim company counsel specializing in corporate matters may have little or no background in matters of fraud. Acknowledgment by an attorney that s/he needs additional expertise is a testament to his or her integrity. Furthermore, the client’s attorney may contribute value by participating throughout the duration of the investigation and possible prosecution and by bringing to bear his or her cumulative knowledge of the company to the benefit of the organization.

Next, depending on the nature of the fraud and on the degree of its fiscal impact, CFEs should meet with the client’s CPA firm but exercise caution. The client CPA may be well versed in their involvement with your client through their work on income taxes, audit, review, and compilations, but not in forensic analysis or fraud examination. Larger CPA firms may have departments that they claim specialize in financial forensics; the truth is that actual experience in these matters can vary widely. Furthermore, remember that the situation occurred under your client CPA’s watch, so the firm may not be free of conflict.

Finally, do determine from management as early as possible the range of actions it might want to take with respect to the suspect employee if subsequent investigation confirms the suspicion that fraud has indeed occurred.  Deciding how to handle the matter of what to do with the employee by relying upon advice from management and from the legal team can be quite helpful in shaping what investigative steps are taken subsequently. Ratley pointed out that the level and availability of evidence often drive actions relating to the suspect. For example, the best course of action for management may be to do nothing immediately, to closely monitor and document the employee’s activities, to suspend the employee with pay, or immediately terminate the suspect’s employment. There may be valid reasons to exercise any one of these options.

Let’s say the CFE is advised by management to merely monitor and document the employee’s activities since the CFE currently lacks sufficient evidence to suspend or terminate the employee immediately. The CFE and the client’s IT operation could both be integral parts of this option by designing a plan to protect the client from further loss while the investigation continues behind the scenes. The investigation can take place after hours or under the guise of an “efficiency audit,” “business planning,” or other designation. In any case, this option will probably require the investigator to devote substantial time to observe the employee and to concurrently conduct the investigation.  The CFE will either assemble sufficient evidence to proceed or conclude there is inadequate substantiation to support the accusation.

A fraud is a devastating event for any company but Mr. Ratley’s guidance about the first steps in an investigation of employee perpetrated financial fraud can help minimize the damage.  He concluded his remarks by making two additional points; first, few executives are familiar by experience with situations that require CFE or forensic accountant expertise; consequently, their often-well-meaning actions when confronted with the actuality of a fraud can result in costly mistakes regarding time, money and people. Although many such mistakes can be repaired given sufficient money and time, they are sometimes devastating and irrecoverable.  Second, attorneys, accountants and others in the service professions frequently lack sufficient experience to recognize the vast differences between civil and criminal processes.  Consequently, these professionals often can provide the best service to their corporate clients by referring and deferring to more capable fraud examination specialists like certified fraud examiners and experienced forensic accountants.

Vendor Assessment – Backing Corporate Counsel

Pre-emptive fraud risk assessments targeting client vendor security are increasingly receiving CFE attention. This is because in the past several years, sophisticated cyber-adversaries have launched powerful attacks through vendor networks and connections and have siphoned off money, millions of credit card records and customers’ sensitive personal information.

There has, accordingly, been a noticeable jump in those CFE client organizations whose counsel attribute security incidents to current service providers, contractors and to former partners. The evolution of targets and threats outside the enterprise are powerfully influencing the current and near-future of the risk landscape. CFEs who regard these easily predicted changes in a strategic manner can proactively assist their client’s security and risk leadership to identify new fraud prevention opportunities while managing the emerging risk. To make this happen enterprises require adequate oversight insight into vendor involved fraud security risk as part of a comprehensive cyber-risk management policy.

Few managements anticipated only a few years ago that their connectivity with trusted vendors would ever result in massive on-line exploits on sister organizations like retailers and financial organizations, or, still less, that many such attacks would go undetected for months at a time. Few risk management programs of that time would have addressed such a risk, which represents not only a significant impact but whose occurrence is also difficult to predict. Such events were rare and typically beyond the realm of normal anticipation; Black Swan events, if you will. Then, attackers, organized cyber-criminals and some nation-states began capturing news headlines because of high-profile security breaches. The ACFE has long told us that one-third (32 percent) of fraud survey respondents report that insider crimes are costlier or more damaging than incidents perpetrated by outsiders and that employees are not the only source of insider threat; insider threat can also include former employees, service providers, consultants, contractors, suppliers and business partners.

Almost 500 such retailer breaches have been reported this year alone targeting credit card data, personal information, and sensitive financial information. There has, accordingly, been a massive regulatory response.  Regulators are revisiting their guidelines on vendor security and are directing regulated organizations to increase their focus on vendor risk as organizations continue to expand the number and complexities of their vendor relationships. For example, the US Office of the Comptroller of the Currency (0CC) and the Board of Governors of the US Federal Reserve System have released updated guidance on the risk management of third-party relationships. This guidance signals a fundamental shift in how retail financial institutions especially need to assess third-party relationships. In particular, the guidance calls for robust risk assessment and monitoring processes to be employed relative to third-party relationships and specifically those that involve critical activities with the potential to expose an institution to significant risk. CFEs and other assurance professionals can proactively assist the counsels of their client enterprises to elevate their vendor-related security practices to keep pace with ever-evolving fraud threats and security risk associated with their client’s third-party relationships.

Vendor risk oversight from a security point of view demands a program that covers the entire enterprise, outlining the policy and guidelines to manage and mitigate vendor security risk, combined with clearly articulated vendor contracts negotiated by the corporate counsel’s function. Such oversight will not only help organizations improve cybersecurity programs but also potentially advance their regulatory and legal standing in the future. What insights can CFEs, acting proactively, provide corporate counsel?

First, the need for executive oversight. Executive alignment and business context is critical for appropriate implementation throughout the organization. Proper alignment is like a command center, providing the required policies, processes and guidelines for the program. The decision to outsource is a strategic one and not merely a procurement decision. It is, therefore, of the utmost importance that executive committees provide direction for the vendor risk management program. The program can obtain executive guidance from:

–The compliance function to provide regulatory and other compliance requirements that have specific rules regarding vendor risk management to which the vendor organizations must adhere;

–The IT risk and control function to determine the risk and the risk level, depending on the nature of access/data sensitivity shared with the vendor(s). The vendor risk management program should utilize the key risk indicators provided by this function to address risk during vendor assessments;

–The contract governance function and corporate counsel to ensure that vendor contracts adequately address the need for security assessments and define vendors’ obligations to complete these assessments.

Most larger organizations today deal with a considerable amount of third parties and service providers. Missing contact information, responsibility matrices or updated contracts are typical areas of concern about which risk managers might have engaged CFEs initiate fraud risk assessments. This can pose a significant challenge, especially, when there are multiple teams involved to carry out the procurement business process. A vendor and contract database (VCD) ensures that an accurate and complete inventory of vendors is maintained, including other third-party relationships (e.g., joint ventures, utilities, business partners, fourth parties, etc.).

In effectively assessing a vendor risk management program, the CFE can’t conduct the same type of fraud risk assessment for all vendors. Rather, it’s necessary to identify those vendor services deemed to carry the greatest risk and to prioritize them accordingly. The first step is to understand which vendors and services are in the scope from an active fraud risk management perspective. Once this subset of vendors has been identified and prioritized, due diligence assessments are performed for the vendors, depending on the level of client internal versus vendor-owned fraud prevention and detection controls. The results of these assessments help establish the appropriate trust-level rating (TLR) and the future requirements in terms of CFE assisted reassessments and monitoring. This approach focuses resources on the vendor relationships that matter most, limiting unnecessary work for lower-risk relationships. For example, a vendor with a high TLR should be prioritized over a vendor with a low TLR.

Proper control and management of vendor risk requires continuous re-assessment. It’s important to decide the types of on-going assessments to be performed on vendors depending on the level of their TLR and the risk they represent.

Outsourced relationships usually go through iterations and evolve as they mature. As your client organizations strategize to outsource more, they should also validate trust level(s) in anticipation of more information and resources being shared. With technological advancements, a continuously changing business environment and increased regulatory demands, validating the trust level is a continuous exercise. To get the most rational and effective findings, it’s best to use the results of ongoing assessments. In such a reiterative process, it is necessary to continuously monitor and routinely assess vendors based on the trust level they carry. The program should share information about the vendor security posture and risk levels with corporate counsel or other executive sponsor, who can help the organization progress toward the target profile. Clearly communicating the fraud risk from a business perspective can be an additional feature, especially when reports are furnished to inform internal stakeholders, internal audit functions, lines of business and the board of directors, if necessary.

Vendor fraud risk management elevates information security from a technical control business process to an effective management business process. Regular fraud risk security assessments of vendors give organizations the confidence that their business is aware of the security risk involved and is effectively managing it by transferring, mitigating or accepting it. Comprehensive vendor security assessments provide enterprises with insight on whether their systems and data are being deployed consistently with their security policies. Vendor fraud risk management is not a mere project; it is an ongoing program and requires continuous trust to keep the momentum going. Once the foundational framework has been established, our client organizations can look at enhancing maturity through initiatives such as improving guidelines and procedures, rationalizing assessment questionnaires, and more automation. Awareness and communication are key to ensuring that the program is effective and achieves its intended outcome, securing enterprises together with all their business partners and vendors.