Category Archives: Fraud Prevention

Authority Figures

As fraud examiners and forensic accountants intimately concerned with the on-going state of health of our client’s fraud management programs, we find ourselves constantly looking at the integrity of the critical data that’s truly (as much as financial capital) the life blood of today’s organizations. We’re constantly evaluating the network of anti-fraud controls we hope will help keep those pesky, uncontrolled, random data driven vulnerabilities to fraud to a minimum. Every little bit of critical financial information that gets mishandled or falls through the cracks, every transaction that doesn’t get recorded, every anti-fraud policy or procedure that’s misapplied has some effect on the client’s overall fraud management picture and on our challenge.

When it comes to managing its client, financial and payment data, almost every small to medium sized organization has a Sandy. Sandy’s the person to whom everyone goes to get the answers about data, and the state of system(s) that process it; quick answers that no one else ever seems to have. That’s because Sandy is an exceptional employee with years of detailed hands-on-experience in daily financial system operations and maintenance. Sandy is also an example of the extraordinary level of dependence that many organizations have today on a small handful of their key employees. The now unlamented great recession, during which enterprises relied on retaining the experienced employees they had rather than on traditional hiring and cross-training practices, only exacerbated an existing, ever growing trend. The very real threat to the Enterprise Fraud Management system that the Sandy’s of the corporate data world pose is not so much that they will commit fraud themselves (although that’s an ever-present possibility) but that they will retire or get another job across town or out of state, taking their vital knowledge of company systems and data with them.

The day after Sandy’s retirement party and, to an increasing degree thereafter, it will dawn on Sandy’s management that it’s lost a large amount of information about the true state of its data and financial processing system(s). Management will also become aware, if it isn’t already, of its lack of a large amount of system critical data documentation that’s been carried around nowhere else but in Sandy’s head. The point is that, for some smaller organizations, their reliance on a few key employees for day to day, operationally related information goes well beyond what’s appropriate and constitutes an unacceptable level of risk to their entire fraud prevention programs. Today’s newspapers and the internet are full of stories about hacking and large-scale data breeches, that only reinforce the importance of vulnerable data and of the completeness of its documentation to the on-going operational viability of our client organizations.

Anyone whose investigated frauds involving large scale financial systems (insurance claims, bank records, client payment information) is painfully aware that when the composition of data changes (field definitions or content) surprisingly little of change related information is formally documented. Most of the information is stored in the heads of some key employees, and those key employees aren’t necessarily involved in everyday, routine data management projects. There’s always a significant level of detail that’s gone undocumented, left out or to chance, and it becomes up to the analyst of the data (be s/he an auditor, a management scientist, a fraud examiner or other assurance professional) to find the anomalies and question them. The anomalies might be in the form of missing data, changes in data field definitions, or changes in the content of the fields; the possibilities are endless. Without proper, formal documentation, the immediate or future significance of these types of anomalies for the fraud management system and for the overall fraud risk assessment process itself become almost impossible to determine.

If our auditor or fraud examiner, operating under today’s typical budget or time constraints, is not very thorough and misses the identification of some of these anomalies, they can end up never being addressed. How many times as an analyst have we all tried to explain something (like apparently duplicate transactions) about the financial system that just doesn’t look right only to be told, “Oh, yeah. Sandy made that change back in February before she retired; we don’t have too many details on it.” In other words, undocumented changes to transactions and data, details of which are now only existent in Sandy’s no longer available head. When a data driven system is built on incomplete information, the system can be said to have failed in its role as a component of the origination’s fraud prevention program. The cycle of incomplete information gets propagated to future decisions, and the cost of the missing or inadequately explained data can be high. What can’t be seen, can’t ever be managed or even explained.

In summary, it’s a truly humbling to experience to be confronted with how much critical financial information resides in the fading (or absent) memories of past or present key employees; what the ACFE calls authority figures. As fraud examiners we should attempt to foster a culture among our clients supportive of the development of concurrent systems of transaction related documentation and the sharing of knowledge on a consistent basis about all systems but especially regarding the recording of changes to critical financial systems. One nice benefit of this approach, which I brought to the attention of one of my audit clients not too long ago, would be to free up the time of one of these key employees to work on more productive fraud control projects rather than serving as the encyclopedia for the rest of the operational staff.

Regulators & Silos

I was reading last week on LinkedIn about a large, highly regulated, financial institution that was defrauded over a long period of time by two different companies, both of which where its suppliers. To add insult to injury, subsequent investigation by a CFE revealed that the two vendors were subsidiaries of a third, which proved also to be a supplier of the victim concern; all three cooperated in the fraud and our victim was completely unaware prior to the investigation of any relationship between them; the kind of ignorance that can draw intense regulatory attention.

This is not as uncommon an occurrence as many might think but it is illustrative of the fact that today’s companies are increasingly forced to expend resources simply trying to understand and manage the complex web of relationships that exist between them and the organizations and people with which they deal; that is, if they want to avoid falling victim to frauds running the whole gamut from the simple to the complex. Such efforts involve gaining perspective on individual vendors and customers but extend far beyond that to include sorting through and classifying corporate hierarchies and complex business-to-business relationships involving partners, suppliers, distributors, resellers, contacts, regulators and employees.

These complex, sometimes overlapping, relationships are only exacerbated by dynamic geographic and cross-channel coordination requirements, and multiple products and customer accounts (our victim financial organization operates in three countries and has over 4,000 employees and hundreds of vendors). No fraud prevention program can be immune in the face of these challenges.

Financial companies that want to securely deliver the best experience to their stakeholders within intensified regulatory constraints need to provide themselves with a complete picture of all the critical parties in their relationships at the various points of service in the on-going process of company operations. The ability to do this requires that organizations have a better understanding of the complicated hierarchies and relationships that exist between them and their stakeholders. You cannot manage what you cannot see and you certainly cannot adequately protect it against fraud, waste and abuse.

The active study of organizational hierarchies and relationships (and their related fraud vulnerabilities) is a way of developing an integrated view of the relationship of risk among cooperating entities such as our CFE client companies between their affiliates, customers and partners, across multiple channels, geographies or applications. The identification of organizational relationships can help our client companies clearly and consistently understand how each of their affiliates, business divisions and contacts within a single multi-national enterprise fit within a broader, multidimensional context. Advanced organizational management approaches can help organizations track when key people change jobs within and between their related affiliates, vendors and companies. Advanced systems can also identify these individuals’ replacements feeding a database of who is where, vital to shifting patterns of enterprise risk.

Our client financial companies that take the time to identify and document their organizational relationships and place stakeholders into a wider hierarchical context realize a broad range of fraud, waste and abuse prevention related benefits, including:

• Enhanced ability to document regulatory compliance;
• More secure financial customer experiences, leading to enhanced reputation, increased loyalty and top-line growth;
• More confident financial reporting and more accurate revenue tracking;
• Reduction of over-all enterprise fraud risk;
• More accurate vetting of potential vendors and suppliers;
• More secure sales territory and partner program management;
• Improved security program compliance management;
• More accurate and effective fraud risk evaluation and mitigation.

The ability to place stakeholders within hierarchical context is invaluable to helping companies optimize business processes, enhance customer relationships and achieve enterprise-wide objectives like fraud prevention and mitigation. Organizations armed with the understanding provided by documented relationship contexts can improve revenues, decrease costs, meet compliance requirements, mitigate risk while realizing many other benefits.

As with our victimized financial enterprise, a company without relational data regarding vendors and other stakeholders can be unknowingly dealing with multiple suppliers who are, in fact, subsidiaries of the same enterprise, causing the company to not only inadvertently misrepresent its vendor base but, even more importantly, increase its vulnerability to fraud. Understanding the true relational context of an individual supplier may allow a company to identify areas of that vendor’s organization that represents enhanced internal control weakness or fraud risk. Conversely, an organization may fail to treat certain weakly controlled stakeholders strategically because the organization is unaware of just how much business it is doing with that stakeholder and its related subsidiaries and divisions.

Risk management has always been a core competency for organizations in general and for financial institutions in particular. However, integrated enterprise risk management (ERM) practices and corporate governance disciplines are now a regulatory imperative. Any institution that views corporate governance as merely a compliance exercise is missing the mark. Regulatory compliance is synonymous with the quality of the integrated ERM framework. Risk and control are virtually inseparable, like two sides of a coin, meaning that risks first must be identified and assessed, and then managed and mitigated by the implementation of a strong system of internal control. Accurate stake holder relational data is, therefore, critical to the effectiveness of the overall ERM process.

In today’s environment, the compliance onus rests with the regulated. In a regulatory environment where client enterprise ignorance of the situation in the client’s own overall enterprise is no longer a defense, responsibility for compliance now rests with the board and senior management to satisfy regulators that they have implemented a mature fraud prevention framework throughout the organization, effectively managing risk from the mailroom to the boardroom.

An integrated control framework with more integrated risk measures, both across risk types and economic and regulatory capital calculations, is warranted. Increased demands for self-attestation require elimination of fragmentation and silos in business and corporate governance, risk management, and compliance.

Compliance needs to be integrated into the organization’s ERM base fraud prevention framework, thereby making the management of regulatory risk a key part of effective overall compliance. Compliance needs to be seen as less of a function and more as an institutional state of mind, helping organizations to anticipate risk as well as to avoid it. Embedding compliance as a corporate discipline ensures that fraud prevention controls are entrenched in people’s roles and responsibilities more effectively than external regulations. The risk management function must not only address the compliance requirements of the organization but must also serve as an agent for improved decision making, loss reduction and competitive advantage within the marketplace.

Organizations can approach investments in corporate governance, relationship identification, risk management practices and regulatory compliance initiatives as one-off, isolated activities, or they can use these investments as an opportunity to strengthen and unify their risk culture, aligning best practices to protect and enhance stakeholder value. A silo-based approach to fraud prevention will not only be insufficient but will also result in compliance processes layered one upon the other, adding cost and duplication, and reducing the overall agility of our client’s business; in effect, increasing risk. This piecemeal reactive approach also leaves a gap between the processes designed to keep the organization in line with its regulatory obligations and the policies needed to protect and improve the franchise. Organizations are only as strong as their weakest components, like the links in a chain.

The ACFE tells us that people tend to identify with their positions, focusing more on what they do rather than on the purpose of it. This leads to narrowed vision on the job, resulting in a myopic sense of responsibility for the results produced when all positions interact. ln the event of risk management breakdowns or when results are below expectations, it is difficult for people to look beyond their silo. The enemy is out there syndrome, a byproduct of seeing only one’s own position, results in people quickly blaming someone or something outside themselves, including regulators, when negative events like long running frauds are revealed and retreating within the perceived safety of their fortress silo. This learning disability makes it almost impossible to detect the leverage that can be used on issues like fraud prevention and response that straddle the boundary between ‘us’ and ‘them’.

However, it is particularly disconcerting that the weakest numbers by industry sector, including financial services, occur in the ACFE studies measuring organization wide accountability and people’s understanding of their accountability. My personal feeling is that much of the reason for this low score is the perpetuation of organizational silos resulting from management’s failure to adequately identify and document all of its stakeholders’ cross-organizational relationships.

Trust but Check

The community support for a business, and business in general, depends on the credibility that stakeholders place in corporate commitments, the company’s reputation, and the strength of its competitive advantage. All of these depend on the trust that stakeholders place in a company’s activities. Trust, in turn, depends on the values underlying corporate activities. Off-shore accounts, manipulation of shell corporations to evade taxes, loan fraud and management self-dealing are just a few instances of the moral cancer that, drop by drop, erodes trust until the point where the free enterprise systems of democratic nations are replaced by naked oligarchy, kleptocracy and cultures of corruption.

If the interests of all stakeholders are systematically not respected, then action that continues to be often painful to shareholders, officers, and directors usually occurs. In fact, it is unlikely that businesses or professions can achieve their long-run strategic objectives without the support of key stakeholders, such as shareholders, employees, customers, creditors, suppliers, governments, and host communities.

A constant theme and trend (as echoed in the trade press) has become increasingly more evident since the turn of the century. The judgment and moral character of executives, owners, boards of directors, and auditors has been often insufficient, on their own, to prevent increasingly severe corporate, ethical, and governance scandals. Governments and regulators world-wide have been required to constantly tighten guidelines and governance regulations to assure the protection of the public. The self-interested lure of greed has proven to be too strong for many to resist, and they have succumbed to conflicts of interest when left too much on their own. Corporations that were once able to shift jurisdictions to avoid new regulations regarding tax and other matters now are facing global measures designed to expose and control questionable ethics and governance practices. Assurance professionals themselves, of all types, are also facing international standards of behavior.

These changes have come about because of the pressures brought to bear on corporations and management by the reporting of scandals and abuses by a still potent free press and by suits by activist investors and other involved stakeholders. But changes in laws, regulations, and standards are only part of what stakeholders have contributed. The expectations for good ethical behavior and good governance practices have changed. Failure to comply with these expectations now impacts reputations, profits, and careers even if the behavior is strictly within legal boundaries.

As ACFE training tells us, it’s become increasingly evident to most executives, owners, and auditors that their individual success is directly related to their ability to develop and maintain a corporate culture of integrity. They cannot afford the loss of reputation, revenue, reliability, and credibility as a result of a loss of integrity. It is no longer an effective, sustainable, or medium or long-term strategy to project or practice questionable ethics. ACFE training goes on to indicate a number of causes, or signs, of ethical problems within any given corporation:

— Pressure to meet goals, especially financial ones, at any cost;
–A culture that does not foster open and candid conversation and discussion;
–A CEO who is surrounded by people who will agree and flatter the CEO, as well as a CEO whose reputation is ‘beyond criticism’;
–Weak boards that do not exercise their fiduciary responsibilities with diligence;
–An organization that promotes people on the basis of nepotism and favoritism;
–Hubris. The arrogant belief that rules are for other people, but not for us;
–A flawed cost/benefit attitude that suggests that poor ethical behavior in one area can be offset by good ethical behavior in another area.

The LIBOR rate scandal of 2012 is an almost perfect example of ethical collapse and manifests a majority of the red flags enumerated above. The scandal featured the systematic manipulation of a benchmark interest rate, supported by a culture of fraud in the world’s biggest banks, in an environment where little or no regulation prevailed. After decades of abuse that enriched the big banks, their shareholders, executives and traders, at the expense of others, investigations and lawsuits were finally undertaken resulting in prosecutions and huge penalties for the banks and the individual traders involved.

The London Interbank Offered Rate (LIBOR) rate is a rate of interest, first computed in 1985 by the British Banking Association (BBA), the Bank of England and others, to serve as a readily available reference or benchmark rate for many financial contracts and arrangements. Prior to its creation, contracts utilized many privately negotiated rates, which were difficult to verify, and not necessarily related to the market rate for the security in question. The LIBOR rate, which is the average interest rate estimated by leading banks that they would be charged if they were to borrow from other banks, provided a simple alternative that came to be widely used.

At the time of the LIBOR scandal, 18 of the largest banks in the world provided their estimates of the costs they would have had to pay for a variety of interbank loans (loans from other banks) just prior to 11:00 a.m. on the submission day. These estimates were submitted to Reuters news agency (who acted for the BBA) for calculation of the average, and its publication, and dissemination. Reuters set aside the four highest and four lowest estimates and averaged the remaining ten.

So huge were the investments affected that a small manipulation in the LIBOR rate could have a very significant impact on the profit of the banks and of the traders involved in the manipulation.

Insiders to the banking system knew about the manipulation of LIBOR rate submissions for decades, but changes were not made until the public became aware of the problem, and until the U.S. Department of Justice (DOJ) forced the U.K. government to act. The president of the New York Federal Reserve Bank (Fed), at that time emailed the governor of the Bank of England in June 2008, suggesting ways to “enhance” LIBOR. Although ensuing emails report agreement on the suggestions, and articles appeared in the trade press from 2008 to 2011, serious changes were not applied until October 2012 when the U.K. government accepted the recommendations of the Wheatley Review of Libor. This Review by Martin Wheatley, managing director of British Financial Services Authority, was commissioned in June 2012 in view of investigations, charges and settlements that were raising public awareness of LIBOR deficiencies.

One of the motivations for creating the Wheatley Review involved the prosecution of a former UBS and later Citigroup Inc. trader, on criminal fraud charges for manipulating the LIBOR rates. The trader, known to insiders as the “Rain Man” for his abilities and demeanor, allegedly sought his superiors approval before attempting to influence the LIBOR rates, an act that some observers thought at the time would provide a strong defense against conviction.

Insiders who knew of LIBOR manipulations were generally reluctant to take a public stand for earlier change. However, on July 27, 2012, a former trader for Morgan Stanley in London, published an article that told of his earlier attempts to bring LIBOR rate manipulations to the attention of authorities, but without success. In his article, he indicated how he learned as a new trader in 1991 that the banks manipulated their rate submissions to make profit on specific contracts, and to mask liquidity problems such as during the subprime lending crisis of 2008. For example, if the LIBOR rate submissions were misstated to be low, the discounted valuation of related assets would be raised, thus providing misleadingly higher levels of short-term, near-cash assets than should have been reported.

Numerous studies since the scandal have detailed the effects of unethical LIBOR manipulation. Just two examples of such manipulation. At the time of the scandal many home owners borrowed their mortgage loans on a variable- or adjustable-rate basis, rather than a fixed-rate basis. Consequently, many of these borrowers received a new rate at the first of every month based on the LIBOR rate. A study prepared for a class action lawsuit has shown that on the first of each month for the period 2007-2009, the LIBOR rate rose more than 7.5 basis points on average. As a consequence, one observer estimated that each LIBOR submitting bank may be liable for as much as $2.3 billion.

Municipalities raise funds through the issue of bonds, and many were encouraged to issue variable-rate, rather than fixed-rate, bonds to take advantage of lower interest payments. For example, the saving could be as much as $1 million on a $100 million bond. After issue, the municipalities were encouraged to buy interest rate swaps from their investment banks to hedge their risk of volatility in the variable rates by converting or swapping into a fixed rate arrangement. The seller of the swap agrees to pay the municipality for any requirement to pay interest at more than the fixed rate agreed if interest rates rise, but if interest rates fall the swap seller buys the bonds at the lower variable interest rate. However, the variable rate was linked to the LIBOR rate, which was artificially depressed, thus costing U.S. municipalities as much as $10 billion. Class action suits were eventually launched to recover these losses, which cost municipalities, hospitals, and other non-profits as much as $600 million a year.

At the end of the day, trust in each other and in our counter-parties is all we really have as economic actors; CFEs and forensic accountants thus have a vital role to play in investigating, documenting and assisting in the identification and possible prosecution of those, like the LIBOR manipulators, who knowingly collude in making the choice to violate that trust.

#We Too

The #Me Too phenomenon is just one of the latest instances of a type of fraud featuring a betrayal of trust by a fellow community member which is as old as humanity itself. The ACFE calls it affinity fraud, and it is one of the most common instances of fraud with which any CFE or forensic account is ever called upon to deal. The poster boy for affinity frauds in our time is, of course, Bernard L. Madoff, whose affinity fraud and Ponzi scheme ended with his arrest in 2008. The Madoff scandal is considered an affinity fraud because the vast majority of his clientele shared Madoff’s religion, Judaism. Over the years, Madoff’s clientele grew to include prominent persons in the entertainment industry, including Steven Spielberg and Larry King. This particular affinity fraud was unprecedented because it was perpetrated by Madoff over several decades, and his investment customers were defrauded of approximately twenty billion dollars.

But not all targets of affinity fraud are wealthy investors; such scams touch all genders, religions, age groups, races, statuses, and educational levels. One of the saddest are affinity frauds targeting children and the elderly.

Con artists prey on vulnerable underage targets by luring them to especially designed websites and phone Aps and then collecting their personal information. TRUSTe, an Internet privacy seal program, is a safe harbor program under the terms of the Children’s Online Privacy Protection Act (COPPA) administered by the U.S. Federal Trade Commission. This was the third safe harbor application approved by the Commission. Safe harbor Aps and programs are submitted by the Children’s Advertising Review Unit (CARL) of the Council of Better Business Bureaus, an arm of the advertising industry’s self-regulatory program, and the Entertainment Software Rating Board (ESRB), which were both previously approved as COPPA safe harbors. Sadly, in spite of all this effort, data collection abuses by websites and Aps targeting children continue to increase apace to this day.

Then there’s the elderly. It’s an unfortunate fact that elderly individuals are the most frequent targets of con artists implementing all types of affinity frauds. Con artists target the elderly, since they may be lonely, are usually willing to listen, and are thought to be more trusting that younger individuals. Many of these schemes are performed over the telephone, door-to-door, or through advertisements. The elderly are especially vulnerable targets for schemes related to credit cards, sweepstakes or contests, charities, health products, magazines, home improvements, equity skimming, investments, banking or wire transfers, and insurance.

Fraudsters will use different tactics to get the elderly to cooperate in their schemes. They can be friendly, sympathetic, and willing to help in some cases, and use fear tactics in others. The precise tactics used are generally tailored to the type of individual situation the con artist finds herself in in relation to the mark.

Ethically challenged fraud practitioners frequently focus on home ownership related schemes to take advantage of the vulnerable elderly. The scammer will recommend a “friend” that can perform necessary home repairs at a reasonable price. This friend may require the mark to sign a document upon completion confirming that the repairs have been completed. In some cases, the elderly victim later learns that s/he signed the title of his house over to the repairman. In other cases, not only is the person overcharged for the work, but the work is not performed properly or at all.

Another frequent scheme targeting the elderly involves sweepstakes or prizes. The fraudster continues to influence the elderly victim over a period of time with the hope that the victim will eventually win the “grand prize” if they will just send in another fee or buy a few more magazines.

Fraudsters also frequently solicit the elderly with “great” investment opportunities in precious metals, artwork, securities, prime bank guarantees, futures, exotics, micro-cap stocks, penny stocks, promissory notes, pyramid and Ponzi schemes, insurance, and real estate. Other common scams involve equity skimming programs, debt consolidation offers, or other debt relief services which only result in the loss of the home used as collateral if the victimized debtor misses a payment.

The societal effects of affinity fraud are not limited solely to the amount of funds lost by investors, churches, the elderly or by other types of victims. Once these frauds are uncovered, investor confidence can diminish the financial and other legitimate markets, and a general level of distrust can decrease the government’s ability to provide protection. Loss of confidence manifested itself after the Madoff fiasco with such negative effects evident throughout the economy. Unfortunately, affinity fraud erodes the trust needed for legitimate investments to occur and grow our economy. Essentially, affinity fraud victims of all types become less likely to trust any future monetary request and honest charitable organizations suffer from a loss of endowments. Subsequent to a large affinity fraud being discovered, time is spent by regulators and law enforcement not only prosecuting these cases but also in the expenditure of endless taxpayer dollars assessing what went wrong. Time consuming, expensive investigations generally also include implementation of regulatory changes in an attempt to assist in detection of these frauds in the future, another costly burden on taxpayers.

Once affinity fraud offenders have targeted a community or group, they seek out respected community leaders to vouch for them to potential victims. By having an esteemed figurehead who appears to be knowledgeable about the investment or other opportunity and endorses it, the offender creates legitimacy for the con. Additionally, others in the community are less likely to ask questions about a venture or investment if a community leader recommends or endorses the fraudster. In the Madoff case, Madoff himself was a highly esteemed member of the community he victimized.

Experts tells us that projection bias is one reason why affinity fraudsters are able to continually perpetrate these types of crimes. Psychological projection is a concept introduced by Freud to explain the unconscious transference of a person’s own characteristics onto another person. The victims in affinity fraud cases project their own morals onto the fraudsters, presuming that the criminals are honest and trustworthy. However, the similarities are almost certainly the reason why the fraudster targeted the victims in the first place. In some cases when victims are interviewed after the fact, they indicate to law enforcement that they trusted the fraudster as if they were a family member because they believed that they both shared the same value system.

Because victims in affinity frauds are less likely to question or go outside of their group for assistance, information or tips regarding the fraud may not ever reach regulators or law enforcement. In religion related cases, there is often an unwritten rule that what happens in church stays there, with disputes handled by the church elders or the minister. Once the victims place their trust in the fraudster, they are less likely to even believe they have been defrauded and also unlikely to investigate the con.

The ACFE tells us that in order to stop affinity frauds from occurring in the first place, one of the best fraud prevention tools is the implementation of increased educational efforts. Education is especially important in geographical areas where tight-knit cultural communities reside who are particularly vulnerable to these frauds. By reaching out to the same cultural or religious leaders that fraudsters often target in their schemes, law enforcement could launch collaborative relationships with these groups in their educational efforts.

In summary, frauds like Madoff’s occur daily on a much smaller scale in communities across the United States. The effects of these affinity frauds are widespread, and the emotional consequences experienced by the victims of these scams cannot be overstated. CFEs, assurance professionals, regulators and law enforcement and investigative personnel need to assess the harm caused by affinity fraud and continue to determine what steps need to be taken to effectively confront these types of scams. State and Federal laws should be reviewed and amended where necessary to ensure appropriate enhanced sentencing is enforced for all egregious crimes involving affinity fraud. Regulators and law enforcement should approach fraud cases from different angles in an attempt to determine if new methods may be more effective in their prosecution.

Additionally, anti-fraud education as provided by the ACFE is needed for both the general and investing publics and for regulators and law enforcement personnel to ensure that they all have the proper knowledge and tools to be able to understand, detect, stop, and prevent these types of scenarios. Affinity frauds are not easily anticipated by the victims because people are not naturally inclined to think that one of their own is going to cheat them. Affinity frauds can, therefore, only be most effectively curtailed by the very communities who are their victims.

Loose Ends

A forensic accountant colleague of mine often refers to “loose-ends”. In his telling, loose-ends are elements of an investigation that get over-looked or insufficiently investigated which have the power to come back and bite an examiner with ill effect. That a small anomaly may be a sign of fraud is a fact that is no surprise to any seasoned investigator. Since fraud is typically hidden, the discovery of fraud usually is unlikely, at least at the beginning, to involve a huge revelation.

The typical audit does not presume that those the auditor examiners and the documents s/he reviews have something sinister about them. The overwhelming majority of audits are conducted in companies in which material fraud does not exist. However, the auditor maintains constant awareness that material fraud could be present.

Imagine a policewoman walking down a dark alley into which she knows a suspect has entered just before her. She doesn’t know where the suspect is, but as she walks down that alley, she is acutely aware of and attuned to her surroundings. Her senses are at their highest level. She knows beyond the shadow of a doubt that danger lurks nearby.

Fraud audits (and audits in general) aren’t like that. Fraud audits are more like walking through a busy mall and watching normal people go about their daily activities. In the back of the examiner’s mind, he knows that among all the shoppers are a few, a very few, shoplifters. They look just like everyone else. The examiner knows they are there because statistical studies and past experience have shown that they are, but he doesn’t know exactly where or who they are or when he will encounter them, if at all. If he were engaged to find them, he would have to design procedures to increase the likelihood of discovery without in any way annoying the substantial majority of honest shoppers in whose midst they swim.

A fraud risk assessment evaluates areas of potential fraud to determine whether the current control structure and environment are addressing fraud risk at a level that aligns with the organization’s risk appetite and risk tolerance. Therefore, it is important during the development and implementation of the risk management program to specifically address various fraud schemes to establish the correct levels of control.

It occurred to me a while back that a fraud risk assessment can of thought of as ignoring a loose-end if it fails to include sufficient consideration of the client organization’s ethical dimension. That the ethical dimension is not typically included as a matter of course in the routine fraud risk assessment constitutes, to my mind, a lost opportunity to conduct a fuller, and potentially, a more useful assessment. As part of their assessments, today’s practitioners can potentially use surveys, Control Self-Assessment sessions, focus groups, and workshops with employees to take the organization’s ethical temperature and determine its ethical baseline. Under this expanded model, the most successful fraud risk assessment would include small brainstorming sessions with the operational management of the business process(s) under review. Facilitated by a Certified Fraud Examiner (CFE), these assessments would look at typical fraud schemes encountered in various areas of the organization and identify the internal controls designed to mitigate each of them. At a high level, this analysis examines internal controls and the internal control environment, as well as resources available to prevent, detect, and deter fraud.

Fraud risk assessments emphasize possible collusion and management overrides to circumvent internal controls. Although an internal control might be in place to prevent fraudulent activity, the analysis must consider how this control could be circumvented, manipulated, or avoided. This evaluation can help the CFE understand the actual robustness and resilience of the control and of the control environment and estimate the potential risk to the organization.

One challenge at this point in the process is ensuring that the analysis assesses not just roles, but also those specific individuals who are responsible for the controls. Sometimes employees will feel uncomfortable contemplating a fellow employee or manager perpetrating fraud. This is where an outside fraud expert like the CFE can help facilitate the discussion and ensure that nothing is left off the table. To ask and get the answers to the right questions, the CFE facilitator should help the respondents keep in mind that:

o Fraud entails intentional misconduct designed to avoid detection.
o Risk assessments identify where fraud might occur and who the potential perpetrator(s) might be.
o Persons inside and outside of the organization could perpetrate such schemes.
o Fraud perpetrators typically exploit weaknesses in the system of controls or may override or circumvent controls.
o Fraud perpetrators typically find ways to hide the fraud from detection.

It’s important to evaluate whether the organization’s culture promotes ethical or unethical decision-making. Unfortunately, many organizations have established policies and procedures to comply with various regulations and guidelines without committing to promoting a culture of ethical behavior. Simply having a code of conduct or an ethics policy is not enough. What matters is how employees act when confronted with an ethical choice; this is referred to by the ACFE as measuring the organization’s ethical baseline.

Organizations can determine their ethical baseline by periodically conducting either CFE moderated Control Self-Assessment sessions including employees from high-risk business processes, through an online survey of employees from various areas and levels within the organization, or through workshop-based surveys using a balloting tool that can keep responses anonymous. The broader the survey population, the more insightful the results will be. For optimal results, surveys should be short and direct, with no more than 15 to 20 questions that should only take a few minutes for most employees to answer. An important aspect of conducting this survey is ensuring the anonymity of participants, so that their answers are not influenced by peer pressure or fear of retaliation. The survey can ask respondents to rate questions or statements on a scale, ranging from 1—Strongly Disagree to 5—Strongly Agree. Sample statements might include:

1. Our organizational culture is trust-based.
2. Missing approvals are not a big deal here.
3. Strong personalities dominate most departments.
4. Pressure to perform outweighs ethical behavior.
5. I share my passwords with my co-workers.
6. Retaliation will not be accepted here.
7. The saying “Don’t rock the boat!” fits this organization.
8. I am encouraged to speak up whenever needed.
9. Ethical behavior is a top priority of management.
10.I know where I can go if I need to report a potential issue of misconduct.

The ethical baseline should not be totally measured on a point system, nor should the organization be graded based on the survey results. The results should simply be an indicator of the organization’s ethical environment and a tool to identify potential areas of concern. If repeated over time, the baseline can help identify both positive and negative trends. The results of the ethical baseline survey should be discussed by the CFE with management as part of a broader fraud risk assessment project. This is especially important if there are areas with a lack of consensus among the survey respondents. For example, if the answer to a question is split down the middle between strongly agree and strongly disagree, this should be discussed to identify the root cause of the variance. Most questions should be worded to either show strong ethical behaviors or to raise red flags of potential unethical issues or inability to report such issues promptly to the correct level in the organization.

In summary, the additional value created by combining of the results of the traditional fraud risk assessment with an ethical baseline assessment can help CFEs better determine areas of risk and control that should be considered in building the fraud prevention and response plans. For example, fraud risk schemes that are heavily dependent on controls that can be easily overridden by management may require more frequent assurance from prevention professionals than those schemes that are mitigated by system-based controls. And an organization with a weak ethical baseline may require more frequent assessment of detective control procedures than one with a strong ethical baseline, which might rely on broader entity-level controls. By adding ethical climate evaluation to their standard fraud risk assessment procedures, CFEs can tie up what otherwise might be a major loose-end in their risk evaluation.

Using Control to Foster a Culture of Honesty

One of the most frequent questions we seem to receive as practicing CFEs from clients and corporate counsel alike regards the proactive steps management can take to create what’s commonly designated a ‘culture of honesty’. What kinds of programs and controls can an entity implement to create such a culture and to prevent fraud?

The potential of being caught most often persuades likely perpetrators not to commit a contemplated fraud. As the ACFE has long told us, because of this principle, the existence of a thorough control system is essential to any effective program of fraud prevention and constitutes one of the most vital underpinnings of an honest culture.

Corporations and other organizations can be held liable for criminal acts committed as a matter of organizational policy. Fortunately, most organizations do not expressly set out to break the law. However, corporations and other organizations may also be held liable for the criminal acts of their employees if those acts are perpetrated in the course and scope of their employment and for the ostensible purpose of benefiting the corporation. An employee’s acts are considered to be in the course and scope of employment if the employee has actual authority or apparent authority to engage in those acts. Apparent authority means that a third party would reasonably believe the employee is authorized to perform the act on behalf of the company. Therefore, an organization could be held liable for something an employee does on behalf of the organization even if the employee is not authorized to perform that act.

An organization will not be vicariously liable for the acts of an employee unless the employee acted for the ostensible purpose of benefiting the corporation. This does not mean the corporation has to receive an actual benefit from the illegal acts of its employee. All that is required is that the employee intended to benefit the corporation. A company cannot seek to avoid vicarious liability for the acts of its employees by simply claiming that it did not know what was going on. Legally speaking, an organization is deemed to have knowledge of all facts known by its officers and employees. That is, if a prosecutor can prove that an officer or employee knew of conduct that raised a question as to the company’s liability, and the prosecutor can show that the company willfully failed to act to correct the situation, then the company may be held liable, even if senior management had no knowledge or suspicion of the wrongdoing.

In addition, the evolving legal principle of ‘conscious avoidance’ allows the government to prove the employer had knowledge of a particular fact which establishes liability by showing that the employer knew there was a high probability the fact existed and consciously avoided confirming the fact. Employers cannot simply turn a blind eye when there is reason to believe that there may be criminal conduct within the organization. If steps are not taken to deter the activity, the company itself may be found liable. The corporation can be held criminally responsible even if those in management had no knowledge of participation in the underlying criminal events and even if there were specific policies or instructions prohibiting the activity undertaken by the employee(s). The acts of any employee, from the lowest clerk on up to the CEO, can impute liability upon a corporation. In fact, a corporation can be criminally responsible for the collective knowledge of several of its employees even if no single employee intended to commit an offense. Thus, the combination of vicarious or imputed corporate criminal liability and the current U.S. Sentencing Guidelines for Organizations can create a risk for corporations today.

Although many of our client companies do not realize it, the current legal environment imposes a responsibility on companies to ferret out employee misconduct and to deal with any known or suspected instances of misconduct by taking timely and decisive measures.

First, the doctrine of accountability suggests that officers and directors aware of potentially illegal conduct by senior employees may be liable for any recurrence of similar misconduct and may have an obligation to halt and cure any continuing effects of the initial misconduct.

Second, the Corporate Sentencing Guidelines, provide stiff penalties for corporations that fail to take voluntary action to redress apparent misconduct by senior employees.

Third, the Private Litigation Securities Reform Act requires, as a matter of statute, that independent auditors look for, and assess, management’s response to indications of fraud or other potential illegality. Where the corporation does not have a history of responding to indications of wrongdoing, the auditors may not be able to reach a conclusion that the company took appropriate and prompt action in response to indications of fraud.

Fourth, courts have held that a director’s duty of care includes a duty to attempt in good faith to assure corporate information and reporting systems exist. These systems must be reasonably designed to provide senior management and the board of directors timely, accurate information which would permit them to reach informed judgments concerning the corporation’s compliance with law and its business performance. In addition, courts have also stated that the failure to create an adequate compliance system, under some circumstances, could render a director liable for losses caused by non-compliance with applicable legal standards. Therefore, directors should make sure that their companies have a corporate compliance plan in place to detect misconduct and deal with it effectively. The directors should then monitor the company’s adherence to the compliance program. Doing so will help the corporation avoid fines under the Sentencing Guidelines and help prevent individual liability on the part of the directors and officers.

The control environment sets the moral tone of an organization, influencing the control consciousness of the organization and providing a foundation for all other control components. This component considers whether managers and employees within the organization exhibit integrity in their activities. COSO envisions that upper management will be responsible for the control environment of organizations. Employees look to management for guidance in most business affairs, and organizational ethics are no different. It is important for upper management to operate in an ethical manner, and it is equally important for employees to view management in a positive light. Managers must set an appropriate moral tone for the operations of an organization.

In addition to merely setting a good example, however, COSO suggests that upper management take direct control of an organization’s efforts at internal controls. This idea should be regularly reinforced within the organization. There are several actions that management can take to establish the proper control environment for an organization and foster a culture of honesty. These include:

–The establishment of a code of ethics for the organization. The code should be disseminated to all employees and every new employee should be required to read and sign it. The code should also be disseminated to contractors who do work on behalf of the organization. Under certain circumstances, companies may face liability due to the actions of independent contractors. It is therefore very important to explain the organization’s standards to any outside party with whom the organization conducts business.

–Careful screening of job applicants. One of the easiest ways to establish a strong moral tone for an organization is to hire morally sound employees. Too often, the hiring process is conducted in a slipshod manner. Organizations should conduct thorough background checks on all new employees, especially managers. In addition, it is important to conduct thorough interviews with applicants to ensure that they have adequate skills to perform the duties that will be required of them.

–Proper assignment of authority and responsibility. In addition to hiring qualified, ethical employees, it is important to put these people in situations where they are able to thrive without resorting to unethical conduct. Organizations should provide employees with well-defined job descriptions and performance goals. Performance goals should be routinely reviewed to ensure that they do not set unrealistic standards. Training should be provided on a consistent basis to ensure that employees maintain the skills to perform effectively. Regular training on ethics will also help employees identify potential trouble spots and avoid getting caught in compromising situations. Finally, management should quickly determine where deficiencies in an employee’s conduct exist and work with the employee to fix the problem.

–Effective disciplinary measures. No control environment will be effective unless there is consistent discipline for ethical violations. Consistent discipline requires a well-defined set of sanctions for violations, and strict adherence to the prescribed disciplinary measures. If one employee is punished for an act and another employee is not punished for a similar act, the moral force of the company’s ethics policy will be diminished. The levels of discipline must be sufficient to deter violations. It may also be advisable to reward ethical conduct. This will reinforce the importance of organizational ethics in the eyes of employees.

Monitoring is the process that assesses the quality of a control environment over time. This component should include regular evaluations of the entire control system. It also requires the ongoing monitoring of day-to-day activities by managers and employees. This may involve reviewing the accuracy of financial information, or verifying inventories, supplies, equipment and other organization assets. Finally, organizations should conduct independent evaluations of their internal control systems. An effective monitoring system should provide for the free flow of upstream communication.

The Complex Non-Profit

Our Chapter was contacted several weeks ago by the management of a not-for-profit organization seeking a referral to a CFE for conduct of an examination of suspected fraud.  Following a lively discussion with the requester’s corporate counsel, we made the referral which, we’ve subsequently learned, is working out well.  Our discussion of the case with counsel brought the following thoughts to mind. When talking not-for-profits, we’re talking programs; projects that are not funded through the sale of a product or service, but projects that obtain outside funding via the government, charitable grants, or donations to achieve a specific outcome. These outcomes can be any of a variety of things, from a scientific research study to find a cure for a catastrophic illness or federally legislated programs to provide health care to the indigent and elderly, as with the Medicaid and Medicare programs, respectively; or a not-for-profit charity that provides several programs, each funded from different sources, but all providing services to the elderly such as delivered meals, community center operations, adult daycare, and wellness programs. Typically, these outcomes are a social benefit. Some of these programs are of a specific duration, while others are renewed on a periodic basis depending on continued funding and the successful management of the program to achieve the desired outcomes.

In an examination for fraud in such entities, it’s typically not the core projects or programs themselves that are the object of the review; it’s the management of the program. Managers are engaged to operate such programs consistent with the program’s scope and budget. The opportunity for fraud in these programs will vary in several specific aspects: by the independence provided to the program manager, by the organizational structure of the program, and by the level of oversight by the funding source. These three elements make the conduct of a fraud examination of program management different from that of investigations for fraud in the typical core business functions of enterprises like those involved in manufacturing or retail trade. The fraud schemes will be similar because of the ACFE defined primary fraud classifications that apply to almost all organizations, but the key is how they’ve been adapted by program management.

The three primary classifications of fraud that are most common in program management fraud are schemes related to asset misappropriation, corruption, and financial statement reporting.

With asset misappropriation, the fraudulent action most commonly involved is embezzlement, not just simple theft of funds.  While they are both criminal actions, embezzlement has a specific meaning. Black’s Law Dictionary states it best: “the fraudulent taking of private property with which one has been entrusted, especially as a fiduciary.” It really is a matter of intent.
Examples of some inherent fraud schemes and of how these schemes are carried out within a program are:

False expenditures:

— The program is not being conducted, but funds are being expended. This sounds like the classic shell company scam, except a program rather than a for profit business is being exploited. The program by itself is legitimate, but it’s the intent of management that makes it a fraud;

–The program is not performed to its completion; however, the funds are fully expended. The decision to be made is whether the intent was to embezzle funds throughout the program or if there are other underlying reasons as to why the program wasn’t completed that resulted in the embezzlement of the funds;

–The program budget does not allow for program completion. Is this a case of bad budgeting or the use of budgeting with the intent to embezzle;

–The work plan is partially or wholly fictitious. It’s important for the examiner to keep in mind that some programs involve work that is so technologically or scientifically complex that it can be difficult for the examiner to understand just what the objective is.

Overbilling:

Unlike false expenditures, the use of overbilling within programs is more of a means to commit the fraudulent act of embezzlement within the program’s specific functions rather than within the overall program as with false expenditures. Specifically, overbilling schemes are found associated with misuse of time or assets by staff or with expenditures not used in an approved manner. For example:

–Staff members are performing non-program duties. Often, personnel are pulled from one program to work on another. There are many reasons for why this decision is made, but was the funding for that amount of personnel intentionally requested with the purpose of using personnel on another program that is not entitled to receive the funding for additional staff members?

–Staff members are misrepresenting the performance of the program. Often, staff will show the project to be operating on a level that seemingly should require more resources. The project is really operating on a lower level of resources, and whoever has the authority to bill uses that authority to overbill.

–Staff members are hired who are not qualified to perform program duties. Many times, often with large grant monies involved, the program manager hires friends or relatives, or perhaps there is such a strict time frame involved with the funding that management will hire a warm body just to fill the approved slot. In both cases, proper vetting procedures should be in place, even though the granting authority may not require them.

–As with staffing, funds are often redirected to other programs for similar reasons.

–Funds expended are not consistent with the proposed budget. The CFE should ask why the budget is out of line with expenditures? Is the approved budget in use, or was it just prepared as window-dressing for a grant proposal?

–Funds are expended that are not consistent with the governing cost principles. The classic example is the outrageous amounts the military spends on commonly used items, like the $5,000 toilet seat the ACFE originally told us about.

–The program is not completed, but the funding has been expended. Embezzlement can occur within the framework of asset misappropriation or overbilling, but because programs can differ in their objectives to a large degree, the vulnerability is greater to asset misappropriation schemes than to schemes involving overbilling.

Program Reporting:

Financial reporting and program reporting are two different things. Financial reporting can be a component of program reporting, but not the other way around. Many funded projects have strict guidelines on how to report project performance.  Like a disease that goes undetected because everything checked out in a physical exam, ethically challenged program managers find subtle ways to misrepresent performance, either to hide misuse of funds or just to indicate program success when there is none.
For example:

–The status of the project is falsely reported. This type of program reporting misstatement is typically done to give the illusion that the project’s objectives will be met to continue the objective of an uninterrupted steam of funding.

–The program results are falsely reported. The difference between project status and program results may not be apparent at first glance. The motivation is the same in that both are done to hide fraud. The false reporting of program status is typically done to keep funds ongoing throughout the project; the falsification of program results is typically done to ensure renewal of funding for another year or for a period of years. The project type will typically determine the likelihood of which type of false reporting is occurring.

–Improper criteria are used to measure performance. This concerns overall performance as opposed to financial performance. Given that funded projects can be difficult to understand considering the complexity of the activity being performed, performance measurement criteria can be manipulated because of the inherently complicated nature of the basic project. No one understands the project, so how can anyone know whether it’s succeeding? This phenomenon is commonly encountered if the project is divided into so many subparts that no one person, except the project manager, knows with certainty just how it’s proceeding.

–Program accomplishments are falsely reported. How many times have newspapers parroted the declaration from a non-profit that their program provided such and such a level of service to the indigent?  How do readers know if the program’s actual goal (and related funding) wasn’t to provide services to a level of recipients three times the amount reported?

–Operating statistics are manipulated to provide false results. Operating statistics are not financial statistics. An example would be a program that provides meals to the homebound elderly. An amount of payment by those receiving the meals is suggested. However, the government reimbursement for those meals deducts any amount contributed by the elderly being served. The project manager may manipulate the statistics to give more weight to the fixed-income, city-dwelling elderly it services, because such recipients are usually unable to pay anything for their delivered meals.

In summary, in approaching the fraud examination of non-profit entities, it’s not the overall programs themselves that are typically fraudulent, meaning that examinations don’t have to start with a determination of whether the entity is real or a shell. Fraud is committed by people, not programs or business systems; they are the tools of fraud. The ultimate funding source of programs are people as well, whether taxpayers (in the case of Federal or State governments) or private citizens (in the case of private charities).   It is not only the vast amount of funding that can flow to not-for-profit programs that constitutes the justification for combating fraud committed by the management of such programs. Programs that rely on funding as non-profits are typically entities that are established to provide a public benefit; to fill in the gaps for services and products not provided through any other means. So, the occurrence of fraud in these programs, no matter the size of the program or the fraud, is an especially heinous act given the loss of social benefit that results. For that reason alone, the examination of program management by CFEs is vital to the public interest.

The Sword of Damocles

The media provide us with daily examples of the fact that technology is a double-edged sword. The technological advancements that make it easy for people with legitimate purposes to engage with our client businesses and governmental agencies also provide a mechanism for those bent on perpetrating theft and frauds of all kinds.

The access to services and information that customers have historically demanded has opened the flood gates through which disgruntled or unethical employees and criminals enter to commit fraud. Criminals are also exploiting the inadequacies of older fraud management policies or, in some instances, the overall lack thereof. Our parent organization, the Association of Certified Fraud Examiners (ACFE) has estimated that about 70 percent of all companies around the world experienced some type of fraud in 2016, with total global losses due to fraud exceeding US $4 trillion annually and expected to rise continually.  Organizations have incurred, on average, the loss of an estimated 7 percent of their annual revenues to fraud, with $994 billion of that total in the US alone. The ACFE has also noted that the frauds reported lasted a median length of 18 months before being detected. In addition to the direct impact of revenue loss, fraud erodes customer satisfaction and drains investments that could have been directed to corporate innovation and growth. Organizations entrusted with personally identifiable information are also held directly accountable in the eyes of the public for any breach. Surveys have shown that about one-third of fraud victims avoid merchants they blame for their victimization.

We assurance professionals know that criminals become continuously more sophisticated and the fraud they perpetrate increasingly complex. In response, the requirements for fraud risk management have significantly changed over the last few years. Fraud risk management is now not a by-product, but a purposeful choice intended to mitigate or eliminate an organizations’ exposure to the ethically challenged. Fraud risk management is no longer a “once and done” activity, but has become an on-going, ideally concurrent, program. As with all effective processes, it must be performed according to some design. To counter fraud, an organization must first understand its unique situation and the risk to which it may be exposed. This cannot be accomplished in a vacuum or through divination, but through structured analysis of an organization’s current state. Organizations are compelled by their increasingly cyber supported environments to establish an appropriate enterprise fraud risk management framework aligned with the organization’s strategic objectives and supported by a well-planned road map leading the organization to its properly defined target state of protection. Performing adequate analysis of the current state and projecting the organization goals considering that desired state is essential.  Analysis is the bedrock for implementation of any enterprise fraud risk management framework to effectively manage fraud risk.

Fraud risk management is thus both a top-down and a bottom-up process. It’s critical for an organization to establish and implement the right policies, processes, technology and supporting components within the organization and to diligently enforce these policies and processes collaboratively and consistently to fight fraud effectively across the organization. To counter fraud at an enterprise level, organizations should develop an integrated counter fraud program that enables information sharing and collaboration; the goal is to prevent first, detect early, respond effectively, monitor continuously and learn constantly. Counter fraud experience in both the public and for-profit sectors has resulted in the identification of a few critical factors for the successful implementation of enterprise-wide fraud risk management in the present era of advanced technology and big data.

The first is fraud risk management by design. Organizations like the ACFE have increasingly acknowledged the continuously emerging pattern of innovative frauds and the urgency on the part of all organizations to manage fraud risk on a daily, concurrent basis.  As a result, organizations have attempted implementation of the necessary management processes and solutions. However, it is not uncommon that our client organizations find themselves lacking in the critical support components of such a program.  Accordingly, their fraud risk mitigation efforts tend to be poorly coordinated and, sometimes, even reactionary. The fraud risk management capabilities and technology solutions in place are generally implemented in silos and disconnected across the organization.  To coordinate and guide the effort, the ACFE recommends implementation of the following key components:

— A rigorous risk assessment process — An organization must have an effective fraud risk assessment process to systematically identify significant fraud risk and to determine its individual exposure to such risk. The assessment may be integrated with an overall risk assessment or performed as a stand-alone exercise, but it should, at a minimum, include risk identification, risk likelihood, significance assessment and risk response; a component for fraud risk mitigation and implementation of compensating controls across the critical business processes composing the enterprise is also necessary for cost-effective fraud management.

–Effective governance and clearly defined organizational responsibilities — Organizations must commit to an effective governance process providing oversight of the fraud management process. The central fraud risk management program must be equipped with a clear charter and accountability that will provide direction and oversight for counter fraud efforts. The fraud risk must be managed enterprise-wide with transparency and communication integrated across the organization. The formally designated fraud risk program owner must be at a level from which clear management guidelines can be communicated and implemented.

–An integrated counter fraud framework and approach — An organization-wide counter fraud framework that covers the complete landscape of fraud management (from enterprise security, authentication, business process, and application policy and procedure controls, to transaction monitoring and management), should be established. What we should be looking for as CFEs in evaluating a client’s program is a comprehensive counter fraud approach to continually enhance the consistency and efficacy of fraud management processes and practices.

–A coordinated network of counter fraud capabilities — An organization needs a structured, coordinated system of interconnected capabilities (not a point solution) implemented through management planning and proper oversight and governance. The system should ideally leverage the capabilities of big data and consider a broad set of attributes (e.g., identity, relationships, behaviors, patterns, anomalies, visualization) across multiple processes and systems. It should be transparent across users and provide guidance and alerts that enable timely and smart anti-fraud related decisions across the organization.

Secondly, a risk-based approach. No contemporary organization gets to stand still on the path to fraud risk management. Criminals are not going to give organizations a time-out to plug any holes and upgrade their arsenal of analytical tools. Organizations must adopt a risk-based approach to address areas and processes of highest risk exposures immediately, while planning for future fraud prevention enhancements. Countering fraud is an ongoing and continually evolving process, and the journey to the desired target state is a balancing act across the organization.

Thirdly, continual organizational collaboration and systemic learning. Fraud detection and prevention is not merely an information-gathering exercise and technology adoption, but an entire life cycle with continuous feedback and improvement. It requires the organization’s commitment to, and implementation of continual systemic learning, data sharing, and communication. The organization also needs to periodically align the enterprise counter fraud program with its strategic plan.

Fourthly, big data and advanced analytics.  Technological breakthroughs and capabilities grounded in big data and analytics can help prevent and counter fraudulent acts that impact the bottom line and threaten brand value and customer retention. Big data technology can ingest data from any source, regardless of structure, volume or velocity. It can harness, filter and sift through terabytes of data, whether in motion or at rest, to identify and relate the elements of information that really matter to the detection of on-going as well as of potential frauds. Big data off-the-shelf solutions already provide the means to detect instances of fraud, waste, abuse, financial crimes, improper payments, and more. Big data solutions can also reduce complexity across lines of business and allow organizations to manage fraud pervasively throughout the entire life cycle of any business process.

In summary, smart organizations manage the sword of potential fraud threats with well-planned road maps supported by proper organization and governance.  They analyze their state to understand where they are, and implement an integrated framework of standard management processes to provide the guidance and methodology for effective, ethics based, concurrent anti-fraud practice. The management of fraud risk is an integral part of their overall risk culture; a support system of interconnected counter fraud capabilities integrated across systems and processes, enabled by a technology strategy and supporting formal enterprise level oversight and governance.

With a Little Help

by Rumbi Petrozzello, CPA/CFF, CFE
2018 Vice-President – Central Virginia Chapter ACFE

In November, my husband and I headed out to our usual spot, on Fourth Avenue in Brooklyn, to cheer for those running the New York marathon. A marathon, for those who don’t know, is 26.2 miles long. People who complete marathons get nothing but respect from me – success in marathoning only comes with a lot of dedication and training. Many people spend at least six months following a training plan that is not just about building distance. For instance, when learning (and it is learning) how to complete 26.2 miles of running (or walking for that matter) people must learn how to remain fueled and hydrated while running. This training also then applies to making lifestyle adjustments such as changing one’s diet and sleeping habits. Years ago, when I was training for the New York Marathon, friends knew to not call after 10PM because I was going to bed early to get enough sleep before early morning runs. I tried not to go out on Friday nights, because I went on my long runs on Saturday mornings and wanted to be energized for them. I spent a lot of time and energy doing research, talking to friends who were seasoned runners and even took running classes to improve my performance and chances of success during the race. Despite the very popular tag line “Just Do It”, a lot of work goes into even getting to that point.

The past few months, I have been doing quite a bit of work that involves assessing the controls that companies have over their systems to detect, deter and prevent fraud and error. Going in, the time energy and money that companies have put into all of this is impressive. They will have an audit committee, an internal audit function and a lot of documentation around what their systems are. There will be volumes of documentation on procedures and protocols and, at the very least, on paper, things look fantastic. However, when we start talking to employees about what their reality is, things often are very different. Some of the issues we found included:

• Staff who did not quite understand what some technical terms meant and, so ignored the parts they didn’t understand. We spoke with people who were very happy to perform and review controls, but they didn’t know how best to do that, and no one was telling them the how;

• Some staff did not understand why they were being asked to change things and, believing that what they had been doing for years constituted a good system, stuck with that;

• In some cases, it wasn’t clear just who was responsible for ownership of a process and that meant, often, that nothing ended up getting done;

• In other instances, staff were given such vague instructions that they resorted to making it up as they went along.

Having the rules is completely useless if your people don’t know what do with them and, just as importantly, why they’re doing what they’ve been asked to do in the first place. What is vital in all of this, is the proper training. As CFEs and Forensic Accountants, we are perfectly positioned to work with clients to ensure that controls and systems go beyond theory. So it’s vitally important for success to constantly work with clients to strengthen systems and controls. This can be done by recommending that our corporate clients:

• Provide training to employees. This training must include the identification of control owners and then the process of working directly with them to ensure that they understand what their roles are and specifically why they need to follow the steps being asked of them. Sometimes, when a control owner is given a requested role, they are told to “review” something. Review can mean anything and often what some people consider to be a review is insufficient for complete understanding. For instance, an employee may think that merely saying they checked something is sufficient. Or that having a verbal conversation is enough proof of review. Be sure to recommend to clients that they let employees know that there should be written evidence of a mandated review and to be equally sure to provide clear examples of what qualifies as evidence of that review.

• Review systems and controls to ensure that they address risks. A company may institute many systems and related procedures but, upon review, a CFE or forensic accountant may find inadequate segregation of duties. You may find that a supervisor is checking a team’s work, but no one is authorizing that supervisor’s. This becomes particularly risky if that supervisor has access to many aspects of the business. A CFE or forensic accountant, can review roles and duties to ensure that duties are sufficiently segregated.

• Training should be ongoing and updated for changes in the company as well as changes in technology and processes. At least once a year, employees should receive updated training and performance reviews. In this way, companies can also learn if there have been material changes that might lead to systems and processes having been adjusted in such a way as to create weakness and holes that could lead to future fraud or error.

It’s all well and good to have ads where famous people run, jump and play and tell you to “just do it”. I remember people rolling their eyes at me when I mentioned that I was dashing to running class – why do you have to learn how to run? Doesn’t everyone know how to do that? Yes, I could run, but with training, I ran a better marathon and lived to tell the tale (unlike the original guy). Yes, employees may know how to do the compliance and control work but as a CFE or forensic accountant, you can help a client company work with their employees to perform their work better, be aware of controls and be cognizant of risk and how to mitigate it. It’s so much better than just doing it.

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.