theinnerauditor

As CFE’s we know organizations that have clearly articulated values and a strong culture of ethical behavior tend to control fraud more effectively. They usually have well-established frameworks, principles, rules, standards, and policies that encompass the attributes of generally accepted fraud control. These attributes include leadership, an ethical framework, responsibility structures, a fraud control policy; prevention systems, fraud awareness, third-party management systems, notification systems, detection systems, and investigation systems.

CFE’s are increasingly being called upon to assist in the planning for an assessment of a client organization’s integrity and ethics safeguards and then as active members of the team performing the engagement. The increasing demand for such assessments has grown out of the increasing awareness that a strong ethical culture is a vital part of effective fraud prevention.  Conducting such targeted research within the client organization, within its industry; and its region will help determine the emerging risk areas and potential gaps in most organizational anti-fraud safeguards. Four key elements of integrity and ethics safeguards have emerged over the past few years.  These are the fraud control plan, handling conflicts of interest, shaping ethical dealings with third parties, and natural justice principles for employees facing allegations of wrongdoing.

The need for a fraud control plan is borne out by an organization’s potential fraud losses; typically, about five percent of revenues are lost to fraud each year, according to the ACFE’s 2016 Report to the Nations on Occupational Fraud and Abuse. A fraud control plan typically will articulate an organization’s fraud risks, controls, and mitigation strategies, including:

–Significant business activities;
–Potential areas of fraud risk;
–Related fraud controls;
–Gaps in control coverage and assurance activities;
–Defined remedial actions to minimize fraud risks;
–Review mechanisms evaluating the effectiveness of fraud control strategies.

Management should review and update the fraud control plan periodically and report the results to the audit committee and senior management. Thus, the role of the board and of the audit committee of the board are vital for the implementation of any ethically based fraud control plan. The chairman of the board is, or should be, the chief advocate for the shareholders, and completely independent of management. It is the chairman’s primary job to direct the company’s executives and drive oversight of their activities in the name of the shareholders. An independent and highly skilled audit committee chairman is essential to maintain a robust system of checks and balances over all operations. To be truly effective, the chairman must be independent of those he or she is charged with watching.  The chairmen of the board and the audit committee must devote material time to their duties. While the board can use the company’s oversight functions to maintain a checks and balances process, there is no substitute for personal, direct involvement. The board must be willing to direct inquiries into allegations of misconduct, and have unquestioned confidential spending authority to conduct reviews and investigations as it deems necessary.

One of the most effective compliance tools available to the board is the day-to-day vigilance of the company’s employees. When an individual employee detects wrongdoing, he or she must have an effective and safe method to report observations, such as a third-party ethics hotline that reports to the chairman of the board and audit committee. All employees must be protected from retribution to avoid any possibility of corrupting the process.

A zero-based budgeting process, requiring that the individual elements of the company’s budget be built from the bottom up, reviewed in detail, and justified, can identify unusual spending in numerous corporate and operating units. This provides an in-depth view of spending as opposed to basing the current year’s spending, in aggregate, on last year’s spending, where irregularities may be buried and overlooked.

In organizations with an internal audit division the overall review would typically be performed by Director of Internal Audit (CAE) whom the CFE and other specialists would support. This review should be integrated into the organization’s wider business planning to ensure synergies exist with other business processes, and should link to the organization-wide risk assessment and to other anti-fraud processes.

The ACFE tells us that there is a growing consensus that managing conflicts of interest is critical to curbing corruption. Reports indicate that unmanaged conflicts of interest continue to cost organizations millions of dollars. To minimize these risks, organizations need a clear and well-understood conflict of interest policy, coupled with practical arrangements to implement and monitor policy requirements. Stated simply, a conflict of interest occurs when the independent judgment of a person is swayed, or might be swayed, from making decisions in the best interest of others who are relying on that judgment. An executive or employee is expected to make judgments in the best interest of the company. A director is legally expected to make judgments in the best interest of the company and of its shareholders, and to do so strategically so that no harm and perhaps some benefit will come to other stakeholders and to the public interest. A professional accountant is expected to make judgments that are in the public interest. Decision makers usually have a priority of duties that they are expected to fulfill, and a conflict of interests confuses and distracts the decision maker from that duty, resulting in harm to those legitimate expectations that are not fulfilled. Sometimes the term apparent conflict of interest is used, but it is a misnomer because it refers to a situation where no conflict of interest exists, although because of lack of information someone other than the decision maker would be justified in concluding (however tentatively) that the decision maker does have one

A special or conflicting interest could include any interest, loyalty, concern, emotion, or other feature of a situation tending to make the decision maker’s judgment (in that situation) less reliable than it would normally be, without rendering the decision maker incompetent. Commercial interests and family connections are the most common sources of conflict of interest, but love, prior statements, gratitude, and other subjective tugs on judgment can also constitute interest in this sense.

The perception of competing interests, impaired judgment, or undue influence also can be a conflict of interest. Good practices for managing conflicts of interest involve both prevention and detection, such as:

–Promoting ethical standards through a documented, explicit conflict of interest policy as well as well-stated values and clear conflicts provisions in the code of ethics;
–Identifying, understanding, and managing conflicts of interest through open and transparent communication to ensure that decision-making is efficient, transparent, and fair, and that everyone is aware of what to do if they suspect a conflict;
–Informing third parties of their responsibilities and the consequences of noncompliance through a statement of business ethics and formal contractual requirements;
–Ensuring transparency through well-established arrangements for declaring and registering gifts and other benefits;
–Ensuring that decisions are made independently, with evidence that staff and contractors routinely declare all actual, potential, and perceived conflicts of interests, involving at-risk areas such as procurement, management of contracts, human resources, decision-making, and governmental policy advice;
–Establishing management, internal controls, and independent oversight to detect breaches of policy and to respond appropriately to noncompliance.

Contemporary business models increasingly involve third parties, with external supplier costs now representing one of the most significant lines of expenditure for many organizations. Such interactions can provide an opportunity for fraud and corruption. An enterprise’s strong commitment to ethical values needs to be communicated to suppliers through a Statement of Business Ethics. Many forward-thinking organizations already have codes of ethics in place that set out the values and ethical expectations of both their board members and staff. The board code of conduct should define the behavioral standards for members, while the staff code of conduct should detail standards for employee conduct and the sanctions that apply for wrongdoing. Similar statements also are appropriate for third parties such as suppliers, service providers, and business partners.

A statement of business ethics outlines both acceptable and unacceptable practices in third-party dealings with an organization. Common features include:

–The CEO’s statement on the organization’s commitment to operating ethically;
–The organization’s values and business principles;
–What third parties can expect in their dealings with the organization and the behaviors expected of them;
–Guidance related to bribery, gifts, benefits, hospitality, travel, and accommodation; conflicts of interest; confidentiality and privacy of information; ethical communications; secondary employment; and other expectations.
–Contact information for concerns, clarification, reporting of wrongdoing, and disputes.

Once established, the organization needs to implement a well-rounded communication strategy for the statement of business ethics that includes education of staff members, distribution to third parties, publication on the organization’s website, references to it in the annual report, and inclusion in future tender proposals and bid packs.

Engaged and capable employees underpin the success of most organizations, yet management does not always recognize the bottom-line effects and employee turnover costs when innocent employees are the subject of allegations of fraud and other wrongdoing. About 60 percent of allegations against employees turn out to be unsubstantiated, according to the ACFE. A charter of rights compiles in a single document all the information that respondents to allegations of wrongdoing may require. Such a charter should be written in an easy-to-understand style to meet the needs of its target audience. It should:

–Outline the charter’s purpose, how it will operate, how it supports a robust complaints and allegations system, and how it aligns with the organization’s values;
–Describe how management handles workplace allegations and complaints, and ensure principles of natural justice and other legislative obligations, such as privacy, are in place;
–Provide a high-level overview diagram of the allegation assessment and investigation process, including the channels for submitting allegations; the distinct phases for logging, assessing, and investigating the allegations; and the final decision-making phase;
–Include details of available support such as contact information for human resource specialists, details about an external confidential employee help line, and processes for updates throughout the investigation;
–Illustrate the tiered escalation process for handling allegations that reflects (at one end) how issues of a serious, sensitive, or significant nature are addressed, and encourages (at the other end) the handling of low level localized issues as close to the source as possible;
–Provide answers to frequent questions that respondents might have about the process for dealing with allegations, such as “What can I expect?” “Are outcomes always reviewable?” “What does frivolous and vexatious mean?” “What will I be told about the outcome?” and “What happens when a process is concluded?”;
–Outline the options for independent reviews of adverse investigation outcomes.