Tag Archives: conducting internal investigations

And the Cash Flows On

As a fraud examiner and information systems auditor, I’ve always been a big fan of the cash flow statement and I think you should be too. For the non-accountant investigators among you, the cash flow statement reveals what happened to the client’s cash during the reporting period. It’s very much like your bank account statement: You have a beginning balance of cash at the start of the month, you deposit your paycheck, you write some checks for your mortgage and groceries, and then you end the month with a new cash balance. This is what a cash flow statement is: simply a beginning balance of cash, plus or minus some cash transactions, to arrive at an ending cash balance.

Another way to view the cash flow statement is as an income statement that is adjusted for non-cash transactions and transactions that have not yet impacted cash. Non-cash transactions are transactions that affect the income statement but will never affect cash. Depreciation is a non-cash transaction that is added back to profits on the cash flow statement since cash is never paid out or collected when an asset is depreciated. The cash flow statement also clarifies transactions that immediately impact cash. A company can make a sale but not collect on it, or incur an expense and not immediately pay for it in cash. These are called accounts receivable and accounts payable, respectively. Revenues that are earned but not received and expenses that are incurred but not paid would show up on the income statement, but not on the cash flow statement. So the formula for the statement is simply …

Beginning Cash Balance
+I- Net Cash Flows from Operating Activities
+I- Net Cash Flows from Investing Activities
+I- Net Cash Flows from Financing Activities
= Ending Cash Balance

There are two methods of reporting cash flows from operations; in the direct method, the sources of operating cash flows are listed along with the uses of operating cash flows, with the difference between them being the net cash flow from operating activities. In contrast, the indirect method reconciles net income per the income statement with net cash flows from operating activities; that is, accrual-basis net income is adjusted for non-cash revenues and expenses to arrive at net cash flows from operations. The net cash flows from operating activities is the same amount regardless of which method is used. The indirect method is usually easier to compute and provides a comparison of the company’s operating results under the accrual and cash methods of accounting. As a result, most companies choose to use the indirect method, but either method is acceptable.

So what does all this provide as a tool for the fraud examiner? Simply, the cash flow statement provides any CFE with lots of neat information for further analysis in a very compact form. First of all, the statement tells you what the company’s cash receipts and cash payments were for the period. Remember that it’s unlike the income statement in that the income statement takes into account all revenue and expense transactions, whether or not they affected cash. The cash flow statement only considers transactions that involve cash.

The cash flow statement divides the company’s cash transactions into three categories:

• Operating activities, which include all cash received and paid out in connection with the company’s normal business operations, such as cash received from customers and funds paid to vendors. This category essentially encompasses any cash transactions that affect items on the income statement.
• Investing activities, which are cash flows related to the sale or purchase of non-current assets, such as fixed assets, intangible assets, and investments. This category generally covers those cash transactions that affect the asset side of the balance sheet.
• Financing activities, which are all cash inflows and outflows pertaining to the company’s debt and equity financing. Inflows include the proceeds received from issuing stocks and bonds and from borrowing money from a bank. Outflows include debt repayments and cash dividends paid to shareholders. In general, this category includes the cash transactions that affect the liabilities and owners’ equity side of the balance sheet.

In a perfect world, a company should only need loans when it has a timing problem between collecting and spending money or when it’s expanding. However, if a company expends more money than it will ever make, it will eventually go out of business. This is where the cash flow statement is so useful to the fraud examiner. You will want to get an idea of the cash flow necessary to run the business so that you will be able to tell whether the company is generating enough cash from operations to continue to do business. The examiner can also evaluate the relationship between total cash generated from financing and investing activities and the amount generated by operating activities.

Some things you will want to note from the cash flow statement in connection with any suspected financial fraud:
• Does the company have heavy demands on its operating cash each period?
• Do the inflows equal or exceed the outflows?
• Is the cash balance increasing or decreasing over time?
• Is the company making smart decisions about sources and uses of cash given its apparent financial condition?

This is information pertinent to the investigation of a wide range of fraud scenarios, the successful investigation of which involves different data than that commonly available in the income statement. The income statement alone does not reveal a complete picture of the company’s financial health, necessary for a full investigation of so many types of fraud. Evaluating income and cash flows includes considering the timing of items, such as collections of accounts receivable. In the end, a company might have a fabulous looking income statement, but might not have any cash available for operations. This may occur because the revenues recorded on the income statement have not been collected. Remember, as part of doing business, companies usually allow customers to make purchases on credit; this means the companies will collect the cash subsequent to the actual recording of the revenues. For example, a small high-tech manufacturer might have a healthy looking profit on its income statement, but not be able to pay its employees’ salaries. However, the entrepreneurial owners of the company expect all is well, since they think the net income on the income statement to be equal to the amount of cash in the company’s bank account. But, as is often the case, there’s a timing difference between when the company records a sale and when it actually receives the cash from its customers. As a result, the cash balance seldom, if ever, will match the income on the income statement. Other transactions – such as accrued or prepaid expenses, depreciation, and inventory purchases – will also cause a disparity between an organization’s net income and its net cash flows.

The statement of cash flows represents a trove of invaluable information that can cast light on virtually every aspect of a client’s financial health and, thus inform any investigation. Use it to your advantage.

Reaching Behind the Curtain

Not too long ago a close friend of one of our Chapter members paid a substantial sum of money to a relative, the owner of a closely held corporation, in exchange for a piece of the relative’s real estate to which, it turns out,  the relative/owner did not have clear title.  The relative apparently used a substantial portion of the funds to immediately clear debts of his corporation of which he and his wife are the sole officers and shareholders.  He now claims that, since he used the sale proceeds for corporate purposes, the refund of the purchase price he owes our Chapter member’s friend is a debt of the corporation and not of his personally.   Our Chapter’s friend has engaged an attorney at the suggestion of our certified Chapter member.

Our legal system recognizes that corporations have a separate existence from their shareholders/owners and are treated as ‘individuals’ under the law. There are two ways for a wrong-doer to use the existence of a corporation to avoid efforts to recover a money damage judgment from him or her:

–As in this case, the scammer argues that the corporation and not the shareholder/owner committed the offense, and therefore the shareholder’s personal assets and property should not be used to satisfy any judgment for the offense.

–Argues that the wrongdoer/shareholder’s property is held in the name of the corporation, and therefore s/he has no personal assets that can be used to satisfy a judgment against him  or her.

The first reflects the classic doctrine that shareholder/owners are not liable for the debts or liabilities of the corporation. Of course, if the shareholder/owner also controls the corporation and personally acted wrongfully, s/he may still be liable for her misconduct, and the corporation may simply be jointly and severally liable together with her. Whether the wrongful conduct was that of the corporation or that of an individual shareholder usually is a question of fact to be decided by the jury.

The second reflects the corporation’s ability, as a separate legal entity, to own its own property. If the corporation owns the property, then the individual shareholder does not.  Since both pre-judgement attachment writs and writs of execution can only reach a defendant’s interest in leviable assets, a wrongdoer can appear without assets and judgment proof – and your client can be unable to satisfy a money judgment against her- if the wrongdoer/shareholder has transferred title in her personal assets to the corporation. This does not apply to a non-money judgment to recover specific money or property which can reach proceeds or property in the hands of the wrongdoer or of third persons. Of course, if the wrongdoer’s transfer of assets to the corporation was to defraud creditors, the injured party can seek to have the transfers set aside.

However, even where a corporation apparently shields the defendant or his or her property, the wrongdoer and her leviable property can still be reached if the court can be convinced to disregard the corporation or to regard it merely as her alter ego. The court may do so if it can be proved that the corporation is merely a sham whose sole purpose is to help the wrongdoer fraudulently avoid liability for her conduct. This is sometimes called piercing the corporate veil.

If the corporation is found to be the alter ego of the shareholder, then either or both of the following consequences apply, depending on the goal in piercing the corporate veil:

–The wrongdoer is no longer shielded from liability for the corporation’s misconduct because the wrongdoer and the corporation are viewed by the court as one and the same.

–Corporate property can be reached to satisfy a judgment against the wrongdoer because the property is now regarded, properly, as the wrongdoer/shareholder’s property.

One of the factors to consider in attempting to pierce the corporate veil is whether the corporation is closely held; i.e. owned or directed by one or by a small or limited number of shareholders, officers, and directors (often all the members of the same family). Obviously, the larger the number of shareholders, and the more broadly the corporation’s directing positions are distributed, the less likely it is to be a sham or alter ego for one person. However, given the lawful goals and purposes of incorporation, even a small, closely held corporation may be legitimate. Conversely, the existence of other shareholders or other directors and officers may not mean that the corporation is not a sham.

The ACFE tells us that there is no hard and fast test to determine whether a corporation is a sham. Instead, courts will look at a variety of factors to determine whether to pierce the corporate veil. These factors include:

–As in this case, does the wrongdoer exercise sole or ultimate control over the activities of the corporation?

–Does the corporation’s charter describe the approved activities of the corporation with some specificity, or is it left largely to the discretion of the wrongdoer?

–Does the corporation fail to hold director’s and shareholder’s meetings, record minutes of those meetings, and otherwise observe the formalities of corporate existence?

–Is the corporation so undercapitalized as to raise questions about its viability as a separate entity?

–Are the corporation’s finances so intertwined or identifiable with those of the wrongdoer as to raise questions about its separate existence?

–Does the corporation own property which does not seem to reasonably relate to its activities, particularly as described in its charter?

–Does the wrongdoer use the corporation’s property as if they were her own, personal assets, including but not limited to whether she uses them for purposes not within the corporation’s approved activities?

These and similar or related facts can indicate that the corporation is a sham and has no true, separate existence from the wrongdoer/shareholder. In that case, the court would be justified in ruling that the corporation should be regarded as an alter ego of the wrongdoer and that the corporation and the wrongdoer be considered as one and the same ‘person’ for purposes of determining liability or levying on assets to satisfy a money judgment.

Many thanks to our member for bringing this case to our attention!

The Man in the Mirror

I readily confess I would not have won any awards for effective delegation during my early years as a fraud examiner/information systems audit professional. To my mind the buck stopped with the guy in the mirror I saw shaving every morning. I prided myself on being personally capable of performing every routine task of every assignment involved in whatever function I was managing at the time. What finally weaned me from the practice of doing it all myself was the threat of burn-out and the seemingly ever-increasing demands of a typical work week of seventy hours.

The demands of managing in an assurance environment featuring risk assessments, regulatory compliance, fraud investigations, corporate governance, and engagement quality control can be crushing for any new (or not so new) manager but especially so for those unwilling or who simply lack the skills to adequately delegate; those skills usually only come with experience.

While some new to assurance or investigative management may think delegating simply means passing off work to subordinates, the lines of delegation also can occur laterally to peers and upward to superiors. The distinction is important, because in delegating to subordinates, one of the goals is to achieve long term investigative team development. This goal comes with a shift in emphasis from managing to leading. Managing is about getting the work done, whereas leading fosters learning, growth, and a greater sense of responsibility among individual members of the your team.

According to the ACFE, the first step to successful delegation within examination work is recognizing when to let go rather than trying to do too much. For CFEs new to leadership responsibilities, a willingness to delegate can be challenging. CFEs typically advance to management positions as a result of their individual achievements and performance. This advancement fosters a sense that the person best suited to accomplish a given task is the one whose already done it satisfactorily, but that is not the way leaders should think. Even though an assurance professional has advanced to a management position based on past accomplishments, he or she needs to take a broader view of what is in the long term interest of her function group and/or organization. A conscious commitment to delegation can enable the individual manager to not only increase their personal productivity but also (and here I speak from personal experience) gain better control of their lives and, hence, prevent burnout.

An honest self-examination is a precursor to delegation. CFEs and other assurance professionals in a management position need to understand their capabilities and role(s) within the organization. One way to do this is by considering their vision for and the needs of the organization. Then, what are the assurance function’s immediate and long-term goals, including capabilities and developmental needs? Realizing that trusting others, not just one self, to do a high quality job is a personal decision and there can be many barriers to it. What is the nature of your own personal career goals and your priorities for work-life balance? A periodic, wholly candid assessment of these and similar issues can give any manager a better perspective on his or her motives in relation to delegating.

Delegating is more than just shoving work on someone who possesses the skill set to fit the task. Rather, delegating is an opportunity to cultivate members of the investigative team by increasing the number of people who are capable of taking on a bigger role, which can help strengthen the team and create a succession plan in the event of unexpected personnel turnover. How often have we all been witness to the chaos which can ensure when a key staff member leaves and no-one has been groomed to fill her place?

To the extent possible, an new staff CFE should be matched strategically with an assignment that is a bit above his or her head as a way of providing a positive learning experience. Delegating with career development in mind means managers will need to resist playing the role of lifeguard. Subordinates will struggle at times, but managers shouldn’t be too quick to act as helicopter parents and come to the rescue. Instead, managers should remain confident in the basic capabilities of their staff and allow reasonable time for learning and growth, which enables the team to gain experience and add more value to the organization.

Knowing whether a particular assignment is within an examiner’s potential capabilities and can enable him or her to grow professionally, however, is often not an easy task. As managers delegate assignments, they should consider not limiting assignments only to those areas in which an investigator has had prior experience. Also, managers need to avoid the tendency toward primarily delegating interesting or important assignments to the most favored team members; managers should groom everyone on the team not just the superstars; it’s the superstars who are, let’s face it, the most desirable targets for external recruiters. The same is true for undesirable assignments; managers also should spread those among the whole team, which can demonstrate that everyone is treated fairly. A thoughtful delegating process helps keep the assurance team challenged and motivated, thereby reducing the likelihood of losing promising but insufficiently challenged staff members.

Initial parameters need to be established to prevent misunderstandings, deficient productivity, or delays in the timely completion of examinations. All parties involved should have a clear understanding of the delegated assignment and of expectations. However, managers should refrain from giving excessively detailed instructions. Successful delegating does not mean micromanaging anyone. Instead, managers should consider focusing on discussing the objectives, scope, and outcomes of the assignment. When examiners are allowed the flexibility and freedom to perform their work, they not only learn more but also may show considerable ingenuity. Managing CFEs can foster an environment of participative management by encouraging input from subordinates toward refining the plans, expectations, and deadlines, as well as emphasize how the present investigation fits into the larger scheme. When a team member sees the whole process rather than only a part, he or she is less likely to miss a critical matter and may become more motivated to deliver a quality product.

The ACFE recommends that the CFE engagement manager should give his or her subordinates authority to operationally pursue their assignment and to make decisions as they see fit. Delegating the authority is no less important than assigning the responsibility for a task. In the absence of conferring an appropriate level of authority, the team member’s performance could be undercut. Also, examination managers should keep an open mind by welcoming new ideas, innovative suggestions, and alternative proposals from others. Nothing is more motivating for a subordinate than to realize that he or she has a significant ownership stake in the results. This is another reason why managers should delegate as much of an entire assignment, rather than a small portion, as possible. Doing so can help instill a sense of importance and self-esteem for the staff investigator no matter what the number of years of their experience.

Communication is an essential element of successful delegating, and regular updates about progress, results, and deadlines should occur weekly, or sometimes daily, depending on the staff member’s level of experience and the type of assignment. Meetings can be conducted face-to-face, by phone, or through videoconferencing and do not always have to be long to be effective.

As managers check on progress, they should be supportive rather than intrusive and avoid putting a subordinate on the defensive by being too critical. Managers also should allow for communication flexibility by encouraging more immediate contact between progress meetings in the event a matter requiring urgent attention unexpectedly develops.

Any significant delegated assignment should culminate with a constructive evaluation of the subordinate’s performance. Often, there is a tendency to view the simple act of delegation itself as work done. As an old colleague of mine used to say, “A task delegated is a task completed.” Even in a case where the smaller scope of a subordinate’s assignment does not merit an exit session, it is still a boost for team morale to give recognition and show gratitude for the work done.

I have never met an experienced (and successful) CFE investigation team leader who did not embrace the role and significance of delegating. However, the ability to delegate depends on trust, communication, and encouragement. When delegating, assurance managers need to accept the risk that mistakes can and will occur and remember that professionals can learn from their mistakes. Not only is valuable experience gained by the investigative team, but the manager’s time also is freed up for more critical tasks and projects. In the long run, a commitment to delegation serves to strengthen any team of investigators as well as benefit our client organization, whatever and wherever that might be.

Then & Now

I was chatting over lunch last week at the John Marshal Hotel here in Richmond with a former officer of our Chapter when the subject of interviewing came up; interviewing generally, but also viewed in the context of the challenges and obstacles that fraud examiners of the next generation will face as they increasingly confront their peers, the present and future fraudsters of the Millennial and Z generations.

Joseph Wells says somewhere, in one of his excellent writings, that skill as an interviewer is one of the most important attributes that a CFE or forensic accountant can possess and probably the one of all our skills most worthy of on-going cultivation. But, as with any other professional craft, there are common pitfalls of which newer professionals especially need to be aware to increase their chances of successfully achieving their interviewing objectives.

Failure to plan sufficiently is without a doubt, the primary error interviewers make. It seems that the more experience an interviewer has, the less he or she prepares. Whether because of busyness or overconfidence, this pitfall spells disaster. Not only does efficiency suffer because the interviewer might have to schedule another interview, but effectiveness suffers because the interviewer might never discover needed information. Fraudsters often take time before interviews to prepare answers to anticipated questions. The ACFE reports having briefed career criminals on their tactics, thoughts and behaviors about interviews, and they typically respond, “I had my routines that I was going to run down on them” and “I always had my story made up”.

During his or her planning for an interview, the CFE must carefully consider the interviewee’s role in the fraud and his or her relationship to the fraudster (if the interviewee isn’t the fraudster), available information, desired outcomes from the interview and primary interview strategy plus alternate, viable strategies. The success or failure of the interview is determined prior to the time the interviewer walks into the room. Either the interviewer is part of his or her own plan or she is part of someone else’s. The CFE, not the interviewee, has to control the interview.

An interviewer whose mind is made up before an interview even begins is courting danger. Confirmation bias (also known as confirmatory bias or myside bias) greatly decreases the likelihood that an interviewer dismisses, ignores or filters any contradictory information during an interview, whether the interviewee expresses it verbally or non-verbally. Thus, interviewers might not even be aware that they’re missing important information that could increase the examination’s effectiveness.

How many times have experienced practitioners been told by colleagues that they believed that particular interviewees were guilty only to later discover they were actually innocent? If such practitioners hadn’t been aware that their colleagues could have caused them to have confirmation bias, they might have dismissed contradictory interviewee behaviors during subsequent interviews as minor aberrations. It’s imperative that the interviewer maintain an open mind, which isn’t so much a skill set as an attitude. The effective interviewer gives the interviewee a chance by looking at all the data, listening to others and theorizing a hypothesis without precluding anything. Also, the ACFE tells us, if the interviewer maintains an open mind, the interviewee will perceive it and be more cooperative.

A guiding principle should be, the interview is not about the CFE; the CFE is conducting the interview. The interview is a professional encounter. If you don’t conduct the interview, someone else can conduct it, but the interviewee remains the same. Interviewers are replaceable; interviewees aren’t. Never lose sight of this foundational truth. If the interviewer personalizes the interview process s/he will focus on his or her inward emotions rather than on the interviewee’s verbal and non-verbal behavior. An interviewer’s unfettered emotions will have a debilitating impact on a number of levels.

If the interviewer becomes personally involved in an interview, the interviewer becomes the interviewee and the interviewee becomes the interviewer. Most of us want to search for connections to others. But if we connect too strongly, we will become so similar (at least in our own minds) to interviewees that we might have difficulty believing the interviewee is guilty or is providing inaccurate information. Once that occurs, the interviewer probably wont obtain necessary evidence or could discount incriminating evidence.

Before each interview, remind yourself that your objective is to collect evidence in a dispassionate manner; you won’t become emotionally involved. Focus on the overall objective of the interview so that you won’t be caught up in details that could connect you too closely with the interviewee. If, for example, you discover that the interviewee is from the same part of the country you’re from, remind yourself of the many persons you know who also are from that area so you’ll dilute the influence that this information could have on your interview.

With regard to interviewing members of the present and up-and-coming generation, a majority of our youngest future citizens spend an inordinate amount of time looking at plastic screens as a significant mode for learning, communicating, being entertained and experiencing the world instead of interacting directly with others in the same space and time. This places novice CFE interviewers at a disadvantage because they have been formally trained that much of the communication between an interviewer and an interviewee takes place non-verbally. Concurrently, the verbal aspects of communication are replete with meta-messages. For example, what kind of impression does an individual make whose voice inflection rises or falls at the end of a sentence? Can this inflection be as adequately and consistently communicated via a text message compared to in-person communication? This example (and there are many more) contains the essence of the interviewing process. Unfortunately, nuances, interpersonal communication subtleties and appropriate responses that were previously thought to be integral parts of the social modeling process aren’t as readily available to the current generation of interviewers and interviewees as they were to previous generations. Research has shown that electronic devices, such as tablets, cellphones and laptops shorten attention spans. Web surfers usually spend no more than 10 to 20 seconds on a page before ads or links distract them and they move on to burrow down into succeeding rabbit holes.

A great deal of communication now takes place via 244-character communication snippets on Twitter. The average person checks his or her phone once every six minutes. Psychologists have recently coined the term ‘nomophobia’, the fear of being out of cellphone contact; shortened from ‘no-mobile-phone-phobia. A 2015 global study reported that students’ ‘addiction’ to media is similar to drug cravings.

The attention span of the average adult is believed to have fallen from 12 minutes in 1998 to five minutes in 2014. If interviewees’ attentive capacities are just five minutes, or less, then after that point interviews provide diminishing returns. Our attention deficits probably result from a lack of self-discipline and the delusional belief that we can cognitively multi-task. We can’t do anything about our natural limitations, but we can discipline ourselves to pay attention. We can also plan and conduct our interviews with few distractions. Interviewers new and experienced should require that all participants turn off their cellphones and, when possible, interviewers should try to ask questions in an unpredictable order.

So, we can expect that a new generation of fraud examiners will soon be interviewing individuals for extended periods of time who have as much of a dearth of direct, face-to-face interpersonal communication as they do. At the extreme, we can envision two or more uncomfortable people in an interview room. All of whom can only remain in the moment for five minutes or less and are fidgety because they need plastic-screen fixes.

An additional challenge will be that CFEs of the Millennial and Z generations will soon be spending hours interviewing older interviewees who are more familiar, explicitly and implicitly, with the subtleties of interpersonal communication. These are people who have spent significantly more time in direct, face-to-face communication. The interpersonal communication-challenged interviewer will be at a significant disadvantage when interviewing guilty, guilty-knowledge, deceptive and/or antagonistic interviewees. As my lunch companion pointed out, many experienced fraudsters are master manipulators of inexperienced interviewers.

It is urgent that younger fraud examiners and forensic accountants be instructed in the strongest terms to put down their plastic screens and practice engagement with others in direct communication, with friends, family and those who cross their paths in the normal flow of life. As a lead CFE examiner or supervisor, encourage your younger employee-colleagues to write down their communication goals for each day. Suggest they read all they can on face-to face interviewing and questioning plus verbal and non-verbal behaviors. They can take interviewing and public-speaking classes or join a toastmasters group. Anything to get them to converse and observe body language and expressions.

Interviewing techniques are the vehicles that ride up and down the road of interpersonal communication. If that road isn’t adequate, then drivers can’t maneuver their vehicles. Your younger employees are the only persons who can bring themselves up to the necessary interpersonal speed limit to make their one-on-one interviews successful.

RVACFES May 2017 Event Sold-Out!

On May 17th and 18th the Central Virginia ACFE Chapter and our partners, the Virginia State Police and the Association of Certified Fraud Examiners (ACFE) were joined by an over-flow crowd of audit and assurance professionals for the ACFE’s training course ‘Conducting Internal Investigations’. The sold-out May 2017 seminar was the ninth that our Chapter has hosted over the years with the Virginia State Police utilizing a distinguished list of certified ACFE instructor-practitioners.

Our internationally acclaimed instructor for the May seminar was Gerard Zack, CFE, CPA, CIA, CCEP. Gerry has provided fraud prevention and investigation, forensic accounting, and internal and external audit services for more than 30 years. He has worked with commercial businesses, not-for-profit organizations, and government agencies throughout North America and Europe. Prior to starting his own practice in 1990, Gerry was an audit manager with a large international public accounting firm. As founder and president of Zack, P.C., he has led numerous fraud investigations and designed customized fraud risk management programs for a diverse client base. Through Zack, P.C., he also provides outsourced internal audit services, compliance and ethics programs, enterprise risk management, fraud risk assessments, and internal control consulting services.

Gerry is a Certified Fraud Examiner (CFE) and Certified Public Accountant (CPA) and has focused most of his career on audit and fraud-related services. Gerry serves on the faculty of the Association of Certified Fraud Examiners (ACFE) and is the 2009 recipient of the ACFE’s James Baker Speaker of the Year Award. He is also a Certified Internal Auditor (CIA) and a Certified Compliance and Ethics Professional (CCEP).

Gerry is the author of Financial Statement Fraud: Strategies for Detection and Investigation (published 2013 by John Wiley & Sons), Fair Value Accounting Fraud: New Global Risks and Detection Techniques (2009 by John Wiley & Sons), and Fraud and Abuse in Nonprofit Organizations: A Guide to Prevention and Detection (2003 by John Wiley & Sons). He is also the author of numerous articles on fraud and teaches seminars on fraud prevention and detection for businesses, government agencies, and nonprofit organizations. He has provided customized internal staff training on specialized auditing issues, including fraud detection in audits, for more than 50 CPA firms.

Gerry is also the founder of the Nonprofit Resource Center, through which he provides antifraud training and consulting and online financial management tools specifically geared toward the unique internal control and financial management needs of nonprofit organizations. Gerry earned his M.B.A at Loyola University in Maryland and his B.S.B.A at Shippensburg University of Pennsylvania.

To some degree, organizations of every size, in every industry, and in every city, experience internal fraud. No entity is immune. Furthermore, any member of an organization can carry out fraud, whether it is committed by the newest customer service employee or by an experienced and highly respected member of upper management. The fundamental reason for this is that fraud is a human problem, not an accounting problem. As long as organizations are employing individuals to perform business functions, the risk of fraud exists.

While some organizations aggressively adopt strong zero tolerance anti-fraud policies, others simply view fraud as a cost of doing business. Despite varying views on the prevalence of, or susceptibility to, fraud within a given organization, all must be prepared to conduct a thorough internal investigation once fraud is suspected. Our ‘Conducting Internal Investigations’ event was structured around the process of investigating any suspected fraud from inception to final disposition and beyond.

What constitutes an act that warrants an examination can vary from one organization to another and from jurisdiction to jurisdiction. It is often resolved based on a definition of fraud adopted by an employer or by a government agency. There are numerous definitions of fraud, but a popular example comes from the joint ACFE-COSO publication, Fraud Risk Management Guide:

Fraud is any intentional act or omission designed to deceive others, resulting in the victim suffering a loss and/or the perpetrator achieving a gain.

However, many law enforcement agencies have developed their own definitions, which might be more appropriate for organizations operating in their jurisdictions. Consequently, fraud examiners should determine the appropriate legal definition in the jurisdiction in which the suspected offense was committed.

Fraud examination is a methodology for resolving fraud allegations from inception to disposition. More specifically, fraud examination involves:

–Assisting in the detection and prevention of fraud;
–Initiating the internal investigation;
–Obtaining evidence and taking statements;
–Writing reports;
–Testifying to findings.

A well run internal investigation can enhance a company’s overall well-being and can help detect the source of lost funds, identify responsible parties and recover losses. It can also provide a defense to legal charges by terminated or disgruntled employees. But perhaps, most importantly, an internal investigation can signal to every company employee that the company will not tolerate fraud.

Our two-day seminar agenda included Gerry’s in depth look at the following topics:

–Assessment of the risk of fraud within an organization and responding when it is identified;
–Detection and investigation of internal frauds with the use of data analytics;
–The collection of documents and electronic evidence needed during an investigation;
–The performance of effective information gathering and admission seeking interviews;
–The wide variety of legal and regulatory concerns related to internal investigations.

Gerry did his usual tremendous job in preparing the professionals in attendance to deal with every step in an internal fraud investigation, from receiving the initial allegation to testifying as a witness. The participants learned to lead an internal investigation with accuracy and confidence by gaining knowledge about topics such as the relevant legal aspects impacting internal investigations, the use of computers and analytics during the investigation, collecting and analyzing internal and external information, and interviewing witnesses and the writing of effective reports.

Zack is Back on Internal Investigations!

Our Chapter is looking forward with anticipation to our next two-day training event (May 17th and 18th) when we will again have Gerry Zack, one of the ACFE’s best speakers, presenting on the topic ‘Conducting Internal Investigations’.  Gerry was last with us several years ago, when he taught ‘Introduction to Fraud Examination’ to an overflow crowd; judging from the number of early registrations, it looks like this year’s event will be an attendance repeat!

One of the training event segments Gerry presented in detail last time dealt with related party transactions internal to the organization and some of the unique challenges they can pose for fraud examiners.  Such ethical lapses take the form of schemes where individuals who approve one or more transactions for their organizations also benefit personally from them.  Per the ACFE, the business processes most affected by such scenarios are the loan function, the sales function and corporate purchases.

Regarding loan schemes, the key risks fraud examiners should look for are:

— The provision of loans to senior management, other employees, or board members at below-market interest rates or under terms not available in the marketplace;
— Failure to disclose the related party nature of the loan;
— The client organization providing guarantees for private loans made by employees or board members.

In these scenarios, the favorable terms benefit the employee at the expense of the employing organization.  To identify undisclosed loans to senior management, board members, and employees, the CFE could search for related-party loans using data analysis to compare the names on all notes receivables and accounts receivables with employee names from payroll records and board member names from board minutes. If a match occurs, the CFE should assess whether the related-party transaction was appropriately authorized and disclosed in the accounting records and financial statements.  Examiners can also search for undisclosed related-party loans by examining the interest rate, due dates, and collateral terms for notes receivables.  Notes receivable containing zero or unusually low interest rates, or requiring no due dates or insufficient collateral, may indicate related-party transactions.  The CFE can also examine advances made to customers or others who owe money to her client organization. Organizations generally do not advance money to others who owe them money unless a related-party relationship exists.

Gerry’s presentation for related party sales pin-pointed red flags like employees:

— Selling products or services significantly below market price or providing beneficial sales terms that ordinarily would not be granted to arms-length customers.
— Inflating sales for bonuses or stock options using related parties to perpetrate the scheme. Either a sale really has not taken place because the goods were not shipped or there was an obligation to repurchase the goods sold so the sale was incomplete.
— Approving excessive sales allowances or returns as well as accounts receivable adjustments or write-offs for related parties.

To cover up the related-party transaction, employees may deny reviewers access to customers to impede them from acquiring evidence concerning the related-party relationship.  Where the CFE suspects related party sales, s/he should perform analytical procedures to compare price variations among customers to identify those who pay significantly below the average sales price. Examiners can also attempt to identify any customer who pays prices that differ from the approved price sheet. Customer contracts can be directly analyzed for unusual rights of return, obligations to repurchase goods sold, and unusual extended repayment terms. Analytical procedures to identify customers with excessive returns, sales allowances, account receivable adjustments, or write-off’s may also be performed. Any variances in these areas might indicate undisclosed related-party transactions. Gerry also point out that data analysis can be used to efficiently compare employee addresses, telephone numbers, tax identification numbers, and birthdays with customer addresses, telephone numbers, tax identification numbers, and company organization dates. When creating a shell company, many individuals use their own contact information for convenience and their own birth date as the organization date because it is easy to remember. Any matches could indicate a related-party association and should be investigated minutely.

For third party purchases schemes, some of the key red flags are:

— the company paying prices significantly above market for goods or services;
— the company receiving significantly below average quality goods or services that are purchased at market prices for high quality goods or services;
— the company never actually receiving the purchased goods or services.

CFE’s should consider comparing cost variations among vendors to identify those whose costs significantly exceed the average cost. For identified variances, examiners should discover why the cost variations occurred to assess whether a related-party relationship exists. Like the examination steps for customers, it’s important to compare the employee’s address, telephone number, tax identification number, and birth date to vendors’ information to see if a relationship exists. CFE’s can also assess the use of sales intermediaries for products they can purchase directly from the manufacturer at lower costs.

For the comprehensive review of all this information, Gerry stressed that the level and quality of client company documentation is critical.  In reviewing their client organization’s documentation, the CFE may find that the organization does not have in place any policies or procedures prohibiting related-party relationships or transactions without prior approval. The organization also may not provide training to employees around related-party relationships and transactions, or require employees even to certify whether they are involved in any conflicts of interest with the organization. CFE’s should recommend, as a component of the fraud prevention program, that their client organization maintain written policies and procedures defining the process for obtaining approval for related-party relationships and transactions.

Key risks exist if:

— Written related-party policy and procedures are nonexistent or insufficient;
— Employees are not required to certify regularly whether they have a conflict of interest;
— Related-party transactions are not approved in accordance with established organizational policies and procedures;
— Related-party transactions are approved with exceptions to organizational policies and procedures.

The CFE should review approved related-party policies and procedures documentation. If related-party policies or procedures don’t exist or if they don’t sufficiently mitigate the risk of unauthorized or inappropriate related-party relationships or transactions, the examiner should consult with senior management and the board, if necessary, to offer guidance on a pro-active basis toward the development of such policies and procedures as a key fraud prevention measure.  The CFE should also review conflict of interest statements. If an employee documents a conflict of interest in his or her statement, the examiner should assess whether the conflict of interest was appropriately authorized and whether the process recognizes and discloses conflicts of interest.

Third party transactions are but a single topic of many to be covered by Gerry in our May event.  If you are called upon by your employer to investigate instances of fraud, waste and abuse both within your parent company and within related business affiliates, this is a seminar for you.  A well run internal investigation can enhance an enterprise’s well-being and can help detect the source of lost funds, identify responsible parties and recover losses. It can also provide a defense to legal charges by terminated or disgruntled employees. But perhaps most importantly, an internal investigation will signal to other employees that the company will not tolerate fraud. This seminar will prepare you for every step of an internal investigation into potential fraud, from receiving the initial allegation to testifying as a witness. Learn to lead an internal investigation with accuracy and confidence by gaining knowledge about key topics, such as relevant legal aspects of internal investigations, using computers in an investigation, collecting and analyzing internal information, interviewing witnesses and writing reports.

There are only 70 training slots available and our seminars fill up fast!  If you are interested in this vital investigative topic, you can find the seminar agenda, venue information, speaker bio and registration information at http://rvacfes.com/events/conducting-internal-investigations/.