Tag Archives: fraud recovery

New Rules for New Tools

I’ve been struck these last months by several articles in the trade press about CFE’s increasingly applying advanced analytical techniques in support of their work as full-time employees of private and public-sector enterprises.  This is gratifying to learn because CFE’s have been bombarded for some time now about the risks presented by cloud computing, social media, big data analytics, and mobile devices, and told they need to address those risk in their investigative practice.  Now there is mounting evidence of CFEs doing just that by using these new technologies to change the actual practice of fraud investigation and forensic accounting by using these innovative techniques to shape how they understand and monitor fraud risk, plan and manage their work, test transactions against fraud scenarios, and report the results of their assessments and investigations to management; demonstrating what we’ve all known, that CFEs, especially those dually certified as CPAs, CIAs, or CISA’s can bring a unique mix of leveraged skills to any employer’s fraud prevention or detection program.

Some examples …

Social Media — following a fraud involving several of the financial consultants who work in its branches and help customers select accounts and other investments, a large multi-state bank requested that a staff CFE determine ways of identifying disgruntled employees who might be prone to fraud. The effort was important to management not only because of fraud prevention but because when the bank lost an experienced financial consultant for any reason, it also lost the relationships that individual had established with the bank’s customers, affecting revenue adversely. The staff CFE suggested that the bank use social media analytics software to mine employees’ email and posts to its internal social media groups. That enabled the bank to identify accurately (reportedly about 33 percent) the financial consultants who were not currently satisfied with their jobs and were considering leaving. Management was able to talk individually with these employees and address their concerns, with the positive outcome of retaining many of them and rendering them less likely to express their frustration by ethically challenged behavior.  Our CFE’s awareness that many organizations use social media analytics to monitor what their customers say about them, their products, and their services (a technique often referred to as sentiment analysis or text analytics) allowed her to suggest an approach that rendered value. This text analytics effort helped the employer gain the experience to additionally develop routines to identify email and other employee and customer chatter that might be red flags for future fraud or intrusion attempts.

Analytics — A large international bank was concerned about potential money laundering, especially because regulators were not satisfied with the quality of their related internal controls. At a CFE employee’s recommendation, it invested in state-of-the-art business intelligence solutions that run “in-memory”, a new technique that enables analytics and other software to run up to 300,000 times faster, to monitor 100 percent of its transactions, looking for the presence of patterns and fraud scenarios indicating potential problems.

Mobile — In the wake of an identified fraud on which he worked, an employed CFE recommended that a global software company upgrade its enterprise fraud risk management system so senior managers could view real-time strategy and risk dashboards on their mobile devices (tablets and smartphones). The executives can monitor risks to both the corporate and to their personal objectives and strategies and take corrective actions as necessary. In addition, when a risk level rises above a defined target, the managers and the risk officer receive an alert.

Collaboration — The fraud prevention and information security team at a U.S. company wanted to increase the level of employee acceptance and compliance with its fraud prevention – information security policy. The CFE certified Security Officer decided to post a new policy draft to a collaboration area available to every employee and encouraged them to post comments and suggestions for upgrading it. Through this crowd-sourcing technique, the company received multiple comments and ideas, many of which were incorporated into the draft. When the completed policy was published, the company found that its level of acceptance increased significantly, its employees feeling that they had part ownership.

As these examples demonstrate, there is a wonderful opportunity for private and public sector employed CFE’s to join in the use of enterprise applications to enhance both their and their employer’s investigative efficiency and effectiveness.  Since their organizations are already investing heavily in a wide variety of innovative technologies to transform the way in which they deliver products to and communicate with customers, as well as how they operate, manage, and direct the business, there is no reason that CFE’s can’t use these same tools to transform each stage of their examination and fraud prevention work.

A risk-based fraud prevention approach requires staff CFEs to build and maintain the fraud prevention plan, so it addresses the risks that matter to the organization, and then update that plan as risks change. In these turbulent times, dominated by cyber, risks change frequently, and it’s essential that fraud prevention teams understand the changes and ensure their approach for addressing them is updated continuously. This requires monitoring to identify and assess both new risks and changes in previously identified risks.  Some of the recent technologies used by organizations’ financial and operational analysts, marketing and communications professionals, and others to understand both changes within and outside the business can also be used to great advantage by loss prevention staff for risk monitoring. The benefits of leveraging this same software are that the organization has existing experts in place to teach CFE’s how to use it, the IT department already is providing technical support, and the software is currently used against the very data enterprise fraud prevention professionals like staff CFEs want to analyze.  A range of enhanced analytics software such as business intelligence, analytics (including predictive and mobile analytics), visual intelligence, sentiment analysis, and text analytics enable fraud prevention to monitor and assess risk levels. In some cases, the software monitors transactions against predefined rules to identify potential concerns such as heightened fraud risks in any given business process or in a set of business processes (the inventory or financial cycles).  For example, a loss prevention team headed by a staff CFE can monitor credit memos in the first month of each quarter to detect potential revenue accounting fraud. Another use is to identify trends associated with known fraud scenarios, such as changes in profit margins or the level of employee turnover, that might indicate changes in risk levels. For example, the level of emergency changes to enterprise applications can be analyzed to identify a heightened risk of poor testing and implementation protocols associated with a higher vulnerability to cyber penetration.

Finally, innovative staff CFEs have used some interesting techniques to report fraud risk assessments and examination results to management and to boards. Some have adopted a more visually appealing representation in a one-page assessment report; others have moved to the more visual capabilities of PowerPoint from the traditional text presentation of Microsoft Word.  New visualization technology, sometimes called visual analytics when allied with analytics solutions, provides more options for fraud prevention managers seeking to enhance or replace formal reports with pictures, charts, and dashboards.  The executives and boards of their employing organizations are already managing their enterprise with dashboards and trend charts; effective loss prevention communications can make effective use of the same techniques. One CFE used charts and trend lines to illustrate how the time her employing company was taking to process small vendor contracts far exceeded acceptable levels, had contributed to fraud risk and was continuing to increase. The graphic, generated by a combination of a business intelligence analysis and a visual analytics tool to build the chart, was inserted into a standard monthly loss prevention report.

CFE headed loss prevention departments and their allied internal audit and IT departments have a rich selection of technologies that can be used by them individually or in combination to make them all more effective and efficient. It is questionable whether these three functions can remain relevant in an age of cyber, addressing and providing assurance on the risks that matter to the organization, without an ever wider use of modern technology. Technology can enable the an internal CFE to understand the changing business environment and the risks that can affect the organization’s ability to achieve its fraud prevention related objectives.

The world and its risks are evolving and changing all the time, and assurance professionals need to address the issues that matter now. CFEs need to review where the risk is going to be, not where it was when the anti-fraud plan was built. They increasingly need to have the ability to assess cyber fraud risk quickly and to share the results with the board and management in ways that communicate assurance and stimulate necessary change.

Technology must be part of the solution to that need. Technological tools currently utilized by CFEs will continue to improve and will be joined by others over time. For example, solutions for augmented or virtual reality, where a picture or view of the physical world is augmented by data about that picture or view enables loss prevention professionals to point their phones at a warehouse and immediately access operational, personnel, safety, and other useful information; representing that the future is a compound of both challenge and opportunity.

The Class Action Machine

lawsuitThe recent troubles at Wells Fargo raised a number of questions in the mind of one of our Chapter members about the class action lawsuits that seem to immediately follow public announcement of such financially involved frauds.  Specifically, she asked about who among the various classes of defendants in a typical financial fraud case are most likely to get sued after the fact.

As I’m sure most financial professionals know, a class action is a type of lawsuit in which a single representative individual is permitted to sue on behalf of an entire group of similarly situated individuals known as a “class.” A class action theoretically comes about when an aggrieved shareholder (or in Wells Fargo’s case a shareholder or perhaps a type of defrauded account holder) contacts a lawyer and explains that s/he has been harmed. The law then generally permits that single party to sue on behalf of all similar share or account holders. Although the common conceptual justification for class action litigation begins with a single aggrieved affected individual reaching out to a lawyer to seek redress, the reality is somewhat different. As our Chapter member indicated she is aware, shareholder class action litigation tends to be prosecuted by a small number of highly specialized law firms and, over the years, these firms have developed practices and relationships that enable them to take the lead in commencing shareholder litigation almost on their own. A practical consequence is that, within days after issuance of a press release revealing financial fraud, the class action lawyers will normally have their lawsuits already prepared.

The catalyst for commencement of the litigation will often be the company’s initial press release announcing the fraud. Among other things, the lawyers may glean from the press release that accounting irregularities have surfaced, that earlier SEC filings are false, which line items on the financial statements are affected, and the board of directors’ preliminary information as to how far back the accounting irregularities go. With that information in hand, the class action lawyers will quickly extract from their word processors an earlier complaint filed in a similar case and quickly insert the specifics regarding the particular company at hand. In their haste to be the first firm to file a lawsuit, the process of revision is not always completely thorough and factual errors are common in almost all initial filings.

Although an exposition in detail of all the steps involved in such a suit are beyond the scope of this short post, the following are the typical steps that unfold during the process:

  • The company’s initial press release;
  • The company’s receipt of a series of complaints;
  • Production of a single consolidated complaint;
  • Motion to dismiss by the defendant company;
  • Document productions;
  • Depositions;
  • Settlement (if necessary);
  • Trial (almost never).

From the perspective of the board of directors, the result will be that, within several days of the issuance of the company’s initial press release, the company will begin receiving a number of seemingly duplicative lawsuits in which the only significant difference seems to be the name of the representative shareholder seeking to represent the interests of the class. In truth, a shareholder gains no meaningful strategic advantage over the defendants in rushing to be named the class representative. In the end, only one class of similarly situated shareholders will be certified and only one complaint ordinarily will survive.  Rather than trying to get a strategic advantage over the defendants, the interest of a plaintiff in rushing to be named the class representative is to get an advantage over the other plaintiff shareholders—or, more precisely, their lawyers. For a class action plaintiff’s lawyer, having one’s client named the class representative opens the door to the lion’s share of the legal fees.

So, to answer our reader’s question, who are the main candidates most likely to get sued in one of these actions?

  • The company. The corporate entity will almost inevitably be named a defendant. Also named may be a parent company or holding company. The plaintiffs will argue that the corporate entity or entities are responsible for the wrongdoing of their individual officers and directors;
  • Officers who have resigned, been terminated, or placed on leave. It may be that the initial press release will have identified particular officers who have resigned, been terminated by the board, or been placed on paid or unpaid leave. The plaintiffs’ lawyers will infer from any such corporate action the officers’ complicity in wrongdoing;
  • The CEO and the CFO. Prime candidates to be included as defendants are the chief executive officer and the chief financial officer. The plaintiffs will infer from their positions some level of complicity. Also, they will have signed what have now turned out to be incorrect SEC filings, such as a Form 10-K or Forms 10-Q;
  • Particular officers. Beyond the CEO and CFO, other officers may be named as defendants depending on the nature of the fraud (as described in the press release) and a particular officer’s proximity to it. For example, if the fraud involved improper revenue recognition (on fraudulently opened accounts, for example), the plaintiffs may seek to include as a defendant the officer or officers with responsibility in the new account generation area. Similarly, if the fraud involved improprieties at some remote location, those responsible for operations or the financial reporting function of that location may be named;
  • Outside directors. These days, outside directors tend not to be included as defendants. Historically, all outside directors would be named as defendants almost as a matter of course. Congress’s passage of federal securities law tort reform in the mid-1990s, however, has operated as an important impediment to the inclusion of the entire board—at least in the absence of evidence suggesting an individual director’s knowledge or complicity;
  • Underwriters. Where the company has publicly issued stock within the last three years, the underwriters may be included. For the corporate issuer, this is particularly unfortunate insofar as typical underwriting documents will provide for corporate indemnification of the underwriter in the absence of the underwriter’s own wrongdoing;
  • Selling shareholders. An issuance of public stock within the prior three years may also open the door to the inclusion as defendants of shareholders who participated as sellers in the offering. Plaintiffs may seek to show their complicity based on inferences drawn from their natural desire to see the stock price sustained or increased during the period prior to their sale;
  • The outside auditor. Several years ago, inclusion of the outside auditor in an accounting irregularities case occurred as a matter of course. Today, the inclusion of the outside auditor as a defendant, at least in the first complaint, has become less automatic. As with the inclusion of outside directors, the federal securities law tort reform legislation in the mid-1990s erected barriers to naming the outside auditor, at least without particularized facts showing auditor complicity. However, the auditor may not be left out forever. An important objective of the plaintiffs will be assembling detailed evidence sufficient to make claims against the auditor stick.

As to the outcome of these type of suits, in the great majority of cases, the parties will come (sooner or later) to a negotiated settlement dollar number.  A canned form of a settlement agreement will emerge from the files of the plaintiff’s law firm marked up to meet the circumstance of the present case and signed, effectively ending the process.

Our thanks to our Chapter member for a thought provoking question!  Please, keep them coming!