Module 1 - Fraud - Worley

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Module 1 - Fraud | Christina Worley Module 1 – Fraud Introduction The Association of Certified Fraud Examiners (ACFE) defines occupational fraud as, “The use of one’s occupation for personal enrichment through the deliberate misuse or misapplication of the employing organization’s resources or assets” (Albrecht, et al., 2019, pg. 9). Over the years, there have been major fraud cases involving very large organizations such as Enron, WorldCom, HealthSouth, Siemens, Volkswagen, and Wells Fargo. Billions of dollars have been lost, and according to the ACFE, a 2008 study estimated that the United States had approximately $994 billion in fraud losses (Albrecht et al., 2019). With so much money lost and so many well-known organizations being affected by fraud, it is not unusual for one to start asking questions: Why aren’t companies doing more to prevent fraud? How can any good employee, and especially the auditors, not notice when fraud is occurring and costing companies billions of dollars? What more needs to be done? This assignment will review the reasons why organizations may have difficulty preventing fraud and the steps that need to be taken to prevent fraud. Preventing Fraud Even when an organization puts forth the time, money, and effort into preventing fraud, there are several factors at play that can make it more difficult for a company to notice and prevent fraud: 1. Complexity of Fraud Schemes Criminals are becoming more organized in their attempts to fraud organizations, and often, an organization is just one link in the chain of a larger scheme. Fraudsters take

Module 1 - Fraud | Christina Worley advantage of loopholes and weaknesses in internal controls, lack of access to information, and lack of an audit trail (Albrecht et al., 2019). Albrecht et al. provides an example of a 1992 case in which a lack of information allowed fraud to occur with Lincoln Savings and Loan. Charles Keating and his son, Charles Keating III, were convicted of racketeering and fraud, after they created sham transactions to make the bank look more profitable that it really was. This fraud was able to be perpetuated because auditors and regulators were not given complete access to transactions (pg. 47). 2. The Fraud Triangle (Pressure, Opportunity, and Rationalization) The Fraud Triangle was published in the 1970s by a criminologist, Donald R. Cressey and “outlines three conditions that lead to higher instances of occupational fraud: motivation, opportunity, and rationalization” (Embroker, 2023, para. 2). The motivation is also known as the perceived pressure-the fraudster’s reason for committing the fraud. Albrecht et al. notes that most perceived pressures are financially motivated, although “nonfinancial pressures, such as the need to report financial results better than actual performance, frustration with work, or even a challenge to beat the system, can motivate fraud” (2019, pg. 34). The opportunity condition exists if there is a chance to commit fraud without getting caught and is probably the easiest piece of the triangle for organizations to control-a person can only commit fraud if they are given the chance to. An individual can commit fraud when internal controls and oversight are absent, unenforced, ineffective, or unmonitored (Embroker, 2023). Albrecht et al. notes that people who try to prevent fraud typically only work on the opportunity area of the fraud triangle and believe “that having good internal controls can eliminate opportunities, they focus all or most of their

Module 1 - Fraud | Christina Worley preventative efforts on implementing controls and ensuring adherence to them” (2019, pg. 35). The last part of the triangle is rationalization, in which “a perpetrator needs a way to rationalize their actions as acceptable” (Albrecht et al., 2019, pg. 34). Many fraudsters can convince themselves that defrauding a company is a victimless crime-they are justifying to themselves why their fraud is “okay” (Embroker, 2023). 3. Lack of Effective Oversight and Internal Controls Albrecht et al. notes that having an effective control framework is essential to preventing fraud and can help to eliminate the “opportunity” portion of the fraud triangle (2019). The control environment can include “management’s role and example, management communication, appropriate hiring, clear organizational structure, and an effective internal audit department (Albrecht et al., 2019, pg. 39).  Management’s Role and Example - The management’s role and example is very important because if a manager is dishonest, then the employees will learn and model that behavior. Tone at the top is so important that it was included in the Sarbanes-Oxley legislation that was passed in 2002.  Management’s Communication - Additionally, if the communication that management relays to employees is inconsistent or messages change based on circumstances, it can encourage rationalization of fraud (Albrecht et al., 2019).  Appropriate Hiring - Hiring dishonest employees can lead to fraud, and even the best controls may not stop them. Albrecht et al. notes a research study that found that nearly 30 percent of all people in the United States are dishonest, and another 40 percent are situationally honest and 30 percent are honest all the time (2019).

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Module 1 - Fraud | Christina Worley Poor hiring can have dire consequences for an organization and can certainly increase the risk that fraud will occur.  Clear Organizational Structure – The ACFE states, “An overly complex or unclear organizational structure might indicate serious problems” (2019, pg. 45). An example is provided of a brokerage company, ESM, that used a multi-layered organizational structure to hide a $300 million fraud (ACFE, 2019).  Internal Audit Department – While only about 20 percent of all employee frauds are discovered by internal audit departments (Albrecht et al., 2019), having an ineffective audit department can lead to dire consequences for an organization. The lack of an audit department presence can lead fraudsters to believing that it will be easier to commit fraud as there will be no one questioning the actions of the criminals. 4. Whistleblower Retaliation and Fear When fraud occurs in an organization, it is possible that other employee(s) are aware of the fraudulent activity. State and federal laws are in place that prohibit employers from terminating or taking adverse action against whistleblowers; however, that does not mean that the fear of retaliation towards the whistleblower does not exist. The Maine Employee Rights Group described a case in which their client was wrongfully terminated after reporting that his supervisor was submitting false claims to Medicare. The supervisor retaliated against the employee by issuing warnings for alleged performance issues and assigning him less favorable delivery routes and was eventually fired (2023).

Module 1 - Fraud | Christina Worley Preventing Fraud – What More Can Be Done? The ACFE 2014 Report found “that the fraudulent activities studied lasted an average of 18 months before being detected” (CG, 2024, para. 6). An organization should ensure there are fraud prevention and fraud detection strategies in place to reduce the chances of financial losses. There are several measures that should be implemented to address these challenges and prevent future fraud: 1. Employee Education Every employee has a responsibility to reduce occupational fraud and abuse; this is not a responsibility solely for just senior leaders and auditors. Organizations should provide every new employee with anti-fraud training at time of hire. The training should place an emphasis that fraud and abuse “impact raises, jobs, benefits, morale, and profits as well as the integrity of those who perpetrate them. The fraud-educated workforce is the fraud examiner’s best weapon-by far” (Wells, 2017, pg. 371). Additionally, most fraudsters exhibit specific behavioral traits that employees can be trained to recognize. Since employee tips are the most common way that occupational fraud is detected, anti- fraud training is essential (Maurer, 2013). 2. Implement Internal Controls An organization should ensure that there is a formal program in place that consist of internal controls that make fraud harder to commit and easier to detect. Case IQ states, “Internal controls work to prevent corporate fraud, but their visibility also acts as one of the best deterrents to fraudulent behavior” (n.d., para. 33). Some examples of internal controls are: separation of financial duties, two-factor authorization to access company

Module 1 - Fraud | Christina Worley resources/data, mandatory leave requirements, and surprise audits conducted by a third- party (Case IQ, n.d.). 3. Implement Anti-Fraud Policies Organizations should ensure that anti-fraud policies are proactive versus reactive. Many people believe that prosecuting fraudsters will prevent future fraud, but Wells states, “There is nothing proactive about prosecuting people. As some would say, it is like closing the barn door after the cows escaped” (2017, pg. 371). Anti-fraud policies should include: a code of ethics, a conflict-of-interest policy, an open-door policy, and other business procedures. Policies should include information about common types of fraud and the consequences associated with them. All employees should be required to read and sign the corporate fraud policy (Case IQ, n.d.). 4. Formalize the Hiring Process A formal hiring routine will reduce the chances of fraud; the process should consist of background checks and review of past jobs. Patricia Vercillo, VP of Operations at the Smith Investigation Agency and Smith Training Centre states, “You want to learn more about the person you’re bringing on board before it’s too late” (Case IQ, n.d., para. 22). Albrecht et al. stressed the importance of taking extra precautions in it hiring process and provided an example of a company that first trained all employees associated with hiring decisions to be experts in interviewing and second, checked three background references for all candidates. Due to the extra precautions, over 800 applicants were disqualified after it was found they had issues such as falsified employment information, previous arrest records, uncontrollable tempers, alcoholism, drug addiction, and a pattern of being fired from previous jobs (2019, pg. 41).

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Module 1 - Fraud | Christina Worley 5. Segregate Duties Case IQ states, “The general best practice is to ensure no one person has control over all parts of a financial transaction” (n.d., para. 35). Recommended actions to segregate duties include: separate handling functions from recordkeeping functions, separate purchasing functions from payable functions, ensure the same person isn’t authorized to write and sign a check, require manager approval of time sheets, require two signatures above certain amounts (Case IQ, n.d.). 6. Physical Safeguards Physical safeguards should be put in place to make it more difficult for people to access assets. Examples of physical safeguards are vaults, safes, fences, locks, and keys (Albrecht et al., 2019). 7. Documents and Records Documents are typically used more for detective control versus preventative control and are used “to create a record of transactions and an audit trail” (Albrecht et al., 2019, pg. 44). Additionally, a thorough documentation process allows an organization to ensure that all the numbers for the day, month, and year line up correctly. Part of an organization’s anti-fraud strategy should include reminding employees that documentation is reviewed often; this may deter some from committing fraud (Case IQ, n.d.). 8. Routine and Surprise Audits Albrecht et al. states, “Organizations that proactively audit for fraud create awareness among employees that employees’ actions are subject to review at any time. By increasing the fear of getting caught, proactive auditing reduces fraudulent behavior”

Module 1 - Fraud | Christina Worley (2019, pg. 119). Organizations should have either an internal or external auditor routinely audit areas that deal with cash, refunds, product returns, inventory management, and accounting functions (Case IQ, n.d.). While routine audits are a great way to help prevent fraud, fraudsters may expect an audit and find ways to further cover up the fraud. Organizations should conduct surprise audits in high-risk areas as another way to help prevent fraud (Case IQ, n.d.). Conclusion Preventing corporate fraud is not a simple task and no single method is guaranteed one hundred percent. To effectively mitigate the risk of fraud, multiple approaches must be employed. Companies can reduce the risk of fraud by fostering a culture of integrity, implementing robust internal controls, and employing appropriate oversight mechanisms.

Module 1 - Fraud | Christina Worley References Albrecht, W. S., Albrecht, C. O., Albrecht, C. C., & Zimbelman, M. F. (2019). Fraud Examination . Cengage Learning. Retrieved from: http://books.google.ie/books? id=BqNbswEACAAJ&dq=978-0-357-68867-0&hl=&cd=1&source=gbs_api Association of Certified Fraud Examiners. (2019). Fraud-related internal controls. Retrieved from chrome-extension://efaidnbmnnnibpcajpcglclefindmkaj/https://www.acfe.com/-/media/images/ acfe/products/publication/self-study-cpe/workbook/fraud-related-internal-controls/fraud-related- internal-controls_2019_final-extract.ashx Case IQ. (n.d.). Corporate fraud prevention: the ultimate guide. Retrieved from https://www.caseiq.com/resources/corporate-fraud-prevention-the-ultimate-guide/ CG. (2024, February 11). Six strategies for fraud prevention in your business. Retrieved from https://www.cgteam.com/six-strategies-for-fraud-prevention-in-your-business/ Embroker. (2023, September 21). What is the fraud triangle? (three components explained). Retrieved from https://www.embroker.com/blog/fraud-triangle/#:~:text=In%20the %201970s%2C%20criminologist%20Donald,motivation%2C%20opportunity%2C%20and %20rationalization . Maine Employee Rights Group. (2023). Example of a whistleblower case we handled- whistleblower retaliation/false claims act. Retrieved from https://www.maineemployeerights.com/example-of-a-whistleblower-case-we-handled- whistleblower-retalia.html

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Module 1 - Fraud | Christina Worley Maurer, R. (2013, November 4). Fight fraud with employee awareness. Retrieved from https://www.shrm.org/topics-tools/news/risk-management/fight-fraud-employee- awareness#:~:text=Fraud%20Awareness%20Training&text=At%20a%20minimum%2C%20staff %20members,warning%20signs%20of%20their%20actions. Wells, J. T. (2017). Corporate fraud handbook : Prevention and detection . John Wiley & Sons, Incorporated.