Fraud Examination

Most of the 2002 fraud-related scandals that resulted in the Sarbanes-Oxley Act - including Enron and WorldCom - were financial statement frauds. Their scams ranged in level of intricacy, but the end results were similar enough: massive stockholder losses and debts to creditors, not to mention trauma to employees who lost their jobs and retirement funds.

In the 2008 Report to the Nation on Occupational Fraud and Abuse published by the Association of Certified Fraud Examiners, U.S. companies suffered a median loss of $2 million to fraudulent statement schemes. The report notes that this form of fraud differs greatly from other types of occupational fraud because "the typical goal of a fraudulent statement scheme is not to directly enrich the perpetrator, but rather to mislead third parties (investors, owners, regulators, etc.) as to the profitability or viability of an organization."

In other words, it is typically perpetrated by company managers who are seeking to enhance the economic appearance of the company by covering enormous debts or other lost assets. Members of management may benefit directly from the fraud by selling stock, receiving performance bonuses, or by using the false report to conceal other illegal acts. Management benefits indirectly from financial statement fraud when the tactic is used to obtain financing on a company’s behalf, or to inflate the selling price of a company.

Preventing Financial Statement Fraud

According to Dr. Donald R. Cressey’s Fraud Triangle, people commit fraud when they are under financial or social pressure, have an opportunity to gain funds undetected, and can rationalize their actions. Any attempt to prevent financial statement fraud should focus on these three factors:

1. Reduce the Situational Pressures that Encourage Statement Fraud

• Avoid setting unachievable financial goals.
• Eliminate external pressures that might tempt accounting personnel to prepare fraudulent financial statements.
• Remove operational obstacles blocking effective financial performance such as working capital restraints, excess production volume, or inventory restraints.
• Establish clear and uniform accounting procedures with no exception clauses.

2. Reduce the Opportunity to Commit

• Maintain accurate and complete internal accounting records.
• Carefully monitor the business transactions and interpersonal relationships of suppliers, buyers, purchasing agents, sales representatives, and others who interface in the transactions between financial units.
• Establish a physical security system to secure company assets, including finished goods, cash, capital equipment, tools, and other valuable items.
• Divide important functions between employees, separating total control of one area.
• Maintain accurate personnel records including background checks on new employees.
• Encourage strong supervisory and leadership relationships within groups to ensure enforcement of accounting procedures.

3. Reduce Rationalization of Fraud—Strengthen Employee Personal Integrity

• Managers must promote honesty by example. Dishonest acts by management, even if they are directed at targets outside the organization, create a dishonest environment that can be used to rationalize other illicit business activities by employees or externals.
• Honest and dishonest behavior should be defined in company policies. Organizational accounting policies should address any questionable or controversial areas in accounting procedures.

Consequences for violating rules and provisions for punishment of violators should be written and prominently communicated.

Money Laundering:

Money laundering is a process in which the origin of funds from illegal enterprises—drug smuggling, corruption, fraud, and other acts—is concealed. Perpetrators move the funds through various channels before reclaiming them from what appears to be a legitimate source. The International Monetary Fund estimates that laundered funds comprise 2% to 5% of the world’s gross domestic product. These estimates suggest that laundered funds total somewhere between $590 billion and $1.5 trillion each year. Despite stepped-up enforcement efforts during the 1990’s, money laundering continues to grow. According to information from the U.S. Congress, transactions have been getting larger in volume and the schemes more complicated, involving multiple shell corporations or the purchase and sales of securities.

Money Laundering Offenses
Acts prohibited by money laundering laws include:

• Assisting someone to retain the proceeds of crime.
• Acquiring, possession, and use of criminal proceeds.
• Concealing or transferring proceeds to avoid prosecution or a confiscation order, also known as “Own Funds” money laundering.
• Failing to disclose knowledge or suspicion of money laundering.

Alerting targets of a criminal investigation.

Money laundering generally takes place in three stages:

• Placement. Funds are placed into the financial system or retail economy or are smuggled out of the country. Cash is converted into other forms such as travelers’ checks, postal orders, stocks, and other forms.
• Layering. Complex layers of financial transactions are executed to disguise the source and ownership of funds. Funds are transferred between offshore bank accounts and shell companies through electronic funds’ transfer. Trading in stocks, commodities and futures through brokerage houses also creates layers.
• Integration. The funds are integrated into the legitimate economic and financial system. Integration can be accomplished in several ways.

The establishment of anonymous companies in countries where the right to secrecy is guaranteed. Individuals then grant themselves loans from the laundered funds.

Perpetrators may also claim tax relief on the loan repayments and charge themselves interest on the loan.

Sending false export-import invoices in which goods are overvalued allows the launderer to move money from one company and country to another with the invoices serving to verify the origin of the monies placed with financial institutions.

Funds are transferred to a legitimate bank from a bank owned by the launderers. So-called off-the-shelf banks are easily purchased in many tax havens.

ACFE Report Finds Small Businesses Especially Vulnerable to Fraud

AUSTIN – According to a report released by the Association of Certified Fraud Examiners (ACFE), U.S. organizations lose an estimated seven percent of their annual revenues to fraud – but the damage is the worst among small businesses. Among the fraud cases detailed for the survey, the median loss suffered by organizations with fewer than 100 employees was $200,000, higher than the median loss for any other category.

Broyles CPA, LLC is helping to promote awareness of the new research, as it indicates that fraud continues to be a serious problem for businesses and organizations worldwide.

The ACFE’s benchmarking data is compiled from 959 cases of occupational fraud that were investigated by Certified Fraud Examiners between January 2006 and February 2008.

The study also found that check tampering and fraudulent billing were the most common of all small business fraud schemes. In fact, more than one-fourth of all small business frauds in the survey involved check tampering, making it a much more common method of fraud than in larger organizations. Check tampering commonly occurs in situations where duties over the cash disbursement function are not separated.

The Report to the Nation is available for download online at the ACFE’s web site: www.ACFE.com/RTTN.  The Report is in PDF format.

Combating Small Business Fraud

There are some simple steps a small business can take to identify and effectively manage potentially costly fraud losses.

1. Be proactive.
Establish and maintain internal controls specifically designed to prevent and detect fraud. Adopt a code of ethics for management and employees. Set a tone at the top that the company will not tolerate any unethical behavior.

2. Establish hiring procedures.
Every company, regardless of size, can benefit from formal employment guidelines. When hiring staff, conduct thorough background investigations. Check educational, credit and employment history, as well as references. After hiring, incorporate evaluation of the employee's compliance with company ethics and antifraud programs into regular performance reviews.

3. Train employees in fraud prevention.
Once carefully-screened employees are on the job, they should be trained in fraud prevention. Are employees aware of procedures for reporting suspicious activity by customers or co-workers? Do workers know the warning signs of fraud? Ensure that staff know at least some basic fraud prevention techniques.

4. Conduct regular audits.
High risk areas, such as financial or inventory departments, are obvious targets for routine audits. Surprise audits of those and all parts of the business are crucial. A good starting point in identifying fraud risks and establishing a strategy to prevent such losses is ACFE's Fraud Prevention Check-up (PDF).  Contact stevebroyles@broylescpa.com for a free copy.

5. Call us if you suspect fraud within your organization.
When fraud is suspected or discovered, it is imperative to enlist the anti-fraud expertise of a Certified Fraud Examiner (CFE). The CFE credential is recognized by businesses and governments worldwide as the standard for fraud prevention and detection.

About the Association of Certified Fraud Examiners
The ACFE is the world's premier provider of anti-fraud training and education. Together with nearly 50,000 members in over than 125 countries, the ACFE is reducing the incidence of fraud and providing the training and resources to fight fraud more effectively. Founded in 1988 by Joseph T. Wells, CFE, CPA, the ACFE proudly celebrates its 20th anniversary as the leader in the global fight against fraud. For more information about the ACFE, visit www.ACFE.com.