3/10/2013

Fraud and error

Errors:
An unintentional mistake made within the business through carelessness or ignorance.

Identifying and preventing fraud

Fraud: 'deprivation by deceit'

The intentional act of deception, misrepresentation or concealment of information by one or more individuals to obtain an unjust or illegal advantage.

Fraud
In corporate context it could be:
Removal of funds or assets from a business Intentional misrepresentation of the financial position of the business (creative accounting)

Who can defraud your company?

Employees Management Third parties

Removal of funds or assets from a business Theft of cash : stealing from petty cash Theft of inventory: pilfering items from stock Payroll fraud:
falsifying timesheets, for example by claiming overtime for hours which they did not really work. Deliberate miscalculation of payroll Add a bogus employee to the payroll and to pay their monthly salary in to a bank account set up for the purpose by fraudster

Stealing receipts from debtors and then writing them off as bad debts Pocketing the proceeds of cash sales and never entering them to accounting records Teeming and lading:
the theft of cash or cheque receipts Setting subsequent receipts, against the outstanding debt conceals the theft.

Fictitious customers: orders are set up, and goods are despatched on credit write off as bad debts

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Collusion with customers: Employees collude with customers by manipulating prices or the quality or quantity of goods despatched. (E.g. reducing prices, writing debts off, issue credit notes, suppressing invoices or under-record quantities on dispatch notes) Bogus supply of goods or services: falsely invoice the firm for goods or services that were never supplied Advance fee fraud: You must have experienced this!!!

Paying for goods not received: staffs colluding with the suppliers who inflate the invoice value than actual delivered value and the excess could be divided between them. Meeting budgets/target performance measures: once targets have been met, employees and/or management siphon off and pocket any profits in excess of the target. Manipulation of bank reconciliations and cash books Skimming frauds: fraudster diverts small amounts from large number of transactions thinking that no one will bother to investigate.

Misuse of pension funds : Ailing companies may raid the pension fund for the personal gain of managers Disposal of assets to employees: It may be possible for an employee to arrange to buy a company asset (e.g. a car) for personal use. In this situation, there may be scope to manipulate the book value of the asset so that the employee pays below market value for it. This could be achieved by over-depreciating the relevant asset.

False insurance claims: Manager may steal an insured asset and claim it was stolen Using the companys assets for personal use: Taking bland CDs home, using office copier to make copies if personal items, using office computer to access face book or tweet, and using office emails to send personal mails etc.. These are minor but fraud, what would be more serious if for instance managers using companys assets as a collateral for personal loans

Intentional misrepresentation of the financial position of the business

Manipulation of revenue recognition Over-valuation of inventory:
deliberate miscounting at inventory counts Deliveries to customers may be omitted from the books Returns to suppliers may not be recorded Obsolete inventory may not be written off but rather held at cost on the statement of financial position.

Irrecoverable debt policy may not be enforced Fictitious sales:

Generation of false invoices Overcharging customers for goods or services Selling goods to friends (with a promise of buying them back at a later date)

Manipulation of year end events: Deliberately inflating invoices at the year end to record a high profit (window dressing) Understating expenses Manipulation of depreciation figures Off-balance sheet accounting

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Why we commit Fraud?

Factors
Fraud involves three basic factors:
incentive or pressure to commit fraud, a perceived opportunity to do so and some rationalization of the act

Often referred to as:

Dishonesty Motivation Opportunity

Dishonesty
Something related to moral values Some fraud perpetrators are shameless and remorseless, some dont want to think they are evil Individual's pre-disposition or tendency to act in ways which contravene accepted ethical, social, organizational and legal norms for fair and honest dealing. This could be as a result of:
Personality factors: a high need for achievement, status or security; a competitive desire to gain advantage over others; low respect for authority. Cultural factors: national or familial values, which may be more 'flexible' or anti-authority than the law and practice prevailing in the organisation

Motivation
When such an opportunity arises the individual will weigh up the reward and possible sanctions of such opportunity. The individual's goal or motive for fraudulent behavior may be:
Financial needs or wants, or envy of others A desire to exercise negative power over those in authority A desire to avoid punishment

Opportunity
People will need a loophole in the system to commit fraud Every internal control weakness represents an opportunity for fraud to occur May be there could be cover up measures to conceal the wrong doing or the reward is higher than the risk of doing so

Factors increasing the risk of fraud

Poor control systems Poor control environment Lack of supervision Low morale Unusual transactions Personnel who do not take leaves Inadequate segregation of duties Significant transactions with related parties

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External Risk factors

Technological developments New legislation or regulations Economic or political changes Increased competition Changing customer needs

Internal Risk factors

Changed operating environment New personnel New or upgraded management information systems New overseas operations Rapid growth New products

Business risks
Profit levels/margins deviating significantly from the industry norm Market opinion: If the market has a low opinion of the firm, this might indicate something about the company's products, its people or its way of doing business. Complex structures

Personnel risks
Secretive behavior Expensive lifestyles Long hours or untaken holidays Autocratic management style Lack of segregation of duties Low staff morale

Computer Fraud
Computer hackers Lack of training within the management team Difficulty in identifying the risks Need for ease of access and flexible systems Inadequate IT systems

Implications of fraud
Removal of funds or assets from a business
Profits will be lower Less cash or fewer assets Net asset position will be weaken ROE will be reduced Reduction in WC affects operative efficiency Collapse the business (Barings)

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Intentional misrepresentation of the financial position of the business

Financial statements would not show true and fair view Managers in charge of a particular division can artificially enhance their division's results, thereby deceiving senior management.

Preventing fraud
Can creative accounting and fraud ever be stopped? Probably not Part of human nature Best we can do is set up a sound conceptual framework and sound standards Promote good ethical conduct Be aware

Preventing fraud
Prevention of fraud must be an integral part of corporate strategy First of all, management must understand the reasons for fraud such as:
Nature of the industry Personnel factors such as extensive authority given to dominant managers. Unclear structure of responsibility and authority Lack of strategy, reward by result

Reasons for poor controls

Lack of emphasis on compliance or a lack of understanding of why the controls are required Staff problems such as understaffing, poor quality or poorly motivated staff Changes in senior personnel

General prevention policies

Emphasizing ethics Personnel policies and procedures : More concrete recruitment procedures Training and raising awareness

Prevention of fraud in specific business areas

Segregation of duties Appropriate documentation Limitation controls: choosing from approved list of suppliers Certain actions should be prohibited such as leaving a computer terminal without logging off Proper internal audit work

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Internal controls
Physical controls Segregation of duties Authorization policies Customer signatures Using words rather than numbers Documentation Sequential numbering

Dates Standard procedures Holidays Recruitment policies Computer security Availability of information Whistleblowing Investigation of fraud

Responsibilities
Management
Primary responsibility for prevention and detection of fraud and error Audit Committee Line management

Auditors
Are not, and cannot be, held responsible for prevention of fraud and error They must however have a reasonable expectation of detecting material error and fraud plus a healthy professional skepticism Testing controls Investigating specific instances of potential fraud.

Money Laundering

Money Laundering
Hiding the true source of proceeds of crime Money laundering is the process by which criminals attempt to conceal the true origin and ownership of the proceeds of their criminal activity, allowing them to maintain control over the proceeds and, ultimately, providing a cover for their sources of income. Used to avoid the payment of taxes or to distort accounting information

Criminal Property
The proceeds of tax evasions A benefit obtained through bribery and corruption A benefit obtained, or income received through the operation of a criminal cartel A benefit (in the form of saved costs) arising from a failure to comply with a regulatory requirement

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Money laundering process

Placement: initial disposal of the proceeds of the initial illegal activity into legitimate business activities in small sums. Layering: transfer of monies from business to business or place to place to conceal original source. Integration: having being layered, the money has the appearance of legitimate funds.

Effects of regulation
Assessing the risk the risk base approach
Identify the risks Carry out a risk assessment e.g. delivery channels Design and implement controls to reduce such risks Monitor and improve controls Maintain the records and the reasons for action taken

Assessing the customer base Some types of customers are more at a risk of money laundering such as:
PEPs New customers carrying out large and one-off transactions Customers who have been introduced to you by third party who haven't done a risk assessment Customers who arent local to your business Customers whose business handle large amount of cash

Customer due diligence: checking customers who they say they are, official identification (KYC) Applying customer due diligence: business should apply customer due diligence in any of the cases below:
When establishing a business relationship When carrying out an occasional transaction worth more than a sum which the customer do not carry out within an ongoing business relationship When you have doubt about the previously collected information about the identity When the customers circumstances change

Internal controls and policies

Members should ensure their staff receive regular training to ensure that client identification procedures are carried out correctly and that knowledge and suspicions of money laundering or terrorist financing are reported. Firms should identify to their staff a clear procedure for reporting suspected money laundering and an individual; through whom reports of suspicions can be channeled to the relevant authority.

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Ongoing monitoring of the business: good internal control system, trained staffs, policies and procedures on anti-money laundering. Maintaining full and up-to-date records: receipts, invoices, customer correspondence, must be kept for 5 years

In summary
o Putting into place internal controls and policies to ensure compliance with legislation o Appointing a money laundering reporting officer (MLRO) o Establishing/enhancing record keeping systems for all transactions o Maintaining systems for verification of clients identities o Establishing internal suspicion reporting procedures o Educating and training all staff in the main requirements of the legislation

UK legislation
Criminal Justice Act 1993 Terrorism Act 2000 Proceeds of Crime Act 2002 Money Laundering Regulations 2003

UK legislation
Offences under money laundering regulation: Laundering: acquisition, possession or use of the proceeds of criminal conduct, or assisting another to retain the process of criminal conduct and concealing, disguising, converting, transferring or removing criminal property.

Failure of report by an individual: failure to disclose knowledge or suspicion of money laundering to the appropriate authority ( in UK, Serious Organized Crime Agency) Tipping off: disclosing information to any person if disclosure may prejudice an investigation into, drug trafficking, drug money laundering, terrorist related activities, or laundering the proceeds of criminal conduct.

Penalties
14 years imprisonment and/or a fine, for knowingly assisting in laundering of criminal funds 5 years imprisonment and/or a fine, for failure to report knowledge or suspicion of money laundering. 2 years for tipping off a suspected launderer.

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The role of financial service authority

Investment firms are required to have:
Control systems in place to monitor laundering activities MLRO Internal reporting procedures Adequate records such as copy of identity evidence obtained, procedures for external and internal reporting, etc.

There is a legal requirement for organizations to take the following actions:

To set up procedures and establish accountabilities for senior individuals to take actions to prevent money laundering To educate employees about problems of money laundering To obtain satisfactory evidence of identity where transaction is more than 10,000. To report suspicious circumstances Not to alert anyone under investigation or suspicion To keep records for all transactions for 5 years

Financial Action Task Force (FATF)

Inter-governmental body whose purpose is the development and promotion of policies to combat money laundering and terrorist financing All countries need to:
Successfully investigate and prosecute money laundering and terrorist financing Deprive criminals of their criminals proceeds and the resources needed to finance their illicit activities Enhance the transparency of legal persons and arrangements Ensure that financial institutions and other businesses comply with AML/CTF requirements

International Monetary Fund (IMF)

IMFs role in addressing risks of money laundering is increasing IMF promotes itself as a natural forum for sharing information, developing common approaches to issue and promoting desirable policies and standards in order to money laundering and financing of terrorism