FIGHTING FRAUD: AN OVERVIEW
1. Fraud prevention is important because it is the most cost-effective way to reduce losses from fraud. Once fraud occurs, there are no winners.
2. Creating a culture of honesty and high ethics helps to reduce fraud in various ways. Management through its own actions can show that dishonest, questionable, or unethical behavior will not be tolerated. By hiring the right kind of employees, management can select people who are less likely to rationalize their illegal or unethical actions as acceptable. By communicating expectations, management can give fraud awareness training that helps employees understand potential problems they may encounter and how to resolve or report them. And by creating an honesty-driven culture, management can help to develop a positive work environment. Research indicates that fraud occurs less frequently when employees have feelings of ownership toward their organization than when they feel abused, threatened, or ignored.
3. Identifying sources and measuring risk means that an organization needs a process in place that both defines areas of greatest risk and evaluates and tests controls that minimize those risks. Risks that are inherent in the environment of an organization can often be addressed with an appropriate system of control. Once risks have been assessed, the organization can identify processes, controls, and other procedures that can minimize risks. Appropriate internal systems include well-developed control environments, effective accounting systems, and appropriate control procedures.
4. Because most frauds increase dramatically over time, it is extremely important that when frauds occur they be detected early. Once a fraud has been committed, there are no winners. Perpetrators lose because they suffer humiliation and embarrassment as well as legal punishment. Usually, they must make tax and restitution payments, and there are financial penalties and other adverse consequences. Victims lose because assets are stolen and they incur legal fees, lost time, negative public exposure, and other adverse consequences. The investigation of fraud can be very expensive. Organizations and individuals that have proactive fraud prevention measures usually find that those measures pay big dividends.
5. When fraud is suspected it is important to conduct a thorough review in order to (a) avoid wrongly targeting innocent people; (b) gather sufficient factual evidence about the suspected fraud; and (c) ensure a complete report of all the facts and circumstances, both incriminating and exonerating, is prepared.
6. The types of evidence produced while investigating fraud can be classified into evidence square. The evidence square includes testimonial evidence, documentary evidence, physical evidence, and personal observation. Testimonial evidence includes evidence gathered from interviews, interrogations, and honesty tests. Documentary evidence includes evidence gathered from paper, computers, and other written or printed sources. Physical evidence includes fingerprints, tire marks, weapons, stolen property, identification numbers or markers on stolen objects, and other tangible evidences that can be associated with theft. Personal observation includes evidence collected by the investigators themselves, including invigilation, surveillance, and covert operations.
7. The evidence square allows us to identify the different types of evidence that can and should be gathered, to identify the evidence gathered, and then to categorize possible evidence so that it is easily understood and correlated with all other sources of evidence in the investigation.
a. Surveillance – personal observation
b. Tire marks – physical evidence
c. Honesty test – testimonial evidence
d. Interview – testimonial evidence
e. A computer hard drive – physical evidence (Some would classify this aS documentary evidence.)
f. A financial statement analysis – documentary evidence
g. A paper report – documentary evidence
h. Identification numbers on vehicles – physical evidence
i. Audit of financial statements – personal observation (Some would classify this as documentary evidence.)
j. Check stubs – documentary evidence
k. Fingerprints – physical evidence
l. Background checks – documentary evidence (Some would classify this as personal observation.)
m. Interview – testimonial evidence
9. One of the major decisions a company or fraud victim must make when fraud is committed is what kind of follow-up actions should be taken. Most organizations and other victims of fraud usually make one of three choices: take no legal action, pursue civil remedies, and/or pursue criminal action against the perpetrators.
10. Civil proceedings seek to reclaim the assets stolen in the fraud. Often, with employee fraud, the employee quickly liquidates and spends the proceeds of the fraud. Thus, there is usually very little to reclaim in a civil suit. However, when fraud involving organizations occurs, civil actions are often useful because those organizations have assets (deep pockets) from which they can pay the damages.
11. Management often avoids taking legal action against fraud perpetrators because of the legal cost and the bad publicity for the company. They justify that the legal costs and time spent are more than the value of what was stolen, and what was stolen is less valuable than the company’s good reputation. They fail to recognize that they are destroying the company’s culture of honesty, and opening themselves up for future, potentially larger, frauds.
There are three follow-up alternatives available to organizations once fraud has occurred: take no legal action, pursue civil remedies, and/or pursue criminal action against the perpetrators.
While the Men’s Warehouse has disregarded a commonly recommended fraud prevention policy of background checks, they have compensated for this by creating an extremely friendly working environment, creating a culture of honesty. Men’s Warehouse is consistently ranked in the Fortune© list of “100 Best Places to Work,” people feel ownership of the company they work for, and thus do not steal from it. As a result,, Men’s Warehouse has created a culture of honesty in a nonstandard way.
Prior to the policy change, employee fraud was not seen as a serious issue, and prosecutions were unlikely. The general message was that nothing serious will happen to you if you commit fraud (fraud was acceptable), and so it proliferated. But, creating a policy that would essentially prosecute everyone involved in fraud (minimizing these bad-news reports to the CEO), it was clear that fraud would not tolerated. As a result, fraud within the organization decreased.
Jamie needs to understand that most fraud perpetrators have no past history of fraud, and so seemingly “good” people are sometimes involved in fraud. Since fraud requires “confidence,” it is usually those you trust most who are in the best position to commit fraud. By not taking action Jamie is putting in jeopardy the culture of the organization; this destroys the culture of honesty that could exist if it was well known that all fraud would be handled seriously.
1. The management of this company seems too relaxed. They did not provide for an independent check of the accounting records and cash. They created an easy opportunity for Mary to embezzle.
a. There was an inadequate segregation of duties in the company. Peter Jones should have been assigned to do some of Mary’s duties so that there was a reduced opportunity for embezzlement.
2. The company should have paid more attention to internal controls, both preventive and detective. Mary had no accountability to anyone, and no one ever checked her work.
Consistent communication could have been one of the effective ways of reducing the fraud. This would have helped identify and remind the employees of what is expected of them by the company. They could have also required a written and signed statement that stated the possible punishment for committing fraudulent acts.
Periodically, XYZ’s management should have asked Peter Jones to take care of Miller’s books while she was required to take vacation time. This would have helped detect the fraud at its early stages. Additionally, it might have prevented the fraud, since Mary would have known that someone else would be checking her work.