Fraud 101: Techniques and Strategies for Understanding Fraud - Hardcover

Pedneault, Stephen

Hardcover

ISBN 10: 047048196X ISBN 13: 9780470481967

Publisher: Wiley, 2009

Synopsis

A straightforward guide explaining the nature of financial fraud

Fraud continues to be one of the fastest growing and most costly crimes in the United States and around the world. The more an organization can learn about fraud in general and the potential fraud risks that threaten the financial stability of the organization's cash flow, the better that organization will be equipped to design and implement measures to prevent schemes from occurring in the first place.

Fraud 101, Third Edition serves as an enlightening tool for you, whether you are a business owner or manager, an accountant, auditor or college student who needs to learn about the nature of fraud. In this invaluable guide, you will discover and better understand the inner workings of numerous financial schemes and internal controls to increase your awareness and possibly prevent fraud from destroying your organization's financial stability.

It offers guidance, understanding, and new, real-world case studies on the major types of fraud, including

• An understanding of why fraud is committed
• An overview of financial fraud schemes
• White-collar crime
• Uncovering employee embezzlements
• Establishing internal fraud controls
• The nature of collecting evidence

With case studies included throughout the book to gain insight to the real world of fraud, Fraud 101, Third Edition describes the features of fraud and then provides proven methods of prevention, as well as solutions to expose different types of fraud.

About this title

About the Author

Stephen Pedneault, CPA, CFF, CFE, is the founder and Principal of Forensic Accounting Services LLC, a CPA firm located in Glastonbury, Connecticut, specializing in forensic accounting, employee fraud, and litigation support matters. Steve is also the author of the forthcoming Wiley title, Anatomy of a Fraud Investigation. He has written numerous articles appearing in local and national media and is a contributor to Fraud Casebook: Lessons from the Bad Side of Business (Wiley). For more information about Stephen Pedneault, go to www.forensicaccountingservices.com.

From the Back Cover

Praise for Fraud 101 Third Edition

"With this new edition of Fraud 101, I am amazed at how much information Stephen delivers in such a concise and succinct manner. His descriptions are detailed, but easy to understand, and the case examples really help illustrate the schemes. This is an excellent reference book for anyone in the fraud prevention field, whether they are a seasoned veteran or just starting out."
―John D. Gill, JD, CFE Research Director, Association of Certified Fraud Examiners

"Awesome! Sit at the head of the class―read Fraud 101 and get an A+ in understanding fraud. This book takes the reader from the classroom to the real world with its insightful case studies and practical techniques. A must-read for accountants, other professionals, business owners, and students of fraud."
―Thomas Scanlon, CPA, CFP®President, Borgida & Company, PC, CPAs

"The author clearly demonstrates his mastery of the subject matter in this well-written, easy-to-read, comprehensive guide to understanding fraud. The case studies provide insight into the definition of fraud, the different types of fraud, the perpetrator's rationale and a practical approach to investigation and prevention. The ever evolving nature of this relevant subject matter makes this book a must-read for anyone interested in learning about fraud and its wide-reaching effects."
―Jeffrey Rossi, CPA, CVA, CFEPartner, J.H. Cohn, LLP

"This book is very readable and loaded with examples from the author's rich experience in forensic accounting services. The discussions of the types of fraud and the pitfalls to watch for were very practical guidance for accountants and business people in general."
―Lawrence J. Gramling, PhD, CPA Assistant Department Head, Department of Accounting, University of Connecticut

Root out fraud before it happens with the hands-on approach found in Fraud 101, Third Edition

The more your organization can learn about fraud and the potential risks that can threaten its financial stability, the better you will be equipped to prevent schemes from occurring in the first place. The only primer you need to fully understand financial fraud, Fraud 101, Third Edition expertly arms you with the tools to eliminate future frauds and reduce fraud losses.

From the Inside Flap

If an employee brings home some office supplies for their kids to use with their school projects, is that fraud? How about when an employee charges personal items on the company's credit cards, receives vendor kickbacks, or inflates travel expenses? Instances of fraud occur every day and either go undetected, or are not deemed newsworthy enough to bring any attention to the matter. In fact, instances like these may be occurring right now in your organization―how will you know what to look for? And how can you stop it from taking place again?

Now fully revised, Fraud 101, Third Edition explains fraud in a practical, easily understood manner, serving as an enlightening tool for you, whether you are a business owner or manager, an accountant, or an auditor. A valuable introduction for dealing with fraud―from preventing and detecting it to investigating it, Fraud 101, Third Edition provides insightful advice on the inner workings of numerous financial schemes and the internal controls that will increase your awareness and possibly prevent fraud from destroying your organization's financial stability.

Offering guidance, understanding and new, real-world case studies on the major types of fraud, this new edition explores:

• Why fraud is committed

• An overview of financial fraud schemes

• White-collar crime

• Employee embezzlements

• Internal fraud controls

• The nature of collecting evidence

• Investigative issues, including alternatives for resolving fraud-related matters

• How to perform an effective investigation

• Sample investigation procedures for the major fraud categories

Regardless of why an individual perpetrates a fraud, the end result is usually the same: a substantial financial loss to the organization, often involving a significant amount of money that may never be recovered. Fraud 101, Third Edition will show you how fraud schemes are perpetrated, detected, and investigated, with practical advice on how to notice and prevent fraudulent activity, minimizing the loss experienced by your organization.

Highly readable and accessible, this timely book provides you with the methods and tips you need to readily recognize and investigate financial fraud and combat fraud in your organization.

Excerpt. © Reprinted by permission. All rights reserved.

Fraud 101

Techniques and Strategies for Understanding FraudBy Stephen Pedneault

John Wiley & Sons

Copyright © 2009 John Wiley & Sons, Ltd
All right reserved.
ISBN: 978-0-470-48196-7

Chapter One

The World of Fraud

I am often asked for my thoughts on fraud. A common question posed is whether I believe fraud is on the rise. My response usually goes like this: "When you say fraud, what do you mean by fraud, and what kind of fraud are you talking about? If you are asking me about fraud in general, my answer is yes, I believe fraud in general has significantly increased during my professional lifetime. If you are asking me if society has become less honest and more accepting of individuals who are trying to beat the system, my answer again would be yes. However, are you referring to a particular area of fraud?"

Definition of Fraud

What is fraud? Although there are common definitions of fraud, no two definitions are the same. If an employee brings home some office supplies for their kids to use with their school projects, is that fraud? Or is it simply an employee stealing office supplies? Or is it just an accepted practice in business that some office supplies may end up being used for personal purposes-a cost of doing business, if you will? Or are we saying the same thing, but three different ways? How about a business that overstates reserve balances on their financial statements, only to use those overstated balances in future periods to "smooth" earnings trends? Is that considered fraud, or is it simply a widely accepted business practice-technically incorrect, but otherwise allowed and accepted? Lastly, how about a family who wants to have their children attend a particular college that they can't afford? In preparing the financial aid forms, they don't report certain bank and investment accounts, and underreport their true earnings so that their child will be eligible for financial aid. Are they committing fraud, or are they simply working the system to gain access to funds available for that specific reason-to assist families with high tuition costs?

Depending on who is asked each of these questions, we may get consistent answers or (more likely) we will get disparity based on each individual's background, values, and beliefs.

Therefore, before we can get into discussions and cases relating to fraud, it would be a good idea to make sure we are all talking about the same thing-fraud. One of the best resources for an objective, defendable definition of fraud is Black's Law Dictionary. According to Black's Law Dictionary, fraud is defined as "a knowing misrepresentation of the truth or concealment of a material fact to induce another to act to his or her detriment."

As mentioned earlier, to further define and understand fraud, it has to be discussed within a specific context. Fraud can be further broken down into subcategories of fraud, along with various methods used to commit each type of fraud. Unfortunately, fraud has become prevalent within virtually every aspect of our lives, is accepted by many as the status quo, and acts as a constant reminder of the sad state of society in which we live. Personal characteristics that were likely found within individuals living a socially responsible life, things like ethics, morals, and pride, have been replaced by greed, self-promotion, and the "what's in it for me" mentality.

The Many Types of Fraud

Names like WorldCom, Enron, and Arthur Andersen have become more than commonplace in discussions regarding fraud. Their names and others-such as Martha Stewart, who was found guilty of lying to authorities about possible insider trading, and Richard Hatch, a Survivor winner who failed to pay the taxes due on his winnings, can and often are used in analogies of what can go wrong. Instances of fraud occur every day and either go undetected or are deemed not worthy of attention. Only cases involving overwhelming amounts of money or some other news-grabbing aspect make the headlines. Traditionally, only one in nine fraud cases ever appears in the media, which means that for every fraud you read or hear about, eight more will never appear in the public eye.

Two main areas of fraud exist in the world of accounting: management fraud, commonly known as financial statement fraud, and employee fraud, or embezzlement. Many of the notorious frauds of this and past decades fall into one of these two categories. However, many other categories of fraud or fraudulent activity exist. If you watch the news, read the newspaper, or scan news posts on the Internet, you should be able to name a few more categories. How about political malfeasance? These frauds are committed by elected officials who abuse their office or position, usually for some form of personal enrichment. Bribes, gifts, preferential treatment, bid rigging, and kickbacks involving politicians and elected officials have been the target of many investigations and convictions as seen in so many news stories.

Then, of course, there is tax fraud. Tax fraud can be carried out by any business, organization, or individual, at the federal or state level. And for all the types of taxes that are imposed at the local, city, county, state, and federal level, there exists an equal number of tax fraud schemes committed to minimize each type of tax. Based on personal experience, the rate of occurrence of some form of tax fraud, whether a large scheme or simply minor cheating, is present on virtually every tax return filed.

Rounding out the top most widely known fraud categories are crimes committed at the federal level: wire fraud, mail fraud, and bank fraud, to name a few of the most common. Convictions on these types of fraud are generally easy to obtain. A scheme to defraud involving an electronic banking transaction or simply mailing a check or payment is all it would take for a violation. The use of either means, common in so many schemes, can lead to a conviction of a federal law. The only conviction easier to obtain is obstruction of justice. Simply provide any false statement or fact to a federal investigator and you have committed obstruction of justice.

There is a risk for fraud in every type of social program that exists. Unfortunately, the reality of the situation is that every program in existence has a certain level of fraud; due to limited resources available to combat the issue, many individuals successfully defraud the programs. At the local level, for example, many towns offer residents below a set income level assistance with their town tax bills. Typically, a form needs to be completed by each applicant, along with a copy of the most recent tax return. Change the amounts to lower figures, copy the return, and submit it with the form and you will receive assistance. At the state level, complete the forms required for state aid, remain silent about the children's father working, earning a decent amount, and living in the same home, and the household income then falls below the set levels so that rent assistance will be provided by the state.

Financial aid programs are generally available at every private school, from pre-school through college, to assist families who qualify based on income limits and other requirements. Once again, the families often complete the forms and provide a "version" of the latest tax return showing lower than actual income. These fraud schemes are perpetrated against every program in existence.

Let's look at the world of insurance. How many types of insurance fraud can you name? First, there is the fraud committed in the application process to obtain coverage, regardless of the type of coverage. Fraud can be committed in virtually every type of insurance known to exist. Leave the past health issues off the health insurance application, fail to mention that the vehicle will be used primarily for business on the automobile application, or indicate that you will be living in the property when a tenant has already been lined up. Then there are the insurance claim fraud schemes. Staged accidents, torched cars (especially when the amount owed on the vehicle exceeds the car's value), faked injuries, previous undisclosed health conditions, burglaries that never occurred, fires that were set, water damage that was intentional, thefts that never occurred, and inflated inventories supporting a loss claim are just a few scheme areas. The goal is to obtain free money from the insurance company, who supposedly can afford the pay out, especially since high premiums have been paid to the insurance company on time all along-a "return on investment" rationalization.

Financial institutions have their share of fraud as well, committed by both banking customers and bank employees alike. Retail banking schemes could include opening new accounts under false pretenses or using fraudulent information, passing stolen or counterfeit cash or checks, and kiting (building up a fictitious balance in an account). The lending side of banking is at risk for loan application fraud, collateral fraud (the collateral is nonexistent, fictitious, or owned by someone else), and financial statement fraud. Mortgage fraud alone has developed into a multifaceted area for fraud investigations, involving attorneys, appraisers, real estate agents, mortgage brokers, loan originators, lenders, and anyone else party to a real estate closing.

Linked to financial institution fraud are investment fraud schemes. Hedge fund managers and investment advisors churning investments to generate commissions, outright stealing investments or proceeds from inactive investment accounts, and issuing fictitious statements to account holders to conceal the activity are all common practices. Certainly, Bernard Madoff's Ponzi scheme may be the largest in history at $50 billion, but as more facts surface about the scheme, it may have been nothing more than an outright theft of investor funds. Two more similar schemes have recently been discovered in my state alone, each approximating $350 million. It makes you wonder just how many of these exist, waiting to be revealed.

While the recent cases with staggering amounts involved have caught significant attention, making it appear as if these schemes are a new phenomenon, the reality is that investment schemes have been occurring ever since individuals have entrusted others with their funds. The following is a case I worked on early in my career.

The point being made in this chapter is that there are many different types of fraud, more than can ever be covered in one book, let alone one chapter. The focus of the remaining chapters will be on financial fraud schemes perpetrated by employees and organizations. In the next chapter, we discuss why fraud is committed, as well as why the occurrences are increasing at an alarming rate.

Case Study 1.1 - Public Aid Goes "Fraud Proof"

In my state, we have a publicly funded social program available to low-income individuals whereby qualifying recipients receive state aid to purchase food and other qualifying provisions. Our food stamp program used to require individuals to apply for assistance, and once qualified, the individuals received food stamps in the mail each month to be used similar to cash for purchasing food.

There were many fraud schemes perpetrated involving the food stamp program. Food stamps were often mailed to recipients on the same day each month, and the theft of recipients' mail became commonplace, as did simply robbing the recipient of his or her food stamps as they redeemed them. Food stamps became a form of currency on the black market, used in exchange for virtually any item and service. Recipients would pay for things never intended to be covered by food stamps, and in turn the individuals who were redeeming food stamps for food purchases were often living well beyond the intended income levels of the program.

There were also individuals who received multiple food stamp allocations each month by applying and qualifying using different names and multiple addresses. Children of qualified individuals were often claimed by several different individuals in their own qualification process, enabling each applicant to receive more food stamps per month than they were entitled to by listing children who were actually someone else's children who were already receiving food stamp benefits.

I remember waiting in the supermarket checkout lines behind individuals purchasing groceries with food stamps. Although the program required recipients to purchase generic labeled items, they were purchasing brand-name labels intermixed with generic items. I also saw alcohol, cigarettes, magazines and many other non-covered items being purchased. In the stores with more sophisticated registers, the non-covered items would be segregated and could not be paid for using food stamps. The clerk would collect food stamps for the covered items and then I would watch as the customer pulled out a large roll of cash to pay for the remaining items. I often wondered how the person could have qualified for food stamps with such a large amount of cash. In less sophisticated stores, though, all the items (even those specifically deemed as non-qualifying items) went through and were purchased with food stamps.

Once I asked a cashier after the customer had left why the non-covered items were allowed to be paid for by food stamps. The clerk told me that the store is reimbursed by the state for the same amount either way, so why should they tell customers what they can and can't buy with the food stamps? That mentality made the store an accessory to defrauding the food stamp program.

A few years ago, the state recognized the extent of the fraud issues, or more likely decided to finally address the issue and developed a new system. I attended a session sponsored by the food stamp program in which the two individuals who designed the new automated system presented the way the new food stamp system would work. The individuals explained that they had developed a debit card system to eliminate fraud within the program.

Each recipient would be issued a card similar to an ATM card that could be used to purchase qualifying food items. Each card would have an account associated with it, and each month the card would be replenished with the individual's qualifying amount. There would be no mailing of coupons, theft of mail, or robbing recipients. One card would be issued to each recipient, eliminating the risk that recipients would trade cards or use the monthly proceeds as trade in other transactions.

The presentation ended with the individuals feeling confident that their new system would eliminate the prior fraud and abuse, allowing the program to become a better steward over the public's funds.

The program wasn't even a month old when I found myself behind a customer using one of the new cards. I remembered the session, and my interest was piqued to see how this new system would work. I watched as the groceries were rung, and items not covered were segregated for the customary separate cash payment. The individual opened her wallet and removed her state card, then swiped it on the credit card terminal used for debit and credit card purchases. Three swipes later the clerk told the customer the balance on the card was insufficient to cover the cost of the groceries. Without blinking an eye, the customer opened her wallet again and removed three similar cards. By the third card swipe, there were sufficient funds to complete her purchase.

So much for the state's new program! And how much did they invest in this new system?

Case Study 1.2 - Creative Approaches to Funding Higher Education

Many programs have an application process that requires supporting information to be provided to corroborate the information provided. Unfortunately, the programs' screening processes are often inadequate or outdated. Home computers and inexpensive software packages have made it relatively easy to create supporting documentation that, unless scrutinized and challenged, can easily meet the requirements for eligibility for the program. Bank statements can be easily scanned and then altered to reflect any desired balances. Tax returns can be run over and over again using packages like TurboTax to produce different results.

One great example of this type of fraud is the application process for college financial aid. In addition to completing the required forms, the applicant must also provide copies of tax returns and bank statements.

(Continues...)

Excerpted from Fraud 101by Stephen Pedneault Copyright © 2009 by John Wiley & Sons, Ltd. Excerpted by permission.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
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Edition details

• Publisher: Wiley
• Publication date: 2009
• Language: English
• ISBN 10: 047048196X
• ISBN 13: 9780470481967
• Binding: Hardcover
• Edition number: 3
• Number of pages: 256