An Introduction to Fraud

Dr. Richard G. Brody, CPA, CFE, CFF, FCPA

Anderson School of Management
Douglas Minge Brown Professor
University of New Mexico
 Estimated Costs/Impacts of Fraud
Report to the Nation

• $994 billion per year (2010 Global Estimate is

more than $2.9 trillion)
• $6,860 per employee

• $18.30 per day per employee

• 5 - 7% of revenue lost

• 5 - 7 cents on every revenue dollar stolen

 The Seriousness of Fraud
• How is the magnitude perceived to be changing?

• Size and dollars

• Effect on stock price

• Collusion

• Credibility issue
 Fraud is a Costly Business Problem

• Fraud reduces a firm’s • Fraud Robs Income

net income on a
dollar-for-dollar basis.
• If the profit margin is Revenues $100 100%
Expenses 90 90%
10%, revenues must Net Income $ 10 10%
increase by 10 times Fraud 1
Remaining $ 9
losses to recover the
effect on net income. To restore income to $10, need
$10 more dollars of revenue to
generate $1 more dollar of
income.
What Does the Fraudster Look Like?
• Like you and me
• No specific psychological profile
• Male: U.S. 57%; Global 67%
• Occupational fraudsters are generally
first-time offenders.
– Only 7% of fraud perpetrators had prior
convictions, and only 10% had been
previously terminated by an employer for
fraud-related conduct.
 Seven Elements of Fraud
1. A representation
2. About a material point
3. Which is false
4. And intentionally or recklessly so
5. Which is believed
6. And acted upon by the victim
7. To the victim’s damage
 Why Are We so Often Conned?

• Trusting – we trust too much

o Often a “I can’t believe it” response
• Greed – rules many decisions
o The perpetrator is not the only one
 Ways to Classify Frauds

• Fraud against an organization

• Fraud on behalf of or for an organization

The Fraud Triangle
 Personal Integrity and the
Likelihood to Commit Fraud

• The higher the personal integrity, the less

likely to commit fraud.
• Will take much more of the three fraud
elements to move them to commit fraud.
• Fraud studies show that levels of honesty
are decreasing.
 The First Element:
Perceived Pressure

1. Financial

2. Vices

3. Work-related

4. Other
 The Second Element:
Perceived Opportunity

The three components of perceived opportunity:

1. To commit fraud

2. To conceal fraud

3. To avoid punishment
 Factors that Increase Opportunities to
Commit Fraud

1. Ability to get around internal controls that

prevent or detect fraud
2. Inability to judge quality of performance

3. Lack of an audit trail

4. Failure to discipline prior fraud perpetrators
 Conditions that Create
Opportunities for Fraud
• Management not caring about • Unreasonable Budget
honesty or ethics Expectations
• Inadequate Pay • Short-Term Focus
• Low Loyalty • Reactive vs. Proactive
• Crisis Management • Hostile Work Environment
• Poor Promotion Opportunities • Poor Training
• Rapid turnover of key • Failure to inform employees
employees about rules and discipline of
• Absence of periodic rotations fraud perpetrators
or transfers of employees • Lack of internal security
• Absence of mandatory • Familiarity with operations
vacations
• Close association with suppliers
and other key people
 The Third Element:
Rationalization

• People rationalize their unacceptable

behavior
• Helps the fraudster hide from the
dishonesty of the acts
• Involved in nearly every fraud
 Common Rationalizations
• They owe it to me.
• I’m only borrowing the money.
• Nobody will get hurt.
• I deserve more.
• It’s for a good cause.
• We’ll fix the books as soon as we get past this
little financial problem.
• It’s for my sick child.
 Activities Fundamental
to Fraud Prevention

First:
Create and Maintain a Culture of Honesty,
Openness and Assistance
 Activities Fundamental
to Fraud Prevention

Second:
Assess the Risk of Fraud and Develop Concrete
Responses to Minimize Risk and Eliminate
Opportunity
Current Model for Dealing with Fraud

1. Fraud incident
2. Investigation
3. Action
4. Resolution
 Actions Fraud Savvy Organizations
Take to Minimize Fraud

1. Tone at the top

2. Education and training
3. Integrity risk and controls
4. Reporting and monitoring
5. Proactive detection
 Tone at the Top
Management and Directors
• Backgrounds
• Motivations
• Influence on Decision Making
 Tone at the Top (continued)
Management’s Expectations

1. Appropriate Values & Ethics

2. Fraud Awareness & Training
3. Consistent Punishment of Violators
 Education and Training
• Prevention is the key!
• Proactive fraud education
– Employees
– Vendors
– Other outsiders
 Integrity Risk & Controls
• Implement effective internal controls
– An ongoing task
– Override of controls
– Ignore controls

• Learn from frauds that are detected

– Implement controls to prevent future occurrences
– Who was involved in the fraud?
– Were controls compromised or were they absent?
 Reporting and Monitoring
• Most frauds are detected from tips
• Employees must be alert to red flags that
signal fraud
• Employees must be willing and able to report
potential fraud
• Company should report fraud so that
employees know that fraud does exist and it
is THEIR problem, one they can prevent
 Proactive Fraud Auditing/Detection

1. Identify risk exposures

2. Identify fraud symptoms for each exposure

3. Audit programs proactively look for
symptoms and exposures
4. Investigate identified symptoms
 Summary
Keys to Fraud Prevention/Detection

• “Walking the talk” – leading by example

• Educating employees and others – they understand the
problem and know what to do if they suspect fraud
• Hotlines/Anonymous reporting mechanisms – potential
fraud can be reported
• Control procedures prevent and detect fraud
• Fraud audits create fraud awareness – individuals know
their work is always subject to review