Fraud

The Environment of Fraud Preventing Internal Fraud External Fraud

Acknowledgments
Material is from:  Essentials of Corporate Fraud, T L Coenen, John Wiley & Sons, 2008  The Art of the Steal, Frank Abignale, Broadway Books, 2001  CISA Review Manual, 2009  Check Fraud: A Guide to Avoiding Losses  The Art of Deception, Mitnick & Simon, Wiley & Sons, 2002 Author: Susan J Lincke, PhD Univ. of Wisconsin-Parkside Reviewers: Funded by National Science Foundation (NSF) Course, Curriculum and Laboratory Improvement (CCLI) grant 0837574: Information Security: Audit, Case Study, and Service Learning. Any opinions, findings, and conclusions or recommendations expressed in this material are those of the author(s) and/or source(s) and do not necessarily reflect the views of the National Science Foundation.

The Problem

Internal Fraud Recovery

 
$0 Recovered Recovery<=25% Substantial Recovery

Organizations lose 5-6% of revenue annually due to internal fraud = $652 Billion in U.S. (2006) Average scheme lasts 18 months, costs $159,000 25% costs exceed $1M Smaller companies suffer greater average $ losses than large companies

Essentials of Corporate Fraud, T L Coenen, 2008, John Wiley & Sons

Internal or Occupational Fraud

Definition  Violates the employees fiduciary responsibility to employer  Is done secretly and is concealed  Is done to achieve a direct or indirect benefit  Costs the organization assets, revenue, or opportunity
Essentials of Corporate Fraud, T L Coenen, 2008, John Wiley & Sons

Fraud Categories
Categories Asset Misappropriation % of Cases, $ Average 91% $150,000 Examples Theft of checks, cash, money orders, inventory, equipment, supplies, info Bribe to accept contractor bid or Kickback, Collusion, Bid rigging. Extortion: threat of harm if demand not met; False Billing: Providing lower quality, overcharging Conflict of interest in power decision Corporate espionage: Sell secrets Revenue Overstatement: False sales Understating Expenses: Delayed or capitalization of expenses Overstating Assets: No write down of uncollectable accounts, obsolete inventory, Understating Liabilities: Not recording owed amounts Misapplication of Accounting Rules, etc.

Bribery & Corruption

31% $538,000

Financial Statement Fraud

10% $2,000,000

Vocabulary
Skimming: Taking funds before they are recorded into company records Cash Larceny: Taking funds (e.g., check) that company recorded as going to another party Lapping: Theft is covered with another persons check (and so on) Check Tampering: Forged or altered check for gain Shell Company: Payments made to fake company Payroll Manipulation: Ghost employees, falsified hours, understated leave/vacation time Fraudulent Write-off: Useful assets written off as junk Collusion: Two or more employees or employee & vendor defraud together False Shipping Orders or Missing/Defective Receiving Record: Inventory theft
Essentials of Corporate Fraud, T L Coenen, 2008, John Wiley & Sons

Legal Considerations of Fraud



Intentionally false representation

Not an error Lying or concealing actions Pattern of unethical behavior

Personal material benefit  Organizational or victim loss



Essentials of Corporate Fraud, T L Coenen, 2008, John Wiley & Sons

Key Elements of Fraud

Motivation: Need or perceived need Opportunity: Access to assets, information, computers, people Rationalization: Justification for action
Motivation

3 Key
Elements

Opportunity

Rationalization

Essentials of Corporate Fraud, T L Coenen, 2008, John Wiley & Sons

How Fraud is Discovered

How Fraud is Discovered
0 0 2 20 0 0 Tip y Accident nternal Audit nternal Controls E ternal Audit otified by olice

Some fraud is discovered via multiple reporting methods, Thus results do not sum to 00% Tips come from Employee 6 %, Anonymous 8%, Customer %, Vendor 7%
Essentials of Corporate Fraud, T L Coenen, 2008, John Wiley & Sons

After Fraud Discovered

Discipline May include repay ent Ter ination of E ploy ent
Why Fraud not Reported to Law Enforcement
0 0

Civil or Cri inal legal action

0 20 0 0 Fear of ad pu licity nternal dis cipline s ufficient rivate s ettle ent Too cos tly to purs ue

Essentials of Corporate Fraud, T L Coenen, 2008, John Wiley & Sons

Who Does Fraud?

 

Most $$$ internal frauds committed by longer-tenured, older, and more educated staff Executives commit most expensive fraud: $1M
4.5 times more expensive than managers: $218K 13 times more expensive than line employees

Men & women commit fraud in nearly equal proportions, but mens are more expensive:
Mens average: $250k (or 4x) Womens average: $120k

 

92% have no criminal convictions related to fraud To steal a lot of money, you must have a position of power and access: highly degreed > HS grad, older > younger people Collusion dramatically increases duration and $ loss for fraud Essentials of Corporate Fraud, T L
Coenen, 2008, John Wiley & Sons

Discussion Points
What types of fraud could computer programmers or system administrators commit?  For each type of fraud, what methods may help to prevent such fraud?


Example 1: Financial Statement Fraud

Dunlap of Sunbeam had such high expectations that employees needed to meet the standards or be fired. To meet his high standards, it was necessary to play the game, and financial statement fraud was accepted. Methods of such fraud may include: manual adjustments to accounts or improper accounting procedures
Essentials of Corporate Fraud, T L Coenen, 2008, John Wiley & Sons

Example 2: Corruption
The Chief Financial Officer had divisional controllers who oversaw various regions. When one controller left, the CFO permanently took over her responsibilities. Checks and balances between the two positions were violated, and the CFO was able to embezzle from the company. Temporary assumption of some responsibilities may have been acceptable
Essentials of Corporate Fraud, T L Coenen, 2008, John Wiley & Sons

Example 3: Asset Misappropriation

A manager took money from one account, and when payment was due, paid via another account. When that was due, she paid via a third account, etc. This lapping went on for years and was finally caught when a sickness resulted in her being absent from work for an extended period.
Essentials of Corporate Fraud, T L Coenen, 2008, John Wiley & Sons

Detecting & Preventing Fraud

How to Recognize Fraud How to Prevent Fraud Info. Systems Applications
Essentials of Corporate Fraud, T L Coenen, 2008, John Wiley & Sons

Fraud & Audit

   

Audits are not designed to detect fraud Goal: Determine whether the financial statement is free from material misstatements. Auditors test only a small fraction of transactions Auditors must:
Be aware of the potential of fraud Discuss how fraud could occur Delve into suspicious observations and report them
Essentials of Corporate Fraud, T L Coenen, 2008, John Wiley & Sons

Red Flags
 

Significant change in lifestyle: New wealth Financial difficulties may create need
Gambling or drug addiction Infidelity is an expensive habit

    

Criminal background Chronic legal problems: person looks for trouble Dishonest behavior in other parts of life Beat the system: Break rules commonly Chronically dissatisfaction with job
Essentials of Corporate Fraud, T L Coenen, 2008, John Wiley & Sons

Work Habits of Fraudsters

One or more:  Justifying poor work habits  Desperately trying to meet performance goals  Over-protective of certain documents (poor sharing or avoids documentation)  Refusal to swap job duties  Consistently at work in off-time (early or late) or never absent
Essentials of Corporate Fraud, T L Coenen, 2008, John Wiley & Sons

Potential Transaction Red Flags

Unusual transactions:  Unusual timing, too frequent or infrequent  Unusual amount: too much or too little  Unusual participant: involves unknown or closely-related party  Voided checks or receipts, with no explanation  Insufficient supervision  Pattern of adjustments to accounts  Different addresses for same vendor, or vendors with similar names
Essentials of Corporate Fraud, T L Coenen, 2008, John Wiley & Sons

Fraud Control Types

After Fraud Time of Fraud Before Fraud: ***BEST***

Corrective Controls: Fix problems and prevent future problems Includes: Punishment-> Amend controls

Detective Controls: Finding fraud when it occurs Includes: Anonymous hotline*-> Surprise audits*-> Monitoring activities-> Complaint or fraud investigation

Preventive Controls**: Preventing fraud Includes: Risk assessment Develop internal controls Physical security & data security Authorization (Passwords, etc) Segregation of duties Fraud education

Techniques to Discourage Fraud

Realistic job expectations Adequate pay Motivation Training in job duties

Segregation of duties Checks and balances Opportunity Job rotation Physical security of assets Background checks Mandatory vacations Examination of required documentation

Key Elements

Trained in policies Rational- and procedures ization Policy enforcement Sr. Mgmt models ethical behavior to customers, vendors, employees, share holders

Essentials of Corporate Fraud, T L Coenen, 2008, John Wiley & Sons

Segregation of Duties

Authorization Approves Acts on

Distribution

Origination

Double-checks

Verification

CISA Review Manual 2009

IT Segregation of Duties
Requirements/Design Systems Analyst Database Administrator User End User Data Entry Test Environment Quality Assurance Security Control Group Security Admin Development Environment: Application programmer Systems programmer Production Environment Computer Operator System Administrator Network Administrator Help Desk

Segregation of Duties Controls

Transaction Authorization Custody of Assets  Data owners responsibility is specific and documented
Allocates authorization according to least-privilege and segregation of duties


Security Administrator implements physical, system & application security

Authorization forms User authorization tables: who can view/update/delete data at transaction or field level
CISA Review Manual 2009

Compensating Controls
When Segregation of Duties not possible, use:  Audit Trails  Transaction Logs: Record of all transactions in a batch  Reconciliation: Ensure transaction batches are not modified during processing  Exception reporting: Track rejected and/or exceptional (non-standard) transactions  Supervisory or Independent Reviews Separation of duties: authorization, distribution, verification
CISA Review Manual 2009

Software to Detect Fraud



   

Provide reports for customer credits, adjustment accounts, inventory spoilage or loss, fixed-asset writeoffs. Detect unusual anomalies such as unusual amounts or patterns Compare vendor addresses and phone numbers with employee data Use Range or Limit Validation to detect fraudulent transactions Logged computer activity, login or password attempts, data access attempts, and geographical location data access.
Essentials of Corporate Fraud, T L Coenen, 2008, John Wiley & Sons

Red flags software can detect

      

Out-of-sequence checks Large number of voids or refunds made by employee or customer Manually prepared checks from large company Payments sent to nonstandard (unofficial) address Unexplained changes in vendor activity Vendors with similar names or addresses Unapproved vendor or new vendor with high activity Essentials of Corporate Fraud, T L
Coenen, 2008, John Wiley & Sons

Encourage Security in IT Departments

     

Physical security Segregation of duties Employee monitoring Surprise audits Job rotation Examination of Documentation

Quality Assurance

Programmer Analyst

Business Analyst

Business Application Checks

Checks locked up; access restricted  Physical inventory of checks at least every quarter  New accounts payable vendors existence and address double-checked by management  Returned checks sent to PO Box and evaluated by someone independent of Accts Payable

The Art of the Steal, Frank Abignale, Broadway Books 2001

Question
What is the MOST effective means of preventing fraud? 1. Effective internal controls 2. Fraud training program 3. Fraud hotline 4. Punishment when fraud is discovered

Question
Which of the following duties can be performed by one person in a well-controlled IS environment? 1. Software Developer and System Administration 2. Database administration and Data Entry 3. System Administrator and Quality Assurance 4. Quality Assurance and Software Developer

Question
A woman in the accounting department set up a vendor file with her own initials, and was able to steal more than $4 M after 3 years. The auditor should have found that: The vendor was a phony company Purchases from the vendor did not result in inventory received The initials for the vendor matched an employee in the accounting dept. Management did not authorize new vendors with a separate phone call

1. 2. 3. 4.

External Fraud
Social Engineering Check Fraud Other Scams

From: The Art of the Steal, Frank Abignale, Broadway Books 2001 & Check Fraud: A Guide to Avoiding Losses

Social Engineering I
Email:  The first 500 people to register at our Web site will win free tickets to  Please provide company email address and choose a password


You received a message from Facebook. Follow this link log in. Social engineering: Getting people to do something they would not ordinarily do for a stranger Social engineering is nearly 100% effective
The Art of Deception, Mitnick & Simon, Wiley, 2002

 

Social Engineering II
Telephone call from IT:  Some company computers have been infected with a virus that the anti-virus software cannot fix. Let me walk you through the fix  We need to test a new utility to change your password

Social Engineering III

Phone call 1:  I had a great experience at your store. Can you tell me managers name, address? Phone call 2:  This is John from X. I got a call from Alice at your site wanting me to fax a sig-card. She left a fax number but I cant read it can you tell me? What is the code?  You should be telling me the code  Thats ok, it can wait. I am leaving but Alice wont get her information  The code is Phone call or fax 3:  I need Code is

Social Engineering Techniques

  

Learns insider vocabulary and/or personnel names Pretends legit insider: I am <VP, IT, other branch, other dept>. Can you ? Pretends real transaction:
Helping: I am in trouble <or> you need help due to <My,Your> computer is <virused, broke, busy, dont have one>. Can you <do, tell me> ? Deception: Hides real question among others.

Establishes relationship: Uses friendliness to gain trust for future tasks

The Art of Decption, Mitnick & Simon, Wiley 2002

Combating Social Engineering

Verification Procedure  Verify requester is who they claim to be  Verify the requester is currently employed in the position claimed.  Verify role is authorized for request  Record transaction Organization security  Data classification defines treatment  Policies define guidelines for employee behavior  Employees trained in roles, need-to-know, and policies

Fraud Statistics
  

Businesses lose $400 Billion a year in fraud = 2 x US military budget 1/3 of $400B is embezzlement = employees stealing from employer Next highest sources (KPMG 2000)
Check forgery Credit cards Fake invoices Theft

$350 Billion for counterfeit goods

The Art of the Steal, Frank W Abagnale, Broadway Books 2001

Check Fraud Examples

Altered Checks: Chemicals are used to erase the payee or amount, then re-printed OR check is appended to.  An Argentinian modified a ticket-overpayment refund check from Miami, changing a $2 check to $1.45 Million Counterfeit Checks or Identity Assumption  Someone in your checkout line views your check, or does yard work for you  Fishes in a businesss in-mailbox or homes out-mail for a check  Checks can be purchased on-line or mail order Telemarketing Fraud:  Youve won a prize or Would you like to open a VISA? Now give me your account information. Hot Check: Insufficient Funds  90% of insufficient funds checks are numbered between 101 and 200  account opening year is printed on check
The Art of the Steal, Frank W Abagnale, Broadway Books 2001

Be Careful Printing Checks!

 

Paychecks & Accounts Payable should not be printed on blank check paper Laser printer is non-impact (ink does not go into paper but sits on top)
Easy to remove printing Laser Lock or Toner Lock seals laser printing

 

Matrix printer puts ink into the paper

Chemical washing removes the print

Good Practices
Use larger printing: 12 font Reverse toner in software: white on black Control check stock and guard checks Check your bank statements you have 30 days
The Art of the Steal, Frank W Abagnale, Broadway Books 2001

Check Security Features

Watermark: Subtle design viewable at 45-degree angle toward light. Cannot be photo-copied Void Pantograph: Background pattern of checks. When photocopied, the background patter disappears or prints VOID Chemical Voids: When check is treated with eradicator chemical, the word VOID appears Microprinting: When magnified, the signature or check border appears to be written words. The resolution is too fine for a photo-copier 3-Dim. Reflective Holostripe: Metallic stripe contains at least one hologram, similar to credit card. Security ink: React to eradication chemicals, distorting check Thermochromic Ink: Ink reacts to heat and moisture by fading and reappearing
Check Fraud: A Guide to Avoiding Losses

Processing Money Orders

Money order information provides info on a ready checking account  Non-negotiable incoming wire account prevents out-going checks

I would like to send you a money order. What is your account number? THANK YOU SO MUCH!!!

The Art of the Steal, Frank W Abagnale, Broadway Books, 2001

Fraud Scams
   

Get a receipt from the trash, return a product Copy gift certificate and cash in at multiple locations Markdown sale prices reimbursed with receipt copied and collected at multiple locations Fake UPC numbers to pay low prices then return at higher price. If receipt total is sufficient, scam may work.
The Art of the Steal, Frank W Abagnale, Broadway Books 2001

Preventing Scams


    

Receipts must have security marks on them (e.g., twocolored ink on special paper, or better: thermochromatic ink) Line-item detail on receipts and sales records in company database Garbage bins which may receive receipts should be protected from access (e.g., bank garbage bins) Register gift certificates unique numbers Shredders should be used for any sensitive information Protect against shoulder surfing or device attachment for card readers
The Art of the Steal, Frank W Abagnale, Broadway Books 2001

Study Questions


     

What are the key elements of fraud, and what techniques can be used to counteract these key elements? What are the three categories of fraud? What are the legal considerations of fraud? Who commits fraud, and who commits the most expensive fraud? What are the red flags of potential fraud? How does social engineering occur, and how can it be prevented? Apply the concept of segregation of duties.