Fraud Exam 3

1. Conflicts of Interest

2. Bribery

3. Illegal Gratuities

4. Economic Extortion

What are the four types of corruption

True

True or False: Corruption is the medium severity and frequency among fraud types

Conflicts of Interest

What is the most common type of Corruption Scheme

Bribery

Offering, giving, receiving, or soliciting anything of value to influence an official act

Invoice Kickbacks

Bid Rigging

What are the main types of bribery (2)

Kickback Schemes

• Involve the submission of invoices for goods and services that are either overpriced or completely fictitious

• Involve collusion between employees and vendors

• Almost always attack the purchasing function of the victim company

Overbilling Schemes - Employees with Approval Authority

– Vendor submits inflated invoices to the victim company

– Overstates the cost of actual goods or services or reflects fictitious sales

– Ability to authorize purchases is key to the scheme

Overbilling Schemes - Employees lacking approval authority

– Circumvent purchasing controls

– May prepare false vouchers to make it appear that the invoice is legitimate

– May forge an approval signature or have access to a restricted password in a computerized system

– Difficult to detect since the victim company is being attacked from two directions

Ways to detect Kickbacks

• Look for price inflation

• Monitor trends in cost of goods sold and services purchased

• Look for excessive quantities purchased

• Investigate inventory shortages

• Look for inferior goods purchased

• Compare actual amounts to budgeted amounts

Preventing Kickbacks

• Assign an employee independent of the purchasing

department to routinely review buying patterns

• Make sure that all contracts have a “right to audit” clause

• Establish written policies prohibiting employees from

soliciting or accepting any gift or favor from a customer or

supplier

• Expressly forbid any employee from engaging in any

transaction, on behalf of the company, in which he or she

has an undisclosed personal interest

• Implement an ethics policy that clearly explains what

improper behavior is and provides grounds for termination

if an employee accepts a bribe or kickback

Bid-Rigging Schemes

• All bidders are expected to be on an even playing field – bidding on the same specifications

• The more power a person has over the bidding process, the more influence he or she can exert over the selection of the winning bid

Bid-Rigging Schemes

The following are potential targets of what
– Buyers

– Contracting officials

– Engineers and technical representatives

– Quality or produce assurance representatives

– Subcontractor liaison employees

Need Recognition Schemes

– Employee of the purchasing company convinces the company that a particular project is necessary
– Has the specifications tailored to the strengths of a particular supplier

Need Recognition Scheme

The following are trends that indicate what:

– Higher requirements for stock and inventory levels

– Writing off large numbers of surplus items to scrap

– Defining a need that can only be met by a certain supplier

– Failure to develop a satisfactory list of backup suppliers

Specification Schemes

• Specifications include a list of the elements, materials, dimensions, and other relevant requirements

• Set the specifications to a particular vendor’s capabilities

• Use“prequalification” procedures to eliminate certain vendors

• Sole-source or noncompetitive procurement justifications

• Deliberately writes vague specifications requiring amendments at a later date

• Bid splitting

• Gives a vendor the right to see the specifications before his competitors get the specs

Solicitation Phase

The following occur during which phase:

• Restricting the pool of vendors from which to choose
• Bid pooling
• Fictitious suppliers
• Restricting the time for submitting bids
• Soliciting bids in obscure publications
• Publicizing the bid during holiday periods

Fraud in the sealed bid process

– Last bid submitted is the one that is awarded the contract

– Winning bidder finds out what the other competitors are bidding

– Winning bidder may see the other competitors’ bids before submitting his bid

Detect Bid-Rigging Schemes

The following are ways to what:

– Unusual bidding patterns

– Low bids followed by change orders

– A very large unexplained price difference among bidders

– Contractors who bid last and repeatedly receive the contract

– A predictable rotation of bidders

– Losing bidders who become subcontractors

– Vendors with the same address and phone number

– Fewer bidders than expected for the project

– Projects that have been split into smaller ones

Illegal Gratuities

– Given to reward a decision rather than influence it
– Decision made to benefit a person or company but is not influenced by any sort of payment
– May influence future decisions

Economic Extortion

– “Pay up or else”
– Employee demands payment from a vendor in order to make a decision in the vendor’s favor

Conflicts of Interest

• Employee, manager, or executive has an undisclosed economic or personal interest in a transaction that adversely affects the company
• Victim organization is unaware of the employee’s divided loyalties
• Distinguished from bribery–in conflicts of interest, the fraudster approves the invoice because of his own hidden interest in the vendor
• Purchasing schemes
• Sales schemes

Overbilling Schemes and Turnaround Sales

What are the types of purchasing schemes

Turnaround Sales

– The employee knows that the company is seeking to purchase a particular asset and purchases it himself
– Turns around and sells it to the company at an inflated price

Underbillings and Writing off sales

What are the two types of sales schemes

Underbillings

Goods are sold below fair market value to a customer in which the perpetrator has a hidden interest

Writing off sales

Purchases are made from the victim company and credit memos are later issued

Business Diversions

Resource Diversions

Financial Disclosures

Main types of conflict of interest schemes

Business Diversions

Siphoning off clients of the victim company to the employee’s own business

Resource Diversions

Diverting funds and other resources for the development of the employee’s own company

Financial Disclosures

Inadequate disclosures of related-party transactions to the company

The following are main ways to prevent and detect what:

• Implement, communicate, and enforce an ethics policy that addresses conflicts of interest offenses
• Require employees to complete an annual disclosure statement
• Establish an anonymous reporting mechanism to receive tips and complaints
• Compare vendor address and telephone files to employee address and telephone files for matches

Senior Management

Mid and lower level employees

Organized Criminals

Who commits financial statement fraud? (3)

• To conceal true business performance

• To preserve personal status/control

• To maintain personal income/wealth

Why Do People Commit Financial Statement Fraud? (3)

Playing the accounting system

Beating the accounting system

Going outside the accounting system

How do people commit financial statement fraud?

SOX Act

• Establishing higher standards for corporate governance and accountability

• Creating an independent regulatory framework for the accounting profession

• Enhancing the quality and transparency of financial reports

• Developing severe civil and criminal penalties for corporate wrongdoers

• Establishing new protections for corporate whistleblowers

PCAOB

• Registering public accounting firms that audit publicly traded companies

• Establishing or adopting auditing, quality control, ethics, independence, and other standards relating to audits of publicly traded companies

• Inspecting registered public accounting firms

Standards for Audit Committee Indepdence

• Audit committee responsibilities
• Composition of the audit committee
• Financial expert
• Establishing a whistleblowing structure

Fictitious Revenue

What is the most common financial statement scheme

Financial Statement Fraud

Deliberate misstatements or omissions of amounts or disclosures of financial statements to deceive financial statement users, particularly investors and creditors.

Fictitious Revenues

• Recording of goods or services that did not occur

• Fake or phantom customers

• Legitimate customers

• Sales with conditions

• Pressures to boost revenues

Timing Differences

• Recording revenue and/or expenses in improper periods

• Shifting revenues or expenses between one period and the next, increasing or decreasing earnings as desired

• Matching revenues with expenses

• Premature revenue recognition

• Long-term contracts

• Channel stuffing

• Recording expenses in the wrong period

Concealed Liabilities

• Liability/expense omissions

• Capitalized expenses

• Failure to disclose warranty costs and liabilities

Improper Disclosures

• Liability omissions

• Subsequent events

• Management fraud

• Related-party transactions

• Accounting changes

Improper Asset Valuation

• Inventory valuation

• Accounts receivable

• Business combinations

• Fixed assets

Vertical analysis

Analyzes relationships between items on an income statement, balance sheet, or statement of cash flows by expressing components as percentages

Horizontal Analysis

Analyzes the percentage change in individual financial statement item

Ratio Analysis

Measures the relationship between two different financial statement amounts

Ways to deter financial statement fraud

Reduce pressures to commit financial statement fraud

• Reduce the opportunity to commit financial statement fraud

• Reduce rationalization of financial statement fraud

External Fraud

Unauthorized activity, theft, or fraud carried out by a third party outside the institution that is the subject of the fraudulent behavior.

Customers

Vendors

Unrelated Third Parties

What are the three sources of external fraud

• No organization is immune

• It is impossible to conduct business without interacting with outsiders

• All businesses have exposure to the public

Why Should an Organization be Concerned About External Fraud?

Check Fraud

Credit Card Fraud

What are the two main ways customers commit external fraud

Counterfeit Checks

– Easy to produce

– Small business employees do not have the time,

resources, or expertise to scrutinize all checks

– Paperhanger – an expert in check fraud

E-Commerce Check Scams

Victim offers something for sale on the Internet

– After check is deposited but doesn’t clear, fraudster

asks for a refund and pockets the cash

Credit Card Fraud

The misuse of a credit card to make purchases without authorization, or counterfeiting a credit card

– Unauthorized use of a lost or stolen card

– Stolen card numbers

• Albert Gonzalez case

• Usually obtained via the Internet

– Counterfeit cards

Collusion among contractors

– Complementary bids – competitors submit token bids that are too high to be accepted

– Bid rotation – two or more contractors conspire to alternate the business between them on a rotating basis

– Phantom bids – phony bids from shell companies to create the illusion of competition

Contract performance schemes

– Product substitution

• Delivery of inferior material

• Delivery of used, surplus, or reworked parts

– Cost mischarging – contractor charges the procuring entity for costs that are not allowable, unreasonable, or cannot be allocated directly to the contract

Computer Fraud

• Practically all companies use computers and the Internet

• Computer crimes are difficult for fraud examiners because:

– They lack a traditional paper audit trail

– They require an understanding of the technology used in the crime

– They often require help from specialists

Computer Hacking

The use of technology to gain unauthorized access to sensitive information on a computer system

– Methods used to gain unauthorized access:

• Password cracking

• Social engineering

• Phishing

• Wire tapping

Corporate Espionage

the illegal or unauthorized acquisition of a company's sensitive business information, trade secrets, or intellectual property to gain a commercial or financial advantage