The Most Effective Controls in Limiting Fraud Losses

GUEST BLOGGER

John Warren, J.D., CFE
ACFE Vice President and General Counsel

One of the most important things we try to accomplish with our global fraud study, the Report to the Nations, is to identify key characteristics about organizations that have been victimized by occupational fraud. Although every business is vulnerable to fraud, the more we can learn about organizations that suffered frauds in the past, the more information we will have to prevent occupational fraud or at least limit its impact in the future.

Perhaps the most important victim data contained in the Report to the Nations is the information we gather on anti-fraud controls. We ask each of our respondents to tell us which, if any, of 16 common anti-fraud measures were utilized by the victim organizations while the frauds were occurring. We then compare the losses based on whether a particular control was or was not present. For example, in 2012 we found organizations that used a hotline experienced a median loss of $100,000 per occupational fraud case, while organizations that did not use a hotline had a median loss of $180,000.  This analysis gives us a general indication of the impact various anti-fraud controls have in limiting fraud losses. We can say, for instance, that the presence of a hotline was associated with a 44.4 percent lower median fraud loss.  

In the table below, we’ve presented the results of this analysis for each edition of the Report to the Nations dating back to 2008. For each anti-fraud measure, you can see the reduction in fraud losses it was associated with, along with its ranking relative to other controls.[1]One interesting thing to note is that every one of these controls was associated with lower fraud losses in all three editions of the Report.  

The key information in this table is contained in the yellow shaded columns at the right, where we have combined the results from all three editions of the Report. This data comprises more than 4,100 total cases of occupational fraud. The two bold columns show the average loss reduction and overall ranking of each control for the three combined studies. We see here that hotlines have ranked No.1 among all anti-fraud measures in this analysis, typically being associated with a 54.5 percent reduction in fraud losses.  Hotlines were followed by employee support programs, surprise audits, fraud training for managers and executives, job rotation/mandatory vacation, and fraud training for employees.  Every one of those six anti-fraud controls was associated with at least a 45 percent reduction in fraud losses, and all six controls ranked in the top 8, respectively, in each edition of the Report. 

In the two far-right columns of the table above, we have presented the average rate of implementation for each control.  In other words, this shows what percentage of victim organizations were utilizing each control at the time the frauds occurred. We can clearly see that the six most effective anti-fraud measures all scored poorly in terms of implementation. With one exception, these controls all ranked 9^th or lower in terms of implantation rate, and only two of them were used by more than half of the organizations in our studies.

What this data seems to indicate is that the anti-fraud measures which tend to have the greatest impact on fraud losses are being under-utilized. Every control in the table above is important and they all have an impact not only in limiting fraud losses but also in preventing them. But the six highest ranking anti-fraud controls, according to our study, are utilized by an unacceptably low number of companies and agencies. 

Every organization is, at some point, vulnerable to occupational fraud. Ideally we would prevent all such frauds from ever occurring, but sooner or later a fraud will occur, and when it does, the best thing we can do is catch it as quickly as possible and limit the financial impact of the crime. We hope organizations that are serious about reducing their exposure to occupational fraud will consider this data and in future studies we will see the implementation rates for hotlines, support programs, surprise audits, fraud training and job rotation increase substantially.

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[1] “Formal Fraud Risk Assessments” was not a category prior to the 2012 Report.

Dallas is Back, but J.R.-Style CEOs Never Went Away

SPECIAL TO THE WEB

Robert Tie, CFE, CFP
Contributing Editor, Fraud Magazine

Is the recent re-appearance of a 1980s fictional swindler worthy of CFEs' professional attention? You bet, because it's a more-relevant-than-ever character study of a cunning, driven and egocentric fraudster.

Crooked oil baron J.R. Ewing is the antihero of famed soap opera Dallas, which has just returned to television after a 21-year hiatus. As senior partner and de facto chief executive of the family business, J.R. has always been up to no good. And now, in 10 new episodes, he plans more felonious deceptions.

J.R.'s business associates have every reason to be nervous. His past frauds spanned a broad range of targets and techniques: conspiring to "fix" oil prices, violating a U.S. State Department embargo by clandestinely selling oil to Cuba and setting up an illegitimate shell company to fraudulently hide his business interests from others entitled to full disclosure, including his honest junior partner, younger brother Bobby.

Whether or not J.R.'s crimes pay off, the show focuses mostly on what he plots against others and how they retaliate. But seldom do misfortunes befall J.R. or Ewing Oil because of something he has not done.

Of course, real-life executives cut from the same cloth as J.R. hurt their companies actively, by their deliberate frauds, and passively, by their negligent inattention to detecting and preventing others' illicit schemes.

A case in point: At the 23rd Annual ACFE Fraud Conference & Exhibition in June, convicted felon Mark Whitacre told how he and other dishonest executives claimed $660,000 in phony-expense reimbursement from their employer, agribusiness giant Archer Daniels Midland, to cover personal losses they had suffered as victims of an advance fee scam (see Fraud Examiners Manual, section 1.838). Obsessed with their own enormous price-fixing conspiracy to cheat ADM customers, these J.R. clones were greedily blind to any and all fraud risks threatening them or their company.

In the oil business, as in other industries, that kind of myopia can lead to considerable and sometimes undetected fraud-related losses.

PROACTIVE LOSS PREVENTION

Tim J. Leech, CFE, FCA, CIA, CMA, is managing director of global services at Risk Oversight Inc., a Toronto- and Calgary-based consultancy that advises corporate boards and management on mitigating their organizations' vulnerability to fraud and numerous other perils. Early in his career, Leech worked in the energy sector in Calgary as Gulf Canada Resources' audit manager in charge of loss control.

"To do my job as well as possible, I went down to Houston and learned how to steal oil and gas," he recalled. There, an energy industry trade group schooled Leech in the various techniques thieves use to defraud oil producers.

"In one scam, the trucker who hauls crude from your well adds a secret compartment to the inside of his main tank," he said. "And every time he pulls up at your site, he surreptitiously puts some of your product in that hidden extra tank. Then, after he delivers the oil he legitimately took, he makes a second stop to off-load the oil he stole. You never know the difference, but it all comes off your bottom line. And he keeps on bleeding you until you wise up."

Another fraud was more sophisticated. Wells often discharge a mixture of oil and salt water. Producers separate the two, and truck the water away as waste. But scheming employees sometimes divert oil into the water tankers, which haul it off for surreptitious refinement and theft of oil the producer's management never knows it has lost, Leech said.

Read the rest of the article on Fraud-Magazine.com.

The View from ACFE Japan on the Olympus Fraud Case

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Daisuke Wakiyama, CFE
President and CEO, D-Quest Inc., Vice President, ACFE Japan

The Olympus fraud case was and remains a very serious problem. Not only does it raise doubts about the transparency and soundness of the Japanese market, but it also raises questions about the reliability of the Japanese themselves. What’s devastating is not just the amount of money involved, but also the duration of the fraud -- and the fact that the whistleblower was not Japanese, but British.

Some may think, “A Japanese person would take part in fraud, but a British person would not” or, “A British CEO revealed fraud; a Japanese person could not do so.” This impression may stir a sense of distrust of the very character of all Japanese.

As you may be aware, Olympus, the global manufacturer of medical equipment with a market share exceeding 70 percent, avoided being delisted from the Tokyo Stock Exchange despite its concealment of a 100 billion yen loss. Based on the extended period of this concealment, the soundness of the company’s structure is naturally cast into question. People in and outside of Japan may look upon Olympus’ survival optimistically, but has market confidence been truly secured?

This is not something we can overlook as an isolated incident. Yet, we must keep in mind that this is a serious issue involving one company, rather than a sign of the deficient moral fabric of the nation itself and the corporate ethics/governance that shapes everything around it. We must remain vigilant to identify trends that may compromise accountability.

The interest in Olympus’ former CEO Michael Woodford may fade, but we can’t deceive ourselves into thinking that the story is over in the eyes of the world economy. Japan overall is a first-rate, advanced nation, but without a strong economy, Japan may indeed slip into the status of second-rate nationhood.

In the midst of an economic downturn, the eradication of the fraud undermining our nation and companies is critical to the structuring of a robust securities and capital market for efficient corporate activity. Amid such challenges ACFE Japan has many roles to fill and we are up to the challenge.

Follow Up: It’s a New Dawn, It's a New Day in Corporate Governance

GUEST BLOGGER

Sheila Keefe, CFE, CPA
Principal, BDR Advisors LLC

FOLLOW UP: Board directors must devote adequate resources to address fraud

James Murdoch, News Corporation’s deputy chief operating officer, found his career implode shortly after his testimony in front of Parliament was disputed by two high-level News Corp. executives. According to the executives, Murdoch knew that the hacking was a more pervasive problem as early as 2008. Perjury aside, the corporate governance concern has to be the lack of adequate investigation and response employed by Murdoch. Rather than launching a full investigation into the hacking as he had claimed, News Corp. underwrote only two limited-scope investigations. The first in 2006 was a preliminary investigation in the wake of the reporter’s arrest. The second investigation, supposedly more expansive, took place in 2007 in response to a wrongful termination lawsuit by the shady reporter; that investigation involved questions focused on just five staffers related to the terminated reporter.

Lack of adequate investigation into suspected fraud has been at the center of other recent board director woes; specifically, infoGroup Inc. and DHB Industries. For infoGroup, audit committee chairperson Vasant Raval was prosecuted for inadequately investigating fraud. In response to allegations of self-dealing by the CEO, Raval conducted a one-man investigation that lasted just 12 days. According to reports, the audit committee chairman did not look into the CEO’s expenses. With DHB Industries, the SEC charged three ex-directors who served on DHB Industries Inc.'s audit committee for being "willfully blind to numerous red flags" of fraud.

The SEC has come out and said that it does not wish to concern the majority of hard-working board directors: "We will not second-guess the good-faith efforts of directors. But in stark contrast, Krantz, Chasin and Nadelman were [DHB Industries] directors and audit committee members who repeatedly turned a blind eye to warning signs of fraud and other misconduct by company officers," said Robert Khuzami, director of the SEC's Division of Enforcement.

What can be learned from these recent scandals involving News Corporation, infoGroup Inc. and DHB Industries is that board directors and audit committee members must be strident in their investigations into allegations of fraud and devote adequate resources to address fraud, known and unknown.

News of the World: ‘Everybody is Doing It’ is Not a Defense

GUEST BLOGGER

Sheila Keefe, CFE, CPA
Principal, BDR Advisors LLC

At the center of the News of the World scandal is the premise that violating the law is okay as long as it’s done consistently throughout the industry. To wit, as a rising star in tabloid journalism, Rebekah Brooks (then known as Rebekah Wade) stated to investigators in 2003 that she was sure that “we have paid the police for information in the past.” Upon further inquiry about specifics, Brooks declined to comment, implying that while she did not know of any specific bribes, she was indeed aware that payments to law enforcement were prevalent in the tabloid industry.

Even if we were to believe that Brooks did not know of any specific bribes, her statement in 2003 indicates that she was savvy enough about the tabloid journalism industry to know that juicy tidbits often come at a price. As Brooks ascended the, ranks in News of the World, one would reasonably assume that she knew darn well the origins of salacious details that would later bubble up from her staff that are at the center of the current hacking scandal.

Brooks has been arrested, without charges filed at the moment, and has resigned. Aside from the outcome of Brooks individually, the higher lesson of the News of the World case is that tone at the top dictates the course of an organization. News of the World follows in the embarrassing footsteps of other organizations that have previously enjoyed the public trust, specifically Hewlett-Packard and Berkshire Hathaway.

In the case of HP, board chairman Patricia Dunn worked through intermediaries to obtain phone recordings of other HP board members and nine journalists. This scandal was the first of many blunders HP shareholders had to endure, including the misguided ‘leadership’ of Carly Fiorina who questioned the very premise of the honored and revered ‘Bill and Dave Way’ that made HP a legend and, later, the ethical violations attributed to the now-departed Mark Hurd.

As for Berkshire Hathaway, this corporate scandal involved the use of insider information by heir-apparent David Sokol. While Warren Buffett had specifically prohibited the practice of inner circle management proposing investment in a particular company for which a senior staffer had an existing or imminent financial interest, Sokol just couldn’t help himself. He went right ahead and bought a stake in Lubrizol prior to Berkshire Hathaway taking a $9 billion stake in the company. While Sokol’s actions were shameful, Buffett took a share of the blame in the public eye when he was less than forthcoming in initial press dealings as to the reasons for Sokol’s unexpected departure.

Left unchecked, poor ethical practices are likely to recur in organizations that have suffered at least one ethical breach. As such, Rupert Murdoch must be tireless in the coming days, weeks and months to assert affirmative control over the ethical leadership of his many other enterprises to ensure that such shameful events do not recur.