fraud risk assessment: think like a ‘demon’ & add ia value

Fraud Risk Assessment: Think Like a ‘Demon’ & Add IA Value

April 10, 20132:30p – 3:30p

Mark P. Ruppert CPA, CIA, CISA, CHFP, CHC

Director, Internal Audit (CAE)

The Institute of Internal Auditor Los Angeles Chapter

Annual Fraud Conference

Fraud Risk Assessment IA Perspective on Fraud Risk

Why Care? Why Consider Fraud Risk?

What is Fraud Risk?

Engaging Management in the Fraud Risk Discussion:• Fraud Risk Assessment• ‘Angels & Demons’ Data Collection Exercise

Incorporating Fraud Risk into Internal Audit Work Plans

Addressing Fraud Risk on an Ongoing Basis and in Individual Audits

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IA Perspective on Fraud Risk

Why Care? Why Consider Fraud Risk?

What is Fraud Risk?

Engaging Management in the Fraud Risk Discussion:• Fraud Risk Assessment• ‘Angels & Demons’ Data Collection Exercise

Incorporating Fraud Risk into Internal Audit Work Plans

Addressing Fraud Risk on an Ongoing Basis and in Individual Audits

IA’s Perspective: Fraud Risk

Heightened Risk & Challenge:

• IIA professional standards

• Ever increasing legal & compliance requirements

• Management and Board expectations

• High risk environment for fraud, corruption & abuse

• Ever increasing ingenuity on the part of fraudsters

Huge IA Opportunity:

• Get a better sense of management intuition around fraud matters

• Improve organization’s financial performance

• Protect brand value and professional reputation

• Mitigate criminal, regulatory and civil legal risk

• Enhance IA prestige/relevance

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Fraud Risk AssessmentWhy?

Federal Sentencing Guidelines require that

compliance programs:

• address specific areas of potential fraud• use audits and/or other risk evaluation techniques to monitor compliance and assist in the reduction of identified problem areas

Effective 11/2004 = USSG amended to provide greater guidance regarding compliance program criteria for an effective program to prevent and detect violations of the law:

(USSC Guidelines Manual §8B2.1. Effective Compliance and Ethics Program)

(a)(1) exercise due diligence to prevent and detect criminal conduct

(a)(2) otherwise promote an organizational culture that encourages ethical conduct and a commitment to compliance with the law– (b)(1)Establish standards and procedures to prevent and detect

criminal conduct

(c) periodically assess the risk of criminal conduct and take appropriate steps to…..to reduce the risk of criminal conduct identified

United States Sentencing Guidelines (USSG)


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• Antifraud Programs & Controls Assessment: Must evaluate how organization manages risk (IIA Standard 2120)

• Fraud Risk Assessment: CAE must report periodically to management /board on significant fraud risk exposures (IIA Standard 2060)

• Individual Audits: Must consider fraud when developing engagement objectives (IIA Standards 1220, 2210)

• Proficiency: Evaluate the risk of fraud & the manner in which it is managed by the organization (IIA Standard 1210)

Like Compliance Professionals, Internal Audit Professionals must also address fraud risk…

IIA Standards and Fraud Practice Guide Emphasize Internal Audit’s Role in Addressing Fraud


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% of survey respondents hit by fraud in past year = 88%• More “viruses” than “diseases”: under $100M

“Fraudsters’ take” = increased 20% from 2009• Up to $1.4M per $1B sales

Theft of information and electronic data = #1 reported fraud• Overtakes Physical Theft for first time• #3 & #4= Management Conflict of Interest, Vendor/Supplier Fraud

Fear of fraud is dissuading 48% of companies from operating in other countries• China & Africa = most affected (corruption #1 concern)

Companies appear unprepared for heightened FCPA enforcement and lack adequate understanding

• 2005-2009: 60 DOJ cases (more than 1977-2005)• 2010: already 130 open cases

Fraud is largely an inside job• 44% employees, 11% agents/intermediaries

Industry Lens: Fraud Prevalence• Declining: Natural Resources, Construction, Health/Pharma/Bio, Travel,

Manufacturing• Increasing: Financial, Professional Services, Tech/Media/Telecom, Retail, Consumer 7

Look at what companies are saying! -- 2010 Global Fraud Trends** [Source: 2010 Global Fraud Survey – Economist Intelligence Unit/Kroll Consulting (www.kroll.com)]



• US government admits losing 10% of spending to fraud; US government realizes a $9.75 : 1 on fraud management

• Effective fraud management produces 8:1 ROI for financial services industry

• ACFE estimate: companies lose $1 trillion or 7% of revenue to misconduct

• PwC GECS survey–40% increase in fraud,

before the recession–Controls paradox

• Economist Intelligence Unit:85% of companies detected significant frauds over past 3 years)

–10% suffer >$100 million–Large companies - $23 million–Small companies - $8.2 million average loss

Don’t Forget

Operational & Personal

Impact! 8pwc Fall 2010 IART – Fraud Risk Assessment – 11/4/10

The What: Enhanced enforcement requirements detailed in the reform law = Medicare, Medicaid and CHIP

The Why: • Medicare ‘Improper Payments’ in 2009: 8% of 4.5 million claims per day = $24 Billion• Goal to increase fraud detection and increase certainty of punishment

The Impact: Depending on provider type = more work, more expense, getting personal • Easier for CMS to suspend Medicare payments if credible fraud allegations & to prevent new

enrollments in higher-risk service areas

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To Address the Impact of Healthcare Reform: Fed Unveils New Plan for Fraud Detection

* [Source: “Cracking Down”, Modern Healthcare – 9/27/10]


The When:• Sept 2010: Proposed regs released (all 187 pages of it!)• Sept – Nov 2010: Comment period• March 2011: Implementation

Provider Type Risk CMS TreatmentHospitals, ASC, health centers, medical groups, clinics, physicians, publicly traded providers/suppliers, skilled nursing facilities

Limited Risk

Verify licenses and provider/supplier specific regulatory requirements

O/P Rehab, currently enrolled DME/prosthetics/ortho/supplies providers, currently enrolled home-health agencies & hospice organizations

Moderate Risk

Limited + unscheduled or unannounced site visits

Newly enrolled DME/prosthetics/ortho/supplies providers and home-health agencies

High Risk Moderate + criminal background check & fingerprinting

Now More Than Ever, Compliance & Internal Audit Must Have the Fraud Triangle in Focus!!!

Incentives / Pressures• Loss avoidance

•Job•Money•Prestige

• Dissatisfaction with the company

• Management & 3rd party pressures

• Community relationships• Loss of health coverage• Long term unemployment

Opportunity• Insufficient internal controls

• “Survival” mode• External collaboration• Management over-ride• Internal collaboration

• Corrupt business customs

Rationalization• Job dissatisfaction• Family priorities• Health priorities• “Everybody else” syndrome

• Self-denial of consequences to company

• Temporary loans

If Economic Downturn is the “Perfect Storm” for Fraud and Waste, will an Upturn be Even More Perfect?

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So, Why Bother?

• Demonstrate you administer an effective Compliance Program and Internal Audit Function by documenting an understanding of how and where fraud might occur.

• Minimize revenue leakage, cut costs, and safeguard assets.

• Safeguard company and employee reputation.

• Avoid and/or reduce criminal, civil and regulatory penalties, should misconduct occur.

• Help avoid/reduce government sanctions

• Increase IA relevance and add value!

It makes good business sense!!

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Detected Losses QUADRUPLE when

Anti-Fraud Controls are Enhanced!

- pwc 2009 Global Economic Crime Survey

Fraud Risk: Defined / AppliedFraud: (defined)

- Any intentional act committed to secure

an unfair/unlawful gain

Reputational Risk•External and internal impression of the organization

Operational Risk•Loss of earnings or inefficient business operations

Financial Risk•Over statement of revenues, understatement of expenses

Reporting Risk•Non disclosure or false disclosure

Compliance / Legal Risk•Potential criminal, civil or regulatory liability

Strategic Risk•Impact on new products, services, or strategic alliances

“Apply the Fraud Lens to Enterprise Risks”

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Fraud: (defined)- Any intentional act committed to secure

an unfair/unlawful gain

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Federal Sentencing Guidelines:

- Intent not required

Fraud Risk: Types and Categories

"Leakage” vs. “Liability” Fraud

Financial Reporting & Disclosure

Manipulation

Unauthorized Receivables / Acquisition of

Assets

Unauthorized Expenses / Disposal of

Assets

Expenditure

Leakage

Misappropriation of Assets

Revenue Leakage

GREEN Fraud = Leakage related activities, that when prevented or detected early, leads to improved financial results

(“Risk Type = “Opportunity” )

RED Fraud = Liability related activities, that if

not prevented, leads to government sanctions, and damage to brand value and reputation of individual members of the Board and senior management

(Risk Type = “Hazard”)

13pwc Fall 2010 IART – Fraud Risk Assessment – 11/4/10

Fraud Risk Types: “Leakage”Expenditure Leakage


Manipulation


Assets


Assets

Expenditure

Leakage


Revenue Leakage

Illustrations: • Orders from fictitious vendor• Kickbacks in return for allowing

supplier to inflate price• Advertiser charges for

advertising not delivered• Vendors/contractors charge for

work not performed • “Double dips” on p-card and

credit card• Salesperson obtains

reimbursement for fictitious travel expenses


Fraud Risk Type: “Liability”Unauthorized Expenses / Disposal of Assets


Manipulation


Assets


Assets

Expenditure

Leakage


Revenue Leakage

Illustrations: • Payments to public officials for

permits or patents• Payments to public officials for

patents• Gifts to public officials to evade

taxes• Payments to agents to facilitate

sales• Illegal disposal of goods/waste


Fraud Risk Assessment• A comprehensive fraud risk assessment (FRA) is critical to the

effectiveness of an organization’s overall antifraud programs and controls.

• An FRA expands upon traditional risk assessment. It is scheme and scenario based.

• The assessment considers the various ways that fraud and misconduct can occur by and against the company.

• The execution of the assessment requires: oInternal Audit to:

“Think out of the box”! Get creative and get out into/work with the business!

oManagement to: Be participative in the process Openly share schemes, scenarios, concerns, events Reinforces risk and the control ownership!

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Fraud Risk Assessment: A Five Component Process

Planning and Obtaining Senior Management Support and Sponsorship

Update Audit Risk Universe

Integrate into Audit Plan

Assess Antifraud Programs and Controls against PwC Framework

Inventory of High Impact Scenarios & Evaluate Existing Response

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Practical Execution – Theory to Practice:–Approach–Challenges–Benefits–Lessons learned

pwc Fall 2010 IART – Fraud Risk Assessment – 11/4/10





• Assemble team• Consider scope and objectives

Overall antifraud program assessment Categories of fraud and depth within organization Controls evaluation Risk response Use and sustainability

• Design process Format of deliverable (e.g., PwC template) Organize by business unit, function, geography or

combination Role and interviews of management Sustainability

Assess Antifraud Programs and Controls against PwC Framework

Identifying Significant Fraud Risk Exposures: Planning

Cedars-Sinai Plan:• Board and senior management support

built into internal audit plan and compliance work plan development and approval processes.

• Combined Internal Audit and PwC resources including PwC SMEs in key areas.

• Initial Internal Audit Team fraud risk discussion for full day.

• Second phase, facilitated sessions with key director-level groups.

• Roll results into annual planning processes and individual project processes for ongoing update.






• Vitally important that senior management embrace and sponsor the assessment

• Senior management ideally would communicate to middle management the importance of the initiative (drafted by IA or Compliance)

• Recommend an initial meeting with C-suite representatives to: Explain business benefits of FRA process Obtain their perspective of high impact

monetary, compliance and financial reporting fraud risks

Seek input regarding making process efficient and effective

Assess Antifraud Programs and Controls


Identifying Significant Fraud Risk Exposures: Gaining Senior Management Sponsorship

Cedars-Sinai C-Suite Buy-In:• Internal Audit Planning and Compliance

Work Plan processes involve the C-suite for input on risk and project selection.

• Plans are approved by C-suite.• Plans presented to Audit Committee for

review, input and approval.• Plans presented to Board for review, input

and approval.Formal meeting C-Suite meeting not held

relative to kick off.





• Begin with high level assessment of how organization manages fraud risk (e.g., PwC Antifraud, Corruption and Misconduct Assessment Tool)

Self-Evaluation:“Where are we as an organization?”

• Conductvalidation procedures as needed



Identifying Significant Fraud Risk Exposures: Evaluating Antifraud Program & Controls

Cedars-Sinai Assessment: •Internal Audit Team Assessment•PwC Tool•Overall Assessment Results:

Corporate Fraud PolicyCoordinated Investigation ResourcesConsistency in Criminal Prosecution

and Employee Discipline DecisionsHigh Level Fraud Risk & Individual

Audit Fraud Risk Considerations


Identifying Significant Fraud Risk Exposures: PwC Anti-Fraud Assessment Tool

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Element Criteria Leading Practice Generally In Compliance Sub-Standard Description of Existing Policies and Procedures Discussion Points

Management Accountability The organization should: (1) promote an organizational culture that encourages ethical conduct and a commitment to compliance with the law, and (2) exercise due diligence to prevent and detect fraud, corruption, and other misconduct,(3) implement effective programs and controls intended to prevent, detect and respond to fraud, corruption and misconduct.

The organization:(1) demonstrates a strong "tone at the top" that flows up and down and across the organization,(2) views mitigating fraud, corruption and misconduct as a core responsibility, (3) has management participate actively in the fraud, corruption and misconduct risk and controls assessment, (4) ensures that all suspected allegations of misconduct are independently investigated, and (5) takes appropriate, consistent remediation action in instances of violations.

The organization takes sufficient actions with respect to prevention, detection, investigation, remediation, and monitoring of fraud, corruption and misconduct.

Taken as a whole, the organization fails to take sufficient action to prevent and detect high impact fraud, corruption and misconduct; and/or management does not:(1) view mitigating fraud, corruption and misconduct as a core responsibility, (2) participate in the fraud, corruption and misconduct risk and controls assessment, or(3) take appropriate, consistent remediation action in instances of violations.

(1) Describe the actions taken by the organization to promote a culture that encourages ethical conduct.- Corporate Compliance Function and Policies- Code of Conduct- New Manager Orientation training that includes Corporate Compliance and Internal Audit Presentations- New Employee Orientation that includes review of code of conduct and compliance plan.- Hot line- Media Response promoting acknoweldgement, apology and corrective action as applicable.- CEO who's mantra is "do the right thing"

Control Environment

Operations, Finance and Other "Front Line" Personnel

Operations, finance and other "front line" personnel should be equipped with the appropriate knowledge, skills and tools to prevent, detect, and respond to fraud, corruption and abuse.

Operations and finance personnel acknowledge their responsibilities and are equipped with and apply knowledge, skills and tools to: (1) identify significant misconduct risks impacting their component of the organization, (2) tailor control activities to mitigate the risk, and (3) detect and report indications of misconduct.

Operations and finance personnel acknowledge responsibility for preventing, detecting and responding to fraud, corruption and misconduct.

Operations and finance personnel view other functions, e.g., legal, compliance, internal audit, as owning responsibility for presenting and detecting fraud, corruption and misconduct.

(1) Describe the actions taken by the organization to cultivate a culture that curbing fraud, corruption and misconduct is every employee's responsibility. (2) Describe actions to equip front line personnel with necessary knowledge, skills and tools to identify, prevent, detect and respond to fraud, corruption and misconduct.


Predicting the Unpredictable is Key!!

Think Like A Criminal When Assessing the Risk of Fraud, Corruption & Abuse!

What would happen if a criminal were a XYZ vendor or customer?

How would a criminal manage your XYZ business unit?

What if a criminal were hired as a XYZ associate?

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What if a trusted employee begins to think like a criminal?




• Create a list of inherent fraud risks Inventory of common and sector specific fraud

and abuse scenarios by selected process areas Past allegations, suspicions and investigations Industry research of frauds at other companies,

organizational vendors, customers, etc Brainstorming among business, compliance,

internal audit and fraud experts Operational, design and other deficiencies

identified during business reviews, compliance monitoring activity and internal and external audits



Identifying Significant Fraud Risk Exposures: Create “Straw” Schemes List: “the What”

Cedars-Sinai Inventory: • Upcoding; Claims for Services not

Provided; A/R & Rate Manipulation / Outliers

• Theft: Radiology Incident; Heparin Incident; EMTALA

• Bribery: Siemens – 2008 global fraud

• Imaging Room; Chillers; Data Manipulation; Vendor Relationships

• Look at potential impact of identified control deficiencies; broken processes; significant hand-off requirements, etc.





• Determine Fraud Risk Classifications i.e. - Revenue, Expenditure, Reporting

• Take your fraud risks and think/discuss HOW they could occur

Think SCHEMES and SCENARIOS!Get creative!Never mind controls!!Utilize group facilitation sessions!Create your master Gross Risk list



Identifying Significant Fraud Risk Exposures: Create “Straw” Schemes List: “the How”

CSHS: practical application and lessons learned • Fraud classifications: Revenue,

Expense or Reporting Impact• Brainstorm scenarios by organizational

lines of authority and three impact areas

• Director and Manager Level Focus Group Discussions; decision of with/without VP’s

• Angels and Demons!!• Scribe





• Narrow list to capture high impact vulnerabilities Consider likelihood Qualitative and quantitative impact, as well as, direct

and indirect consequences Establish thresholds (risk tolerance) to measure

impact on reputation, operations, financial, legal, compliance, and strategic objectives

• Consider the design of existing controls Consider whether existing processes and controls

are able to withstand intentional misconduct Examine incentives pressures and opportunities to

collude, circumvent and override



Identifying Significant Fraud Risk Exposures:Narrow to Significant Residual Risks

CSHS: practical application and lessons learned • Two Hour facilitated Sessions

Necessary for: Schemes Likelihood & Impact Controls

• Director/Manager but not both• Scribe• Focus on Schemes (how it’s done –

criminal perspective)• Common beliefs / identified schemes

across sessions


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Identifying Significant Fraud SchemesBrainstorming Exercises!!

Angels: Recommend & Evaluate Anti-fraud Controls

Demons : Identify Potential Fraud Schemes

“Angels & Demons”Select a Business Area: i.e.- Hospital Admissions

How it can happen!

Why it won’t!

Schemes Impact/LikelihoodControls


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Demons - Identify Potential Fraud Risks & Schemes

This is how it can

happen!


This is how I would do it

son…

“Angels & Demons”

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If you did, I would know because…


Sorry, partner- it ain’t gonna

happen…

“Angels & Demons”

Angels - Recommend & Explain Anti-fraud Controls




• Entity level of assessment = very limited business value • Assessment needs to be conducted and tailored to

individual business units/functions, particularly in high risk markets; focus on both internal and external risks

• Tailored assessments & group facilitation sessions simultaneously reinforce that management “owns” risk

• Hold focus groups of management & staff to tailor inventory

• Meet and validate results with business unit leaders

• Capture assessment for senior management and board- Self Assessment; A&D Results (Gross & Residual

risk); discuss Risk Tolerance; plans to update universe



Identifying Significant Fraud Risk Exposures:Tailor to Business Units & Functions

CSHS: practical application and lessons learned • Provide fraud

background/concepts• Business units – positive

response to facilitate sessions and Angels and Demons; engage audience

• Lot’s of Aha’s and Really?’s in sessions

• Positive comments from Senior Mgmt!

• Entity Level Assessment – Proof remains to be seen.





• Based upon final listing of scenarios update audit risk universe for key risk factors and indicators

• Refine any pre-existing audit risks based upon additional risk assessment procedures

• Incorporate into annual update process of audit and/or compliance risk universe



Identifying Significant Fraud Risk Exposures:Update Internal Audit Risk Universe

CSHS: practical application and lessons learned • If not already categorized in your

risk universe, add category or metadata for easy identification

• Refining can be time consuming• Annual update development in

progress, to be completed through: Improved annual interviewing Individual Audit Capture

Complete redevelopment of risk model using TeamMate in progress


• Evaluate whether any current year audits should be updated based on new risk universe

• Determine appropriate way to keep fraud risk assessment process evolving rather than static As new investigations or industry trends

occur Automated controls are added into

environment






Identifying Significant Fraud Risk Exposures: Integrate into Audit Plan

CSHS: practical application and lessons learned • In addition to current year

updates, could identify new priority audits

Annual interviewing Individual audits Possible facilitate session

repeats Integrate into individual audit

plans as well by already having the risk scenarios to consider


Integrating Fraud Risk Into Individual Compliance and Audit Engagements:

•Planning

Brainstorming among team and forensics Past incidents Past audits and business reviews Management inquiries Industry research Tailor procedures

• Execution Design and operating effectiveness of

existing response Consider need for substantive testing

•Execution (cont’d) Fraud risk factors & indicators Analytics - - not just ACL Interview, interview, interview!!

• Completion Documentation is essential Identify planning and how audit

tailored

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Close the Loop!Use findings to strengthen controls,

develop & deliver education/awareness to process

owners & mgmt!


Creating Value While Meeting Fraud Standards

Raising Auditor Fraud Proficiency

• Knowledge Scheme components Preventive & detective controls Key risk factors & indicators Detection procedures Operations knowledge

• Skills Critical thinking! Scheme and scenario risk assessment Assessing how organization manages

risk Devising fraud audit procedures Forensic investigation Interviews Use of electronic data tools Working ‘with’ the business!

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Raising Management AwarenessIn addition to scheme discussions and fraud risk identification, management is

also getting interactive awareness training



Antifraud Tools of a Highly Equipped Compliance and/or Internal Audit Function

• Specialized fraud examiners on staff

• Antifraud training for staff

• Investigative training for staff• Use of Computer Assisted Audit Techniques to promote fraud detection• Focused fraud risk assessment with inclusion of functional management

and employees of all levels• Direct and regular interaction with senior management and audit

committee

• Use of specific and targeted fraud audit techniques – SAS 99

• Can lead and/or support investigation and/or remediation efforts


Other Activities Compliance and/or IA Departments are Taking to Deliver Value

• Equip front line to serve as an effective first line of defense; fraud education!!

• Conduct a “good” fraud risk assessment pilot at a high risk entity to develop a sustainable and repeatable process

• Expand FCPA and other compliance reviews to identify opportunities to cut revenue leaks, cut costs and safeguard assets

• Form a “fraud council” comprised of key business and corporate stakeholders

• Host a “perfect crime” dinner and/ or facilitate “angels v. demons” exercise for management, internal audit and/or compliance

• Create on-line or live interactive learning modules tailored to specific functions, e.g., procurement, sales, controllers



Perspectives From IA Industry Leaders*

“ I currently see a lot more management awareness of the possibility of fraud, which in turn is causing a lot more people to come forward and ask Internal Auditing, ‘Is this right?, Is this appropriate?’’ --Richard Schmidt, Vice President of Internal Audit, Del Monte Foods


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“ It is management’s responsibility to institute, establish and monitor controls and uncover fraudsters. Internal Auditing’s job is to encourage management to undertake what is necessary and then provide assurance to the audit committee that management is getting it right.”

--Douglas Anderson, former Corporate Auditor, The Dow Chemical Co.

“ Internal auditing is often the only proactive source of fraud detection that management has. Auditors are out there looking for indicators of fraud during every engagement they conduct; no one else in the organization plays this vital role.”

--Kim Hatley, Assistant VP of Internal Audit, Hospital Corporation of America (HCA)

* [Source: Internal Auditor magazine, October 2010]

IIA - San Gabriel Valley Chapter: 2010 Fraud Symposium, 11/1/10

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Mark P. Ruppert, CPA, CIA, CISA, CHFP, CHC

Director, Internal AuditConflict of Interest AdministratorCedars-Sinai Health SystemLos Angeles, California323-866-6900 office323-866-6901 [email protected]

Don’t be this guy!

Stamp out…

?

mailto:[email protected]

fraud risk assessment: think like a ‘demon’ & add ia value

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