steps to prevent detect occupational fraud in government (final)

Steps To Prevent & Detect

Occupational Fraud in GovernmentJune 15, 2015

Ron Steinkamp, CPA, CIA, CFE, CRMA, CGMA314.983.1238 | [email protected]

6 CityPlace Drive, Suite 900 │ St. Louis, Missouri 63141 │ 314.983.1200 1520 S. Fifth St., Suite 309│ St. Charles, Missouri 63303 │ 636.255.3000

2220 S. State Route 157, Ste. 300 │ Glen Carbon, Illinois 62034 │ 618.654.3100 1.888.279.2792 │ www.bswllc.com

WHAT IS THE LARGEST MUNICIPAL FRAUD IN US HISTORY?

Question?

© 2015 All Rights Reserved Brown Smith Wallace LLC 2

City Comptroller (Rita Crundwell) embezzled over $53 million from 1990-2012.

Facts• City of 15,000 south of Chicago.• Home of Ronald Reagan.• Annual City budget $8-9 million.

Perspective• Per FBI, 5 months ending February 2012:

- Police - $1.1 million- Rita’s pocket - $3.2 million

Dixon, Illinois


How did she do it?• Minimal oversight and small town trust.• Lack of segregation of duties.• Opened a secret bank account and transferred in City

funds from other accounts.• Used funds to pay for her personal and private business

expenses.- Horse farming/ranching operations and shows.- Personal credit cards.- Trips.- Real estate.- Vehicles.

• Fooled the auditors by creating fictitious invoices from State of Illinois.

Dixon, Illinois


How was it detected?• Comptroller took 12 weeks of approved vacation.• Interim replacement received bank account and

determined transactions had nothing to do with City business.

Warning signs• Her lifestyle changed from modest to lavish.• Inadequate segregation of duties.

Results• Rita got 20 years in prison.• Sold off Rita’s assets.• City of Dixon awarded $40M from lawsuit against the

auditors and bank.

Dixon, Illinois


Lessons Learned• Segregate duties.• New bank accounts approved by the Mayor and Council.• Two responsible members of management approve all

invoices.• Payments exceeding a certain amount require two

signatures.• City Council reviews and approves all fund transfers.• Mayor and Council review and discuss financial reports

and audits.• Anti-fraud orientation provided to all new employees.• Mandatory annual fraud reorientation for all employees.• Anonymous fraud hotline.• Mandatory job rotation.• Mandatory annual vacations.• Surprise audits.

Dixon, Illinois


Agenda

© 2015 All Rights Reserved Brown Smith Wallace LLC

• What is Occupational Fraud?

• 2014 ACFE Global Fraud Study

• Red Flags

• Common Areas of Abuse in Government

• 7 Keys to Fraud Prevention & Detection

• Key Process Controls

7

WHAT IS OCCUPATIONAL FRAUD?


The use of one’s occupation for personal enrichment through the deliberate misuse or application of the employing organization’s resources or assets.

Three general categories:

Asset misappropriation

Corruption

Financial statement fraud

Definition


Perpetrator steals or misuses an organization’s resources.

- Examples:• Clerk stealing cash receipts.• Payroll Clerk creating a ghost employee.• Purchasing Clerk creating a fictitious vendor and

false invoice.• Street Department personnel “borrowing”

equipment.• City Manager purchasing personal items on the City

credit card.

Asset Misappropriation


Employee’s use of his/her influence in business transactions in a way that violates his/her duty to the employer for the purpose of obtaining benefit for him/herself or someone else.

- Examples:• City Council member trading votes for personal

favors.• Purchasing Department Manager awarding a City

contract to a vendor for a kickback.• Human Resources Director hiring unqualified

“friends” to fill positions.

Corruption


Intentional misstatement or omission of material information in the organization’s financial reports.

- Examples:• Inflating City revenues on the Consolidated Annual

Financial Report.• Forcing actual expenditures to match budget by

moving expenses between accounts.• Improperly accounting for grant receipts and

expenditures.

Financial Statement Fraud


2014 ACFE Global Fraud Study2014 Report to the Nations on Occupational Fraud and Abuse


1. Typical organization loses 5% of annual revenue to fraud – applied to

2013 Gross World Product translates to potential fraud loss of more than

$3.7 trillion annually.

2. Median loss in the study was $145,000 with more than 22% of the cases

involving losses over $1 million.

3. Fraud lasted a median of 18 months.

4. Asset misappropriation schemes (fraudulent disbursements, theft of

cash receipts, other asset misappropriations) were the most common

form of fraud, representing 85% of the cases and least costly at a

median loss of $130,000.

5. Financial statement fraud schemes were the least common form of fraud,

representing 9% of the cases and most costly at a median loss at $1

million.

Summary of Findings


6. Corruption schemes fell in the middle, comprising just over 37% of cases

and causing a median loss of $200,000.

7. Occupational frauds are most likely to be detected by tips (40%)

followed by management review (15%) and Internal Audit (14%).

8. Small organizations are disproportionately victimized by occupational

fraud.

9. Government/public administration was one of the most commonly

victimized industries.

10. Anti-fraud controls appear to help reduce the cost and duration of

occupational fraud schemes.

11. High-level perpetrators cause the greatest damage to their

organizations.

Summary of Findings (cont.)


12. 77% of frauds were committed by individuals in one of seven departments:

Accounting Operations Sales Executive/upper management Customer service Purchasing Finance

13. More than 85% of fraudsters had never been previously charged or

convicted for a fraud-related offense.

14. Fraud perpetrators often display warning signs – most common

behavioral red flags reported in the survey were perpetrators living

beyond their means (36%) and experiencing financial difficulty (27%).

15. Nearly half of victim organizations do not recover any losses that they

suffer due to fraud.

Summary of Findings (cont.)


RED FLAGS


The Fraud Triangle


Pressure or incentive – need the fraudster is trying to satisfy.

Opportunity – ability to commit the fraud. Organizations can influence this characteristic the most = strong internal controls that avoid putting employees in positions to commit fraud and that detect fraudulent activities if they occur.

Rationalization – ability to justify the fraud.

AKA = Fraud Triangle

Common Characteristics of Fraud


• High personal debts.

• Living beyond their means.

• Excessive investment speculation.

• Excessive gambling.

• Substance abuse.

• Extra-marital affairs.

• Job frustration.

• Resentment of superiors.

Pressure “Red Flags”


• Inadequate internal controls.

• Too “cozy” with suppliers.

• Annual vacation or sick days not taken.

• Weak management or excessive turnover.

• Ineffective or no internal audit.

• No rotation of job duties among employees.

• Procedures not well understood/always in crisis mode.

• Large amounts of cash on hand or processed.

Opportunity “Red Flags”


• Not compensated fairly.

• No recent raises/cost of living adjustments.

• Everyone else does it.

• Intended to pay it back.

• Needed the money.

• Felt cheated and wanted revenge.

• Bribe/kickback too tempting.

Rationalization “Red Flags”


Middle aged male, employed by the organization for a number of years and in a

position of trust.

Educated.

Works in the financial department.

Member of management.

Driven by money and opportunity.

IS THIS TRUE FOR GOVERNMENT?

Typical Fraudster


COMMON AREAS OF ABUSEIN GOVERNMENT


• Skimming• Check Tampering • Billing Schemes• Fraudulent Expense Reimbursement• Payroll Fraud• Bribery and Conflicts of Interest

Common Areas of Abuse in Government


Employee steals cash from the employer before it is recorded on the employer’s books and records. Skimming typically occurs when an employee:

• Has access to customer payments• Directs intercepted receipts to personal

accounts

Skimming


How can skimming be prevented/detected? • Segregate cash receipts and accounting

responsibility.• Issue receipts.• Track receipts in system and reconcile daily.• Surprise cash counts.• Cameras.

Skimming


Any scheme in which an employee steals employer’s funds by:

• Forging or altering a check on the employer’s bank account.

OR• Stealing a check the organization has

legitimately issued to another payee.

Check Tampering


How can check tampering be prevented/detected?• Check stock should be locked in a secure

location to ensure blank checks are not accessible to potential fraudsters.

• Checks should be mailed immediately after signing to reduce the risk of legitimate checks being stolen.

• Positive pay.• Bank reconciliations.

Check Tampering


Billing schemes occur when an employee submits a false invoice or alters an existing one, thus causing the employer to willingly (but unknowingly) issue a check for false expenses.

Billing Schemes


How can billing schemes be prevented/detected?• Prior to authorizing payment, invoices should be checked

for validity of the vendor, validity of the goods or services invoiced, accuracy, and authenticity.

• Prior to processing payment, invoices should be checked for proper authorization, accuracy and authenticity. This will prevent overpayment, as well as payments being made to fictitious vendors.

• Strictly control access to vendor master data.• Regular vendor master file analysis.

Billing Schemes


Expense reimbursement schemes occur when an employee submits false expenses in the hope of being reimbursed.

Fraudulent Expense Reimbursements


How can fraudulent expense reimbursements be prevented/detected?• Expense reimbursement policy.• Require original itemized receipts.• Receipts should be scrutinized to detect alterations or

forgeries.• Other means of proving incurred expenses, such as

airline itineraries, credit card statements, etc. should not be accepted unless approved by a supervisor.

• All expense reimbursements should be reviewed and immediately processed upon approval.

• Use a specific credit card for all business expenses. Receive this information electronically from credit card company and require electronic filing of expense reports by employees. This will minimize the possibility of fraud and, if fraud is occurring, will provide an easier means to identify it.

Fraudulent Expense Reimbursements


Payroll fraud occurs when an employee submits false documentation (i.e., timecards) in an effort to inflate his/her wages/salary. Such documentation prompts the organization to unknowingly disburse funds to the perpetrator.

Possible ways in which Payroll Fraud can occur:• Falsified hours and salary• Ghost employees

Payroll Fraud


How can payroll fraud be prevented/detected? • All timecards should be reviewed for validity and

accuracy.• Once submitted for approval, employees should never

see their timecard again. • Overtime hours must be authorized by a supervisor.• If employees use a time clock to “punch in” and “punch

out”, they must do so when they arrive for work, take breaks, go to lunch, leave for the day, etc.

• Monitor employees to ensure one employee is not punching out for another.

• Strictly control access to payroll master data.

Payroll Fraud


Schemes involving the employee’s use of his/her influence in transactions in a way that violates duty to the employer for the purpose of obtaining a benefit for themselves or someone else.

Usually involves collusion.

Bribery and Conflicts of Interest


How can bribery and conflicts of interest be prevented/detected? • Well publicized fraud hotline.• Strong ethics and conflict of interest policy.• Required reporting of potential conflicts of interest.• Limiting gifts from vendors and contractors.• Well defined procurement process.• Rotate buyers.• Contract audits.

Bribery and Conflicts of Interest


7 Keys To FraudPrevention And Detection


Anti-Fraud Culture

Fraud Policy

Fraud Awareness/Traini

ng

HotlineAssess Fraud Risks

Review/Investigation

Improved Controls


Set the tone at the top = Lead by Example Responsibility of Directors and Officers Behave ethically and openly communicate expectations to

employees Treat all employees equally Zero tolerance

Create a positive workplace environment Focus on employee morale Empower employees Communicate

Hire and promote appropriate employees Conduct background investigations before hiring or

promoting Check candidate’s education, employment history,

references Continuous and objective evaluation of compliance with

entity values Violations addressed immediately

1. Anti-Fraud Culture


Code of Conduct Formalized and founded on integrity Defines acceptable employee behavior Communicated to all employees All employees are held accountable for compliance

Discipline Sends a strong message throughout the entity Should be appropriate and consistent Consequences of committing fraud clearly communicated

throughout the entity



Oversight Process Audit Committee or Board of Directors

Evaluate management’s “tone at the top”, identification of fraud risks and implementation of anti-fraud controls

Ensure that management implements anti-fraud measures Consider the potential for management override of controls

Management Directs, implements and monitors anti-fraud controls Sets the ethical tone Trains employees

Internal Auditor Identifies fraud indicators Assesses fraud risks Evaluates anti-fraud controls Recommends actions to mitigate risks Investigates potential frauds



Demonstrate commitment to combating fraud

Apply to all Directors, Management, employees, consultants, vendors, contractors, etc.

Should include: Statement of organization’s position on fraud Scope of the policy – who does it apply to Management’s responsibility for prevention and detection of

fraud Definition of fraud Actions constituting fraud Fraud reporting process/procedures Fraud investigation process/procedures Unit responsible for administration of the policy and

investigating fraud allegations Statement on anonymity/confidentiality Consequences

2. Fraud Policy


Reviewed and updated regularly.

Signed off and agreed to by the CEO and Board Chair.

See the ACFE for an example Fraud Policy. http://www.acfe.com/uploadedFiles/ACFE_Website/Content/documents/Sample_Fraud_Policy.pdf

2. Fraud Policy


http://www.acfe.com/uploadedFiles/ACFE_Website/Content/documents/Sample_Fraud_Policy.pdf

http://www.acfe.com/uploadedFiles/ACFE_Website/Content/documents/Sample_Fraud_Policy.pdf

All new employees should be trained at time of hiring on the Code of Conduct and Fraud Policy.

Training should include: Their duty to communicate certain matters A list of the types of matters to be communicated along with

examples How to communicate those matters Affirmation from senior management regarding employee

expectations and communication responsibilities

Refresher training periodically

3. Fraud Awareness/Training


Enable employees, vendors, customers and others to communicate concerns about known or suspected wrongdoing.

Telephone, email, internet.

Anonymous.

Adequately publicized.

Internal or external.

Complaint monitoring and investigation/resolution.

4. Hotline


Conduct an annual fraud risk assessment. Assists management in systematically identifying where and how

fraud may occur and who may be in a position to commit fraud.

Focus on fraud schemes and scenarios to determine the presence of internal controls and whether or not the controls can be circumvented.

General steps: Identify areas and processes to assess Identify potential fraud schemes in each area/process Assess likelihood and significance of each scheme Map existing anti-fraud controls to potential fraud schemes Test operating effectiveness of anti-fraud controls Identify any control gaps and/or deficiencies = Residual risks Document and report on the fraud risk assessment

5. Assess Fraud Risks


Mitigate Fraud Risks Make changes to activities and/or processes = transfer or eliminate

the risks Improve anti-fraud controls

Monitor Fraud Risks Develop data analytics for management to use to monitor fraud

risks Utilize Internal Audit to conduct audits of risk areas

5. Assess Fraud Risks


All concerns/suspicions of wrongdoing should be reviewed and determination made whether a fraud investigation is warranted.

Develop a policy for fraud reviews and investigations that specifies: Who is responsible for the review/investigation Roles of Legal Counsel, Human Resources, Internal Audit, others Process for conducting the review/investigation Documentation requirements Reporting requirements When to involve law enforcement

6. Fraud Review/Investigation


Gather sufficient information and perform procedures necessary to determine: Whether fraud has occurred Loss or exposure associated with the fraud Who was involved and how it happened

Must prepare, document and preserve evidence sufficient for potential legal proceedings.

Include experts = Certified Fraud Examiner (CFE)

6. Fraud Review/Investigation


Periodic internal control reviews.

Use lessons learned from any reviews or investigations to improve anti-fraud controls.

All reviews and investigations should include a report to management with recommendations for control improvement.

7. Improved Controls


KEY PROCESS CONTROLS


• Code of conduct• Policies and procedures manual• Segregation of duties• Records retention• Documentation of transactions• Budgetary• Fraud Policy and reporting• Access to systems

General Controls


• Policies and procedures.• All bank accounts opened and maintained in

organization’s name with proper approval.• Segregate access to cash from accounting for

cash.• Monthly reconciliation of recorded balances to

bank account detail by employees not involved in cash activities.

• Control credit cards and reconcile to receipts on a timely basis.

Cash Management Controls


• Policies and procedures.• All orders received are processed and recorded.• All orders processed are invoiced.• All invoices are posted to customer accounts.• Billings are accurate.

Revenue Cycle Common Controls


• Policies and procedures.• All purchase orders are authorized.• All vendors are authorized.• Individuals have authorization limits.• Check stock is controlled.• EDI/ACH transactions require authorization.• Credit card purchases are controlled and

statements are reconciled to detailed receipts.

Procurement Cycle Common Controls


• Procedures for adding, changing, removing employees and related pay and benefits.

• Payroll personnel can not add/change/delete employees and related pay and benefits.

• All changes are authorized by management.• Payroll preparation segregated from payroll

authorization, check signing and distribution.• Access to payroll is restricted.• Safeguard checks.• Reconciliations.

Payroll Common Controls


• Procedures for adding and removing fixed assets.

• Detailed records of all fixed assets.• Tracking of fixed assets.• Inventory fixed assets and reconcile to records

periodically.

Fixed Assets Common Controls


• Accurate, Timely, and Consistent Reporting.• Recorded balances should be periodically

substantiated and evaluated.

Management Reporting Common Controls


• Exception reporting• Shipping/Receiving• Physical inventory monitoring• Perpetual records• Controlling slow-moving and obsolete

inventories• Scrap• Adjustments are controlled• Cycle counting• Disposal

Inventory Monitoring Common Controls


• Back-ups• Disaster Recovery• Security (physical & logical)• Virus Protection• Administrative

-Change control- Trouble reporting-Helpdesk- Systems Development Life Cycle

IT Common Controls


Ron Steinkamp, CPA, CIA, CFE, CRMA, CGMA

Member, Advisory Services

Brown Smith Wallace, LLC

314.983.1238 (Direct)

[email protected]

Contact Information


steps to prevent detect occupational fraud in government (final)

Documents

occupational fraud

city of dixon

city funds

city business

largest municipal fraud

antifraud orientation

anonymous fraud hotline

state of illinois