Prepare a two-to-three page case study report on the following case: COVER STORY: INTERNAL FRAUD on pages 104-106 in Chapter 4: Billing Schemes of the Fraud Examination text by Wells. Discuss the coincidences involved in this case study. Use the 2010 Global Fraud Survey (also located in Doc Sharing) for references concerning perpetrator, size of fraud, detection, and controls. Sometimes fraud is discovered by chance instead of deliberate effort. In the $4 million embezzlement fraud by an employee of a magazine publisher, more than one coincidence brought down the perpetrator. A popular magazine and large direct-mail publishing house decided to outsource much of its direct-mail operations to specialized mail vendors. The company began converting its plant in Pleasantville, New York, from a direct-mail-order factory to an office complex. Part of the office complex construction involved building an auditorium that was to be identical to another auditorium in historic Williamsburg, Virginia. Terrence McGrane had just begun his third day on the job as chief internal auditor. In an effort to get to know his new company, he had scheduled a series of interviews with all the vice presidents. His first interview was with the vice president of administrative services, Harold J. Scott, who was in charge of many construction projects and maintenance services. Because of the massive renovation project, it was not unusual for hundreds of invoices to be forwarded to Scott. Coincidence one: McGrane stopped by the accounts payable department and retrieved a series of recently submitted invoices for various trade expenses related to the auditorium construction project. ?One of the things I wanted to accomplish was to understand how the accounting codes worked?what was capitalized; what was expensed; how it was recorded, etc.? So he grabbed a stack of processed invoices with accounting codes and went up to the construction site to meet with the vice president for an hour-long interview. As the two walked around the grounds, McGrane asked the vice president if he could explain the accounting codes to him: ?He stared at the [top] invoice for approximately 30 seconds and said: ?That is not my signature on the invoice!? As he looked through the stack, he found what appeared to be about three or four other forgeries. He was completely baffled.? The initial investigation revealed that all of the forgeries were in the painting division, budgeted at approximately $500,000 a year. The company employed only one person to oversee the painting operations in its facilities department: Albert Miano. Miano, a 35-year-old from New Fairfield, Connecticut, earned about $30,000 a year. It was his job to coordinate time-and-materials contracts with the scores of painters, carpenters, electricians, and plumbers who toiled daily on the renovation, repair, and construction of the building complex. As facilities supervisor, Miano regularly forwarded invoices to the vice president of administration services for approval. Miano launched his scheme by crafting false invoices for the jobs done by the painters. He took a copy of a trade invoice from an existing painting contractor and, using his home computer, created a replica into which he would record slightly different hours for the trade contractors? work. McGrane related a probable scenario of how Miano executed his scheme. ?Let?s say he knew that during the month of February, as an example,? McGrane said, ?there were twenty-seven painters on the grounds during the course of one week.? Miano also knew the total number of hours and the volume of materials used in that time. ?He would create invoices that were similar in nature, but record only eleven painters on the grounds,? McGrane said. Miano would not reinvoice exactly the same work done during a week, but he would make it look so similar that no one?s suspicions were ever aroused. Effectively, there were no work orders on the ?phantom work? he created on these invoices. Miano always listed fewer painters on the false invoice than the actual number who had worked that week, and he registered less time for their services than they had actually worked. As part of his job, he regularly brought the trade invoices into the administrative VP?s office for signature approval. After delivering a stack of these invoices, he would return to collect them within the next day or two and deliver the approved invoices to the accounts payable department. ?It was this opportunity,? McGrane said, ?that this individual was allowed to go and collect the approved invoices and insert his own replicated fraudulent invoices as approved. This was the first piece of an ?electronic circuit? that allowed him to commit the fraud.? The second piece of the circuit for the fraud to ignite, McGrane said, was allowing this same employee to transport the invoices to the accounts payable department, and ultimately to collect the check. After seeing how easy it was to slip in his own false invoices in the stack of approved ones, Miano became bolder in his scheme. He began calling accounts payable, claiming that a carpenter or painter had arrived on the grounds and needed his check ?immediately.? To keep the project flowing, the employees in the accounts payable department accommodated him. Many employees knew and liked Miano, who had worked for the company for nearly 15 years. Eventually, this routine became so familiar to employees in accounts payable that Miano did not even need to make up an excuse to pick up checks. Each time he would collect them, he stashed the check for the false invoice in his pocket. When he returned home to New Fairfield, Connecticut, he took the check to his bank, forged the contractor?s name on the back, then endorsed it with his own name and deposited the check. McGrane explains that Miano was able to pull off the scam due to failure of internal controls and employees not following standard accounting procedures. ?For any business transaction, the invoices should be dispatched independently to the approving authority. Once signed, the approved invoices should be sent independently to accounts payable. When the check is prepared by accounts payable, they should mail it directly to the third party. Under a strong internal control system, the employees and/or contractors should not be allowed to come in and collect checks directly. Direct contacts with accounts payable personnel make it too tempting for someone to try to misappropriate funds.? Accounts payable also failed to combine the invoices into a single check?they wrote a check for each invoice. ?Had they combined it,? McGrane said, ?his false invoice would have been added into the legitimate painter?s monthly invoice summary, and the money would be mailed to the legitimate contractor,? McGrane said. Accounts payable neglected to study the invoice signatures for forgeries, and the accounting department dropped the ball by not perusing processed checks for dual endorsements, another red flag for potentially misappropriated funds. Miano?s first transaction totaled $1,200. His second transaction jumped to $6,000?his third, $12,000. His largest single transaction came to over $66,000. Miano refined his strategy by pacing, on a parallel basis, a certain amount below the total due the painter. ?If the painter submitted an invoice for $20,000 a month,? McGrane said, ?Miano would submit an invoice for, say, $14,000. If the painter submitted a $6,000 invoice, he?d submit one for $3,000.? The individual invoice amounts, because of the continuing construction, would not have alarmed even an auditor. Miano?s behavior at the office was the same as ever. He dressed the same way, drove the same car to work, and shared little of his private life with other workers. He had not taken a vacation in over four years, and his boss thought he should be promoted (a move Miano resisted, for reasons now obvious). After hours, however, Miano was a different person. Coincidence two: McGrane?s secretary was not only on Miano?s bowling team, she was also his neighbor. They saw each other regularly at the local bowling alley. She took notice when Miano?s behavior became somewhat extravagant. At first he took to buying the team drinks, a habit most appreciated by his teammates. However, the secretary began wondering where all the money was coming from when he showed up in his new Mercedes (one of five cars he bought) and talked about a new $18,000 boat. He also invested in real estate and purchased a second home costing $416,000. McGrane?s secretary approached Miano one night after he had spent some $800 on drinks for the team. ?Did you win the lottery, or what?? she asked. He explained that his father-in-law had recently died and left a substantial inheritance to his wife and him. Miano?s father-in-law was actually quite alive, but no one ever bothered to check out the claim. No one suspected Miano of doing anything sinister or criminal. All of his associates considered him ?too dumb? to carry out such a scheme. One person described him as ?dumb as a box of rocks.? Coincidence three: After four years without a vacation, Miano took what he considered a well-deserved trip to Atlantic City. But he wasn?t there long before he was called back to Pleasantville. One can imagine his chagrin at having to leave the casinos and boardwalks and head back to the office. Little did he know that things were about to get a lot worse. Upon his return, Miano found himself confronted by the auditor, the vice president, and two attorneys from the district attorney?s office. He readily admitted guilt. ?He said he had expected to get caught,? McGrane said. ?He did it strictly based on greed. Miano claimed there was no one else involved, and the sum total of his fraud was about $400,000.? But the internal audit found that Miano had forged endorsements on more than fifty checks in those four years, totaling $1,057,000. Ironically, the auditors could only identify about $380,000 spent on tangible items (boats, cars, down payment on a home, etc.). The investigators could not account for the other $700,000, although they knew Miano had withdrawn at least that much from the bank. Miano served only two years of an eight-year sentence in a state penitentiary. At the time of his indictment, his wife filed for divorce, claiming she knew nothing of her husband?s crimes. Miano told a reporter in jail that the loss of his family and the public humiliation had taught him his lesson. ?For a nickel or for $5 million, it doesn?t pay,? Miano said. ?You enjoy the money for a while, but you lose your pride and your self-respect. It ends up hurting your family, and no money can ever change that.?

REPORT TO THE NATIONS O N O C C U PAT I O N A L F R A U D A N D A B U S E 2010 Global Fraud Study Letter from the President When the ACFE published its first Report to the Nation on Occupational Fraud and Abuse in 1996, it broke new ground in anti-fraud research by providing an analysis of the costs, the methodologies and the perpetrators of fraud within U.S. organizations. The collective body of knowledge contained in the first five editions of the Report to the Nation published between 1996 and 2008 has become the most authoritative and widely quoted research publication on occupational fraud. Now, for the first time, the data contained in the Report have been drawn from fraud cases throughout the world. As readers will see, it reflects the truly universal nature of occupational fraud. This expansion of our research is denoted in the modified title for this study, which has now become the Report to the Nations on Occupational Fraud and Abuse. The information contained in this report is based on 1,843 cases of occupational fraud that were reported by the Certified Fraud Examiners (CFEs) who investigated them. These offenses occurred in more than 100 countries on six continents, and more than 43% took place outside the United States. What is perhaps most striking about the data we gathered is how consistent the patterns of fraud are around the globe. While some regional differences exist, for the most part occupational fraud seems to operate similarly whether it occurs in Europe, Asia, South America or the United States. The Report to the Nations is the brainchild of the ACFE's founder and Chairman, Dr. Joseph T. Wells, CFE, CPA who throughout his career has contributed more to the study of fraud and the development of the anti-fraud profession than any other person. On behalf of the ACFE, and in honor of its founder, Dr. Wells, I am pleased to present the 2010 Report to the Nations on Occupational Fraud and Abuse to practitioners, business and government organizations, academics, the media and the general public throughout the world. The information contained in this Report will be invaluable to those who seek to deter, detect, prevent or simply understand the global economic impact of occupational fraud. James D. Ratley, CFE President, Association of Certified Fraud Examiners 2 | 2010 Report to the Nations on Occupational Fraud and Abuse Table of Contents Executive Summary..............................................................................................................................................................4 Introduction...........................................................................................................................................................................6 The Cost of Occupational Fraud...........................................................................................................................................8 Distribution of Losses How Occupational Fraud Is Committed.............................................................................................................................10 Asset Misappropriation Sub-Schemes Duration of Fraud Schemes Detection of Fraud Schemes..............................................................................................................................................16 Initial Detection of Occupational Fraud Schemes Source of Tips Impact of Hotlines Detection Methods Based on Organization Type Detecting Fraud in Small Businesses Detection of Occupational Fraud Based on Region Victim Organizations...........................................................................................................................................................24 Geographical Location of Organizations Type of Organizations Size of Organizations Methods of Fraud in Small Businesses Industry of Organizations Anti-Fraud Controls at Victim Organizations Anti-Fraud Controls at Small Businesses Anti-Fraud Controls by Region Effectiveness of Controls Importance of Controls in Detecting or Limiting Fraud Control Weaknesses that Contributed to Fraud Modification of Controls Perpetrators.........................................................................................................................................................................48 Perpetrator's Position Perpetrator's Gender Perpetrator's Age Perpetrator's Tenure Perpetrator's Education Level Perpetrator's Department Perpetrator's Criminal and Employment History Behavioral Red Flags Displayed by Perpetrators Methodology.......................................................................................................................................................................75 Appendix Breakdown of Geographic Regions by Country...........................................................................................78 Fraud Prevention Checklist.................................................................................................................................................80 About the ACFE...................................................................................................................................................................82 2010 Report to the Nations on Occupational Fraud and Abuse | 3 Executive Summary Summary of Findings Survey participants estimated that the typical organization loses 5% of its annual revenue to fraud. Applied to the estimated 2009 Gross World Product, this figure translates to a potential total fraud loss of more than $2.9 trillion. The median loss caused by the occupational fraud cases in our study was $160,000. Nearly one-quarter of the frauds involved losses of at least $1 million. The frauds lasted a median of 18 months before being detected. Asset misappropriation schemes were the most common form of fraud in our study by a wide margin, representing 90% of cases though they were also the least costly, causing a median loss of $135,000. Financial statement fraud schemes were on the opposite end of the spectrum in both regards: These cases made up less than 5% of the frauds in our study, but caused a median loss of more than $4 million by far the most costly category. Corruption schemes fell in the middle, comprising just under one-third of cases and causing a median loss of $250,000. This Report is based on data compiled from a study of 1,843 cases of occupational fraud that occurred worldwide between January 2008 and December 2009. All information was provided by the Certified Fraud Examiners (CFEs) who investigated those cases. The fraud cases in our study came from 106 nations with more than 40% of cases occurring in countries outside the United States providing a truly global view into the plague of occupational fraud. Occupational frauds are much more likely to be detected by tip than by any other means. This finding has been consistent since 2002 when we began tracking data on fraud detection methods. Small organizations are disproportionately victimized by occupational fraud. These organizations are typically lacking in anti-fraud controls compared to their larger counterparts, which makes them particularly vulnerable to fraud. The industries most commonly victimized in our study were the banking/financial services, manufacturing and government/public administration sectors. Anti-fraud controls appear to help reduce the cost and duration of occupational fraud schemes. We looked at the effect of 15 common controls on the median loss and duration of the frauds. Victim organizations that had these controls in place had significantly lower losses and time-to-detection than organizations without the controls. 4 | 2010 Report to the Nations on Occupational Fraud and Abuse One-fourth of the frauds in this Report caused at least $1 million in losses. High-level perpetrators cause the greatest damage to their organizations. Frauds committed by owners/executives were more than three times as costly as frauds committed by managers, and more than nine times as costly as employee frauds. Executive-level frauds also took much longer to detect. More than 80% of the frauds in our study were committed by individuals in one of six departments: accounting, operations, sales, executive/upper management, customer service or purchasing. More than 85% of fraudsters in our study had never been previously charged or convicted for a fraud-related offense. This finding is consistent with our prior studies. Fraud perpetrators often display warning signs that they are engaging in illicit activity. The most common behavioral red flags displayed by the perpetrators in our study were living beyond their means (43% of cases) and experiencing financial difficulties (36% of cases). Conclusions and Recommendations Occupational fraud is a global problem. Though some of our findings differ slightly from region to region, most of the trends in fraud schemes, perpetrator characteristics and anti-fraud controls are similar regardless of where the fraud occurred. Fraud reporting mechanisms are a critical component of an effective fraud prevention and detection system. Organizations should implement hotlines to receive tips from both internal and external sources. Such reporting mechanisms should allow anonymity and confidentiality, and employees should be encouraged to report suspicious activity without fear of reprisal. Organizations tend to over-rely on audits. External audits were the control mechanism most widely used by the victims in our survey, but they ranked comparatively poorly in both detecting fraud and limiting losses due to fraud. Audits are clearly important and can have a strong preventative effect on fraudulent behavior, but they should not be relied upon exclusively for fraud detection. Employee education is the foundation of preventing and detecting occupational fraud. Staff members are an organization's top fraud detection method; employees must be trained in what constitutes fraud, how it hurts everyone in the company and how to report any questionable activity. Our data show not only that most frauds are detected by tips, but also that organizations that have anti-fraud training for employees and managers experience lower fraud losses. Surprise audits are an effective, yet underutilized, tool in the fight against fraud. Less than 30% of victim organizations in our study conducted surprise audits; however, those organizations tended to have lower fraud losses and to detect frauds more quickly. While surprise audits can be useful in detecting fraud, their most important benefit is in preventing fraud by creating a perception of detection. Generally speaking, occupational fraud perpetrators only commit fraud if they believe they will not be caught. The threat of surprise audits increases employees' perception that fraud will be detected and thus has a strong deterrent effect on potential fraudsters. Small businesses are particularly vulnerable to fraud. In general, these organizations have far fewer controls in place to protect their resources from fraud and abuse. Managers and owners of small businesses should focus their control investments on the most cost-effective mechanisms, such as hotlines and setting an ethical tone for their employees, as well as those most likely to help prevent and detect the specific fraud schemes that pose the greatest risks to their businesses. Internal controls alone are insufficient to fully prevent occupational fraud. Though it is important for organizations to have strategic and effective anti-fraud controls in place, internal controls will not prevent all fraud from occurring, nor will they detect most fraud once it begins. Fraudsters exhibit behavioral warning signs of their misdeeds. These red flags such as living beyond one's means or exhibiting control issues will not be identified by traditional controls. Auditors and employees alike should be trained to recognize the common behavioral signs that a fraud is occurring and encouraged not to ignore such red flags, as they might be the key to detecting or deterring a fraud. Given the high costs of occupational fraud, effective fraud prevention measures are critical. Organizations should implement a fraud prevention checklist similar to that on page 80 in order to help eliminate fraud before it occurs. 2010 Report to the Nations on Occupational Fraud and Abuse | 5 Introduction A wide variety of crimes and swindles fall under the umbrella of fraud. From Ponzi schemes and identity theft to data breaches and falsified expense reports, the ways perpetrators attempt to part victims from their money are extremely diverse and continually evolving. At their core, The stated goals of the first Report were to: Summarize the opinions of experts on the percentage and amount of organizational revenue lost to all forms of occupational fraud and abuse. however, all frauds involve a violation of trust. Examine the characteristics of the employees who commit occupational fraud and abuse. For businesses, no trust violations have the potential to be Determine what kinds of organizations are victims of occupational fraud and abuse. as harmful as those committed by the very individuals who are relied upon to make the organization successful: its Categorize the ways in which serious fraud and abuse occur. employees. This report focuses on the category of fraud occupational fraud in which an employee abuses his Since the inception of the Report to the Nation more than or her position within the organization for personal gain. a decade ago, we have released five updated editions in More formally, occupational fraud may be defined as: 2002, 2004, 2006, 2008 and the current version in 2010. Like the first Report, each subsequent edition has been based The use of one's occupation for personal enrichment on detailed case information provided by Certified Fraud Ex- through the deliberate misuse or misapplication of aminers (CFEs). With each new edition of the Report, we the employing organization's resources or assets. add to and modify the questions we ask of our survey participants in order to enhance the quality of the data we col- This definition is very broad, encompassing a wide range lect. This evolution of the Report to the Nation has enabled of misconduct by employees at every organizational level. us to continue to draw more meaningful information from Occupational fraud schemes can be as simple as pilferage the experiences of CFEs and the frauds they encounter. of company supplies or manipulation of timesheets, or as complex as sophisticated financial statement frauds. In our 2010 Report, we have, for the first time ever, widened our study to include cases from countries outside One of the ACFE's primary missions is to educate anti- the United States. This expansion allows us to more fully fraud professionals and the general public about the seri- explore the truly global nature of occupational fraud and ous threat occupational fraud poses. To that end, we have provides an enhanced view into the severity and impact undertaken extensive research to provide an in-depth look of these crimes. Additionally, we are able to compare the at the costs and trends in occupational fraud. In 1996, the anti-fraud measures taken by organizations worldwide in ACFE released its Report to the Nation on Occupational order to give fraud fighters everywhere the most appli- Fraud and Abuse, which was the largest known privately cable and useful information to help them in their fraud funded study on the subject at the time. prevention and detection efforts. A Note to Readers: Throughout this Report, we have included several comparisons of our current findings with those from our 2008 Report. However, it is important to note that the 2010 data include reported frauds from CFEs in 106 countries, while the 2008 data pertain to frauds reported only by CFEs in the United States. Although the populations of respondents for the two studies are not entirely analogous, we have nonetheless included these prior-study comparisons, as we believe interesting and useful trends can be seen by comparing and contrasting the frauds reported in the two studies. To enhance data clarity, we have included comparisons of 2008 data with both all-case data and U.S.-only data from our 2010 research when noteworthy discrepancies in our current findings are present. 6 | 2010 Report to the Nations on Occupational Fraud and Abuse Occupational Fraud and Abuse Classification System Asset Misappropriation Corruption Conflicts of Interest Bribery Purchasing Schemes Invoice Kickbacks Asset/Revenue Overstatements Sales Schemes Bid Rigging Timing Differences Internal Documents Ficticious Revenues External Documents Other Illegal Gratuities Fraudulent Statements Economic Extortion NonFinancial Financial Other Asset/Revenue Understatements Employment Credentials Concealed Liabilities and Expenses Improper Disclosures Improper Asset Valuations Cash Non-Cash Larceny Skimming Misuse Larceny Asset Requisitions and Transfers Refunds and Other Cash on Hand Sales Receivables From the Deposit Unrecorded Write-off Schemes False Sales and Shipping Other Understated Lapping Schemes Purchasing and Receiving Unconcealed Unconcealed Larceny Fraudulent Disbursements Billing Schemes Payroll Schemes Expense Reimbursement Schemes Check Tampering Register Disbursements Shell Company Ghost Employees Mischaracterized Expenses Forged Maker False Voids Non-Accomplice Vendor Commission Schemes Overstated Expenses Forged Endorsement False Refunds Personal Purchases Workers Compensation Fictitious Expenses Altered Payee Falsified Wages Multiple Reimbursements Concealed Checks Authorized Maker 2010 Report to the Nations on Occupational Fraud and Abuse | 7 The Cost of Occupational Fraud Measuring the cost of occupational fraud is an important, yet incredibly challenging, endeavor. Arguably, the true Fraud, by its very nature, does not lend itself to being scientifically observed or measured in an accurate manner. One of the primary characteristics of fraud is that it is clandestine, or hidden; almost all fraud involves the attempted concealment of the crime. cost is incalculable. The inherently clandestine nature of fraud means that many cases will never be revealed, and, of those that are, the full amount of losses might not be uncovered, quantified or reported. Consequently, any measurement of occupational fraud costs will be, at best, an estimate. Nonetheless, determining such an approximation is critical to illustrate the pandemic and destructive nature of white-collar crime. We asked each CFE who participated in our survey to provide his or her best estimate of the percentage of annual revenues that the typical organization loses to fraud in a given year. The median response was that the average organization annually loses 5% of its revenues to fraud. Applying this percentage to the 2009 estimated Gross World Product of $58.07 trillion1 would result in a projected total global fraud loss of more than $2.9 trillion. Readers should note that this estimate is based solely on the opinions of 1,843 anti-fraud experts, rather than any specific data or factual observations; accordingly, it should not be interpreted as a literal representation of the worldwide cost of occupational fraud. However, because there is no way to precisely calculate the size of global fraud losses, the best estimate of anti-fraud professionals with a frontline view of the problem may be as reliable a measure as we are able to make. In any event, it is undeniable that the overall cost of occupational fraud is immense, certainly costing organizations hundreds of billions or trillions of dollars each year. 8 | 2010 Report to the Nations on Occupational Fraud and Abuse The typical organization loses 5% of its annual revenues to occupational fraud. United States Central Intelligence Agency, The World Factbook (https://www.cia.gov/ library/publications/the-world-factbook/geos/xx.html) 1 Distribution of Losses We received information about the total dollar loss for 1,822 of the 1,843 frauds reported to us in our study.2 The median loss for these cases was $160,000. Nearly one-third of the fraud schemes caused a loss to the victim organization of more than $500,000, and almost one-quarter of all reported cases topped the $1 million threshold. Distribution of Dollar Losses 30% 29.3% 25% Percent of Cases 23.7% 20% 18.4% 15% 10% 10.6% 5% 0% 8.4% 7.2% 2.4% Less than $1,000 $1,000 - $9,999 $10,000 - $49,999 $50,000 - $99,999 $100,000 - $499,999 $500,000 - $999,999 $1,000,000 and up Dollar Loss Although this Report includes fraud cases from more than 100 nations, all monetary amounts presented throughout this Report are in U.S. dollars. 2 2010 Report to the Nations on Occupational Fraud and Abuse | 9 How Occupational Fraud Is Committed Previous ACFE research has identified three primary categories of occupational fraud used by individuals to defraud their employers. Asset misappropriations are those schemes in which the perpetrator steals or misuses an organization's resources. These frauds include schemes such as skimming cash receipts, falsifying expense reports and forging company checks. Corruption schemes involve the employee's use of his or her influence in business transactions in a way that vio- Based on previous ACFE research we have broken down the schemes reported to us into three primary categories: asset misappropriation, corruption, and financial statement fraud. lates his or her duty to the employer for the purpose of obtaining a benefit for him- or herself or someone else. Examples of corruption schemes include bribery, extortion and a conflict of interest. Financial statement fraud schemes are those involving the intentional misstatement or omission of material information in the organization's financial reports. Common methods of fraudulent financial statement manipulation include recording fictitious revenues, concealing liabilities or expenses and artificially inflating reported assets. As indicated in the following charts, asset misappropriations are by far both the most frequent and the least costly form of occupational fraud. On the other end of the spectrum are cases involving financial statement fraud. These schemes were present in less than 5% of the cases reported to us, but caused a median loss of more than $4 million. Corruption schemes fell in the middle category in both respects, occurring in just under one-third of all cases involved in our study and causing a median loss of $250,000. 10 | 2010 Report to the Nations on Occupational Fraud and Abuse Financial statement fraud is the most costly form of occupational fraud, causing a median loss of more than $4 million. Occupational Frauds by Category Frequency3 2010 86.3% Type of Fraud Asset Misappropriation 2008 88.7% 32.8% Corruption 26.9% Financial Statement Fraud 0% 4.8% 10.3% 20% 40% 60% 80% 100% Percent of Cases Occupational Frauds by Category Median Loss 2010 $4,100,000 Type of Fraud Financial Statement Fraud 2008 $2,000,000 $250,000 Corruption $375,000 $135,000 Asset Misappropriation $150,000 $0 $1,000,000 $2,000,000 $3,000,000 $4,000,000 $5,000,000 Median Loss 3 The sum of percentages in this chart exceeds 100% because several cases involved schemes from more than one category. 2010 Report to the Nations on Occupational Fraud and Abuse | 11 How Occupational Fraud Is Committed As previously mentioned, our 2010 data include fraud cases from countries throughout the world, while our 2008 data contain only U.S.-based cases. In the following charts, we isolated the U.S. cases from our current study to make a more direct comparison to our 2008 data. Interestingly, while financial statement fraud remained the least common and most costly form of fraud among U.S. cases, there was a much lower percentage of financial statement cases in this study (four percent) as compared to 2008 (ten percent). Additionally, the median losses for all three categories of fraud were notably smaller in 2010 than they were in 2008. Occupational Frauds by Category (U.S. only) Frequency4 2010 89.8% Type of Fraud Asset Misappropriation 2008 88.7% 21.9% Corruption 26.9% 4.3% Financial Statement Fraud 10.3% 0% 20% 40% 60% 80% 100% Percent of Cases 4 The sum of percentages in this chart exceeds 100% because several cases involved schemes from more than one category. 12 | 2010 Report to the Nations on Occupational Fraud and Abuse Occupational Frauds by Category (U.S. only) Median Loss 2010 $1,730,000 Type of Fraud Financial Statement Fraud 2008 $2,000,000 $175,000 Corruption $375,000 Asset Misappropriation $0 $100,000 $150,000 $500,000 $1,000,000 $1,500,000 $2,000,000 Median Loss In addition to observing the frequency and median losses Percent of Total Reported Dollar Losses caused by the three categories of fraud, we analyzed the proportion of the total losses suffered based on scheme category. The cases in our study represented a combined total loss of more than $18 billion. As indicated in the chart Asset Misappropriation 20.8% Corruption 11.3% to the right, of the total reported losses that were attributable to a specific scheme type, 21% were caused by asset misappropriation schemes, 11% by corruption and 68% by fraudulent financial statements. Financial Statement Fraud 68.0% 2010 Report to the Nations on Occupational Fraud and Abuse | 13 How Occupational Fraud Is Committed Asset Misappropriation Sub-Schemes With nearly 90% of occupational frauds involving some form of asset misappropriation, it is instructional to further delineate the methods used by employees to embezzle organizational assets. We divided asset misappropriation schemes into nine sub-categories, as illustrated in the table on page 15. The first eight sub-categories represent schemes targeting cash; these frauds account for approximately 85% of all asset misappropriations. Two of the sub-schemes skimming and cash larceny involve pilfering incoming cash receipts, such as sales revenues and accounts receivable collections. The next five sub-categories billing, expense reimbursement, check tampering, payroll and fraudulent register disbursement schemes involve fraudulent disbursements of cash. The eighth form of cash misappropriation targets cash the organization has on hand, such as petty cash funds or cash in a vault. The final sub-category of asset misappropriations covers the theft or misuse of non-cash assets, including inventory, supplies, fixed assets, investments, intellectual property and proprietary information. The table on page 15 provides the frequency and median loss associated with each asset misappropriation sub-category. Duration of Fraud Schemes In addition to examining the monetary cost of the fraud cases reported to us, we analyzed the length of time these schemes lasted before being detected. The median duration the time period from when the fraud first occurred to when it was discovered for all cases in our study was 18 months. Not surprisingly, cases involving financial statement fraud the most costly form of fraud lasted the longest, with a median duration of 27 months. Fraudulent register disbursements, on the other hand, were not only the least costly form of fraud in our study, but also tended to be detected the soonest. Scheme Type Median Duration of Fraud Based on Scheme Type Financial Statement Fraud Check Tampering Expense Reimbursements Payroll Billing Corruption Cash on Hand Skimming Larceny Non-Cash Register Disbursement 27 24 24 24 24 18 18 18 18 15 12 0 5 10 15 20 Median Months to Detection 14 | 2010 Report to the Nations on Occupational Fraud and Abuse 25 30 Note: Because asset misappropriation schemes are both so common and so diverse in their methods, for the remainder of the Report, we will break down our analysis of the fraud schemes into 11 categories corruption, financial statement fraud and the nine sub-categories of asset misappropriation so as to provide a meaningful understanding of the full spectrum of ways in which employees defraud their employing organizations. Asset Misappropriation Sub-Categories Category Description Skimming Any scheme in which cash is stolen from an organization before it is recorded on the organization's books and records Cash Larceny Any scheme in which cash is stolen from an organization after it has been recorded on the organization's books and records Cases Reported Percent of all cases5 Median Loss Employee accepts payment from a customer, but does not record the sale, and instead pockets the money 267 14.5% $60,000 Employee steals cash and checks from daily receipts before they can be deposited in the bank 181 9.8% $100,000 479 26.0% $128,000 Examples Schemes Involving Theft of Cash Receipts Schemes Involving Fraudulent Disbursements of Cash Billing Any scheme in which a person causes his employer to issue a payment by submitting invoices for fictitious goods or services, inflated invoices or invoices for personal purchases Employee creates a shell company and bills employer for services not actually rendered Expense Reimbursements Any scheme in which an employee makes a claim for reimbursement of fictitious or inflated business expenses Employee files fraudulent expense report, claiming personal travel, nonexistent meals, etc. 278 15.1% $33,000 Check Tampering Any scheme in which a person steals his employer's funds by intercepting, forging or altering a check drawn on one of the organization's bank accounts Employee steals blank company checks, makes them out to himself or an accomplice 274 13.4% $131,000 Any scheme in which an employee causes his employer to issue a payment by making false claims for compensation Employee claims overtime for hours not worked 157 8.5% $72,000 Cash Register Disbursements Any scheme in which an employee makes false entries on a cash register to conceal the fraudulent removal of cash Employee fraudulently voids a sale on his cash register and steals the cash 55 3.0% $23,000 Cash on Hand Misappropriations Any scheme in which the perpetrator misappropriates cash kept on hand at the victim organization's premises Employee steals cash from a company vault 121 12.6% $23,000 Non-Cash Misappropriations Any scheme in which an employee steals or misuses non-cash assets of the victim organization Employee steals inventory from a warehouse or storeroom 156 16.3% $90,000 Payroll Employee purchases personal items and submits invoice to employer for payment Employee steals outgoing check to a vendor, deposits it into his own bank account Employee adds ghost employees to the payroll Other Asset Misappropriation Schemes 5 Employee steals or misuses confidential customer financial information The sum of percentages in this table exceeds 100% because several cases involved asset misappropriation schemes from more than one category. 2010 Report to the Nations on Occupational Fraud and Abuse | 15 Detection of Fraud Schemes One of the principal goals of our research is to identify how past frauds were detected so that organizations can Respondents to our survey were asked to identify how the frauds were first discovered. Three times as many frauds in our study were uncovered by a tip as by any other method. apply that knowledge to their future anti-fraud efforts. Tips were by far the most common detection method in our study, catching nearly three times as many frauds as any other form of detection. This is consistent with the findings in our prior reports. Tips have been far and away the most common means of detection in every study since 2002, when we began tracking the data. Management review and internal audit were the second and third most common forms of detection, uncovering 15% and 14% of frauds, respectively. It is also noteworthy that 11% of frauds were detected through channels that lie completely outside of the traditional anti-fraud control structure: accident, police notification and confession. In other words, 11% of the time, the victim organization either had to stumble onto the fraud or be notified of it by a third party in order to detect it. Frauds are much more likely to be detected by tips than by any other method. Detection Method Initial Detection of Occupational Frauds Tip Management Review Internal Audit By Accident Account Reconciliation Document Examination External Audit Surveillance/Monitoring Notified by Police Confession IT Controls 40.2% 15.4% 13.9% 8.3% 6.1% 5.2% 4.6% 2.6% 1.8% 1.0% 0.8% 0% 10% 20% 30% Percent of Cases 16 | 2010 Report to the Nations on Occupational Fraud and Abuse 40% 50% Source of Tips Source of Tips Not surprisingly, employees were the most common 50% source of fraud tips. However, customers, vendors, competitors and acquaintances (i.e., non-company sources) 13.4% 3.7% to anonymously report fraud or misconduct by phone or 1.8% do r eh O old w er n / Co er m pe tit Pe or A r cq pe ua tr in ato ta r' nc s e s Ve n m ou er ny ar oy pl Em Sh A fraud reporting systems. Such systems enable employees 2.5% 0% to detect fraud, the impact of tips is, if anything, understated by the fact that so many organizations fail to implement 12.1% 10% om While tips have consistently been the most common way 17.8% no Impact of Anonymous Reporting Mechanisms (Hotlines) 20% st dors and other external stakeholders. 30% ee cized not only to employees, but also to customers, ven- Cu fraud reporting policies and programs should be publi- 40% Percent of Tips provided at least 34% of fraud tips, which suggests that 49.2% Source of Tips through a web-based portal. The ability to report fraud 6 anonymously is key because employees often fear making repeatedly been shown to be the most effective way to reports due to the threat of retaliation from superiors or catch fraud. The better an organization is at collecting and negative reactions from their peers. Also, most third-party responding to fraud tips, the better it should be at detect- hotline systems offer programs to raise awareness about ing fraud and limiting losses. how to report misconduct. Consequently, one would expect that the presence of a fraud hotline would enhance In 67% of the cases where there was an anonymous fraud detection efforts and foster more tips. tip, that tip was reported through an organization's fraud hotline. This strongly suggests that hotlines are an effec- This turns out to be true. As seen on page 18, the pres- tive way to encourage tips from employees who might oth- ence of fraud hotlines correlated with an increase in the erwise not report misconduct. Perhaps most important, as number of cases detected by a tip. In organizations that noted on page 43, organizations that had fraud hotlines suf- had hotlines, 47% of frauds were detected by tips, while fered much smaller fraud losses than organizations without in organizations without hotlines, only 34% of cases were hotlines. Those organizations also tended to detect frauds detected by tips. This is important because tips have seven months earlier than their counterparts. 6 For simplicity's sake, we will refer to all reporting mechanisms as hotlines in this study. 2010 Report to the Nations on Occupational Fraud and Abuse | 17 Detection of Fraud Schemes Impact of Hotlines Tip Internal Audit 11.2% Detection Method By Accident Organizations With Hotlines 16.5% Organizations Without Hotlines 15.7% 15.7% Management Review Account Reconcilliation 47.1% 33.8% 4.7% 7.8% 4.6% 11.9% Document Examination 3.7% 6.5% Surveillance/Monitoring 3.0% 2.2% External Audit 1.4% 7.3% IT Controls Notified by Police Confession 1.4% 0.4% 1.0% 2.3% 0.9% 1.1% 0% 10% 20% 30% 40% 50% Percent of Cases Detection Methods Based on Organization Type The chart on page 19 shows how frauds were detected based on the victim's organization type. We see that privately owned companies tended to have the fewest frauds detected by tip and the most frauds caught by accident, both of which were also true in our 2008 study. Publicly held companies tended to detect more frauds by management review and internal audit than their counterparts. Government agencies had the highest rate of detection by tips and had a proportionately high rate of frauds caught through external audit. Detecting Fraud in Small Businesses Small businesses historically tend to suffer disproportionately high occupational fraud losses, according to our previous reports. The trend was not as pronounced in this study as in past years, but we still saw that 31% of all occupational frauds were committed against small businesses (the highest rate of any category) and the median loss in those schemes was $155,000 (see page 29). One reason that small businesses are particularly good targets for occupational fraud is that they tend to have far fewer anti-fraud controls than larger organizations (see page 39). 18 | 2010 Report to the Nations on Occupational Fraud and Abuse Initial Detection Method by Organization Type 35.8% Tip Public Company 16.7% 15.1% 6.5% By Accident Detection Method Private Company 10.7% 11.6% Internal Audit 6.8% 5.3% Account Reconcilliation 3.9% 4.6% Government 11.2% 8.9% 8.2% 6.5% 6.0% 5.0% 3.9% Document Examination 6.5% 5.2% 2.3% 7.4% External Audit Notified by Police Not-for-Profit 46.3% 13.0% 15.4% 17.6% 11.6% Management Review Surveillance/Monitoring 43.2% 41.1% 1.2% 2.6% 3.0% 2.8% 1.8% 2.5% 1.2% 1.4% Confession 1.2% 1.0% 1.1% 1.4% IT Controls 0.6% 0.5% 1.2% 0.4% 0% 10% 20% 30% 40% 50% Percent of Cases When we look at how small businesses detect frauds, it is apparent that they catch a much lower proportion of schemes through tips or internal audits than larger organizations. According to the chart on page 20, only 33% of small business frauds are detected by a tip, and only 8% are detected by an internal audit. Additionally, a relatively large percentage of frauds are caught by accident at small companies nearly twice as many as at larger organizations. Many of these discrepancies are likely due to the low rates of control implementation at small businesses. 2010 Report to the Nations on Occupational Fraud and Abuse | 19 Detection of Fraud Schemes Initial Detection of Frauds in Small Businesses 33.3% Tip 15.3% 15.8% Management Review By Accident Detection Method