Protecting Your Business From Fraud

1. Protecting Your Business From Fraud Jacque James, MBA, MAFM President of Asset Recovery Associates, LLC September 27, 2012

2. Overview of Presentation • Discussion topics: • Overview of Occupational Fraud • Fraud Statistics • Red Flags of Fraud • Hiring Ethical Employees • Payroll Fraud Schemes • 4 Step Fraud Prevention Process • Prevention Best Practices • Q&A

3. What is Occupational Fraud?

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

5. Classifications of Fraud

6. 51 Fraud Schemes

7. Fraud Statistics In Small Business • Accounts for 31% of all fraud • Small businesses are targets for fraud due to fewer anti-fraud controls compared to that of larger organizations • The most common types of fraud are: • Payroll Fraud Schemes • Billing Fraud Schemes • Skimming Schemes

8. The Cost of Fraud • The average organization loses 5% of its revenues to fraud annually • The median loss caused by occupational fraud cases is $140,000 • Most frauds last an average of 18 months before being detected *Source: 2012 Report of the Nation - Association of Certified Fraud Examiners

9. Median Duration of Fraud Based on Scheme Type

10. Why Fraud Occurs Three Criteria Needed For FraudTo Occur:

11. Why Fraud Occurs • Opportunity • Poor company culture • Knowledge of weak internal controls • Accounting anomalies not monitored • Lack of supervision • Employees believe they will not get caught • Motive • Financial struggles • Pressure to perform • Divorce • Family or peer pressure • Addiction problems (Alcohol, drugs, gambling)

12. Why Fraud Occurs • Ability to Rationalize Behavior • Employee believes he/she is not being adequately compensated • Employee believes the organization OWES him/her • Feeling of insufficient recognition for job performance • Personal need for money • Have the intent to repay the money

13. Who Commits the Fraud? • 65% of men commit acts of fraud compared to 35% of women. • Average median loss caused by males is $200,000 vs $91,000 caused by females.

14. Top 10 Behavioral Red Flags • Employees living beyond their means • Financial difficulties • Control issues, unwillingness to share duties • Unusually close vendor/customer relationship • Wheeler dealer attitude • Divorce, family pressures • Irritability, suspiciousness or defensiveness • Addiction problems • Refusal to take vacations • Past employment related issues

15. Hiring Ethical Employees

16. Did You Know? • 53% of all job applications contain inaccurate information • 34% of all application forms contain outright lies about experience, education, and ability to perform essential functions on the job • 11% of job applicants misrepresented why they left a former employer

17. Purpose of Interview Process • Get to know the “real” candidate • Who they normallyare vs. who they want us to believe they are • Assess skill set and past employment history • Determine fit for your organization

18. The Application • Does everyone require an application? • Candidates often omit or exaggerate important information • Is the application filled out completely? • Are there gaps in employment? • Is there language regarding falsifying the application? • Did the candidate sign the application?

19. Interview Room Set Up • Select a quiet and comfortable room • Clear table or desk • Sit next to the interviewee • Do NOT sit behind a desk – creates a psychological barrier

20. What is Baseline Behavior? • The individuals normal behavior in a relaxed state • Posture  • Eye contact  • Gestures with hands and arms  • Legs and feet • Speech • Tone of voice

21. Behavioral vs. Assumptive Questioning • Behavioral Based • Open ended question that probes into behavior • Tell me about a time when you didn’t meet individual performance. • Assumptive Based • Open ended questions that “assumes” a behavior or action • When was the first time you were disciplined on the job, either verbally or written? • Ask follow up questions

22. Threatening vs. Non Threatening Questions • Ask non threatening questions to determine baseline • Tell me about your hobbies • What type of skills do you possess? • Threatening • When was the last time you were ever terminated from an employer?

23. Detecting Deception Through Verbal & Non Verbal Indicators

24. Body Language Basics Positive Body Language Negative Body Language • Moving or leaning closer to you • Relaxed, uncrossed limbs • Long periods of eye contact • Looking down and away out of shyness • Genuine Smiles • Moving or leaning away from you • Crossed arms or legs • Looking away to the side • Feet pointed away from you, or towards an exit • Rubbing/scratching their nose, eyes, or the back of their neck

25. Non Verbal Indicators • Typical signs that that may indicate deception: • Closed position • Arms / Legs crossed • Body is turned away from you • Facial expressions • Hand or fingers cover mouth

26. Non Verbal Indicators • Typical signs that that may indicate deception: • Signs of stress • Breathing rate increases • Perspiration increases • Complexion changes • Lack of eye contact

27. Verbal Indicators • Paralinguistics – Gestures immediately after a verbal response • Coughing • Laughter • Clearing of throat • Words spoken in wrong tense • Deceptive people refer to past events as if the event was occurring in the present

28. Verbal Indicators • Lack of self – reference • The subject removes him / herself from the story • "The safe was left unlocked" • Euphemisms / Minimizers • “took” vs “stole” • “borrowed” • Lack of detail

29. Other Deceptive Indicators • Distractors • Grooming • Repeating the question • Answering questions with questions

30. Pre-Employment Interview Guide

31. Pre-Employment Interview Guide • Purpose of the Interview Guide • Designed to obtain information about the candidates background that may not otherwise be discovered • Identifies possible integrity issues • Determines past employment issues

32. Role Play

33. Payroll Fraud

34. What is Payroll Fraud? • Occupational fraud in which a person who works for an organization causes that organization to issue a payment by making false claims for compensation • Ghost Employee Schemes • Falsified Hours and Salary Schemes • Commission Schemes • Payroll fraud represents 9.3% of all fraud cases • Average loss is $49,000

35. Ghost Employee Scheme • A Ghost employee is someone on the payroll who does not actually work for the victim company

36. Ghost Employee Scheme • Add the ghost to the payroll • Using names similar to real employees • Failing to take terminated employees off the payroll • Collecting timekeeping information • Fake timecards • Approval of timecards • Delivery of the paycheck • Mailed to the employees address • Direct deposited

37. Preventing and Detecting Ghost Employee Scheme • Separate the hiring function from the payroll function • Personnel records maintained separate from payroll & timekeeping • Owners / Manager should approve all payroll changes • Check payroll records against personnel records • Periodically run computer reports for employees • Are there duplicate social security numbers for two employees? • Are there duplicate bank account numbers for multiple employees? • Compare payroll to schedules

38. Falsified Hours and Salary • Overpayment of wages is the most common form of misappropriating payroll funds • Increase hours worked • Change rate of pay • Time clock & time card manipulation • Being paid for time not worked • Underreport leave time • “Accomplice” clocks in absent employee

39. Preventing and Detecting Falsified Hours and Salary Schemes • A manager should verify all wage rate changes • Time cards should be secured and monitored • Supervisor should initial any changes to timecard • Run programs to actively seek out fraudulent payroll activity • Compare payroll to production schedules

40. Preventing and Detecting Falsified Hours and Salary Schemes • Preparation, authorization, distribution, and reconciliation should be segregated • Review payroll report to scheduled hours • No sick leave/vacation without management approval • Look for individuals with excessive overtime • Look for payroll expenses that exceed budget projections or prior years

41. Commission Schemes Commission fraud is very common in companies whose culture is sales orientated • Falsify the amount of sales made • Create fraudulent sales orders, customer purchase orders, credit authorizations, packing slips, invoices, et • Ring up a false sales on the cash register • Overstate legitimate sales • Alter price on existing sales • Claim sales made by other employees

42. Detecting Commission Schemes • Run periodic reports to show an unusual relationship between sales figures and commission figures • Look for high levels of uncollected sales • Track commission earned per salesperson; investigate unreasonably high levels • Randomly contact customers to verify sales • Commissions should be handled independently of sales department

43. Payroll Controls • Separate the following duties: • Payroll preparation • Payroll disbursement • Payroll distribution • Payroll bank reconciliation • Human resources • Payroll accounting should be independent of general ledger function • Appropriate approval for time worked, overtime, rate of pay, commission rates, etc.

44. Create a Fraud Free Culture with the 4 Step Fraud Prevention Process

45. 4 Step Fraud Prevention Process • Hire ethical candidates • Perform assessments and/or conduct integrity interviews • Conduct Background Screenings on key personnel • Pre-employment statement analysis (LSAT) • Create a positive company culture • People won’t steal when they have a sense of ownership and loyalty to the organization • Implement and assess internal controls • Implement and enforce anti fraud policies and procedures • Instill a system of checks and balances • Conduct Fraud Risk Assessments • Instill mechanism for reporting fraud • Implement a hotline and reward system • Hotline will reduce the time to detection from 24 months to 12 months

46. Fraud Prevention Best Practices • Create a “Perception of Control” • Educate employees on fraud • Have a Conflict of Interest & Code of Conduct Policy • “Inspect what you expect” by conducting surprise audits • Reconcile bank statements on a monthly basis • Separation of duties • Insure for loss • “Crime Policy” or Fidelity Bond • “Cybercrime Insurance”

47. Fraud Prevention Best Practices • Have policies and procedures in place that outline what is and what is not acceptable • Proper check signing authorizations / secure signature stamp • Match employee addresses on payroll records againstaddresses on vendor lists • Spot check expense reimbursements • Open the mail periodically • Conduct Fraud Risk Assessments annually

48. Why Are Controls Important?

49. Protect Your Investment • Do your employees rate the company culture a 9 or 10? • Do you conduct pre-employment screenings? • Do you have policies and procedures in place to prevent misconduct? This includes HR • Do you have a crime policy & cyber crime policy in place? • Do you have the proper amount of coverage? • Have you conducted a Fraud Risk Assessment lately? • If fraud occurs in your business, call a professional!

50. Test Your Fraud IQ Answers 1. How much do small businesses lose to fraud each year? d. 140,000 2. What percentage of revenue is lost to employee theft and occupational fraud each year? a. 5% 3. Most employee theft is committed by 1st time offenders. True 4. What percentage of your employees arelikely to steal? d. 61–90%