FRAUD

1. FRAUD Prevention IT IS All OUR RESPONSIBILITY Fraud Presentation MAM September 15, 2004 by Internal Audit

2. Introduction • The value of public resources lost each year because of fraud, waste and abuse defies precise quantification, but almost certainly runs to many millions of dollars. • In the climate of fiscal restraint which has become normal for all local California governments, it is more important than ever that public funds are managed responsibly.

3. Fraud Scenario • A government agency official directs the owner of a company doing business under contract to provide equipment and contractor staff that will be used to perform non-contract related work for the agency. When seeking payment, the contractor bills the hours for non-contract work as having been expended on contract related activity. The billing occurs with the knowledge of the agency official, and the agency official instructs lower level staff to approve the bill for payment from agency accounts. Because the contract is part of a federally funded program, the agency in turn files a claim for reimbursement with the federal government, which the federal government, in good faith, pays. Some people might say that the agency official is a creative manager. I'd saythat agency official is a crook.

4. Penalty of Fraud • There are acts of fraud that you can be put in jail for and others for which a lesser penalty can be imposed.

5. Most County Employees are Ethical • INTERNAL AUDIT believe the vast majority of Riverside County personnel are ethical, well-intentioned and desire to conduct County business activities with utmost propriety. • The ideas and concepts discussed today will provide County employees with specific measures to help ensure that high professional standards of integrity are adhered to by all members of the Riverside County community.

6. Fraud, Waste & Abuse • The terms fraud, waste and abuse are often used interchangeably, even though they are conceptually and legally distinct. • Nevertheless often coexist, frequently arise from the same underlying factors, and, in terms of prevention, they are often amenable to the same countermeasures.

7. Fraud • To illustrate, fraud is understood to mean a dishonest and deliberate course of action which results in the obtaining of money, property or an advantage to which the recipient would not normally be entitled. • This would include, theft of government property or the submission of artificially inflated invoice by a contractor

8. Waste • Waste entails the expenditure or allocation of resources significantly in excess of need. • An example would be the negligent or reckless requisition of three times as much perishable produce as required. • Waste need not necessarily involve an element of private use nor of personal gain, but invariably signifies poor management.

9. Abuse • Abuse, defined here as a subset of waste, entails the exploitation of "loopholes" to the limits of the law, primarily for personal advantage. • One abuses a system of travel allowances by intentionally and unnecessarily scheduling meetings in another city on a Friday afternoon and on the following Monday morning in order to claim per diem over a weekend. • Power-Plays: Office politics are major creators of power-play opportunities.

10. Abuse • Another common tactic is when a superior or supervisor uses their credibility and position to damage someone they don’t particularly like in the hopes of getting rid of them. • Extreme attention and being overly helpful towards one’s senior or supervisor in hopes of special gain is frequently seen as "brown nosing", "apple polishing" and other unflattering terms.

11. Abuse • This activity is used by one against others to gain favor with their superiors for their own gain. A common tactic in this activity is to diminish another employee to make oneself look better. A common term for this is "back stabbing". • At no time do power plays benefit the County’s operations as a whole.

12. Formula for Fraud • Motivation=Access + Creditability + Opportunity

13. Formula for Fraud, continued • Someone with no motivation to cheat you would not cheat you even if they had the other three components.  • Someone with the motivation would need to attain the three other components to be able to cheat you. 

14. How Fraud Exists • Fraud against the government is more easily accomplished in an environment of administrative and fiscal laxity. • It may well be that a significant proportion of revenue loss flows less from deceit than from careless or inefficient management of public resources.

15. Where Fraud Occurs • There are three basic modes of government activity in which fraud can occur - • paying, collecting and contracting. Governments bestow a variety of benefits, subsidies, and • payments to individuals and organizations. Not all recipients are entitled to what they receive.

16. How Fraud Occurs, continued • Governments collect revenues from individuals and organizations, in the form of taxes and fees, or as payment for services. • There are those who do not pay what is due. • Governments themselves are consumers of goods and services. There are those providers of goods and services who charge the government for goods not delivered or for services not rendered, or • Who knowingly provide defective or substandard products.

17. How Fraud Occurs, continued • Beyond this, governments control billions of dollars of capital resources, some of which are vulnerable to conversion for private use by unauthorized persons. • Fraud against the government is by no means the exclusive province of unscrupulous citizens. • Fraud can be perpetrated by individuals and by companies as taxpayers, contractors, or as beneficiaries of public payments.

18. How Fraud Occurs, continued • But government employees themselves can be offenders. And certain types of fraud require the collaboration of public sector employees and citizen offenders. • The problem of fraud against the government cannot be analyzed in isolation from the more general issue of unnecessary revenue loss. • It is often more useful to broaden our focus. • This includes not only fraud, but waste and abuse in public programs.

19. Method of Fraud • Most theft is accomplished by the employee acting alone. • It is possible for an employee to engage the help of one of the County’s major vendors. • The employee may approve invoices for items never delivered. • He or she then splits the overpayment with the vendor. • Or they join forces with a delivery person who shorts the company a few items from the truck, sells the products, and splits the take.

20. Methods of Fraud • Abuse of company funds: This is a frequent story in the news today. Abuse of company funds is using the company’s own money for uses that benefit an individual but do not benefit the company. These funds are used for the personal benefit of the person who authorized the use of those funds.

21. Methods of Fraud • Internal theft: This refers generally to the pilferage of company assets by employees. • Companies dealing in products have the most problems in this area. • Example  Retail stores suffer from inventory shrinkage where goods are taken without being paid for.

22. Methods of Fraud • Skimming: Taking money directly from the receipts and not recording them on the books.  In larger scale, I call it "income diversion".

23. Methods of Fraud • Misappropriation of company funds for personal gain: This is using the company's cash as one's own piggy bank.  • When this happens in a privately owned company, it is rarely reported.  • In a publicly owned company, or government it can be considered abuse of investor or public funds and may be a crime.

24. Methods of Fraud • Conflict of interest: This kind of fraud suggests the government employee has some affiliation with the vendor that might suggest favoritism.

25. Methods of Fraud • Payoff/kickback: These activities refer to bribes. A bribe is a direct payment in order to gain where one would not likely gain in normal circumstances. • The recipient of a bribe can be referred to as being corrupt. • Bribes are frequently paid to buyers or influence peddlers to gain orders for a company that it may otherwise not get. • A payoff is paid before the sale is made. • A kickback is paid after the sale is made.  • A payoff is like saying "please"; • A kickback is like saying "thank you".  • Bribery is rarely reported or litigated. 

26. Methods of Fraud • Cooking the books: This old accounting phrase refers to the manipulation of financial statements and records to conceal the reality. • Example   Enron cooked the books. 

27. Methods of Fraud • Deceit: Deliberately misleading someone for personal gain though no actual crime has been committed. • Embezzlement: This is the illegal use of funds placed in someone's control.  • Larceny is another name. • Example  The bookkeeper takes company money for their own use.

28. Methods of Fraud • Falsified financial statements: This is similar to cooking the books; the lawyers prefer this term. • False/fraudulent claims: Insurance claims overvaluing the loss or creating the loss for secret gain.

29. Methods of Fraud • Influence peddling: When one attempts to control the actions of another by offering a personal gain outside the normal course of business. • This is accused of happening frequently with politicians.  • It can also be called "swinging one’s weight around" and coercion.

30. Methods of Fraud • Insider trading: Gaining from or reducing a loss from a publicly traded security by selling it or buying it on important news learned before it is released is called insider trading. • From whom this news is learned is the difference between being legal or illegal. • Overhearing a conversation in a restaurant is not illegal; hearing it from the company’s president is illegal. • Example  The Martha Stewart case.

31. Behavior to Look For • Marked Personality Changes in Employees • Employee Having Outside Business Interests • Poor Internal Controls • Rising Department Expenses • Too Much Control in Key Employees • Lax Management • Failure to Pre-Screen Employees

32. Behavior to Look For • They live beyond their means when it comes to cars, houses, and vacations. • They may have a drinking, drug, or gambling problem. • They may have family financial problems they are dealing with. • They may suggest replacing or getting rid of the outside accounting firm. They say they can handle the duties of the independent accountant and "save the company the added expense."

33. Behavior to Look For • While the traits mentioned do not guarantee that fraud exists in your department, they do indicate a higher likelihood of fraud. • Therefore, management should be alert to the possibility of fraudulent activities.

34. System of Internal Control • Internal controls can be categorized as accounting controls or administrative controls. • Accounting controls are designed to safeguard County assets and ensure the accuracy of financial records. • Administrative controls are designed to promote operational efficiency and adherence to County policies and procedures.

35. System of Internal Control • Accounting controls can be further categorized as either preventive controls or detectivecontrols. • Preventive controls are designed to prevent • invalid transactions from being processed • assets from being misappropriated. • Detective controls are designed to: • identify errors or irregularities in transactions already processed • identify missing assets or invalid disbursements.

36. System of Internal Control • We in INTERNAL AUDIT believe the best approach is to prevent illegal and inappropriate acts from occurring in the first place.

37. Role of INTERNAL AUDIT • During the past few years, INTERNAL AUDIT has modified its auditing programs to include specific fraud detection procedures. • This action was made in response to the changing role of both internal and external auditors concerning responsibility for detecting fraud. • Fraud detection auditing procedures are now applied to most audit engagements based on an analysis of the risks of fraud occurring in the organization being reviewed.

38. Role of INTERNAL AUDIT • INTERNAL AUDIT reviews the adequacy of the system of internal control in all major aspects of County operations in accordance with the annual Board of Supervisor’s approved Audit Plan. • The basis of selecting audit engagements and the frequency of reviews is a County Operations Risk analysis. • Audit engagements are scheduled based on selected criteria noted in the Risk Analysis.

39. Role of Every County Employee • It is important to understand that as a Riverside County employee, you have stewardship responsibilities for County assets under your purview. • This means, you are responsible for ensuring departmental assets are safeguarded from loss. • One important underlying concept which must be accepted is the reality that a fraud is possible in your organization. • If you do not believe fraud is possible, you will not identify it even if it is clearly evident. • Very often fraud symptoms are viewed as administrative errors because individuals cannot conceive of the existence of fraud particularly in organizations where there is a longtime affiliation with coworkers.

40. Role of Every County Employee • As a member of the Riverside community you are expected to report any instance of a suspected fraud to the Chief of INTERNAL AUDIT. • If an instance of suspected fraud is reported instead to a supervisor, manager, director, or other responsible person, that person is to report the instance to the Chief of INTERNAL AUDIT. • Where appropriate, such investigations may be coordinated with the District Attorney.

41. Role of Every County Employee • If presented with reasonable evidence of a suspected fraud, the Chief of INTERNAL AUDIT will conduct an investigation to determine if the reported suspicions of fraud are valid. • The following procedures should be in place to help reduce the risk of impropriety in your organization:

42. Procedures to Reduce the Risk of Fraud • Identify assets for which you have responsibility, including: • Department expenditures • Supplies • Personal computers • Software • Petty cash • Amounts collected as revenue.

43. Risks Associated with Safeguarding Assets • Ask yourself: • How could these assets be misused or improperly used? • If these assets were misused or misappropriated, how would I know? • What controls exist to prevent or detect inappropriate use or loss of assets? • What additional controls are necessary to ensure that assets are adequately protected from loss? • Is the cost of additional controls reasonable in relation to the risk involved?

44. The Major Tenets of an Internal Control System • Separation of duties • Physical safeguards over assets • Proper documentation • Proper approvals • Adequate supervision • Independent validation of transaction accuracy.

45. Whistle blowing • Fraud, waste and abuse are primarily low visibility incidents. Many defy detection through audits; only occasionally do they involve self-reporting. • Improved detection of fraud thus requires the assistance of personnel who become aware of an incident and are willing to disclose it. • Whistle blowing should not be portrayed or perceived as the first and only response to an incident of fraud, waste or abuse.

46. Whistle blowing, continued • There is always the possibility reporting acts of fraud or deceit occurring at work may end with being demoted, stigmatized or even fired.   • Whistle blowing can be a lonely, risky and heroic act.

47. HOTLINE • Therefore, to have fraud reported it must be made easier for employees to do so. • One obvious vehicle is a hotline. • This would exist to receive confidential disclosure of irregularities via telephone, or intranet and may be available on a 24 hour basis, during normal business hours, or periodically. • INTERNAL AUDIT is conducting research to establish a hotline here at Riverside County.

48. Personnel Incentive Programs • One initiative that could fulfill this role is a program of symbolic and/or material incentives for contributions to the reduction of fraud, waste and abuse. • This need not entail informing on or “whistle blowing" • The program could be structured positively to invite beneficial suggestions. • Cash rewards and commendations can be offered to personnel in every division or unit for useful ideas. • A "grand prize" could be offered annually to that individual or unit within an agency or department who has produced the most constructive suggestion.. • Exemplary performance in the efficient management of resources can be made an explicit criterion for promotion.

49. Contact INTERNAL AUDIT • If you have reasonable concerns regarding possible fraud, the Chief of INTERNAL AUDIT should be contacted immediately at (951) 955-3866. THANK YOU FOR YOUR ATTENTION!