The Calm Before Your Business Fraud Storm
What is fraud and how to detect it.May 6, 2010
by Ruby Sharma and Michael Sherrod, CPA, CFE
Quite often, however, a fraud investigation reaches business professionals who are not familiar with how investigations are conducted, their role in an investigation and possible outcomes. With frauds such as Enron, WorldCom, Tyco, Parmalat, Adelphia, Société Générale, the Ponzi scheme recently perpetrated by Bernard Madoff and the recent billion dollar fraud at Satyam in India, it has become even more important that business owners, controllers and management understand how a fraud investigation is run. These cases are just a few examples of frauds that have occurred, resulting in devastating effects on their organization, employees and investors. The continued onset of one of the worst global economic downturns in recent history has now created a robust environment for fraud. Based on these painful lessons learned in the past and the current environment, companies, regulators and other key stakeholders are putting more emphasis into addressing their approach to fraud investigations and how they view fraud proactively and reactively.
The Fraud Investigation Framework
Combating business fraud crimes is not an optional exercise. One of the difficult but necessary aspects of business ownership involves planning for potentially fraudulent activities to occur within the business at some point and time. It is shocking to think that even in Fortune 500 businesses, fraud risk management plans can be in disarray. Too often, in both big and small business culture, policy and practicality do not intersect. There is no one correct way of approaching a fraud investigation. It is the primary responsibility of management to take appropriate action when an event involving fraud or alleged fraud is brought to his or her attention. An inadequate response to fraud or an allegation of fraud can result in a protracted investigation that involves rework and wasted time and resources. In such instances, a fraud investigation framework comprises involvement of people who lack credibility or are perceived to lack objectivity relative to the issue, activities or persons involved. Another investigation scenario could involve participants, investigators and advisors who lack sufficient competence in critical areas. Investigators and decision makers stumble into preventable pitfalls. The potential downsides of certain decisions are not understood until after the fact. Poor decision making in the first few hours after an allegation or a fraudulent activity is brought to light can lead to disastrous consequences.
By contrast, a strong, credible and competent response ensures that adequate, relevant and complete information is assembled to support decision making; legal rights and responsibilities are respected; and any applicable legal privileges are preserved.
Basics of Investigations
|Unique considerations for each business are on the front end of fraud investigation planning, but the most critical consideration involved in implementing a fraud investigation framework for any business is practicality and timeliness. What is key for any fraud management architecture, regardless of how the framework is structured, is that the architecture is followed consistently over time. The best way to encourage the proliferation of fraudulent activity in a business is to either not follow an investigation framework or to do so inconsistently.|
|The Guide to Investigating Business Fraud is available on cpa2biz.|
The American Heritage Dictionary defines fraud as “a deception deliberately practiced in order to secure unfair or unlawful gain,” and the Collins Essential English Dictionary defines an investigation as a “careful search or examination to discover facts.” Although these two definitions provide guidance on what legally constitutes a fraud investigation, they do not address the practical nature of uncovering and remediating a fraud scenario. What is more important is being able to encompass the entirety of not only what the crime is and who has perpetrated it but the effect(s) that the crime and an investigation may have on a company or organization.
In grade school, most of us were introduced to the five “Ws,” which are generally understood to represent fundamental rhetorical questions to be used in scholarly, journalistic and other evidence-based treatises. Although it seems reasonable that arriving at evidence-based conclusions in an investigation need not be mentioned in a field that deals with forensics, it should be.
Types of Fraud
Fraudulent activities in businesses can fall into three main classes of activity: asset misappropriation, financial statement fraud and corruption. Understand that the type of event is a significant factor in determining a proper response. Furthermore, in each class, unique activities (if understood) can help focus an investigation even further.
Financial Statement Fraud
Understand that each fraud case is different and every investigation must be adjusted to the variables encountered by the investigation team. The timeline of the investigation either can be focused and short in duration (a few weeks to a couple months) or wide ranging and last for several months or even years. Although the specific procedures employed to investigate an alleged fraud vary depending on the size of the fraud and its potential scope, each investigation will typically include all of the following steps:
These steps align are generally sequential and it is important to understand that all investigations, regardless of scope, should address all of these considerations across time. View sidebar for additional business fraud internal control measures.
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Ruby Sharma, principal, Ernst & Young, has investigative and forensic accounting experience in internal corporate investigations, white-collar fraud, damage assessment, accounting, and financial issues and contract disputes including inventory, contract accounting and pricing, purchase-price disputes, and financial statement accounting practices and procedures. She has provided analysis of financial, economic, and accounting issues in internal investigations, discovery, and pre-trial analysis, deposition preparation, and assistance in arbitrations. Michael H. Sherrod, CPA, CFE, is a senior manager in Ernst & Young’s Fraud Investigation & Dispute Services practice. Sherrod was selected to lead the firm’s efforts in the U.S. in creating and delivering its anti-fraud service into the marketplace. In addition to Mike’s work in dealing proactively with fraud, he also focuses attention in the area of fraud investigations, specifically on revenue recognition, embezzlements, audit malpractice and other internal investigations.