Five-Step Approach to Fraud Detection: #3 Be Alert to Symptoms
June 2010
The "Five-Step Approach to Fraud Detection"
is a strategy I use to detect fraud in any area and a template I provide to
company executives and managers when helping them establish control systems
design to detect frauds in their day-to-day operations. This is the third in
a series of articles in which I will demonstrate how to apply this strategy
to your own environment.
by
Scott Langlinais
Langlinais Fraud and
Audit Advisory Services
Here is the Five-Step Approach:
- Know the Exposures
- Know the Symptoms
of Occurrence
- Be Alert for Symptoms and Behavior Indicators
- Build Audit Programs/Detective Processes To Look for Symptoms
- Follow Through on All Symptoms Observed
Step one halts most people because if they have no idea what can go wrong
in their area, the rest of the strategy collapses. This continues a series of
articles in which I will walk through some very common and dangerous frauds
that affect all organizations, regardless of industry, to help you understand
how to apply the strategy to create an environment hostile to fraud.
Risk: Collusion
Suppose an employee or vendor offers your employees a kickback to enlist
their participation in embezzlement? In this article, I want to focus on the
concept of collusion—involvement by two or more perpetrators in a fraud. This
risk intimidates auditors, finance and accounting managers, and risk professionals;
their opinion in collusion enables a circumvention of controls established to
prevent a particular fraud, thus rendering collusive frauds difficult to detect.
In one particular embezzlement, for example, the husband was a trucker for
the company, his wife an accountant. Warehouse and inventory operations were
properly segregated from accounting, but the two were able to violate the company's
controls when the husband stole goods from the truck because the wife was able
to book false sales, then subsequently write them off as uncollectible to cover
the inventory shortages.
If multiple people can thus circumvent a control structure, how are we as
managers and officers supposed to prevent such a fraud? The answer is by committing
yourself to seeking the symptoms of the fraud.
Whether I am performing a tactical review of an area or discussing fraud-prevention
strategy with executives, I always begin with a "What Can Go Wrong" list, in
which I brainstorm potential perpetrators and fraud acts. Considering the risk
of certain collusive frauds, here are a few good examples of what can go wrong.
A supervisor approaches several hourly student laborers: if the students
record extra overtime on their timesheets that they did not work, the supervisor
will approve those hours and not alert anyone. She'll do this as long as
the students split the extra overtime money with her. Fourteen people (including
the supervisor) become involved in stealing over $250,000.
Two operations employees of a construction company determine a method for
overbilling indirect costs (such as rent, insurance) to their customers
on multimillion dollar projects. Those two employees are able to siphon
the extra billings into their personal bank accounts while allowing their
company to collect on the legitimate charges. The company's chief financial
officer (CFO) detects the fraud by his company's employees; however, he
agrees to join in the fraud for a cut of the proceeds. The total amount
of the overbillings is $36 million.
The procurement director agrees to share with a vendor the prices their
competitors are bidding for the business. After the vendor wins the business
from their low bid, they agree to provide a kickback to the procurement
director.
Three employees of a pipeline company, including an accounting clerk, a
terminal operator, and a terminal supervisor, conspire with two employees
of a trucking vendor to steal 1.5 million gallons of fuel. They sold the
fuel to unsuspecting fuel service station owners. The accounting clerk destroyed
bills of lading and fabricated the numbers on the location's fuel variance
report provided to headquarters.
Typically, my What Can Go Wrong documents for a particular area will list
at least two or three dozen frauds stated in a single sentence or two. In the
cases such as those above, we are dealing with multiple perpetrators, so list
them all.
Symptom Identification
This is how we avoid the problem of collusion, by listing symptoms of the
frauds regardless of the number of people participating. Symptoms are what these
frauds would look like in the books and records. Here is a short list derived
from the frauds listed above—you are likely to come up with many more.
Student employees are absent from the workplace during overtime hours.
Departmental labor expenses are over budget.
Overtime hours are strange, odd, or curious (30 hours of overtime posted
during Thanksgiving week when offices were closed, or a full-time student
recording 80-hour workweeks).
Indirect charges on a construction project exceed a reasonable percentage
(e.g., >25 percent) of total billings.
Indirect charges are unsupported by adequate documentation, or the documentation
appears to have been altered.
The bid winner/lowest bid is almost always the last bid received by Procurement,
and the bid is almost always pennies lower than the second lowest bid.
Bid losers declined the procurement director's offers of favored status
in exchange for some form of kickback.
Unexplained or "miscellaneous" losses in a particular division are higher
than normal.
Service station owners complain their competitors are receiving below-market
pricing on fuel.
Bills of lading are missing from the supporting documentation.
You will notice that I did not list a single control weakness. I did not
say that duties were not properly segregated here, a signature was missing there.
A control weakness is not a symptom of fraud. Just because a control is present
does not mean a fraud is not occurring. Conversely, just because a control is
absent does not mean a fraud is occurring. Just because someone smokes does
not mean they have lung cancer, and just because they do not smoke does not
mean their lungs are clear. A doctor must look for the symptoms.
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