This document discusses various types of fraud, famous fraudsters, how fraud is detected, and ways to prevent fraud. It provides details on common fraud schemes like asset misappropriation, corruption, and financial statement fraud. The largest fraudsters discussed are Bernie Madoff, whose Ponzi scheme resulted in $65 billion in losses, and Ken Lay of Enron, which led to a $100 billion loss for investors. Fraud is most often detected through tips, internal controls, and audits. Strong internal controls like surprise audits and job rotation were found to significantly reduce median fraud losses.

1. Fraud Understanding Fraud and Our Responsibilities Presented by Jason Lundell

2. Famous Fraudsters

3. Charles Ponzi (March 3, 1882 – January 18, 1949) was an Italian swindler, who is considered one of the greatest swindlers in American history. His aliases include Charles Ponei, Charles P. Bianchi, Carl and Carlo. The term "Ponzi scheme" is a widely known description of any scam that pays early investors returns from the investments of later investors. He promised clients a 50% profit within 45 days, or 100% profit within 90 days, by buying discounted postal reply coupons in other countries and redeeming them at face value in the United States as a form of arbitrage. Ponzi was probably inspired by the scheme of William F. Miller, a Brooklyn bookkeeper who in 1899 used the same scheme to take in $1 million.

4. Bernie Ebbers Bernard John "Bernie" Ebbers (born August 27, 1941, Edmonton, Alberta) is a Canadian-born businessman. He co-founded the telecommunications company WorldCom and is a former chief executive officer of that company. In 2005, he was convicted of fraud and conspiracy as a result of WorldCom's false financial reporting, and subsequent loss of US$100-billion to investors. The WorldCom scandal was, until the Madoff schemes came to light in 2008, the largest accounting scandal in United States history. He is currently serving a 25-year prison term at Oakdale Federal Correctional Complex in Louisiana. Portfolio.com and CNBC named Ebbers as the fifth-worst CEO in American history; Time Magazine named him the tenth most corrupt CEO of all time.

5. Walt Pavlo As a senior manager at MCI, and with a meritorious employment history, Mr. Pavlo was responsible for the billing and collection of nearly $1 billion in monthly revenue for MCI’s carrier finance division. Beginning in March of 1996, Mr. Pavlo, one member of his staff and a business associate outside of MCI began to perpetrate a fraud involving a few of MCI’s own customers. When the scheme was completed, there had been seven customers of MCI defrauded over a six-month period resulting in $6 million in payments to the Cayman Islands. In January 2001, in cooperation with the Federal Government, Mr. Pavlo pled guilty to wire fraud and money laundering and entered federal prison shortly thereafter. His story highlights the corrupt dealings involving the manipulation of financial records within a large corporation. His case appeared as a cover story in the June 10, 2002 issue of Forbes Magazine, just weeks before WorldCom divulged that it had over $7 billion in accounting irregularities. (Source: Walt Pavlo executive bio provided by himself)

6. Dennis Kozlowski (Born November 16, 1946, Newark, New Jersey) is a former CEO of Tyco International, convicted in 2005 of crimes related to his receipt of $81 million in purportedly unauthorized bonuses, the purchase of art for $14.725 million and the payment by Tyco of a $20 million investment banking fee to Frank Walsh, a former Tyco director. He is currently serving 8.33 to 25 years at the Mid-State Correctional Facility in Marcy, New York.

7. Ken Lay (April 15, 1942 – July 5, 2006) was an American businessman, best known for his role in the widely reported corruption scandal that led to the downfall of Enron Corporation. Lay and Enron became synonymous with corporate abuse and accounting fraud when the scandal broke in 2001. Lay was the CEO and chairman of Enron from 1985 until his resignation on January 23, 2003, except for a few months in 2000 when he was chairman and Jeffrey Skilling was CEO. On July 7, 2004, Lay was indicted by a grand jury on 11 counts of securities fraud and related charges. On January 31, 2006, following four and a half years of preparation by government prosecutors, Lay's and Skilling's trial began in Houston. Lay was found guilty on May 25, 2006, of 10 counts against him; the judge dismissed the 11th. Because each count carried a maximum 5- to 10-year sentence, legal experts said Lay could have faced 20 to 30 years in prison. However, he died while vacationing in Snowmass, Colorado on July 5, 2006, about three and a half months before his scheduled October 23 sentencing. Preliminary autopsy reports state that he died of a heart attack caused by coronary artery disease. As a result of his death, on October 17, 2006, the federal district court judge who presided over the case vacated Lay's conviction.

8. Bernie Madoff (Born April 29, 1938) is a former stock broker, investment adviser, non-executive chairman of the NASDAQ stock market, and the admitted operator of what has been described as the largest Ponzi scheme in history. In March 2009, Madoff pleaded guilty to 11 felonies and admitted to turning his wealth management business into a massive Ponzi scheme that defrauded thousands of investors of billions of dollars. Madoff said he began the Ponzi scheme in the early 1990s. However, federal investigators believe the fraud began as early as the 1980s, and the investment operation may never have been legitimate. The amount missing from client accounts, including fabricated gains, was almost $65 billion. The court appointed trustee estimated actual losses to investors of $18 billion. On June 29, 2009, he was sentenced to 150 years in prison, the maximum allowed. Madoff founded the Wall Street firm Bernard L. Madoff Investment Securities LLC in 1960, and was its chairman until his arrest on December 11, 2008. The firm was one of the top market maker businesses on Wall Street, which bypassed "specialist" firms by directly executing orders over the counter from retail brokers. On December 10, 2008, Madoff's sons told authorities that their father had just confessed to them that the asset management arm of his firm was a massive Ponzi scheme, and quoting him as saying it was "one big lie.“ The following day, FBI agents arrested Madoff and charged him with one count of securities fraud. The U.S. Securities and Exchange Commission (SEC) had previously conducted investigations into Madoff's business practices, but did not uncover the massive fraud; critics contend that these investigations were very incompetently handled.

9. Corporate Frauds and Scandals

10. Understanding Fraud

11. Defintion Black’s Law Dictionary defines fraud as: …all multifarious means which human ingenuity can devise, and which are resorted to by one individual to get an advantage over another by false suggestions or suppression of the trust. It includes all surprise, trick, cunning or dissembling, and any unfair way by which another is cheated.

12. Nature of Fraud 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.

13. Fraud Triangle

14. Fraud TreeComplete Classification of Occupational Fraud

15. Three Common Types of Fraud

16. Asset Misapproriation Asset misappropriation schemes are frauds in which the perpetrator steals or misuses an organization’s resources. Common examples of asset misappropriation include false invoicing, payroll fraud, and skimming.

17. Corruption In the context of occupational fraud, corruption refers to schemes in which fraudsters use their influence in business transactions in a way that violates their duty to their employers in order to obtain a benefit for themselves or someone else. For example, employees might receive or offer bribes, extort funds from third parties, or engage in conflicts of interest.

18. Financial Statement Fraud The third category of occupational fraud, financial statement fraud, involves the intentional misstatement or omission of material information from the organization’s financial reports; these are the cases of “cooking the books” that often make front page headlines. Financial statement fraud cases often involve the reporting of fictitious revenues or the concealment of expenses or liabilities in order to make an organization appear more profitable than it really is.

19. Occurrences of Fraud

20. Association of Certified Fraud Examiners (ACFE) Survey, 2006 Asset misappropriation schemes were both the most commonly reported and the least costly of the three major categories of occupational fraud (although the median loss in asset misappropriation schemes was $150,000, which is still quite significant). Fraudulent statements, on the other hand, were the least commonly reported type of occupational fraud, but they caused considerably more damage than frauds in the other two categories. The median loss caused by fraudulent statement schemes in our study was $2,000,000, which dwarfed the losses in the other two categories. Corruption schemes fell in the middle of the spectrum in terms of frequency and cost. Corruption occurred in just over one quarter of the cases reviewed in ACFE study, with a median loss of $375,000.

21. Occupational Frauds by Category — Frequency

22. Occupational Frauds by Category — Median Loss

23. Breakdown of All Occupational Fraud Schemes — Frequency

24. Breakdown of All Occupational Fraud Schemes — Median Loss

25. Most Common Fraud Schemes Revenue recognition fraud schemes are by far the most prevalent, at 41% of the total. This is consistent with previous fraud studies and reinforces the need for focus on this area. Other fraud schemes involving manipulation of various financial statement items account for more than a third of all fraud schemes identified.

27. Recording fictional revenue is the most common type of revenue-recognition fraud.

28. Next was recognizing inappropriate revenue from swaps, “round-tripping,” or barter arrangements.

30. With 480 fraud schemes, the Technology, Media & Telecommunications industry was responsible for 39% of identified schemes.

31. Consumer Business, with 371 fraud schemes, was second, at 30% of identified schemes.

33. Survey of Fraud Warning Signs Managers have lied to auditors or overly evasive Management places undue emphasis on meeting earnings projections, other targets Frequent disputes with or hostile towards auditors Attitude toward financial reporting is unduly aggressive Weak control environment Substantial compensation tied to quantified targets Disrespect for regulatory bodies Frequent and significant difficult-to-audit transactions Decentralized organization without monitoring Accounting personnel exhibit inexperience or laxity in duties

34. Common Types of Fraud By Industry

35. Banking and Financial Services Misappropriations of cash on hand were much more common than among all cases. Cash on hand schemes involve the theft of cash maintained on the premises of a victim organization. Banks have significant stores of cash on their premises, which can make them targets for this type of fraud. Cash on hand schemes tend to be relatively low-cost, with a median loss of $35,000 among the cases in the ACFE study.

36. Banking and Financial Services Corruption cases, on the other hand, tend to be much more costly; their median loss was $375,000. One-third of those frauds involved corruption. Conversely, other common forms of occupational fraud like false billing, skimming, non-cash theft, and check tampering were much less common in banking institutions.

37. Healthcare Both schemes that target incoming revenue —skimming and cash larceny — were more common in the healthcare industry. Cash larceny made up 16% of the health care industry cases but only 10% in other industries. Non-cash misappropriations, check tampering, and payroll fraud were also slightly more common.

38. Manufacturing Nearly 25% of cases in ACFE study involved financial statement fraud. This was more than twice the rate of financial statement fraud in general. Non-cash schemes were less common in the manufacturing industry. Non-cash schemes involve the misuse or misappropriation of inventory and equipment.

39. Retail Non-cash frauds were far more common, as well as cash register disbursements, cash larceny, and misappropriations of cash on hand. Each of these categories of fraud are highly compatible with the retail industry, where inventory pilferage and theft from cash registers are known to be common.

40. Education Billing schemes and expense reimbursement frauds were two of the most common schemes in the education industry, and both categories exceeded the overall rate of occurrence by approximately 10%. Cash larceny and payroll fraud were also more common in education organizations than in all cases.

41. Insurance Most common schemes were billing frauds, corruption, check tampering, and skimming. Check tampering, in particular, was much more common in the insurance industry than in general. Insurance industry check tampering schemes often involve the theft of checks to legitimate insureds or the generating of checks to fictitious insureds.

42. Industries with the Most Corruption Cases The oil and gas industry had the greatest percentage of corruption cases at 47%. Arts, Entertainment, and Recreation had about 38% of cases involve corruption. 33% of banking sector cases also involved corruption. Healthcare, which ranked 12th, had 26%.

43. Industries with the Most Financial Statement Fraud Cases According to study conducted by ACFE, at least one financial statement fraud case was reported in every industry except utilities, and only three industries — banking, manufacturing, and retail — had 10 or more financial fraud cases. In terms of percentages, the telecommunications industry had the highest rate of financial statement fraud at 25%. Healthcare ranked 12th out of 21 with 8%.

44. Detection of Fraud

45. Initial Detection of Occupational Frauds

46. Detecting Fraud Committed by Owners and Executives Tips were by far the most commonly cited detection method in cases that were perpetrated by owners and executives. Not surprisingly, internal controls were not as effective at detecting frauds committed by top-level perpetrators, as these individuals are often uniquely positioned to override even the best-designed controls. In contrast, external audits detected a greater percentage of cases involving owners and executives; this finding underscores the importance of independent assessments and external accountability as well as the need for auditors to be especially vigilant in reviewing transactions involving owners and executives.

47. Detecting the Largest Frauds The value of effective independent audits is illustrated by their role in detecting large frauds. Among the 237 cases involving a loss of $1 million or more, external audits were cited as the detection method 16% of the time, as compared to 9% of all cases. Tips were the most common detection method for these cases with 42% of million-dollar frauds being uncovered through a tip or complaint.

48. Detection of Fraud Internal audits were the source of detection in over a quarter of the government fraud cases, which exceeded the rate for any other type of organization. Surprisingly, publicly traded companies cited the smallest percentage of fraud detected by external audits even though they are generally required to undergo an independent audit. However, public companies also had the largest percentage of frauds detected through both tips and internal controls; this may reflect the continued impact of the Sarbanes-Oxley Act of 2002, which mandates the establishment of anonymous reporting mechanisms and increases the emphasis on strong internal control systems for publicly traded organizations.

49. Anti-Fraud Controls in Place at Time of Fraud External audits of financial statements were the most common anti-fraud control. 70% utilized independent external audits of their financial statements. Over 50% had a formal code of conduct, an internal audit or fraud examination department, one or more employee support programs, an independent audit committee, as well as two controls mandated by the SOX Act: an external audit of the entity’s internal controls over financial reporting and certification of the financial statements by management.

50. Effectiveness of Internal Controls Surprise audits and job rotation/mandatory vacations had largest reduction in median losses, but were among the least commonly employed controls. Only 25% of companies had surprise audits as an internal control, yet they suffered 66% losses than those organizations without surprise audits. Median loss for 12% of entities who implemented job rotation or mandatory vacation policies was $64,000, compared to $164,000 at the organizations lacking similar procedures. Independent external audits appeared to be associated with a lower median loss but were not as effective at reducing fraud losses.

51. Effectiveness of Internal Controls

52. SOX-Related Internal Controls The Sarbanes-Oxley Act of 2002 was a landmark piece of legislation that widely impacted the way many organizations approach their anti-fraud efforts. As part of the law’s requirements, organizations were instructed to implement several specific controls to help combat fraud. The vast majority of the Act’s provisions were mandatory for public corporations in the U.S.

53. Effectiveness of SOX-Mandated Internal Controls

54. Our Responsibilities

55. Control Weaknesses that Contribute to Fraud Lack of controls, absence of management review, and override of existing controls were the three most commonly cited factors that allowed fraud schemes to succeed.

56. Preventing Fraud Reduce the Situational Pressures that Encourage Financial Statement Fraud Avoid setting unachievable financial goals. Eliminate external pressures that might tempt accounting personnel to prepare fraudulent financial statements. Remove operational obstacles blocking effective financial performance such as working capital restraints, excess production volume, or inventory restraints. Establish clear and uniform accounting procedures with no exception clauses.

57. Preventing Fraud – continued Reduce the Opportunity to Commit Fraud Maintain accurate and complete internal accounting records. Carefully monitor the business transactions and interpersonal relationships. Establish a physical security system to secure company assets. Divide important functions between employees, separating total control of one area. Maintain accurate personnel records including background checks on new employees. Encourage strong supervisory and leadership relationships within groups to ensure enforcement of procedures.

58. Preventing Fraud – continued Reduce the Rationalization of Fraud – Strengthen Employee Personal Integrity Managers should set an example by promoting honesty in the accounting area. It is important that management practice what they preach. Honest and dishonest behavior should be defined in company policies. Consequences for violating rules should be clear.

59. Whistleblower Resources Question: Does the company have a hotline or other means to provide whistleblower information confidentially?

60. Tips Of the 417 cases in the ACFE study in which a tip or complaint was instrumental in the detection of the fraud, 31% were received via a hotline or other formal reporting mechanism. This is a relatively high number considering that less than half of the victim organizations in the ACFE survey had a formal reporting mechanism. The fact that tips continue to be the most effective means of detecting fraud suggests that organizations could improve their detection efforts by establishing formal structures to receive reports about possible fraudulent conduct.

61. Insider Tips By far, the greatest percentage of tips came from employees of the victim organization. The fact that over half of all fraud detection tips came from employees suggests that organizations should focus on employee education as a key component of their fraud detection strategies. Employees should be trained to understand what constitutes fraud and how it harms the organization. They should be encouraged to report illegal or suspicious behavior, and they should be reassured that reports may be made confidentially and that the organization prohibits retaliation against whistleblowers.

62. Outsider Tips It is also worth noting that over 30% of tips came from external sources. While training and educating employees about reporting fraud is clearly an important step, organizations should also involve these third parties in their fraud detection programs by making them aware of the organization’s reporting mechanism and encouraging them to report improper conduct.

63. Whistleblowers

64. Cynthia Cooper Native of Clinton, Mississippi who formerly served as the Vice President of Internal Audit at WorldCom. In 2002, Cooper and her team of auditors worked together and often at night and in secret to investigate and unearth $3.8 billion in fraud at WorldCom. At the time, this was the largest incident of accounting fraud in U.S. history. Since leaving MCI, Cooper has started her own consulting firm. In addition, Cooper speaks to professionals as well as high school and college students to share her experiences and lessons learned. Cooper's book about her life and the WorldCom fraud, Extraordinary Circumstances: The Journey of a Corporate Whistleblower, was published in 2008. Profits from the book were given to universities for ethics education. Cooper previously worked for the Atlanta offices of public accounting firms PricewaterhouseCoopers and Deloitte & Touche. She earned her Bachelor of Science in Accounting from Mississippi State University and a Master of Science in Accountancy from the University of Alabama. She is a Certified Public Accountant (CPA) in Georgia, Certified Information Systems Auditor (CISA) and a Certified Fraud Examiner (CFE). Cooper was named one of three "People of the Year" by Time magazine in 2002. She maintains an office in Brandon, Mississippi.

65. Sherron Watkins (Born August 28, 1959) was Vice President of Corporate Development at the Enron Corporation. She is considered by many to be the whistleblower who helped to uncover the Enron scandal in 2001. It has been remarked that her actions cannot be considered whistleblowing in a strict sense, because she only wrote a concerned internal email message to Enron CEO Kenneth Lay warning him of potential whistleblowers in the company and pointing out that there were misstatements in the financial reports. Her memo did not reach the public until five months after it was written. Dan Ackmanargued in Forbes Magazine and in the Wall Street Journal that, for this reason, her actions did not constitute whistleblowing and actually helped provide legal cover for Lay. She testified before the U.S. Congress and Senate at the beginning of 2002 and was selected as one of three "People of the Year 2002" by Time. (The two whistleblowers who joined her as "People of the Year" were Cynthia Cooper of WorldCom and Coleen Rowley of the FBI.) Watkins was born in Tomball, Texas. She had joined Enron in 1993, having worked for Arthur Andersen the previous eight years. She departed from Enron in November 2002. Since then she has been giving speeches at management congresses and has co-written a book about her experiences at Enron and the problems of the US corporate culture. Watkins holds a Bachelor of Business Administration (with honors) from the University of Texas, where she was a member of Alpha Chi Omega sorority, and a Masters of Professional Accounting. She is a Certified Public Accountant (CPA).

66. Harry Markopolos (Born October 22, 1956 in Erie, Pennsylvania) is a former securities industry executive turned independent financial fraud investigator for institutional investors and others seeking forensic accounting expertise. He has risen to prominence as an early and unheeded whistleblower of suspected securities fraud by Bernard Madoff, tipping off the United States Securities and Exchange Commission (SEC) repeatedly, both orally and in writing starting in 1999, when he argued that it was not legally possible for Madoff to deliver the returns he had claimed to deliver.

67. Matthew Lee Lehman Whistle-Blower's Fate: Fired Mr. Lee Raised Red Flags About 'Repo 105' Accounting Device; Let Go for Downsizing, Said Firm Lehman Brothers Holdings Inc. ousted a whistle-blower just weeks after he raised red flags about the securities firm's accounting in 2008. Matthew Lee, a 14-year Lehman veteran, was let go in late June 2008 amid steep losses at the firm as it tried to maneuver through the global financial crisis. Earlier that month, he had raised concerns with Lehman's auditor, Ernst & Young, that the securities firm was temporarily moving $50 billion in assets off its balance sheet. This accounting strategy helped to mask the risks Lehman was taking amid scrutiny by investors and regulators about the health of Wall Street firms. Lehman said at the time it let go Mr. Lee, a senior vice president, as part of a broader downsizing at the firm, according to people familiar with the matter. Lehman filed for bankruptcy in September 2008, and its assets were sold off to, among others, Barclays PLC. A Barclays spokesman declined to comment. Erwin Shustak, Mr. Lee's lawyer in San Diego, asserts that "it was easier to just shut him up and let him go." Ernst & Young never mentioned Mr. Lee's concerns to Lehman's board, according to a federal bankruptcy-court examiner's report released last week. In a statement, Ernst & Young said that Lehman's management investigated Mr. Lee's allegations and informed the board that "the allegations were unfounded and there were no material issues identified." Once an obscure Lehman executive, the 56-year-old Mr. Lee now is at the center of allegations that the high-profile Wall Street firm misled investors by using, among other things, an unusual accounting device known internally as "Repo 105" to park assets temporarily off its balance sheet. Mr. Lee first raised concerns on May 16, 2008, when he sent a letter to senior Lehman management about his concerns over the firm's valuations of illiquid investments and the quality of its accounting controls. In June 2008, Lehman's board instructed Ernst & Young to investigate Mr. Lee's allegations. An auditing team interviewed Mr. Lee on June 12, according to the bankruptcy report, at which point he raised the issue of Repo 105, the report says. Bloomberg News Lehman Brothers Holdings ousted a whistle-blower just weeks after he raised red flags about the securities firm's accounting in 2008. WSJ article By MICHAEL CORKERY http://online.wsj.com/article/SB10001424052748704588404575124134271085018.html?mod=WSJ_hps_MIDDLESecondNews

69. Fraud Examiners Manual, Association of Certified Fraud Examiners

70. Corporate Fraud Handbook, Joseph T. Wells

71. Publically available SEC and other legal presentations and materials

72. wikipedia.com

73. wsj.com