CFFE NOTES – FRAUD AND CORRUPTION SCHEMES NOTES

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INTRODUCTION

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PAPER NO. 2 FRAUD AND CORRUPTION SCHEMES

 

UNIT DESCRIPTION

This paper is intended to equip the candidate with knowledge, skills and attitudes that will enable him/her to identify schemes and categories of fraud, the red flags and the preventive and detective measures and procedures related to the various fraud schemes.

 

LEARNING OUTCOMES

A candidate who passes this paper should be able to:

  • Identify fraud schemes in fraudulent and corrupt activities
  • Identify the red flags related to the specific fraud schemes
  • Design and implement preventive and detective controls
  • Identify the universal and specific risks related to the schemes
  • Identify organisational and occupational fraud/corruption

 

CONTENTS:

  1. Fraud/Corruption Schemes
    • Definition of fraud
    • Definition of corruption
    • Occupational fraud
    • Organisation fraud/crime
    • The fraud tree
    • The red flags/indicators of fraud
    • Current trends of fraud schemes
    • Emerging fraud /corruption schemes

 

2.            Financial Statement Fraud

  • Definition of Financial Statement Fraud
  • Why Financial Statement fraud is committed
  • The cost of financial statement fraud
  • Types of financial statement fraud schemes
  • Trends in Financial Statement fraud
  • Red flags associated with financial statement fraud
  • Techniques of Detecting financial statement fraud
  • Financial statement analysis
  • Controls related to financial statement fraud

 

3.            Asset Misappropriation

  • Definition of asset misappropriation
  • Types of asset misappropriation frauds
  • Cash receipts: Skimming, cash larceny and theft of cash on hand
  • Fraudulent disbursements: Register disbursement schemes, check tampering schemes, electronic payment tampering schemes, billing schemes, payroll and expense reimbursement schemes
  • Inventory and other assets: Misuse of inventory and theft
  • Misappropriation of intangible assets
  • Prevention of asset misappropriation schemes

 

4.            Bribery and Corruption

  • Definition of bribery and corruption
  • Corruption schemes
  • Techniques of detecting bribery /corruption schemes
  • Methods of making corrupt payments
  • Prevention and detection of corruption

5.            Theft of Data and Intellectual Property

  • Definition of theft of data and intellectual property
  • Types of data and intellectual property
  • Ways information is lost or stolen
  • Electronic counter-surveillance
  • Insider threats to propriety information
  • Methods of investigating corporate espionage
  • Programs for safeguarding proprietary information
  • Measures and procedures of minimizing theft of data and intellectual property

 

6.            Identity Theft

  • Definition of identity theft
  • Perpetrators of identity theft
  • Characteristics of victims of theft
  • Methods of committing identity theft
  • Types of identity theft schemes
  • Ways of stealing information
  • Responding to identity theft
  • Methods of preventing identity theft

 

7.            Contract and Procurement Fraud

  • Definition of contract and procurement fraud
  • Methods of procurement
  • Stages/phases in procurement process
  • Categories of procurement fraud schemes
  • Preventing and detection of contract and procurement fraud

 

8.            Computer and Internet Fraud/Cyber Crime

  • Definition of computer and internet fraud
  • Definition of Cyber Crime
  • Types of computer and internet/Cyber fraud:
    • Electronic Commerce and information Security
  • Prevention, detection of computer and internet/Cyber Crime
  • Computer/Cyber Security

 

9.            Financial Institution Fraud

  • Definition of financial Institution fraud
  • Types of financial institution frauds
  • Prevention and detection of financial institution frauds:
    • Financial Action Task Force and money laundering and Terrorist
  • Basel committee on banking supervision recommendations

 

10.          Payment System Fraud Schemes

  • Definition of payment system fraud
  • Types of payment system and the fraud schemes
  • Prevention and detection of payment system fraud schemes

 

11.          Insurance and Health Fraud

  • Definition of insurance fraud
  • Insurance fraud schemes
  • Prevention and detection of insurance fraud
  • Definition of Health care fraud
  • Health care fraud schemes
  • Prevention and detection of health care fraud

12.          Consumer Fraud

  • Investment fraud schemes
  • Telemarketing fraud schemes
  • Confidence games fraud schemes

 

13.          Case Study – Occupational and Organisational Crimes

  • Identify the asset misappropriation and corruption schemes
  • Identify the health care fraud schemes
  • Identify the red flags
  • Identify the preventive and detective control gaps that were present when the fraud occurred

 

CHAPTER ONE

FRAUD/CORRUPTION SCHEMES

Corruption can be found in any business or organization, and it is one of the three major categories of occupational fraud and abuse (along with asset misappropriation and financial statement fraud). An organization that understands the specific factors involved in corruption schemes can take steps to prevent, detect, and investigate them.

 

What Is Corruption?

Corruption is a term used to describe various types of wrongful acts designed to cause an unfair advantage. It can take on many forms, including bribery, kickbacks, illegal gratuities, economic extortion, and collusion. Generally, corruption involves the wrongful use of influence to procure a benefit for the actor or another person, contrary to the duty or the rights of others. The various forms of corruption are often used in combination, which reinforces the schemes’ potency and makes them more difficult to combat.

 

Corruption is a significant problem for organizations, particularly due to the desire for growth in international markets. Despite the multitude of anti-corruption legislation and increased enforcement efforts around the world, corruption is still prevalent.

 

The most common area for corruption in an organization is in the purchasing environment, and most corruption schemes involve employees acting alone or in collusion with vendors or contractors.

 

 

Forms of Corruption

Bribery

Bribery may be defined as the offering, giving, receiving, or soliciting of corrupt payments (i.e., items of value paid to procure a benefit contrary to the rights of others) to influence an official act or business decision. Bribes do not necessarily involve direct payments of cash or goods.

 

Fundamentally, a bribe is a business transaction, albeit an illegal or unethical one. Bribery involves collusion between at least two parties. A person “buys” influence over the recipient of the bribe to procure a benefit that is contrary to the duty or the rights of others. In the

employment context, bribery involves a conflict of interest in which the employee’s personal

interest overwhelms their professional responsibilities.

 

Though bribery schemes are much less common than other forms of occupational fraud, such as asset misappropriations, they tend to be much more costly.

 

Bribery schemes are classified into two types: official bribery and commercial bribery.

 

Official bribery refers to the corruption of a public official to influence an official act of government. The term official act stems from traditional bribery statutes that only proscribe payments made to influence the decisions of government agents or employees.

 

In contrast, commercial bribery refers to the corruption of a private individual to gain a commercial or business advantage. In commercial bribery schemes, something of value is offered to influence a business decision rather than an official act, as is the case in official bribery.

 

Commercial bribery may or may not be a criminal offense. For example, in the United States, there is no general federal law prohibiting commercial bribery in all instances. By contrast, the UK Bribery Act prohibits commercial bribery throughout the United Kingdom. Therefore, the law of the particular jurisdiction and the facts of the case will determine whether bribery in the private sector may be prosecuted criminally.

 

Kickback Schemes

Bribery often takes the form of kickbacks, a form of negotiated bribery in which a commission is paid to the bribe-taker in exchange for the services rendered. Thus, kickbacks are improper, undisclosed payments made to obtain favorable treatment. In the government setting, kickbacks refer to the giving or receiving of anything of value to obtain or reward favorable treatment in relation to a government contract. In the commercial sense, kickbacks refer to the giving or receiving of anything of value to influence a business decision without the employer’s knowledge and consent.

Usually, kickback schemes are similar to the billing schemes described in the “Asset Misappropriation: Fraudulent Disbursements” chapter. They involve the submission of invoices for goods and services that are either overpriced or fictitious. (See the “Kickbacks” flowchart that follows.)

 

Kickbacks are classified as corruption schemes rather than asset misappropriations because they involve collusion between employees and third parties. In a common type of kickback scheme, a vendor submits a fraudulent or inflated invoice to the victim organization and an employee of that organization helps make sure that a payment is made on the false invoice. For their assistance, the employee-fraudster receives a payment from the vendor. This payment is the kickback.

Kickbacks

Diverting Business to Vendors

In some kickback schemes, an employee-fraudster receives a kickback for directing excess business to a vendor. In these cases, there might not be any overbilling involved; the vendor simply pays the kickbacks to ensure a steady stream of business from the purchasing company.

 

If no overbilling is involved in a kickback scheme, one might wonder how this might be harmful. Assuming the vendor wants to get the buyer’s business and does not increase their prices or bill for undelivered goods and services, how is the buyer harmed? The problem is that, having bought off a purchasing company employee, a vendor is no longer subject to the normal economic pressures of the marketplace. This vendor does not have to compete with other suppliers for the purchasing company’s business, and thus has no incentive to provide a low price or quality merchandise. In these circumstances, the purchasing company almost always overpays for goods or services.

 

Once a vendor knows it has an exclusive purchasing arrangement, it is motivated to raise prices to pay for the cost of the kickback.

 

Most bribery schemes become overbilling schemes even if they do not start that way. This is one reason why most business codes of ethics prohibit employees from accepting undisclosed gifts from vendors. In the end, an organization is sure to pay for its employees’ unethical conduct.

 

Overbilling Schemes

EMPLOYEES WITH APPROVAL AUTHORITY

In most instances, kickback schemes involve overbilling. In these schemes, a vendor submits inflated invoices to the victim organization, and the false invoices either overstate the cost of actual goods and services or reflect fictitious sales. To ensure that the inflated invoices get approved, the corrupt vendor offers kickbacks to an employee of the victim organization who has the authority to approve payment of the fraudulent invoices. By enlisting the help of an employee with such authority, the corrupt vendor ensures that the invoices will be paid without undue hassles.

 

FRAUDSTERS LACKING APPROVAL AUTHORITY

While the majority of kickback schemes involve individuals with authority to approve purchases, this authority is not an absolute necessity. When employees cannot approve fraudulent purchases themselves, they can still orchestrate a kickback scheme if they can circumvent accounts payable controls. In some cases, they can do this by filing a false purchase requisition. If a trusted employee tells their superior that the company needs certain materials or services, this is sometimes sufficient to get a false invoice approved for payment. Such schemes are generally successful when the person with approval authority is inattentive or is forced to rely on their subordinate’s guidance in purchasing matters.

 

Corrupt employees might also prepare false vouchers to make fraudulent invoices appear legitimate. Where proper controls are in place, a completed voucher is required before accounts payable will pay an invoice. To do this, the fraudster must create a purchase order that corresponds with the vendor’s fraudulent invoice. The fraudster might forge the signature of an authorized party on the purchase order to show that the acquisition has been approved. If the company’s payables system is computerized, an employee with access can enter the system and authorize payments on fraudulent invoices.

 

Other Kickback Schemes

Kickbacks are not always paid to employees to process phony invoices. Some outsiders seek other fraudulent assistance from employees of the victim organization. For instance, inspectors are sometimes paid off to accept substandard materials or to accept short shipments of goods.

 

Representatives of companies wishing to purchase goods or services from the victim organization at unauthorized discounts sometimes bribe employees with billing authority. The corrupt employees make sales to their accomplices at greatly reduced rates sometimes even selling items at a loss and in return, they receive a portion of the discount.

 

Illegal Gratuities

Illegal gratuities are items of value given to reward a decision, often after the recipient has made the decision. Illegal gratuities are similar to bribery schemes except that, unlike bribery schemes, illegal gratuity schemes do not necessarily involve an intent to influence a particular decision before the fact. That is, an illegal gratuity occurs when an item of value is given for, or because of, some act. Often, an illegal gratuity is merely something that a party who has benefited from a decision offers as an underhanded thank-you to the person who made the beneficial decision.

 

Economic Extortion

An extortion case is often the other side of a bribery case. Extortion is defined as the obtaining of property from another, with the other party’s consent induced by wrongful use of actual or threatened force or fear. Economic extortion is present when an employee or official, through the wrongful use of actual or threatened force or fear, demands money or some other consideration to make a particular business decision. That is, economic extortion cases are the “Pay up or else … ” corruption schemes.

 

To constitute extortion, the threat must be the controlling reason that the victim gives up a right or property. The following types of threats can constitute extortion:

  • Physical harm
  • Property damage
  • Accusing a person of a crime
  • Disgracing a person
  • Public exposure

 

 

Collusion

Collusion refers to an agreement between two or more individuals to commit an act designed to deceive or gain an unfair advantage. Typically, collusion involves some sort of kickback, which can result in fraudulent billing or inferior goods.

 

Methods of Making Corrupt Payments

Often, corruption schemes involve corrupt payments—items of value paid to procure a benefit contrary to the rights of others. There are various ways to make corrupt payments, and many do not involve money. Any tangible benefit given or received with the intent to corruptly influence the recipient can be an illegal payment, but there are certain traditional methods of making corrupt payments that fall into the following hierarchical categories.

 

Gifts, Travel, and Entertainment

Most corruption schemes begin with gifts and favors. Common gifts and favors that are given at an early stage include:

  • Wine and liquor (consumable)
  • Clothes and jewelry for the recipient or spouse
  • Sexual favors
  • Lavish entertainment
  • Paid vacations
  • Free luxury transportation
  • Free use of resort facilities
  • Gifts of the briber’s inventory or services, such as construction of home improvements
  • by a contractor

 

Cash Payments

Corrupt payments do occur in the form of cash payments, but paying in cash is not a practical method when dealing with large sums. Accordingly, corrupt payers generally avoid using cash when making large payments.

 

Checks and Other Financial Instruments

Corrupt payments are often made by normal business check, cashier’s check, or wire transfer. When such payments are made, they must be disguised. When a payer makes such payments, they might be disguised as some sort of legitimate business expense (e.g., consulting fees).

Also, such payments can be made directly or through an intermediary.

 

Hidden Interests

Additionally, the payer might give the recipient a hidden interest in a joint venture or other profit-making enterprise.

Such corrupt payments are hard to detect for several reasons. The recipient’s interest might be concealed through a straw nominee, hidden in a trust or other business entity, or included by an undocumented verbal agreement. Also, even if such payments are identified, proving they originated with corrupt intent is also difficult to demonstrate.

 

Loans

Corrupt payments often take the form of loans. There are three types of loans often found in corruption cases:

  • An outright payment that is falsely described as an innocent loan
  • A legitimate loan in which a third party—the corrupt payer—makes or guarantees payments to satisfy the loan
  • A legitimate loan made on favorable terms (e.g., an interest-free loan)

 

Credit Cards

A corrupt payment can be in the form of credit card use or payments toward a party’s credit card debt. The payer might use a credit card to pay a recipient’s transportation, vacation, or entertainment expenses, or the payer might pay off a recipient’s credit card debt. In some instances, the recipient might carry and use the corrupt payer’s credit card.

 

Transfers Not at Fair Market Value

Corrupt payments might occur in the form of transfers for a value other than fair market. In such transfers, the corrupt payer might sell or lease property to the recipient at a price that is less than its market value, or the payer might agree to buy or rent property from the recipient at an inflated price. The recipient might also “sell” an asset to the payer but retain the title or use of the property.

 

Promises of Favorable Treatment

Corrupt payments might come in the form of promises of favorable treatment. Such promises commonly take the following forms:

  • A payer might promise a government official lucrative employment when the recipient leaves government service.
  • An executive who resigns from a private company and takes a related government position might be given favorable or inflated retirement and separation benefits.
  • The spouse or other relative of the intended recipient might also be employed by the payer company at an inflated salary or with minimal actual responsibility.

Detection of Corruption Schemes

 

Red Flags of Corruption Schemes

 

Red Flags of Corrupt Employees

Some common red flags of corrupt employees include:

  • A high success rate in markets where competitors are known to bribe
  • Reputation for regularly accepting inappropriate gifts
  • Extravagant lifestyle
  • Reputation for taking action without being instructed to do so or directing subordinates to bend, break, or ignore standard operating procedures or rules to benefit the payer
  • Tendency of employees to insert themselves into areas in which they are normally not involved
  • Propensity to assert authority or make decisions in areas for which the employees are not responsible
  • Inclination to make excuses for deficiencies in a third party’s products or services, such as
  • poor quality, late deliveries, or high prices
  • Circumstances that generate extreme personal pressures, such as ill family members or drug addiction
  • History of not filing conflict of interest forms
  • Frequent hospitality and travel expenses for foreign public officials
  • Friendly social relationship with a third-party contractor

 

Red Flags of Corrupt Third Parties

Some common red flags of a corrupt third party include a party who:

  • Routinely offers inappropriate gifts, provides lavish business entertainment, or otherwise tries to obtain favor with an organization
  • Consistently receives contracts without any apparent competitive advantage
  • Provides poor-quality products or services but is continually awarded contracts
  • Charges unjustified high prices or price increases for common goods or services
  • Receives or pays fees in cash
  • Receives or pays fees in a country different from where the underlying business takes place
  • Offers no apparent value to the organization
  • Charges high commissions
  • Claims to have special influence with a specific buyer
  • Displays any of the following indicators suggesting lack of qualification:
  • Inadequate financial resources
  • Operating in a region with a history of corruption
  • Decentralized operations
  • Lack of qualifications or experience
  • Poor performance record
  • Reputation for dishonesty
  • Past complaints or criminal or civil actions against the third party
  • A history of fraudulent conduct
  • Undisclosed interests in a company or business owned by an employee
  • Family connections to an employee
    • Does not relate well to competitors
    • Has an address or telephone number that matches an employee’s address, the address of an employee’s outside business, or an employee’s relative’s address
    • Provides an incomplete address (e.g., a post office box, no telephone number, or no street address)
    • Provides multiple addresses
    • Has a reputation for corruption or works in an industry or country with a reputation for corruption
    • Works as an independent sales representative, consultant, or other intermediary who does not have the reporting and internal control requirements of their larger, publicly held competitors

 

Internal Control Red Flags of Corruption

Common red flags of corruption that occur in an organization’s internal controls include:

  • Poor internal controls over key areas, such as purchasing, inventory receiving, and warehousing
  • Poor recordkeeping
  • Poorly defined roles and responsibilities
  • Insufficient capacity to monitor high-risk employees or units
  • Inadequate anti-corruption control plan
  • Poor separation of duties in purchasing
  • Lack of transparency in expenses and accounting records
  • Poor enforcement of existing policies on conflicts of interest or acceptance of gratuities
  • Poor documentation supporting award of contracts or subcontracts
  • Inadequate monitoring procedures

 

Methods of Proving Corrupt Payments

There are three basic ways to prove corrupt payments. First, the fraud examiner may seek to prove illicit funds by turning an inside witness. This approach—assuming the testimony can be corroborated—has obvious advantages and should be pursued whenever feasible.

 

Second, the fraud examiner may engage in a covert sting operation to secretly infiltrate or record ongoing transactions. A covert sting operation might be effective if the scheme is ongoing and the subject is not aware of the investigation. But there are legal and security issues associated with this approach, which requires considerable experience.

 

Third, the fraud examiner may identify and trace the corrupt payments through audit steps. The remainder of this discussion focuses on proving corrupt payments through audit steps.

 

When identifying and tracing corrupt payments through audit steps, the fraud examiner might focus on the point of suspected payment (i.e., from where the funds are initially generated, earned, or stolen), point of receipt (i.e., from where the illicit funds are deposited, spent, or invested), or both.

 

In general, there are two methods used to conceal corrupt payments in a business: on-book schemes and off-book schemes. On-book schemes are those that occur within an organization; therefore, these schemes will appear within that entity’s financial records. In on-book

schemes, illicit funds are drawn from the payer’s regular, known bank accounts and recorded

on its books and records in a disguised manner as some sort of legitimate trade payable.

 

Off-book schemes refer to those in which the suspect transactions do not appear anywhere on

the payer’s books or records. That is, off-book schemes leave no direct audit trail. Therefore, off-book schemes are more difficult to trace than on-book schemes. Even though off-book schemes do not leave a paper trail, business and financial records might contain indirect evidence of off-book sales or income (e.g., unaccounted-for shipping or warehouse expenses, or discrepancies in particular accounts or ratios between certain accounts).

 

The Business Profile—Analysis

The business profile begins the examination process. It will contain all the important information about a subject organization, such as its money flow pattern and financial condition, and it will identify prospective witnesses and targets, as well as relevant documents and transactions. It should also provide leads as to whether an on-book or off-book scheme is being used.

 

To develop the business profile, the fraud examiner should obtain information about the suspect business’s organization, personnel, money flow pattern (e.g., source of available funds, related expenditures), bank account location, financial condition, and recordkeeping system. This information can be obtained through interviews of employees, customers, and competitors; business bank account and loan records; financial statements; tax returns; business reporting companies; and business public filings.

 

To establish a business profile, fraud examiners should seek to answer the questions listed below.

 

HOW IS THE BUSINESS ORGANIZED, LEGALLY AND STRUCTURALLY?

Determine how the business is legally and structurally organized because this knowledge will help determine what records are available (e.g., corporate, partnership) and where to go to obtain them.

 

WHO ARE THE KEY PERSONNEL ASSOCIATED WITH THE ENTERPRISE?

Identify the key personnel associated with the subject business because doing so will help to identify potential witnesses and informants, as well as possible subjects. Key positions include the owners of the business; the people directly involved in the suspect transactions, including administrative assistants, clerical staff, and present and former employees; the number crunchers; the bookkeeper, outside accountants, and tax preparers; outside consultants, sales representatives, and independent contractors (a popular conduit for payoffs); and competitors (often eager witnesses who can identify leads to sources of off-book funds such as customers and rebate practices).

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Ghost Employee Schemes

Illicit funds can be generated by funneling phony salary payments to fictitious or former employees (i.e., ghost employees), or by making extra payments to presently salaried employees who then either return them to the payer or pass them on to the recipient. To trace such payments, obtain payroll and employee lists, personnel files, employment applications, tax withholding forms, and payroll checks from the suspect payer company. Attempt to identify the ghost through the following steps:

  • Compare a list of all current and former employees from the personnel office to the payroll list. Note discrepancies. Determine whether any employees have failed to execute tax withholding forms or have not elected to receive any health benefits or other optional withdrawals, such as enforced savings plans. The absence of such elections is often an indication that the employee does not exist.
  • A regular employee’s normal salary might also be inflated or, more commonly, travel and expense reimbursements might be padded to generate illicit funds. Look for unusual disbursements from the accounts in which such checks are deposited.

 

Once a suspect paycheck has been identified, determine whether the check was cashed or deposited. Note the endorsement, the bank, and the account where the check was deposited. Determine whether there are any second endorsements that might transfer the check to the ultimate recipient.

Overbilling Schemes

In overbilling schemes, the payer adds a corrupt payment to a legitimate business expense or trade payable. And subsequently, a cooperative third party then either forwards the excess payment directly to the intended recipient or returns it, usually in cash, to the payer for distribution.

 

Thus, illicit funds might be added to legitimate payments for goods or services provided by actual suppliers, subcontractors, engineers, and agents, with the additional amounts being passed on by the supplier or returned to the payer (usually in cash) for distribution.

 

Proving Off-Book Payments

Again, off-book payments refer to those schemes in which the funds used for illegal payments or transfers are not drawn from the regular, known bank accounts of the payer. Thus, off-book payments do not appear anywhere on the payer’s books or records.

 

In contrast to on-book payments, which are proven at the point of payment, off-book payments are typically proven at the point of receipt; that is, they are proven at the point from where the illicit funds are deposited, spent, or invested.

 

Accordingly, identifying and tracing off-book payments is usually more difficult than locating on-book payments. Success in proving off-book payments generally depends upon identifying the source of the funds or accounts (from which payments can be traced out), using an inside witness, and focusing on the point of receipt. The source of off-book funds might be located through the following indicators.

 

Indirect Evidence of Unrecorded Sales on the Suspect Company’s Books and Records

The suspect company’s books and records might reflect unusual costs and expenses not associated with the business’s known sales, such as rental payments for an undisclosed warehouse, shipping documents reflecting deliveries to an unlisted customer, and commissions paid to sales agents in a region where sales are not reported. These indicate possible unrecorded sales.

 

Unbalanced Ratios of Costs to Sales

The cost of producing and selling a particular item usually bears some fixed relationship to the revenue it generates. A significant imbalance in such a ratio, such as in a situation where twice the supplies are ordered than are needed to produce the reported sales (and the extra is not located in inventory), indicates possible unrecorded transactions. This technique is used to identify unreported sales by bars and restaurants.

 

Investigation in the Marketplace

Customers of the suspect business whose payments might have been diverted to off-book accounts might have records, including canceled checks, that would reflect such sales and the bank and account to which the funds were deposited. Customers might also reveal cash payments that could be used to create a slush fund. Additionally, competitors might be aware of other customers and transactions that could lead to evidence of off-book sales.

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Proving Payments in Cash

The following techniques can be used to prove cash payments circumstantially or to corroborate testimony of such payments by an inside witness:

  • Match evidence of cash withdrawals or disbursements by the payer with corresponding deposits, expenditures, or visits to a safe deposit box by the recipient.
  • Look for the purchase of cashier’s checks or wire transfers payable to the recipient at, or shortly after, cash withdrawals or disbursements. Also look for a correlation between cash-generating transactions and money wires or courier services, which are sometimes used to send cash.
  • If the scheme is ongoing, consider the use of visual or electronic surveillance (if a member of law enforcement), or try to introduce an undercover agent or implement a sting operation.
  • Unexplained or unusual cash disbursements or withdrawals, particularly from a business that does not normally deal in cash, might indicate illicit transactions or corroborate such testimony. To be effective, the fraud examiner must identify and rebut all legitimate explanations, which usually requires interviewing the payer.
  • Focus the investigation on the suspected recipient, as discussed in the following sections.

 

Examining Off-Book Payments by Focusing on the Point of Receipt

Because the point of receipt focuses on where the illicit funds are deposited, spent, or invested, this method is preferred if the suspected payer is not known or is inaccessible, or if cash payments are suspected. Accordingly, the point of receipt method is preferred when investigating off-book payments because they do not leave an audit trail. And because there is no audit trail, the fraud examiner must focus on the records regarding where the illicit funds are deposited, spent, or invested.

 

THE FINANCIAL/BEHAVIORAL PROFILE

The financial/behavioral profile is outlined in the “Tracing Illicit Transactions” chapter in the

Investigation section of the Fraud Examiners Manual. The financial profile will identify most illicit funds deposited to accounts or expended in significant amounts. It will not reveal relatively small currency transactions, particularly if they were for concealed activities, consumables, or unusual one-time expenses, such as medical bills. The financial profile might give inaccurate or false negative readings unless such activities are identified. This is done through preparation of the behavioral profile.

The behavioral profile contains information about the suspect’s personal characteristics (e.g., carries large amounts of cash, wears expensive clothes, or has club memberships), home and furnishings, automobiles, and leisure activities.

 

Information for the behavioral profile is gathered from interviews and observation of lifestyle and habits, as well as from documentary sources. When conducting interviews, the fraud examiner should be alert and review documents for signs that the target has:

  • A drug and/or alcohol addiction
  • A gambling habit
  • A loan shark or other private debts
  • A girlfriend or boyfriend supported by the target
  • Extraordinary medical expenses
  • Significant, regular cash expenses for entertainment and/or travel

 

The behavioral profile might also provide evidence of a possible motive for the crime, such as large debts, as well as additional evidence of illicit funds. For example, if the suspect spent significant amounts of cash and had no corresponding cash withdrawals from disclosed bank accounts or no admitted sources of cash income, there must be other, undisclosed sources of income.

 

Generally, when trying to prove illegal payments from the point of receipt, the fraud examiner should interview the suspect recipient and any third-party witnesses.

 

THE SUSPECT RECIPIENT

Again, when trying to prove corrupt payments from the point of receipt, the fraud examiner should almost always request an interview with the target. When interviewing the target, the fraud examiner should use the target’s financial/behavioral profile as a guide. The fraud examiner should try to ascertain the target’s income, assets, and accounts. If, during the interview with the suspect recipient, the witness claims to have legitimate sources of large sums of currency, the fraud examiner should determine the following:

  • What was the source of the cash?
  • What was the amount of cash on hand at the start of the investigation, at the end of each year thereafter, and on the date of the interview?
  • Where was the cash kept?
  • Why was the cash not deposited in a financial institution or invested?
  • Who knew about the cash?
  • What records of the cash exist?
  • What were the denominations?
  • When and for what was any of the cash spent?
  • Will the subject consent to an inventory of the remaining cash during the interview? If not, why not? If so, the cash should be counted at least twice in the presence of another fraud examiner. A list of serial and series numbers should also be made.

 

If, when interviewing the target, the target claims that the suspect funds were proceeds from a legitimate loan, the fraud examiner should ask:

  • Who was the lender?
  • When was the loan made?
  • What was the amount of the loan?
  • What was the purpose of the loan?
  • Was the loan repaid?
  • How was the loan documented?

 

Also, the fraud examiner should attempt to interview the subject’s spouse separately. If the interview is handled carefully, spouses can be an important source of lead information.

 

THIRD-PARTY WITNESSES

When trying to prove illegal payments from the point of receipt, the fraud examiner should also interview any third-party witnesses. Potential third-party sources include business colleagues, personal associates, bankers, brokers, real estate agents, accountants and tax preparers, ex-spouses, and romantic interests (particularly former romantic interests). Subjects often boast to their close associates of their new wealth or entertain them with the proceeds of their crime. Subjects are sometimes exposed by casual remarks made to their colleagues (and repeated to a fraud examiner), even when intensive audits have failed. Follow the financial/behavioral profile format to the extent feasible. Of course, no single third-party witness is likely to possess all this information, but a complete depiction can be assembled from the information provided by a few of these types of sources.

 

 

Conflicts of Interest

A conflict of interest occurs when an employee or agent—someone who is authorized to act on behalf of a principal—has an undisclosed personal or economic interest in a matter that could influence their professional role. These schemes involve self-dealing by an employee or agent and can occur in various ways. For example, a conflict might occur when an employee accepts inappropriate gifts, favors, or kickbacks from vendors, or when an employee engages in unapproved employment discussions with current or prospective contractors or suppliers.

 

Conflict of interest schemes generally constitute violations of the legal principle that an agent or employee must act in good faith, with full disclosure, and in the best interest of the principal or employer. An agent is any person who, under the law, owes a duty of loyalty to a principal or employer. Agents include officers, directors, and employees of a corporation; public officials; trustees; brokers; independent contractors; attorneys; and accountants. A principal is an entity that authorizes an agent to act on its behalf. In a principal-agent relationship, the agent acts on behalf of the principal. The agent should not have a conflict of interest in completing the act on the principal’s behalf.

 

As with other corruption frauds, conflict schemes involve the exertion of an employee’s influence to the principal’s detriment. In contrast to bribery schemes, where fraudsters are paid to use their influence on behalf of a third party, conflict of interest cases involve self- dealings by employees or agents.

 

Conflict Schemes

Conflict schemes do not always mirror bribery schemes, though. There are a number of ways in which an employee can use their influence to benefit a company in which they have a hidden interest. This section will discuss some of the more common conflict schemes, including conflicts in:

  • Purchase schemes
  • Sales schemes
  • Delayed billings
  • Business diversions
  • Resource diversions
  • Financial interest in companies under perpetrator’s supervision
  • Financial disclosures

 

 

Conflicts in Purchasing Schemes

Many times, conflicts of interest arise in the purchasing process. For example, an employee can have a conflict if they:

  • Have an undisclosed financial interest in a supplier or contractor
  • Set up a bogus contractor or vendor or buy through a broker or intermediary that the employee controls
  • Are involved in other business ventures with a supplier or contractor
  • Have an interest in a business that competes with their employer
  • Accept inappropriate gifts, travel, entertainment, or “fees” (i.e., kickbacks) from a vendor
  • Negotiate for or accept employment with a supplier

 

Often, such purchasing schemes are very similar to the billing schemes discussed in the

“Asset Misappropriation: Fraudulent Disbursements” chapter, so it will be helpful to discuss the distinction between traditional billing schemes and purchasing schemes that constitute conflicts of interest.

Conflicts of Interest

 

INTEREST IN THE ACQUISITION OF ASSETS

Not all purchasing conflicts occur in the traditional vendor-buyer relationship. Sometimes purchasing conflicts involve employees negotiating for the purchase of some unique, typically large asset such as land or a building in which the employee had an undisclosed interest. It is in the process of these negotiations that the fraudster violates their duty of loyalty to their employer. Because they stand to profit from the sale of the asset, the employee does not negotiate in good faith to their employer; they do not attempt to get the best price possible. The fraudster will reap a greater financial benefit if the purchase price is high.

 

For example, an employee in charge of negotiating mineral leases on land that they secretly own is obviously in a conflict. Though they are an employee in charge of negotiating the lease, and it is their responsibility to negotiate the best price for their employer, they also own the land, so it is in their personal interest to lease the land at the highest price possible. And because the employee has a personal interest in the land transaction, they have no financial motive to negotiate a favorable lease on their employer’s behalf.

 

TURNAROUND SALES

A purchasing scheme that is sometimes used by fraudsters is called the turnaround sale, or the flip. In this type of scheme, an employee knows their employer is seeking to purchase a certain asset and takes advantage of the situation by purchasing the asset themselves (usually in the name of an accomplice or shell company). The fraudster then turns around and resells the item to their employer at an inflated price.

 

Conflicts in Sales Schemes

There are two principal types of conflict schemes associated with sales of goods or services by the victim company: underselling and writing off sales.

 

UNDERSELLING

The first and most harmful is the underselling of goods or services. Just as a corrupt employee can cause their employer to overpay for goods or services sold by a company in which they have a hidden interest, so, too, can they cause the employer to undersell to a company in which they maintain a hidden interest.

 

Also, many employees who have hidden interests in outside companies sell goods or services to these companies at below-market prices. This results in a diminished profit margin or even a loss for the victim organization, depending upon the size of the discount.

 

SAMPLE WORK

Complete copy of CFFE FRAUD AND CORRUPTION SCHEMES NOTES  is available in SOFT copy (Reading using our MASOMO MSINGI PUBLISHERS APP) and in HARD copy 

Phone: 0728 776 317

Email: info@masomomsingi.com

WRITING OFF SALES

The other type of sales scheme involves tampering with the victim company’s books to decrease or write off the amount owed by the company in which the employee has a hidden interest. For instance, after an employee’s company purchases goods or services from the victim organization, credit memos might be issued against the sale, causing it to be written off to contra accounts such as Discounts and Allowances. A large number of reversing entries to sales might be a sign that fraud is occurring in an organization.

 

Conflicts Influencing Delayed Billings

In other examples, the perpetrator might not write off the scheme, but simply delay billing. This is sometimes done as a favor to a friendly client and is not an outright avoidance of the bill but rather a dilatory tactic. The victim organization eventually gets paid but loses time value on the payment, which arrives later than it should.

 

Conflicts in Business Diversions

Several employees end up starting their own businesses that compete directly with their employers, and when this occurs, such employees might begin siphoning off clients for their own business. This activity clearly violates the employee’s duty of loyalty to the employer, and frequently violates the company’s internal policies. There is nothing unscrupulous about free competition, but while a person acts as a representative of their employer, it is improper for them to try to take their employer’s clients. Normal standards of business ethics require employees to act in the best interests of their employers.

 

Conflicts in Resource Diversions

Some employees divert the funds and other resources of their employers to the development of their own businesses. This kind of scheme involves elements of both conflicts of interest and fraudulent disbursements.

 

Conflicts in Financial Disclosures

Management has an obligation to disclose to the shareholders significant fraud committed by officers, executives, and others in positions of trust, but misplaced loyalties might prevent management from making such disclosures.

 

The inadequate disclosure of conflicts of interest is among the most serious of frauds. Inadequate disclosure of related-party transactions is not limited to any specific industry; it transcends all business types and relationships.

 

Appearance of Conflict of Interest

A final type of conflict of interest is the appearance of a conflict of interest. The appearance of a conflict is nearly as problematic as the existence of a true conflict. Examples involving the appearance of a conflict of interest include ownership in a blind trust, in which the employee has no authority to make investment decisions, or an external auditor owning a minority interest in a company that is audited by the auditor’s firm. Such matters are rarely prosecuted as criminal offenses.

 

Detection of Conflicts of Interest

Conflicts of interest are one of the most difficult schemes to uncover. Therefore, there are no fast and easy detection methods for this type of fraud. Some of the more common methods by which conflicts are identified include tips and complaints, comparisons of vendor addresses with employee addresses, review of vendor ownership files, review of exit interviews, comparisons of vendor addresses to addresses of subsequent employers, policies requiring certain employees to provide the names and employers of immediate family members, and interviews with purchasing personnel regarding favorable treatment of one or more vendors.

 

 

Review Tips and Complaints

Conflicts are often revealed by tips. If a particular vendor is being favored, then competing vendors may file complaints. Additionally, employee complaints about the service of a favored vendor could lead to the discovery of a conflict of interest. Often, tips include allegations that raise common red flags of conflicts. Such red flags include:

  • Unexplained or unusual favoritism of a particular contractor or vendor
  • Employee lives beyond their means or displays new wealth
  • Employee fails to file conflict of interest or financial disclosure forms or questionnaires
  • Employee displays a keen interest in a particular customer, vendor, or supplier
  • Employee has discussions about employment with a current or prospective vendor
  • Transactions that are not in the best interest of the corporation
  • Employee appears to conduct side business
  • Vendor address or telephone number matches that of an employee

 

Compare Vendor Addresses with Employee Addresses

Look for employees posing as vendors by comparing employee and vendor addresses. If nominees or related parties are used as owners of vendors, then the business address of the vendor might match the employee’s address. Also, look for post office box addresses for vendors. This method is similar to that used for locating phony vendors.

 

Review Vendor Master File

The vendor master file is a database that contains a record of all vendors with whom a company conducts business, and it can be used to test for conflict schemes. Review changes to the vendor master file, including new vendors added and address changes. Also, comparing the vendor master file and the employee master file might reveal conflicts of interest. So, match the vendor master file to the employee master file on various key fields, such as address or tax ID number.

 

Review Exit Interviews and Compare Vendor Addresses to Addresses of Subsequent Employers

If a review of an employee’s exit interview yields the name and address of the employee’s subsequent employer, compare that employer’s name and address with the vendor file to identify any conflicts of interest wherein the employee has obtained employment from

a contractor.

 

Interview Purchasing Personnel Regarding Favorable Treatment of One or More Vendors

Unexplained or unusual favoritism of a particular contractor or vendor is a red flag of a conflict of interest. And because employees are generally the first to observe that a vendor is receiving favorable treatment, purchasing personnel should be interviewed for evidence of such favoritism. By asking employees if any vendor is receiving favorable treatment, the fraud examiner might discover conflicts of interest that would otherwise have gone unnoticed.

 

Also, because evidence that a company accepts inferior products or services from a vendor is a red flag of corruption, purchasing personnel should be asked whether any vendor’s service (or product) has recently become substandard.

 

Prevention of Conflicts of Interest

Organizations should take steps to prevent conflicts of interest. They should establish policies clearly defining what constitutes a conflict of interest and prohibiting any such entanglements by officers, directors, employees, or other agents of the organization. A policy requiring employees to complete an annual disclosure statement is an excellent proactive approach to dealing with potential conflicts. Furthermore, such policies will reinforce the idea that engaging in conflicts of interest is unacceptable for employees and will result in severe consequences.

Also, managers must establish an ethical tone for the companies they lead. The tone management sets will have a trickle-down effect on employees of the company.

 

Moreover, organizations must educate their employees about conflicts of interest. In fact, there is not a more effective tool in the prevention and detection of fraud than a network of employees who are knowledgeable about fraud and look for indicators of their organization’s vulnerabilities.

 

Anti-Corruption Programs

An anti-corruption program is a good strategy to communicate an organization’s philosophy regarding fraud and ethical behavior. The program should extend beyond the enactment of a written anti-corruption policy. It should include active support of management, ongoing employee education, a well-publicized reporting mechanism, swift and public action in the

case of violations, and monitoring of the overall program’s effectiveness.

 

SAMPLE WORK

Complete copy of CFFE FRAUD AND CORRUPTION SCHEMES NOTES  is available in SOFT copy (Reading using our MASOMO MSINGI PUBLISHERS APP) and in HARD copy 

Phone: 0728 776 317

Email: info@masomomsingi.com

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