Fraud risk management: a guide to good practice

Fraud risk management: a guide to good practice
Fraud risk management
A guide to good practice
Acknowledgements
This guide is based on the first edition of Fraud Risk Management: A Guide to Good Practice. The first edition was
prepared by a Fraud and Risk Management Working Group, which was established to look at ways of helping
management accountants to be more effective in countering fraud and managing risk in their organisations.
This second edition of Fraud Risk Management: A Guide to Good Practice has been updated by Helenne Doody, a
specialist within CIMA Innovation and Development. Helenne specialises in Fraud Risk Management, having worked
in related fields for the past nine years, both in the UK and other countries. Helenne also has a graduate certificate
in Fraud Investigation through La Trobe University in Australia and a graduate certificate in Fraud Management
through the University of Teeside in the UK.
For their contributions in updating the guide to produce this second edition, CIMA would like to thank:
Martin Birch FCMA, MBA
Director – Finance and Information Management, Christian Aid.
Roy Katzenberg
Chief Financial Officer, RITC Syndicate Management Limited.
Judy Finn
Senior Lecturer, Southampton Solent University.
Dr Stephen Hill
E-crime and Fraud Manager, Chantrey Vellacott DFK.
Richard Sharp BSc, FCMA, MBA Assistant Finance Director (Governance), Kingston Hospital NHS Trust.
Allan McDonagh
Managing Director, Hibis Europe Ltd.
Martin Robinson and
Mia Campbell
on behalf of the Fraud Advisory Panel.
CIMA would like also to thank those who contributed to the first edition of the guide.
About CIMA
CIMA, the Chartered Institute of Management Accountants, is the only international accountancy body with a key
focus on business. It is a world leading professional institute that offers an internationally recognised qualification
in management accounting, with a full focus on business, in both the private and public sectors. With 164,000
members and students in 161 countries, CIMA is committed to upholding the highest ethical and professional
standards of its members and students.
© CIMA 2008. All rights reserved. This booklet does not necessarily represent the views of the Council of the
Institute and no responsibility for loss associated to any person acting or refraining from acting as a result of any
material in this publication can be accepted by the authors or publishers.
1
Fraud risk management: a guide to good practice
Contents
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
2
1
Fraud – its extent, patterns and causes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
1.1 What is fraud? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
1.2 The scale of the problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
1.3 Which businesses are affected? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
1.4 Why do people commit fraud? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
1.5 Who commits fraud? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
1.6 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
2
Risk management – an overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
2.1 What is risk management? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
2.2 Corporate governance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
2.3 The risk management cycle . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
2.4 Establish a risk management group and set goals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
2.5 Identify risk areas . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
2.6 Understand and assess the scale of risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
2.7 Develop a risk response strategy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
2.8 Implement the strategy and allocate responsibilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
2.9 Implement and monitor suggested controls . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
2.10 Review and refine and do it again . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
2.11 Information for decision making . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
2.12 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
3
Fraud prevention . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
3.1 A strategy to combat fraud . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
3.2 Developing a sound ethical culture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
3.3 Sound internal control systems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32
3.4 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36
4
Fraud detection . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37
4.1 Detection methods. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37
4.2 Indicators and warnings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39
4.3 Tools and techniques . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41
4.4 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43
5
Responding to fraud . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44
5.1 Purpose of the fraud response plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44
5.2 Corporate policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44
5.3 Definition of fraud . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45
5.4 Roles and responsibilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45
5.5 The response . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47
5.6 The investigation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48
5.7 Organisation’s objectives with respect to dealing with fraud . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50
5.8 Follow-up action . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50
5.9 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51
Appendices
Appendix 1
Appendix 2
Appendix 3
Appendix 4
Appendix 5
Appendix 6
Appendix 7
Appendix 8
Appendix 9
Appendix 10
Appendix 11
Fraud and the law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52
Examples of common types of internal fraud . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57
Example of a risk analysis. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60
A sample fraud policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61
Sample whistleblowing policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62
Examples of fraud indicators, risks and controls . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64
A 16 step fraud prevention plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67
Outline fraud response plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68
Example of a fraud response plan. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69
References and further reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77
Listed abbreviations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80
Figures
Figure 1
Figure 2
Figure 3
Figure 4
Figure 5
Figure 6
Types of internal fraud . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
The fraud triangle. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
The CIMA risk management cycle . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
Anti-fraud strategy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
Ethics advice/services provided . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
Methods of fraud detection . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37
Case Studies
Case study 1
Case study 2
Case study 3
Case study 4
Case study 5
Case study 6
Case study 7
Case study 8
Case study 9
Case study 10
Fraud doesn’t involve just money . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Size really doesn’t matter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
A breach of trust . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Management risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
A fine warning . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35
Vet or regret? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36
Tipped off . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38
Risk or returns. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42
Reporting fraud . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45
TNT roots our fraud . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48
3
4
Introduction
Periodically, the latest major fraud hits the headlines
as other organisations sit back and watch, telling
themselves that ‘it couldn’t happen here.’ But the
reality is that fraud can happen anywhere. While
only relatively few major frauds are picked up by the
media, huge sums are lost by all kinds of businesses as
a result of the high number of smaller frauds that are
committed.
Despite the serious risk that fraud presents to business,
many organisations still do not have formal systems
and procedures in place to prevent, detect and respond
to fraud. While no system is completely foolproof,
there are steps which can be taken to deter fraud and
make it much less attractive to commit. It is in assisting
organisations in taking such steps that this guide should
prove valuable.
Surveys are regularly carried out in an attempt to
estimate the true scale and cost of fraud to business
and society. Findings vary, and it is difficult to obtain a
complete picture as to the full extent of the issue, but
these surveys all indicate that fraud is prevalent within
organisations and remains a serious and costly problem.
The risks of fraud may only be increasing, as we see
growing globalisation, more competitive markets, rapid
developments in technology, and periods of economic
difficulty.
The original guide to good practice was based on the
work of CIMA’s Fraud and Risk Management Working
Group that was established as part of the Institute’s
response to the problem of fraud. Since the publication
of the original guide, we have continued to see high
profile accounting scandals and unacceptable levels of
fraudulent behaviour. This second edition of the guide
includes updates to reflect the many changes in the
legal environment and governance agenda in recent
years, aimed at tackling the ongoing problem of fraud.
Among other findings, the various surveys highlight
that:
• organisations may be losing as much as 7% of their
annual turnover as a result of fraud
• corruption is estimated to cost the global economy
about $1.5 trillion each year
• only a small percentage of losses from fraud are
recovered by organisations
• a high percentage of frauds are committed by senior
management and executives
• greed is one of the main motivators for committing
fraud
• fraudsters often work in the finance function
• fraud losses are not restricted to a particular sector
or country
• the prevalence of fraud is increasing in emerging
markets.
The guide starts by defining fraud and giving an
overview of the extent of fraud, its causes and its
effects. The initial chapters of the guide also set
out the legal environment with respect to fraud,
corporate governance requirements and general
risk management principles. The guide goes on to
discuss the key components of an anti-fraud strategy
and outlines methods for preventing, detecting and
responding to fraud. A number of case studies are
included throughout the guide to support the text,
demonstrating real life problems that fraud presents
and giving examples of actions organisations are taking
to fight fraud.
5
Fraud risk management: a guide to good practice
Management accountants, whose professional training
includes the analysis of information and systems, can
have a significant role to play in the development
and implementation of anti-fraud measures within
their organisations. This guide is intended to help
management accountants in that role and will also be
useful to others with an interest in tackling fraud in
their organisation.
The law relating to fraud varies from country to
country. Where it is necessary for this guide to make
reference to specific legal measures, this is generally to
UK law, as it would be impossible to include references
to the laws of all countries where this guide will be
read. It is strongly advised that readers ensure they
are familiar with the law relating to fraud in their
own jurisdiction. Although some references may
therefore not be relevant to all readers, the general
principles of fraud risk management will still apply and
organisations around the world are encouraged to take
a more stringent approach to preventing, detecting and
responding to fraud.
6
1 Fraud: its extent, patterns and causes
1.1 What is fraud?
Definition of fraud
The term ‘fraud’ commonly includes activities such as
theft, corruption, conspiracy, embezzlement, money
laundering, bribery and extortion. The legal definition
varies from country to country, and it is only since the
introduction of the Fraud Act in 2006, that there has
been a legal definition of fraud in England and Wales.
Fraud essentially involves using deception to
dishonestly make a personal gain for oneself and/or
create a loss for another. Although definitions vary,
most are based around these general themes.
Fraud and the law
Before the Fraud Act came into force, related offences
were scattered about in many areas of the law. The
Theft Acts of 1968 and 1978 created offences of false
accounting, and obtaining goods, money and services
by deception, and the Companies Act 1985 included
the offence of fraudulent trading. This remains part of
the Companies Act 2006. There are also offences of
fraud under income tax and value-added tax legislation,
insolvency legislation, and the common law offence of
conspiracy to defraud.
The Fraud Act is not the only new piece of legislation.
Over the last few years there have been many changes
to the legal system with regard to fraud, both in the
UK and internationally. This guide focuses mainly
on UK requirements, but touches on international
requirements that impact UK organisations. In the UK,
the Companies Act and the Public Interest Disclosure
Act (PIDA) have been amended and legislation such as
the Serious Crimes Act 2007 and the Proceeds of Crime
Act 2002 (POCA) have been introduced. Internationally
the Sarbanes-Oxley Act 2002 (Sarbox) has been
introduced in the United States (US), a major piece of
legislation that affects not only companies in the US
but also those in the UK and others based all over the
globe. Further information on these pieces of legislation
can be found in Appendix 1.
As well as updating the legislation in the UK, there
have been, and will continue to be, significant
developments in the national approach to combating
fraud, particularly as we see implementation of actions
resulting from the national Fraud Review. Appendix 1
gives further information on the Fraud Review. There
are also many law enforcement agencies involved in
the fight against fraud in the UK, including the Serious
Fraud Office, the Serious Organised Crime Agency
(SOCA), the Financial Services Authority (FSA), and
Economic Crime Units within the police force.
Different types of fraud
Fraud can mean many things and result from many
varied relationships between offenders and victims.
Examples of fraud include:
• crimes by individuals against consumers, clients or
other business people, e.g. misrepresentation of the
quality of goods; pyramid trading schemes
• employee fraud against employers, e.g. payroll fraud;
falsifying expense claims; thefts of cash, assets or
intellectual property (IP); false accounting
• crimes by businesses against investors, consumers
and employees, e.g. financial statement fraud; selling
counterfeit goods as genuine ones; not paying over
tax or National Insurance contributions paid by staff
• crimes against financial institutions, e.g. using lost
and stolen credit cards; cheque frauds; fraudulent
insurance claims
• crimes by individuals or businesses against
government, e.g. grant fraud; social security benefit
claim frauds; tax evasion
• crimes by professional criminals against major
organisations, e.g. major counterfeiting rings;
mortgage frauds; ‘advance fee’ frauds; corporate
identity fraud; money laundering
• e-crime by people using computers and technology
to commit crimes, e.g. phishing; spamming; copyright
crimes; hacking; social engineering frauds.
7
Fraud risk management: a guide to good practice
This guide focuses on fraud against businesses, typically
by those internal to the organisation. According
to the Association of Certified Fraud Examiners
(ACFE), there are three main categories of fraud
that affect organisations. The first of these is asset
misappropriations, which involves the theft or misuse
of an organisation’s assets. Examples include theft
of plant, inventory or cash, false invoicing, accounts
receivable fraud, and payroll fraud.
The second category of fraud is fraudulent statements.
This is usually in the form of falsification of financial
statements in order to obtain some form of improper
benefit. It also includes falsifying documents such as
employee credentials.
The final of the three fraud categories is corruption.
This includes activities such as the use of bribes or
acceptance of ‘kickbacks’, improper use of confidential
information, conflicts of interest and collusive
tendering. These types of internal fraud are summarised
in Figure 1.
Surveys have shown that asset misappropriation is the
most widely reported type of fraud in UK, although
corruption and bribery are growing the most rapidly.
Further information on common types of internal fraud,
and methods by which they may be perpetrated, is
included in Appendix 2.
Figure 1 Types of internal fraud
Internal fraud
Asset
misappropriation
Cash
8
Non-cash
Fraudulent
statements
Financial
Non-financial
Corruption
Conflicts of
interest
Bribery and
extortion
1.2 The scale of the problem
There have been many attempts to measure the
true extent of fraud, but compiling reliable statistics
around fraud is not easy. As one of the key aspects of
fraud is deception, it can be difficult to identify and
survey results often only reflect the instances of fraud
that have actually been discovered. It is estimated
that the majority of frauds go undetected and, even
when a fraud has been found, it may not be reported.
One reason for this may be that a company that has
been a victim of fraud does not want to risk negative
publicity. Also, it is often hard to distinguish fraud from
carelessness and poor record keeping.
Although survey results and research may not give a
complete picture, the various statistics do offer a useful
indication as to the extend of the problem. There can
be no doubt that fraud is prevalent within organisations
and remains a serious issue. PricewaterhouseCooper’s
Global Economic Crime Survey (PwC’s survey) in 2007
found that over 43% of international businesses were
victims of fraud during the previous two years. In the
UK, the figures were higher than the global average,
with 48% of companies having fallen victim to fraud.
Some surveys put the figures much higher. For example,
during 2008, Kroll commissioned the Economist
Intelligence Unit (EIU) to poll nearly 900 senior
executives across the world. The EIU found that 85% of
companies had suffered from at least one fraud in the
past three years1. This figure had risen from 80% in a
similar poll in 2007. KPMG’s Fraud Barometer, which has
been running since 1987, has also shown a considerable
increase in the number of frauds committed in the UK
in recent years, including a 50% rise in fraud cases in
the first half of 2008.
According to the UK report of PwC’s survey, the average
direct loss per company over a two year period as a
result of fraud has risen to £1.75 million, increasing
from £0.8 million in the equivalent 2005 survey. These
figures exclude undetected losses and indirect costs to
the business such as management costs or damage to
reputation, which can be significant. Management costs
alone were estimated to be on average another £0.75
million. Participants of the ACFE Report to the Nation
2008 (ACFE report) estimated that organisations lose
7% of their annual revenues to fraud.
It is difficult to put a total cost on fraud, although many
studies have tried to. For example an independent
report by the Association of Chief Police Officers (the
ACPO) in 2007 revealed that fraud results in losses
of £20 billion each year in the UK. The World Bank
has estimated that the global cost of corruption and
bribery is about 5% of the value of the world economy
or about $1.5 trillion per year. It is thought that these
estimates are conservative, and they also exclude other
types of fraud such as misappropriation of assets.
While it may be impossible to calculate the total cost
of fraud, it is said to be more significant than the total
cost of most other crimes. According to the Attorney
General in the UK, fraud is an area of crime which is
second only to drug trafficking in terms of causing harm
to the economy and society2.
1 Kroll Global Fraud Report, Annual Edition 2008/2009
2 Attorney General’s interim report on the government’s Fraud Review, March 2006
9
Fraud risk management: a guide to good practice
Fraud is often mistakenly considered a victimless
crime. However, fraud can have considerable social
and psychological effects on individuals, businesses
and society. For example, when a fraud causes the
collapse of a major company, numerous individuals
and businesses can be affected. In addition to the
company’s own employees, employees of suppliers
can be affected by the loss of large orders, and
other creditors, such as banks, can be indirectly
affected by huge losses on loans. Consumers have
to pay a premium for goods and services, in order to
compensate for the costs of fraud losses and for money
spent on investigations and additional security.
Taxpayers also suffer due to reduced payments of
corporation tax from businesses that have suffered
losses. Fraud drains resources, affects public services
and, perhaps of more concern, may fund other criminal
and terrorist activity. According to the Fraud Review,
fraud is a major and growing threat to public safety and
prosperity. Case study 1 demonstrates just how much
of a threat fraud can be to public safety and that there
truly are victims of fraud.
Case study 1
Fraud doesn’t just involve money
Counterfeiting is one example of fraud that can have extremely serious consequences. Technology is ever
improving, making it easier for counterfeiters to produce realistic looking packaging and fool legitimate
wholesalers and retailers. Counterfeiting is a potentially lucrative business for the fraudster, with possibilities
of large commercial profits, and it is a problem affecting a wide range of industries including wines and
spirits, pharmaceuticals, electrical goods, and fashion. However, there are often many victims affected by
such a fraud and not just the business that has been duped or had their brand exploited. For some, the
outcome of counterfeiting goes way beyond financial losses and can even be fatal:
• In late 2006, 14 Siberian towns declared a state of emergency due to mass poisonings caused by fake
vodka. Around 900 people were hospitalised with liver failure after drinking industrial solvent that was
being sold as vodka. This is not a one off problem and sales of fake alcohol have been known to kill people.
• Also in 2006, a counterfeit product did result in more tragic consequences. At least 100 children died after
ingesting cough syrup that had been mixed with counterfeit glycerine. The counterfeit compound, actually
a dangerous solvent, had been used in place of more expensive glycerine. The manufacturing process had
been sourced to China and the syrup passed through trading companies in Beijing and Barcelona before
reaching its final destination in Panama. The certificate attesting to the product’s purity was falsified and
not one of the trading companies tested the syrup to confirm its contents along the way. It is thought that
the number of deaths is likely to be much higher than the 100 cases that have been confirmed.
10
1.3 Which businesses are affected?
Fraud is an issue that all organisations may face
regardless of size, industry or country. If the
organisation has valuable property (cash, goods,
information or services), then fraud may be attempted.
It is often high profile frauds in large multi-national
organisations that are reported on in the media and
smaller organisations may feel they are unlikely to be
a target of fraudsters. However, according to the ACFE
report, small businesses (classified as those with less
than 100 employees) suffer fraud more frequently than
large organisations and are hit by higher average losses.
When small companies are hit by large fraud losses,
they are less likely to be able to absorb the damage
than a larger company and may even go out of business
as a result.
commissioned by Kroll in 2007 found that respondents
in countries such as India and China have seen a
significant increase in the prevalence of corporate fraud
in the last three years and this trend is likely to increase
in businesses operating in emerging markets3.
Although fraud is prevalent across organisations of all
sizes and in all sectors and locations, research shows
that certain business models will involve greater levels
of fraud risk than others. The control environment
should be adjusted to fit with the degree of risk
exposure. Further guidance on risk assessment and
controls is given in later chapters.
The results of PwC’s survey showed that companies
reporting fraud were spread across many industries,
with at least a quarter of the respondents in any one
industry suffering from fraudulent incidents. Industries
suffering the highest average losses were insurance
and industrial manufacturing. Losses in the financial
services industry, a sector frequently in the press and
one with which fraud is often associated, were actually
below average. Even not-for-profit organisations are
not immune to fraud, with government institutions
and many charities falling victim to unscrupulous
fraudsters. As one director working in the international
development and aid sector has pointed out, ‘In my
sector, fraud is not a possibility, it is a reality and we are
always dealing with a number of suspicious incidents on
a more or less permanent basis.’
PwC’s survey also revealed that incidences of fraud
were highest in companies in North America, Africa
and Central and Eastern Europe (CEE), where more than
half of the companies reported fraud. It was lowest in
the Western European region, although the UK was
much higher than the average for this region, with
levels of fraud similar to those in CEE. The EIU poll
3 Kroll Global Fraud Report, Annual Edition 2007/2008
11
Fraud risk management: a guide to good practice
Case study 2
Size really doesn’t matter
From a family affair...
A member of a small family business in Australia committed a $2m fraud, costing profits, jobs and a great
deal of trust. The business owners became suspicious when they realised that their son in law used the
company diesel card to buy petrol for his own car. On closer scrutiny, they soon uncovered a company
cheque for $80,000 made payable to the son in law’s personal account. BDO’s Brisbane office discovered that
the cheque and the fuel were just the tip of a vast iceberg. The company’s complex accounts system allowed
the son in law to disguise cheques payable to himself as creditor payments. He then became a signatory and
took ever larger cheques. He claimed that the poor cash flow was due to losses in one particular division
which the family therefore closed, creating redundancies and losing what was in truth a successful business.
The costs of inefficient accounting systems and undue trust can be massive. Every business should protect
itself with thorough controls and vigilance.
Adapted from ‘FraudTrack 5 Fraud: A Global Challenge’ published by BDO Stoy Hayward
...to a major corporate scandal
WorldCom filed for bankruptcy protection in June 2002. It was the biggest corporate fraud in history,
largely a result of treating operating expenses as capital expenditure. WorldCom (now renamed MCI)
admitted in March 2004 that the total amount by which it had misled investors over the previous 10 years
was almost US$75 billion (£42 billion) and reduced its stated pre-tax profits for 2001 and 2002 by that
amount. WorldCom stock began falling in late 1999 as businesses slashed spending on telecom services
and equipment. A series of debt downgrades raised borrowing costs for the company, struggling with about
US$32 billion in debt. WorldCom used accounting tricks to conceal a deteriorating financial condition and to
inflate profits.
Former WorldCom chief executive Bernie Ebbers resigned in April 2002 amid questions about US$366 million
in personal loans from the company and a federal probe of its accounting practices. Ebbers was subsequently
charged with conspiracy to commit securities fraud and filing misleading data with the Securities and
Exchange Commission (SEC) and was sentenced to 25 years in prison. Scott Sullivan, former Chief Financial
Officer, pleaded guilty to three criminal charges and was sentenced to five years in prison. Ultimately, losses
to WorldCom shareholders were close to US$180 billion and the fraud also resulted in the loss of 17,000 jobs.
The SEC said that WorldCom had committed ‘accounting improprieties of unprecedented magnitude’ – proof,
it said, of the need for reform in the regulation of corporate accounting.
Adapted from CIMA Official Learning System, Management Accounting Risk and Control Strategy
12
1.4 Why do people commit fraud?
There is no single reason behind fraud and any
explanation of it needs to take account of various
factors. Looking from the fraudster’s perspective, it is
necessary to take account of:
• motivation of potential offenders
• conditions under which people can rationalise their
prospective crimes away
• opportunities to commit crime(s)
• perceived suitability of targets for fraud
• technical ability of the fraudster
• expected and actual risk of discovery after the fraud
has been carried out
• expectations of consequences of discovery (including
non-penal consequences such as job loss and
family stigma, proceeds of crime confiscation, and
traditional criminal sanctions)
• actual consequences of discovery.
A common model that brings together a number of
these aspects is the Fraud Triangle. This model is built
on the premise that fraud is likely to result from a
combination of three factors: motivation, opportunity
and rationalisation.
Figure 2 The fraud triangle
Opportunity
In terms of opportunity, fraud is more likely in
companies where there is a weak internal control
system, poor security over company property, little
fear of exposure and likelihood of detection, or unclear
policies with regard to acceptable behaviour. Research
has shown that some employees are totally honest,
some are totally dishonest, but that many are swayed
by opportunity.
Rationalisation
Many people obey the law because they believe in it
and/or they are afraid of being shamed or rejected by
people they care about if they are caught. However,
some people may be able to rationalise fraudulent
actions as:
• necessary – especially when done for the business
• harmless – because the victim is large enough to
absorb the impact
• justified – because ‘the victim deserved it’ or
‘because I was mistreated.’
Motivation
The fraud
triangle
Opportunity
Motivation
In simple terms, motivation is typically based on either
greed or need. Stoy Hayward’s (BDO) most recent
FraudTrack survey found that greed continues to be the
main cause of fraud, resulting in 63% of cases in 2007
where a cause was cited. Other causes cited included
problems from debts and gambling. Many people are
faced with the opportunity to commit fraud, and only
a minority of the greedy and needy do so. Personality
and temperament, including how frightened people
are about the consequences of taking risks, play a role.
Some people with good objective principles can fall into
bad company and develop tastes for the fast life, which
tempts them to fraud. Others are tempted only when
faced with ruin anyway.
Rationalisation
13
Fraud risk management: a guide to good practice
Case study 3
A breach of trust
A good example of the fraud triangle in practice is the highly publicised case of the secretary that stole over
£4.3 million from her bosses at Goldman Sachs.
Motivation
There were some suggestions that Joyti De-Laurey originally started down her fraudulent path because
of financial difficulties she found herself in before starting work at the investment bank. De-Laurey had
previously run her own sandwich bar business, but it was closed down due to insufficient finances. According
to her defence, De-Laurey’s ‘first bitter experience of financial turmoil coincided with a novel introduction to
a Dallas-type world where huge, unthinkable amounts of money stared her in the face, day in and day out.’
The motive behind the fraud was primarily greed though, with De-Laurey spending her ill gotten gains on a
luxury lifestyle, including villas, cars, jewellery, designer clothes and first class holidays. De-Laurey has even
admitted that she did not steal because she needed to, but because she could. She explained that she first
started taking money simply to find out if she could get away with it. She says that it then became ‘a bit
addictive’ and that she ‘got a huge buzz from knowing they had no idea what I was doing.’
Opportunity
In terms of opportunity, De-Laurey’s bosses trusted her and held her in high regard. She had proved herself
indispensable, on both business and personal fronts, and was given access to their cheque books in order to
settle their domestic bills and personal finances.
A little over a year after starting at Goldman Sachs, De-Laurey began forging her bosses’ signatures on
personal cheques to make payments into her own accounts. Realising she had got away with it, De-Laurey
continued to steal money by issuing forged cheques and making false money transfers. Before long she was
forging signatures on a string of cash transfer authorities, siphoning off up to £2.5 million at a time from
supposedly secure New York investments.
Rationalisation
De-Laurey was able to rationalise her actions by convincing herself that she had earned the money she stole.
De-Laurey believed that she deserved the plundered amounts as a just reward for her dedication, discretion
and loyalty, and claims that she had the consent of her bosses to take money in return for her ‘indispensable
services’. The fact that they were so rich they did not even notice the money was missing, only served to
fuel De-Laurey’s fraudulent activities. She justified her actions through the belief that her bosses had cash to
spare. According to De-Laurey; ‘They could afford to lose that money.’
Caught out
After four years of siphoning off vast amounts of money, De-Laurey was eventually caught when her boss
at the time decided to make a six-figure donation to his former college. He took a look at his bank accounts
to see if he could cover the donation and was surprised to find the balance on the accounts so low. He
investigated further and realised that large sums had been transferred to an unknown account. De-Laurey
was the obvious suspect. By this time, De-Laurey had actually stolen around £3.3 million from this particular
boss.
De-Laurey was the first woman in the UK to be accused of embezzling such a large sum and, after a long and
high profile trial in 2004, she was sentenced to seven years imprisonment.
Various sources including The Guardian, The Times, The Independent and the BBC News
14
One of the most effective ways to tackle the problem
of fraud is to adopt methods that will decrease motive
or opportunity, or preferably both. Rationalisation is
personal to the individual and more difficult to combat,
although ensuring that the company has a strong
ethical culture and clear values should help. These
methods and principles are developed further in later
chapters of this guide.
1.5 Who commits fraud?
Different types of fraudster
Fraudsters usually fall into one of three categories:
1 Pre-planned fraudsters, who start out from the
beginning intending to commit fraud. These can be
short-term players, like many who use stolen credit
cards or false social security numbers; or can be
longer-term, like bankruptcy fraudsters and those
who execute complex money laundering schemes.
2 Intermediate fraudsters, who start off honest but
turn to fraud when times get hard or when life
events, such as irritation at being passed over for
promotion or the need to pay for care for a family
member, change the normal mode.
3 Slippery-slope fraudsters, who simply carry on
trading even when, objectively, they are not in a
position to pay their debts. This can apply to ordinary
traders or to major business people.
In 2007, KPMG carried out research on the Profile of a
Fraudster (KPMG survey), using details of fraud cases
in Europe, India, the Middle East and South Africa. The
ACFE carried out similar research on frauds committed
in the US. These surveys highlight the following facts
and figures in relation to fraudsters:
• perpetrators are typically college educated white
male
• most fraudsters are aged between 36 and 55
• the majority of frauds are committed by men
• median losses caused by men are twice as great as
those caused by women
• a high percentage of frauds are committed by senior
management (including owners and executives)
• losses caused by managers are generally more than
double those caused by employees
• average losses caused by owners and executives are
nearly 12 times those of employees
• longer term employees tend to commit much larger
frauds
• fraudsters most often work in the finance
department, operations/sales or as the CEO.
The ACFE report also found that the type of person
committing the offence depends on the nature of the
fraud being perpetrated. Employees are most likely
to be involved in asset misappropriation, whereas
owners and executives are responsible for the majority
of financial statement frauds. Of the employees,
the highest percentage of schemes involved those
in the accounting department. These employees
are responsible for processing and recording the
organisation’s financial transactions and so often have
the greatest access to its financial assets and more
opportunity to conceal the fraud.
15
Fraud risk management: a guide to good practice
Case study 4
Management risk
In 2007, a major British construction firm suffered from extensive fraud committed by management
at one of its subsidiaries. Accounting irregularities dating back to 2003 were said to include systematic
misrepresentation of production volumes and sales by a number of senior figures at the division.
Management at the subsidiary attempted to cover their behaviour by selling materials at a discounted price
and the fraud went undetected for several years despite internal and external audits. The irregularities were
eventually uncovered by an internal team sent to investigate a mismatch between orders and sales.
Following an initial internal investigation, a team of external experts and the police were brought in to
identify the full extent of malpractice. The investigation found that the organisation was defrauded of nearly
£23 million, but the fraud was said to cost the company closer to £40 million due to the written down value
of the business and factoring in the cost of the investigation. The managing director of the subsidiary was
dismissed, another manager faced disciplinary action and five others left before disciplinary proceedings
could be commenced. Civil proceedings were ruled out on the basis that losses were unlikely to be recovered.
Operations at the centre of the incident had to be temporarily closed and more than 160 jobs were cut at the
business.
In addition to individual fraudsters, there has also
been an increase in fraud being committed by gangs of
organised criminals. Examples include false or stolen
identities being used to defraud banks, and forms of
e-fraud exploiting the use of internet by commercial
businesses. SOCA is responsible for responding to such
threats, with the support of the victim organisations.
1.6 Summary
A major reason why people commit fraud is because
they are allowed to do so. There are a wide range
of threats facing businesses. The threat of fraud can
come from inside or outside the organisation, but the
likelihood that a fraud will be committed is greatly
decreased if the potential fraudster believes that the
rewards will be modest, that they will be detected or
that the potential punishment will be unacceptably
high.
16
The main way of achieving this must be to establish a
comprehensive system of control which aims to prevent
fraud, and where fraud is not prevented, increases the
likelihood of detection and increases the cost to the
fraudster.
Later chapters of this guide set out some of the
measures which can be put in place to minimise fraud
risks to the organisation. Before looking specifically
at fraud risk, the guide considers risk management in
general.
2 Risk management – an overview
2.1 What is risk management?
2.2 Corporate governance
Risk management is defined as the ‘process of
understanding and managing risks that the entity
is inevitably subject to in attempting to achieve its
corporate objectives’ (CIMA Official Terminology,
2005).
Risk management is an increasingly important process
in many businesses and the process fits in well with the
precepts of good corporate governance. In recent years,
the issue of corporate governance has been a major
area for concern in many countries. In the UK, the first
corporate governance report and code of best practice
is considered to be the Cadbury Report in 1992, which
was produced in response to a string of corporate
collapses. There have been a number of reports since,
covering provisions around areas such as executive
remuneration, non-executive directors, and audit
committees. The principles of these various reports
have been brought together to form the Combined
Code on Corporate Governance (Combined Code).
For an organisation, risks are potential events that
could influence the achievement of the organisation’s
objectives. Risk management is about understanding
the nature of such events and, where they represent
threats, making positive plans to mitigate them. Fraud
is a major risk that threatens the business, not only
in terms of financial health but also its image and
reputation.
This guide is primarily focused on managing the risk
of fraud, but first, this chapter looks at more general
aspects of risk management and corporate governance.
The Combined Code was first introduced in 1998 and
among other matters, calls for boards to establish
systems of internal control and to review the
effectiveness of these systems on a regular basis. UK
listed companies are required to provide a statement
in their annual reports confirming that they comply
with the Combined Code, and where they do not, they
must provide an explanation for departures from it
(the ‘comply or explain’ principle). The assessment of
internal controls should be included in the report to
shareholders. The Combined Code is reviewed regularly
and the most recent version was published in June
2008.
Following the original introduction of the Combined
Code, the Turnbull Committee was set up to issue
guidance to directors on how they should assess
and report on their review of internal controls. The
Turnbull Committee made it clear that establishment
of embedded risk management practices is key to
effective internal control systems. The Turnbull
guidance was first published in 1999 and revised in
2005. In the revised report (sometimes referred to as
Turnbull 2) there is now a requirement for directors to
give explicit confirmation that any significant failings or
weaknesses identified from the review of effectiveness
of internal controls have been, or are being, remedied.
17
Fraud risk management: a guide to good practice
The Financial Reporting Council is responsible for
maintaining and reviewing the Combined Code,
although the Combined Code is annexed to the rules of
the UK Listing Authority, which is part of the FSA. The
FSA is responsible for ensuring that listed companies
provide the appropriate ‘comply or explain’ statement
in their annual report. While the guidance is generally
applicable to listed companies, the principles are
relevant to all organisations and have been widely used
as a basis for codes of best practice in the public and
not-for-profit sectors. Fraud risk management practices
are developing along the same lines.
Many other countries have also produced reports on
corporate governance, usually accompanied by codes
of best practices. For example, South Africa has had the
King Report (version I and now II) since 1994, Malaysia
has had its Code of Corporate Governance in place
since 2000 and Sri Lanka issued the Rules on Corporate
Governance as part of its Listing Rules in January 2007.
IT Governance
IT governance is about ensuring that the
organisation’s IT systems support and enable
achievement of the organisation’s strategies
and objectives. It encompasses leadership,
organisational structures, businesses processes,
standards and compliance.
There are five specific drivers for organisations to
adopt IT governance strategies:
• regulatory requirements e.g. IT governance is
covered by the Combined Code and Turnbull
guidance in the UK
• increasing intellectual capital value that the
organisation has at risk
• alignment of technology with strategic
organisational goals
• complexity of threats to information security
• increase in the compliance requirements of
information and privacy-related regulation.
Corporate governance requirements in the US are
now largely set out within the Sarbox legislation,
further details on which are provided at Appendix 1.
As previously mentioned, these requirements extend
beyond the US, capturing any company that is SEC
listed and its subsidiaries. Some other countries have
also introduced a statutory approach to corporate
governance, such as that in the US, although none are
currently as comprehensive. A number of international
organisations have also launched guidelines and
initiatives on corporate governance, including
the Organisation for Economic Co-operation and
Development (OECD) and the European Commission.
A key benefit of an effective, integrated IT
governance framework is the integration of IT into
the strategic and overall operational approach of
an organisation. There are a series of international
Information Security (IS) standards that provide
guidance on implementing an effective IT
governance framework, known as the ISO 27000
series. For example, ISO/IEC 27001 defines a
set of IS management requirements in order to
help organisations establish and maintain an IS
management system.
An example of a growing area of corporate governance
is IT governance, which has developed in light of rapid
and continuing advances in information technology.
The following box gives more information on IT
governance.
The standards apply to all types of organisation
regardless of size or sector. They are particularly
suitable where the protection of information is
critical to the business, for example in the finance,
health and public sectors, and for organisations
which manage information on behalf of others,
such as IT outsourcing companies.
ISACA also offers a series of IS standards and
certification. ISACA is a leading global association
in the IT governance and control field. With a
network across more than 160 countries, its IS
standards are followed by practitioners worldwide.
18
2.3 The risk management cycle
Controls assurance
Controls assurance is the process whereby controls are
reviewed by management and staff. There are various
ways to conduct these exercises, from highly interactive
workshops based on behavioural models at one end of
the spectrum to pre-packaged self audit internal control
questionnaires at the other. These models all include
monitoring and risk assessment among their principal
components.
The risk management cycle is an interactive process of
identifying risks, assessing their impact, and prioritising
actions to control and reduce risks. A number of
iterative steps should be taken:
1
2
3
4
5
6
7
Establish a risk management group and set goals.
Identify risk areas.
Understand and assess the scale of risk.
Develop a risk response strategy.
Implement the strategy and allocate responsibilities.
Implement and monitor the suggested controls.
Review and refine the process and do it again.
Figure 3 The CIMA risk management cycle
Establish risk
management group
and set goals
Identify risk areas
Review and refine
process and do it
again
Understand and
assess scale of risk
Information for
decision making
Implementation
and monitoring of
controls
Develop risk response
strategy
Implement strategy
and allocate
responsibilities
19
Fraud risk management: a guide to good practice
2.4 Establish a risk management group
and set goals
2.6 Understand and assess the scale of risk
A risk management group should be established whose
task it is to facilitate and co-ordinate the overall risk
management process. Possible members of the group
could include a chief risk officer, a non executive
director, finance director, internal auditor, heads of
planning and sales, treasurer and operational staff.
Depending on the size and nature of the organisation,
the risk management group may be in the form of a
committee who meet from time to time.
Once risks have been identified, an assessment
of possible impact and corresponding likelihood
of occurrence should be made using consistent
parameters that will enable the development of
a prioritised risk analysis. In the planning stage,
management should agree on the most appropriate
definition and number of categories to be used when
assessing both likelihood and impact.
The risk management group will promote the
understanding and assessment of risk, and facilitate the
development of a strategy for dealing with the risks
identified. They may also be responsible for conducting
reviews of systems and procedures to identify and
assess risks faced by the business, which include the
risk of fraud, and introducing the controls that are best
suited to the business unit. However, line managers and
their staff may also be involved in the risk identification
and assessment process, with the risk management
group providing guidance.
2.5 Identify risk areas
Each risk in the overall risk model should be explored
to identify how it potentially evolves through the
organisation. It is important to ensure that the risk is
carefully defined and explained to facilitate further
analysis.
The techniques of analysis include:
• workshops and interviews
• brainstorming
• questionnaires
• process mapping
• comparisons with other organisations
• discussions with peers.
The assessment of the impact of the risk should not
simply take account of the financial impact but should
also consider the organisation’s viability and reputation,
and recognise the political and commercial sensitivities
involved. The analysis should either be qualitative
or quantitative, and should be consistent to allow
comparisons. The qualitative approach usually involves
grading risks in high, medium and low categories.
Impact
The assessment of the potential impact of a particular
risk may be complicated by the fact that a range of
possible outcomes may exist or that the risk may occur
a number of times in a given period of time. Such
complications should be anticipated and a consistent
approach adopted which, for example, may seek to
estimate a worst case scenario over, say, a 12 month
time period.
Likelihood of occurrence
The likelihood of a risk occurring should be assessed on
a gross, a net and a target basis.
The gross basis assesses the inherent likelihood of the
event occurring in the absence of any processes which
the organisation may have in place to reduce that
likelihood.
The net basis assesses the likelihood, taking into
account current conditions and processes to mitigate
the chance of the event occurring.
The target likelihood of a risk occurring reflects the risk
appetite of the organisation.
20
Where the net likelihood and the target likelihood for
a particular risk differ, this would indicate the need to
alter the risk profile accordingly.
It is common practice to assess likelihood in terms of:
• high – probable
• moderate – possible
• low – remote.
An example of a risk analysis is contained in Appendix
3. The resulting document is often referred to as a
risk register. The overall risk registers at organisational
and operational levels should include the risk of fraud
being perpetrated. Some organisations also prepare
detailed fraud risk registers that consider possible
fraudulent activity. The fraud risk register often directs
the majority of proactive fraud risk management work
undertaken by an organisation.
Analysing fraud risks
Fraud risk is one component of operational risk.
Operational risk focuses on the risks associated with
errors or events in transaction processing or other
business operations. A fraud risk review considers
whether these errors or events could be the result of a
deliberate act designed to benefit the perpetrator. As
a result, fraud risk reviews should be detailed exercises
conducted by teams combining in depth knowledge of
the business and market with detailed knowledge and
experience of fraud.
Risks such as false accounting or the theft of cash
or assets need to be considered for each part of the
organisation’s business. Frequently, businesses focus on
a limited number of risks, most commonly on thirdparty thefts. To avoid this, the risks should be classified
by reference to the possible type of offence and the
potential perpetrator(s).
Fraud risks need to be assessed for each area and
process of the business, for example, cash payments,
cash receipts, sales, purchasing, expenses, inventory,
payroll, fixed assets and loans.
21
Fraud risk management: a guide to good practice
2.7 Develop a risk response strategy
2.9 Implement and monitor suggested
controls
Once the risks have been identified and assessed,
strategies to deal with each risk identified can be
developed by line management, with guidance from the
risk management group.
The chosen strategy may require the implementation
of new controls or the modification of existing controls.
Businesses are dynamic and the controls that are in
place will need to be monitored to assess whether or
not they are succeeding in their objectives. The risk
management group should be empowered to monitor
the effectiveness of the actions being taken in each
specific area, as these can be affected by internal and
external factors, such as changes in the marketplace or
the introduction of new computer systems.
Strategies for responding to risk generally fall into one
of the following categories:
• risk retention (e.g. choosing to accept small risks)
• risk avoidance (e.g. stopping sale of certain products
to avoid the risk to occurring)
• risk reduction (e.g. through implementing controls
and procedures)
• risk transfer (e.g. contractual transfer of risk;
transferring risks to insurers).
Before strategies are developed, it is necessary to
establish the risk appetite of the organisation. Risk
appetite is the level of risk that the organisation is
prepared to accept and this should be determined
by the board. The appetite for risk will influence the
strategies to be developed for managing risk. It is
worth noting that a board’s risk appetite may vary for
different types of risk and over time. For example, the
board may have a low risk tolerance on compliance and
regulatory issues, but be prepared to take significant
strategic risks. The board may also reduce their risk
appetite as the external environment changes, such as
in times of recession.
2.8 Implement the strategy and allocate
responsibilities
The chosen strategy should be allocated
and communicated to those responsible for
implementation. For the plan to be effective it is
essential that responsibility for each specific action is
assigned to the appropriate operational manager and
that clear target dates are established for each action.
It is also important to obtain the co-operation of those
responsible for the strategy, by formal communication,
seminars, action plans and adjustments to budgets.
22
2.10 Review and refine and do it again
All of the elements outlined above form part of an
iterative cycle where risk management is continually
reviewed and developed. As the cycle continues, risk
management should increasingly become embedded
in the organisation so that it really becomes part of
everyone’s job.
2.11 Information for decision making
Risk management should form a key part of the
organisation’s decision-making process. Information is
gathered at all stages of the risk management cycle and
this information should be fed into the decision-making
mechanisms.
For more information on risk management, please refer
to CIMA’s publication Risk Management: A guide to good
practice.
2.12 Summary
There are risks in most situations. Risk management
is an important element of corporate governance and
every organisation should review their risk status and
develop their approach as described in the CIMA Risk
Management Cycle in 2.3 to 2.11 above.
Managing the risk of fraud is the same in principle as
managing any other business risk. First, the potential
consequences of fraud on the organisation need to
be understood, using the principles set out in this
chapter. The risks should then be reduced by developing
and implementing an anti-fraud strategy across the
organisation. This is best approached systematically,
both at the organisational level, for example by using
ethics policies and anti-fraud policies, and at the
operational level, through introduction of controls and
procedures. The following chapters expand on the fraud
risk management process in the context of an antifraud strategy.
23
Fraud risk management: a guide to good practice
3 Fraud prevention
3.1 A strategy to combat fraud
Given the prevalence of fraud and the negative
consequences associated with it, there is a compelling
argument that organisations should invest time and
resources towards tackling fraud. There is, however,
sometimes debate as to whether these resources should
be committed to fraud prevention or fraud detection.
Fraud prevention
Based on the earlier discussion around why people
commit fraud, it would seem that one of the most
effective ways to deal with the problem of fraud is
to adopt methods that will decrease motive, restrict
opportunity and limit the ability for potential fraudsters
to rationalise their actions. In the case of deliberate
acts of fraud, the aim of preventative controls is to
reduce opportunity and remove temptation from
potential offenders. Prevention techniques include the
introduction of policies, procedures and controls, and
activities such as training and fraud awareness to stop
fraud from occurring.
It is profitable to prevent losses, and fraud prevention
activities can help to ensure the stability and continued
existence of a business. However, based on recent
surveys, many organisations do not have a formal
approach to fraud prevention. Once a fraud has already
occurred, the likelihood of recovering stolen funds from
the perpetrator or through insurance is often relatively
low. According to KPMG’s survey in 2007, only 16% of
organisations profiled were able to recover their losses.
A number of others are still trying to recover stolen
assets, but the process is often difficult and lengthy.
At least half of the organisations have been unable to
recover any assets at all. As such, it is preferable to try
to prevent the loss from occurring in the first place and
the old adage ‘prevention is better than cure’ certainly
applies to fraud.
It is worth bearing in mind though, that fraud
prevention techniques, while worth investing in,
cannot provide 100% protection. It is difficult, if not
impossible, to remove all opportunities for perpetrating
fraud.
24
Fraud detection
As fraud prevention techniques may not stop all
potential perpetrators, organisations should ensure that
systems are in place that will highlight occurrences
of fraud in a timely manner. This is achieved through
fraud detection. A fraud detection strategy should
involve use of analytical and other procedures to
highlight anomalies, and the introduction of reporting
mechanisms that provide for communication
of suspected fraudulent acts. Key elements of a
comprehensive fraud detection system would include
exception reporting, data mining, trend analysis and
ongoing risk assessment.
Fraud detection may highlight ongoing frauds that are
taking place or offences that have already happened.
Such schemes may not be affected by the introduction
of prevention techniques and, even if the fraudsters
are hindered in the future, recovery of historical losses
will only be possible through fraud detection. Potential
recovery of losses is not the only objective of a
detection programme though, and fraudulent behaviour
should not be ignored just because there may be no
recovery of losses. Fraud detection also allows for the
improvement of internal systems and controls. Many
frauds exploit deficiencies in control systems. Through
detection of such frauds, controls can be tightened
making it more difficult for potential perpetrators to
act.
Fraud prevention and fraud detection both have a role
to play and it is unlikely that either will fully succeed
without the other. Therefore, it is important that
organisations consider both fraud prevention and fraud
detection in designing an effective strategy to manage
the risk of fraud.
An anti-fraud strategy
An effective anti-fraud strategy in fact has four main
components:
• prevention
• detection
• deterrence
• response.
The following diagram summarises these components
and the context within which an anti-fraud strategy
sits.
It is clear from Figure 4 that the various elements of an
effective anti-fraud strategy are all closely interlinked
and each plays a significant role in combating fraud.
Fraud detection acts as a deterrent by sending a
message to likely fraudsters that the organisation
is actively fighting fraud and that procedures are in
place to identify any illegal activity that has occurred.
The possibility of being caught will often persuade
a potential perpetrator not to commit a fraud.
Complementary detection controls should also be in
place to counter the fact that the prevention controls
may be insufficient in some cases.
Figure 4 Anti-fraud strategy
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25
Fraud risk management: a guide to good practice
3.2 Developing a sound ethical culture
A consistent and comprehensive response to suspected
and detected incidents of fraud is also important. This
sends a message that fraud is taken seriously and that
action will be taken against perpetrators. Each case
that is detected and investigated should reinforce
this deterrent and, therefore, act as a form of fraud
prevention.
The various components of an effective anti-fraud
strategy are discussed over the next few chapters. The
remainder of this chapter examines some of the main
preventative approaches which can be implemented to
minimise the occurrence and cost of fraud within an
organisation. These approaches are generic and can be
applied, as appropriate, to different organisations and
particular circumstances.
Attitudes within an organisation often lay the
foundation for a high or low fraud risk environment.
Where minor unethical practices may be overlooked
(e.g. petty theft, expenses frauds), larger frauds
committed by higher levels of management may
also be treated in a similar lenient fashion. In this
environment there may be a risk of total collapse of
the organisation either through a single catastrophic
fraud or through the combined weight of many smaller
frauds.
Organisations which have taken the time to consider
where they stand on ethical issues have come to
realise that high ethical standards bring long term
benefits as customers, suppliers, employees and
the community realise that they are dealing with a
trustworthy organisation. They have also realised that
dubious ethical or fraudulent practices cause serious
adverse consequences to the people and organisations
concerned when exposed.
The definition of good ethical practice is not simple.
Ideas differ across cultural and national boundaries
and change over time. But corporate ethics statements
need not be lengthy to be effective. The following is an
example of guiding business principles that BT applies
to all employees, agents, and others representing BT.
These principles could form the basis of an ethics
statement in an international environment.
26
BT’s business principles
• Legal
•
•
•
•
•
•
•
•
•
•
•
We will act within the law, our licensing/
authorisations obligations and any other
regulations.
Compete fairly
Compete vigorously but fairly in our markets,
being honest and trustworthy in all our dealings.
Inducements
Not offer or accept gifts, hospitality or other
inducements which encourage or reward a
decision, or engage in any form of bribery.
Report and record any incident.
Conflicts
Avoid or declare conflicts of interest that may
lead (or be seen to lead) to divided personal
loyalties.
Commitments
Ensure others have confidence in the
commitments we make on behalf of BT, and that
agreements are suitably authorised.
Risks
Assess and manage risks to our business.
Assets
Protect our brand, physical, financial and
intellectual assets.
Information
Protect the confidentiality of company,
employee and customer information.
Communication
Be truthful, helpful and accurate in our
communication.
Diversity
Treat all individuals fairly and impartially,
without prejudice, and never tolerate harassment
in any form.
Health and safety
Care for the health and safety of each other, our
products and our operations.
Environment
Minimise the potential harmful effects of our
activities on the environment.
Organisations which have created a positive ethical
culture have normally either been driven by a
committed chief executive or have been forced to do so
because of incidents which caused, or almost caused,
significant loss to the organisation.
With regards to establishing a sound ethical culture,
CIMA recommends that organisations have:
• a mission statement that refers to quality or, more
•
•
•
•
•
unusually, to ethics and defines how the organisation
wants to be regarded externally
clear policy statements on business ethics and
anti-fraud, with explanations about acceptable
behaviour in risk prone circumstances (a sample fraud
policy is included at Appendix 4)
a route through which suspected fraud can be
reported
a process of reminders about ethical and fraud
policies – e.g. annual letter and/or declarations
an aggressive audit process which concentrates on
areas of risk
management who are seen to be committed through
their actions.
IFAC’s Professional Accountants in Business (PAIB)
Committee has produced guidance that focuses on the
role of accountants in developing and promoting codes
of conduct within their business (see Further Reading
in Appendix 10 for more detail). CIMA members
should also bear in mind the CIMA Code of Ethics for
Professional Accountants, which sets out standards
around ethical conduct and acting with integrity and
objectivity, even in potentially difficult circumstances.
For example, the CIMA Code of Ethics deals with
safeguarding assets, potential conflicts, preparation
and reporting of information, threats of financial self
interest, inducements, and confidentiality. Members
of other professional bodies are likely to be bound by
similar codes.
Reproduced with kind permission of BT
27
Fraud risk management: a guide to good practice
A code of ethics or an anti-fraud policy is not sufficient
to prevent fraud though. Ethical behaviour needs to
be embedded within the culture of an organisation.
Commitment from senior management and ‘tone at
the top’ is key. Employees are more likely to do what
they see their superiors doing than follow an ethics
policy, and it is essential that management do not apply
double standards.
To demonstrate commitment, resources should be
allocated to communicating ethics and values to
all employees, suppliers and business partners, and
providing training programmes where necessary.
Research by the Institute of Business Ethics (IBE) has
demonstrated that, through helping to establish an
ethical culture, there is a correlation between ethics
training and improved financial performance4. However,
a recent survey conducted by CIMA, in conjunction
with the IBE, found that although most organisations
have adopted a code of ethics, many are not backing up
their written statements with action. Less than half of
the respondents’ organisations provide ethics training
or a hotline for reporting unethical conduct, and only
a few offer incentives for employees to uphold ethical
standards. These results are summarised in Figure 5.
In addition to encouraging senior management to
set ethical examples by their actions, organisations
should ensure that senior management are committed
to controlling the risks of fraud. Senior management
should be assigned with responsibility for fraud
prevention, as this sends a message to employees that
the organisation is serious about fraud and ensures
that tackling fraud will be considered at senior levels.
Adherence to policies and codes should be regularly
monitored and policed by appropriate people within
Figure 5 Ethics advice/services provided
Does your organisation provide?
A statement of its ethical values, business
principles or commitments to its stakeholders?
7
A code of ethics or similar document to guide
5
staff about ethical standards in their work?
Training on ethical standards at work?
9
A hotline for reporting conduct that violates
the organisaton’s standards of ethics?
8
A helpline where you can get advice or
information about behaving ethically at work?
72
23
72
46
46
53
11
Incentives for staff to uphold the organisation’s
standards of ethical conduct?
Base: All respondents (1300)
21
40
55
35
13
0
10
68
20
30
40
Don’t know
50
60
No
70
80
19
90 100%
Yes
Source: Managing Responsible Business, CIMA, 2008
28
the organisation (such as management and/or internal
audit), and the documents themselves should also be
regularly reviewed and amended.
Periodic assessment of fraud risk
In order to manage fraud risk, organisations should
periodically identify the risks of fraud within their
organisation, using the process set out in Chapter
2. Fraud risks should be identified for all areas and
processes of the business and then be assessed in terms
of impact and likelihood. In addition to the monetary
impact, the assessment should consider non financial
factors such as reputation.
An effective fraud risk assessment will highlight risks
previously unidentified and strengthen the ability for
timely prevention and detection of fraud. Opportunities
for cost savings may also be identified as a result of
conducting the fraud risk assessment.
Fraud risk training and awareness
Almost every time a major fraud occurs many people
who were unwittingly close to it are shocked that
they were unaware of what was happening. Therefore,
it is important to raise awareness through a formal
education and training programme as part of the
overall risk management strategy. Particular attention
should be paid to those managers and staff operating
in high risk areas, such as procurement and bill paying,
and to those with a role in the prevention and detection
of fraud, for example human resources and staff with
investigation responsibility.
There are arguments about how far training on fraud
risk management should go within an organisation
beyond the audit group – for example a question
often raised is whether management and staff who
have been trained in fraud prevention techniques will
then use the knowledge to commit fraud. Fraud is
often highlighted through a tip off and therefore it is
essential that all employees are made aware of what
constitutes fraud, how to identify fraudulent behaviour,
and how to respond if they suspect or detect instances
of fraud. There is advantage in covering the subject of
fraud in generic terms, the corporate ethic, the audit
approach and the types of checks and balances built
into processes. Such training is more likely to decrease
rather than increase the number of fraudulent incidents.
Opposing double standards
It is too often presumed that there should be one set of rules for ordinary people and another for their leaders.
Such attitudes breed cynicism and resentment. Though there will be some valid exceptions, leaders must
almost always live by the rules they impose on others. Amongst other things this means taking a firm line on
fraud by senior executives.
Reproduced with kind permission of the Fraud Advisory Panel from its Ninth Annual Review 2006-2007
‘Ethical behaviour is the best defence against fraud’
4 Does business ethic pay – revisited, IBE
29
Fraud risk management: a guide to good practice
Employees may be educated through a number of
mediums, such as formal training sessions, group
meetings, posters, employee newsletters, payroll
bulletins or awareness pages on internal websites.
Communication should be ongoing and a combination
of methods is usually most successful. For example,
the UK’s National Health Service (NHS) uses several
different media to raise fraud risk awareness, including
a quarterly staff newsletter called Insight that covers
topics such as training updates, fraud case studies, risk
measurement and prosecution examples.
It is clear that spending money on preventing fraud
brings many benefits – but the cost benefit analysis
is not easy to construct. The downside risk of fraud
prevention is that excessive and expensive controls may
be created, which reduce efficiency and demotivate
staff. However, the head of fraud investigation for a
major bank made the following observation: ‘A £1m
increase in expenditure on fraud prevention has led to a
£25m increase in profits.’
Reporting mechanisms and whistleblowing
Establishing effective reporting mechanisms is one of
the key elements of a fraud prevention programme
and can have a positive impact on fraud detection.
Many frauds are known or suspected by people who
are not involved. The challenge for management is
to encourage these ‘innocent’ people to speak out
– to demonstrate that it is very much in their own
interest. Research by the IBE has shown that although
one in four employees are aware of misconduct in the
workplace, over half of those people stay silent6.
6 Speak Up Procedures (2007), IBE
30
In this area there are many conflicting emotions
influencing the potential ‘whistleblower’:
• working group/family loyalties
• disinterest/sneaking admiration
• fear of consequences
• suspicion rather than proof.
The organisation’s anti-fraud culture and reporting
processes can be a major influence on the
whistleblower, as it is often fear of the consequences
that has the impact. To the whistleblower the impact
of speaking out can be traumatic, ranging from being
dismissed to being shunned by other employees.
Where fraud is committed by senior managers (and
this can be as high as the chief executive), then the
predicament faced by the whistleblower is exacerbated.
And this is where management’s greatest challenge
lies – to convince staff that everyone is responsible
for combating fraud and that the good health of the
organisation, and potentially their future employment,
could be at risk from fraud. Organisations that
encourage openness and can overcome the culture of
silence are likely to benefit in many ways (see box on
page 31).
Benefits of a culture that encourages whistleblowing
An organisation where the value of open whistleblowing is recognised will be better able to:
• deter wrongdoing
• pick up potential problems early
• enable critical information to get to the people who need to know and can address the issue
• demonstrate to stakeholders, regulators, and the courts that they are accountable and well managed
• reduce the risk of anonymous and malicious leaks
• minimise costs and compensation from accidents, investigations, litigation and regulatory inspections
• maintain and enhance its reputation.
Enlightened organisations implement whistleblowing arrangements because they recognise that it makes good
business sense.
Reproduced with kind permission of BSI from
PAS 1998:2008 Whistleblowing Arrangements Code of Practice
In the UK, there is legislation protecting whistleblowers,
known as PIDA. Further information on PIDA is given
in Appendix 1. Other countries also have legislation
protecting whistleblowers, for example this is covered
by Sarbox in the US. Legal redress should be a last
resort though, and organisations should strive for a
culture that actively encourages people to speak up and
challenge inappropriate behaviour.
Although PIDA exists to protect whistleblowers, there
is no statutory requirement for a whistleblowing
policy under the legislation. However, organisations
are encouraged to develop a written policy statement,
and corporate governance codes in the UK provide
more direction on this. Under the Combined Code,
listed companies are obliged to have whistleblowing
arrangements or explain why they do not, and public
bodies are expected to have a policy in place, which
are assessed regularly as part of the external audit and
review of local authorities and NHS bodies. Companies
captured under Sarbox are also required to have
whistleblowing arrangements. A sample whistleblowing
policy can be found in Appendix 5.
The British Standards Institute (BSI) has recently
published a Publicly Available Specification (PAS),
developed by Public Concern at Work, that gives
guidance on ‘good practice for the introduction,
revision, operation and review of effective
whistleblowing arrangements’ (PAS 1998:2008
Whistleblowing Arrangements Code of Practice). The
nature of the whistleblowing arrangements will be
determined by an organisation’s size, structure, culture,
nature of the risks that it faces and the legal framework
in which it operates.
A confidential 24/7 hotline is said to be one of the best
methods for reporting fraud. However, open channels
of communication from employees to management
are also essential in creating an environment that
encourages fraud prevention and detection. An open
and honest culture should improve morale among
employees and give them the confidence to come
forward with concerns.
31
Fraud risk management: a guide to good practice
3.3 Sound internal control systems
Following up on disclosures is an important part of
any whistleblowing arrangement. Employees are more
likely to speak up if they know that something will be
done about their concern. This is supported by the
findings of the CIMA ethics survey referred to earlier.
A small percentage of respondents had personally
observed unethical conduct and most reported the
wrongdoing when they came across it, but many were
dissatisfied with the response. By not handling concerns
in a satisfactory way, organisations risk losing the
confidence of their employees and discouraging them
from speaking up in the future. The survey highlighted
that the most common reason for not reporting
a concern was thinking that it would not make a
difference.
Management has to be aware of the risk of anonymous
and malicious accusations, but they cannot afford to
ignore any report in case it is correct. They may wish
to state in their policy that anonymous advice will be
treated with extreme caution. Companies captured
under Sarbox have no choice but to offer a facility for
anonymous reporting. This can cause difficulty for
organisations operating in Europe, as it may conflict
with EU data protection rules, which state that
personal data should only be collected fairly. The EU
data protection authorities have issued guidance on
this (Guidance on Whistleblowing Schemes, 2006) and
information can also be obtained from Public Concern
at Work.
32
A strong system of internal controls is considered by
the ACFE to be ‘the most valuable fraud prevention
device by a wide margin’. Having sound internal control
systems is also a requirement under the Companies
Act, Sarbox and various corporate governance codes.
Responsibility for internal control
Overall responsibility for the organisation’s system
of internal control must be at the highest level in the
organisation. Under the Companies Act, directors
are responsible for maintaining adequate accounting
records. The Combined Code prescribes that ‘the board
should maintain a sound system of internal control to
safeguard shareholders’ investment and the company’s
assets’. This should include procedures designed to
minimise the risk of fraud. As mentioned in the previous
chapter, the board should satisfy itself that the system
is effective and report that it has undertaken such a
review to its shareholders. The Turnbull report provides
guidance on how this should be achieved.
There is often an expectation that auditors have
responsibility for fraud prevention and detection. While
auditors doubtless have a role to play in fraud risk
management, they do not have primary responsibility.
This lies with management and those charged
with governance of the organisation. International
Standard on Auditing 240 (ISA 240) clarifies these
responsibilities, an extract of which is included in the
box below. ISA 240 has recently been revised and the
redrafted standard is effective for audits of financial
statements for periods beginning on or after 15
December 2008.
Although primary responsibility for fraud prevention
and detection does not sit with the auditor, ISA 240
does call for auditors to include methods for identifying
potential cases of fraud when planning and conducting
the audit. It requires auditors to:
• discuss the risk of fraud with management and those
charged with governance
• discuss with the audit team the susceptibility of the
accounts to material misstatements due to fraud
• consider whether one or more fraud risk factors are
present
• perform audit procedures to address the risk of
management override
• test journal entries and review accounting estimates
for bias
• understand the business rationale for transactions
outside the normal course of business
• obtain representations from management
• bear in mind the implications for money laundering
reporting (taking care not to tip off the client).
In addition to the international auditing standard,
some countries also have their own auditing standards
that give further direction on roles and responsibilities
in relation to fraud. For example, in October 2002,
the US issued Statement on Auditing Standards No.
99 Consideration of Fraud in a Financial Statement
Audit (SAS 99), partly in response to accounting
scandals such as Enron and WorldCom. SAS 99 is more
prescriptive about the role of the auditor in preventing
and detecting fraud and error than ISA 240 and was
designed to create a substantial change in auditors’
performance, thereby improving the likelihood that
auditors will detect material misstatements due to
fraud.
The requirements do not only affect auditors. Given the
nature and extent of the new procedures in both ISA
240 and SAS 99, management should plan to provide
auditors with more information and open themselves
up to more extensive fraud detection procedures.
Extract from ISA 240 The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements
(redrafted)
Responsibility for the prevention and detection of fraud
The primary responsibility for the prevention and detection of fraud rests with both those charged with
governance of the entity and management. It is important that management, with the oversight of those
charged with governance, place a strong emphasis on fraud prevention, which may reduce opportunities for
fraud to take place, and fraud deterrence, which could persuade individuals not to commit fraud because of
the likelihood of detection and punishment.
This involves a commitment to creating a culture of honesty and ethical behavior which can be reinforced by
an active oversight by those charged with governance. In exercising oversight responsibility, those charged
with governance consider the potential for override of controls or other inappropriate influence over the
financial reporting process, such as efforts by management to manage earnings in order to influence the
perceptions of analysts as to the entity’s performance and profitability.
Responsibilities of the auditor
An auditor conducting an audit in accordance with ISAs is responsible for obtaining reasonable assurance
that the financial statements taken as a whole are free from material misstatement, whether caused by fraud
or error... (O)wing to the inherent limitations of an audit, there is an unavoidable risk that some material
misstatements of the financial statements will not be detected, even though the audit is properly planned and
performed in accordance with the ISAs.
Reproduced with kind permission of IFAC
33
Fraud risk management: a guide to good practice
Internal control systems
An internal control system comprises all those policies
and procedures that taken together, support an
organisation’s effective and efficient operation. Internal
controls typically deal with factors such as approval
and authorisation processes, access restrictions and
transaction controls, account reconciliations, and
physical security. These procedures often include the
division of responsibilities and checks and balances
to reduce risk. The following box gives an example
of division of responsibilities within the purchasing
process.
Division of responsibilities in the purchasing
process
Ideally, the purchasing process would involve the
following separate roles:
• the originator who specifies the goods or services
and probably price
• the superior who approves the purchase
• the purchasing department who negotiate the
best value through competitive quotations
• the recipient of goods or services who confirms
that the invoice is in line with goods or services
received
• the purchase ledger/accounting department who
make entries in the accounts
• the treasury manager who ensures that
payments are properly supported and in line
with policy
• the management accountant who ensures that
costs are in line with budgets/standards and
purchase ledger payment statistics are in line
with policy.
Segregation of duties is not always possible though,
and it may be necessary to introduce additional
management examination and control, including some
form of internal audit as a regular feature.
34
The number and type of internal controls that an
organisation can introduce will again depend on the
nature and size of the organisations. Internal controls
to minimise fraud should, where possible, address fraud
red flags (see Chapter 4 and Appendix 6). Examples of
the variety of such controls include:
• requiring multiple signatories on high value
transactions (e.g. within a finance or procurement
department)
• enforcing employees to take holiday (e.g. many
employees in the banking sector must take a
minimum of two weeks holiday in a given period)
• restricting belongings that can be brought into the
office environment (e.g. many call centre employees
are not allowed to take in pens, paper or mobile
phones, and some organisations have restricted the
use of USB sticks)
• conducting random searches of staff (e.g. in factories,
distribution centres or retail outlets).
Wherever new internal control procedures are
introduced, they should be documented clearly and
simply, in order that any deviation can be identified.
Internal controls should be regularly reviewed as part
of the risk management process, and there should be
continual improvement of controls in light of new risks,
such as new markets and technologies, changes in
structure, or innovative fraudsters. Not only does this
reflect good practice, but it is also a requirement of the
Combined Code and Sarbox. Ultimately, the internal
control system should be embedded within the culture
and operations of an organisation.
Case study 5
A fine warning
A major European banking group has suffered in more ways than one from having weak internal controls.
In 2007, a senior employee at the bank was able to transfer £1.3 million out of client accounts without
permission. This was possible because the bank did not have effective review processes in place for
transactions over £10,000 and its checking procedures were unclear.
Not only did the organisation suffer from losses and reputational damage at the hand of the fraudster, but
the bank was also fined £350,000 by the FSA because of its ineffective anti-fraud measures. The bank had
been warned by the FSA in 2002 that its internal controls needed to be improved. However, no steps were
made to change the systems in place. Following the fine in 2007, the bank strengthened its controls and now
claims to be among the best in the industry.
This is the first fine that the FSA has issued against a private bank for weaknesses in anti-fraud controls but
it is stepping up its game in this area and this should serve as a caution for other organisations. The FSA has
warned that ‘senior management must make sure their firms have robust systems and controls to reduce the
risk of them being used to commit financial crime.’
Source: Weak anti-fraud measures earn bank hefty fine, CIMA Industry focus, 15 May 2007
Pre-employment screening
Pre-employment screening is the process of verifying
the qualifications, suitability and experience of a
potential candidate for employment. Techniques used
include confirmation of educational and professional
qualifications, verification of employment background,
criminal history searches, and credit checks. For all
screening, the organisation must obtain the individual’s
written permission and all documents must bear the
individual’s name.
Screening applicants should reduce the likelihood
of people with a history of dishonest or fraudulent
behaviour being given a role within the company, and
is therefore an important fraud prevention procedure.
A significant proportion of CVs contain serious
discrepancies, and in fraud cases investigated, there
are often signs in the employee’s background that
would have been a warning to a potential employer
had screening been conducted. Research has also
shown that employers who conduct pre-employment
screening experience fewer cases of fraud by
employees.
At a minimum, organisations should consider screening
for cash handling positions, senior management posts
and other trusted positions such as treasury, accounts
payable, and security. Screening should also not be
limited to new joiners. An organisation should run
checks before offering promotions and secondments
into more senior or sensitive positions.
Organisations should also never assume that agency
staff have been properly vetted by the contracting
agency. As is demonstrated by the following case study,
a recruitment agency’s screening process cannot always
be relied upon.
35
Fraud risk management: a guide to good practice
Case study 6
Vet or regret?
Without a trace
A finance house needed an extra junior accountant for a short period of time. The company went to a
reputable agency and employed an appropriately qualified person. The company relied on the agency’s
screening policy which had failed to uncover a series of discrepancies in the accountant’s personal history,
including a false address. The accountant removed a company chequebook from his work place and used it
to make a series of high value purchases on his own behalf. The matter came to light when a routine enquiry
was made with the finance house to verify the issue of one of the cheques. By this time the temporary
accountant had left the company. He could not be traced and the matter was referred to the police.
All in a week’s work
In another case, an organisation employed a temporary accounts clerk to work in their shared service
accounting centre. The organisation assumed the recruitment agency would perform adequate checks on
the clerk’s background. This did not happen. The clerk was able to use his access to the accounting system to
divert supplier payments to his own bank account. After a week of such diversions, he left the company with
over £150,000.
Reproduced with kind permission of the Fraud Advisory Panel from
Fighting fraud – a guide for SMEs, 2nd edition
3.4 Summary
In conclusion, a sound ethical culture and an effective
system of internal control are essential elements of an
anti-fraud strategy. Effective internal controls reduce
exposure to financial risks and ‘contribute to the
safeguarding of assets, including the prevention and
detection of fraud’ (Turnbull Guidance, 2005). However,
a sound system of internal control cannot provide
complete protection against all fraudulent behaviour,
highlighting the importance of other fraud prevention
and fraud detection measures.
Appendix 7 provides an example of a 16 step fraud
prevention plan that brings together many of the
elements described in this chapter.
36
4 Fraud detection
4.1 Detection methods
Hindsight is a wonderful thing! Fraud is always obvious
to the fraudster’s colleagues after the event. Their
statements, and those of internal auditors, when taken
by the police or other investigatory bodies, frequently
highlight all the more common fraud indicators.
However, the mistake is always the same – fraud was
never considered a possibility. No matter how innocent
an action may be, or how plausible an explanation may
be, fraud is always a possibility!
The UK report of PwC’s survey looked at the method
of detection of the most serious frauds within
organisations. The results are shown in Figure 6.
It is clear from this, and other anecdotal evidence,
that external auditors do not generally find fraud. As
mentioned in Chapter 3, it is not the external auditor’s
responsibility to prevent and detect fraud, although
they should be providing reasonable assurance that the
financial statements are free from material fraud and
error.
Figure 6 Methods of fraud detection
Whistleblowing hotline
Internal tip-off
By accident
External tip-off
Law enforcement investigation
Change of personnel/duties
Internal audit
External audit
Corporate security
Risk management
0
5
10
15
20
% of respondents
Source: Economic crime: people, culture and controls, PricewaterhouseCoopers, 2007
37
Fraud risk management: a guide to good practice
Although external auditors did not detect many cases
of fraud, internal auditors on the other hand were found
to be the most successful in identifying serious frauds.
Risk management procedures were also found to be one
of the more useful methods. If resources will allow it,
an organisation should establish a strong internal audit
function that monitors and advises on risk management
and actively looks for instances of fraud.
A lot of frauds, however, are discovered accidentally or
as a result of information received, either via a tip off
or through a whistleblowing hotline. In many cases,
greater losses are suffered as a result of employees
at all levels ignoring the obvious. It is everyone’s
responsibility to find and report fraud and irregularity
within an organisation, and it is therefore essential that
an organisation has appropriate reporting mechanisms
in place to facilitate this.
Frauds may also be discovered as a result of controls
and mechanisms put in place on the advice of internal
and external auditors.
Case study 7
Tipped off
A bank clerk who helped fraudsters to fleece customers out of nearly £500,000 was originally identified as
a result of a tip off. Ruth Akinyemi passed on the personal details of eight wealthy Barclays account holders,
including dates of birth and account passwords. The thieves to whom she gave the details then posed as real
customers and emptied vast amounts of money from the bank accounts. One victim lost nearly £400,000 in
just four days.
Investigators received an anonymous tip off that Akinyemi was the insider and she was suspended pending
investigation. Due to insufficient supporting evidence, the bank initially cleared Akinyemi of any involvement.
She simply switched branches and continued with the scam. The computer system revealed the involvement
of a bank insider in subsequent frauds and investigators were able to go through computer records and
identify the accounts that Akinyemi had accessed using her ID and password.
Akinyemi was convicted of conspiracy to steal and sentenced to 18 months imprisonment in September
2008. The operators of the fraud have never been traced and most of the money is still missing.
38
4.2 Indicators and warnings
It will never be possible to eliminate all fraud. No
system is completely fraud proof, since many fraudsters
are able to bypass control systems put in place to stop
them. However, greater attention paid to some of the
most common indicators can provide early warning
that something is not quite right and increase the
likelihood that the fraudster will be discovered. With
that in mind, this section provides details of some of
the more common indicators of fraud.
Fraud indicators fall into two categories:
• warning signs
• fraud alerts.
Warning signs
Warning signs have been described as organisational
indicators of fraud risk and some examples are set out
below. For convenience these have been subdivided into
business risk, financial risk, environmental risk and IT
and data risk. Further examples of warning signs can be
found in Appendix 6.
Business risk
This has been subdivided into cultural issues,
management issues, employee issues, process issues
and transaction issues.
Cultural issues
• Absence of an anti-fraud policy and culture.
• Failure of management to implement a sound
system of internal control and/or to demonstrate
commitment to it at all times.
Management issues
• Lack of financial management expertise and
professionalism in key accounting principles, review
of judgements made in management reports and the
review of significant cost estimates.
• A history of legal or regulatory violations within the
organisation and/or claims alleging such violations.
• Strained relationships within the organisation
between management and internal or external
auditors.
• Lack of management supervision of staff.
• Lack of clear management control of responsibility,
authorities, delegation, etc.
• Bonus schemes linked to ambitious targets or directly
to financial results.
Employee issues
• Inadequate recruitment processes and absence of
screening.
• Unusually close relationships – internal and external.
• Potential or actual labour force reductions or
redundancies.
• Dissatisfied employees who have access to desirable
assets.
• Unusual staff behaviour patterns.
• Personal financial pressures on key staff.
• Low salary levels of key staff.
• Poor dissemination of internal controls.
• Employees working unsocial hours unsupervised.
• Employees not taking annual leave requirements.
• Unwillingness to share duties.
Process issues
• Lack of job segregation and independent checking of
key transactions.
• Lack of identification of the asset.
• Poor management accountability and reporting
systems.
• Poor physical security of assets.
• Poor access controls to physical assets and IT security
systems.
• Lack of and/or inadequacy of internal controls.
• Poor documentation of internal controls.
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Fraud risk management: a guide to good practice
Transaction issues
• Poor documentary support for specific transactions
such as rebates and credit notes.
• Large cash transactions.
• Susceptibility of assets to misappropriation.
• Manipulation of programs or computer records to
Financial risk
• Management compensation highly dependent on
meeting aggressive performance targets.
• Significant pressures on management to obtain
additional finance.
• Extensive use of tax havens without clear business
justification.
• Complex transactions.
• Use of complex financial products.
• Complex legal ownership and/or organisational
structures.
• Rapid changes in profitability.
• Existence of personal or corporate guarantees.
Fraud alerts
Fraud alerts have been described as specific events or
red flags, which may be indicative of fraud. A list of
possible fraud alerts is provided below. This should not
be considered an exhaustive list, as alerts will appear in
many different guises according to circumstances.
Environmental risk
• The introduction of new accounting or other
regulatory requirements, including health and safety
or environmental legislation, which could significantly
alter reported results.
• Highly competitive market conditions and decreasing
profitability levels within the organisation.
• The organisation operating in a declining business
sector and/or facing prospects of business failure.
• Rapid technological changes which may increase
potential for product obsolescence.
• Significant changes in customer demand.
IT and data risk
• Unauthorised access to systems by employees or
external attackers.
• The wealth of malicious codes and tools available to
attackers.
• Rapid changes in information technology.
• Users not adopting good computer security practices,
e.g. sharing or displaying passwords.
• Unauthorised electronic transfer of funds or other
assets.
40
disguise the details of a transaction.
• Compromised business information.
• Breaches in data security and privacy.
• Sensitive data being stolen leaked or lost.
• Anonymous emails/letters/telephone calls.
• Emails sent at unusual times, with unnecessary
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
attachments, or to unusual destinations.
Discrepancy between earnings and lifestyle.
Unusual, irrational, or inconsistent behaviour.
Alteration of documents and records.
Extensive use of correction fluid and unusual
erasures.
Photocopies of documents in place of originals.
Rubber Stamp signatures instead of originals.
Signature or handwriting discrepancies.
Missing approvals or authorisation signatures.
Transactions initiated without the appropriate
authority.
Unexplained fluctuations in stock account balances,
inventory variances and turnover rates.
Inventory adjustments.
Subsidiary ledgers, which do not reconcile with
control accounts.
Extensive use of ‘suspense’ accounts.
Inappropriate or unusual journal entries.
Confirmation letters not returned.
Supplies purchased in excess of need.
Higher than average number of failed login attempts.
Systems being accessed outside of normal work hours
or from outside the normal work area.
Controls or audit logs being switched off.
The above lists of fraud indicators can be indicative of
any fraud type. Appendix 6 provides examples of more
specific fraud indicators.
4.3 Tools and techniques
The training received by management accountants
is a very good basis for implementing an anti-fraud
programme. The broad understanding of business
processes, expected of a management accountant,
is an important asset, as is their knowledge of the
systems and procedures that should be in place within
an organisation, to allow it to operate efficiently and
effectively. A further asset is the ability to think and
act logically, which is something the management
accountant develops with experience. Therefore, the
first important tool available is training and experience.
The second tool is the necessary mindset – that fraud
is always a possibility. A healthy amount of professional
scepticism should be maintained when considering
the potential for fraud. This does not mean that every
time someone seems to be working excessive overtime,
without taking leave, they are in the process of
committing a fraud, or that inaccuracies in the accounts
are there to cover up a fraud. Nevertheless, they might.
Having considered the possibility of fraud, the next step
may be to undertake some further research or pass
concerns to a line manager.
In addition to the tools described above, there
are everyday techniques available to help identify
irregularities which may be fraud, and research the
anomaly to decide whether further action should be
taken. Organisations should ensure that resources are
allocated to identifying such anomalies and detecting
cases of fraud.
Identifying anomalies
Background reading: it is important to keep up to date
with fraud trends and issues. The general press can
be a useful source of information for this, along with
technical magazines, which often carry articles on fraud
and financial irregularity. Also useful is a subscription
to a publication specialising in fraud or buying a good
reference book. The Internet is also a valuable, and vast,
research tool.
Benchmarking: comparisons of one financial period
with another; or the performance of one cost centre,
or business unit, with another; or of overall business
performance with industry standards, can all highlight
anomalies worthy of further investigation.
Systems analysis: it is important to examine the
systems in place and identify any weaknesses that
could be opportunities for the fraudster.
Ratio analysis: can be used to identify any abnormal
trends or patterns.
Mathematical modelling: using the ‘sort’ tool
on a spreadsheet can help to identify patterns in
expenditure, etc. There are also specialist mathematical
models such as Benfords Law, a mathematical formula
which can help identify irregularities in accounts.
Database modelling can also be utilised.
Specialist software: such as audit tools for data
matching analysis can prove very useful. Other
tools allow for analysis such as real time transaction
assessment, targeted post-transactional review, or
strategic analysis of management accounts.
Exception reporting: many systems can generate
automatic reports for results that fall outside of
predetermined threshold values (exceptions), enabling
immediate identification of results deviating from the
norm. With today’s technology it is possible for an
email or text alert to be sent directly to a manager
when exceptions are identified.
Many of these identification techniques can be
automated to make the process more efficient. Fraud
detection systems should be monitored and updated
regularly to keep up with changing technology and new
methods of manipulation.
Risk assessment: undertake a fraud risk assessment
and design specific tests to detect the significant
potential frauds identified through the risk assessment.
Act on irregularities which raise a concern.
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Fraud risk management: a guide to good practice
Case study 8
Risk or returns
Many retail companies are investing in specialist fraud prevention and detection software and have quickly
seen the benefits from doing so:
• Within weeks of implementing new data-mining software, clothing retailer Peacocks dismissed five
employees for fraudulent activities identified by the fraud detection tool and a further 15 investigations
were underway based on information highlighted by the software. Employee were found to be involved in
activities such as processing genuine sales for customers then voiding the transaction, taking money from
the tills, and applying refunds to their own credit cards. Peacocks believe that the increased chances of
detection will stop some fraud before it is even committed. Peacocks are also using the system to pinpoint
process improvement and training requirements.
• Boots saw its investment in loss-prevention software ‘returned in only a matter of weeks’ and have found
that it continues to deliver reduced fraud losses that would have cost the business millions. The software
sends an automatic message to store managers when anomalies in till transactions are identified, such as
an above average number of refunds.
• In just over a year of using data-mining software, Lloydspharmacy identified around £400,000 of
‘previously invisible fraud’ and dismissed a number of ‘unscrupulous employee(s). One of the main types of
fraud suffered by Lloydspharmacy is where a till operator suspends a sale and then uses a ‘no-sale’ facility
to open the till drawer. The linked activity between suspended sales and no sales can be easily identified
using data-mining software though. The first investigation was within two weeks of the system going live
and in the following year there were more than 100 investigations. The investigation payback increased
through using data-mining software and further analysis showed that successful investigations have led
to higher sales figures in the stores concerned. Introduction of the software has also freed loss prevention
managers to focus on other activities, such as risk assessment and training.
• B&Q claims that its investment in a till monitoring system saved the company ‘£1 million on staff fraud in
a year’.
Source: various articles from Retail Week
42
Analysing the anomaly – a methodical approach
All of the tools covered so far have their uses in
identifying the irregularity, but to be effective they
must be combined with a methodical approach to the
analysis of the problem identified. At this stage, it is not
a fraud investigation or internal management review
but an analysis of a problem to decide whether such a
review should be carried out. One approach which can
be considered is detailed below.
1 Establish the objective
The objective of the research must be clear as this
will enable decisions to be made about the best way
forward.
2 Identify the systems and procedures
Undertaking a systems and risk analysis, and comparing
the laid-down systems and procedures that should have
been in place with those actually in use, can help to
identify system or procedural failures.
3 Establish the scale of the risk
This involves identifying the potential loss and assessing
whether it is material. Actual losses should be identified
where possible.
4 Situation analysis
This involves background research, such as company
searches, and identifying those involved.
5 Analyse all available data
Analysis of all the data will give an understanding of
what has occurred and how it occurred.
6 Prepare schedules (include graphics)
Graphical and numerical schedules/spreadsheets should
be prepared to support the analysis and findings. It is
important to make it as easy as possible for those with
little or no financial knowledge to understand what
has occurred. These, when consolidated, would be in
the form of an audit pack detailing the documents that
have led to the formulation of the conclusions.
7 Prepare the report
In preparing the report it is important to bear in mind
that, whatever the original objective, there is always the
possibility of it being used in evidence at some form of
legal proceedings. The report should be factual as far as
possible, and where opinion is given, it should be clearly
identified as such – for example, professional opinion
used in the conclusions of the report.
4.4 Summary
Included in this chapter and in Appendix 6 are examples
of specific fraud alerts associated with activities
common to most types of organisation. However, none
of these will be of any use unless it is accepted that
fraud is possible. It is that mindset, that awareness,
which will enable an organisation to stop an incidence
of fraud before it becomes catastrophic. A warning
sign is not effective unless it is appreciated as such and
this awareness can only be achieved by means of a
continuing programme of education and training.
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Fraud risk management: a guide to good practice
5 Responding to fraud
5.2 Corporate policy
An organisation’s approach to dealing with fraud
should be clearly described in its fraud policy and fraud
response plan. An outline fraud response plan and an
example of a fraud response plan are contained in
Appendices 8 and 9 respectively. Appendix 9 includes a
series of flowcharts that help to highlight the decisions
an organisation might face when a fraud is suspected
and give guidance on process to follow in response to
such suspicions.
This chapter expands on parts of the outline fraud
response plan, where they have not already been
covered in earlier chapters, and highlights some issues
and considerations when dealing with fraud. Paragraph
headings in this chapter are those which should form
the basis of the fraud response plan and relate to those
in the outline response plan in Appendix 8.
5.1 Purpose of the fraud response plan
The fraud response plan is a formal means of setting
down clearly the arrangements which are in place for
dealing with detected or suspected cases of fraud.
It is intended to provide procedures which allow for
evidence gathering and collation in a manner which will
facilitate informed decision-making, while ensuring that
evidence gathered will be admissible in the event of any
civil or criminal action. Other benefits arising from the
publication of a corporate fraud response plan are its
deterrence value and the likelihood that it will reduce
the tendency to panic. It can help restrict damage
and minimise losses, enable the organisation to retain
market confidence, and help to ensure the integrity of
evidence.
44
The fraud response plan should reiterate the
organisation’s commitment to high legal, ethical and
moral standards in all its activities and its approach to
dealing with those who fail to meet those standards. It
is important that all those working in the organisation
are aware of the risk of fraud and other illegal acts, such
as dishonesty or damage to property. Organisations
should be clear about the means of enforcing the rules
or controls which the organisation has in place to
counter such risks and be aware of how to report any
suspicions they may have. The fraud response plan is
the means by which this information is relayed to all
members of staff and, possibly, other stakeholders, such
as customers, suppliers, and shareholders.
One question worthy of consideration is – how much
publicity should be given to exposed fraud? A publicised
successful fraud investigation can be a sharp reminder
to those who may be tempted and a warning to those
who are responsible for the management of controls.
While there may be embarrassment for those who were
close to the fraud and did not identify it, and an adverse
impact on the organisation’s public image, there can be
advantages in publishing internally the outcome of a
successful fraud investigation.
Regulated financial services companies do not have
a choice on whether or not to keep identified cases
of fraud an internal issue. These organisations are
now legally obliged to report financial crime. Other
businesses should follow this example and make it clear
that they will not sweep fraud under the carpet.
Case study 9
Reporting fraud
It is possible to exaggerate the risks involved in reporting fraud. Aid to the Church in Need UK suffered a high
tech website attack in November 2005 which led to hundreds of its benefactors being defrauded. ‘The press
were surprised by how we went public and that we admitted what had happened – but as a Christian charity
we decided we had to be honest and we hope that others will learn from this case about the ‘conspiracy of
silence’ over internet fraud. 98% of people have been very understanding.’
Reproduced with kind permission of the Fraud Advisory Panel from its Ninth Annual Review 2006-2007
Ethical behaviour is the best defence against fraud
5.3 Definition of fraud
As has been explained in Chapter 1, fraud encompasses
criminal offences that involve deception and dishonesty
to obtain some benefit or to cause detriment to some
person or organisation. This section of a fraud response
plan could provide for legal definitions or simply a
list of activities which would or could be considered
fraudulent.
5.4 Roles and responsibilities
The division of responsibilities for fraud risk
management will vary from one organisation to
the next, depending on the size, industry, culture
and other factors. The following are some general
guidelines which can be adapted to suit the individual
circumstances.
Managers and supervisors
Generally managers and supervisors are in a position
to take responsibility for detecting fraud and
other irregularities in their area. Staff must assist
management by reporting any suspected irregularities.
Managers and supervisors should be provided with a
response card, or aide-memoire, detailing how they
should respond to a reported incidence of fraud. The
aide-memoire should include a list of contacts with
telephone numbers.
Finance director
The finance director will often have overall
responsibility for the organisation’s response to fraud,
including the responsibility for co-ordinating any
investigation and for keeping the fraud response plan
up to date. They will hold the master copy of the fraud
response plan, and should have their own aide-memoire
to assist with the management of the investigation. The
finance director will also be responsible for maintaining
an investigation log. An investigations log is typically a
log of all reported suspicions, including those dismissed
as minor or otherwise not investigated. The log will
contain details of actions taken and conclusions
reached. It is an important tool for managing, reporting
and evaluating lessons learned.
Fraud officer (where applicable)
In larger organisations it may be appropriate to
designate a senior manager as the fraud officer in
place of the finance director. The fraud officer will have
responsibility for initiating and overseeing all fraud
investigations, for implementing the fraud response
plan and for any follow-up actions. The fraud officer
should be authorised to receive enquiries from staff
confidentially and anonymously, and be given the
authority to act and/or provide advice according to
individual circumstances, and without recourse to
senior management for approval. In the event that the
fraud officer’s superior is a suspect, he should report
to a more senior manager or non executive director,
perhaps the chair of the audit committee.
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Fraud risk management: a guide to good practice
The fraud officer will manage any internal investigations
and act as a liaison officer with all other interested
parties both internal and external, including police,
regulators and auditors. He should have his own job
description, appropriate to the role, an extended list of
contacts and his own response card. One of his primary
tasks would be the updating of the investigation log.
director, the matter should be reported directly to the
chairman of the audit committee. In small companies
a nominated non executive director may fulfil the
role of the audit committee. The audit committee
is also responsible for reviewing and evaluating the
effectiveness of the internal audit function, where one
exists.
Human resources
The human resources department will usually
have responsibility for any internal disciplinary
procedures, which must be in line with, and support,
the fraud policy statement and fraud response plan.
Their advice should be sought in relation to the
organisation’s personnel management strategies,
individual employment histories, and issues relating to
employment law, or equal opportunities.
Internal auditors (where applicable)
Where an organisation has its own internal audit
department the likelihood is that the task of
investigating any incidence of fraud would fall to
them. Caution should be exercised in allowing an
investigation to be conducted by those without training
and experience in this area, as this may jeopardise the
outcome of an investigation. It may be appropriate
to designate specific auditors as fraud specialists and
to ensure that they have the appropriate skills and
knowledge to undertake the task.
Audit committee (where applicable)
Due to recent legislative and regulatory changes (as
set out in Chapter 1 and Appendix 1), the role of the
audit committee in preventing and detecting fraud is
now more defined. Audit committee members have
responsibility for reviewing the organisation’s internal
control and risk management systems, including the
design and implementation of anti-fraud programmes
and controls. The audit committee should monitor
the integrity of the financial statements, assess the
organisation’s performance in fraud prevention, review
the investigation log of cases at least once a year, and
report any significant matters to the board.
The audit committee should review arrangements by
which employees can confidentially raise concerns
about possible wrongdoing, and the audit committee’s
objective should be to ensure that arrangements
are in place for the proportionate and independent
investigation of such matters and for appropriate
follow-up action. If a suspicion involves the nominated
fraud contact, the finance director or an executive
46
External auditors (where applicable)
An organisation without its own internal audit
department may consider consulting their external
auditors should they discover a fraud, if only to obtain
the expertise to establish the level of loss. The external
auditors may also be in a position to provide expert
assistance from elsewhere within the audit firm,
such as from a specialist fraud investigation group. A
decision to call on external auditors should, however, be
considered carefully, as there is always the possibility
that if the auditor has missed obvious fraud alerts, the
organisation may eventually seek damages from its
auditor.
Legal advisers (internal or external)
Legal advice should be sought as soon as a fraud is
reported, irrespective of the route the organisation
intends to follow. Specific advice would include such
issues as guidance on civil, internal and criminal
responses, and recovery of assets.
5.5 The response
IS/IT staff
IS and IT staff can provide technical advice on IT
security, capability and access. If computers have been
utilised to commit the fraud, or if they are required for
evidential purposes, specialist advice must be sought
immediately.
Public relations (PR)
Organisations with a high profile, such as larger
businesses, public sector organisations or charities,
may wish to consider briefing their PR staff, so they can
prepare a brief for the press in the event that news of a
fraud becomes public.
Police
When the police are consulted, if at all, is a matter
of internal policy in the UK. However, if it is policy to
prosecute all those suspected of fraud, then the police
should be involved at the outset of any investigation, as
any unnecessary delay could diminish the likelihood of
success. In respect of public bodies, Audit Commission
guidance states that the police/external auditors should
be informed as soon as a fraud is suspected.
External consultants
Any organisation could consider bringing in specialist
investigation skills from outside the organisation.
Many such specialist firms exist to provide a discreet
investigation and/or asset recovery service in
accordance with their clients’ instructions.
Insurers
Many organisations take out fidelity insurance to
protect themselves against large fraud losses. The
timeframe for a report to fidelity insurers, and any
additional requirements, should be included in the fraud
response plan and is usually laid down in the insurance
document.
Reasonable steps for responding to detected or
suspected instances of fraud include:
• clear reporting mechanisms
• a thorough investigation
• disciplining of the individuals responsible (internal,
civil and/or criminal)
• recovery of stolen funds or property
• modification of the anti-fraud strategy to prevent
similar behaviour in the future.
Reporting suspicions
The procedures for reporting fraud should be spelt
out clearly and succinctly. This may be by means of a
formal whistleblowing policy, as outlined in Chapter 3,
but the procedures should also be summarised within
the fraud response plan.
Establish an investigation team
After recording details of the allegations, the finance
director, or the fraud officer if appropriate, should call
together the investigation team and the organisation’s
advisers. This could involve any, or all, of those listed
above.
Formulate a response
The objectives of the investigation should be clearly
identified, as should the resources required, the
scope of the investigation, and the timescale. The
objectives of the investigating team will be driven by
the organisation’s attitude to fraud and the preferred
outcome for dealing with fraud. An action plan should
be prepared and roles and responsibilities should be
delegated in accordance with the skills and experience
of the individuals involved. The individual in overall
control of the investigation should be clearly identified,
as should the powers available to team members.
Reporting procedures and procedures for handling and
recording evidence should be clearly understood by all
concerned.
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Fraud risk management: a guide to good practice
Case study 10
TNT roots out fraud
The security function of TNT, a leading global express and mail business, conducts professional investigations
into suspected cases of fraud and has embedded procedures for dealing with whistleblowers.
It has also taken the lead in developing proactive measures against fraud as a way of improving integrity for
all stakeholders. TNT carries out security financial reviews of its business units aimed at identifying, analysing
and dealing with the red flags of fraud.
Parallel with the security financial review, employers are trained through the TNT integrity programme, which
was developed by a newly created group integrity department in conjunction with other key departments,
including security and corporate audit.
Simon Scales, TNT’s Deputy Global Security and Compliance Director, says: ‘Prevention is better than cure.
It’s about doing the right things as well as doing things right.’
Source: Cut out a rotten core, Excellence in Leadership, Issue 2 2007
5.6 The investigation
Preservation of evidence
A key consideration in any investigation must always be
how to secure or preserve sufficient evidence to prove a
case of fraud. It is vitally important that control is taken
of any physical evidence before the opportunity arises
for it to be removed or destroyed by the suspect(s).
Physical evidence may therefore need to be seized at
an early stage in the investigation, before any witness
statements are collected or interviews conducted. If
a criminal act is suspected, the police should also be
consulted early in the process, before any overt action
is taken and the suspect is alerted.
In English and Welsh law, for the purposes of criminal
proceedings, the admissibility of evidence is governed
by the Police and Criminal Evidence Act 1984 (PACE).
In addition, the Criminal Procedures and Investigations
Act 1996 provides a statutory framework and code
of practice for disclosure of material collected during
the course of investigations. Although PACE does not
apply in civil or disciplinary proceedings, it should
nevertheless be regarded as best practice.
48
If an individual does end up being charged with a
criminal offence, and this may not be planned at the
outset of the investigation, all investigations, and
relevant evidence arising from such investigations, will
be open to discovery by that individual’s defence. It is,
therefore, important that proper records are kept from
the outset, including accurate notes of when, where and
from whom the evidence was obtained and by whom.
The police, or legal advisers, will be able to advise on
how this should be done.
If appropriate, written consent should be obtained
from the relevant department or branch manager
before any items are removed. This can be done with
senior management authority, as the items are the
organisation’s own property. Similarly, electronic
evidence must be secured before it can be tampered
with by the suspect.
Physical evidence
If an internal investigation is being conducted, then an
organisation has a right to access its own records and
may bring disciplinary action against any member of
staff who tries to prevent this. Where physical evidence
is owned or held by other organisations or individuals
who are not employees, it may be necessary to obtain
a court order or injunction to secure access to or to
allow seizure of the evidence. The exact means of
obtaining physical evidence depends on the particular
circumstances of the case and whether criminal or civil
action is being pursued, or both.
When taking control of any physical evidence, original
material is essential. Photocopies are not acceptable.
Records should be kept of when it was obtained and
the place that it was taken from. If evidence consists
of several items, for example many documents,
each one should be tagged with a reference number
that corresponds with the written record. Taking
photographs or video recordings of the scene, such as
the suspect’s office, may also prove helpful.
Electronic evidence
In order to ensure case integrity and compliance with
current UK legislation, retrieval of electronic evidence
should be treated in a similar manner to that of other
physical evidence, although there will be some distinct
differences. These are covered in the UK Good Practice
Guide issued by the ACPO, which sets outs four
principles for dealing with computer-based electronic
evidence. These principles are as follows:
Principle 1
No action taken by law enforcement agencies or their
agents should change data held on a computer or
storage media, which may be relied upon in court.
Principle 2
In exceptional circumstances, where a person finds it
necessary to access original data held on a computer
or on storage media, that person MUST be competent
to do so and be able to give evidence explaining the
relevance and the implications of their actions.
Principle 3
An audit trial or other record of all processes applied to
computer based electronic evidence should be created
and preserved. An independent third party should be
able to examine those processes and achieve the same
result.
Principle 4
The person in charge of the investigation (the case
officer) has overall responsibility for ensuring that the
law and these principles are adhered to.
Interviews (general)
Managers are quite entitled to interview staff under
their direction and to ask them to account for
assets which were, or are, under their direct control,
or to explain their performance in respect of the
management or supervision of specific employees.
However, the point at which it is considered that there
are reasonable grounds for suspicion of an individual is
the point where questioning should be stopped and the
individual advised that their actions will be the subject
of a formal investigation (should criminal prosecution
be considered). From this moment on any interviews
should be conducted by trained personnel or by police
officers. Detailed notes should be kept of questions and
answers, and interviews should be taped if possible.
Statements from witnesses
If a witness is prepared to give a written statement, it
is good practice for someone else, normally a trained
or experienced manager, to take a chronological record
of events using the witness’s own words. The witness
must be happy to sign the resulting document as a
true record. The involvement of an independent person
usually helps to confine the statements to the relevant
facts and the witness should be given the opportunity
to be supported by a colleague, acquaintance or trade
union official.
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Fraud risk management: a guide to good practice
5.7 Organisation’s objectives with respect
to dealing with fraud
Statements from suspects
If a criminal act is suspected, the requirements of PACE,
and other legislation, must be considered before any
interview with a suspect takes place, since compliance
determines whether evidence is admissible in criminal
proceedings. Before initiating any interview under
caution, the interviewer must ensure that they fully
understand the requirements of PACE, as laid down in
the codes of practice issued in accordance with Section
66 of the Act. These codes are periodically reviewed
and the most recent amendment to the codes came
into effect from 1 February 2008. As PACE is essentially
aimed at police officers and other trained investigators,
if the need for an interview under caution arises, police
involvement should again be considered.
The codes of practice under PACE do still apply to
others, with Section 67 of the Act making it clear that
‘Persons other than police officers who are charged with
the duty of investigating offences, shall ...have regard
to any relevant provision of such a code.’ Failure to
observe the codes of practice may therefore jeopardise
vital evidence, rendering it useless. In practice,
therefore, it is suggested that interviews should only
be conducted by trained personnel, with advice and
guidance from the organisations legal advisers or the
police. This guidance could be supported by means of a
brief or an aide-memoire for the personnel concerned
and supplemented with formal training.
When conducting investigations it is also important to
be mindful of the provisions of the Human Rights Act,
in particular the rights to privacy and to a fair trial or
hearing.
50
The thoroughness of an investigation may depend on
the course of action that the organisation plans to
take with regard to a case of fraud. The organisation’s
policy may include any or all of the following preferred
outcomes in dealing with fraud.
Internal disciplinary action
In accordance with the organisation’s personnel and
disciplinary guidelines.
A civil response
Whereby action is taken through the civil courts to
recover losses.
Criminal prosecution
Whereby action is taken against the individual(s)
concerned in a police managed enquiry.
A parallel response
Where civil action to recover misappropriated assets is
taken in parallel with a police investigation.
5.8 Follow-up action
Lessons learned
There are lessons to be learned from every
identified incident of fraud, and the organisation’s
willingness to learn from experience is as important
as any other response. The larger organisation may
consider establishing a special group to examine the
circumstances and conditions which allowed the fraud
to occur, with a view to making a report to senior
management detailing improvements to systems
and procedures. A smaller organisation may consider
discussing the issues with some of its more experienced
people, with the same objectives in mind.
5.9 Summary
Management response
Internal reviews
Having experienced an incident of fraud, the
organisation may consider a fundamental review of
all of its systems and procedures so as to identify any
other potential system failures or areas of weakness.
Changes to systems or policy should be implemented
as soon as possible.
Implement changes
Should weaknesses have been identified, it can only be
of benefit to the organisation to take the appropriate
remedial action. Recent statistics have again confirmed
that many organisations suffer more than one incident
of fraud per year.
It is important that organisations have a documented
plan for responding to suspected or detected cases
of fraud. A fraud response plan should include a
clear statement on the corporate policy with regard
to dealing with fraud, and set out the roles and
responsibilities of those involved in responding to
suspicions. It should outline how an investigation should
be handled, ensuring that due process is followed and
integrity of evidence is maintained. The fraud response
plan may also detail follow up action that will be taken
by an organisation in light of established incidents of
fraud.
Annual report
An investigations log should be maintained and an
annual report should be submitted to the board of
all investigations carried out, outcomes and lessons
learned.
Enforcement policies
A growing number of organisations are introducing
enforcement policies that highlight the organisation’s
zero tolerance approach to fraud and clearly state
that if a case of fraud is identified, appropriate action
will be taken and those responsible will be made an
example of, no matter who the perpetrator is. For
example, financial institutions are keen to demonstrate
a commitment to dealing with wrongdoers and are
increasingly prosecuting fraudulent employees rather
than ‘sweeping the matter under the carpet’.
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Fraud risk management: a guide to good practice
Appendix 1 Fraud and the law
UK law
The Fraud Act
The Fraud Act made fraud a criminal offence and
provides for the following ways of committing the
offence:
• fraud by false representation
• fraud by failing to disclose information
• fraud by abuse of position.
For each of the different ways of perpetrating fraud
set out in the Fraud Act, the common theme is that a
person has acted dishonestly with the intent to make
a gain for himself or another, cause loss to another, or
expose another to a risk of loss.
In addition to those listed above, the Fraud Act
also covers the offences of carrying on a business
fraudulently; making, supplying or possessing articles
for use in frauds; and obtaining services dishonestly.
These offences include the creation or possession
of software which has been created or adapted for
fraudulent use. The newly created fraud offences carry
a maximum penalty of 10 years’ imprisonment, a fine
or both.
The Fraud Act affects both companies and individuals
and is part of a wider initiative to combat the increasing
problem of fraud. It has been loosely drafted so that it
will be able to capture forms of fraud using the internet
and new technologies. Previous legislation proved
inadequate at keeping up with rapid developments in
technology and the wide range of possible fraudulent
activity resulting from it.
The Fraud Act also extends the territorial scope of
previous legislation. Not all activities of the offence
must take place in the UK in order for a prosecution
under the Fraud Act. UK courts have jurisdiction even
where the only activity to have taken place in the UK is
the gain or loss of property.
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The Companies Act 2006
The Companies Act in the UK has been subject to major
reform, resulting in the Companies Act 2006, which
came into force in its entirety in October 2008. The
new legislation sets out a statutory statement of the
general duties of directors and introduces a right for
shareholders to sue directors individually for breach of
these duties, either as a result of negligence or fraud.
The duties include:
duty to promote the success of the company
duty to exercise reasonable care, skill and diligence
duty to avoid conflicts of interest
duty to declare interests in proposed transactions or
arrangements
• duty not to accept benefits from third parties.
•
•
•
•
The Companies Act 2006 includes the offence of
fraudulent trading and also creates a new offence in
relation to documents to be delivered to Companies
House. Under Section 1112 of the Act, where a person
knowingly or recklessly delivers or causes to be
delivered a document or statement that is misleading,
false or deceptive in a material particular, they will be
liable to up to two years imprisonment, a fine, or both.
Public Interest Disclosure Act (PIDA)
PIDA is known as the whistleblowing law in the UK,
as it offers protection to employees who blow the
whistle in one of the ways set out in the Act. Under
PIDA, employers should not victimise a ‘worker’ if they
make ‘qualifying disclosures’. PIDA’s definition of a
worker covers all forms of employment but excludes
Crown Servants whose work covers national security
issues, police officers and employees who ordinarily
work outside the UK. Qualifying disclosures are defined
as information which, in the reasonable belief of the
worker making the disclosure, tends to show one or
more of the following is either happening now, has
happened already or is likely to happen:
•
•
•
•
•
•
a criminal offence
failure to comply with a legal obligation
a miscarriage of justice
danger to the health and safety of an individual
damage to the environment
deliberate concealment of information tending to
show any of the above.
PIDA has a stepped disclosure regime, which helps
to balance the public interest and the interests of
employers. Under this regime, the worker will be
protected if the disclosure is made to their employer,
some other responsible person if the disclosure is
relevant to that person, or to a third party, where this
is in accordance with outlined and agreed procedures.
PIDA most readily protects workers where disclosures
are made internally.
With regard to internal disclosures, the worker is
protected if the disclosure has been made in good
faith and with reasonable belief that there has been
wrongdoing. There are then different levels of external
disclosure. Protection is given for disclosures to
prescribed regulators where the worker reasonably
believes that the information or allegation is
substantially true. Wider public disclosures (including to
the media or a consumer group) may still be protected
under PIDA, and more readily so where whistleblowing
arrangements are not in place within the organisation
or are ineffective. There must be justifiable cause for
going wider and the particular disclosure must be
reasonable.
Serious Crimes Act
The Serious Crimes Act aims to improve the ability of
law enforcement agencies to tackle fraud and other
serious organised crime, and strengthen the recovery of
criminal assets. It also introduces additional measures
to prevent or disrupt serious crime, including the
prevention of fraud. Most of the provisions of the
Serious Crimes Act came into force in early 2008 and
make several radical changes to criminal law.
The Serious Crimes Act gives certain courts in the UK
the ability to issue serious crime prevention orders.
These create a new form of civil injunction, the breach
of which is a criminal act punishable by imprisonment
and a fine. A prevention order can be imposed where
the court is satisfied that a person (including an
individual, a partnership or a company) has been
involved in a serious crime and where it has reasonable
grounds to believe the order would protect the public
by prohibiting or restricting the person’s activities,
including financial holdings, business dealings, working
arrangements and communications. Serious crimes
covered by this Act include attempting, committing,
facilitating or encouraging serious offences such as
fraud, money laundering, corruption and bribery.
With regard to additional measures, the Serious
Crimes Act makes new provisions for disclosure and
information sharing by public authorities to any
anti-fraud organisation, in order to prevent fraud or
in relation to proceeds of crime. The government is
to prepare a code of practice with respect to such
disclosure. The Act also authorises certain bodies to
conduct data matching exercises for the purpose of
preventing or detecting fraud. This provision puts a
statutory basis around the National Fraud Initiative that
has operated in the UK for some years.
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Fraud risk management: a guide to good practice
Proceeds of Crime Act (POCA)
POCA was brought into effect during 2002 and 2003,
and allows for the civil recovery of the proceeds of
crime. It consolidated existing laws on confiscation and
money laundering into a single piece of legislation, in
order to improve the efficiency of the recovery process
and increase the amount of illegally obtained assets
recovered from criminals.
POCA also created new money laundering offences
and provided financial investigation officers with new
investigative powers. Under POCA, a money laundering
offence is committed where someone conceals,
disguises, converts or transfers criminal property or
removes it from the UK or even between countries
with in the UK. It is also an offence to enter into an
arrangement that one knows or suspects facilitates
the acquisition, retention, use or control of criminal
property. As such, partaking or assisting in many
activities aimed at defrauding a business may also be
money laundering offences.
The Fraud Review
Between 2005 and 2006, the UK Attorney General’s
office conducted an extensive review of the national
arrangements for dealing with fraud (The Fraud
Review), with the aim of reducing the extent of fraud
and minimising the harm that it causes to the economy
and wider society.
The Fraud Review was completed in July 2006 with
the publication of an extensive report that contained a
number of recommendations covering measurement,
reporting, prevention, investigation and prosecution of
fraud. The report was welcomed by the government
and selected key recommendations were taken forward
as part of an integrated strategy to tackle fraud (the
National Fraud Programme).
The National Fraud Programme includes:
• formation of a National Fraud Strategic Authority to
•
Under POCA, there is no de minimis limit (i.e. it covers
proceeds of any criminal conduct and not just ‘serious’
crime) and there is no requirement for the activities
resulting in the offence to have been conducted in the
UK. The Serious Organised Crimes and Police Act 2005
made some adjustments to POCA, intended to clarify
the situation in cases where doubt arose under POCA.
The Asset Recovery Agency (ARA) was established
under POCA in 2003. ARA had the powers to use civil
court procedures to recover the proceeds of crime by
way of an action in the High Court. However, from April
2008, ARA ceased to exist following its transfer to the
Serious Organised Crime Agency under the provisions
of the Serious Crimes Act.
For further information on money laundering, please
refer to the Anti-Money Laundering page on CIMA’s
website (www.cimaglobal.com).
54
•
•
•
co-ordinate strategy between organisations both in
the public and private sectors who tackle fraud
creation of a Fraud Loss Measurement Unit to provide
robust estimates for the measurement of fraud losses
and assessment of value and risks of future fraud
threats
enhanced data sharing provisions through creation of
a National Fraud Reporting Centre and Intelligence
Bureau
creation of a National Lead Force for Fraud based on
the City of London Police Fraud Squad to act as a
centre of excellence
extension of sentencing provisions through new
powers for the Crown Court.
The National Fraud Programme brings a greater
emphasis on prevention and deterrence of fraud, but
spans the entire spectrum of counter fraud activity,
including detection, prosecution, sanctioning, and
redress for victims. In October 2007 the government
announced that £29 million of new funding would
be put forward to implement the National Fraud
Programme and many of the recommendations have
started to be put into place during 2008.
US law
Sarbanes-Oxley Act (Sarbox)
Sarbox is a US federal law. However, it is far reaching
legislation and impacts on many businesses in the
UK and globally, and has therefore been included
in this guide. Sarbox was passed in US Congress in
January 2002 and came into effect in November 2004.
Compliance is mandatory for all companies listed in the
US, regardless of the size of the company or where the
company is actually based.
Sarbox was introduced in response to a number of
major corporate and accounting scandals, the most
well known probably being the collapses of Enron
and WorldCom. The Act introduced major changes
to the regulation of financial practice and corporate
governance, aimed at improving accuracy and
transparency around financial reporting and increasing
oversight of the assurance process. Sarbox is a large
piece of legislation, arranged into 11 titles. This guide
will focus on the specific requirements relating to fraud
risk management.
Sarbox targets the perceived drivers of financial
statement fraud (or accounting fraud) by attempting
to strengthen risk management and internal controls,
increase board and audit committee oversight, improve
auditor vigilance and independence, and create
accounting fraud penalties that act as a significant
deterrence. It requires companies to implement
extensive corporate governance policies, procedures
and tools to prevent and respond to fraudulent activity
within the company.
Title 3 requires chief executives and chief financial
officers (the signing officers) to certify the integrity
of the financial reports. Pursuant to Section 302, the
signing officers must attest that they have evaluated
the internal control system and must give information
on any fraud, regardless of materiality, that involves
management or employees who have significant
involvement in internal control activities.
Title 4 describes enhanced reporting requirements
for financial transactions and includes Section 404.
Section 404 of Sarbox is one of the more controversial
parts of the act, and requires management and the
external auditor to report on the effectiveness of the
company’s internal controls over financial reporting.
The Securities Exchange Commission (SEC) has noted in
its final rules for Section 404 that an adequate internal
control structure must include ‘controls related to
the prevention, identification and detection of fraud.’
This covers more than just accounting fraud. Insider
trading, intellectual property theft, misappropriation
of customer data and other internal frauds would all
need to be considered. There has been debate over
whether Sarbox, and Section 404 in particular, has
been too onerous. In 2007, the SEC responded to this
criticism by issuing management guidance to ensure
that companies focus efforts on what truly matters.
According to the Financial Reporting Council, the SEC
has also identified the Turnbull guidance as a suitable
framework for complying with the requirements of
Section 404.
Title 8 describes specific penalties for altering,
manipulating or destroying financial records or evidence
in an investigation, and for defrauding shareholders
of publicly traded companies. It is also referred to
as the Corporate and Criminal Fraud Accountability
Act of 2002, based on a fraud bill that was originally
proposed following the fall out of Enron. Penalties
include imprisonment of up to 20 years and fines of
up to $5 million. Title 8 also includes protections for
whistleblowers under Section 806. Procedures for
handling whisteblower reports are covered by Section
301.
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Fraud risk management: a guide to good practice
Title 9 increases the criminal penalties for white collar
crimes and conspiracies, and is also called the White
Collar Crime Penalty Enhancement Act of 2002. It
recommends stronger sentencing guidelines and
creates a new criminal offence of failure to certify
corporate financial reports. Attempts and conspiracies
to commit a criminal fraud offence are subject to the
same penalties as committing the offence itself. Again,
penalties of up to 20 years and fines of up to $5 million
can be imposed.
Title 11 makes it a criminal offence to tamper with
records and interfere with official proceedings, and
is also known as the Corporate Fraud Accountability
Act of 2002. It revises sentencing guidelines and
strengthens the associated penalties. Under this title,
the SEC has authority to temporarily freeze large or
unusual payments to directors, officers, agents and
employees of a company during investigations of
security law violations. It also codifies the SEC’s right
to prohibit persons convicted of securities fraud from
serving as a director or officer of a public company.
Sarbox also encourages companies to establish an
ethical culture and requires disclosure of whether
the company has adopted a code of ethics for senior
finance officers. It also has whistleblower provisions to
help uncover lapses in ethics and fraudulent behaviour.
56
Appendix 2 Examples of common types of internal fraud
This appendix looks at common types of internal fraud
and some of the methods through which they may be
perpetrated.
Asset misappropriation
Cash
Theft of cash
• Stealing from petty cash.
• Taking money from the till.
• Skimming of cash before recording revenues or
receivables (understating sales or receivables).
• Stealing incoming cash or cheques through an
account set up to look like a bona fide payee.
False payment requests
• Employee creating false payment instruction with
forged signatures and submitting it for processing.
• False email payment request together with hard copy
printout with forged approval signature.
• Taking advantage of the lack of time which typically
occurs during book closing to get false invoices
approved and paid.
Cheque fraud
• Theft of company cheques.
• Duplicating or counterfeiting of company cheques.
• Tampering with company cheques (payee/amount).
• Depositing a cheque into a third party account
without authority.
• Cheque kiting (a fraud scheme using two deposit
accounts to withdraw money illegally from the bank).
• Paying a cheque to the company knowing that
insufficient funds are in the account to cover it.
Billing schemes
• Over-billing customers.
• Recording of false credits, rebates or refunds to
customers.
• Pay and return schemes (where an employee creates
an overpayment to a supplier and pockets the
subsequent refund).
• Using fictitious suppliers or shell companies for false
billing.
Misuse of accounts
• Wire transfer fraud (fraudulent transfers into bank
accounts).
• Unrecorded sales or receivables.
• Employee account fraud (where an employee is also
a customer and the employee makes unauthorised
adjustments to their accounts).
• Writing false credit note to customers with details
of an employee’s personal bank account or of an
account of a company controlled by the employee.
• Stealing passwords to payment systems and
inputting series of payments to own account.
Non-cash
Inventory and fixed assets
• Theft of inventory.
• False write offs and other debits to inventory.
• False sales of inventory.
• Theft of fixed assets, including computers and other
IT related assets.
• Theft or abuse of proprietary or confidential
information (customer information, intellectual
property, pricing schedules, business plans, etc).
• Receiving free or below market value goods and
services from suppliers.
• Unauthorised private use of company property.
• Employees trading for their own account.
Procurement
• Altering legitimate purchase orders.
• Falsifying documents to obtain authorisation for
payment.
• Forging signatures on payment authorisations.
• Submitting for payment false invoices from fictitious
or actual suppliers.
• Improper changes to supplier payment terms or other
supplier details.
• Intercepting payments to suppliers.
• Sending fictitious or duplicate invoices to suppliers.
• Improper use of company credit cards.
• Marked up invoices from contracts awarded to
supplier associated with an employee.
• Sale of critical bid information, contract details or
other sensitive information.
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Fraud risk management: a guide to good practice
Payroll
• Fictitious (or ghost) employees on the payroll.
• Falsifying work hours to achieve fraudulent overtime
•
•
•
•
•
•
•
•
payments.
Abuse of commission schemes.
Improper changes in salary levels.
Abuse of holiday leave or time off entitlements.
Submitting inflated or false expense claims.
Adding private expenses to legitimate expense claims.
Applying for multiple reimbursements of the same
expenses.
False workers’ compensation claims.
Theft of employee contributions to benefit plans.
Fraudulent statements
Financial
Improper revenue recognition
• Holding the books open after the end of the
accounting period.
• Inflation of sales figures which are credited out after
the year end.
• Backdating agreements.
• Recording fictitious sales and shipping.
• Improper classification of revenues.
• Inappropriate estimates for returns, price adjustments
and other concessions.
• Manipulation of rebates.
• Recognising revenue on disputed claims against
customers.
• Recognising income on products shipped for trial or
evaluation purposes.
• Improper recording of consignment or contingency
sales.
• Over/under estimating percentage of work completed
on long-term contracts.
• Incorrect inclusion of related party receivables
• Side letter agreements (agreements made outside of
formal contracts).
• Round tripping (practice whereby two companies
buy and sell the same amount of a commodity
at the same price at the same time. The trading
lacks economic substance and results in overstated
revenues).
58
• Bill and hold transactions (where the seller bills the
•
•
customer for goods but does not ship the product
until a later date).
Early delivery of product/services (e.g. partial
shipments, soft sales, contracts with multiple
deliverables, up front fees).
Channel stuffing or trade loading (where a company
inflates its sales figures by forcing more products
through a distribution channel than the channel is
capable of selling).
Misstatement of assets, liabilities and/or expenses
• Fictitious fixed assets.
• Overstating assets acquired through merger and
acquisitions.
• Improper capitalisation of expenses as fixed assets
(software development, research and development,
start up costs, interest costs, advertising costs).
• Manipulation of fixed asset valuations.
• Schemes involving inappropriate depreciation or
amortisation.
• Incorrect values attached to goodwill or other
intangibles.
• Fictitious investments.
• Improper investment valuation (misclassification
of investments, recording unrealised investments,
declines in fair market value/overvaluation).
• Fictitious bank accounts.
• Inflating inventory quantity through inclusion of
fictitious inventory.
• Improper valuation of inventory.
• Fraudulent or improper capitalisation of inventory.
• Manipulation of inventory counts.
• Accounts receivable schemes (e.g. creating fictitious
receivables or artificially inflating the value of
receivables).
• Misstatement of prepayments and accruals.
• Understating loans and payables.
• Fraudulent management estimates for provisions,
reserves, foreign currency translation, impairment,
etc.
• Off balance sheet items.
• Delaying the recording of expenses to the next
accounting period.
Non-financial
Personal interests
• Collusion with customers and/or suppliers.
• Favouring a supplier in which the employee has a
financial interest.
• Employee setting up and using own consultancy
for personal gain (conflicts with the company’s
interests).
• Employee hiring someone close to them over another
more qualified applicant.
• Transfer of knowledge to a competitor by an
employee who intends to joins the competitor’s
company.
• Misrepresentation by insiders with regard to a
corporate merger, acquisition or investment.
• Insider trading (using business information not
released to the public to gain profits from trading in
the financial markets).
• Falsified employment credentials e.g. qualifications
Bribery and extortion
Other accounting misstatements
• Improper treatment of inter-company accounts.
• Non clearance or improper clearance of suspense
accounts.
• Misrepresentation of suspense accounts for
fraudulent activity.
• Improper accounting for mergers, acquisitions,
disposals and joint ventures.
• Manipulation of assumptions used for determining
fair value of share based payments.
• Improper or inadequate disclosures.
• Fictitious general ledger accounts.
• Journal entry fraud (using accounting journal entries
to fraudulently adjust financial statements).
• Concealment of losses.
•
and references.
Other fraudulent internal or external documents.
Corruption
Conflicts of interest
Kickbacks
• Kickbacks to employees by a supplier in return for the
supplier receiving favourable treatment.
• Kickbacks to senior management in relation to the
acquisition of a new business or disposal of part of
the business.
• Employee sells company-owned property at less
than market value to receive a kickback or to sell the
property back to the company at a higher price in the
future.
• Purchase of property at higher than market value in
exchange for a kickback.
• Preferential treatment of customers in return for a
kickback.
Bribery
• Payment of agency/facilitation fees (or bribes) in
order to secure a contract.
• Authorising orders to a particular supplier in return
for bribes.
• Giving and accepting payments to favour or
not favour other commercial transactions or
relationships.
• Payments to government officials to obtain a benefit
(e.g. customs officials, tax inspectors).
• Anti-trust activities such as price fixing or bid rigging.
• Illegal political contributions.
Extortion
• Extortion (offering to keep someone from harm in
exchange for money or other consideration).
• Blackmail (offering to keep information confidential
in return for money or other consideration).
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Fraud risk management: a guide to good practice
Appendix 3 Example of a risk analysis
The risk analysis set out below is an example of the
results of an assessment by a risk management group of
the fraud risks in the contracts function. This document
is a summary of the work undertaken by the risk
management group, and they will have working papers
to document their workings and assessments.
The risks identified are in the first column, and the
dates of the risk assessment in the second column. The
column Probability/likelihood records the assessment of
the likelihood of this risk occurring in the organisation.
The ratings are graded high, medium or low. The
next column, impact, is an assessment of the impact
of a fraud in this area. The next column records the
Take for example, the risks relating to an unchanging list
of suppliers. The risk management group believes fraud
has a high likelihood of occurring and if so, it could
cause significant financial loss to the business. The
controls are thought to be weak and unlikely to reduce
the risk. They have assessed the net likely impact to be
high and recommend that this is an immediate priority
in the contracts area.
Factor/risk area and
description contracts
Date of
Probability/
assessment likelihood
Unchanging list of
preferred suppliers
2007
Consistent list of single
source suppliers
Changes in contract
specifications
Personal relationships
between staff and suppliers
60
assessment of the controls in this area, and the net
likely impact is an assessment of the likelihood of a
fraud not being detected by the controls. At this stage
the risks in the contracts area can be reviewed and
priorities set for action to address the risk.
Impact
Controls
impact
Net likely
Action
High
High
Low
High
Priority –
immediate
2007
Medium
High
High
Medium
–
2007
Low
Low
Medium
Low
–
2008
Low
High
Low
High
Priority –
within
x months
Appendix 4 A sample fraud policy
The following is an example of a policy which can be
modified for use by any organisation.
Background
This organisation has a commitment to high legal,
ethical and moral standards. All members of staff are
expected to share this commitment. This policy is
established to facilitate the development of procedures
which will aid in the investigation of fraud and related
offences.
The board already has procedures in place that reduce
the likelihood of fraud occurring. These include standing
orders, documented procedures and documented
systems of internal control and risk assessment. In
addition the board tries to ensure that a risk and fraud
awareness culture exists in this organisation.
This document, together with the fraud response
plan and investigator’s guide, is intended to provide
direction and help to those officers and directors who
find themselves having to deal with suspected cases
of theft, fraud or corruption. These documents give a
framework for a response and advice and information
on various aspects and implications of an investigation.
These documents are not intended to provide direction
on prevention of fraud.
Fraud policy
This policy applies to any irregularity, or suspected
irregularity, involving employees as well as consultants,
suppliers, contractors, and/or any other parties with
a business relationship with this organisation. Any
investigative activity required will be conducted
without regard to any person’s relationship to this
organisation, position or length of service.
Actions constituting fraud
Fraud comprises both the use of deception to obtain
an unjust or illegal financial advantage and intentional
misrepresentations affecting the financial statements
by one or more individuals among management, staff
or third parties.
All managers and supervisors have a duty to familiarise
themselves with the types of improprieties that might
be expected to occur within their areas of responsibility
and to be alert for any indications of irregularity.
The board’s policy
The board is absolutely committed to maintaining an
honest, open and well intentioned atmosphere within
the organisation. It is, therefore, also committed to the
elimination of any fraud within the organisation, and to
the rigorous investigation of any such cases.
The board wishes to encourage anyone having
reasonable suspicions of fraud to report them.
Therefore, it is also the board’s policy, which will be
rigorously enforced, that no employee will suffer in any
way as a result of reporting reasonably held suspicions.
All members of staff can therefore be confident
that they will not suffer in any way as a result of
reporting reasonably held suspicions of fraud. For these
purposes ‘reasonably held suspicions’ shall mean any
suspicions other than those which are shown to be
raised maliciously and found to be groundless. The
organisation will deal with all occurrences in accordance
with the Public Interest Disclosure Act.
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Fraud risk management: a guide to good practice
Appendix 5 Sample whistleblowing policy
Introduction
How the whistleblowing policy differs
from the grievance procedure
This whistleblowing policy has been introduced in
response to the Public Interest Disclosure Act 1998 and
provides a procedure which enables employees to raise
concerns about what is happening at work, particularly
where those concerns relate to unlawful conduct,
financial malpractice or dangers to the public or the
environment. The object of this policy is to ensure that
concerns are raised and dealt with at an early stage and
in an appropriate manner.
This policy does not apply to raising grievances about
an employee’s personal situation. These types of
concern are covered by the organisation’s grievance
procedure. The whistleblowing policy is primarily
concerned with where the interests of others or of
this organisation itself are at risk. It may be difficult to
decide whether a particular concern should be raised
under the whistleblowing policy or under the grievance
procedure or under both. If an employee has any doubt
as to the correct route to follow, this organisation
encourages the concern to be raised under this policy
and will decide how the concern should be dealt with.
This organisation is committed to its whistleblowing
policy. If an employee raises a genuine concern under
this policy, he or she will not be at risk of losing their
job, nor will they suffer any form of detriment as a
result. As long as the employee is acting in good faith
and in accordance with this policy, it does not matter if
they are mistaken.
62
Protecting the employee
This organisation will not tolerate harassment or
victimisation of anyone raising a genuine concern under
the whistleblowing policy. If an employee requests
that their identity be protected, all possible steps will
be taken to prevent the employee’s identity becoming
known. If the situation arises where it is not possible to
resolve the concern without revealing the employee’s
identity (e.g. if the employee’s evidence is needed in
court), the best way to proceed with the matter will
be discussed with the employee. Employees should be
aware that by reporting matters anonymously, it will be
more difficult for the organisation to investigate them,
to protect the employee and to give the employee
feedback. Accordingly, while the organisation will
consider anonymous reports, this policy does not cover
matters raised anonymously.
How the matter will be handled
Independent advice
Once an employee has informed the organisation of
his or her concern, the concerns will be examined and
the organisation will assess what action should be
taken. This may involve an internal enquiry or a more
formal investigation. The employee will be told who is
handling the matter, how they can contact him/her and
whether any further assistance may be needed. If the
employee has any personal interest in the matter, this
should be declared by the employee at the outset. If
the employee’s concern falls more properly within the
grievance procedure, then they will be advised of this.
If an employee is unsure whether to use this procedure
or wants independent advice at any stage, they may
contact the independent charity Public Concern at
Work on 020 7404 6609. Their lawyers can give free
confidential advice at any stage about how to raise
a concern about serious malpractice at work. An
employee can, of course, also seek advice from a lawyer
of their own choice at their own expense.
How to raise a concern internally
Step 1
If an employee has a concern about malpractice, he
or she should consider raising it initially with their
line manager. This may be done orally or in writing.
An employee should specify from the outset if they
wish the matter to be treated in confidence so that
appropriate arrangements can be made.
Alternatively, employees can call the 24 hour
whistleblowing telephone hotline. This service is strictly
confidential and callers will not be asked to give their
name if they do not want to.
Step 2
If these channels have been followed and the employee
still has concerns, or an employee feels that they
are unable to raise a particular matter with their line
manager, for whatever reason, they should raise the
matter with their head of department, the head of
human resources or the chief internal auditor.
External contacts
It is intended that this policy should give employees
the reassurance they need to raise concerns internally.
However, this organisation recognises that there may
be circumstances where employees should properly
report matters to outside bodies, such as regulators or
the police. If an employee is unsure as to whether this is
appropriate and does not feel able to discuss the matter
internally, Public Concern at Work will be able to give
advice on such an option and on the circumstances in
which an employee should contact an outside body
rather than raise the matter internally.
Matters raised maliciously
Employees who are found to maliciously raise a matter
that they know to be untrue will be subject to the
disciplinary policy.
63
Fraud risk management: a guide to good practice
Appendix 6 Examples of fraud indicators, risks and controls
The following are examples of indicators for two
specific types of fraud – procurement fraud and fraud
in the selling process. There are many other types of
fraud and each will have its own set of indicators as
well as some of the general indicators that are set out
in Chapter 4.
After the award of contract
• Unexplained changes in the contract after its award.
• Contract awarded to a supplier with a poor
performance record.
• Split contracts to circumvent controls or contract
conditions.
• Suppliers who are awarded contracts
Example 1: Procurement fraud
Fraud in the purchasing or procurement function is a
particular risk. The following may be indicators of fraud
in the tendering and contract award process.
Before contract award
• Disqualification of suitable tenderers.
• ‘Short’ invitation to tender list.
• Unchanging list of preferred suppliers.
• Consistent use of single source contracts.
• Contracts specifications that do not make
commercial sense.
• Contracts that include special, but unnecessary
specifications, that only one supplier can meet.
• Personal relationships between staff and suppliers.
During the contract award process
• Withdrawal of a lower bidder without apparent
reason and their subsequent sub-contracting to a
higher bidder.
• Flexible evaluation criteria.
• Acceptance of late bids.
• Changes in the specification after bids have been
opened.
• Consistently accurate estimates of tender costs.
• Poor documentation of the contract award process.
• Consistent favouring of one firm over others.
64
disproportionate to their size.
• Frequent increases in the limits of liability.
• Frequent increases in contract specifications.
Organisations may wish to consider at invitation to
tender acknowledgement stage, or at bid submission,
formally requesting the tenderer to sign a document
confirming that no fraud or corrupt practice has
occurred when developing the bid.
This has two effects:
1 It acts as a deterrent – tenderers are alerted to the
fact that the client is aware of the risk of fraud and
will be on the lookout for any evidence that it has
occurred.
2 It ensures that should something fraudulent come to
light, tenderers can have no excuse that they were
unaware of the client’s policy.
Activity
Fraud risk
Prevention
Scoping of contract
The contract specification is
written in a manner which favours
a particular technical, end user and
financial supplier.
Use of control/assessment panel made up
of representatives, to ensure that more than
one person is involved in drawing up the
specification.
Contract
documentation
Conditions of contract are changed
to accommodate a favoured supplier,
or , to exclude competitors
Standard contract conditions and
specifications to be used. Any variations to
be approved by senior management.
Setting evaluation
criteria
Original evaluation criteria are
changed after the receipt of
submissions to ensure that favoured
suppliers are shortlisted
Use evaluation criteria as agreed by the
contract panel prior to tendering. Where EU
procurement rules apply evaluation criteria
are required to be stated in advance.
Contractual
correspondence
Altering terms and conditions to suit
a preferred supplier
Contract terms and conditions should be
those of the purchasing department and
not subject to change without the written
approval of senior management.
Contact
management
False claims for work not carried
out, or exaggerated claims for actual
work done
Clear audit trails with written records.
Authorisation of changes to original
documentation. Random and systematic
checks of activity.
Claims negotiation
Assisting the contactor to justify
claims.
Claims negotiation should be carried out
using professional advisers.
Certification
Inadequate certification may lead to
overpayments, or payments for work
not carried out.
Clear separation of duties between ordering
the work, certification and authorisation for
payment. Certification documents should be
returned to the originator.
Authorisation
Contract splitting to keep contract
values under a particular staff
member’s authorisation financial
limit.
The splitting of contacts should not
be allowed unless authorised by senior
management. Internal controls should be
established to detect this.
Pricing
Tender prices appear to drop
whenever a new supplier is invited
to bid.
Management reviews of the reasonableness
and competitiveness of prices
Suppliers
Contract awarded to a company with
a poor performance record.
Ensure contractors with a poor performance
record are removed from the approved
supplier’s list.
Contract awarded to a contractor
who is not the lowest tenderer.
Senior management review.
65
Fraud risk management: a guide to good practice
Example 2: Fraud in the selling process
Tender procedure – audit checks
Tender board: Should be chaired by senior manager.
Tender register: Should be held and reviewed by a
senior manager.
Checks should include:
• Were all tenders secured in a locked cabinet/box prior
to opening?
• Who had access to the keys/combination?
• If no tender box/cabinet utilised, what is the
procedure for dealing with tenders?
• Does the tender register show an unbroken,
sequentially numbered and dated list of all tenders
received?
• Were all the entries signed by the tender board
chairperson?
• Confirm that tender lists show no evidence of
patronage or incestuous relationships.
• Confirm that firms which persistently fail to tender
are excluded from subsequent tender lists.
• Has relevant approval been obtained before accepting
any tenders whose prices exceed approval limits?
• Has relevant approval been obtained where the
lowest compliant bid is not accepted?
• In the event of a clear differential in bid prices
confirm that the same tender specification has been
sent to all prospective tenderers.
• Confirm that there is no excessive use of single
sources of supply or tender action.
• Confirm that the tender board has been advised of
the signs which would indicate tender rigging/ringing.
• Confirm that the recommended method of
procurement has been followed.
• Confirm that the contract makes commercial sense.
66
Fraud risks also exist in the selling process. Those
involved can include any combination of the clients’
management or staff and the organisation’s own
management or staff, with or without any collusion.
The following are indicators of fraud in the selling
process:
• Overcharging from an approved list or standard profit
mark-up.
• Short-changing by not delivering the contracted
quantity or quality.
• Diversion of orders to a competitor or associate.
• Bribery of a customer by one of the organisation’s
own sales representatives.
• Bribery of a customer by a competitor – no proper
explanation of why the contract went elsewhere.
• Insider information by knowing competitor’s prices.
• False warranty claims that are made or paid.
• Over selling of goods or services that are not
necessary.
• Giving of free issues/samples when not necessary
• Links with cartels or ‘rings’.
• Bribery to obtain contracts which would not
otherwise be awarded.
• Issuing invoices or credit notes which do not reflect
reality and of which the ultimate payer is unaware.
• Issuing credit notes to hide additional discounts or
rebates.
• The use of sales intermediaries (fixers).
• Sales commission gates, which can often cause
misreporting of orders.
Appendix 7 A 16 step fraud prevention plan
1
Consider fraud risk as an integral part of your overall corporate risk-management strategy.
2
Develop an integrated strategy for fraud prevention and control.
3
Develop an ownership structure from the top to the bottom of the organisation.
4
Introduce a fraud policy statement.
5
Introduce an ethics policy statement.
6
Actively promote these policies through the organisation.
7
Establish a control environment.
8
Establish sound operational control procedures.
9
Introduce a fraud education, training and awareness programme.
10 Introduce a fraud response plan as an integral part of the organisation’s contingency plans.
11 Introduce a whistle-blowing policy.
12 Introduce a reporting hotline.
13 Constantly review all anti-fraud policies and procedures.
14 Constantly monitor adherence to controls and procedures.
15 Establish a learn from experience group.
16 Develop appropriate information and communication systems.
Source: Defence Mechanism, Financial Management, September 2002
67
Fraud risk management: a guide to good practice
Appendix 8 Outline fraud response plan
1 Purpose of the fraud response plan
2 Corporate policy
3 Definition of fraud
4 Roles and responsibilities
Managers and supervisors
Finance director
Fraud officer
Human resources
Audit committee
Internal auditors
External auditors
Legal advisers
IS/IT staff
Public relations
The police
External consultants
Insurers
•
•
•
•
•
•
•
•
•
•
•
•
•
5 The response
• Reporting suspicions
• Establish an investigation team
– objectives
– reporting procedures
– responsibilities
– powers
– control
• Formulate a response
– in accordance with corporate policy
6 The investigation
• Preservation of evidence
• Physical evidence
• Electronic evidence
• Interviews (general)
• Statements from witnesses
• Statements from suspects
68
7 Organisation’s objectives with respect to fraud
• Internal report
– no further action
– disciplinary action
• Civil response
– legal advisers’ control
– legal submissions
– case file
• Criminal response
– police controlled
– case file
• Parallel response
– civil recovery
– criminal prosecution
8 Follow up action
• Lessons learned
• Management response
– internal reviews
– implement changes
– annual report
– enforcement policies
Appendix 9 Example of a fraud response plan
3 The definitions of fraud
This example has been based on a response plan from
an organisation within the UK’s NHS.
1 Introduction
This document is intended to provide direction and help
to those officers and directors who find themselves
having to deal with suspected cases of theft, fraud
or corruption. It gives a framework for a response
and provides information on various aspects of
investigation. The document also contains a series of
flowcharts which provide a framework of procedures
that allow evidence to be gathered and collated in a
way which facilitates informed initial decisions, while
ensuring that evidence gathered will be admissible in
any future criminal or civil actions. This document is
not intended to provide direction on fraud prevention.
The term fraud encompasses a number of criminal
offences involving the use of deception to obtain
benefit or causing detriment to individuals or
organisations.
This document is intended to provide a framework
for investigating all suspected cases of fraud, theft or
corruption where:
• the value of the organisation has suffered or may
have suffered; or
• has been misrepresented for personal gain
as a result of the actions or omissions of:
• directors and staff employed by the organisation; or
• customers, contractors and other external
stakeholders.
2 Corporate policy
The board is committed to maintaining an honest,
open and well intentioned atmosphere within the
organisation. It is, therefore, also committed to the
elimination of all fraud and to the rigorous investigation
of any such cases.
The board wishes to encourage anyone who has
reasonable suspicions of fraud to report them. The
organisation has a published whistleblowing policy
which aims to ensure that concerns are raised and
dealt with in an appropriate manner. Employees raising
genuine concerns will be protected and their concerns
looked into.
69
Fraud risk management: a guide to good practice
4 Roles and responsibilities
Chart 1 Reporting fraud
You suspect fraud or other illegal act
involving the organisation by an employee or
perpetrated on the organisation
Either/or
Discuss with your line manager/head of
department
Discuss with
head of HR/FD
If suspicions appear well grounded,
department head or head of HR tells the
financial director (FD)
FD records details immediately
in a log
FD considers need to inform chief internal
auditor and/or chief executive, external auditor
and police
Where applicable FD to initiate action to end
loss, and correct any weaknesses in controls or
supervision
To Chart 2
70
Fraud and other illegal
acts log
Log reviewed by audit
committee
Finance director
Responsibility for investigating fraud has been
delegated to the finance director. Where appropriate/
necessary he is also responsible for informing third
parties such as the external auditors or the police about
the investigations. The finance director will inform and
consult with the chief executive in cases where the loss
is potentially significant or where the incident may lead
to adverse publicity.
The finance director will maintain a log of all reported
suspicions, including those dismissed as minor or
otherwise not investigated. The log will contain details
of actions taken and conclusions reached and will
be presented to the audit committee for inspection
annually.
The finance director will normally inform the chief
internal auditor at the first opportunity. While the
finance director will retain overall responsibility,
responsibility for leading any investigation will be
delegated to the chief internal auditor. Significant
matters will be reported to the board as soon as
practical.
Head of human resources
Where a member of staff is to be interviewed or
disciplined the finance director and/or chief internal
auditor will consult with, and take advice from, the
head of human resources.
The head of human resources will advise those involved
in the investigation in matters of employment law,
company policy and other procedural matters (such as
disciplinary or complaints procedures) as necessary.
Line and other managers
If, in accordance with the organisation’s whistleblowing
policy, a member of staff raises a concern with their
line manager, head of department or the head of
human resources the details must be immediately
passed to the finance director for investigation. If a
concern involves the finance director, the matter should
be reported directly to the audit committee.
Staff
All staff have a responsibility to protect the assets of
the organisation, including information and goodwill as
well as property.
Chief internal auditor
The chief internal auditor will:
• initiate a diary of events to record the progress of the
investigation throughout
• agree the objectives, scope and timescale of the
investigation and resources required with the finance
director at the outset of the investigation;
• ensure that proper records of each investiation are
kept from the outset, including accurate notes of
when, where and from whom evidence was obtained
and by whom.
71
Fraud risk management: a guide to good practice
5 Objectives with respect to fraud
See Chart 2 – managing the investigation
Investigations will try to establish at an early stage
whether it appears that a criminal act has taken place.
This will shape the way that the investigation is handled
and determine the likely outcome and course of action.
If it appears that a criminal act has not taken place, an
internal investigation will be undertaken to:
• determine the facts
• consider what, if any, action should be taken against
those involved
• consider what may be done to recover any loss
incurred
• identify any system weakness and look at how
internal controls could be improved to prevent a
recurrence.
The chief internal auditor will present the findings of
his investigation to the finance director who will make
the necessary decisions and maintain a record of the
subsequent actions in relation to closing the case. Once
concluded, details of such cases will be reported to the
audit committee on an annual basis for information.
Where an investigation involves a member of staff and
it is determined that no criminal act has taken place
the finance director will liaise with the head of human
resources and appropriate line manager to determine
which of the following has occurred and therefore
whether, under the circumstances, disciplinary action is
appropriate:
• gross misconduct (i.e. acting dishonestly but without
criminal intent)
• negligence or error of judgement was seen to be
exercised
• nothing untoward occurred and therefore there is no
case to answer.
72
The disciplinary procedures of the organisation will
be followed in any disciplinary action taken towards
an employee. This will usually involve a disciplinary
hearing at which the results of the investigation will be
considered.
Where, after having sought legal advice, the finance
director judges it cost effective to do so, the
organisation will normally pursue civil action in order
to recover any losses. The finance director will refer the
case to the organisation’s legal advisers for action.
Where initial investigations point to the likelihood of
a criminal act having taken place the chief internal
auditor will, with the agreement of the finance director,
contact the police and the organisation’s legal advisers
at once. The advice of the police will be followed in
taking forward the investigation.
Where there are sufficient grounds, the organisation
will, in addition to seeking recovery of losses through
civil proceedings, also seek a criminal prosecution. The
finance director will be guided by the police in arriving
at his decision on whether a criminal prosecution is to
be pursued.
Where appropriate the finance director will consider the
possibility of recovering losses from the
organisation’s insurers.
Chart 2 Managing the investigation
From Chart 1
FD appoints chief internal
auditor to oversee and start
investigation
Does it appear
that a criminal act has
taken place?
Diary of events
Yes
Inform police and
external auditors
To
Chart 3
Gross
misconduct
From
Chart 4B
Loss recovered?
Consider
possibility of
making good
the loss
including a
civil action
for recovery
No
No case
to answer
Either
Investigate
internally to decide which
of the following
Or
Or
FD and/or head of dept to
decide what, if any, action
to take in conjunction with
head of HR
Consider possibility of
making good the loss
Error of judgement/
negligent conduct
No
No
Loss recovered?
From
Chart 4A
Yes
Yes
In conjunction with head of
HR, implement disciplinary
procedures if appropriate
Initiate
dismissal
procedures
FD updates the fraud and
other illegal acts log
Fraud and other
illegal acts log
73
Fraud risk management: a guide to good practice
6 The response
See Charts 3 and 4 – gathering evidence and interview
procedure.
The chief internal auditor will normally be responsible
for managing investigations, including interviewing
witnesses and gathering any necessary evidence.
However, each case will be treated according to the
particular circumstances and professional advice will be
sought where necessary. Where there are reasonable
grounds for suspicion, the police will be involved at
an early stage but the chief internal auditor may still
undertake part or all of the investigations on their
behalf, as agreed between the finance director, chief
internal auditor and the police.
Witness statements
If a witness is prepared to give a written statement
the head of HR or chief internal auditor will take a
chronological record using the witness’s own words.
The witness will be asked to sign the document as a
true record.
Physical and electronic evidence
The chief internal auditor will take control of any
physical evidence and maintain a record of where, when
and from whom it was taken. Where the evidence
consists of several items these will be tagged with a
reference number which corresponds with the written
record of the investigation. He should also ensure that
electronic evidence is appropriately handled.
Before interviewing any suspect(s) the chief internal
auditor will provide a verbal or written report of the
investigation to the finance director. The finance
director may consult others e.g. head of human
resources, the chief executive and the police before
reaching a decision on how to proceed.
74
Interviewing suspect(s)
If the finance director decides to proceed with
interviewing a suspect, and where the suspect is
an employee of the organisation, the interview will
usually be carried out by the line manager and head of
human resources. The individual(s) being interviewed
should be informed of the reason for the interview
and a contemporaneous record will be made of all
that is said. They should also be advised that they are
not under arrest and are free to leave at any time.
The individual(s) being interviewed will also be given
the opportunity to be supported by a friend or trade
union official. This type of interview will not take
place under caution. If the need for caution arises
during the course of an interview, the interview will
be terminated immediately after the caution is given
and the individual concerned advised to seek legal
advice. The finance director will be notified and police
advice sought at this point. Once the interview is over,
the suspect will be given the opportunity to read the
written record and sign each page in acknowledgement
of its accuracy. All other persons present will also be
asked to sign to acknowledge accuracy.
Where external organisations/individuals are involved,
interviews will generally be undertaken by the
police unless the finance director is able to gain the
co-operation of the organisation’s management or
auditors.
Chart 3 Gathering evidence
From
Chart 2
Criminal act believed to have
taken place
Is there
any physical
evidence?
No
Yes
Collect evidence with documentary
record of time and place
Are
there any
witnesses?
No
Yes
Discuss events with witnesses
Investigation manager to obtain
written statement(s) of the events
Yes
Are witnesses
prepared to give a written
statement
No
Make a written note of any
discussion
Chief internal auditor to report
to FD
FD to consider if suspect should be
interviewed
To
Chart 4
75
Fraud risk management: a guide to good practice
Chart 4 Interview procedure
From
Chart 3
Does
matter warrant interview
of suspect?
No
Yes
Advise suspect that chief internal
auditor wishes to discuss incident
with suspect, who may have a
representative present
Is
suspected person willing to
be interviewed?
Yes
Arrange a meeting at
earliest practicable time,
that allows suspect
opportunity to have
representative present
No
Is evidence
gathered sufficient for
dismissal?
Yes
Is there
a case to answer?
No
Confer with
FD, review
events with
Police
To
Chart 2B
76
No
Confer with FD and review events
with Police
To
Chart 2A
Interview
Appendix 10 References and further reading
The Association of certified fraud examiners (ACFE),
(2008), Report to the Nation on Occupational Fraud and
Abuse, www.acfe.org
Felson, M. and Clarke, R., (1999), Opportunity Makes
the Thief, Police Research Series 98, London: Home
Office.
The Association of certified fraud examiners, ACFE,
(2008), Fraud Examiners Manual.
Finn, J. and Cafferty, D., (September 2002), Defence
Mechanism, Financial Management.
BDO Stoy Hayward LLP, (January 2008), BDO
Fraudtrack 5: A global challenge,
www.bdo.co.uk/fraudtrack
Fisher, C. and Lovell, A., (2000), Accountants Responses
to Ethical Issues at Work.
BT Group (2008), BT The way we work: a statement of
business practice, www.bt.com
BSi British Standards, (2008), Whistleblowing
Arrangements Code of Practice, PAS 1998-2008,
www.bsigroup.com/en/Standards-andPublications/Industry-Sectors/Risk/PAS-19982008Whistleblowing
CIMA (2000), Corporate Governance – History, Practice
and Future.
CIMA, (2005), CIMA Official Terminology.
CIMA, (2002), Risk Management: A guide to good
practice.
CIMA and the IBE, (2008), Managing responsible
business.
Collier, P.M. and Agyei-Ampomah, S., (2007),
CIMA Official Learning System Management Accounting
Risk and Control Strategy.
DirectNews, (2007), Weak anti-fraud measures earn
bank hefty fine, CIMA Industry Focus.
Ernst & Young, (2003), Fraud, the Unmanaged Risk,
www.ey.com
FEE Brussels, (2005), How SME’s can reduce the risk of
fraud, www.fee.be/publications
Fraud Advisory Panel, (2006), Sample Fraud Policy
Statements, www.fraudadvisorypanel.org
Fraud Advisory Panel, (2006), Fighting Fraud: A guide for
SME’s 2nd Edition.
Fraud Advisory Panel, (2006-2007), Ninth Annual
Review 2006-2007 Ethical behaviour is the best defence
against fraud.
HM Treasury, (May 2003), Managing the Risk of Fraud.
Institute of Business Ethics, (2003), Developing a Code
of Business Ethics: A guide to best practice including the
IBE Illustrative Code of Business Ethics.
Institute of Business Ethics, (2007), Does Business Ethics
Pay?
Institute of Business Ethics, Good Practice Guide, Speak
up Procedures www.ibe.org.uk/SpeakUp
Institute of Business Ethics, Living Up to our values:
developing ethical assurance,
www.ibe.org.uk/LUTOVcontents_overview.pdf
The Institute of internal auditors, The Association
of certified public accountants, The Association of
certified public examiners, (2008), Managing the
business risk of fraud: A practical guide.
International Federation of Accountants (IFAC), (2006),
International Auditing and Assurance Standards Board,
ISA’s 240,300,315 and 330.
77
Fraud risk management: a guide to good practice
Useful Web links
Iyer, N. and Samociuk, M., (2006), Fraud and
Corruption: Prevention and Detection.
Iyer, N. and Samociuk, M., (2007), Rotten to the Core,
Excellence in Leadership Issue 2, SPG Media.
Kroll and the Economist Intelligence Unit, (2007/2008),
Kroll Global Fraud Report, Annual Edition 2007/2008,
www.kroll.com/about/library/fraud
Kroll and the Economist Intelligence Unit, (2008/2009),
Kroll Global Fraud Report Annual Edition 2008/2009,
www.kroll.com/about/library/fraud
KPMG, (2007), Profile of a Fraudster Survey 2007,
www.kpmg.co.uk/pubs/ProfileofaFraudsterSurvey
Levi, M., Burrows J., Flemming, M.H., and Hopkins,
M., with the assistance of Matthews, K., (2007), The
Nature, extent and economic impact of fraud in the UK.
PricewaterhouseCoopers, (2007), Economic Crime:
people, culture and controls The 4th biennial Global
Economic Crime Survey United Kingdom,
www.pwc.com/crimesurvey
Governance
Combined Code on Corporate Governance
www.frc.org.uk/corporate/combinedcode.cfm
European Corporate Governance Network:
www.ecgn.org
Good governance standard for public services, CIPFA,
www.opm.co.uk/index.html
How to use Turnbull to comply with Sarbox
www.frc.org.uk/documents/pagemanager/frc/
draft_guide.pdf
International Corporate Governance Network:
www.icgn.org
OECD Anti-Corruption Unit:
www.oecd.org/daf/nocorruptionweb
Legislation
Companies Act 2006 www.opsi.gov.uk/ACTS
Fraud Act in 2006 www.opsi.gov.uk/ACTS
PricewaterhouseCoopers, (2007), Economic Crime:
people, culture and controls The 4th biennial Global
Economic Crime Survey, www.pwc.com/crimesurvey
Professional Accountants in Business committee,
(2006), Defining and developing an effective code of
conduct.
Turner, C., (2007), Fraud risk management: a practical
guide for accountants.
Police and Criminal Evidence Act 1984 (PACE),
www.police.homeoffice.gov.uk/operationalpolicing/powers-pace-codes/pace-code-intro
Proceeds of Crime Act 2002 www.opsi.gov.uk/acts
Public Interest Disclosures Act (PIDA)
www.opsi.gov.uk/acts
Sarbanes – Oxley Act 2002 (Sarbox) www.soxlaw.com
Wells, J., (2007), Corporate fraud handbook: prevention
and detection 2nd ed. Hoboken, NJ: John Wiley and
Sons.
78
Serious Crimes Act 2007 www.opsi.gov.uk/ACTS
Organisations
Financial Services Authority (FSA): www.fsa.gov.uk
Fraud Advisory Panel: www.fraudadvisorypanel.org
ISACA: www.isaca.org
National Fraud Strategic Authority:
www.attorneygeneral.gov.uk/national_fraud_
strategic_authority_page.html
Public Concern at Work: www.pcaw.co.uk
Serious Fraud Office: www.sfo.gov.uk
Serious Organised Crime Agency (SOCA):
www.soca.gov.uk
World Bank Anti-Corruption Resource Center:
www1.worldbank.org/publicsector/anticorrupt
79
Fraud risk management: a guide to good practice
Appendix 11 Listed abbreviations
ACFE
ACPO
ARA
BDO
BSi
CEE
CEO
CIMA
CV
EIU
FSA
IBE
IFAC
IP
IS
ISA
IT
OECD
PACE
PAIB
PAS
PIDA
POCA
PR
PwC’s
Sarbox
SAS
SEC
SOCA
80
Association of Certified Fraud Examiners
Association of Chief Police Officers
Asset Recovery Agency
BDO Stoy Hayward LLP
British Standards Institute
Central & Eastern Europe
Chief executive officer
The Chartered Institute of Management Accounts
Curriculum vitae
Economist Intelligence Unit
Financial Services Authority
Institute of Business Ethics
International Federation of Accountants
Intellectual property
Information securities
International Standard on Auditing
Information technology
Organisation for Economic Co-operation and Development
Police and Criminal Evidence Act 1984
Professional Accountants in Business
Publicly Available Specification
Public Interest Disclosure Act 1998
Proceeds of Crime Act 2002
Public relations
PricewaterhouseCoopers
Sarbanes-Oxley Act 2002
Statement on Auditing Standards
Securities & Exchange Commission
Serious Organised Crime Agency
978-1-85971-611-3 (pdf)
January 2009
Chartered Institute of
Management Accountants
26 Chapter Street
London SW1P 4NP
United Kingdom
T. +44 (0)20 8849 2275
F. +44 (0)20 8849 2468
E. [email protected]
www.cimaglobal.com
TEC050V0110
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