Fraud Examination, 3E

Chapter 1: The Nature of Fraud

COPYRIGHT 2009 South-Western, a part of Cengage Learning.

Learning Objectives
Recognize the seriousness and
effects of fraud
Define fraud
Classify types of fraud
Distinguish between criminal and
civil fraud laws
Identify fraud-fighting careers

The Seriousness of Fraud

Government
Agencies
Research
ers

Fraud
Victims

Sources of Fraud
Statistics

Insurance
Companies
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Association of
Certified Fraud
Examiners (ACFE)

The Seriousness of Fraud

U.S. organizations lose five
percent of annual revenues to
fraud
Applied to the estimated 2006 U.S.
GDP, this five percent translates to
approximately $652 billion in
losses

The Seriousness of Fraud

Fraud reduces a firms net income
on a dollar-for-dollar basis

FRAUD
INCOME

NET

The Definition of Fraud

General Definition
a deception made for personal
gain

The Definition of Fraud

Seven Specific Parts of Fraud

A representation
about a material point
which is false
and intentionally or recklessly
so
which is believed
and acted upon by the
victim
to the victims damage.

The Definition of Fraud

Fraud is
Fraud is not
intentional.
taken by
physical force.
to trick or
a mistake or
deceive
someone out of
error.
his/her
victimless.
assets.
insignificant
theft.
because
no
a crime.
one is hurt.
acceptable or

The Various Classifications of

Fraud

The Two General Classifications

Committed against an organization
Committed on behalf of an
organization

The Various Classifications of

Fraud

Occupational Fraud
Occupational fraud is the use of
ones occupation for personnel
enrichment through the deliberate
misuse or misapplication of the
employing organizations
resources or assets.

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The Various Classifications of

Fraud
With occupational fraud, the
activity

is clandestine
violates the employees obligations
to the organization
is for direct or indirect financial
benefit
costs the organization assets,
revenues, or reserves

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The Various Classifications of

Fraud
Classifications of
Occupational Fraud
Asset Misappropriations

Corruption

Fraudulent Statements

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The Various Classifications of

Fraud
Fraud classification according to
victims:

Company or Organization as victim

Employee embezzlement
Vendor fraud
Customer fraud

Shareholders as victims
Management fraud

Unwary individuals as victims

Investment and other consumer fraud

Anyone as a victim
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Miscellaneous fraud

The Various Classifications of

Fraud
Employee Embezzlement

Occupational fraud (most common)

Employees steal company assets
Is direct or indirect
Direct: employee directly steals
company cash, inventory, tools, supplies,
or other assets
Indirect: employee takes bribes or
kickbacks from vendors, customers, or
others for lower sales prices, higher
purchase prices, nondelivery of goods, or
the delivery of inferior goods
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Example: Liahona Construction

The Various Classifications of

Fraud
Vendor Fraud

Two main varieties:

through vendors alone
through collusion between buyers and
vendors

Usually results in:

overcharge for purchased goods
shipment of inferior goods
Non-shipment of purchased goods

Example: Halliburton
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The Various Classifications of

Fraud
Customer Fraud

Where customers
do not pay for goods
get something for nothing
deceive organizations into giving them
something they should not have

Example: Chicago bank

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The Various Classifications of

Fraud
Management Fraud

Also known as financial statement

fraud
top management deceptively
misstates financial statements
Examples:
Enron
WorldCom
John Blue and his CFO

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The Various Classifications of

Fraud
Investment and Other Consumer
Fraud

Worthless investments sold to investors

Examples:

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Ponzi schemes
Senior investment fraud
Promissory notes
Unscrupulous stockbrokers
Affinity fraud
Unlicensed individuals, such as independent
insurance agents, selling securities
Prime bank schemes
Internet fraud
Mutual fund business practices
Variable annuities

The Various Classifications of

Type of Fraud
Victim Fraud
Perpetrator
Explanation
Employees directly or
indirectly steal from
employers

Employee
Embezzlement

Employers

Employees

Management

Stockholders,
lenders, &
others relying
on financial
statements

Top managements
Top
misrepresentation of
management
financial information

Investment
Scams

Vendor

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Investors

Individuals

Individuals trick
investors into putting
money into fraudulent
investments

Organizations
that buy goods
& services

Organization
s/
individuals
selling goods
& services

Overcharged for goods &

services or non-shipment
of goods paid for

Organizations

Customers deceive

Criminal and Civil Fraud Laws

Law
Criminal
Law

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Civil Law

Criminal and Civil Fraud Laws

Criminal Law Case

Civil Law Case

Purpose

To right a wrong

To obtain a remedy

Consequenc
es

Jail and/or fines

Restitution & damage

payments

Burden of
Proof

Beyond a reasonable doubt

Preponderance of evidence

Jury

Must have 12 people

May be fewer than 12 persons

Organizatio
n

Determination by a grand jury

that sufficient evidence exists Filing of a claim by a plaintiff
to indict

Verdict

Unanimous verdict

Parties may stipulate to a less

than unanimous verdict

Claims

Only one claim at a time

Various claims my be joined

in one action

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Fraud-fighting Careers

Type of Career

Government and law

enforcement

CPA firms

Corporations

Consulting

Law firms
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Types of Employers and Career

Description
FBI, postal inspectors, Criminal Investigation
Division of the IRS, U.S. marshals, inspector
generals of various governmental agencies,
state investigators, and local law enforcement
officials.
Conduct investigations, support firms in
litigation, do bankruptcy-related accounting
work, provide internal audit and internal control
consulting work.
Prevent, detect, and investigate fraud within a
company. Includes internal auditors, corporate
security officers, and in-house legal counsels.
Serve as an independent consultant in litigation
fraud work, serve as expert witness, consult in
fraud prevention and detection, and provide
other fee-based work.
Lawyers provide litigation and defense work for
companies and individuals being sued for fraud
and provide special investigation services when

Prepare for a Fraud-fighting

Career

Skills for Fraud-fighting Professionals

Analytical Skills
examine data for symptoms of fraud

Communication Skills
effectively interview witnesses and
suspects
communicate findings to witnesses,
courts and others

Technology Skills
search for fraud by effectively using
information systems
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Prepare for a Fraud-fighting

Career
More Skills for a Fraud-fighting
Professional

Some understanding of accounting

and business
A knowledge of civil and criminal
laws, criminology, privacy issues,
employee rights, fraud statutes, and
other legal fraud-related issues
The ability to speak and write in a
foreign language
A knowledge of human behavior
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Become a Certified Fraud

Examiner

Be an associate member of the ACFE

in good standing
Meet minimum academic and
professional requirements:
Bachelors Degree
Two years of professional experience
directly or indirectly related to fraud
examination

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Be of high moral character

Agree to abide by the Bylaws and
Code of Professional Ethics of the
ACFE